To get a sense of how the eurozone is handling its latest economic crisis, look no further than this key question: How is Germany handling the crisis? The nation has emerged as the strongest leader in the region, and its enormous economic clout is putting Germany in the incredibly influential position of deciding how the currency union will clamber out of the current situation. 

The eurozone’s largest economy, Germany can essentially “make or break”the euro, especially now at this critical juncture of the crisis. Though Germany isn’t the only European country doing well economically, it’s the biggest one in the eurozone. And that heft is putting Germany in the role as “rule-maker — providing order and discipline,” notes Wharton finance professor Bulent Gultekin.

It’s a no-nonsense approach that has rattled some countries, especially southern European nations that are struggling under the weight of numerous burdens, including austerity programs championed by Germany. Many are questioning whether Germany’s severity will lead the eurozone to a confident economic recovery —or leave it cracked beyond repair.

‘Germany Has the Checkbook’

Currently, Germany is the fourth-largest economy in the world and the strongest in the 19-member euro bloc, not only in terms of its growth rate, but also its size. “Germany has the power now because it has its own house in order. Austria, Denmark and the Netherlands are doing well, but they certainly don’t have the size,” says Mauro Guillén, Wharton management professor and director of The Lauder Institute. “Germany has the checkbook.” 

Germany, by most measures, is successful. The country is experiencing slower economic growth than the U.S. and the U.K., but is still expanding. The Germans regard themselves as a model for the rest of the eurozone, and leadership there wants to apply that same model of fiscal rectitude to the other countries, predicting that economic success will follow, adds Franklin Allen, Wharton finance professor.

“I think there’s no question that austerity eventually works, like in 10 years. Meanwhile, you have lots of hardship and high unemployment.”–Mauro Guillen

Germany “believes austerity is the solution,” Guillén says. “I think there’s no question that austerity eventually works, like in 10 years. Meanwhile, you have lots of hardship and high unemployment.” 

According to Wharton finance professor Joao Gomes, Germany thinks the struggling economies need to shape up with structural reform and strict budget cuts. “Germany wouldn’t call it austerity; they call it reforms,” Gomes notes. “They want to focus [household spending on] what really matters and cut out the extraneous stuff. If people want to spend on things they can’t really afford, that’s not a growth model.”

While many economists support the Keynesian view that public sector investment can shore up the economy when the private sector is shrinking during a downturn, German Chancellor Angela Merkel has been leading the country with the belief that the government has a very limited role, and markets can operate freely in a social market economy. “They have a particular view of the world, and they want to impose that on other countries, in effect,” says Allen, who is also a professor at Imperial College in London and head of its Brevan Howard Centre

When the International Monetary Fund first helped Greece in 2010, that support was presented as a bailout. But IMF executive director Paulo Batista told Greek Alpha TV in an interview that the “IMF gave money to save German and French banks, not Greece. In reality, it was more of a bailout of the private creditors for Greece. It required a lot of sacrifice from Greece and not enough sacrifices from Greece’s creditors. And I think this needs to change going forward.” 

“I have considerable sympathy for the Greeks, but I don’t think that you can blame their plight on the Germans,” says Richard Herring, Wharton finance professor and co-director of the Wharton Financial Institutions Center. “Their problem was years in the making, and it is largely attributable to their poor economic policy-making since they joined the euro. The current problem is that given the constraints of being a member of the euro system, they simply don’t have powerful enough tools to mitigate the painful cuts in aggregate demand. As members of the eurozone, they cannot change their exchange rate and have no control over monetary policy. That means they must rely on tightening fiscal policy or default,” he notes.

More than a decade ago, Germany was in the fiscal dumps with a deep recession. “Germany realized that it needed a long-term plan about how the country was going to grow when it went through reunification and went through serious questions about who it is and how it is going to compete in the next 10 to 15 years,” Gomes says. “Germany went through major reforms to increase productivity and manufacture goods the rest of the world wants.” 

