A historic breakthrough. A “Hamiltonian” moment. A very deep transformation.
Political leaders and analysts have reached for momentous analogies to describe the €500bn European coronavirus recovery fund proposed by France and Germany this week.
Given longstanding differences between Paris and Berlin over the need for more risk-sharing in the eurozone, an agreement to raise €500bn through common EU debt and hand it out as grants, and not loans, marks an important shift.
But how does the plan measure up against the goal of fiscal union, argued by many to be essential for the euro’s long-term survival?
Fiscal union means different things to different people, but arguably there are four components: debt issuance, fiscal transfers, revenue-raising and centralised governance.
Defending the plan in an interview with Die Zeit on Wednesday, German finance minister Olaf Scholz invoked Alexander Hamilton who in 1790, along with Thomas Jefferson and James Madison, persuaded the American states to agree to a new national capital in return for the federal government assuming their war debts.
“Our ability to convince others of our proposal will determine if this is actually a European Hamilton moment,” Jörg Kukies, Germany’s deputy finance minister, told the Financial Times. “The new element here is the proposal to pool revenue collection powers and autonomous borrowing powers at the level of the central government.”
In multiple respects, however, the plan falls well short of Hamiltonian nation-building. There would be no mutualisation of outstanding debt. The recovery fund is intended to be a temporary measure. And other member states may yet water down the proposal.
The plan would mean the joint issuance of European debt. The European Commission has borrowed money on several occasions to help countries in difficulty, albeit not on this scale. Under this proposal, debt would be issued against future EU budget resources.
An EU bond with a triple A rating would be a safe asset, said Vitor Constâncio, former vice-president of the European Central Bank, and would add to the risk-free securities already issued by other institutions such as the European Investment Bank.
A safe asset is considered another desirable feature of fiscal union, providing a eurozone benchmark for other securities akin to US Treasury debt. But the proposed recovery fund may be too modest to make much of a difference.
“For the market to have a risk-free asset you need to have a lot more than €500bn to have liquidity all along the maturity curve,” said Erik Nielsen, chief economist at UniCredit. “And an assurance that it will carry on being issued.”
A central budget
True fiscal union would incorporate some centralised spending power, and here matters are further advanced. The EU’s €1tn seven-year budget already redistributes funding received from member states to poorer regions via its cohesion programme.
Germany and France are proposing to take a significant further step by allowing the EU to borrow money on the capital markets and funnel this to member states that need it in the form of EU “budgetary expenditure”.
If targeted at the worst-hit countries, €500bn, which, amounts to nearly 4 per cent of EU gross national income, could provide a chunky fiscal boost.
Yet if the overall objective of the fund is to help countries avoid unsustainable debt burdens, it might not make that much difference, noted Mr Nielsen. If Italy were to take €100bn from the fund, its debt-to-gross-domestic-product ratio would stand at 149 per cent at the end of next year instead of 155 per cent, according to UniCredit calculations.
For many analysts, the symbolism of Berlin’s embrace of mutual debt issuance in the name of solidarity is more powerful than the real macroeconomic impact of the scheme.
“The German-French proposal carries historic weight and should be understood as a eurobond trial balloon, with Germany taking a relatively huge leap of faith,” Katharina Utermöhl, chief economist at Allianz, wrote in a note.
New EU taxes
To constitute a real “Hamiltonian” moment the member states would have to go a long way and confer significant taxation powers on the EU, said Shahin Vallée of the German Council on Foreign Relations. Nothing in the agreement approaches that now.
The commission’s plans, likely to be unveiled next week, will probably contain proposals for it to be granted additional “own resources”, officials say. Already the EU is partly funded via own resources including customs duties, but additional revenue streams could help service the commission’s new debt.
A truly decisive step towards fiscal union would require much larger quantities of own resources to be handed over. This would also require unanimous agreement from the member states, and would be anathema to many national treasuries.
Mr Kukies insisted there was scope to go a very long way. “If we had a proper capital markets union, you could have a uniform capital gains tax at the EU level in the future. Then there’s what Germany’s Mr Scholz suggested — a financial transaction tax, or an emissions trading system for air and sea traffic.”
A fiscal union would normally have a single finance minister responsible for borrowing and spending. But the Franco-German plan would do little to change the EU’s hybrid governance system. As well as approving the EU budget every seven years, national capitals also have the final say on new EU-wide taxes.
One key question is what conditions would be attached to transfers made under the new fund. Mark Rutte, the Dutch prime minister, has insisted that aid would have to be linked to far-reaching reforms, in terms that will trigger anxiety among some southern European member states.
For its part, the commission wants to create a clear link with the economic policy recommendations it agrees annually with each country. Valdis Dombrovskis, the commission’s executive vice-president for economic policy, said on Wednesday that this process would “provide guidance to member states” in preparing their recovery plans, which would be used by governments to support their requests for EU funds.
Additional reporting by Martin Arnold and Jim Brunsden
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