Home The Washington Diplomat July 2020 European Union Hopes to Rise to the Challenge with ‘Next Generation’ Budget

European Union Hopes to Rise to the Challenge with ‘Next Generation’ Budget

European Union Hopes to Rise to the Challenge with ‘Next Generation’ Budget

With the head of its central bank predicting the worst economic downturn since World War II, a global pandemic raging and its second-largest economy about to completely depart, these are trying times — yet again — for the European Union.

The economy of the world’s largest trading bloc will likely shrink between 5% to 12% this year, according to the European Central Bank, due to a combination of anti-coronavirus lockdown measures, an already sluggish economy and major global uncertainty.

That latter factor bundles together a potentially apocalyptic number of factors, too — any one of which would ordinarily be a major cause for concern. The U.S.-China trade war, an unpredictable U.S. election in November, the fallout from the oil and gas market collapse and the pandemic-driven, worldwide crash in economic demand are just some of the looming dangers — not to mention a possible second wave of the coronavirus in the fall.

With this convergence of crises, the EU faces the herculean task of having to meet extraordinary times with extraordinary measures.

What has surprised many Brussels-watchers — skeptical after the EU’s disappointing, plodding responses to past crises — was that this time, the bloc may have finally come up with a plan to address the urgency of the times: the “Next Generation EU” budget.

The plan could see the European Commission borrow €750 billion to distribute to EU member states over the next seven years to combat the economic impact of the virus. The funds would be added to the EU’s proposed €1.1 trillion budget for 2021 to 2027.

Unlike previous rescue packages, Next Generation will be made up mostly of grants (€500 billion), rather than loans — a major turnaround from the EU financial crisis over a decade ago, when wealthier nations, led by Germany, offered loans and austerity measures, as opposed to direct relief, to cash-strapped eurozone members like Greece and Italy.

The Next Generation plan would mark the first large-scale effort to transfer funds from richer EU countries to struggling ones — namely southern states that have been hit hard by the pandemic — using money borrowed collectively by the European Union and backed by all 27 members. These grants would be free and not add to the national debt of the member states that receive them. Instead, they would be repaid over the long term (a period of 30 years) by the bloc as a whole.

Creating a common recovery fund is an unprecedented move considering that fiscally prudent countries like Germany have long sought to avoid putting their citizens on the hook for bailing out their poorer, indebted neighbors.

If passed, Next Generation would deepen European integration after years of populist movements have fought to distance their countries from Brussels. Some have even hailed the new fiscal union as Europe’s “Hamiltonian moment,” referring to U.S. Treasury Secretary Alexander Hamilton, who transformed the United States from a loose confederation of former colonies into a real federation with a central government.

“The pandemic has played into a sense that we have to help each other,” Boris Ruge, Germany’s former deputy chief of mission to the U.S. and vice chairman of the Munich Security Conference, told The Washington Diplomat. “To keep our economies, our single market going, we realized we have to reach out.”

Yet a lot still has to happen before this massive fiscal injection can be administered. Negotiations will start in July and objections from fiscally hawkish EU member states still have to addressed, while a lengthy period of approvals in Brussels and in national parliaments will also have to be worked out to reach unanimous approval. And if the plan fails, it could re-energize euro-skeptic populist parties.

Nonetheless, there is widespread optimism in Brussels that a new chapter is being written for the EU, with the hope that it may also help address a string of other pressing problems within its ranks.

Sea of Troubles

Indeed, the Next Generation package is being proposed at a time of great political challenge — and strain — for the EU.

The U.K., which long vied with France as the bloc’s second-largest economy, will complete its 11-month transition to a full Brexit divorce on Dec. 31, with no deal in sight for finalizing a trading relationship with the EU, setting both sides up for yet another dramatic Brexit economic cliff.

At the same time, east and southeast of Brussels, trouble has been brewing for a while with the “Visegrád Four” — Hungary, Poland, the Czech Republic and Slovakia. Recent years have seen a number of increasingly bitter disputes between the leaders of these countries and EU institutions.

