President François Hollande of France and Chancellor Angela Merkel of Germany meet in Berlin, May 15 (Bundesregierung)

German chancellor Angela Merkel and newly elected French president François Hollande are bracing for their first proper fight. The debate between austerity and growth is expected to narrow to the question of whether countries in the eurozone should jointly issue sovereign bonds when leaders meet in Brussels on Wednesday.

Hollande, a socialist who became president this month, supports the creation of Eurobonds. So did his predecessor, the conservative Nicolas Sarkozy, but he was willing to drop the issue to allow France and Germany to combat the continent’s debt crisis together.

There was no such Franco-German unity on display in Camp David this weekend where leaders of the G8 countries met to discuss the global economic crisis.

American president Barack Obama embraced Hollande’s push for “growth”—which, to them, means more stimulus spending. He and other leaders paid lip service to fiscal consolidation but appear to have grown weary of austerity. Merkel insists that industrialized nations must get their fiscal houses in order to restore consumer and investor confidence.

British prime minister David Cameron, otherwise considered a champion of austerity, unexpectedly backed the creation of Eurobonds before the G8 summit. The United Kingdom, outside of the eurozone, wouldn’t have to participate. Italy’s Mario Monti also supports the idea. It left Merkel without allies at Camp David.

The European Commission floated the notion of creating Eurobonds last year as a way to stem Europe’s spiraling debt crisis. Joonatan Jakobs explained at the time how Eurobonds would work at the Atlantic Sentinel.

Since most countries in the single currency area are economically stable, a Eurobond would enable the least competitive among them to receive funding from the markets, substantially lowering the costs for countries that are currently in trouble.

Hence the German apprehension. Berlin fears that the creation of Eurobonds will ultimately lead to a “transferunion,” the permanent bailing out of weaker states in the single currency union at its expensive if they’re able to free ride on Germany’s pristine creditworthiness.

Spain endorses the proposal. Slovakia has come around to it. The previous conservative government was skeptical but left wing prime minister Robert Fico, who assumed office in April, told parliament on Monday that he would back the French position.

Finland and the Netherlands remain opposed. With Germany, they argue that more progress is needed on coordinating fiscal policies across the eurozone before members can consider jointly issuing sovereign bonds.

President Barack Obama and Angela Merkel discuss policy during the G20 summit in Seoul, South Korea, November 11, 2010

German chancellor Angela Merkel will likely be isolated among G8 leaders in Camp David this weekend. With the possible exception of Canada’s Stephen Harper, the leaders of the world’s other major industrial nations are all growing weary of austerity.

The divide is a familiar one. American president Barack Obama has urged his overseas counterparts to do more to stimulate economic recovery in the eurozone for two years while the Germans are adamantly opposed to more deficit spending as well as an expansionary monetary policy as has been pursued in the United States.

Treasury secretary Timothy Geithner lamented Europe’s “negative spiral of growth killing austerity” this week. The German finance minister, Wolfgang Schäuble, was exasperated. “One cannot now seriously demand taking on even more debt to solve the crisis,” he told Focus magazine earlier in the month.

The Germans regard America’s nearly $1 trillion stimulus program with disbelief and insist that Europe’s approach should be different. Solid public finances, they say, is a key condition for consumer and investor confidence and therefore growth.

Transatlantic discord over austerity has become a recurring theme at international summits. President Obama urged Europe to do more stimulus at the G20 summit held in Toronto, Canada in 2010 and reiterated that call in Seoul the next year. The Germans opposed him both times and were able to sway other major powers their way.

In Toronto, the G20 countries agreed to cut their deficits in half by 2013, a targets which the Americans are almost certain to miss. Nations failed to reach agreement on monetary policy however. China and Germany remain critical of America’s willingness to print money, even if the European Central Bank has since done the same to finance Italian and Spanish deficit spending.

The difference for Merkel this weekend is that she has lost two allies. France’s Nicolas Sarkozy was replaced by socialist François Hollande this week who brings with him an agenda for “growth” (which means more public spending) while British prime minister David Cameron is now in favor of issuing Eurobonds or joint sovereign debt paper in the eurozone—so the United Kingdom wouldn’t have to participate.

The German high court preempted this proposal in September of last year when it decreed that parliament would have to consent to such a joint issuance of bonds. It is unlikely to. The Germans fear “transferunion,” the permanent bailing out of weaker states in the single currency union at Germany’s expensive if they’re able to free ride on Germany’s pristine creditworthiness.

