Financial Wizardry

In her Brussels speech, von der Leyen said the Next Generation fund would “sit on top of a revamped long-term EU budget of €1.1 trillion,” bringing the new measures she was announcing to €1.85tn, on top of the earlier package of €540bn. “In sum, this would bring our recovery effort to a total of €2.4 trillion.” But a breakdown of the numbers shows this is a serious distortion of reality.

The first response package that supposedly consisted of €540bn includes €100bn in loans for short-time work schemes and €240bn in potential loans from the European Stability Mechanism bailout fund (ESM) – that has so far been left untouched because it is politically toxic due to its association in the minds of the public with the hated Troika.

The last component of the first response package consists of €200bn in European Investment Bank loans to SMEs – but the Commission is basing this figure on “leveraging” €25bn to mobilise private capital to make up the remainder. In reality this “€540bn package” consists of €100bn in loans that will actually be disbursed, and €25bn of additional funding for the EIB.

The European Parliament, usually on board with massaging the numbers through “leveraging” in order to impress their constituents, warned the Commission earlier this month “against the use of financial wizardry and dubious multipliers to advertise ambitious figures” in its response to the pandemic because the EU’s credibility was at stake.

The €1.1tn figure is the EU’s long-term budget so should not be included in examining the specific responses to the coronavirus pandemic and related lockdowns. In any case, this figure is even lower than the Commission’s 2018 legislative proposal for the budget that will run from 2021 to 2027. The EU’s budget consists almost entirely of contributions from member states based on their GNI.

The long-term budget has been steadily declining as a percentage of GNI-based contributions since 1995. The three institutions – the Parliament, Commission and Council of 27 member states – have been arguing fiercely over the size and content of the next MFF since 2018. The MFF operating from 2014-2020 was set at 1.03 per cent of EU28 GNI, but that rises to 1.16 per cent of EU27 GNI, once the British contribution is removed.

The Commission’s 2018 proposal for the 2021-2027 MFF was for 1.11 per cent of EU27 GNI, a sum of €1.135tn. The Parliament wants more, while a group of member states refuse to countenance contributions of more than one per cent of their GNI. 

The current proposal before the Council, put forward earlier this year by its president Charles Michel, is for an MFF of 1.069 per cent of GNI. It includes a massive increase in expenditure on security and defence, with severe cuts to spending on cohesion and the Common Agricultural Policy, by -12% and -14% respectively in comparison to the current MFF.

Cuts of this magnitude would be devastating to many of the EU’s so-called peripheral economies, who are disadvantaged by the architecture of the monetary union. For example, 80 per cent of public investment in Portugal relies entirely on EU cohesion funds.

The von der Leyen proposal for a budget of €1.1tn is slightly higher than what is currently on the table at the Council but still represents a retreat from the Commission’s original proposal. Her plan includes using the funds borrowed by the Commission to reinforce certain budget programmes including adding €55bn to cohesion policies, around €32bn to the planned Just Transition Fund (originally proposed to receive a paltry €7.5bn), and €15bn to rural development.

While directing some of the borrowed funds back into cohesion and rural development will help restore some of the resources these programmes were to lose in the next MFF, the final outcome actually represents a cut to the existing level of funding.

The centrepiece of the von der Leyen proposal – a new Recovery and Resilience Facility of €560bn – consists of grants of €310bn and loans of €250bn. Loans of any kind should not be included in assessing the response to the coronavirus pandemic; all member states can borrow at low interest rates.

If we remove all the spin, the amount of real new funds from the EU for this recovery plan is €310bn. It is not an insignificant sum, and it has been welcomed by countries such as Italy and Spain. But it is nowhere near the €2.4 trillion touted by von der Leyen in her speech. 

Even the proposed €750bn in borrowing represents is in reality less than what was put forward in the German-French plan for €500bn in grants.

Crunching the numbers, Eurointelligence estimates that, “The recovery element of the package amounts to an annual 0.56% of the EU’s 2019 GDP, for four years”.

