The stakes for the European Union have never been higher. In a year when the latest Commission economic forecasts project a 8% decline in GDP as a result of the measures taken to contain the spread of the coronavirus, the question is whether the European Union can provide a response that is macroeconomically significant and builds on the principles of solidarity inherent in the concept of a common citizenship. If it fails to deliver, we can say good-bye to the European Union and prepare to take our chances in an unforgiving geo-political world where the only other leaders are an increasingly authoritarian and self-centred China and an increasingly unpredictable and self-centred America.
The Commission has done its homework. Building on a Franco-German initiative the previous week, it put forward on 27 May 2020 a proposal for a recovery plan instrument and a reinforced Multi-annual Financial Framework (MFF) that is innovative, ambitious, and worthy of support. Although it tries hard to take account of the many sensitivities around budgetary policy in the Union, its success is by no means guaranteed. If it fails, decide now if you want a Chinese or American passport. Europe, as an idea and as an actor, may limp on but it will no longer have global relevance.
The new Commission proposal also has implications for agricultural spending in the EU budget. While the sum proposed has obvious significance for farm beneficiaries, it is important to keep a sense of proportion. Set against the broader issues at stake, what happens to agricultural spending is of second-order importance.
In this blog post, I discuss the Commission’s proposal for the next MFF and the complementary recovery instrument. I leave its agricultural spending proposals to a later post. The latter will be irrelevant unless the whole of the Commission’s ‘grand design’ comes together, which is by no means certain at the time of writing.
Commission emergency response to support jobs and the economy
It is helpful to see the Commission’s recovery proposal in the context of its previous economic interventions to address the fallout from the coronavirus lockdown and those of other economic actors, particularly the European Central Bank.
The Commission’s first response to the COVID-19 pandemic was to propose an increase of €3.0 billion in the 2020 EU budget on 2 April 2020, largely intended to fund the provision of emergency healthcare support. This made available almost all of the remaining money in the 2020 budget to fight the pandemic. These amendments to the EU budget were adopted by Council and Parliament on 14 April 2020 (see here for the Commission’s full infographic on the 2020 budget amendments). The Commission also relaxed the fiscal and state aid frameworks to give Member States room to act. Up to the end of April, state aid amounting to €1.8 trillion has been approved by the Commission.
The EU also redirected EU funds in the 2020 budget to help Member States tackle the COVID-19 crisis. This included two packages, the Coronavirus Response Investment Initiative and the Coronavirus Response Investment Initiative Plus, which mobilised cash reserves and unspent monies in the EU structural funds as well as allowing greater flexibility in the spending of these funds to redirect resources to where they are most needed. This initiative also included limited support for farmers and fishermen (see Commission infographic on the support made available for farmers). I discussed these aid measures for agriculture in this previous post.
Resolute action by the European Central Bank
The impact of these EU budget measures is limited, both because of the relatively small size of the EU budget but also because it is unable to borrow. Instead, the heavy lifting has been done by national governments. Eurozone governments have provided a fiscal stimulus worth around 4% of GDP and provided liquidity support in the form of loan guarantees, deferred tax payments etc. worth a further 20% of eurozone GDP. Also taking account of the working of automatic stabilisers, the aggregate government deficit has surged from 0.6% of GDP in 2019 to 8.5% of GDP in 2020 in both the eurozone and EU. The European Central Bank (ECB) estimates that eurozone governments’ national responses would result in additional funding requirements equal to 10 percent of eurozone gross domestic product, leading to national debt issuance in the range of €1tn to €1.5tn in 2020 alone.
The ECB has been supporting larger national fiscal deficits by helping to keep sovereign bond yields under control. According to the Financial Times, the ECB has already committed to buying more than €1tn of assets this year and to providing banks with about €3tn of ultra-cheap loans while also freeing up more than €120bn of capital for lenders to support the eurozone economy. However, the recent ruling on ECB policy by Germany’s Constitutional Court has raised doubts about the future of ECB monetary policy and further underlines the importance of a fiscal policy response from the European authorities.
The problem is that the fiscal firepower available to Member States differs widely across the bloc. This is underlined by the fact that 52% of the value of the national state aid measures put in place to shelter the economy from the worst impacts of the corona lockdown have been approved for Germany alone which accounts for just one-quarter of EU GDP. Without a common European response the recovery risks further fragmenting the single market and ultimately risking the future of the Union itself.