Part of that plan involved keeping wages low for German workers. “Germany has indeed raised wages over the last three to four years, but it’s not enough,” says Guillén. From the time of the euro introduction in 1999 to 2008, Germany’s unit labor cost grew much slower than the eurozone average, according to John Ryan, research associate at the University of Cambridge, in an article in Policy Review. The wage restraint policy has also driven domestic consumption down.

Guillén points out that wage increases in surplus economies, like Germany, Denmark and The Netherlands, would help buy more goods from more troubled nations, including Greece, Italy, Portugal and Spain. “Even German consumers could do more to put skin in the game,”he says.

Consumer spending is starting to rise in Germany, which has almost been a cultural change for the country. Typically, German households save 9.2% of their income, one of the highest rates in the world. “Germans are very frugal and save a lot of money,” notes Guillén. However, with falling oil prices, wage hikes, minimal inflation and low interest rates on savings, the new-found, if modest, rise in German consumer spending could help fuel growth in neighboring countries.

“Finding different ways to promote growth in the long term that don’t require as much austerity”is the way to go, says Gomes. Adds Allen: “The best way to get rid of debt is not to pay it back, but to grow.”

“Germany wouldn’t call it austerity; they call it reforms.”–Joao Gomes

An Economic Stalwart 

While many eurozone countries are struggling with growth, Germany is posting more optimistic figures. After Germany (along with France) flirted with a triple-dip recession in the third quarter of 2014, recent OECD numbers showed the nation’s GDP growth rose to 0.7% in the last quarter, compared with the same quarter last year. Germany’s so-far modest recovery could bode well for the rest of the eurozone since it contributes to nearly one-quarter of the eurozone’s GDP. 

In addition, Germany has the largest export trade surplus in Europe.People want to buy German goods, known for their high quality and reliability. “Germany generates 65% of the trade in Europe…. German companies need the rest of Europe to do well,” Guillén notes.

For the first time since 1969, Germany has reached a balanced budget, ahead of the schedule German finance minister Wolfgang Schäuble had targeted. The Germans also have the largest current-account surplus in the world, meaning they have an excess of savings over investment. Meanwhile, Greece is facing an insurmountable debt burden that many believe will be impossible to pay back. 

Moreover, Germany’s unemployment level is one of the lowest in Europe, and has reached its lowest level since reunification in 1990, according to Reuters. The latest OECD figures for 2015 show the German unemployment rate at 4.7% compared to the eurozone average of 11.2%. Meanwhile, Greece is struggling with 26% unemployment. 

In terms of youth unemployment, Germany has a level of 7.1%, while more than 50% of Greece’s young population is unemployed. Large-scale youth unemployment been identified as one of the biggest worries plaguing Greece and other troubled eurozone economies, not only for financial reasons, but for its social and political implications as well. Gomes notes that for a long-term growth plan, a country needs young people to contribute to its future. In addition, governments don’t want talented, early career professionals to emigrate for better opportunities. Also, political malcontent, particularly among the young, can spark the embers for extremist groups, which is happening everywhere in Europe.

Given its economic weight, Germany is also the biggest creditor in the currency union and currently contributes 190 million euros, more than any other eurozone country, to the European Stability Mechanism, which essentially finances the bailouts of other nations. Because Germany is throwing in the largest stake in the ante, it also exerts hefty influence on how other countries are going to pay back their loans. “It’s playing a big role in the Greek crisis,” Allen says. “If things go wrong, Germany will be hit with a big portion of the bill. Whatever happens with defaults, Germany will be a big donor.”

“Despite all the rhetoric, [the Germans] have been quite generous,” Herring adds. “They are indirectly supporting the Greek banking system currently, and they are accepting substantial reductions in the present value of their claims, both direct and indirect, on Greece. But there is only so much that can be accomplished by extending maturities, extending grace periods and reducing interest rates.”

According to Gomes, the easiest thing for creditor countries like Germany to do, if they operated in a vacuum, would be to give aid to the troubled countries and forgive the debt. Notes Herring: “This will not be easy, however, because it is by no means clear that a special deal can be arranged for the Greeks that is not also extended to the Portuguese, the Spanish and the Irish, who have all, with enormous pain, made more progress in adjusting their economies than the Greeks.” 