Long Depression

The economic outlook has grown darker each week for the past there months. The Commission estimates that EU GDP has already fallen by 15 per cent in the second quarter of 2020 compared with 2019. The optimistic estimate is that GDP will fall by more than seven per cent in 2020 – but the Commission notes that this will be around 10 per cent in the worst-affected countries. 

However, if a second wave of infection leads to extended lockdown measures, EU GDP may drop by 16 per cent this year. It is increasingly unlikely that a second wave can be avoided, given that several countries that eased lockdown measures, such as China and Germany, quickly experienced an spike in the infection rate.

Eurozone member states have so far spent around four per cent of eurozone GDP, with around 20 per cent of eurozone GDP committee to loan guarantee schemes. But there is a huge difference between the member states’ responses, based on the sate of their public finances. German spending accounts for more than half of all state aid used so far, with its measures totally 29 per cent of German GDP. Italy, by comparison, has spent 17 per cent of its GDP.

The debt and deficit rules of the Stability and Growth Pact – that states’ debt-to-GDP ratio must be kept below 60 per cent, and annual budget deficits must be limited to three per cent of GDP – have been temporarily suspended but are enshrined in the Treaty and will return.

Under the Next Generation plan, the Commission’s €750bn debt will be repaid using three possible options, with von der Leyen saying her preference is for the EU to raise new own resources in future, such as a digital tax, a carbon border adjustment tax, the expansion of the emissions trading scheme, and a tax on large multinationals. The other two options are to pay back the money through future EU budgets until 2058, either through increased member state contributions or reduced programmes.

Raising significant new own resources will be difficult without changing the Treaty on the Functioning of the EU, which requires unanimous voting on taxation in the Council. A carbon border adjustment tax may gain the support of member states, but corporate tax proposals always stumble in the Council due to the opposition of a cabal of the EU’s tax haven member states – which includes the Netherlands, Luxembourg, Ireland, Belgium, Hungary, Malta and Cyprus.

Proposals for a financial transaction tax, a common consolidated corporate tax base, and a turnover tax on digital companies have been defeated or blocked in the Council. The proposal in the German-French plan for a minimum corporate tax rate in the EU was absent from von der Leyen’s proposal.

In its Financial Stability Review released on May 26, the European Central Bank predicted public debt will reach 200 per cent of GDP in Greece, 160 per cent in Italy, 130 per ent in Portugal and 120 per cent in France and Spain. On average, eurozone debt will rise from its current 86 per cent of GDP to above 100 per cent, while average deficits will be eight per cent of GDP.

Several states including Italy, Spain, France and Portugal will have to refinance large proportions of their debt within the next year. It warned: “The associated increase in public debt levels could also trigger a reassessment of sovereign risk by market participants and reignite pressures on more vulnerable sovereigns.”

The Commission acknowledges, “Government finances may be permanently weakened.” This presents a unique problem in the eurozone due to the ‘no bailout clause’ in the Treaty that prohibits direct monetary financing of government debt by the central bank, and the Stability and Growth Pact rules that impose a deflationary dynamic in a downturn.

The issuance of common bonds could be welcomed if the ECB was permitted to purchase unlimited bonds and cancel the debt or hold them in perpetuity. The Next Generation plan fails to deal with the fundamental contradictions of the EU’s economic architecture; it will add to member states’ national debt and trap them in a permanent austerity spiral.

Germany did an about-face on the question of eurobonds this month after its constitutional court ordered the country’s central bank, the Bundesbank, to stop participating in the ECB’s quantitative easing programme within three months unless certain conditions are met.

The implication of the ruling is that the German court believes for the ECB to comply with the monetary financing prohibition, it can no longer take the “whatever it takes” approach of guaranteeing unlimited support for eurozone economies.

Far from being a “Hamilton moment,” this plan represents German acquiescence to doing the bare minimum to hold the eurozone together in the short term.