Merkel is no stranger to isolation. She has few allies among Europe’s leaders. Italy’s Mario Monti and Spain’s Mariano Rajoy, both conservative prime ministers, try to reduce their deficits and introduce market reforms to make their nations more competitive relative to Germany—as Merkel put it in Seoul two years ago, “the benchmark has to be the countries that have been most competitive, not to reduce to the lowest common denominator”—but they also support a more expansionary monetary policy on the part of the European Central Banks which the German chancellor rejects for fear of inflation.

It may be convenient for the Germans if China were finally let into the G8. Until that happens, Merkel will stand her ground, alone.

Prime Minister Mario Monti of Italy and Chancellor Angela Merkel of Germany in Berlin, January 11 (AFP/Getty Images/Odd Andersen)

French president Nicolas Sarkozy’s election defeat on Sunday robbed German chancellor Angela Merkel of one of her key allies in combatting the European debt crisis. Italian prime minister Mario Monti may be the next best thing for her.

Monti suggested last Wednesday that he could help France and Germany find “a new equilibrium” after Sundays’ election. “We have become more pressing and, I hope, more persuasive in a European context,” he said.

The former European commissioner took charge of Italy’s technocratic cabinet in December of last year and pushed for austerity measures and market reforms to balance his nation’s budget and make its economy more competitive relative to other members of the eurozone. His very appointment came after Merkel and Sarkozy had publicly questioned Prime Minister Silvio Berlusconi’s ability to save Italy from a debt crisis.

France’s new president, the socialist François Hollande, is far more critical of the sort of austerity measures that are championed by Germany than his predecessor was.

Sarkozy said in January that he wanted the French to be more like Germans—work harder while enjoying fewer benefits. Hollande insists that the emphasis should be less on cuts, rather on “growth,” which means: more room for fiscal stimulus and increased European financing for regions that have been hit hardest by the recession.

The socialist leader does believe there is something to be learned from France’s neighbor. “In Germany, they make room for social partners, unlike in France.” What he doesn’t mention is that Germany’s trade unions accepted cuts in wages and working hours to preserve employment whereas France’s call a strike whenever layoffs loom. Nor does he seem to recognize France’s 34.4 percent corporate tax rate as an impediment. In Germany, the rate is 15.8 percent.

In the context of Europe’s sovereign debt crises, Hollande’s call to “renegotiate” the European fiscal compact that was signed in December and capped deficits at 3 percent of gross domestic product at the risk of a fine, is Berlin’s main worry. The Germans may not find a better partner in Monti though.

Merkel praised the economic reforms that were enacted by the Italian prime minister in January—”they will improve Italy’s economic perspective,” she said—and Monti has had kind words for the chancellor’s iron will to rein in deficits. “Germany for a long time has offered to every European country concrete proof of how public budget discipline and an economy founded on market principles are the best recipe for growth.” He just doesn’t want to follow the German model too closely.

When it comes to central bank financing of government debt, Monti, like Hollande, would like to see more “flexibility” from Frankfurt. The European Central Bank there created €1 trillion out of thin air last year to prop up European banks. Much of that money didn’t go toward financing private businesses. Rather, it was largely spent strengthening banks’ balance sheets and invested in government bonds.

The ECB printed several hundreds of billions more to buy Italian and Spanish debt itself to stop their interest rates from rising to unsustainable levels which would have raised the specter of both countries defaulting and plunging the currency union in an even deeper crisis.

The unprecedented bond buying operation was regarded warily in Germany where it is believed that the central bank’s mission should be to tame inflation, not finance governments’ deficit spending, even indirectly.

The ECB’s balance sheet grew from some €700 billion in 1999 to €2 trillion in 2010. Then, in 2011, the aforementioned €1 trillion was added. As a result, the money supply in the eurozone has expanded by 50 percent more than its economy in the last fifteen years.

The Germans are very anxious about this development. Besides driving up inflation, they’re afraid that it will remove the incentive on the part of heavily indebted eurozone nations to rein in government spending and liberalize their economies. “It’s important that we get away from the idea that it always costs money to get economic growth,” Merkel told the Hamburger Abendblatt on Tuesday.

Hollande evidently doesn’t share her concern but it’s not at all clear if Monti does.

