Those calling for a strong EU response to the coronavirus recession seem close to political victory. France and Germany agreed on a sizeable bond-funded spending package, and the European Commission followed up last week with an even more ambitious proposal for a €750bn recovery fund. The economic argument, however, is far from closed.
The case for common EU-level spending has been that the countries worst hit by the pandemic have also tended to be those with the weakest public finances. The fear is that this would hamper their ability to engage in the massive deficit spending better-placed EU states, above all Germany, quickly engaged in despite being less affected by Covid-19.
When commission president Ursula von der Leyen presented her proposal last week, she justified it by saying the “asymmetric impact of the crisis is exacerbated by the different capacities of member states to support their economies”.
But the fiscally most hawkish members of the bloc have been quick to point out that even Italy’s bond rates are very low. Borrowing is cheap and the normal fiscal rules have been suspended, so why not let each country finance its own recovery programme?
“The bottom line is that the governments in question, in particular Italy, have not been constrained”, says Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics. While some countries have been slower than others in putting in place big fiscal rescue packages for their economies, that is caused “more by political inertia than by the bond markets”, according to Mr Kirkegaard.
Taking official forecasts for the increase in spending expected over the next year, he points out, there is at best a weak relationship between public debt burdens going into the crisis and the forcefulness of each European country’s fiscal effort to combat the economic fallout from Covid-19.
Strong action by the European Central Bank, which has committed to bond purchases at roughly the same scale as eurozone governments are expected to issue new debt this year, means borrowing costs have remained low.
“Market participants will continue to buy the bonds of Italy and others because they think the ECB is there”, says Mr Kirkegaard, so a degree of “solidarity” with vulnerable member states is already in place. But that also means that in a strict economic sense, there may be little need for fiscal transfers on top.
The proponents of common borrowing and spending may have sensed the possible weakness in the argument from “fiscal space”, because they have increasingly emphasised another: that different degrees of coronavirus-related support for business in different countries are a threat to the integrity of the EU’s single market. The commission’s plan includes a “solvency support” programme for equity injections in struggling companies.
This argument can also be overdone, thinks Mr Kirkegaard. He accepts there is a “clear risk” of destabilising the level playing field in the EU, but it is an “empirical question” whether this is happening.
“On paper, these loan guarantees are very, very large,” he says, but the actual rate of take-up can be much smaller. Rather than affordability, he thinks the big question is whether the suspension of normal state aid rules will drag on for much longer, beyond the end of this year.
Most observers expect the commission’s plan to go through because the most “frugal” countries — Denmark, Sweden, Austria and the Netherlands — will find it hard to resist now that Germany is on board. Instead, they are likely to redouble their efforts to ensure that the money is spent well.
In the case of the solvency support instrument, for example, “you don’t want to make this a vehicle for domestic industrial policy and saving weak national champions”, says one official from a Nordic country.
Even if the economic case is not watertight, the recovery fund is politically significant. “We should be honest”, says Mr Kirkegaard. “People in the south need to see that there is an insurance policy aspect to the EU.”
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