But “at the end of the day, governments need to make things more palatable to their citizens,” Gomes adds. “The German government couldn’t convince their citizens to do that. Economically, [debt forgiveness] makes sense, but politically, it’s very hard.” 

‘Extend and Pretend’

However, there is a bit of an “extend-and-pretend”policy going on regarding certain sovereign debt, such as Greece’s, says Allen. No politician wants to admit that those who are owed money are not getting it back. “They keep pushing the payback into the future,” he adds. “They lower interest rates as low as they can go. Everybody says they’ll pay it back 20 to 30 years from now. But by then, they’ll say, ‘Let’s write it off.’”

“If things go wrong, Germany will be hit with a big portion of the bill. Whatever happens with defaults, Germany will be a big donor.”–Franklin Allen

With the beginning of a quantitative easing program, the crisis in Europe should improve in the short term, according to Guillén.“It’s important to note the European Central Bank is the central bank of central banks. That’s the euro system. The bond purchases won’t be on the balance sheets of the ECB, but on the balance sheets of national banks. That was a compromise to keep the Germans happy. In theory, each country is responsible for its own debt. In practice, every debt will be backed up by the Germans.”

In the near term, expect more flexibility in postponing debt repayment and that the Greek banks will lend more to Greek firms and households, says Gomes. This should help create jobs as well, adds Guillén. What remains to be seen, however, is how quantitative easing in Europe will pan out in the longer run. “In the U.S., it took five years for things to work out after the Federal Reserve began quantitative easing,” Guillén points out. 

As the eurozone’s new monetary policies work to stimulate the economy, they also aim to quell any rumors of a eurozone breakdown. In a Pew poll, more than 60% of Germans wanted to keep the eurozone intact, a higher percentage than in other countries.Not surprisingly, Germany has benefitted massively from having a euro shared between its most important trading partners — other European countries. “If there was no euro, they would have a very high Deutsche Mark and they would have to expand domestically and import more goods,” notes Gultekin. 

According to Guillén, if one country leaves the euro, like Greece, not only will it set a precedent that it’s OK to leave the eurozone, it will also imply that the euro is a temporary scheme and countries can be in it when it suits them. If one country decides to leave the euro, it can cut down the credibility of the entire system.

“The real problem is that the euro area is not a coherent economy yet. Although they have succeeded in controlling monetary and exchange rate policy from the center, they have not been willing to cede the additional sovereignty necessary to centralize fiscal policies. The issue for the euro system is whether member states are willing to move forward with economic integration. If they are not, the grand experiment is unlikely to continue,” notes Herring. 

Without a doubt, it’s in Germany’s best interests to keep the eurozone together, in Gultekin’s view. “You’re always better off when everyone is prospering all around you, and Germany has to be more concerned because Russia is in its backyard,” he says. Germany has had closer links to Russia than any other Western economy, so Merkel needs to foster other channels for Germany’s growth.

Smooth Sailing Ahead?

Within the eurozone, Germany’s economic growth is following a divergent route from many of its brethren. While Germany is playing taskmaster, some European countries, suffering from high unemployment and other woes, are not keen to follow the path of austerity as stringently as Germany would like. 

However, some policies are coming together for those countries that need help, especially with the start of quantitative easing. “If the euro is to be preserved, then Germany will be taking the responsibility. That’s a subtle, small detail. The big picture is that Germany is bankrolling everything,” says Guillén. 

“Hopefully, things will improve in 2015,” Gomes adds. “Most of the difficult steps have been taken. Making the path to recovery more palatable will provide a way for folks to see a light at the end of the tunnel.”

Still, much will depend on whether the early signs of an economic turnaround in Germany pick up steam and how much of any new-found growth can be translated into imports from struggling southern European countries. In the meantime, the region continues to battle slow economic growth overall, and the threat that deflation could drag things back down if quantitative easing succeeds in inflating asset prices but does not contribute much to growth in the real economy.