The EU as a Whole is Greater than the Sum of its Parts
Thoughts on the European Council marathon weekend and historic decision on the next budget and the Recovery Fund – The Bumblebee now has two wings
The marathon EU Council over the weekend was a breakthrough moment of European integration. The approval of the extra €750 bn (now known as Next Generation EU – NGEU) as an addition to the Multiannual Financial Framework (MFF) is an important step in furthering the European project and gives hope that the EU is indeed there for its citizens in times of crisis. “Historic, unprecedented, essential” are only some of the adjectives that have been used to celebrate this achievement, which was by no means certain as late as Monday evening, the 4th day of the EU Council. What is more, as is now popular to say, the Rubicon on common debt has been crossed and €390 bn in new debt, taken on financial markets, will be distributed in the form of grants to Member States – extra spending, to be tilted down in the future with sources yet undetermined. Even though the size was partly watered down due to the demands of the “frugal four”, it does not change the fact that the Euro and the EU have now gotten some limited and timely version of a macroeconomic stabilisation instrument, that was previously discussed so many times in recent years, yet failed to materialize. Markets reacted positively to the news.
The economics of the deal:
Let there be no doubt – this is a huge breakthrough. The total amount of funds proposed by the European Commission (€750 bn) survived the cuts. Yes, the share and size of transfers/grants has been reduced from €500 bn to €390 bn. The smaller amount of grants will mean a smaller push to a faster recovery. The Recovery and Resilience Facility (RRF), the major component of the Next Generation EU instrument, stands at €672.5bn, with €312.5bn in grants (up from €310bn) and €360bn in loans (up from €250bn). In 2021 and 2022 70 % of these funds will be distributed, with the rest 30 % (93,75 bn Euro) distributed in 2023. The key for these final €94 bn will however be GDP performance in 2020 and 2021, so it is not yet known exactly how these will be allocated. However, the symbolic part – that the EU is ready to conduct the important role of risk-sharing in difficult situations stands intact.
This European fiscal risk-sharing deal comes after a decade of economic research pointing towards the need for immediate fiscal action in the face of deep recessions. But also on the back of the theoretical considerations about the importance of risk-sharing as an important tool to stabilisation in monetary unions (See Farhi – Werning 2017 and Auclert – Rognlie 2017)[1].
The Recovery Fund might not seem to be a direct consequence of high-level academic considerations – especially after previously the detailed proposals of a synthetic common European bond (especially the proposals regarding European Safety Bonds), designed by some of the top macroeconomists in the world, failed to gather political and institutional backing in Europe after years of work designing them. But the fact that the European Union is now willing to use its AAA status to borrow jointly and redistribute according to needs and losses due to the pandemic comes just short enough of a real fiscal policy tool. The issuance of this joint debt should be a welcomed precedent. Part of these bonds will be bought by the ECB. Therefore, the EU is making first steps to align its response ability to the Federal Reserve- US Treasury duo, which has been able to use its full firepower to stop the crisis in the US. The Bumblebee now finally has two wings.
[1] The underlying thinking here however comes from Kenen 1976: “It is a chief function of fiscal policy, using both sides of the budget, to offset or compensate for regional differences, whether in earner income or in unemployment rates. The large-scale transfer payments built into fiscal systems are interregional, not just interpersonal”
Joe Weisenthal thinks that this European turn, combined with the first evidence of the effectiveness of the CARES stimulus act in the US to boost economic activity, are a sign that demand stabilisation is gaining considerable dominance again as a policy tool.
The politics
Emmanuel Macron, in a statement on Wednesday evening, claimed victory for what he started as his European integration project three years ago and projected most vocally at the famous Sorbonne speech. However, we have to be fair that hadn’t the global pandemic and the current crisis happened, his project of achieving the duly needed next step of European integration was dead in the water. But the victory is also for Angela Merkel, which finally persuaded herself to move forward on Europe. Her realization and admittance that “Europe must act together, the nation state alone has no future” is what brought the Macron-Merkel Recovery Fund proposal in May and is what got us through the finish line over this weekend. Yes, this is a success for European integration and a hard battle won at the end, even though it had to suffer some collateral damages.
In an interview for the national TV on Tuesday, Sebastian Kurz already admitted that the very loud opposition by the “Frugal Four” was used only to obtain a better bargaining position, that could be used by the frugals to obtain concessions on other fronts, e.g. rebates. Some people have criticised him for that, but I think the assessment on this act of political bargaining will depend on which side do you stand – if you do not share the positions of the “frugal four” you will see this as an act of political extortion. If you think the “frugal four” has been right all along, you will see it as a genius move on their behalf to force the much bigger and stronger countries to succumb to their wishes, which they partly achieved. In the end, the frugals seem to have lost, as their supposed goal was to block any common debt issuance, but since that was impossible and implausible, they actually won quite a bit given their extreme position.
