Life after Merkel

Annegret Kramp-Karrenbauer has replaced Angela Merkel as leader of Germany’s ruling CDU party, and may soon take her place as chancellor. What does this mean for Germany – and Europe?

6 minute read

Angela Merkel is nothing if not adaptable. Some call her the ‘Iron Chancellor’, after the ruthless Prussian leader Otto von Bismarck; others affectionately use the nick-name Mutti (‘Mummy’). Her pragmatic streak has even inspired a new coinage: ‘Merkeln’ means ‘to dither’, a reference to her habit of kicking the political can down the road.

angela merkel

In 2018, Merkel has finally run out of road. On December 7 she was replaced as leader of the Christian Democratic Union (CDU) by her former protégé, Annegret Kramp-Karrenbauer. And although Merkel will remain as German chancellor for now, she will not seek re-election in 2021.

Merkel announced she was stepping down in October, after a disastrous result for the CDU and its Bavaria-based sister party in regional elections; the latest in a series of defeats that has lessened her authority and damaged Germany’s longstanding centrist consensus. Some commentators point to her decision to accept one million Syrian refugees in 2015 and 2016; a move the far-right Alternative for Deutschland (AfD) has used to whip up nativist sentiment (the AfD is now the official opposition in the German parliament). Others argue voters’ familiarity with the long-serving chancellor has bred contempt.

Whatever the reason for her party’s problems, Merkel’s leadership – and the era she defined – is coming to an end. Her successor will need to address some pressing challenges, according to Helen Thompson, professor of political economy at the University of Cambridge.

“The protectionist threat from Trump; the issue of Nord Stream; the domestic political legacy of the migrant/refugee crisis; the growing influence of Austria within the EU and its ability to make alliances with states like Italy – all these are difficulties that German governments haven’t had to deal with in a long time and are not set up to deal with,” says Thompson.

CDU chooses AKK

The emergence of Kramp-Karrenbauer as CDU leader is unlikely to mark a drastic change in German politics in the short term. Like Merkel, she hails from the CDU’s centrist, social welfare-friendly tradition; in the party vote she narrowly beat Friedrich Merz, a conservative veteran who might have moved the CDU further to the right.

Kramp-Karrenbauer was Merkel’s preferred candidate. In a farewell speech at the party conference before the hustings, the chancellor pointedly praised Kramp-Karrenbauer’s success as chief minister of the state of Saarland.

“We don’t expect a big shift in the German political landscape, as Kramp-Karrenbauer represents continuity in the short term,” says Geoffroy Lenoir, head of euro sovereign rates at Aviva Investors in Paris. “Significantly, she has ruled out a coalition with the AfD, which will limit the far-right party’s influence on German politics for the time being.”

Kramp-Karrenbauer is now Merkel’s probable successor as chancellor, regardless of whether Merkel serves her term until 2021 or steps down before then. (The former appears more likely now that Merkel’s right-wing opponents within the CDU have been side-lined.) Either way, she will be a tough act to follow. Take her economic record: In 2005, when Merkel took office, unemployment hit 12.6 per cent, the highest level since the 1930s; by October 2018 it had dropped to 4.9 per cent, the lowest since German reunification. She inherited a budget deficit of 3.5 per cent; that has become a budget surplus of three per cent in 2018, according to recent estimates.

“Growth has averaged 1.6 per cent over the last 13 years – a good level for a euro zone economy and in line with the potential of the German economy. And debt is now around 60 per cent of GDP, seven per cent lower than in 2005, so from a macro perspective Merkel has done a good job,” says Lenoir.

Future of the German economy

But look beneath the surface and there are issues that may explain why voters have turned against the CDU and the Social Democratic Party (SPD), its partner in the Grand Coalition that has governed Germany since 2013. GDP growth has started to slow and looks increasingly unbalanced by the dominance of large export companies in the industrials and autos sectors (see figure 1).

An indication of Germany’s reliance on its car industry came when figures for the third quarter showed a 0.2 per cent contraction in GDP growth – the first since 2015 – that analysts attributed to a sharp drop in production among companies such as Volkswagen and Daimler. Germany’s auto giants are scrambling to tool up new vehicles to meet the emissions standards enshrined in the EU’s Worldwide Harmonised Light Vehicle Test Procedure (WLTP), introduced in September.

“This regulation is likely to continue to weigh on growth in the German auto sector over the medium term,” says Ed Kevis, European equities fund manager at Aviva Investors, who also points to the impact of rising trade protectionism on German exporters. “If trade wars result in slower Chinese growth, this will hit car companies too, as well as German multinationals in other sectors with exposure to China, such as Bayer and BASF.”

Figure 1. Slowing exports weigh on German growth

graph

The DAX, the German benchmark stock index of mostly multinational companies, fell more than 17 per cent in the year to December 10 in local currency terms, after rising 12.5 per cent in 2017. In addition to the big carmakers, shares in electronics firms (Siemens), pharmaceuticals (Bayer) and banks (Deutsche Bank) have slumped.

Kevis says auto regulation and trade wars will continue to weigh on the big exporters into 2019 - as will trade tensions, if they persist - though German banks could rebound in line with the wider European financial sector if the European Central Bank (ECB) starts raising interest rates as expected next year.

