German election shows eurozone vulnerable to populism, too

German election shows eurozone vulnerable to populism, too
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Earlier this year, globalists hoped that continental Europe would be spared from the widespread populist wave that was all too evident in the June 2015 Brexit referendum and last November’s U.S. presidential election.

It was also hoped that the European project would move toward closer economic and political integration. Then, there was Sunday's surprise German parliamentary election.

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With that German election, there can no longer be the illusion that Europe has somehow bucked the global populist trend or that those reforms needed to buttress the shaky euro project will be adopted anytime soon. 

 

Following last May’s French presidential election, Europe breathed a collective sigh of relief. Against all odds, a young and reform-minded Emmanuel Macron managed to stave off challenges from both Jean-Luc Melenchon on the far left and Marine Le Pen on the far right of the political spectrum.

After the election, it was widely believed that, at last, France would be able to implement real economic reforms to galvanize its sclerotic economy, while at the same time, a new German-French alliance would be forged to produce a more integrated Europe.

Even before the German election, there should have been doubts about whether the global populist tide had indeed turned. After all, in the first round of the French presidential election, the candidates of the extreme left and the extreme right had collectively polled almost 50 percent of the vote.

Then, soon after his inauguration, the newly installed President Macron saw his poll numbers plummet to the lowest level at this stage in a presidency throughout the Fifth Republic. 

One would think that Sunday's German election must have shattered any illusions about a rosy European political outlook entertained by those who had missed the telltale signs from recent French political developments.

Not only did the support for Germany’s two establishment centrist parties drop to barely 50 percent from the normal 75-90 percent in the post-war period; but support for the extreme-left and extreme-right parties rose to an unprecedented 25 percent.

Further clouding the outlook for both German politics and for deeper European integration is the fact that Chancellor Angela Merkel is likely to be forced to form a coalition government with the unlikely bedfellows of the Free Democratic Party and the Green Party.

This is bound to make for a weak German coalition government that is more than likely to curtail Merkel’s room for maneuvering in European affairs. In particular, it makes it highly improbable that Merkel will be in any position to respond positively to President Macron’s recent speech calling for greater eurozone integration.

The next important indication regarding Europe's political direction will come from the Italian parliamentary elections that will be held early next year. Sadly, against the backdrop of Italy’s highly disappointing economic performance over the past decade, the indications do not look at all promising.

According to the most recent electoral polls, the populist anti-euro Five Star Party is now tied with the governing Democratic Party. It is also far from reassuring that these polls suggest that no party will come anywhere near receiving a majority of the votes.

This very likely means that we will have a weak Italian government coalition incapable of making the economic reforms that the country so sorely needs.

Europe’s deteriorating political landscape is especially concerning considering that the euro crisis is likely far from over. Public-debt-to-GDP levels in a number of eurozone countries are higher today than they were in 2010, while banking systems, especially in Italy, appear to be very shaky.

Meanwhile, the European Central Bank (ECB) appears poised to start scaling back on its massive government bond-buying program that has been so important in holding the euro together.

By cheapening the euro, that program has been the mainstay of the eurozone economic recovery, and it has also succeeded in calming European bond markets despite the limited improvement in bringing down public debt levels.

It remains to be seen how well the eurozone economic recovery weathers a return to a more normal ECB monetary policy and a stronger euro. However, judging by recent eurozone political developments and the remaining economic vulnerabilities in key eurozone countries like Italy, it would seem that there can be no room for policy complacency. 

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.