External Enablers. The Role of Foreign Demand Upholding Domestic Policy Configurations in Germany and Ireland

Why do some Eurozone countries manage to suppress domestic spending amidst relative political stability while others cannot? This paper establishes the role of external enablers beyond the literature’s usual focus on domestic factors. It analyzes the cases of Germany and Ireland after the Eurozone crisis by using quantitative techniques nested in a most different case comparison framework. It unveils that in the studied period (2010-2018), these countries’ success in suppressing domestic spending was contingent on more demand from China, the United States and the United Kingdom. After the Global Financial Crisis, China rebalanced its economy considerably while the US and UK continued to run deficits. These tectonic shifts in the global distribution of aggregate demand enabled the Eurozone to forgo adjustment towards more accommodative policies. In both cases, suppressed domestic spending functions as a kind of implicit subsidy to export sectors. In Germany, below-productivity wage growth redistributes income from labor (with a larger propensity to consume) to capital owners - but compensates with employment growth. In Ireland, a corporate tax regime shifts income away from the government sector but attracts capital so that the country can function as an export platform for multinational companies. Weak domestic spending would normally undermine purchasing power and lead to unemployment. However, through these channels, external demand washes away domestic economic and political costs of weak spending at home, lending political stability to the model. But on the long run, over-reliance on external demand creates a trade-off: it decreases political conflict at home, but simultaneously increases conflict with trading partners.