The European Union President, Ursula von der Leyen, presented the first draft of the EU recovery plan “Next Generation EU” last week. This initiative, should it come to pass in its current form (or close to its current form), will go down in history as the moment that the collective states of the EU dipped their toes into fiscal union waters. Of course many are cynical that this will happen – the water might just be too cold.
This comes after the worst health crisis for 100 years, the worst economic crisis since the Great Depression and at a time when the President of the European Central Bank, Christine Lagarde, has been telling her political masters that the Central Bank will do what it can, but is running out of monetary ammunition. None of this has passed Angela Merkel by. The Chancellor of Germany, and arguably the most influential leader amongst the EU nations and importantly the leader of the richest country in the Union, is in her last full year of power.
These three women have decided that now is the time when the EU should take the first steps towards fiscal union – the part that needs to evolve if the monetary union is going to be sustained. This is not complete union but a step in that direction, binding the nations of the European Union ever closer as they make joint financial liabilities in pursuit of funding economic recovery.
The plan involves raising €750bn from the public debt markets to fund a series of grants and loans to be spent across the EU on a number of initiatives. These come under the broad headings of Supporting Member States to Recover; Kick-starting the Economy and Helping Private Investment; and Learning Lessons from the Crisis – all under the umbrella aim of Investing in a Green, Digital and Resilient Europe. What has surprised many has been the mix and scale of grants (€500bn) and loans (€250bn) rather than the scope. Grants tend not to have to be repaid and come with less conditionality than loans, and it is the scale proposed that is highly controversial amongst EU members. Some countries would prefer more conditionality and more repayment (i.e. loans rather than grants). Already the so called “Frugal Four” (Austria, Netherlands, Sweden and Denmark) have expressed their dissatisfaction.
The immediate financing comes from the bond markets. But the EU debt will have to be repaid in the future. To do this the European Union will have to raise revenue, increasing what is known as “additional new own resources”. To do this the EU is proposing to increase the ceiling on member country contributions to closer to 2% of country level GDP. Also there is the proposal of EU wide taxes, the often talked about digital tax, carbon and emissions taxes and the suggestion of a corporate tax on companies that benefit from the EU single market. All of this is still to be debated and agreed upon of course, but this could be the genesis of an era of larger EU budgets with tax and spending powers. The size of the current plan is meaningful at around 5% of GDP at an EU level, as compared with the existing budget of around 1% GDP. It could be the first of a series, depending how electorally and politically popular it becomes.
The money will be distributed according to a number of programmes with some countries benefiting and some countries contributing. There is a direct fiscal transfer of €300bn from contributors to beneficiaries. This, if it is agreed upon will be a significant moment in the EU‘s history. It goes some way to remove the existential risk of the euro and thus the financing premium that some countries pay for debt. It starts to remove the country risk for investment as EU members are more closely financially intertwined. The chances of sovereign debt crises begin to recede, leading to a more stable economic environment across the EU and benefiting the region as a whole.
What is interesting, but purely hypothetical to think about, is whether this could have ever been possible if the UK had still been a member of the EU. The UK almost certainly would be a net contributor rather than a beneficiary from the programme. EU contributions would almost double and as a result it would have been highly likely that the UK would veto the plan. The three most powerful women in Europe will be delighted to have avoided this obstacle, allowing them to take the step no one thought possible. Ironically, many UK commentators forecasted the demise of the EU after the UK departure. I would suggest the opposite, the absence of the UK has made a stable EU economic environment more likely. The UK government and their Brexit negotiators should take note.