Voters celebrate as François Hollande's election victory is announced in Tulle in the south of France, May 6 (Benjamin Géminel)

Elections are held across Europe on Sunday. From national polls in France and Greece to local elections in Germany and Italy, austerity is on the ballot as voters are expected to vent their frustration with the slow peace of economic recovery in the eurozone.

The marque event is France’s presidential vote. Right wing incumbent Nicolas Sarkozy trailed his socialist opponent François Hollande by just several points in the most recent opinion poll.

An Hollande victory, expected to be followed by a left wing swing in June’s parliamentary election, could dent German chancellor Angela Merkel’s hopes of imposing fiscal austerity across the single currency area.

Hollande has promised to “renegotiate” the fiscal compact that was signed in December which capped government deficits at 3 percent of gross domestic product. He insists that the emphasis should be less on cuts, rather on “growth,” which means: more room for fiscal stimulus and increased European financing for regions that have been hit hardest by the recession.

Merkel’s christian democrats are struggling to hold onto power in Germany’s northernmost and largely rural state of Schleswig-Holstein. The party is in coalition there with the right wing liberal party which is also its partner at the national level. While the chancellor’s conservatives are still the largest in national polls at 36 percent, the liberals wouldn’t even make the 5 percent election threshold if parliamentary elections were held today.

If the conservatives win the election in Schleswig-Holstein, they will likely seek a “grand coalition” with the social democrats. If rather the left secures a majority with the Green party, the christian democrats could be ousted altogether.

There will also elections in the industrial state of North Rhine-Westphalia next week after the ruling left wing coalition failed to pass a budget. Both the conservatives and social democrats lost heavily there two years ago but the Greens nearly doubled their seats in the state parliament. Merkel’s party is not expected to recover. The social democrats are expected to come out stronger, drawing votes from the Green party and the far left.

Local elections in Italy, too, will test the popularity of the government’s austerity agenda. Prime Minister Mario Monti is not on the ballot but the main left and right wing parties that support his technocratic government are.

The center left Democratic Party had a narrow overall lead in preelection polls over former prime minister Silvio Berlusconi’s conservative Il Popolo della Libertà (“The People of Freedom”) with the third biggest share of support going to Beppe Grillo, a blogger and comedian who wants Italy to leave the euro and default on its debt.

Fringe parties are also on the rise in Greece where the traditional conservative and socialists parties are struggling to secure a majority.

PASOK, the former ruling party now led by finance minister Evangelos Venizelos, and the conservative Néa Dimokratía (“New Democracy”), which both supported Prime Minister Lucas Papademos’ caretaker government and its austerity agenda, would together win between 35 and 45 percent of the vote, according to opinion polls conducted last month. Most third parties are opposed to sticking to the conditions of the two European bailouts that Greece has received to prevent a sovereign default.

In an interview with the British newspaper The Guardian this week, Venizelos warned that Greece’s future in the eurozone is at stake in this election. “The Greek people will have to give a clear answer as to whether it wants (to follow) a pro-European course, which is safe and responsible, or something else.”

The German finance minister Wolfgang Schäuble warned that Athens must respect the commitments made or “it will have to bear the consequences.” He told the Reuters press agency that the Greek and French elections “will not have, in essence, any impact on German financial policies.”

French Socialist Party presidential candidate François Hollande, April 22

Shivers are running down the spines of Europe’s champions of austerity. If, as expected, socialist François Hollande wins France’s presidential election on Sunday and the Greeks return a parliament that is hopelessly divided on the same day, the pressure on Germany and its allies to surrender the push for budget restraint and allow for more deficit spending will increase.

Hollande has pledged to renegotiate the European fiscal compact that was signed in December—but has yet to be ratified in all eurozone states. The main conservative and socialists parties in Greece will likely fail to achieve a majority, forcing them to enter a coalition with third parties that mostly hostile to the austerity effort.

The Greeks have had to endure the worst of Europe’s debt crisis. In exchange for two international bailouts, totaling €240 billion, Athens has had to implement spending cuts and enact market reforms. Salaries in the private but especially the public sector were cut. So were pension payments and government subsidies.

Anticipating public resistance to mere budget cuts, Europe’s leaders in January stressed competitiveness in their fiscal treaty besides fiscal consolidation. Deficits had to reduced to under 3 percent of gross domestic product with fines for profligate member states but highly indebted governments in the periphery of the single currency area were also expected to liberalize their economies.