Eurogroup package
Following a request in the conclusions of the European Council meeting on 26 March 2020, the Eurogroup of Finance Ministers meeting in inclusive format (meaning that all EU27 Finance Ministers took part in the discussions) adopted a report on 9 April 2020 agreeing on several safety net measures worth up to €540 billion, following several failed attempts.
The three safety net measures are intended for workers via a temporary support to mitigate unemployment risks in the emergency (SURE); for businesses via the European Investment Bank (EIB); and for Member States via the European Stability Mechanism (ESM). The hope is that these will all be in place by 1 June, with the latest update given by the Eurogroup President Mário Centeno on 15 May 2020 .
The SURE package was adopted by the Council on 19 May 2020. SURE is a temporary scheme which can provide up to €100 billion of loans under favourable terms to Member States. Member States can request EU financial support to help finance the sudden and severe increases of national public expenditure, as from 1 February 2020, related to national short-time work schemes and similar measures, including for self-employed persons, or to some health-related measures, in particular at the work place in response to the crisis. SURE loans will be backed by the EU budget and guarantees provided by Member States according to their share in the EU’s GNI. The total amount of guarantees will be €25 billion. SURE will become available after all member states have provided their guarantees.
The European Investment Bank will create a pan-European guarantee fund of €25 billion based on Member State guarantees, which could support €200 billion of financing for companies with a focus on SMEs, throughout the EU, including through national promotional banks. Both SURE and EIB financing will be available to all Member States.
Loans through the ESM Pandemic Crisis Support will be reserved for euro countries. These countries will be able to seek loans up to 2% of their GDP (amounting to €240 billion if all countries borrowed their maximum entitlement but this is not envisaged) for expenditure on health-related expenses in response to the coronavirus, directly or indirectly. The latter limitation reflected the compromise reached between those countries (led by the Netherlands) that wanted to insist on macrostructural reforms as a condition for eligibility, and those countries (led by Italy) that rejected any form of conditionality.
The Eurogroup report also agreed to work on a Recovery Fund which would mobilise future-oriented investment and help to spread the costs of the extraordinary crisis over time through appropriate financing. However, the divisions on this issue were spelled out in the Eurogroup President’s letter forwarding the Eurogroup report to the European Council President. “Some Members were of the view that it should be based on common debt issuance, while others advocated alternative solutions, in particular in the context of the multi-annual financial framework.”
European Council mandate
The Joint Statement of the members of the European Council adopted on 26 March 2020, although primarily focused on the immediate response to the COVID-19 outbreak, also called for a co-ordinated exit strategy, a comprehensive recovery plan and unprecedented investment. It invited both the President of the European Council and the President of the Commission, in consultation with other institutions, especially the European Central Bank, to start work on a roadmap for recovery.
On the basis of this mandate, a Joint Roadmap for Recovery was jointly presented by the Commission President and the European Council President on 21 April 2020 to address the need for a comprehensive recovery plan and unprecedented investment to help relaunch and transform EU economies. It was drawn up after consultation of other EU institutions, social partners as well as Member States.
The Joint Roadmap is a high-level document outlining general principles and highlighting some key areas for action. These include restoring and deepening the single market while also ensuring greater strategic autonomy through a dynamic industrial policy: a Marshall Plan-type investment effort focused on the green and digital transitions and the circular economy, alongside other policies such as cohesion policy and the common agricultural policy; taking on the EU’s global responsibilities in helping a frame a global response to the pandemic as well as providing assistance to countries in need; and addressing the weaknesses in governance that were so evident in the early days of the crisis.
The European Council at its video meeting on 23 April 2020 welcomed the Joint Roadmap for Recovery and endorsed its guiding principles and the key areas for action. The Council also agreed to work towards establishing a recovery fund with the following parameters.
This fund shall be of a sufficient magnitude, targeted towards the sectors and geographical parts of Europe most affected, and be dedicated to dealing with this unprecedented crisis. We have therefore tasked the Commission to analyse the exact needs and to urgently come up with a proposal that is commensurate with the challenge we are facing. The Commission proposal should clarify the link with the MFF, which in any event will need to be adjusted to deal with the current crisis and its aftermath.
