Will German State-level Politics be Felt Throughout the Euro-zone?

By: Victoria_Marklew

An upset in the regional election in one of Germany's 16 states could be expected to generate reams of newsprint in the local press, but wouldn't normally have implications for the continent's energy sector or for EU-level plans to support the financial sector. However, we live in unusual times and the surge in support for the Green party in Baden-Wuerttenberg will have consequences far beyond the borders of Germany's third-largest state.

It appears that the Green Party surged to about 25% of the vote in Baden-Wuerttenberg, more than doubling its share in the last vote in 2006, and leaving it well placed to head a coalition with the Social Democrats (SDP), who took around 23%. The Christian Democrat (CDU) party of German Chancellor Angela Merkel did still win the largest share of the votes at 39%, down from 44%, but the national coalition ally FDP barely managed to pass the 5% threshold needed to claim seats. At a combined 44% the center-right came in behind a Green-SDP alliance. Claiming over a third of the votes in a state of 11 million may not seem all that bad, but for the CDU the result is being seen as a rout.

The loss occurred in one of the country's most prosperous states, the heart of the Mittelstand - the medium-sized, export-oriented industrial companies that have underpinned Germany's economic success in recent years - and a state that has been dominated by the CDU for 58 years. In contrast, the Green Party is clearly on the ascendant. The Greens had performed well in the regional election in Saxony-Anhalt earlier this month and are also heading for an alliance with the SDP in Rhineland-Palatinate (both states where the FDP failed to pass the 5% threshold). Now, they anticipate heading a German state government for the first time.

Politically, Merkel is unlikely to be brought down by the result - there is no viable alternative leader waiting in the wings of the CDU, and the partner FDP has been so weakened in Baden-Wuerttenberg and elsewhere that it will be in no hurry to bring down the national coalition. The state's outgoing CDU premier tried to point out that environmentalists had already been mobilized by public opposition to the giant Stuttgart 21 railway project in the state capital, and that the vote was not necessarily a referendum on the national party. However, it adds to the perception of a weakened national government in disarray. Merkel had already lost her majority in the Bundesrat or upper house, where the 16 states are represented, and gains for the opposition will make it that much harder to pass any controversial legislation.

The result will have an impact on Germany's energy sector. Back in 2001 the then-SDP-led national government had passed legislation to start winding down the nation's nuclear power program from 2022. Last fall, Merkel's government extended the life of the nation's seventeen reactors by another 12 years. Then, in the wake of Japan's nuclear crisis, the Chancellor abruptly declared a three-month moratorium on that extension, the immediate closure of the seven oldest reactors, and an urgent review of the entire program. However, the move did not win her any political points but was instead seen as evidence of a national government driven more by opinion polls than by clear policy priorities. European energy prices jumped today as analysts warned that the victory of anti-nuclear sentiment in Baden-Wuerttenberg - home to two of the oldest reactors - may mean permanent closure of the seven plants and probably jeopardizes any extension of the life of the other plants past 2022.

Having received a body-blow in Baden-Wuerttenberg, Merkel will be unlikely to take risks over the ongoing Euro-zone negotiations over how to beef up the European Financial Stability Facility (EFSF). A much-touted summit late last week was supposed to confirm that the EFSF's lending power would be increased by expanding the national guarantees given by AAA-rated countries to back the Facility. It was also supposed to firm up the details on the permanent European Stability Mechanism (ESM) that will replace the EFSF from 2013. These decisions were effectively scuppered by Finland's electoral calendar. A general election is due in that country on April 17. With the Finnish parliament now dissolved, any decision on increasing the EFSF's lending capacity can only be taken by the next legislature. As a result, the EU's leaders had to delay final approval on how to increase the EFSF's lending power to the end of June. The picture is further complicated by the fact that the populist True Finns party, which opposes increasing the national guarantee and is demanding that the whole program be re-negotiated, has been enjoying a surge in support in recent months and could well hold the balance of power in the next parliament.

Meanwhile, Merkel had already insisted that the timetable for paying into the ESM be extended over a period of five years, rather than making bigger payments in a shorter time period - likely a way to give her government more fiscal room to potentially cut taxes before the federal elections scheduled for 2013. With the government now further weakened, Merkel will be even less inclined to take any EU-level decisions that could generate negative headlines in the national press. Once again, grand EU designs could be undone by national political considerations.

By Victoria Marklew
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Victoria Marklew is Vice President and International Economist at The Northern Trust Company, Chicago. She joined the Bank in 1991, and works in the Economic Research Department, where she assesses country lending and investment risk, focusing in particular on Asia. Ms. Marklew has a B.A. degree from the University of London, an M.Sc. from the London School of Economics, and a Ph.D. in Political Economy from the University of Pennsylvania. She is the author of Cash, Crisis, and Corporate Governance: The Role of National Financial Systems in Industrial Restructuring (University of Michigan Press, 1995).

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

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