László Andor / Jul 2017
Brexit and the politics of EU budget
Brexit, from a budgetary point of view, is driving a net contributing country out of the European Union. Pure arithmetics suggest that it necessarily leads to a smaller EU budget and less funding for common EU policies. Expenditures also have to be cut, and we urgently need to explore « how to do more with less euros ».
However, a budget is not only a question of math but also politics. In 2013, the UK was a member of a group of four countries that insisted on reducing the EU budget in net terms, after the Commission actually proposed a modest increase. At a time of recession and investment drought, squeezing the EU budget was a bad message and unwise policy. Shortly after, the Juncker Plan had to be invented to boost investment through common European financial instruments.
As the UK leaves, the group that favours a smaller budget will become weaker, as long as all other countries maintain their earlier position. The overall size of the EU budget can be, and has to be, reconsidered, together with how exactly the money is raised. In that context, one should not forget that the net contribution of the UK has not been as big as many would believe. This is because of the extraordinary rebate won by Margaret Thatcher in 1984 at the battle of Fontainebleau. Once the UK leaves, this particular rebate would end but others should as well.
While ending all rebates would significantly lower (perhaps even halve) the budgetary loss in proportion to overall EU GDP, it is also true that how we spend has to be reviewed and improved in many fields. Stamping out waste, abuse and errors would be important anyhow, but it is even more pressing in the current circumstances.
But what exactly is wasteful also depends on the political or ideological angle. Many, and especially free trade supporters, would consider the Common Agricultural Policy (CAP) a pointless policy. However, Brexit may again come to the rescue, since the British public has largely been on the CAP-sceptic side, and it will be harder to claim that the CAP is wrong because Her Majesty the Queen is the greatest single beneficiary.
Cohesion and conditionality
When speaking about eradicating abuse and strengthening the link between policies and budgets, the focus shifts to cohesion policy (three EU funds amounting to over one third of the budget). Current debates about purpose and the functioning of these instruments revolve around the concept of conditionality, that is supposed to be widened and strengthened. But conditionality has different meanings and different effects depending on the different types : the so-called ex ante, the macroeconomic and the newly emerging political conditionalities.
Ex ante conditionality means that before a programme can be launched from the structural funds (now « ESIF »), specific measures have to be taken in order to ensure that spending money in a particular area leads to the expected result. The content of such conditionalities is usually developed in line with EU policy guidelines and country-specific recommendations (CSRs). The experience with such ex ante conditionalities is largely positive and helps ESIF funds demonstrate not only a net GDP growth effect but also a transformative impact (towards « smart, sustainable and inclusive growth »).
Macroeconomic conditionality, on the other hand, means that the normal flow of EU funds can be interrupted and funds can be withdrawn if the country violates the Stability and Growth Pact (SGP). This rule has been part of the game ever since Maastricht for the Cohesion Fund but, in 2011, the Commission suddenly proposed it for all the ESIF funds. The European Parliament and the Committee of the Regions were not united in support. It has many problems, starting with the fact that it would punish regions (and the more disadvantaged ones) for the failures of the central government of a country. It kills one of the most important feature of the structural funds, namely that they provide certainty and security of investment resources in low-income regions. One should note that in recent years the EU has managed to bring down excessive deficits, without the macroeconomic conditionality playing any significant role. It was introduced at a time when pro-cyclical fiscal policy was trendy, and it is not today. No harm would come from dropping it.
Instead of re-confirming the macroeconomic conditionality, the Zeitgeist today points towards new, and namely political conditionality. There are rogue states inside the EU, promoting an illiberal counter-revolution. Hungary and then Poland introduced problematic constitutional changes weakening the rule of law, and whipped up opposition to the burden sharing policies the EU rolled out in 2015 to tackle the immigration emergency. Should they continue receiving EU funds as before? Well, things have to change, but we need to think first about what exactly needs to be done and what would be counter-productive.
Regarding political conditionality, again a question is whether poorer regions should suffer because of nasty governments. The instrument to be invented must allow even handed intervention, and it is not necessarily the case here, given the risk of illiberal populists coming to power in higher income countries like the Netherlands, France or Italy, which are not so dependent on investment support from the EU budget. If the defence of the rule of law becomes an EU policy, it requires instruments that can be used in all member states with equal power. Sanctions without a proper focus and without guarantees against double standards may politically backfire and strengthen the hand of nationalist forces at all levels.
Conditionality can result in better functioning, but the right types and doses have to be found. For that one should distinguish between endogenous and exogenous conditionalities. The first category restricts the choices of the beneficiaries and helps ensuring that the instrument delivers on its mandate. The second, on the other hand, widens the scope of objectives, and thus dilutes the original mandate of the instrument, potentially leading to weaker performance what concerns the original goals (in this particular case: economic, social and territorial cohesion). Such exogenous conditionalities, whether they are about fiscal austerity or structural reforms, have to be handled with care, and a confusion with the goals of cohesion and convergence should be avoided if possible. In a policy area which is primarily about support, enabling rather than disciplinary innovations would be more consistent.
