Mujtaba Rahman is the head of the Europe practice of the Eurasia Group and the author of POLITICS‘s Beyond the Bubble Column. He tweets to @Mij_Europe.
COVID-19 has been good for the EU.
Unlike any other region in the world, Europe is now both more cohesive and resilient in the aftermath of the crisis. But these precious gains risk being lost if the economic recovery is not managed sensibly. As policymakers begin to negotiate the bloc’s fiscal rules, worrying signs are looming on the horizon.
Two reasons explain the greater resilience of the EU after COVID. Most important is the creation of the recovery fund – a vehicle set up at the height of the crisis to enable large-scale European-wide borrowing in capital markets, which is then transferred to the most affected member countries. by the pandemic. By facilitating their economic recovery, without increasing their debts, the fund has made the euro area more robust and will set a precedent for how the EU will deal with external shocks in the future.
The stimulus fund has also made it more difficult for populism to prosper. It’s hard to criticize € 180 billion – nearly 10.5% of gross domestic product (GDP), in Italy’s case – for why Matteo Salvini’s nationalist far-right party duly joined a coalition reformer led by Prime Minister Mario Draghi.
There are other reasons the populists have had a bad crisis. The simplistic country-focused solutions offered by Salvini and French Marine Le Pen in recent years have become much more implausible in a pandemic, which is global in nature. Countries where populists have been successful in pitching voters against immigration have also found that immigrants tend to occupy critical front-line roles. With growing deference to scientists, anti-expert sentiment across the continent has also receded, and the EU’s vaccination effort is now a resounding success – with 70 percent of adults fully vaccinated.
However, these achievements risk collapsing if EU countries mismanage the recovery. The key to this will be whether – and how – the EU’s fiscal rulebook, known as the Stability and Growth Pact, is reformed.
The pact stipulates that the deficits and debt levels of EU countries must not exceed 3% and 60% of GDP, respectively, and must fall quickly if they do. But during the pandemic, he was suspended under a provision known as the “general safeguard clause”. The pact is expected to come back into force in 2023, and if the rules don’t change, EU national governments will be forced into unprecedented tightening, having put in place unprecedented budget support throughout their lockdowns.
A public ‘reflection’ of the rules, involving expert speakers, academics and think tanks, will be launched by the Commission later this month. The conclusions that emerge are clear: they will suggest that the focus of fiscal policy should shift from austerity to growth and that more attention should be paid to incentivizing public investment in Europe’s green and digital transitions.
As sensible as these suggestions may be, substantive negotiations between member countries and EU institutions will only begin once a new German government is in place. Based on the events in Berlin, it could be early next year.
However, the Commission must provide clear guidance to national governments on the EU’s fiscal targets for 2023. The deadline for this is next April, when EU countries submit their so-called Stability and Convergence Programs , previewing their budgets for the fall.
Assuming a coalition is in place in Germany by the end of the year, that leaves around four months to reach consensus on what the EU’s forward-looking fiscal rules should be. It is this truncated time frame that the fiscal hawks are trying to exploit opportunistically.
Valdis Dombrovskis, executive vice president for all things economics, will oppose substantial change. Dombrovskis remains keen to put countries with relentlessly high deficits and debt – including France, Italy, Spain, Greece and Belgium – into an “excessive deficit procedure”.
Other high-level voices within the Commission are also seeking a more orthodox implementation of the Stability and Growth Pact and fear that the Commission will still be perceived as being too lenient. Indeed, even those who are in favor of the reform are not pushing for a new suspension of the rules in 2023.
Facing Dombrovski are the European Central Bank, the European Fiscal Council, a majority of the College of European Commissioners and, above all, Commission President Ursula von der Leyen. She wants a “new set of rules in the medium term”, says a senior EU official familiar with her thinking, “in particular to facilitate the green transition”.
While Northern Europe is likely to oppose big reforms, Berlin’s position is less clear and will ultimately depend on the nature of the new government. The risk is that an inexperienced Chancellor devoured by coalition management will be more cautious and less ambitious in Europe.
In light of these signals, French Finance Minister Bruno le Maire downplayed expectations of a deal under the French presidency in the first six months of next year. Nonetheless, the best scenario for reformers would be for the French Presidency to adopt concrete legislative proposals on new European fiscal rules early next year. The Stability and Growth Pact deficit and debt levels are set in the Maastricht Treaty, but the pace at which debt levels are to be reduced each year is not.
This leaves room for a new, simpler framework that would also exclude investments in high-quality public goods from EU deficit calculations and change the debt rule which states that member countries with a debt ratio of above 60% would reduce their excess debt to GDP by 1 / 20th every year.
Some in Brussels and Paris would also like more decentralized fiscal governance, allowing EU capitals to design their own adjustment trajectory, with the Commission playing the role of arbiter and drawing consequences from the failure of national efforts.
If there is no consensus on these issues by March, the Commission would instead be forced to publish a communicated – interpretive advice for member countries indicating where Brussels thinks the budgetary framework will end. The goal would be to give governments enough leeway to interpret the rules more flexibly – depending on where they go, as opposed to what they say today.
It is in this scenario that the fiscal hawks of Northern Europe will rush – pushing member countries to break the old rules while the new ones are renegotiated. This could give rise to a large number of excessive deficit procedures. As another senior Commission official put it: “Some people argue that you can decouple thinking and our annual budget cycle. You can therefore open the EDP and then see how the exam goes. The official continues: “The dynamic could disappear if we discuss too long without tabling legislation. “
Most Brussels officials believe that the Stability and Growth Pact will not be fully mechanically reapplied in 2023 and that the “brakes will not be fully squeezed”. The idea of putting France in an excessive deficit procedure in the wake of Emmanuel Macron’s presidential election, on the one hand, is extremely unlikely.
But this result remains far from clear. The EU’s recovery and the credibility of its net zero transition are at stake.