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Why making Europe ‘German’ won’t fix crisis

by Ivan Krastev and Georgi Ganev

Bloomberg

Most people see Europe’s economic crisis as a cautionary tale of good and bad policymaking, in which fiscally prudent countries, such as Germany, remain stable, while reckless ones, such as Greece, unravel.

So ingrained is this idea that it’s now common to hear analysts say Europe must become “German” to exit from the crisis, adopting Teutonic approaches to policy — from fiscal tightening to labor- and product-market reforms. If only societies on Europe’s periphery can learn to do what the Germans do, the argument goes, the European Union and its single currency will have a stable future.

This is wrong and we already have evidence to show it. The question isn’t whether Germany’s policies are correct. It is whether they will produce the same outcomes in different economic and political environments. To see that they don’t, you need to ignore Greece and look at its neighbor, Bulgaria.

Like Germany, Bulgaria went through several years of prudent budgets and economic reforms aimed at improving competitiveness before the financial crisis began in 2008. Both countries initially responded to the shock with sudden increases to their budget deficits, but also quickly reined these back in. Bulgaria’s deficit was 0.7 percent of gross domestic product in February, according to the Finance Ministry. Government debt was 16 percent of GDP. So pretty German already.

In both countries, per capita economic growth has been positive through the crisis (except for a dismal year in 2009), with average annual German per capita GDP growing at 2.1 percent in 2010-2012, only slightly faster than Bulgaria’s 1.7 percent.

The two countries’ monetary policies have also has been virtually identical. Although Bulgaria isn’t a euro member, its currency (the lev) is pegged to the euro and its central bank is banned from lending to commercial banks. As a result, monetary policy is, in reality, set by the European Central Bank in Frankfurt.

Lest anyone think this Bulgaria-Germany connection is fanciful, Chancellor Angela Merkel has made it on several occasions, praising Bulgaria as a model for other European economies to follow.

Despite all this, Bulgaria’s Germanic calm was shattered in February, when street protests over rising electricity prices triggered the collapse of the government. Why? Because ordinary Bulgarians can’t afford German policies, any more than they can afford a German BMW or a Mercedes.

Germany is one of the richest members of the EU and by far its most influential. Bulgaria is the poorest country in the EU, as well as being one of its newest and least influential members. Bulgarians are more than 2½ times poorer than Germans and have a much lower rate of employment.

This isn’t about liking or disliking the EU. Both populations score highly in terms of trust in the bloc, though for different reasons: Germans because they trust their own government and its ability to influence the EU, and Bulgarians because they don’t.

According to the EU’s Eurobarometer survey, 70 percent of Germans believe their voice counts in what their national institutions do, compared with 37 percent of Bulgarians.

Wealth and institutions explain why the same fiscally prudent policies played out so differently in the two countries. To wealthy Germans, fiscal conservatism in their institutionally functional country promises that tomorrow won’t be too different from today — their lifestyle will be protected.

In poor, dysfunctional Bulgaria, the same policies make people angry that tomorrow will be too much like today. They are angry because their poor lifestyle won’t change.

This may help to explain why the trigger for the government’s collapse in Bulgaria was rising electricity prices, which make up a far larger portion of people’s incomes than in Germany and were eroding already poor standards of living. Lost hope for a better future is probably the most important feature of Bulgaria’s political crisis.

For decades, the formula that drove the EU’s integration has been one of divergent policies producing convergent economic performances. The EU is the most impressive economic catchup machine the world has known. So why is it that the shift toward policy convergence today is threatening to destroy this machine?

In the last 15 years, both Germany and Bulgaria underwent important economic reforms, but the political context for these could not have been more different. Former German Chancellor Gerhard Schroeder’s Agenda 2000 reforms were marked by consensus and institutional stability. The two largest political parties (Schroeder’s Social Democrats and the Christian Democratic Union) supported the reforms. Initiated by the political elite, the changes were broadly — if not enthusiastically — endorsed by the electorate.

Bulgaria’s situation is the opposite. The country’s macro-economic policies altered little over the years, while its governments changed all the time. Since the collapse of the Soviet bloc in 1989, not a single government has been re-elected to power in Bulgaria. Voters constantly demanded change, but no matter whom they chose, they got the same macro-economic policies.

If Germany’s economic transformation was a classic case of politically driven reform, Bulgaria’s experience was an equally clear example of the “there is no alternative” doctrine. That’s the same one now on offer to voters in Greece, Italy and other peripheral euro-area economies.

Bulgarian politicians, one after the other, justified their loyalty to fiscal conservatism by arguing that this was the precondition for joining the EU — something Bulgarians overwhelmingly wanted, and achieved in 2007. Governments compensated for their inability to change economic policy in response to voter unhappiness, by constantly churning personnel. Protests therefore swing instantly from complaints that won’t get addressed — such as high electricity prices — to demands for radical political and constitutional change.

Both countries face elections this year, Bulgaria on May 12 due to the collapse of the government, and Germany in a routine vote on Sept. 22. Opinion polls suggest the ruling center-right parties are likely to win in both cases, but the similarities end there.

Few predict significant changes for Germany. In Bulgaria, by contrast, expect a prolonged period of Italian-style political instability.

A convergence of policies has led to opposite outcomes in Germany and Bulgaria, showing that Europe won’t necessarily be cured by becoming German. This is because it is wide differences in wealth and institutional performance, rather than divergent policies, that threaten the EU and its currency.

Ivan Krastev is chairman of the Center for Liberal Strategies in Sofia and is a permanent fellow at the Institute for Human Sciences in Vienna. Georgi Ganev is a program director at the Center for Liberal Strategies and is assistant professor at Sofia University. The opinions expressed here are their own.