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Europe’s next budget is another twist in long road to solidarity

Summary:
Despite the failure of European leaders to agree on next steps battling the COVID-19 pandemic, their meeting on April 23 hinted that progress toward economic recovery and a pro-European approach is becoming more likely. The political and financial proof of such progress would come in the form of the European Union’s forthcoming €170 billion annual budget. Member states have begun political negotiations on the next multiannual financial framework (MFF) budget, scheduled to start in 2021. Europe should reorganize the 7-year regular MFF to better address the aftermath of the pandemic, and to agree to an additional temporary recovery fund aimed “towards the sectors and geographical parts of Europe most affected” by the health crisis. Why choosing the MFF budget signals EU solidarity This

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Despite the failure of European leaders to agree on next steps battling the COVID-19 pandemic, their meeting on April 23 hinted that progress toward economic recovery and a pro-European approach is becoming more likely.

The political and financial proof of such progress would come in the form of the European Union’s forthcoming €170 billion annual budget. Member states have begun political negotiations on the next multiannual financial framework (MFF) budget, scheduled to start in 2021. Europe should reorganize the 7-year regular MFF to better address the aftermath of the pandemic, and to agree to an additional temporary recovery fund aimed “towards the sectors and geographical parts of Europe most affected” by the health crisis.

Why choosing the MFF budget signals EU solidarity

This choice means that additional fiscal solidarity in Europe probably won’t occur until the next MFF starts in 2021. Until then, the European Central Bank (ECB) must continue to provide much of the macroeconomic stabilization, helped at the margin by the support package endorsed in April by EU finance ministers.

The EU treaty requires that the MFF, like the EU budget, must be approved by the European Parliament. Unlike the European Stability Mechanism (ESM), its coverage goes beyond the euro area. Choosing the MFF signifies EU solidarity and avoids another attempt at using the pandemic to reform euro area institutions. The relative ease of this process also suggests that Brexit has facilitated EU level agreement.

Member states fund the regular EU budget according to their ability to pay. By definition, to channel money where it is most needed, the budget will involve redistributive fiscal transfers from richer and larger member states. Fiscal transfers among countries, a perpetual reality in any EU budget, are somewhat constrained by politics but not politically unacceptable. Accordingly, transfers from a revised and/or expanded regular MFF could be steered toward countries most affected by the pandemic, especially Mediterranean countries dependent on tourism.

An MFF recovery fund could be created by increasing member state contributions to EU budget

The MFF recovery fund’s elements remain undecided. But EU Commission president Ursula von der Leyen, tasked by EU leaders to present a proposal, said the Commission would propose a temporary 2- to 3-year increase in the maximum allowed scale of the EU budget’s own resources (revenue) from member states from 1.2 to 2 percent of annual EU gross national income (GNI). The GNI for the 27 member states (EU27) in 2018 was €13.5 trillion,[1] implying a revenue increase from this source would range from €162 billion to €270 billion in total, or €108 billion annually. In 2018, however, the 27 member states contributed only €90 billion to the EU budget in GNI-based revenue, or only 0.67 percent of EU27 GNI. The total possible increase by going to 2 percent of GNI contributions would have therefore been €180 billion in 2018. Von der Leyen’s proposal could thus, assuming 2018 figures, suggest a 3-year recovery fund of €540 billion.

Member states may bridle at such a sum, but von der Leyen’s proposal cannot be dismissed out of hand. The Commission president also announced her intent with EU leaders’ blessing to “explore innovative financial instruments in relation to the MFF.” This is clearly a hint that the Commission intends to rely on financial leverage to maximize the firepower of the new recovery fund.

A precedent for leverage exists with the European Fund for Strategic Investments (EFSI)—the Juncker Plan first proposed in 2014—which with relatively few public resources (€33.5 billion from the EU budget and European Investment Bank) aimed to unlock €500 billion in public and private investments by 2020. EFSI hence operated with a leverage factor of almost 15.

But if the Commission were intent on replicating the EFSI today and attempt to predominantly attract private investment capital to meet its recovery fund goals, it would be making a terrible policy error. Private investors in the midst of the current downturn will be understandably risk averse and not likely to commit enough of their money. For the recovery fund to succeed, it would need far more new public money in it than the EFSI did. It would also need to use this money to raise new jointly guaranteed bonds backed by all EU member states. That goal is realistic, given the proposal to increase the EU budget’s GNI-based resources to 2 percent, even if the increase is not fully granted by EU member states. Concerns that just another EFSI is being planned appear too cynical at this stage.

With an additional annual €100 billion in budget commitments (0.74 percent of 2018 GNI), the Commission would have a total of €300 billion available between 2021 and 2023, enough to back raising between €1 trillion and €1.5 trillion in new jointly guaranteed bonds, depending on what leverage factor between three and five is chosen. The smaller the amount of new GNI-based resources for the recovery fund, the higher the leverage factor required to reach a relevant scope of at least €1 trillion.

Functionally, the recovery fund is likely to be focused on investments in Europe’s Green Deal, digital infrastructure, health care, and innovative green transportation. A big visionary strategy is most likely to win broad public and political support.

The EU Commission is scheduled to propose its budget plan by May 6. Tough negotiations about size, grants versus loans, and who will pay how much will quickly ensue. Germany’s position will be decisive. Chancellor Angela Merkel has made it clear that Germany will contribute considerably more to the next MFF, and many other member states can be expected to follow suit. As EU president in the second half of 2020, Merkel is already preparing her 6-month EU presidency to conclude a final agreement, securing her a European legacy before stepping down in 2021. Merkel’s current approval ratings of over 80 percent suggest she has the political capital to spend on this, if she chooses.

Notes

1. Estimates exclude the United Kingdom from 2018 values. All budget data available from the EU Commission.

Jacob Funk Kirkegaard
Jacob Funk Kirkegaard, senior fellow, has been associated with the Institute since 2002. Before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector. He is a graduate of the Danish Army's Special School of Intelligence and Linguistics with the rank of first lieutenant; the University of Aarhus in Aarhus, Denmark; the Columbia University in New York; and received his PhD from Johns Hopkins University, School of Advanced International Studies.

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