Looking further ahead, Germany’s next chancellor will have deeper structural weaknesses to attend to. Infrastructure is crumbling in many parts of the country and Germany’s industrial economy is struggling to adapt to the digital age. An Organisation for Economic Cooperation and Development (OECD) study, published in 2017, ranked Germany 29th out of 34 industrialised economies for fast internet connections. And just 16 per cent of German firms make use of cloud services, well below the OECD average of 25 per cent.1

Merkel has spoken of her concern that German manufacturers are falling behind their Chinese competitors, which are more advanced in their use of data-driven methods. But she has done little to fix the problem. Lenoir says the chancellor’s shrewd management of public finances means there is plenty of scope to increase spending to upgrade and rebalance the economy, should her successor choose to do so.

The European economy

Merkel’s departure may also bring Germany’s awkward relationship with the rest of Europe into focus. Some German politicians have grumbled about the ECB’s quantitative easing (QE) programme, accusing it of supporting Europe’s spendthrift peripheral countries at the expense of German taxpayers, but it has also held German borrowing costs low. (The ECB’s purchases of German bonds have actually exceeded the country’s allocation under the ‘capital key’, which divvies up each member’s share of bond purchases based on the amount it has paid in.)

“German 10-year bond yields have hovered around the 0.4 per cent mark in recent months, but as the ECB tapers bond-buying and starts reducing its balance sheet we can assume yields would move towards one per cent. That would apply to other countries as well,” says Lenoir. “Spreads in Europe are trading relatively tight thanks to QE; however, political risks pushed spreads higher this year, especially for Italy. With QE ending, there will be a risk premium attached to the normalisation of policy by the ECB.”

Merkel has been the EU’s de facto power-broker in the past decade, taking the lead on issues such as the controversial bailouts of Greece and other peripheral European countries. If her successor takes a more inwards-looking stance, Europe could be left with a leadership vacuum in the event of another standoff.

One such challenge is already looming, as the European Commission confronts Italy over its intentions to implement a budget that would breach the bloc’s spending limits. The withdrawal of QE could also expose economic vulnerabilities in southern Europe and political divisions over whether the bond-buying programme should be extended.

But while Merkel’s diplomatic nous will be missed, her departure may actually be beneficial to the cause of European unity. Her government’s insistence on running a large current account surplus has fed Europe-wide trade imbalances; according to the Munich-based Ifo Institute for Economic Research, Germany is set to run a current account surplus of US$300 billion (7.8 per cent of GDP) in 2018 – the largest in the world for the third year running.

If Merkel’s successor proves more willing to implement fiscal stimulus to improve infrastructure and boost consumption, this would bring benefits across the European bloc, says Kevis. “Europe needs a rebalancing of the German economy, but it’s politically difficult for Germany to give up its hard-earned current account surplus. Germany has benefited from an artificially weak currency; even as other countries have suffered. Ideally, the German government would invest in infrastructure both at home and in wider Europe to redistribute some of that money.”

Germany and the world

There is a possibility Merkel, with one eye on her legacy, will use her remaining time in office to work on healing the political divisions in Europe. Lenoir argues that by stepping down as leader of the CDU, Merkel may be able to act without worrying about how her foreign policy decisions will play out at home, freeing her up to be more conciliatory in negotiations with her European counterparts.

Then there is the matter of Germany’s engagement with the wider world. In the wake of Donald Trump’s election as US president in 2016, Merkel called for Germany to take on more geopolitical responsibility and was hailed by political pundits as the ‘new leader of the free world’.2 But since then, she has become embroiled in domestic challenges and unwilling – or unable – to lead her country to a more prominent role.

Germany remains reliant on Russian gas supplies via the Nord Stream pipeline, which constrains its ability to oppose Vladimir Putin’s revanchist actions in Eastern Europe. And its armed forces are inadequate for a country with aspirations to wield global influence: it spends only 1.2 per cent of GDP on defence, well below the NATO guideline of two per cent. This means that it must deal with the consequences of problems that lie beyond its borders – such as the Syrian refugee crisis – without being able to solve them.

“Merkel’s government understands these challenges, but I don’t think it knows how to change the predicament Germany finds itself in: it is a prosperous country at the centre of a less prosperous continent and a country that, in part because of its history, has no geopolitical capacity,” says Thompson.

“Germany has been quite parasitic on the US for a long time, and to some extent in military matters it has been parasitic on France and Britain as well. The period where Germany has not had to take geopolitical responsibility, but still benefited from the international political and economic order, is coming to an end.”

Brexit will bring further pressure, as the EU stands to lose its biggest army (albeit with agreements about future cooperation between the UK and European forces). Whether Kramp-Karrenbauer would be willing to sign up to French President Emmanuel Macron’s plan to create an EU army to supplement NATO – Merkel recently expressed support for the idea3 – remains to be seen. What is clear is that when it comes to matters of defence, as with the domestic economy and its relationship with the euro zone, the German government won’t be able to Merkeln for much longer.

References 

  1. ‘Rebooting Germany,’ Reuters, June 2018
  2. Angela Merkel is now the leader of the free world, not Donald Trump,’ The Independent, February 2017
  3. ‘Merkel joins Macron in calling for EU army to complement NATO,’ Politico, November 2018

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