While world markets rallied Monday on news of a European Union stabilization fund worth nearly $1 trillion, German Chancellor Angela Merkel was left reeling after state elections gave power to the opposition in the upper house of the German parliament, threatening to derail what is left of her political agenda.
Merkel’s election setback and weakened position could further weigh down a German economy struggling to maintain growth after emerging from recession last year. The chancellor had pinned her hopes for sustained economic recovery on increased consumer and business spending spurred by tax cuts. Now, with the tax cuts on hold, a debate about increases in social spending looming and possible bailouts in other EU member states, Merkel will be fortunate to keep debt-adverse Germany from falling deeper into the red this year.
Last week, the parliament passed a $28 billion contribution to the E.U. bailout fund for Greece. This was widely seen as a victory for Merkel, who pushed hard for the unpopular contribution in past weeks.
On Sunday, however, voters rewarded Merkel by voting her Christian Democratic-Free Democratic coalition out of power in North Rhine-Westphalia, Germany’s struggling industrial region and most populous state. Voters there cited economic hardships, the unpopular Greek bailout and displeasure with Merkel’s perceived inaction on a host of regional, national and international issues as the reasons for her coalition’s ouster.
The election leaves German politics and Merkel’s agenda in disarray just six months after the chancellor was sworn in for a second term.
The liberal Social Democratic (SPD) and Green parties are now in position to demand a greater role in the policy-making process in the Bundesrat, Germany’s upper house of parliament. A whole host of options for possible coalitions now exist, none of which will allow Merkel to move forward with planned economic reforms.
“The SPD is back!" Social Democrat candidate Hannelore Kraft declared as the results came in late Sunday, while Christian Democratic Union party General Secretary Hermann Gröhe conceded that the results were “extremely painful.”
Merkel is well known for her measured, even-handed approach to governing and diplomacy. As Germany’s first East German and female chancellor, Merkel broke down barriers without flash but with pragmatism and sensible policy positions. This combination made her wildly popular with the German public.
But some analysts say her pragmatic style betrayed her in this instance. When the Greek crisis began, Merkel baffled critics and allies alike when she refused to agree to a bailout, despite the consensus that one was needed. It was not until a massive rescue package became inevitable did Merkel shift her stance and champion it, making her seem less like the leader of Europe’s largest economy and more like a reactionary leader struggling to maintain power. Exit polls show that voters in North Rhine Westphalia were dissatisfied with Merkel’s refusal to act decisively once the extent of the crisis became known earlier this year, as well as her eventual acquiescence to the unpopular bailout plan.
Merkel’s CDU-FDP coalition can now be named the first political casualty caused by the E.U.’s cumbersome and slow response to the Greek crisis.
“She looks on the one hand late and the other hand weak-kneed,” Mitchell Orenstein, a professor of European Studies at Johns Hopkins University School of Advanced International Studies in Washington, D.C., told The Fiscal Times. “She never looked like she was leading… Had she come out sooner and gotten control of the situation, there might have been a better result. That never happened.”
Loss hurts immediately
The effect of the loss was felt immediately in Berlin on Monday, when Merkel announced that she would not pursue previously announced tax cuts.
"In my view, tax relief can't be implemented in the foreseeable future,” she said, adding that the tax measures would not come before 2012, if ever.
Merkel also conceded that her efforts at financial regulation reform had fallen flat. The chancellor had called for international coordination to deal with speculators, as well as increased supervision of international markets.
“Certainly, the many gaps that remain in financial regulation and speculation against the euro are issues about which the public continues to ask, 'What sway can politics have?'" she said. "I am determined that we will implement [financial reforms], but one has to say honestly that it hasn't happened yet. So, we in the federal government also have an essential assignment to fulfill.”
It will now also be difficult for Merkel to pass social service spending cuts in order to cut Germany’s debt, which last year was 3.3 percent of annual gross domestic product. Despite a constitutional mandate to balance the budget in the coming years, the Social Democratic and Green parties have been calling for increases in social service benefits to sustain Germans who are struggling financially because of the financial crisis.
Euro rebounds, but concerns remain
Merkel’s concession comes as the bailout for Greece and a euro stabilization fund to stop the assault on the E.U.’s currency calmed world markets and prompted a major stock rebound. After a week of volatility and steep losses world markets rallied today, as the value of the euro increased.
However, it remains to be seen if the formation of the euro stabilization fund is enough to calm fears about Greece and the E.U.’s debt contagion. In the past, markets have calmed after E.U. action, only for additional doubts to emerge followed by additional losses in countries like Spain and Portugal.