Italy, where former European commissioner Mario Monti became prime minister in November, has led the way. His technocratic government cut spending and raised taxes to balance its budget but also introduced entitlement and labor market reforms, the effect of which will take years to gauge as the country is burdened by excessive regulations, a mammoth bureaucracy and powerful trade unions that resist Monti’s efforts.

The conditions in France are fairly similar except taxes are even higher and the state claims an even larger share of annual economic output. Unlike Monti, Socialist Party presidential candidate François Hollande has displayed no willingness to meet market demand for flexibility and spending restraint. Instead, he promises to hire more civil servants and raise taxes on the rich.

Hollande’s push is one for “growth.” It is the European left’s newest buzzword for more government spending, implying that a recovery can only came about as a result of public “investments”—financed by borrowing.

When the British complained in January that the fiscal compact, heralded by German chancellor Angela Merkel, “essentially makes Keynesianism illegal,” they were isolated. Prime Minister David Cameron was one of two European leaders who opposed the treaty. The Czechs also vetoed. Neither country is in the eurozone so the fiscal compact could go ahead regardless.

Now, the call to end austerity is heard louder across the continent. Rallying against supposed “cuts” in government programs and spending—which is usually a euphemism for reductions in planned increases in spending; in few countries have outlays actually come down—left wing political parties and labor unions are forcing even right wing leaders to make concessions.

In the Netherlands, liberal prime minister Mark Rutte’s minority government, otherwise a stalwart German ally, had to forego some planned spending cuts and raise taxes instead to appease a centrist coalition that was willing to support a budget that will reduce the country’s shortfall to under 3 percent of GDP next year.

In Italy and Spain, conservative prime ministers are urging further flexibility on the part of the European Central Bank to finance their deficit spending. The central bank in Frankfurt purchased billions worth of peripheral bonds late last year when interest rates on Italian and Spanish debt rose over 7 percent, deemed unsustainable. This temporarily calmed markets but is far from a permanent fix. France’s Hollande also likes to see a more activist central bank.

The Germans, for their part, remain skeptical. “It’s important that we get away from the idea that it always costs money to get economic growth,” Merkel told the Hamburger Abendblatt on Tuesday.

President Joachim Gauck of Germany (Steffi Loos)

German president Joachim Gauck has canceled a visit to the Ukraine that was scheduled for next month amid growing concern about the persecution of former Ukrainian prime minister Yulia Tymoshenko.

Tymoshenko is serving a seven year prison sentence on corruption charges. She had gone on a hunger strike to protest her treatment but denied medical care.

The German ambassador to Ukraine added to the pressure on Friday when he warned that an association agreement between the European Union and Ukraine will likely not be signed. The Czech foreign minister earlier warned the same thing. There is also talk of boycotting the European football championship which is to take place in Poland and Ukraine this summer.

Gauck, a former human rights activist from East Germany, was elected president in March and due to attend a summit of Central and Eastern European leaders in the Black Sea resort of Yalta in May.

Most former Soviet satellite states in the region have joined the European Union and the NATO alliance since the end of the Cold War in 1991. Ukraine is an exception. Tymoshenko was a proponent of European Union membership but incumbent president Viktor Yanukovich is considered pro-Russian. Ukraine’s eastern half is largely populated by people of Russian descent and Moscow’s Black Sea Fleet is headquartered in the Crimea.

Germany’s public condemnations of the Ukrainian Government are notable because at least in Eastern Europe, Berlin is seen as strengthening ties with Russia, Yanukovich’s patron.

The construction of the Nord Stream gas pipeline symbolizes Central and Eastern European fears of Germany sacrificing pan-European interests to its own. If the Germans import gas from Russia directly, they can balance their relations with Moscow at the expense of other European Union member states, they worry.

The countries that are caught in the middle depend on Germany economically but derive their security through NATO from the United States. As Poland’s foreign minister Radoslaw Sikorski put it in February, “When Germany gets too big for its boots, we always automatically add allies.”

In 1939, it was France and Great Britain. Today, it’s America. Except with the Obama Administration “pivoting” to Asia, there is concern about that commitment.

Former president George W. Bush heralded Ukraine’s 2004 Orange Revolution, which swept Tymoshenko to power, as a sign of changing times. He favored expansion of NATO membership to include all of Eastern Europe’s former communist states, alarming the Kremlin which saw it as part of a concentrated effort to encircle Russia.

