After the European Council summit – the EU changes course

The European Union summit dedicated to supporting the crisis-stricken EU economy was exactly what many had expected. In terms of duration, it even outdid the negotiations on the Lisbon Treaty. It was also a festival of national selfishness and mutual grudges. It fully deserves to be called a lose-lose scenario with a long list of crossed-out best solutions and unfulfilled expectations. Finally, it was publicly hailed as a great success, bringing hope for economic revival and new dynamics of integration.

Expert debates turned into reality

When some think-tanks began formulating plans to create a huge fund that would support European economies in the amount of hundreds of billions of euros at the beginning of the pandemic crisis in March this year, politicians treated them as fantasies of little relevance. They argued that there were too many political obstacles and legal barriers that were difficult to overcome.

However, in May, German Chancellor Angela Merkel and French President Emmanuel Macron presented a joint idea that clearly referred to the experts’ concepts from two months earlier. Shortly thereafter, the European Commission went even further with the idea of an emergency fund, the ‘Next Generation EU’, for a total of 750 billion EUR, 500 billion of which was supposed to be grants, and the remainder was low-interest loans. The source of funding for the whole project was not national contributions, but the issuance of common bonds, which were to be repaid over the decades to come. The President of the European Commission, Ursula Von der Leyen, presented a plan that represents a chance to overcome the crisis, but is also a harbinger of a profound political change in the functioning of the EU.

Financial lifebuoy

In the course of the negotiations started on 18 July at the European Council, the ambitious Commission proposal was corrected. Although the rigid stance of the so-called ‘frugal four’ (the Netherlands, Austria, Denmark, and Sweden) did not change the total amount, it did force a reduction of the subsidy amount to 390 billion EUR in favour of loans.

The final package, to which we must add 1.074 trillion EUR from the seven-year budget (for the period 2021–2027), brings hope for clear macroeconomic results. This is not homeopathic dispensing of cash in a few thoroughly selected areas, but rather a broad stimulation of the economy that will affect the figures on unemployment, wages, and the overall fiscal sphere for many years to come.

Critics of these solutions emphasise that the European reconstruction plan came too late for it to have an impact on the most difficult, initial stage of fighting the crisis. They claim that in two years, when the scheduled funds will actually hit the market, it may be too late for that. However, they fail to recognise the crucial importance of companies’ and consumers’ expectations. The very decisions of the summit may induce businesses not to delay investment or hire new employees.

The great value of the adopted programme is that it can stop the dangerous diversification of the economic situation in the EU. According to data from the European Commission, the pandemic is not striking uniformly: in some countries it will cause a decline in GDP of up to 12%, while in others around 5%–6%. Furthermore, due to low public debt, some Member States can afford larger state support and emergency programmes for their own companies than the more indebted ones, e.g. Italy, Spain, and Greece.

In these countries, still suffering from the aftermath of the previous crash in 2008, the feeling that economic integration serves mainly the stronger states might grow. From there, it’s just a short path to aversion towards the EU and questioning the sense of the common market. The EU support programme reduces the risk of such a scenario. It also blurs other divisions, e.g. between the euro area and other countries. If the aid programme were only offered to members of the monetary union, the rest of the EU would perceive it as political discrimination, which would only strengthen Eurosceptic sentiments.

In addition, the ‘Next Generation EU’ may reduce the risk of the euro area being associated with the indebtedness of southern countries, particularly Italy. Optimists hope that more than 200 billion EUR, that will go to the Italian economy, will initiate a rapid growth in GDP and a gradual ‘growing out of debt’. If the government focusses on a balanced budget, while the nominal national income (i.e. along with inflation) increases by a few percent annually, the debt ratio – currently approaching 150% of GDP – will eventually start to decline.

Hopes for this scenario are associated with the fact that, having a promise of aid from Brussels, Prime Minister Giuseppe Conte may boldly persuade the society to reform public administration or the educational system or increase investment at the expense of some social budgetary items. Without a plan for European reconstruction, Italy would likely begin to slide into a spiral of recession and rising debt. Given that this is the EU’s third-largest economy (in terms of GDP), the fate of the single currency as well as the stability of the European banking sector would be at stake.

The EU on a new fiscal course

The expected economic recovery and greater cohesion of the EU are not the only possible effects of the Next Generation.

Perhaps even more important is the great qualitative change in the functioning of the European Union. A debt community is emerging: hundreds of billions of euros incurred by the bond issue will be repaid – in one form or another – by all Member States. The way of thinking about common transnational fiscal tools in the event of major crises will also change.