These have ranged from the European Parliament (EP) condemning Czech Prime Minister Andrej Babiš in a conflict of interest case; European Commission threats to withdraw funding from Polish provinces that have declared themselves “LGBT-free zones”; and EP condemnation of Hungarian anti-coronavirus legislation that gave Prime Minister Viktor Orbán the power to rule by decree, with no time limit.

The decree prompted Sophie in’t Veld, chair of the EP Rule of Law Committee, to declare at the end of March that, “The actions of the Hungarian government are incompatible with EU membership.” (Hungary counters that its emergency measures curbed the spread of the virus in record time and that the decree has since been lifted.)

The criticism follows years of frustration in Brussels with what EU diplomats say are Hungary and Poland’s attacks on the judiciary, media and immigration.

Meanwhile, a highly damaging event for the European Central Bank’s (ECP) efforts to prop up the bloc’s economy occurred on May 12 when the German Constitutional Court ruled that the ECB’s coronavirus relief bond-buying program was illegal under German law. It also suggested that German courts could overrule the European Court of Justice (ECJ) — a move that undermines the ECJ’s role as the bloc’s final legal authority.

French President Emmanuel Macron and German Chancellor Angela Merkel are seen at a NATO heads of state meeting in July 2018. For years, Merkel has resisted Macron’s attempts at greater European economic and security integration, but with the onset of the coronavirus pandemic, the two leaders agreed on a €500 billion grant recovery fund that would be added to the EU’s seven-year, €1.1 trillion budget. (Photo: North Atlantic Treaty Organization)

The European Central Bank quickly countered that it follows decisions taken by the ECJ, not national courts, but the ruling does bolster the position of eurozone members that oppose the bank’s quantitative easing program to stimulate growth in the wake of the pandemic. That program stands at €1.35 trillion, with the bank saying it can ramp up its bond-buying until June 2021 to address what ECP President Christine Lagarde called an “unprecedented” economic contraction.

The German ruling could also have implications for the EU’s attempts to call out members that it accuses of straying from the bloc’s democratic norms.

“The risk that this sets a precedent looms large. It may even be more relevant in political than in economic and financial terms — think Hungary and Poland, for example, whose leaders have their own disputes with European institutions,” Holger Schmieding, European economist at Berenberg Bank, told CNBC’s Silvia Amaro.

Lessons Learned

The Next Generation EU budget was thus unveiled in a far-from-ideal context. In addition, its rollout is haunted by memories of the acrimonious disputes among EU states over how to respond to the 2007-08 global financial crisis — and the consequent economic pain that response wrought on some states.

“The EU response back then was very weak,” Zsolt Darvas, senior fellow at the Brussels-based think tank Bruegel told The Washington Diplomat.

When the economies of Greece, Cyprus, Portugal, Italy, Ireland and Spain went into meltdown, many in those countries slammed the wealthier EU member states for abandoning them.

“Back then,” Darvas says, “solidarity between EU countries came in the form of loans and these, of course, have to be repaid.”

This resulted in onerous austerity programs and long-term debts, further weakening the most badly affected economies and hurting millions of people who lost jobs and social services while seeing their taxes jump. This economic pain has been widely blamed for many of the EU’s subsequent political and social problems, including the rise of populism.

The bloc’s inability to form a unified response to the 2015 refugee crisis — when over 1 million asylum-seekers from poorer, war-torn countries flooded Europe’s shores — also fueled a huge populist backlash that shifted the political landscape.

Christine Lagarde, president of the European Central Bank, addresses a call-in audience during an ECB Governing Council press conference in Frankfurt, Germany, on April 30. Lagarde has previously said that the bank will do what it takes to address what she describes as an “unprecedented” economic contraction due to the coronavirus pandemic. (Photo: Dirk Claus / European Central Bank)

Then, when coronavirus began to arrive in Europe, it was Italy and Spain that were impacted the most heavily, with many there initially feeling that, once again, the EU was not helping, as their hospitals quickly became overwhelmed and countries like Germany initially hoarded personal protective equipment. Germany subsequently donated equipment and other critical supplies to other member states, but the damage in public opinion was already done. One survey by pollsters Tecme showed that support for leaving the EU in Italy had risen from 26% in November 2018 to 42% by April 2020.

