WAR IN EUROPE
Putin’s triple backfire unites his enemies militarily, politically and economically
However Russian President Vladimir Putin’s war against Ukraine ends, one thing is sure: it has backfired in hugely strengthening and expanding the Western alliance ranged against him. Nowhere is this more apparent than in Germany. Peter Fabricius reports from Berlin.
Before 24 February, Germany was rather a pacifist outlier in Europe regarding Russia especially, constrained both by its post-World War 2 wariness about being seen as an aggressor and by its large reliance on Russian gas.
Germany’s ambivalence was embarrassingly personified by former chancellor Gerhard Schröder’s lucrative employment as an agent for Russia’s state gas corporations.
In January, Chancellor Olaf Scholz’s new coalition government prompted global ridicule by offering Ukraine no more than 5,000 helmets to help it fend off the expected Russian attack. Since Russia invaded, the government’s position has changed radically. It has donated 50 tank-mounted anti-aircraft guns and heavy-artillery howitzers.
It has also announced an extra €100-billion on top of its annual €50-billion defence budget to modernise its neglected military. It decided to increase its regular defence budget to the 2% of GDP that all Nato member states are supposed to spend.
Scholz also announced the suspension of the Nord Stream 2 gas pipeline from Russia and joined the rest of the EU in a commitment to wean itself off its energy dependence on Russia, by terminating coal imports in autumn, oil imports by the end of 2022 and gas imports – the most difficult – as soon as possible thereafter.
It’s been a major and crucial shift in Europe’s largest economy.
The German grinch that once stole Christmas loosens its purse strings
Less perceptibly, Berlin has shifted towards supporting a more expansive and integrated fiscal policy in the European Union. The two are related; a more integrative European fiscal policy is likely to be needed to support European rearmament against Russia.
Apart from being one of the most cautious countries in Europe militarily, Germany also used to be one of the most cautious fiscally. At the time of the global financial crisis in 2008/09 and the subsequent European debt crisis, Germany was widely seen as the grinch that stole Christmas, insisting that the EU demand austerity from troubled members like Greece and Italy that had plunged into debt.
But as European Central Bank official Gabriel Glöckler points out, by the time Covid-19 struck more than a decade later, Germany’s attitude had already changed markedly. “The biggest difference between the euro crisis and the corona crisis has been fiscal policy,” he notes.
The EU now understood that mutual support was needed, and had provided it through its Next Generation EU fund and through joint borrowing by the EU.
“At the same time, we’ve also learnt during our recent monetary policy strategy review that an active use of fiscal policy doesn’t immediately lead to large inflation,” he told Daily Maverick during a recent meeting with visiting international journalists in Berlin. “There were important insights in how we look at the economy and the role of fiscal policy to get countries like Greece, like Italy and others through a crisis.”
Glöckler recalled that the debate in the EU during the financial crisis was about the need for fiscal consolidation, austerity and structural reforms. “Now, when corona struck, [ECB president] Christine Lagarde said, ‘we’ll be there for the first wave, for the second wave, we’ll be there for EU citizens. We’ll help together with fiscal policy to weather this so that the recession doesn’t go deeper and doesn’t last longer than absolutely necessary.’
“This is a different approach you’ve seen, particularly in fiscal policymaking. We’ve seen an adjustment particularly in the German mindset, about the role of fiscal policy.”
He notes how quickly Germany’s new finance minister, Christian Lindner, had understood that this was the time for fiscal policy to be more supportive – by spending more, not only to tackle Covid but also to weather the Ukraine crisis, which is affecting German and wider European security.
“And it brings the German approach a bit more in line with the approach of other countries,” Glöckler said.
This means that, militarily and economically, Germany is now aligned with a more assertive, expansive and coordinated European response to Russia’s aggression against Ukraine.
The war could also drive greater EU fiscal union
Germany’s more expansive fiscal policy comes at an opportune time because Europe is facing other large financial challenges, besides Covid and the war. As Claus Tigges of the Deutsche Bundesbank points out, digitalisation and the challenges of adapting to climate change – mainly through the EU’s Green Deal – demand huge investments too.
The Bundesbank is asking itself if all of these large new challenges can be mastered within the current tight fiscal framework of the Eurozone. “Or do we need fundamental reforms?”
That fiscal framework is founded on a set of rules called the Stability and Growth Pact (SGP) which the 19 EU member states that use the euro are supposed to obey to keep their spending within manageable limits.
Essentially, the structural deficit of any member state should not exceed 0.5% of its GDP, if the country’s debt-to-GDP ratio exceeds 60%. If it is less than 60%, the structural deficit may rise to 1% of GDP. The SGP also sets a maximum fiscal deficit of 3% of GDP and a maximum public debt of 60% of GDP for Eurozone member states.
