AFTER four days of tough negotiations and painful compromises, European leaders have agreed a €750bn recovery fund.
As a gesture towards Italy, Spain, and other countries reeling from the Covid-19 crisis, the agreement is a major step forward for the European Union (EU), but doesn't address the eurozone’s deepest problems.
The Covid-19 crisis has strained the monetary union. While the pain has been shared, some countries have been hit harder. Italy, France, and Spain have suffered the most deaths and the deepest recessions, and tourist-reliant southern Europe seems headed for an especially slow recovery.
Government debt is soaring across the eurozone, but is perilously high in southern countries.
The initial response to the pandemic left Italians aggrieved, owing to the perception that northern Europeans had blamed them. Even the pro-European Italian mainstream felt alienated from the EU at the height of the crisis.
German chancellor, Angela Merkel, recognised the gravity of the situation. In May, she and French president, Emmanuel Macron, proposed a €500bn recovery fund, to be financed through EU-issued debt. It would allocate grants to the hardest-hit regions and sectors.
The European Commission increased the headline total to €750bn, by adding EU loans to the grants.
The deal struck in the early hours of July 21 is welcome. While an agreement was always likely, the negotiations could have dragged on, deepening the EU’s divisions and distracting policymakers. Agreement before Europe shuts down in August is significant.
The deal preserves many positives of the Merkel-Macron proposal, notably €390bn for EU grants, with few strings attached. Four richer northern European countries, led by the Netherlands, had previously insisted that the EU provide only loans, conditional on recipient governments enacting reforms dictated by the EU (and subject to national vetoes). But the stigma of such conditionality was anathema to southern European countries.
Moreover, with government borrowing costs so low — due to the European Central Bank’s (ECB) €1.35tn Pandemic Emergency Purchases Program — EU loans would have been of little help. If anything, they would aggravate debt-sustainability concerns, not least in Italy, where public debt will soar to 160% of GDP next year.
€390bn in grants over the next three years will provide a significant boost. The commission expects the EU economy to contract by 8% this year, to €12.8tn. As such, the recovery-fund grants would be equivalent to 3% of GDP, or 1% for each year. If Italy’s economy shrinks by 10% this year, the €82bn earmarked for it would amount to 5% of GDP. Thus, while much smaller than national fiscal stimulus packages, the EU grants will boost the ECB’s monetary firefighting.
The biggest benefit of the recovery fund, though, is political. The EU is demonstrating that it can come to Europeans’ aid. That should provide a sorely needed antidote to Euroscepticism and alleviate anger. The deal is a major win for the commission, which was bypassed during the 2010-12 eurozone crisis. The commission will be the one borrowing the €750bn, and directing the grants and loans through the EU budget, which it administers.
And with an eye toward repaying the debt after 2027, it will also oversee the search for new EU revenue sources, such as a digital-services or carbon-border-adjustment tax. The downside is that, because the recovery fund was folded into the broader negotiations over the EU’s 2021-27 budget, the deal required regrettable compromises. Funding to support a clean-energy transition has been slashed.
Another big challenge is authoritarianism. Illiberal governments, like that of Hungarian prime minister, Viktor Orbán, continue to subvert the rule of law, while misappropriating EU regional cohesion funds, which is why Ms Merkel wanted to tie future EU funding to respect for the rule of law.
But conditionality provisions were gutted, to overcome Mr Orbán’s threatened veto (which was scarcely credible, because Hungary would have remained a large net beneficiary of EU funding). With the departure of Britain in January, there was hope of doing away with national rebates, a perk first secured by British prime minister, Margaret Thatcher, in the 1980s, and obtained by other net contributors to the EU budget. These provisions encourage a penny-pinching, zero-sum mentality that undermines European solidarity.
But instead of curbing rebates, the budget deal 'bribes' the obstreperous Dutch, Austrians, Swedes, and Danes with even larger ones.
The recovery fund is a step forward, but it does not resolve the eurozone’s fundamental problems, which include Italy’s unsustainable debt, Germany’s deflationary bias, and the lack of a fiscal rebalancing mechanism. The eurozone has dodged a bullet, but is still a target.