Erik Jones / Jul 2020
Photo: European Union, 2020
Europe’s leaders have made a historic decision to expand the borrowing capacity of the European Union in order to fund a collective recovery from the economic consequences of the novel coronavirus pandemic. It is worth pausing for a moment to let the significance of that statement sink in. The EU will spend an additional €750 billion over the next three years. That is a huge commitment. The questions now are how that money will be spent, how it will be paid back over the next four decades, and how all of this will be explained to different national electorate. Forging an agreement was challenging. It was also only the beginning.
Spending the money will be complicated. National governments are much better at designing spending plans than implementing them. When they try to spend the money too quickly, it tends to wind up in the hands of the wrong people; when they try to spend it more slowly, it tends to get tangled up in projects that cost more than anyone ever expected. These problems are not unique to national governments or even to the public sector. Private sector firms wrestle with many of the same issues when they launch ambitious new projects. The difference between public and private is the constituency: governments face voters; managers face shareholders; each group creates its own adverse incentives.
The difference with Next Generation EU, as the new recovery fund is called, is that national governments will be monitoring the spending habits of each other. Worse, they already expect to find problems related to fraud, mismanagement, inefficiency, or rule of law. It does not matter that the rules for conditionality leave the final decision in the hands of the European Commission. What matters is that spending these new recovery funds will create tensions between governments that are struggling to recover from the crisis and governments that are struggling to justify the unprecedented scale of Europe’s new recovery effort. Since we can be confident that difficulties will arise in even the best-laid plans, it is safe to assume that Europe’s heads of state or government will face a major challenge in expectations management both as a group and in dealing with their national constituencies.
Paying back the money will be harder still. Just under half of the money, or €360 billion, will operate as back-to-back lending to Member State governments. The remaining €390 billion will need to be financed using resources raised by the European Commission. The agreement does not specify where the Commission will get those resources. Instead it lists areas where new taxes may be possible. None of these areas is uncontroversial. A tax on plastics may be good for the environment, but it will impose a heavy cost on the packaging industry. Just ask the Italian government, which had to withdraw such a tax during the run-up to the regional elections in Emilia Romagna where the Italian packaging industry is concentrated. A financial transactions tax will hurt the reorganization of European financial markets after Britain’s exit from the European Union. A carbon levy with border offsets will complicate Europe’s energy transition (even if it will create powerful incentives to shift to green technology). And a digital tax will trigger a confrontation with the United States.
Of course, no revenue is cost free; that is why they call it a tax. The point is simply that once the bonds are sold the clock will start ticking. Europe’s leaders will need to agree on new financial resources. Those agreements will be difficult but finding no agreement will be even harder, because the alternative will be to shift some of the repayment into the multiannual financial framework (MFF). The fact that the new seven-year budget is smaller now than what was proposed last February suggests that the linkage between the recovery fund and the MFF can work that way. It is also a healthy reminder that in fiscal battles cutting expenditures often prevails over raising taxes. Europe’s leaders will need to be alert to the possibility that today’s new borrowing authority may come at the expense of budgetary outlays in the distant future.
A lot will depend upon how national leaders sell this agreement in the domestic political arena. The tendency with these kinds of packages is to focus on narrow forms of cost-benefit accounting. That tendency was on full display in the Italian press this morning. The focus for reporting was on estimates of how much Italy would receive in grants and loans, why the rebates given to Austria, Denmark, the Netherlands, and Sweden were irrelevant to Italian national interests, and whether it would be possible for Italian Prime Minister Giuseppe Conte to avoid making a decision about borrowing from the European Stability Mechanism. Moreover, it is easy to imagine a similarly self-centred narrative being the focus for reporting in other countries. Such narratives will likely form the backbone of parliamentary debates as well, as the whole agreement goes through ratification in each of the Member States.
For most national governments, the primary goal in selling the agreement will be to neutralize the opposition from populist movements that are sceptical of European integration. Italy and the Netherlands are similar in that respect, but those two countries are hardly unique. It is difficult to identify a Member State where such anti-European movements do not exist. The challenge for national leaders will be to neutralize such opposition without somehow apologizing for what the European Union has accomplished. There is no point selling an historic achievement as a concession. Doing so will only increase suspicions about what other countries received in the bargain and how much they can be trusted to live up to their side of the agreement. It will only encourage national parliaments to look even more closely at tax proposals from the Commission to make sure they do not create a further disadvantage. And it will cement the tendency to see the European project as a narrow calculation of national costs and benefits.
Europe’s leaders have made an unprecedented decision to borrow money together. The greater challenge will be to manage the consequences of that decision. That means working together despite inevitable shortcomings, committing new financial resources even when these fall unevenly across countries, and moving beyond narratives that apologize for what they surrendered to the rest of Europe to those that celebrate what Europeans can accomplish together. This greater challenge will not unfold over a long weekend. It will not end with the ratification of this new budgetary agreement either. Europe’s leaders will wrestle with this challenge for the next forty years. That is the commitment they have accepted. Its importance is too great to be ignored.