As a consequence of the COVID-19 pandemic, countries around the world are facing a serious economic crisis. The European Union is no exception. To restore the economy and sustainably improve the market position of various sectors, the EU agreed to set up a recovery fund worth 800 billion euros (in current prices) for its member states. More than half of the money flows directly into the member states’ coffers as non-refundable grants, but 360 billion euros will be granted as a loan.
Deciding on the conditions was not an easy process. Austria, the Netherlands, Sweden, and Denmark in particular have advocated for stricter control on the spending procedure and a smaller funding size. For a long time, these fiscally more conservative countries – informally known as the “Frugal Four” – have promoted tighter fiscal policies in the eurozone and argued against a large distributive European budget and collective EU debt. Together with Finland, these countries have supported the introduction of harsher financial penalties for breaching the rule of law and a lower EU budget.
In May 2020, Germany, which had been similarly fiscally conservative for a long time, supported the French initiative for a loan-based recovery fund with non-repayable grants. While the Franco-German initiative went through, the Frugal Four and Finland could negotiate a more considerable discount for themselves. The agreement, called the Next Generation EU (NGEU), stipulates that the member states start to submit their spending plans from April 2021 onwards. They are free to spend the money according to their needs, but they must allocate a minimum of 37% to climate change mitigation and 20% to digitalization.
This spring, the EU started borrowing on the markets after all 27 member states ratified the Own Resources Decision. The funding strategy provided by the EU foresees that between 2021 and 2026, the EU will raise a staggering amount of 800 billion euros. The Funding Strategy consists of medium and long-term bonds, and short-term EU bills, ensuring flexibility and effective management of liquidity and maturity for the investors.
To member states in a difficult economic situation, this joint borrowing of the EU provides advantageous terms, manifested by individually different borrowing rates. Although the countries receive the first part of the fund this year, the repayment will start only after 2027 and will end in 2058 at the latest, which is another advantage. On the other hand, member states in a good economic condition such as the Frugal Four usually have lower borrowing costs. For them, joint borrowing at an average EU rate would entail more costs than borrowing money independently. But the fact that all member states accepted the NGEU fund highlights the collective commitment to closer cooperation within the European Union.
However, the NGEU plan is still not the perfect solution for three main reasons. First, it remains unclear how the money is spent. For example, critics confronted Hungary and Poland, claiming that they continuously violate the rule of law in light of growing corruption, declining media freedom, and endangered independence of the judiciary. These issues bring uncertainty to the sectors and projects that will receive funding. Hungary and Poland have also vetoed the condition about a mechanism envisaging the protection of the rule of law, thus endangering the implementation of the fund. The coming into effect of the mechanism has been postponed, but a framework on money distribution is essential to boost the economy effectively.
The importance of the NGEU’s effectiveness has been underlined by the European Union. The former German finance minister, Wolfgang Schäuble, emphasized another important issue. Mr Schäuble criticized the lack of transparency when it comes to allocating the money and the missing capacity of the European Commission to control how and where states receive their shares. To enhance monitoring, the EU established the European Public Prosecutor’s Office (EPPO), which is responsible for investigating crimes related to the EU budget. Implementing the COVID-19 relief plan is going to be under the EPPO’s control as well, a first challenge and opportunity to show how effectively this new office works.
The second key question is the amount of money that will actually be spent. To measure that, economists use the absorption rate, which measures actual payment compared to the pre-allocated funding. Between 2014 and 2020, only around half of the provided money was spent by the states and the absorption rate of Spain and Italy was only 39% and 40%, respectively. Adding to the concerns discussed so far, these two countries are also the largest recipients of the NGEU fund. However, historical data show that governments tend to be more efficient during economic slowdowns, a positive sign. Accordingly, after the financial crisis lasting from 2008 to 2014, the absorption rate was around 90% on average in the EU.
Thirdly, its slow progress is a worrisome aspect of the fund as well because it weakens the effect on the economy and might result in a slower recovery. However, the strength of the fund lies in its goals. The NGEU fund is not only a stimulus package, but also a long-term investment plan which focuses on substantial issues such as climate change, digitalization, sustainability, and increased resilience to ensure a green future for the next generation.
These questions remain open. Although the Next Generation Fund is the largest stimulus package in the history of the EU, its real effect on the economy is difficult to estimate. Morgan Stanley and Standard & Poor’s best scenarios predict that until 2026, the stimulus could increase the EU’s economic growth by 3.5% or 4.1%, respectively. In contrast, governments’ and public institutions’ forecasts are more conservative. For instance, the International Monetary Fund (IMF) only expects a 0.75% effect on GDP growth, while the European Central Bank expects a GDP growth rate of around 1.5% over the medium term. The reason for these different predictions is that they are strongly dependent on assumptions about several uncertain factors, such as absorption or efficiency rates.
To sum up, while the long-term consequences of the EU Next Generation recovery fund are questionable, we can be certain that besides the economic boost and the improvement in different sectors, the fund will have a considerable impact on the future of the EU. With the NGEU fund, joint lending will be implemented for the first time in the history of the EU, moving in the direction of an “ever closer union”.
Thus, by supporting countries in a difficult economic situation, wealthier member states embarked on the course of a “stronger Europe”. This contribution can be considered a huge success for the European Community. It can create a closer bond between the member states, ensuring a peaceful and prosperous future in the European Union.
Edited by Caspar Friedrich Kleine