We asked a group of analysts to share with us their insights on the Franco-German deal.
«It represents a welcome rebalancing of the policy mix towards fiscal policy»
How should one judge the Franco-German proposal? Against a first best of a permanent safe asset mechanism, mutualising debt on a large scale and introducing a transfer union? Or as a political compromise which nevertheless opens up hitherto unthinkable policy options? I would argue the latter, and in that sense, it ticks many boxes. First, it represents a welcome rebalancing of the policy mix towards fiscal policy, especially in light of the German Constitutional Court ruling on ECB action.
The proposed size (500 billion euro), while not as high as some other proposals circulating, represents real money rather than leveraging and as such is ambitious enough. In terms of financing, the explicit link to the MFF provides legal certainty and democratic accountability but sets the stage for a difficult budgetary negotiation requiring unanimity. While some new own resources are alluded, the proposal unfortunately does not break much new ground, as would an explicit link to a carbon tax and a digital tax. Finally, when it comes to choosing the borrowing institution, the decision to task the European Commission is a welcome return to the Community method, after years in which the balance had decidedly tilted towards inter-governmental agreements.
«Nothing is agreed until everyone agrees»
Many described the French-German plan as Europe’s Hamilton moment, referring to the mutualisation of US debt in the aftermath of the revolutionary war. Indeed the call to issue joint debt is an important step to putting Europe’s economy on solid grounding. Yet, when it comes to the EU budget, nothing is agreed until everyone agrees – and the leaders of four frugal states are still holding out. They, and more importantly their voters, will have to see that a strong EU economy is in their self-interest. And that only grant-based EU action can help Europe recover, as a whole. We can take the sting out of this debate by moving away from a EU funded by Member States’ contributions towards a EU with more own sources of income.
Our internal market has benefitted big corporates for decades. It is time that they contribute to its maintenance. Also, the EU can raise money by greening its economy. Higher prices for CO2 emissions could flow to the EU budget, as could import levies on polluting products produced outside our borders. The French-German proposal sets the door wide open to these own resources, but only upon their implementation has Europe truly lived its Hamilton moment.
«Their proposal for a Recovery Plan has the right basic design»
It can be an historical agreement in the history of the EU. It has been released a week before the scheduled presentation by the European Commission of their Recovery Plan, or Fund, following the mandate of the European Council (April 23, 2020). Since then all the attention, and discussion, has focused on their ambitious plan of a €500 bn Recovery Fund, to complement the EU €540 bn initiative (EIB, ESM, and EC – SURE). Both together would amount to 7,4% of EU GDP and 6,3 times the yearly budget of the EU.
However, before discussing their Recovery Fund initiative, it’s important to note that it is only one of the four components of their initiative, the others are equally important. One, simply reinforces the programme of Ursula von der Lyden’s European Commission: “speeding up the green and digital transition” as a guideline for the post-Covid reconstruction process. Aligning, this way, their initiative with the EC, when the latter is finalizing their plans. The other two are, in my view, more innovative: “developing our strategic health sovereignty with an Health Strtategy” and “Enhancing EU economic and industrial resilience and sovereignty and give a new impulse to the Single Market”. In other words, they set the EU recovery agenda not just as a “support to EU countries in their recovery efforts” (and to the EC in their agenda), but focus on the need of recovering and reinforcing the European Union, badly hit by the Covid-19 crisis – in particular, the Single Market as a level playing field with free mobility. They recall one of the main policies of the EU, competition policy, and enlarge the scope of ‘European public goods’ to include health security, after a dismal joint management of the crisis.
Their proposal for a Recovery Plan has the right basic design: a EU, not just euro area, Fund, attached to the EU budget, but not part of the seven-years budget, with the EU borrowing, up to €500 bn, leveraged on the EU members’ commitment, to be dispensed mostly in the form of grants. Exactly what is needed when the hardest Covid-hit countries suffer debt fatigue – in fact, their post-Covid debt levels may be unsustainable if interest rates and, correspondingly spreads, increase. Of course, these are no longer the times where a French-German agreement would go through the EU council (provided UK would not block), so it is uncertain whether the document will only have interest for the historians, or mark the start of the process, where the ECB is the only effective supporter of the EU (actually EA) and the Fiscal Union within the EMU finds its own identity; for the latter, it the initiative will not only will need to be endorsed but also efficiently implemented, something on which the initiative is mute. Alternatively, if it is blocked, the post-Covid EU is in danger of, as Commissioner Gentilone says, of fragmentation.
«The Franco-German proposal is a significant step forward but not the final compromise»
The Franco-German proposal has clearly moved the lines of the debate on the EU Covid Recovery Fund. Above all, it signals Germany’s readiness to jointly issue large sums of money and distribute it to the most needed countries in form of grants, breaking two historical German taboos on EU integration: the joint issuance of debt and explicit fiscal transfers.
Yet, building consensus on this plan will not be easy. The frugal countries are opposed to the idea of EU borrowing to finance grants. They will push to reduce the size of the Recovery Fund or disburse a part of it in form of loans. Alternatively, they may concede on this point in exchange of the introduction of strict conditionality to the recovery aid and/or reductions in non-recovery EU spending (e.g., cuts in agriculture). Beneficiary countries will be opposed to that. So will be the Parliament, which has requested that the Recovery Fund comes on top of existing EU programmes. The Franco-German proposal does not say anything about other potentially divisive issues such as the criteria to allocate the recovery funding or how the debt will be repaid out of future EU budgets. This gives a margin for negotiation but it also creates possible points of blockage.
To sum up, the Franco-German proposal is a significant step forward but not the final compromise. It is now up to the European Commission to present the formal proposal of Recovery fund and next seven-year EU budget, trying to accommodate the demands of the remaining 25 countries and the Parliament. This will be far from easy.
«Europe is facing a colossal excess savings situation of the private sector as a result of the pandemic»
Much of the ongoing debate on the European Recovery Fund has focused on financing mechanisms and whether the recipient countries will receive transfers or else loans. Thus, the France-German proposal is for the set up of a half trillion Euro mechanism, which would consist of joint emission of bonds. The funds so collected would be disbursed in the form of grants taking into account the impact of the pandemic in each country.
This initiative, which is now awaiting the Commission’s own proposal, has been received as a gesture of solidarity towards the countries most affected by the crisis. However, if well-designed, it would also serve the economic interest of all EU countries. Indeed, Europe is facing a colossal excess savings situation of the private sector as a result of the pandemic –simply because both households and enterprises prefer to compress their spending for fear of losing their job or their business.
According to the latest Commission’s projections for 2020, all EU would register an increase in the financial surplus of the private sector. The combined private surplus of the six large economies alone (France, Germany, Italy, Netherlands, Poland and Spain) would increase by 705 billion Euro. And the prospects are for only a slight reduction in the surplus in 2021.
If not mobilized by government through a well-designed investment programme, such excess savings will be wasted, thus reducing growth opportunities in Europe. And enhancing them elsewhere, mainly in the US where the surpluses would be invested.