European politics are taking it to the brink

Brinksmanship is alive and well in European politics. Should the Germans pay more? Should the Greeks do more? Who will blink first? Will the European Central Bank ride to the rescue?

Writing about the Greek elections in June I made the point that all the parties were rejectionist to some extent, that whoever formed a government would try to renegotiate the support package agreed with the Troika of the European Union, the ECB and the International Monetary Fund.

I am not claiming special insight. It was to some extent stating the obvious. The Greek economy has been shrunk by 20 per cent over the past five years. Successive governments have imposed austerity measures to a value – mostly in increased taxes – of €43bn. Another round of cuts of €11.6bn is about to be put before parliament. This in an economy with a total output of €315bn in 2012, for a reduction in the deficit from nearly 25 per cent of output in 2010 to less than 10 per cent next year and less than 5 per cent in 2014.

This adds up to considerable change and it is little wonder the Greeks would like the pressure to be eased. Apart from anything else, austerity risks being self-defeating if carried to extremes. Despite the fiscal re-alignment, Greek public debt as a proportion of GDP is expected to worsen as each round of cuts contracts the economy.

On the other hand, few doubt that the Germans have little taste for underwriting further guarantees or for letting – as they would see it – their profligate neighbours loosen the terms of settled agreements. Germany has done well from the eurozone and this appears to be understood at a political level. But the benefits tend to be generalised, such as a lower overall exchange rate or an improved competitive position relative to the eurozone peripheral economies. The costs, by contrast, tend to be immediately quantifiable, such as the €190bn for which Germany will be liable under the terms of the European Stability Mechanism.

The tensions between north and south, between core and periphery, are not going to go away, but they may ease over the next few weeks as changes that have taken time to gestate come into being. Two significant milestones are due in September. The first will be the emergence of the ESM itself. The only important barrier at this point is a decision by the German Constitutional Court, needed to ratify the treaty founding the mechanism.

The decision – due on September 12 – will almost certainly be positive. The establishment of the ESM institutionally should help to take some of the sting out of eurozone support. As a permanent institution it will be able to operate without constant recourse to fractious and nervous political leaders.