The cover of the Financial Times on the 16th of April, 2020
The downsides:
Yes, key priorities have suffered, especially so: healthcare (with the programme Health4EU being almost wiped out), research and development (with Horizon EU being reduced by more than €10bn), compensations for the green transition (the Just Transition Fund was slashed from €30bn to €10bn). The sizes of these cuts do not seem huge in comparison to the overall size of the deal. However they constitute a huge share of these programmes, but also – more importantly – show that the in face of adverse situations the EU is willing to sacrifice the long-term priorities it was manifesting as its main goals for the next decade. The optics of this does not bode well with a communicated idea of ensuring the EU will be more resilient and stronger in the future.
The rebates question, in which the United Kingdom was historically the most vocal player, instead of disappearing with Brexit, has come even stronger in play. While rebates can be a good solution to difficult situations in which there are important concessions to be made, the discussions have left the impression the EU can always be held hostage by countries demanding further rebates from their contributions in exchange for them accepting positions that are not to their political liking. The new MFF was a chance to leave such rebates in history and Germany has voiced its preparedness to scrap its rebate to replenish the funds that vanished with Brexit, however the new budget will still lose €53 bn in the new seven year period due to rebates. These rebates are higher than the budget for all the scrapped funds for research and development, healthcare and just transition.
What is more – we have to remind ourselves that the only country that has left the EU so far is a rich Northern country, which was granted concessions and renegotiated its rebates multiple times. While the current stressful situation has made it necessary for a solution to be found as quickly as possible, this appeasement strategy towards countries threatening to block awaited reforms cannot be a working strategy in the long-run. It also fills in the already dangerous net payers narrative.
The Rule of Law conditionalities and a stricter control of EU money towards Eastern Europe has been a defeat. There seems to be different interpretations to this – and some commentators have seen some positives in the EU Council communication that “the Commission will propose measures in case of breaches for adoption by the Council by qualified majority”. However, I would believe Lucas Guttenberg assessment on this, which is more sobering and points that this mechanism for protecting the budget and NGEU in terms of breaches to the Rule of Law is yet to be determined by the European Council – which means by unanimity of all countries – pointing that the end result will most probably not have much bite. This is a pity, given the amount of negligence and misuse of EU Funds in some parts of Eastern Europe. For example, there is a current wave of hefty protests in Bulgaria, already in their second week, against the corruption and misuse of public institutions.
New own resources, which was a source of much discussion in recent years, did not receive much attention, even though it could be one way to repay back the €750 bn Recovery fund between 2028 and 2058. The only real new tax adopted for now would be a non-recyclable plastic waste tax coming into action already next January.
Unanimity decisions continue to be a major challenge for the future of European integration. In a fast-moving world, we will continue to move forward only from one crisis to another. Only ultima ratio decisions would be made at the darkest hour and under huge stress and uncertainty. In normal times, decisions on important issues will either face death by committee or would be a non-starter because they would be “politically infeasible”. Just think about how many people have written that a common joint issuance of debt is not “politically feasible”, thus blocking it from finer consideration, that would probably have made the current solution better and more efficient.But now, we got this politically infeasible answer to the current crisis in 67 days. We should all start wondering what is possible… It seems “only a common external threat could provide the political momentum.”
Finally, although the EU will indeed obtain debt from financial markets, this does not come near a real market for Euro area safe asset. A few hundred billion of bonds will not be enough to help in strengthening the international role of the euro – one of the important priorities for the current European Commission. To achieve that, the euro needs an European safe asset with a liquid market with the size of trillions, as Vitor Constancio points out, so that international traders can have the full liquidity to trade it daily. To achieve that, we will need new proposals after the strange and silent non-death of the previous synthetic proposals such as the Blue/Red Bonds, the ESBies and the Eurobills, discussed here by Thomas Philippon.
So who won in the end?
Well, Europe and EU citizens won. All of the above shortfalls cannot in any way cloud the fact that the EU has gotten its act together in this crisis so far, in contrast to the last one, which was partly self-imposed. Citizens will get a faster recovery out of this deal, but more importantly should feel more confident that EU institutions and Member States can act together in dare situations. The fact that citizens should feel like this, does not mean they will actually feel like this. It is normally in the aftermath of crises that political instability sets in and different political actors try to profit from the narrative that the crisis was not taken care of properly. This will inadvertently happen sooner or later.
What leaves me hopeful is that in the EU today, the whole is stronger than the sum of its parts. This was not always true. The minimalistic structure of the European monetary union, the lack of risk-sharing, capital flight and rapid market sentiment changes, the divergence of business cycles of some countries, were the reason for previous stress situations and shortcomings. The ESM, the OMT, “whatever it takes”, QE and now the European Recovery and Resilience Fund were all attempts to overcome these problems and are the pieces that have so far contributed to the Odyssean journey of completing the monetary union in the last decade. Each one complements the previous one, while also making it partly redundant. The fact that the EU is ready to take collective responsibility in 2020, even though the politics of it require long, dramatic and often infuriating discussions, should make us more confident that in the long-run we will achieve the final, successful stage of this journey.