How Poland and Germany Can Close Ranks

Germany finally has a coalition government. With the recent shake-up of the Polish cabinet, the two neighboring nations have an opening to mend fences and “reset” the relationship.

The normally tight bond between Germany and Poland loosened last year when the Polish government announced that it was considering filing for damages sustained in World War II and asking Germany to foot the bill.

Instead of pursuing the case, Polish leaders should quietly “forget” about it and shift gears instead. Their focus ought to be Europe, where Germany and France are about to embark on reforms to strengthen the EU. Poland would be wise to secure a seat at the table.

The demand for German reparations is not only futile. It needlessly distracts attention from issues vital to Poland’s real concerns in Europe. Aside from the United States, Germany is Poland’s most consequential partner. Much is at stake if the ties were to loosen further, from hard-won reconciliation between peoples, European budget reforms, defense cooperation or economic bonds.

The new German cabinet is likely to team up with France’s Emmanuel Macron soon in a push to strengthen the euro area governance. Poland should send strong signals that it supports the effort.

Staying on the outside would not only marginalize Poland further from “core” Europe. It would run counter to the country’s long-term economic interests. In fact, Poland can take small pragmatic steps that bring the country closer to the euro area without committing to euro adoption. Berlin would applaud the effort and might even forget about the reparations fuss.

Poland and the Banking Union

One practical measure Poland could take is open the way for joining the European Banking Union (EBU). Only euro area member states are currently involved in building a banking union, but others may enter into “close cooperation agreements” with the European Central Bank (ECB).

Under a banking union, the ECB would directly supervise some Polish banks. Domestic supervisory authorities would share financial information with the ECB for the purpose of periodic assessments (e.g., “stress tests”).

Foreign banks (predominantly European) already control most financial assets in Poland. With the SSM and SRM mechanisms in place, Polish banks would be in a better position to withstand possible financial stress. The banking union aligns domestic governance with the pan-European one. European banks run their Polish operations through local subsidiaries that are fully capitalized according to Polish law.

Polish taxpayers would be better off if they leveraged banking union resources for supervision, resolution and indemnification of deposits in the event of a crisis. Incidentally, Poland might not be the only non-euro area member to consider joining the banking union. Denmark and Sweden, whose banking sectors remain less international than Poland’s, are studying the issue with a view to joining.

This is not an argument in favor of Poland joining the euro area. Yet, a stable euro area is critical to the Polish economy. About two-thirds of Polish exports go to euro area countries, which in turn account for more than two-thirds of inbound foreign direct investment in Poland.

If the euro area were to buckle in a new crisis, let alone collapse, Poland might not be as lucky as in 2009-2012 when it was the only major European economy to escape a recession.

A stronger financial sector in the euro area and in Poland creates a more resilient economy, which in turn minimizes risks of financial crises. A healthy euro area is in Poland’s interest – even when joining the common currency is not desirable or feasible in the near term.

Supporting practical reforms

Another area where Germany and Poland might see eye-to-eye are practical reforms to stabilize the euro area. The euro area is not likely to federalize public finances any time soon. Absent a federal treasury with full powers to tax and spend, the functioning of the euro area must be repaired (if repaired it can be) well before full political integration takes place.

German policymakers are likely to press for full application of Article 125 of the Lisbon Treaty, which prohibits states from being bailed out. This is sound economics (and politics) that should appeal to Polish sensitivities.

Fiscal policy coordination has failed miserably. The “six-pack”, “two-pack” and other amended rules of the Stability and Growth Pact turned out to be toothless. If member states want to control taxing and spending as prerogatives of their national sovereignty, then they should be allowed to do so.

On the other hand, no euro area-wide pooled resources would be available for indemnifying recklessness. Poland, which likes to think of itself as of the “north” of Europe, would find a lot to like in such reasoning.

Trust in the ECB

Finally, there is the sensitive area of central bank trust and independence. Here, subtle differences of philosophies exist between Berlin and Warsaw. Germany remains much more adamant about central bank independence than Poland.

The gap is more nuance than substance, however. This is not an area worth spending the political capital on. Where action should be is in turning the ECB into a true central bank. Here, Poland stands a chance of nudging its neighbor to change course in the interest of a better euro area.

The ECB lost some face during the financial crisis. It was rightly perceived as pandering to special or national interests, and it was late to forestall deflationary trends. Despite the mishaps, the central bank retains high dollops of public confidence throughout the EU.

This trust should be leveraged to push for making the ECB a lender of last resort (LOLR) to financial institutions. Currently, national central banks remain LOLR to their domestic banks. Yet, once the BU is operational, the ECB would be in a much better position to safeguard financial health of the EA banking sector.

Poland will not adopt the common currency in the foreseeable future. As such, its banks would not enjoy the benefits of a LOLR provided by the ECB. But it would matter to foreign banks operating their Polish subsidiaries whether their national central banks or the ECB provided the umbrella of a LOLR. It is thus in Poland’s interest to support the ECB becoming the LOLR for the whole of the EA.

Conclusion

In conclusion, joining the banking union would grant Poland the requisite goodwill and moral upper hand to credibly advocate for changes to ECB policy or status. Germany will welcome Poland’s involvement in repairing the EU’s financial architecture if Warsaw puts the money where its mouth is.

Even when notionally in disagreement, the two countries can work together. Poland should abandon old grievances against Germany and embrace its neighbor as a friend and ally.

The German political class will appreciate and welcome Polish advice and may even stomach occasional admonitions. This will be possible once the goodwill is well ensconced and the relationship is free from recriminations.