However, this text concealed the strong disagreements within the Council over both the size of the fund, how it would be financed and whether it should be allocated in the form of loans or grants. In her press conference after the Council meeting, Commission President von der Leyen, made clear her preference for linking the recovery fund to the EU’s MFF.
“The budget is time-tested,” she said. “Everybody knows it. It is trusted by all member states and it is per se designed for investment, for cohesion and convergence.” Von der Leyen added: “The next seven-year MFF budget has to adapt to the new circumstances, post-corona crisis. We need to increase its firepower to be able to generate the necessary investment across the whole European Union.”
The European Parliament, in its resolution on EU coordinated action to combat the COVID-19 pandemic and its consequences adopted on 17 April 2020 also called on the Commission “to propose a massive recovery and reconstruction package for investment to support the European economy after the crisis, beyond what the European Stability Mechanism the European Investment Bank and the European Central Bank are already doing, that is part of the new multiannual financial framework (MFF). To that end, it reiterated its proposals for an increased MFF budget, a revision of the own resources ceiling to gain sufficient fiscal room for manoeuvre, and the need for new own resources.
The Franco-German axis weighs in, but frugal four not impressed
The Commission’s plans for a European Recovery Fund got a boost in a joint Franco-German proposal on 18 May 2020. This called for “an ambitious, temporary and targeted Recovery Fund in the context of the next MFF, boosting a front-loaded MFF during its first years”. It went on to state that “France and Germany propose to allow the European Commission to finance such recovery support by borrowing on markets on behalf of the EU under the provision of a legal basis in full respect of the EU Treaty, budgetary framework and rights of national parliaments”. It envisaged a recovery fund of €500m in EU budgetary expenditure for the most affected sectors and regions on the basis of EU budget programmes and in line with European priorities, particularly the green and digital transitions and research and innovation. The financing of the recovery fund would be “an extraordinary complementary provision, integrated in the own resource decision, with a clearly specified volume and expiry and linked to a binding repayment plan beyond the current MFF on the EU budget”.
The Franco-German proposal was met with a immediate response in the form of a non-paper from the ‘frugal four’ – Austria, Denmark, the Netherlands and Sweden. They attacked the key strategic idea in the Commission’s thinking and the Franco-German proposal that allocating resources through grants is precisely what the MFF does, and thus building on the MFF is a way of getting around fears about debt mutualisation. The frugal four instead proposed a separate Emergency Fund based on a ‘loans for loans’ approach that would have a strong commitment to reforms and the fiscal framework and would avoid any debt mutualisation. Importantly, the frugal four’s paper rejected any significant increase in the EU MFF budget.
The Commission’s recovery package
The Commission response was delivered last week on 27 May 2020 under the heading ‘Repair and Prepare for the next generation’. It has two elements: a Next Generation EU recovery instrument to boost the Community budget with new financing raised on the financial markets for 2021-2024, and reinforcement of the long-term EU budget (2021-2027). The recovery fund includes a total of €500 billion which will be given to Member States through grants, and an additional €250 billion via favourable loans. The Commission proposal therefore includes the Franco-German proposal but adds a further loan element. It comes on top of the EU’s current liquidity package of up to €540 billion, including potential credit lines from the European Stability Mechanism.
Although the Commission proposal is divided into two components, the total package is fully anchored in a revised but front-loaded MFF for the 2021-27 period. The European Recovery Instrument (‘Next Generation EU’) amounting to €750 billion will temporarily boost the EU budget with new financing raised on the financial markets. It will be used to reinforce EU programmes in the MFF with an end date by 31 December 2024. Raising funding on the financial markets will help to spread the financing costs over time, so that Member States will not have to make significant additional contributions to the EU budget during the 2021-2027 period..
The reinforced MFF is essentially an update of the Michel MFF proposal to the European Council in February 2020 with slightly altered priorities and a tiny boost in overall volume to €1.1 trillion.
In addition, in order to make funds available as soon as possible to respond to the most pressing needs, the Commission proposes to amend the current multiannual financial framework 2014-2020 to make an additional €11.5 billion in funding available already in 2020. This additional funding would be made available for REACT-EU, the Solvency Support Instrument and the European Fund for Sustainable Development, reflecting the urgency of these needs.