President Barack Obama tried to “reset” relations with Moscow and announced the withdrawal of at least one combat bridge from Europe in favor of a more activist presence in East Asia. Given the American emphasis on countering a rising China, successor administration are unlikely to reverse course, leaving the British and French to maintain a balance of power in Europe.

Countries like the Czech Republic and Poland may fear that they won’t succeed. After all, it wasn’t until the United States interfered that the tide of the Second World War turned in the allies’ favor.

Given their security environment, Central and Eastern European NATO allies will welcome Gauck’s tough talk on Ukraine but unless the Germans clearly distance themselves from Russia too, they still need an outside balancer like the United States because Germany’s interests clearly suggest an Ostpolitik of a different sort, one that bypasses Kiev entirely.

A French Dassault Rafale fighter jet, June 11, 2011 (Prowler)

As David Cameron’s now infamous veto of a treaty for greater fiscal integration in the European Union, the leaders of France and Germany bonded closer, overcoming to a large extent their difficult personal chemistry.

Thousands of kilometers away in India, this realignment coincided with the victory of the French made Dassault Rafale in India’s Multi Role Medium Combat Aircraft (MMRCA) contest. The emerging schism which the tantrum was symptomatic of, had already begun to play out in India.

The MMRCA contest has been India’s biggest fighter contest of this century, worth about $20 billion or $60 billion if spread out over the next thirty years. It coincided with a similar quest for a new fighter jet in Japan.

The Eurofighter also participated in both contests. Italy and Spain, junior partners in the joint fighter project, took a backseat while Germany took the lead in India (unusually, given that the British are much more familiar with it) while the British were given charge of the Japanese campaign (again, unusual, since the Germans consider themselves to have penetrated the Japanese psyche more).

The otherwise successful plane faltered in both contests. The loss in Japan was understandable given that it was up against a supposedly superior plane that is a full generation ahead. The loss in India was galling however given that the Rafale is considered the lowest performing of all modern western warplanes.

Expectedly, the British press went into a tizzy, demanding a revoking of the $1 billion worth of aid India received while The Sunday Times ran an investigative article on how the competition was “fixed” by some “shady” Frenchmen.

That the process was tainted and corrupt is undeniable. All Indian defense acquisitions are. What is surprising is the German disinterest in winning this contact and the way in which Germany appears to be maneuvering at the highest levels to scuttle any British move to appeal the Indian decision.

One thing everyone in Delhi seems clear about is that the Eurofighter was the only horse in the race without state support. The Swedes, Russians and Americans all backed their ponies to the hilt, while the French by all accounts resorted to a massive campaign of electronic espionage and presumably bribery to win.

Indeed, the French were so exasperated with what they saw as Dassault’s negotiating incompetence that they went to great lengths to exclude it entirely from the Indian campaign.

Berlin, on the other hand, did exactly nothing. Several times in the contest the British reportedly expressed serious reservations about the way Germany was sleeping on the job but apparently to no avail.

If there was one piece of critical analysis missing from The Sunday Times‘s reporting, it was why Germany would be so reluctant to win $60 billion worth of business.

Once the Rafale’s victory was sealed, things started getting a lot murkier. While the British were crying themselves hoarse, the standard German line paraphrased was, “India is a big market with several opportunities, this is one deal that didn’t go our way—c’est la vie.” This in spite of several indicators being dug by the Indian press, institutions and even bureaucrats of the contest being manipulated.

The standard claim is that Germany is “hiring”—i.e., the jobs lost on the Eurofighter production line will be absorbed into other sectors of German industry.

Britain is not hiring though nor is France and the insinuations floating around are that this deal is a secret bailout package for the French in addition to the considerable sums of money Germany has to spend to finance European deficit spending.

The severe conflict of interest and possibilities for European collusion in this contest are reflected in the ownership. The European Aeronautic Defence and Space Company owns 46 percent of the Eurofighter Consortium and 46.3 percent of Dassault Aviation which produces the Rafale. This .3 percent difference means a higher cut for EADS in the profit share should the Rafale win. Its French boss, Louis Gallois, went on the record after the Eurofighter loss claiming as much.

Curiously, coinciding with the timing of the Indian loss was news that Cassidian, EADS’s subsidiary that had led the Indian campaign, was to move its headquarters from Munich to Toulouse—ostensibly to be nearer to Airbus.