Scope for better control and management
Before piling up new layers of conditionalities, one should think about changing management and control mechanisms and avoid throwing out the baby with the bathwater. Progress has been made towards establishing an EU prosecutor with a power to pursue judiciary consequences if EU funds are abused. Such an EU prosecutor with powers beyond OLAF is a good idea, but this is still an action that is possible ex post, i.e. after mishandling already happens. In recent years, however, new practices have also been developed to prevent abuse, and one could think about building on those.
The Commission already can interrupt payments and suspends programmes if there is a strong suspicion of abuse, and less than 100 per cent confidence in the integrity of management or audit at the national level. Such interruptions and suspensions can lead to financial corrections and delays but, under the current framework, the member state is not losing the resources or the control over the funds. One possible incentive for better performance would be to transfer those funds that suffer big delays due to interruptions and suspensions into direct management by the Commission. The largest bulk of funds would still remain in shared (i.e. member state) management, but the country in question would be incentivised to avoid losing control and to correct behaviour. The Commission would need to invest in some more management capacity, but the returns on that investment would be significant in both financial and ethical terms. This solution would be far superior to linking the disbursement to « rule of law » conditionality, not least because it takes ages, if not an eternity to establish that this or that country is actually violating the values and democratic standards of the EU.
There is no need for a better example here than Hungary, where many pro-Europeans have the feeling that the EU actually rewards a rogue leader instead of punishing him. Since Viktor Orbán has been re-elected as prime minister, he started to create what was « the family » (semya) at the time of Russian leader Boris Yeltsin twenty years before. Assets and grants (including EU funds) being transfered in large quantity to those close to the leader is certainly not what is the original mission of EU cohesion policy. Notwithstanding this woeful waste of resources, Orbán’s political family (the European People’s Party) has been defending him from the consequences of rogue behaviour, perhaps to avoid the fall of the stigma on a family member and the group losing a dozen European Parliament seats. It is of course for the EPP to decide on its domestic affairs, but without enforcing different practices the cohesion policy of the EU will continue to lose support as well as resources, leading not only to moral but also economic disintegration.
If the Commission had the power to take part of structural funds allocations for such a country under its direct management, still for the benefit of the country's development but bypassing the rogue government's corrupt network, better results could be achieved both in developing the country and in enforcing the rule of law.
Honesty about transfers
Re-distribution through instruments like the structural funds is not a gift but an indispensable pillar of a single market between diverse countries of uneven levels of development in the European Union. Textbook economic geography explains clearly that economic activity in a large market tends to be clustered around the centre and that transfers to the periphery are necessary for maintaining public goods, preventing major divergence in economic potential and keeping living standards at an acceptable level.
According to the latest Cohesion Report (published in April this year), one sixth of the EU population lives in regions with income level less than half of the EU average. Most of these regions can be found on the Eastern and Southern periphery. Even with receiving ESIF support, they stagnate economically and they experience demographic decline, generating further imbalances.
Besides, today we are not only speaking about maintaining and improving the conventional budget framework of the EU but also a potential budget for the eurozone as well. The elections in France have opened a new horizon, and even from Germany there are occasionally some encouraging voices coming out in that direction. Slowly, slowly, it is being understood that certain functions (cross-country risk sharing and counter-cyclical stabilisation) can only be performed through fiscal instruments in a monetary union, and those functions should not be mixed with the budget of the whole EU, or the operations of the central bank. If we have more objectives we need more instruments as well. Cohesion instruments can improve, but they cannot become overly tricky so as to combine delivering economic and social convergence, tackling business cycles, safeguarding fiscal discipline and sanctioning political degeneration as well.
Without raising expectations about great leaps forward, more honesty is needed about the importance of fiscal policies and instruments in order to build a wide and lasting consensus for a well-functioning EU. In the absence of orderly fiscal transfers, the monetary union can collapse. And if the current budget debate leads to a significant reduction of transfers by downgrading the cohesion funding instruments, the single market can also disintegrate.
Building a fiscal capacity for the eurozone is of vital importance and it is possible without a federal leap or a treaty change. Political leaders have to be able to convince the public also in the surplus countries about the necessity of repairing the EMU and preparing it for the next downturn. Transfer -- like « sorry » for Elton John – seems to be the hardest word for politicians in the higher income member states, but the EU cannot limp on for too long with such a small and simple budget. And without better management and smarter conditionality there will be no trust in maintaining the current level of centralisation, let alone an increased one.