The pandemic is “the biggest existential crisis in the history of the EU,” Germany’s current ambassador to Washington, Emily Haber, said during a virtual meeting hosted by the Council on Foreign Relations on June 15.

Conscious of this, key EU players France and Germany decided they had to take more radical action.

“The breakthrough moment was May 17,” said Darvas. That day, German Chancellor Angela Merkel and French President Emmanuel Macron proposed that the €500 billion Next Generation recovery fund be added to the EU’s seven-year, €1.1 trillion budget.

By targeting the worst-off states, the rescue plan could have a huge impact. Greece, for example, could obtain grants equivalent to 15% of its GDP — a major boost for its beleaguered economy.

“Extraordinary circumstances call for extraordinary measures,” Merkel said at a press conference following a video call with Macron after sealing their agreement.

It’s a sharp about-face for Merkel, who for years insisted on austerity — not handouts — to countries like Greece. Now in the twilight of her political career, however, the longtime German leader has staked a large part of her legacy on preserving European unity in the face of a litany of seemingly intractable crises.

After initially resisting Macron’s calls for greater EU fiscal and security integration, Merkel appears to have recognized that this crisis is different. In part that’s because it doesn’t involve bailing out profligate countries who gorged on credit and mismanaged their finances. Rather, it’s about protecting the entire bloc from a global health crisis that threatens everyone’s well-being. As Haber put it, “there’s no single responsibility for this development.”

The pragmatic German chancellor is also likely well aware that all EU member states — hers included — depend on one another for trade. Quarantining affected nations will not prevent the economic hemorrhaging of the entire continent.

And while Merkel has insisted that Next Generation grants will be a “one-off” measure, her break from her northern counterparts — which insist fiscal discipline is the long-term solution to the economic woes of southern EU states — is an enormous shift.

Frugal Four

As the most powerful member of the European Union, Germany’s support of Next Generation carries significant weight. Still, the package is not universally popular. Austria, Denmark, Sweden and the Netherlands — known as the “frugal four” for their advocacy of EU financial conservatism —oppose the measure and will be a force to be reckoned with during negotiations. (Opposition could also come from less-well-off Central and Eastern countries that have largely managed to contain the virus.)

The frugal four argue that the EU’s €1.1 trillion budget is already being badly spent. For example, around a third goes to agricultural subsidies, while there is also considerable “leakage,” i.e. money that disappears in unaccounted-for activities. What would be better, they say, is to undertake a root-and-branch revision of the budget to free up money that can then be used to help those worst impacted by the virus.

Austria, Denmark, Sweden and the Netherlands also point out that there is no such thing as “free money,” and that any rescue funds will eventually have to be paid back by taxpayers. That’s why they prefer loans with favorable — but time-limited — terms for hard-hit nations.

At the same time, nothing in the EU ever moves fast. A meeting of the European Council on June 19 decided to continue the debate over Next Generation with more meetings over the summer — negotiations that will likely alter the eventual balance between grants and loans, as well as their overall size. “It could be months before the package is passed,” Ruge said.

The bulk of the money will not be disbursed for many years, either.

“The European Commission predicts that only 6% of the money will be spent in 2021,” said Darvas, “and 18% in 2022. The largest portion will be in 2023 to 2024” — potentially long after the pandemic has passed.

One factor boosting the proposal’s chances, however, is the start of the German EU presidency on July 1 (a fact watchers say could also bode well for Brexit negotiations, given that Merkel will want an orderly departure).

“It will be a test case for the German presidency,” said Ruge, “and for the EU.”

About the Author

Jonathan Gorvett (jpgorvett.com) is a contributing writer for The Washington Diplomat and a freelance journalist specializing in Near and Middle Eastern affairs.