If either of these targets is not met, the EU ought to step in to bring the state back into line.
However, the EU permits higher deficits to finance structural or pension reforms, expansion of public investments and unavoidable expenditures incurred, such as by natural disasters.
The Bundesbank believes the present system of rules, with all its exceptions, has become too complex and is not being enforced. It should be simplified, but also then enforced.
The basic debt and deficit ceilings of the SGP should be maintained, though the limits may be stretched a little to allow for public spending. But this must be explicit and quantified.
So, if a country’s debt-to-GDP ratio is above 60%, its maximum structural deficit could rise to 0.5% of GDP. But only if public investment is at least 0.5% of GDP. Otherwise, no structural deficit should be allowed.
And if the debt-to-GDP ratio is less than 60%, the maximum structural deficit may rise to 1.5% of GDP – but again, only if public investment is at least 0.5% of GDP. Otherwise, it should not exceed 0.5% of GDP.
These more flexible rules on public investment could be used to finance increased defence spending, for instance.
The SGP could be a first step along the path to an envisaged fiscal union in the EU. The war in Ukraine might accelerate the process.
Some ideas on the table which are now being dusted off include creating an EU finance minister to manage joint budgets; granting the EU authority to issue Eurobonds; creating a borrowing facility for the European Commission and establishing a full banking union.
Germany is not opposed in principle to this direction, though Tigges points out that if all EU countries are going to share more financial burdens, they must be prepared also to surrender a corresponding amount of their national sovereignty over financial decisions.
Experts suggest an EU fiscal union could be created all at once or in phases.
In light of the war in Ukraine, one option for phasing in a fiscal union now could be to start by integrating defence spending because there is already common ground in the EU about defence policy and a common understanding that more financing is needed.
And the war may also accelerate EU expansion
Putin’s attack on Ukraine has likewise lent impetus not only for deepening the EU but also expanding it. At Davos last week, influential billionaire businessman and pro-democracy philanthropist George Soros punted a proposal by Enrico Letta, leader of Italy’s Democratic Party, for a wider EU “confederation” which would immediately admit aspirant EU members Ukraine, Georgia, Moldova, Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia.
This would allow them to “have their say in a common political platform and share the same strategic space” while their applications for full EU membership were being processed. This confederation would be an interim measure because Letta said the normal process of EU accession was slow and sometimes troublesome, citing particularly Hungary and Poland which have clashed with the EU over democracy issues. Soros said Italian Prime Minister Mario Draghi has endorsed Letta’s proposal.
French President Emmanuel Macron floated a similar idea at the European Parliament earlier in May.
The idea is meeting some resistance though. Ukraine’s feisty foreign minister, Dmytro Kuleba, has voiced suspicion that the EU is trying to fob off his country with diluted membership. Questions have been raised about whether membership of this proposed confederation would include participation in the EU’s mutual defence clause.
Nevertheless, “Europe seems to be moving in the right direction”, Soros said at Davos. “It has responded to the invasion of Ukraine with greater speed, unity and vigour than ever before in its history.”
A shock to the system
But can the European economy bear the shockwave of the war, coming so soon after the impact of Covid-19?
Glöckler believes so. He grants that inflation across the Eurozone has risen – to 7.4% in March – well beyond the European Central Bank (ECB) target of 2%, largely pushed by energy inflation of 44.7%, a by-product of the war. Energy prices are likely to remain high.
Economic growth has also been dampened by business and consumer uncertainty over the war and Western sanctions. This compounded the effect of the bottlenecks in supply chains caused by the war and the strict new anti-Covid lockdowns in China.
But Glöckler said neither the Eurozone nor the wider EU were in a recession and the ECB did not predict one. The economy is being buoyed by a surge of post-Covid catch-up spending.
Unemployment was at its lowest since the creation of the Eurozone. Since people had jobs, they had money to spend and were doing so. Glöckler said the ECB did not see an upwards wage-price spiral which could entrench inflation. So, it forecast a drop in inflation to 4.3% this year and 2.8% next year.
Also, the impact of the sanctions on the financial sector had been manageable so far. It had shown some volatility “but no crisis”.
Glöckler did acknowledge that unexpected developments in the war could change these forecasts.
Indeed, the Bundesbank had just warned that if Russia slapped a total embargo on natural gas exports to Germany, that could slash growth by 5%, turning predicted 3% growth in 2022 into a 2% contraction.
And Germany has just embarked on gas rationing for industry, which will clearly have an economic impact.
Nevertheless, Germany and Europe seem to be weathering the economic impacts of the war and emerging stronger and more united militarily, politically and economically.
So, it’s looking like a triple backfire for Putin’s hopes of dividing and weakening his enemies. DM
Peter Fabricius recently visited Germany as a guest of the German government and the European Academy Berlin.