An Economic Government for the Euro Zone?: Merkel's Plan Could Transform the European Union

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It is primarily the answer to the last question that remains totally unclear. Sources in the German government argue that EU leaders would adhere to the agreed objectives to avoid losing face in front of their colleagues. The experts say that peer pressure would ensure that the pact is a success.

That, to put it bluntly, is wishful thinking. If push comes to shove, national leaders would rather keep their own voters happy than gratify their colleagues in Europe. On the domestic front, it won't be easy to push through the proposals included in the pact.

Even getting EU member states to mutually recognize each others' professional qualifications within the stated timeframe of 12 months would be a significant challenge. But the goal of raising the retirement age within the same period appears totally unrealistic. The heated debates on raising the retirement age in Germany and other countries demonstrated that such a move is hardly possible without political turmoil.

Overly Broad Targets

Things don't look any better on other fronts. Merkel's plan to prevent tax dumping is aimed at countries like Ireland, where the corporate tax rate is a mere 12.5 percent. The question is where legitimate tax competition ends and dumping begins.

According to sources in the German government, these difficulties mean that, on most of the issues involved, no concrete targets will be agreed upon. Instead, there will be a target range for countries to aim at. Since all countries have to agree on these goals, there is a danger that these target ranges will be extremely broad, which would render them virtually ineffective. There are already proposals for how to proceed should the euro-zone countries be unable to agree on common standards. In this case, according to French Finance Minister Christine Lagarde, there would have to be an arbitration process within the euro zone.

Merkel's plan totally fails to address another problem: There is no strategy for how to bolster Europe's shaky banks. Yet it is precisely in this area that the European Commission feels that member states have a responsibility to act. "Wherever necessary, the member states will have to recapitalize, restructure or liquidate banks," reads a strategy paper.

Nevertheless, the chancellor has a good chance of pushing through her plan in Brussels. After all, she has a bargaining chip. Germany will only agree to additional guarantees for the euro rescue fund -- as the Commission and other parties have called for -- if its partners approve its competitiveness pact. The Chancellery estimates that 23 EU countries will go along with it. Denmark and Sweden are said to be on the fence, while the UK and the Czech Republic are reportedly reluctant.

Resistance in Berlin

There may actually be greater resistance to the plan in Berlin than in Brussels. Merkel, who heads the conservative Christian Democratic Union (CDU), still has to win support for her proposals from her coalition partner, the pro-business Free Democratic Party (FDP). Last Wednesday, the chancellor discussed the plan with Finance Minister Wolfgang Schäuble (CDU), Vice Chancellor Guido Westerwelle (FDP) and Economy Minister Rainer Brüderle (FDP). The two FDP politicians appeared reserved.

In principle, they have nothing against closer cooperation within the euro zone, but the campaign against tax dumping is problematic for the FDP. After all, they have been singing the praises of low corporate taxes for years. It certainly wouldn't be easy for Westerwelle to explain to his already disappointed supporters that he now intends to oppose low tax rates for companies. As it is, there is already growing euroskepticism within the FDP's parliamentary group. The week before last, FDP parliamentarians agreed to take a tough stance on the euro rescue fund. The liberals are not prepared to approve further amendments to the fund.

The issue of economic government is just as unpopular. "The FDP doesn't want an economic government, and it won't approve it in the Bundestag," says the party's spokesman on financial issues in the German parliament, Frank Schäffler. "It would not be acceptable for us to be liable (for other countries) and yet have no influence on (those countries') spending," says Volker Wissing, an FDP politician who is the chairman of the Bundestag's finance committee.

Since a deep sense of euroskepticism is shared by many people in the FDP, Merkel is primarily pinning her hopes on there being other opinions within the ranks of the liberals, for example, among FDP representatives in the European Parliament. An internal paper reads that the euro requires "greater harmonization and coordination of national economic and financial policies."

FDP euroskeptics are also under pressure because German industry supports the Merkel plan. "There is no question that we need closer cooperation in the economic sector," says Deutsche Bank CEO Josef Ackermann. "Everything that leads to better coordination makes sense," says Paul Achleitner, who is chief financial officer at the insurance giant Allianz, while Nikolaus von Bomhard, CEO of leading reinsurance company Munich Re, argues that one shouldn't allow oneself to be deterred by "shock words" like economic government.

Power Struggle with France

It remains to be seen, however, whether the competitiveness pact will actually lead to better coordination. It is also very possible that the Germans are about to enter into a prolonged conflict with France. Merkel's plan touches on more than just the economic health of the euro-zone countries. It also concerns the issue of how power is divided between Paris and Berlin.

On a number of occasions, Sarkozy has already tried to create structures within the EU that increase France's political weight. For instance, two-and-a-half years ago he campaigned to establish a "Mediterranean Union" -- an organization with its own institutions, where France would have assumed the leading role. The plan was thwarted thanks to Merkel's veto.

To foil France's ambitions, Merkel long opposed a special role for the euro zone within the broader European Union. But since the onset of the financial crisis, Germany's resistance has been crumbling. At first, Berlin was generally opposed to special summits for the euro-zone countries. Later, the German government agreed to meetings of national leaders in the event of particularly sensitive issues.

Now such summits will be held on a regular basis. Just how often this will occur is something that Merkel and Sarkozy will have to agree to over the coming months. The French president would prefer to have the euro-zone leaders reach agreements ahead of each EU summit. Then the 27 members of the broader EU would, in principle, merely rubber stamp what the 17 euro-zone members had already decided.

Getting a Bigger Say

That would appeal to Sarkozy, as France would have more influence within this small group. EU member states like Poland, the UK and Sweden, which are more closely aligned with Germany on important economic and financial policy questions, would be excluded, as they don't have the euro.

Working within the smaller group would also make it easier for the French to address issues where their views have differed from the Germans for many years, for example, on topics such as trade and industrial policy.

But these are issues that actually concern every member of the EU. Indeed, Merkel has been pushing for every EU member to be allowed to attend the euro summits. She also wants to prevent these events from being held too often. Ideally, she would like the euro meetings to take place after the regular EU summits. Then the euro-zone countries could not make any pre-arrangements that would affect the entire Union.

The European Commission also has its objections. Although the Eurocrats in Brussels are pleased with Merkel's promise to allow them to oversee the decisions of the Eurogroup, they are afraid that they could lose influence over economic policy in the future voting process. "The Commission has the best expertise to guarantee economic and fiscal surveillance," says Marco Buti, the European Commission's director-general for economic and financial affairs. "Moving it to an inter-governmental level would be a mistake."

'We Will Defend the Euro'

But Merkel is not about to let such objections put the brakes on her plan. At the World Economic Forum in Davos last Friday, she made a plug for her plan in front of top business and political leaders from around the world. In order to protect the euro, new approaches must be adopted, she said. Merkel added that nothing less than Europe's position in the world is at stake.

The often hesitant chancellor appeared highly determined. She said the euro was "the embodiment of Europe today." Then she even allowed herself an uncharacteristic touch of pathos. "We will defend the euro," she said. "There can be no doubt about it."

PETER MÜLLER, RALF NEUKIRCH, CHRISTIAN REIERMANN, MICHAEL SAUGA, CHRISTOPH SCHULT, ANNE SEITH

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• Part 1: Merkel's Plan Could Transform the European Union
• Part 2: Plan to Be Presented to EU Leaders This Week
• Part 3: Wishful Thinking