The Coronavirus Is Reducing Merkel’s EU Legacy to Ashes

This article was co-authored with Matthias Matthijs and first published by Foreign Policy.

The German government surprised most international observers on Friday by announcing its own version of a “bazooka” to protect the German economy from the economic and financial consequences of the coronavirus. German Finance Minister Olaf Scholz pledged unlimited credit for businesses affected by the pandemic alongside an expansion of its short-time work scheme, which gives support for companies that are forced to reduce working hours of their employees. After years of adhering to financial orthodoxy and obsessing about moral hazard, the German government ostensibly revealed itself as willing to act boldly in response to a crisis.

This might prove an effective Band-Aid to stop the bleeding in Germany. But the sheer scale and speed of the coronavirus outbreak will likely require a Europe-wide fiscal response if the continent hopes to avoid to prevent another eurozone financial crisis that could be the death knell for the 19-country currency union. German Chancellor Angela Merkel has given little indication whether she is willing to lead such an effort—and her record is highly discouraging.

The EU response to the coronavirus crisis has been lackluster, characterized mainly by a complete and utter lack of European coordination or solidarity. The European Commission unveiled a 37-billion-euro ($41 billion) Coronavirus Response Investment Initiative last week that allows members to increase public health care spending to combat the virus. Ursula von der Leyen, the European Commission’s president, also recently announced a Schengen travel ban, an export authorization scheme to prevent vital medical equipment from leaving the EU single market, and help in securing ventilators and testing kits. But it is hard to disagree with the 88 percent of Italians who, in a recent poll, agreed with the statement that the “EU was not helping [them].”

And yet the EU’s reticence is consistent with Merkel’s preferred vision for Europe. Unless she quickly realizes the error of her earlier ways, one of the victims of the coronavirus may turn out to be her own carefully cultivated EU legacy.

For more than 10 years, four German governments led by Merkel have preached the virtues of austerity in the eurozone. She passed a constitutional debt brake in Germany in 2009, insisted on fiscal consolidation elsewhere, and proudly celebrated budget surpluses since 2014. Even Scholz, a member of the Social Democratic Party, has been reluctant to abandon the so-called schwarze Null (the “black zero” of a balanced budget) in the past few years, despite rising domestic and international pressure to loosen Germany’s purse strings. Rather, Germany’s vision for the EU was to encourage structural reforms and fiscal consolidation aimed at enhancing the bloc’s international competitiveness. Limited and conditional solidarity was given to countries in need in order to prevent a collapse of the financial system, while expansionary monetary policy, rather than loose fiscal policy, was used to preserve the eurozone’s integrity.

The coronavirus crisis exposes this house of cards for what it is and provides a glimmer of how Merkel’s earlier vision for the EU can unravel and fail. The eurozone recorded a slow recovery from its previous debt crisis, and economic discontent remains extremely widespread in many countries after more than a decade of stagnation. The debt crisis and the EU response to it provided a hotbed for a surge in Euroskeptic populism across the continent, which already put the survival of the eurozone at risk prior to the outbreak of the pandemic. The economic crisis induced by COVID-19 thus comes at a critical moment for the EU, and the Merkel government clearly recognizes the severity of it. In effect it is both a supply and a demand shock to the economy. As large parts of Europe are quarantined or voluntarily going into self-isolation, economic activity will largely grind to a halt. With international supply chains interrupted by border closures and necessary inputs no longer available, both foreign and domestic demand will rapidly fall at the same time. No wonder stock markets are in free fall.

The German crisis response this time, as compared with the previous financial crisis, will need to be informed by the fact that monetary policy alone will not be enough. With interest rates at or below zero and unconventional monetary policies already stretched to the limit, central banks’ room for maneuver is severely restricted. Christine Lagarde, the new European Central Bank (ECB) president, called for fiscal action in response to the crisis last week—although she also seemed to imply that widening spreads between Italian and German bond yields was not the ECB’s problem, which added to crisis-stricken Italy’s financial stress. Lagarde’s performance is consistent with expectations that, as a lawyer and politician, she would take a more strict and legalistic approach to the ECB’s governing mandate than her predecessor Mario Draghi, an economist and former banker who instinctively knew how to talk to financial markets.