This is particularly visible at the level of the euro area. So far, the rescue could have come mainly from the European Central Bank (ECB), which supported the economy with record-low interest rates and massive bond purchases. As a result, even Member States in poor financial condition could issue very cheap debt. This unconventional monetary policy, however, has the significant side effects of discouraging the public from saving and worsening the condition of banks. The president of the ECB, Christine Lagarde, at the beginning of the pandemic crisis, had called for fiscal policy (through, e.g. taxes and government spending) to be much more actively involved in the stabilisation measures—this time not only at the national level, but also as a community. It looks like we’ve finally reached that point.

However, the Council’s decisions mean a deepening integration not only for the euro area, but for the entire EU. After all, the issued debt will refer to the ‘27’, and pan-European taxes will be the best solution to settle that. The CoE has already agreed to charges on plastics, and more taxes are waiting in line: the limit on CO₂ emissions, the digital tax, and the tax on capital transactions. A market of joint, safe, and low-interest bonds is also emerging, which will encourage the creation of new EU funds. Therefore, the assurances raised (e.g. by Chancellor Merkel) that the Next Generation is a one-off mobilisation do not sound very credible. The financial incentives to repeat these mechanisms will be too strong.

The course to build a fiscal union marks the beginning of the political rearrangement of the group. There are new opportunities, but also dilemmas, many of which were revealed at the last summit.

First of all, the easier it will be to acquire funds from debt issuance, the greater the resistance to financing common EU spending from national contributions. During the summit, the current payers of the multiannual financial framework demanded not only to maintain, but even to increase contribution discounts, e.g. Austria to 652 million EUR and the Netherlands to 1.92 billion EUR per year. As a result, the seven-year spending pool has dwindled compared to the Commission’s original plans – and at the expense of the much -needed resources for research and the green transition.

Secondly, payers will also push through various mechanisms for controlling the use of funds more aggressively, if only because of their growing scale. The Netherlands fought hard to introduce the principle of unanimous approval of reform plans, which all beneficiaries would be obliged to carry out. Ultimately, this decision will be made by a qualified majority voting, as will the assessment of whether a beneficiary is complying with the rule of law. Therefore, in the long run there is a need to clarify the rules, and even to create specialised joint supervision agencies, similar to those that have already been established within the banking union. Today, it is easier to understand the postulates of establishing an EU treasury or minister of finance, as put forward a few years ago; in a fiscal union in statu nascendi these would make sense, as they would help avoid political disputes between states.

Thirdly, the prospect of deeper fiscal integration will further aggravate disputes over the EU’s economic model. Those who hoped for a greater consensus in the EU following the departure of liberal Britain must now feel disappointed. At the summit, the Prime Minister of the Netherlands, Mark Rutte, passionately played the role of David Cameron, not to say Margaret Thatcher. In fact, he has been promoted to the leadership of those countries in the north of the continent that are committed to the free market, competition, and limited redistribution. He will most likely have no qualms about demanding a return to the policy of budget austerity and to hard enforcement of the Stability Pact after the worst of the crisis has passed.

A dispute for years

The South has no intention of submitting to the pressure of the Northern countries – and it has some arguments for this.

Italians, Spaniards, and Greeks will strive to convince the rest of the members that the euro area gives countries like the Netherlands a structural advantage in the form of undervaluing the exchange rate and puts the burden on Mediterranean economies.

This way, according to Professor Alexandre Alfonso from Leiden University, there are ‘market transfers’, taking place as part of competition on the common market, less visible to voters, but still ‘devastating’ to the resources of the South. In order to balance them out, it is necessary to activate ‘political transfers’, i.e. government intervention in the market, preferably through redistribution. The problem is that they are difficult to agree at the EU level, and without them, the continued existence of the euro area may be endangered.

An example of a ‘market transfer’ – which is used as a strong accusation against the Dutch – is unfair tax competition. By attracting EU companies with low tax rates, Rutte’s government is making billions at the expense of other Member States, which is especially painful for the indebted South striving to increase its fiscal revenues. Tolerance towards the Dutch tax haven is decreasing in the EU and there may be an EU initiative targeting this type of practice in the coming months. This will very likely become a battlefield in a future North–South confrontation.

In the conditions of deepening fiscal integration, the dispute between the liberal Hansa model centred on the Netherlands and the interventionist alliance led by Italy will increasingly affect the development dilemmas of Central European countries. Their forms of capitalism involve fewer simple choices inherent in transitional economies that seek capital to ‘catch up’. There are more and more dilemmas regarding the proper combination of the free market and the state interventionism – the very essence of the economic division between North and South. The time is approaching when Central Europe will have to decide which model is more appropriate for them.

Sebastian Płóciennik – Coordinator of the Weimar Triangle programme at the Polish Institute of International Affairs. He specialises in research on the German economy and economic integration in Europe. A graduate of law and a doctor in economics, holder of DAAD and Commerzbank Foundation scholarships. From 2015 to 2017 he was co-chairman of the board of the Foundation for Polish–German Cooperation (FPGC). 

Polish version is available here.