The German Elections and the Euro Crisis

The German federal elections on September 22 will have importance well beyond Germany’s borders, particularly in Europe. However, the effects on the rest of Europe are likely to be subtle rather than constituting a decisive turning point. There is also considerable uncertainty about the outcome and its immediate consequences.

What we know

Merkel will remain in charge. To be fair, this is not an absolute certainty but rather a very high probability. Polls clearly show that her parliamentary faction will be the single largest, with over a third of the seats. That lead, combined with the increasing fragmentation of the party structure in Germany, makes it difficult at this point to envision a viable coalition without her faction, although it is not impossible. Her status as the current Chancellor, her personal popularity, and control of the largest parliamentary faction effectively would guarantee her the Chancellorship yet again in any such coalition. This would give her a great deal of control over government policy, even if she is forced to share power with the Social Democrats rather than her much weaker current partner, the Free Democrats.

There will be no popular mandate to renounce Europe. Many German voters harbor concerns about the Euro Crisis and whether Germany will be forced to write large checks to bail out other countries. But they are not showing a willingness to demand a major pullback from European commitments. There is a new Euro-skeptic party, the Alternative For Germany, which wants to pull out of the Euro. It is currently polling at 3-4% and may manage to cross the 5% threshold that allows it to be represented in parliament. However, this is a far cry from the populist fervor in France or Italy or Greece. Further, the Free Democrats do not seem to be benefitting from an apparent decision a year or two ago to try to capture some of the Euro skeptic vote by calling for a tougher German line. It appears likely that they will re-enter parliament by crossing the 5% threshold only if some members of Merkel’s party give their vote to the Free Democrats in order to keep them in parliament, as is highly probable. The larger opposition parties, the Social Democrats and the Greens, have taken more Europe-friendly positions than Merkel, although without allowing themselves to get too far away from the German consensus.

Germany will continue to resist external pressures. Many countries in Europe and elsewhere, including the US, would like to see Germany take steps to rev up its domestic spending, reduce its massive trade surplus, and allow inflation to move up to 3-4%, easing the adjustment process for the troubled nations in the Eurozone by allowing them to reduce relative costs without undergoing serious deflation.  A new German government may move a bit in those directions, but not very far. The German public, and most of the politicians, believe strongly in: fiscal austerity (which reduces the ability to stimulate consumer spending); big trade surpluses; and inflation as close to zero as they can manage. These are articles of faith in Germany and politicians are simply not going to stray too far from them.

What we don’t know

Which small parties will be in parliament? As noted, the Alternative for Germany might make it over the 5% threshold, but is not there in current polls. The Free Democrats are over 5% in the polls and will very likely enter parliament, but it will depend heavily on tactical voting decisions that are difficult to predict.

Will there be a Grand Coalition? Merkel might be able to assemble a parliamentary majority for her current coalition, but it is not the most likely result. If not, there is a high likelihood that she will have to cohabit again with the Social Democrats as in her first government.

Might Merkel lose her position as Chancellor? I will be very surprised if she does, but, for completeness, it must be noted that there is a potential shaky coalition without her. The Social Democrats and Greens could take enough seats to potentially form a coalition with The Left (Die Linke) party. However, that party is viewed by many as being too extreme to be an acceptable part of any coalition government. The Social Democrats have spent months reassuring voters that they would not consider such a coalition. Thus, the Social Democrats would be quite leery about taking this route, fearing a backlash from centrist voters in future elections. Reaching a coalition agreement would also be difficult given the ideological differences. If the Social Democrats and Greens do well, it remains much more probable that the Social Democrats use this theoretical option of a coalition with The Left as leverage for a better deal from Merkel in a Grand Coalition.

Will Germany be more flexible after the election if the Euro Crisis worsens? Germany’s overall orientation on Europe is not likely to change very much after this election. However, the election could give Merkel more flexibility in cutting any crisis deals that may be necessary if Italy starts to fall over or another truly major problem arises that threatens market stability. Simply getting past this election will be helpful in terms of flexibility, as there will be less need to worry about the near-term reaction of the public. Further, a Grand Coalition, if it occurs, would include the Social Democrats, who have views more in line with the majority of Eurozone nations. Merkel’s views, and that of the German public, would limit the flexibility, but it would still be greater than she has had in her existing coalition with Free Democrats, who have moved towards mild Euro skepticism. We will not really know the answer to this particular question until and unless a major flare-up in the crisis occurs and then the answer may be heavily influenced by the specifics of the circumstances.

In sum, expect Merkel to be running Germany and for overall policy relevant to Europe to remain much as it is, but with the possibility that there is more room for flexibility next time the Eurozone’s leaders find themselves on the cliff edge, should that happen again.