The Next Generation EU instrument
Most of the Next Generation EU recovery instrument will be allocated to Member States for support to investment and reforms, with a particular focus on the green and digital transitions. Four components are envisaged. The largest will be a €560 billion European Recovery & Resilience Facility available to all Member States but concentrated on the most affected and where the resilience needs are greatest. This facility will be embedded in the European Semester. Member States will draw up recovery and resilience plans as part of their National Reform Programmes. These plans will set out the investment and reform priorities and the related investment packages to be financed under the facility, with support to be released in instalments depending on progress made and on the basis of pre-defined benchmarks. Disbursements must also fully respect the rule of law.
In addition, there will be a €55 billion top-up of the current cohesion policy programmes between now and 2022 under a new REACT-EU initiative to be allocated based on the severity of the socio-economic impacts of the crisis, including the level of youth unemployment and the relative prosperity of Member States. It is also proposed to strengthen the Just Transition Fund up to €40 billion, to assist Member States in accelerating the transition towards climate neutrality.
Also under this heading the Commission proposes a €15 billion reinforcement for the European Agricultural Fund for Rural Development to support rural areas in making the structural changes necessary in line with the European Green Deal and achieving the ambitious targets in line with the new biodiversity and Farm to Fork strategies.
Financing the Next Generation EU. Financing will be raised by temporarily lifting the ‘Own Resources’ ceiling to 2% of EU Gross National Income (GNI), allowing the Commission to use its credit rating to borrow up to €750bn on behalf of the Union on the financial markets. This would be done through the issuance of bonds, for measures during the recovery period (2021-2024).
The loans would be paid back between 2028 and 2050. This can be done in various ways. Member States could agree to pay more into the common EU budget in future MFFs. They could cut expenditure to create headroom in future MFFs to pay back the loans. Or, the Commission’s dream, the Union would be given additional own resources. Proposals on additional new own resources reflect ideas that the Commission has previously put forward. They include a possible planned extension of the emissions trading scheme to cover maritime transport and aviation, a carbon border adjustment mechanism to counterbalance imports of cheap products from abroad or a new digital tax on companies with a global annual turnover of above €750 million. The Commission has promised to table proposals on these possible revenue sources at a later stage of the financial period.
Importantly, the Commission has signalled, in a gesture to the frugal four, that it is not realistic to pursue the phasing out of national rebates within the next financial period and this will only be possible over a longer period.
Next steps
The Commission has invited EU leaders and co-legislators to “examine these proposals rapidly” with a view to hammering out a political agreement at European Council level by July 2020. Officials pledge to “then work closely with the EP & Council to finalise an agreement on the future long-term framework & the accompanying sectoral programmes” in the early autumn, so the new Community budget is “up and running and driving Europe’s recovery on Jan 1, 2021.”
The Commission proposal is a well-judged response to the economic state in which Europe finds itself and builds on some solid technical work by the Commission services. It is a radical proposal that would exceptionally allow the EU to borrow and run a deficit to finance the recovery. Pascal Lamy has likened it to “crossing the Rubicon for member states”. For that reason, its passage is by no means secure.
The Commission proposal for the borrowing against the security of increased EU government guarantees for the 2021-2027 budget will be discussed by EU leaders at a European Council meeting on June 19th. Initial reactions from Member States suggest it is unlikely to get immediate approval because states are wary of taking on extra risk. Linking the recovery fund to agreement on the MFF is a gamble given that talks on the latter have been at a stalemate for two years. Chancellor Merkel has suggested that an agreement is more likely in the second half of the year under the German Presidency. At this point, the chemistry between the two German women who have previously worked together, Merkel and von der Leyen, will be crucial. It must be recalled that it is not only the European Council leaders as well as the European Parliament who must sign off on the final agreement, but also each and every national parliament. It will be important that the frugal four (or five, if we include Finland) realise that failure to support the Commission’s proposal now will cost them far more in lost GDP after 2028 than what they will expect to pay back in loan repayments.
It is already clear that the decisions to be taken over the coming weeks and months will be a defining moment for the European project.
This post was written by Alan Matthews
An excellent post, congratulations !!