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Europe's latest step toward fiscal integration



The elusive goal of establishing collective European responsibility for funding the battle against the COVID-19 pandemic got a big boost this week with an endorsement from German chancellor Angela Merkel and French president Emmanuel Macron. In a joint announcement on May 18, the two leaders stole the limelight from the European Commission, declaring their agreement on a far-reaching proposal for the new €500 billion EU Pandemic Recovery Fund backed by joint indebtedness. It was another step in the “Hamiltonian moment” in Europe of “joint struggles addressed with joint expenditure” in the face of dire necessity.[1]

The plan calls for jointly funded debt to support the European pandemic recovery under the EU Treaty’s Article 122, covering “a spirit of solidarity between Member States…if severe difficulties arise.” The two leaders’ announcement makes it likely that all 27 EU member states will adopt the scheme, a milestone in European fiscal integration and a fitting European legacy for Merkel.

The Franco-German announcement would increase the part of the EU budget that is funded by contributions from member states according to their gross national income (GNI). At present, member states contribute only around 0.67 percent of EU27 GNI to the budget through this channel. Raising that amount to 2 percent, as the accord calls for, would release €170 billion to €180 billion annually, or €500 billion over a three-year period. Crucially, however, EU member states are not expected to actually contribute this money from their national budgets but instead would authorize the European Commission to raise it in the financial markets, backed fully by the newly created EU budget room up to the annual 2 percent of EU27 GNI. Proceeds would go to spending in the “most affected sectors and regions” in the European Union—enough to have a real macroeconomic effect—though not to rescuing individual member states from their existing high national debt levels.

The debt is to be repaid gradually from the EU budget over a long lifespan of the recovery fund—likely several decades. Given that the European Union now can issue new debt with a negative yield out to a nine-year maturity, if it issues up to this maturity it will in fact likely be paid to do so. A negative interest rate might prevail for the entirety of the next seven-year Multiannual Financial Framework (MFF) EU budget. Earmarked revenue streams from potential climate-related projects, including EU carbon trading schemes, could also be directed to help repay this debt.

German leaders have long resisted the idea of both a regional redistributive EU budget and common EU debt issuance. This new proposal, however, amounts to both, and because Germany has mounted an effective antipandemic effort, it will probably receive considerably less than what it puts into the recovery fund. That is why adoption of such a redistributive approach would amount to a genuine European legacy toward the end of Angela Merkel’s political career. So far, she seems to have received strong backing from her own CDU/CSU party in the Bundestag, and both the Social Democratic Party and the Green Party presumably will also support it.

A major question concerns whether the other 25 member states will support this Franco-German gambit, which they must do if it is to be implemented. Both the traditionally frugal Northern and poorer Eastern members may resist something seen as benefiting countries along the Mediterranean, where pandemic deaths have been high, tourism industries are large, and/or government debt is high. But they may cooperate, once they have stood firm for a while for their domestic constituents, if they have the incentive to export the capital equipment used in recovery fund investments in needy countries.

For example, the recovery fund envisions funding 5G investments, likely benefiting Nokia (Finland) and Ericsson (Sweden), which would encourage their governments to agree. Denmark is the world’s largest exporter of wind turbines and home to large offshore wind development companies (in one of which, Orsted, the Danish government owns a major share), which could persuade its inward-looking prime minister Mette Frederiksen to support Green Deal–focused recovery projects. And Merkel’s emphasis on “innovative mobility” and other R&D could unleash benefits for the German car industry and its large subsidiaries in Eastern Europe. The list goes on for other EU contributing members, and including all EU27 member states in the recovery fund could potentially increase its size beyond what a euro area-only fund might have accomplished.

Since the recovery fund would include all 27 member states, it will also add complexity to the simmering European debate on the need to reform the EU fiscal surveillance framework, not least the Stability and Growth Pact (SGP), for the postpandemic era. Fiscally conservative Northern and Eastern member states will want stricter enforcement of new fiscal rules and may well seek to impose these views on the new SGP as a quid pro quo for signing up for the recovery fund. It would de facto amount to imposing a degree of indirect conditionality on recovery fund recipient countries through other means.

Perhaps most important in the Merkel-Macron agreement is the precedent for jointly funded debt to address the crisis. For many years, the European Union has issued small amounts of debt for various long-term purposes but never for cyclical stabilization reasons or on the scale invoked in the latest agreement. The recovery fund will be presented as a unique, one-off endeavor, but the experience of existing European fiscal instruments is that they always get adjusted to fit the political and economic circumstances of the day. The European Stability Mechanism (ESM), which was created in 2012 to provide conditional loans to bail out debt-stricken European countries, is now offering to lend without country-specific conditionality during this pandemic. The precedent set today could pave the way for future such efforts with political support. Perhaps in time climate change or new migration waves will meet the political test for joint debt funding.

The recovery fund would be a new and limited European fiscal instrument, but its existence and future adaptability would benefit everyone in Europe, not least the European Union’s most highly indebted countries.


1. Alexander Hamilton famously managed to mutualize the debts from the joint struggle of the War of Independence accumulated by the 13 original US states into a single US federal government debt security in 1790.

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