The German reaction to all this? Silence. High level political pressure when Nicolas was coochie cooing Angela? Perhaps. Serge Dassault, the president of Dassault Aviation, is a close ally and major funder of President Sarkozy in addition to being a member of the French conservative party. Moreover, he owns the influential newspaper Le Figaro.

Given all this shadow play, it seems Goethe got it right. Licht! Mehr Licht!

German Chancellor Merkel and Luxembourg's Prime Minister Jean-Claude Juncker during a European summit in Brussels, December 17, 2010 (Reuters/Francois Lenoir)

Germany’s approach to the euro crisis stems from deeply entrenched neoclassical economic views. The fundamentals of these views will not change and must be taken into consideration when negotiating with Germany, for example by making the case for pan-European investment programs instead of outright atttacking austerity as a concept.

Contrary to popular belief, Germany’s reaction to the euro crisis—its strict focus on price stability and austerity—is not a result of historical experiences with hyperinflation, a selfish intent to maintain a surplus at the expense of others, or an intent to punish southern European deadbeats.

Rather, the German approach stems from an entrenched belief in price stability coupled with budgetary discipline as the only road to prosperity. German economic orthodoxy holds that a European coordination of taxes, labor laws, retirement age, etc. is unnecessary. If everyone “does their homework” prosperity will naturally result. Hence the emphasis on fiscal discipline.

The European Council on Foreign Relations in a policy brief (PDF) recommends that member states accept these concepts when dealing with Germany. Instead of attacking austerity as such, they should demand pan-European investments, Europe level taxation and more time to implement austerity measures. The basic German position will remain the same regardless of government, even if a center left coalition may be more open to Eurobonds.

Analysis

Traditionally social democratic dominated Europe is shifting toward a more liberal (in the European sense) path.

Any solution to the euro crisis is unthinkable without German support. The economic reality of tomorrow’s Europe will thus have a distinctly German flavor. The German penchant for a strict seperation of fiscal and monetary policy, coupled with debt brakes hardwired into national law, has an obvious right wing/left wing element to it, which could affect the trajectory of European societies for years to come.

The dominance over the past fifty years of Europe’s social democratic parties is arguably waning. This can be seen in both the acceptance of Germany’s economic concepts and in the fact that center right governments now rule in most European capitals.

One variable in this scenario is, when the sense of urgency has passed, will the still strongly entrenched left wing continue its acquiescence of the German line?

A counter reaction to the current trend could be fuelled from both the left and the right. For example, by right wing nationalistic anti-German, pro-sovereignty sentiments and by left wing sentiments of Germany (and the European Union by association) favoring big business.

Wikistrat Bottom Lines

Graham O’Brien and Miguel Nunes Silva contributed to this analysis.

German Social Democratic Party leader Frank-Walter Steinmeier in Dresden, November 13, 2009 (Marco Urban)

Opposition social democrats in Germany and the Netherlands want concessions in exchange for their support of a European fiscal compact that is supposed to into effect next year.

German left wing leader Frank-Walter Steinmeier said his conference will only back new eurozone budget rules if the continent also adopts a financial transaction tax.

Chancellor Angela Merkel requires opposition support to gather a two third majority in both houses of parliament to ratify the new fiscal treaty. German left wing political parties, along with their Dutch counterparts, have previously supported European bailout efforts of Greece, Ireland and Portugal.

The liberal party junior coalition partners in Merkel’s government have said that they will only accept a financial transaction tax if it is implemented across Europe. Because the United Kingdom, the staunchest opponent of such a levy, refused to enter the fiscal compact, that may now be possible.

Steinmeier told the Frankfurter Rundschau that “additional measures to promote economic growth” must also be enacted. “For this, you would obviously need the funds that must come from things like a tax on financial markets,” he said.

French Socialist Party candidate François Hollande, who is likely to replace incumbent Nicolas Sarkozy in May, favors a financial transaction tax as well. He has characterized “the world of finance” as his “enemy” in the upcoming presidential election and seeks to “renegotiate” the fiscal compact so there is greater emphasis on measures that help economic growth—presumably more room for an expansionary fiscal policy that isn’t confined by strict deficit limits.

The Dutch Labor Party, whose votes are critical to the minority government’s foreign policy, prompted the Netherlands’ center right cabinet to study a bank tax last year. Ronald Plasterk, a member of parliament who now seeks the party leadership, lamented at the time that, “Everyone is tightening their belts except the sector that caused the crisis.”

