It happened over dessert at a recent dinner in the European Council building in Brussels. Just before midnight, German Chancellor Angela Merkel did what European leaders have wanted her to do for months: She showed leadership. The chancellor said the euro countries must become more competitive, and argued the European Commission's controls have been insufficient, that "a stronger commitment" is needed. Furthermore, the "social dimension" could not be ignored, she said. Europe needs a "qualitative leap."
In her third term, Merkel -- who is also the head of Germany's center-right Christian Democratic Union (CDU) and will soon rule her country in a coalition with Germany's second-biggest party, the Social Democrats (SPD) -- is determined to become the chancellor of Europe. In the recent German elections, more Germans voted for her party than ever before. The Economist has called her "Europe's dominant politician." Merkel is convinced that she is now favorably positioned to advance the project that she hopes will become her political legacy: the reform of the European Union.
For the time being, the threat of the euro's collapse has been averted and, for the first time in years, the economy in the euro zone is showing new signs of life. But Merkel also knows the crisis could reignite at any time -- from France to Italy, parties skeptical of the euro are gaining ground; reforms are faltering in many debt-ridden countries; banks are hesitant to lend money.
This has prompted the chancellor to prepare a European reform offensive, and she already knows how to achieve her goal. Together with her likely new coalition partners, the SPD, she now intends to tackle more social issues with her European policy. There is talk of programs to address issues ranging from youth unemployment to tax evasion, and of the creation of a separate euro-zone budget to promote growth. In return, Brussels would receive more rights and thus greater control over the fiscal and economic policies of member states. Merkel intends to carry on with her controversial doctrine of demanding reforms in exchange for money, albeit with a Social Democratic -- ie. progressive -- tint.
An Unexpected New Ally
She has already set her sights on who will be her most important ally in this project: European Parliament President Martin Schulz. Schulz who is a member of the SPD, is now carrying out coalition negotiations on European policy with an eye to both SPD interests and his next career move. First, Schulz wants to become the socialists' top candidate in the European elections next May. And if he secures enough votes, he plans to seek the powerful position of European Commission president.
If this happens, Merkel would finally be rid of the current, unpopular Commission President José Manuel Barroso, whom she formerly supported. At the same time, she and Schulz could then jointly initiate reforms aimed at promoting growth and competition.
The reforms are urgently needed. At an early October preparatory meeting for the Brussels summit, Nikolaus Meyer-Landrut, Merkel's European policy advisor, made it clear that things must change in Europe. A representative of the European Central Bank (ECB) presented a series of charts showing a significant decline in the competitiveness of many EU countries in the last seven years. Crisis-ridden countries like Greece, Cyprus and Portugal are among those who have dropped down, whereas, in the same period, Germany advanced from eighth to fourth place, putting it just behind Switzerland, Singapore and Finland.
A total of 131 recommendations for improving economic dynamism were made to the member states of the monetary union last year. But, as ECB Director Jörg Asmussen said at a meeting of top officials from the member states in early June, implementation has been lacking. "Last year, only 10 percent of the European Commission's country-specific recommendations were implemented," Asmussen now says publicly.
The European Commission, on the other hand, is defending the current system. "It works," says EU Monetary Affairs Commissioner Olli Rehn, noting the euro zone has achieved "an unparalleled deepening of economic integration." He adds, "In the last three years, we have made a quantum leap toward more coordination of economic policy."
Cash to Encourage Cooperation
The German government does not agree with the ECB and Asmussen says the lack of implementation shows "the processes of economic policy coordination, which are correct in principle, aren't working properly." Europe needs more coordination and better implementation, Asmussen argues. "It makes little sense to constantly come up with new ways to coordinate economic policy if the existing ones aren't being applied."
Chancellor Merkel now intends to use financial incentives to encourage member states to follow the recommendations. Under a proposal she and French President François Hollande unveiled last May, countries that signed agreements to implement extensive programs would be enticed with fresh money from a new fund.
Officials at the German Finance Ministry are working feverishly on finding ways to ensure the new "solidarity mechanism" could work. The aid payments would be tied to strict conditions while also being "limited and degressive." In other words, payments would decline as the reforms become increasingly successful.
Where Does the Money Come From?
The experts are considering two monetary sources for the new fund. Revenues from a planned tax on financial transactions could be sent to Brussels, and a portion of the EU's own funds could also be diverted.
No decisions have been reached yet on the proposal, or on the amount of money in the new fund. However, Finance Ministry officials are aware such far-reaching resolutions could lead to a separate budget for the euro zone -- a step which, for Merkel, was long a taboo.
That could now change, partly because it will make the SPD more compliant in the upcoming coalition negotiations. Given recent policy papers by the two sides of the negotiations, the new Berlin coalition government's policy will likely involve no euro bonds -- proposed government bonds jointly issued by euro zone nations -- but more money for growth programs and additional powers for Brussels.
Two Secret Friends
And thus Merkel -- affectionately known in her ranks as Mutti (Mommy) -- has chosen European Parliament President Schulz as a new favorite. Openly, the SPD politician claims "Angela Merkel is not by best friend." But when the microphones are switched off, the two politicians speak with one another with great respect.
Schulz meets the chancellor regularly in Berlin, and they exchange text messages, hammering out compromises, most recently over the EU supplementary budget. They are even in general agreement over the path to a stronger monetary and economic union.
Last Wednesday, Schulz met with Finance Minister Wolfgang Schäuble in Berlin. The CDU politician advocated expediting cooperation among the euro countries in economic policy and changing the Lisbon Treaty - an agreement which amended the constitutional treaties of the EU and was implemented in 2009 - to do so. Schäuble wants to give the European Commission more power and appoint a European finance minister with the power to intervene in nation budget decisions. He also favors the establishment of a euro parliament in which representatives from the countries of the monetary union and members of the national parliaments monitor the decisions of the European Commission, making a time-consuming constitutional convention and referendums unnecessary.
An Important Connection
As European Commission president, Schulz would be an important connection for the grand coalition. He is a close friend of SPD Chairman Sigmar Gabriel, but could also benefit Merkel. Next year's European Parliament election will be the first held under the terms of the Lisbon Treaty, meaning its outcome must be taken into account when nominating the Commission president from among the member states' 28 heads of government.
Having assiduously collected allies, the 57-year-old Schulz is a favorite for the position. He expects broad support in the European Parliament and the European Council, well beyond the ranks of the family of social democratic parties. Merkel knows this and, given that Schulz has the confidence of French President François Hollande, hopes he could help restart the stuttering German-French relationship.
Merkel has only one problem: As head of the CDU, she cannot openly support the SPD politician. Although they are future coalition partners, the CDU/CSU and the SPD will still campaign separately in the European elections.
The leaders of the conservative European People's Party met last Thursday to discuss the upcoming European election and many advocated sending their own conservative candidate into the race against Schulz. But Merkel, together with European Council President Herman Van Rompuy, expressed reservations over this approach. She wants to leave the door open to deciding who will be her favorite for the influential Commission post.
It is clear that Merkel will need the help of German Social Democrats to achieve her agenda in Europe. At the EU summit last week, European leaders debated for more than an hour over which economic and social criteria will figure in the planned agreements to foster competition.
But many politicians from the European left are unhappy with the overall direction of the debate. As Austrian Chancellor Werner Faymann put it, "The Austrian parliament will not agree to an oppressive contract, merely because of the prospect of a reward."