This is all the more reason for the German government to take a leading role in crafting a coordinating European response to the crisis. After years of austerity measures encouraged by Merkel’s governments, state capacity across the EU has been weakened, automatic stabilizers undermined, and domestic demand dampened. Aggressive fiscal stimulus packages will be necessary to combat the economic crisis, but many countries in the eurozone—not least Italy—are still burdened with large piles of government debt.

To overcome this problem, Germany will have to finally shift its position on eurozone governance and EU integration. It will need to abandon previously drawn red lines and show more solidarity with its European partners than it has in the past decade. Scholz has already stated that EU states with higher debt levels should have the flexibility to pass fiscal measures. On Monday, the Eurogroup pledged “to do whatever it takes to effectively address the current challenges.” Collectively, EU finance ministers promised a fiscal boost of 1 percent of gross domestic product. Yet budgetary resources are asymmetrically distributed across the eurozone, and supranational resources are small. The European Stability Mechanism can be used to help countries in need, but the conditions under which that help is supplied should be loosened. Currently, member states have to agree to a program of structural reforms and fiscal consolidation before funds can be disbursed in order to avoid moral hazard.

But moral hazard is not an issue in case of an EU-wide external shock as this one. Rather, the current crisis provides a golden opportunity to finally complete the eurozone’s unfinished business, including the creation of a European deposit insurance scheme, Eurobonds or common debt instruments, and an EU budget that is big enough to deal with EU-wide external shocks. Merkel has always argued that German voters would be against such steps, but the new risks that accompany the current shock will demonstrate the necessity of completing the eurozone’s architecture. She should use her vast reserve of built-up political capital to explain as much to the German public. Rather than expediently accommodate her electorate’s preferences against what they see as a fiscal transfer union, Merkel should finally attempt to change German preferences in the direction of stability through solidarity.

Germany should also immediately lead the way in the European Union by pushing for even more expansive stimulus at home. Germany’s healthy fiscal position should make it easier to justify bold measures. In 2019, the finance ministry collected a record surplus of 13.5 billion euros ($15 billion). While Berlin had again planned to balance its books in 2020, Scholz last Friday explicitly acknowledged that it may be necessary to pass an emergency budget for 2020 and go into the red. As a Social Democrat, Scholz never fetishized the schwarze Null the way his German conservative colleagues did after it was instituted by then Finance Minister Wolfgang Schäuble in 2014. Rather, Scholz believed that the balanced budget policy was popular among voters and feared an electoral backlash if his party should abandon it without a compelling reason for doing so. Scholz should not let this coronavirus crisis go to waste. He finally has as good a reason as any to get rid of the schwarze Null, one that can shield him against criticisms from conservative media outlets and the Christian Democratic Union, his coalition partner.

Thus far, Merkel herself has been largely absent in the crisis, with the exception of one press conference last week in which she warned her fellow Germans that up to 70 percent of the population was at risk of contracting the illness. But in general, she has let her health minister, Jens Spahn, coordinate the government’s response. Merkel is in the twilight of her career and has nothing left to lose. Having promised to step down at the end of this term, most likely in the summer of 2021, she no longer has to worry about reelection. Her legacy may well depend on whether she is able to take on Europe’s leadership mantle once more. She is uniquely positioned to do so.

Ten years ago, in the midst of the eurozone crisis, Merkel famously claimed that “the rules must not be oriented towards the weak, but toward the strong.” She admitted at the time that it was a tough message, but said it was one of economic necessity. It is time to turn that logic on its head. In times of a global pandemic such as this one, the rules need to be flexible enough not just to allow for the survival of the weak, but also to spur a quick economic recovery once the worst is over and prevent the collapse of the eurozone. The next few days and weeks will prove crucial. They will show whether Merkel is up to the task—and whether she is prepared to admit that her EU crisis management of the previous 10 years has always been fatally flawed.