The fiscal treaty that was signed by European leaders, except the British and Czech prime ministers, in January of this year demands that countries write balanced budget requirement into national law and reaffirms the Stability and Growth Pact deficit and debt limits of 3 and 60 percent of gross domestic product respectively. Countries that are found to be in excess of these caps can be fined up to .1 percent of national income by the European Court of Justice in Luxembourg.

European Commission president José Barroso and Chancellor Angela Merkel of Germany during a European People's Party summit in Brussels, March 24, 2011

Europe is at a crossroads. The European model is failing and the Brussels Consensus seems to be at an end.

Until now, Europe was managed through careful compromise, centrism was the rule and social democracy the means.

The Brussels Consensus consisted in economic deregulation coupled with environmental and social caveats, all bungled together with an agreement in promoting human rights worldwide.

This consensus has been at the base of the acquis communautaire (“common body of law”) subsequently reflecting itself in the Copenhagen criteria for accession to the European Union and the Maastricht criteria for economic harmonization.

The consensus was the result of decades of negotiation and compromise between, fundamentally, France and Germany.

In 1957, the Rome Treaty was signed giving way to the Coal and Steel Community and Euratom, after Paris and Berlin had agreed to allow West Germany into the European community of nations politically and economically but protecting in the process the French steel industry which would have underperformed under free market competition with Germany.

Decades later, with a much enlarged EU, the method was still the same: in the negotiations for the Maastricht Treaty and the Treaty of Amsterdam, French agriculture was protected through subsidization and the Deutsche Mark formed the basis for the euro currency in return for the permission to reunify the two Germanys.

The construction of Europe was political. Angela Merkel referred to it in her Brugge speech as the “Union method,” a hybrid between Jean Monnet’s gradual federalist “community method” and the pure and classic “intergovernmental method.”

Whenever an exception emerged against the consensus, there was an immediate ostracizing reflex by the community as a whole. Britain was often sidelined in spite of its economic and political importance and this tendency eventually came to be institutionalized as the opt out mechanism. The British faced difficulties even joining the European Economic Community and remain to this day outside of the euro area group.

Weaker countries such as Austria saw themselves ostracized diplomatically when they elected politicians (anti-immigration far right leader Jörg Haider) from outside of the politically correct ideological spectrum and elections for the European Parliament were even more blatantly affected by this trend with candidates for the Barroso Commission being pushed away due to their ideological convictions (anti-gay rights Rocco Buttiglione).

In essence, Europe’s social democracy run system depends on a political compromise over most matters with dissenting voices being unwelcomed. However, Europe’s current tribulations are economic rather than political and they seem to require a clear radical and stark choice: more integration or none at all.

The maintenance of the euro is untenable according to many economists. Long term sustainability is threatened by the partial financial integration process of the seventeen currencies which saw interest rates harmonized but not the labor market, where the European Central Bank fights inflation and capitals are free to move across borders but economic policies are still run separately. This gives rise to too many externalities and distortions and cannot be maintained.

The problem now is that the Brussels Consensus of political compromise as a solution for all problems is insufficient to handle the crisis.

Germany has been living in paradise being able to import basic agricultural products and cheap manufacturing goods making use of its strong currency but exporting back high end technology and industrial products which bring it greater comparative returns. There is nothing wrong with a semi-protectionist policy so long as international integration is not at stake. But Berlin cannot on one hand uphold “cohesion policies” aimed at streamlining development in Europe and on the other maintain a constant positive commercial balance.

Chancellor Merkel still lives in the past though. The “fixes” being applied to the Greek economy are nothing but band aids and will not solve Greece’s structural problems.

The other Mediterranean states look at Greece and are alarmed at how badly the lab rat is doing. They will push for a different agenda. Germany will have to eventually make an unpopular choice—escape forward or escape backward.

For the moment, Merkel is trying to escape making such a choice and keeps hoping to jump start the Greek economy but this populist stance deprives her of statesmanship. Angela Merkel is no Margaret Thatcher, even if her political career may turn out to be longer. It may be difficult, and even implosive for Europe, to generate a Berlin Consensus but in this case it seems to be more urgent to try and fail rather than not act at all. Ultimately, as a closet Euroskeptic, Chancellor Merkel simply lacks the political courage to give federalist elites in Europe a fatal diagnosis.

In the meantime, while Europe does not sort out its internal shortcomings, European power projection abroad will remain feeble and the Europeans will continue to be ignored in the most pressing issues of today’s international scene.