By STEVEN ERLANGER
BERLIN — Faced with financial turmoil that has resisted every emergency fix the European Union has adopted, European leaders are considering a radical step: giving up some of their independence to set domestic economic policies and cutting back many of the wage and welfare benefits that have defined the region’s politics for decades. In return, the European Union would provide funds to shore up the weakest member states, including Portugal, Greece and Spain.
The proposals, originally pressed by the newly assertive German chancellor, will be debated Friday in what is expected to be a contentious session of the leaders of the 17 countries that use the euro.
Germany is calling for several measures: raising retirement ages to reduce the burden on pension funds, ending the linking of wages to increases in the cost of living, committing to debt reduction and submitting to a level of budget scrutiny that was until recently considered anathema — and is still viewed by many as a step too far.
The meeting is made more urgent by a continuing financial crisis that, despite occasional lulls, has kept markets on edge for months. On Thursday, Moody’s Investors Service downgraded the Spanish government’s debt, sending stock prices sharply down in Europe and contributing to a selloff in the United States as well. More analysts are suggesting that Portugal will need a bailout and that Greece’s debt will need to be restructured, despite earlier rescue packages that were intended to make such steps unnecessary.
If the euro is to be saved and a solution found for the divisions in the euro zone, Germany must agree to act as the region’s lender of last resort. And for that, Chancellor Angela Merkel, with political problems even within her own governing coalition, has a steep price. She has moved into a visible position of European leadership, trying to frame the debate in German terms and impose her will on her neighbors.
But a comprehensive deal will be difficult to reach. The proposals under debate now have already been watered down from a more robust program of integration and monitoring first put forward by Germany, and will be subject to further negotiation before a full European Union summit meeting on March 24-25, two days before an important German state election.
“There’s a common understanding that we need to help Merkel get something that looks like a victory,” said a senior European Union official, who, like other officials interviewed, was not authorized to comment by name. “And for the markets, we need to end March with a comprehensive approach.”
For Mrs. Merkel, the answer is a permanent bailout fund for euro-zone governments in trouble now and in the future. The debts of the most indebted nations, like Greece and Ireland, will be covered, with room, if necessary, for Portugal and Spain.
But in return for this “solidarity,” the Germans say they want “solidity” on limiting benefits and accepting monitoring. Among the measures it is pressing is an agreement to raise retirement ages closer to Germany’s, where access to government pensions begins at age 67, well above the European average. Germany would also like others to stop pegging wage increases automatically to inflation. That is a necessary step if wages are to shrink in absolute terms, which some economists argue is necessary if bitter medicine to inject some competitiveness into the economies of Europe’s southern tier.
The Germans would also force private bondholders who bought the high-yielding debt of the most troubled euro-zone countries to bear part of the burden if countries defaulted or needed to restructure their debt — and not be protected by taxpayers.
Since November, the Germans have been in nonstop talks with officials in Brussels and with the French, with whom they have an extraordinarily close relationship. They have been working on at least three levels for a comprehensive package.
The most important is a “permanent regime” — the so-called European Stability Mechanism, which will replace the temporary bailout fund called the European Financial Stability Facility, set up during the Greek crisis last May. That fund ends in June 2013, and the Germans want a permanent fund of perhaps 500 billion euros ($695 billion) to show the markets that the euro zone is prepared for future problems.
But that fund must also show Germans that private investors will not be bailed out by taxpayers, that no country will assume the debts of another and that there will be collateral offered and penalties for bad behavior.
The governments are also in heated discussions about whether and how to strengthen and extend the existing temporary fund of 440 billion euros ($612 billion), intended to help Greece and Ireland, to allow it to lend the entire amount, which could then cover Portugal and Spain. But Berlin does not want the fund to be used to buy back Greek or Irish bonds.
The issue that has gotten the most attention is the German-French Pact for Competitiveness, a name chosen for German ears. The intention was to lay down specific commitments to coordinate euro-zone economies — a common basis for corporate taxes for instance, or a common age for retirement — intended to unify policies across the region while raising tax revenue and reducing spending. Wage indexation was to be banned and high deficits punished.
But when the pact was first broached at the European level last month, there was anger from other leaders, who had not been consulted. While the pact might help in the future, it would do nothing to solve the current problems of Greece, Ireland and Portugal. Nor, critics argue, does it deal with a looming problem for Germany and the euro zone — huge private debt and shaky banks, including some German state banks. Berlin has resisted serious stress tests of its banks.
Still, on Friday, euro-zone leaders are expected to approve a watered-down version of the pact, negotiated by the European Council president, Herman Van Rompuy, that eliminates fixed pension ages and wage indexation and gives states more latitude to reach objectives, with monitoring of compliance left unclear. The main fight is about whether to align corporate tax systems, and if so, how to do so.
But German officials contend that commitments remaining in the pact are important, that retirement ages and benefit systems should be adjusted to fiscal and demographic realities and that each country must find a way to make debt limits binding, as Berlin has done.
Mrs. Merkel is insisting that all three levels represent a package, and that there will be no increase even in the temporary bailout fund unless there is a deal on the pact.
A senior French official said: “The Germans have moved far in the last months from their initial position, but they knew they had our support. The face-saving aspect is very important for Germany. A lot of countries are infuriated with Berlin but can’t say so, because they need Germany, so in a way they’re hostages and have to go along.”
But it will still be a difficult case for Mrs. Merkel to sell domestically. By the end of the month, another senior European Union official said, “Merkel will have to swallow” an increase in the temporary fund to allow it to lend fully; a non-German as head of the European Central Bank, probably an Italian, Mario Draghi; and a two-sentence change in the Lisbon Treaty that will not produce the binding criteria and penalties Berlin wanted to reinforce fiscal discipline.
The euro crisis will not be over, said Henrik Enderlein, a political economist at the Hertie School of Governance in Berlin. “The result will be a watered-down package that won’t change a lot and won’t end the crisis,” he said.
Jean Pisani-Ferry, the director of Bruegel, a Brussels-based economic research institution, said the steps under discussion now were necessary, but were likely to prove insufficient. There still must be an intense effort to create competitiveness in the euro zone, to help the lagging nations of southern Europe liberalize their economies and labor markets, to bring down manufacturing costs and to produce growth.
“Even if we do all the right things, how fast will southern Europe catch up?” Mr. Pisani-Ferry asked. “Because it must. If not, these countries will find themselves in permanent unemployment and not growing, and then you will need real transfers to keep the euro zone together.”
The US Federal Reserve's insouciant claims on inflation risks are not backed by the latest producer prices. They do unpleasantly recall Rudolf von Havenstein, the great money-printer of the Weimar Republic, who increasingly appears a possible role model for Fed chairman Ben Bernanke. - Martin Hutchinson