Five Challenges for the European Union

Symmetric shock, asymmetric consequences

There is no such thing as a symmetric shock. In addition to the grim toll of victims and the incredible pressure on the health systems of all countries, the lockdown of activities to reduce contagion meant a tremendous plunge in production and incomes and enormous pressure on public finances all over the world. However, the lockdown is expected to affect economies differently. The Central and Eastern European countries have been less affected by Covid than the Western European countries: not trusting the resilience of their fragile health systems, they have had to rely on rigid social distancing. Even within this group of countries there are differences: thanks to their more robust health systems, the Czech Republic and Slovenia were less constrained by rigid social distancing and able to start economic recovery earlier. Moreover, due to their strong productive links with Austria - a country relatively less affected by the pandemic which came out of the lockdown earlier - and their favourable positioning in the development of digital economy, their economic outlook is rather better. Conversely, it will be tougher for the economies, like those of the SP, which are more dependent on services - tourism and hospitality in particular (Fig. 5) - and for CEE countries and southern regions that rely to a greater extent on production of intermediate products for final producers, since the latter can better defend themselves from fall in demand by cutting down orders to their suppliers (the so-called "whip effect").

Fig. 5 Number of active enterprises: industry (except construction) and tourism. Rate of change (2010–2017), Germany, SP and EP.

Policies have also differed widely across countries and regions. While all the central banks of the developed world promptly intervened to provide almost unlimited liquidity, in the EU public spending in support of the economy has been left to the national states. Although the Stability Pact has been temporarily suspended, there are obvious differences in how much member states can spend, depending on their fiscal space. Member states are making use of the new flexibility granted by the EC on state aid rules, strictly enforced beforehand to ensure fair competition within the internal market. Germany, which accounts for about a quarter of the EU's GDP, accounts for more than half (52%) of the emergency coronavirus state aid approved by the EC, prompting concerns that countries with the deepest pockets might be getting an unfair advantage by such a sudden (and temporary) abandonment of one of the Common Market's key pillar (France and Italy each account for 17% of the total). An EU official, speaking on condition of anonymity, observed that "if you look at the scale of what Germany in particular, but also some others, are doing - any notion of level playing field or single market integrity has gone out of the window".

Debt sustainability: public, private

These concerns underpin the ailing south's demand for a joint EU financial plan. In the absence of a prompt and massive common effort, the SP will pay the highest price to the health crisis. Indeed, the different firepower will entail a still greater asymmetry in the economic and power relations between the various member states.

The ECB, alone among the Eurozone institutions, is doing as much as it can to avoid breakdown of the EMU. To address the Covid-19 crisis, it launched a new asset purchasing programme: the Eurosystem's balance sheet shot up from 4692 billion Euros on 28 February to 5395 billion by 1st May 2020. Despite this massive monetary injection (700 billion in two months) the spread on Italian bonds, which had fallen in mid-March following the ECB's announcements, again rose very rapidly, fluctuating in response to political developments. Indeed, as Tooze and Schularick point out, if, in the 2008 crisis, the liquidity injected into the system by the ECB was enough to prevent deflagration of the banking system,Footnote 9 the current crisis would require a coordinated fiscal policy of enormous proportions. Despite some recent moves (inaugurated by a Merkel–Macron agreement), this still does not seem to be looming on the horizon. The newly released 'Next Generation' (NG) plan, based on the 2021–2027 budget, celebrated by some as a "Hamiltonian moment", has yet to qualify as forerunner of an EU-wide up-to-the–challenge fiscal capacity. First of all, it is meant to be temporary and, moreover, it is too little, too late. The Plan should mobilize 750 billion euros, 500 in the form of grants and 250 in loans. Apart from the fact that these are gross figures - once the member states' contributions to the EU budget are subtracted, the net amount received by the neediest countries is much smaller - their disbursement will not start before 2021, will be distributed over a 4-year period, with amounts that grow over time, and, as stated in the EC's "Proposal for a Regulation" the financial contribution will "be paid in instalments once the Member State has satisfactorily implemented the relevant milestones and targets identified in relation to the implementation of the recovery and resilience plan". As Darvas emphasizes, the incorporation of the NG plan into the EU's next multiannual budget would take advantage of a well-established framework, 'already subject to various checks and balances'. On the other hand, NG resources risk to be trapped in a 'slow-moving machine'. In order to be financed, NG-related projects need to be designed, approved and implemented as part of a process that can take several years. As a result, the timing of disbursements is just the opposite of what would be required to respond to the urgency imposed by the current situation and, even more so, by the expected collapse of incomes that the European economies are going to face. However, the Commission expects that barely 24.9% of the total new firepower for grants would be spent in 2020–2022, when the recovery needs will be greatest. Far from being a tool to counter the immediate effects of the crisis, the NG plan is more similar to the Juncker plan, and shares all its weaknesses. It is highly unlikely that countries like Italy, severely hit by the pandemic and in persistent financial distress, will be able to afford to refrain from asking for other funds (namely, ESM, SURE and others for a total amount of about 59 billion euros) which could be paid out immediately, subject to the usual conditionality.

Long term sustainability of the EU project

The Merkel-Macron agreement has been hailed as the first step towards a more supportive Union. Behind the good intentions, there are the concrete interests of both France and Germany for the survival of the EMU: they look with growing concern at the rise of Euroscepticism in the SP. The French economy has been hit hard by the pandemic, and was already in difficulty before. GDP forecasts for 2020 vary widely, but all agree in estimating a fall in the French GDP of much the same proportions as in the case of Italy. On the other hand, Germany was, together with the Netherlands, the main beneficiary of the creation of the euro, and Italy and France were the main losers. As Chancellor Merkel told the German lawmakers, "it is essential for Germany, as an export nation, that its EU partners also do well". Indeed, the history of the EU has taught that excessive German surpluses are deleterious for the south of the Eurozone.

Greater government action, retreat from hyper-globalism, and lower growth rates predate the pandemic. The COVID-19 crisis has given yet more voice to calls for protectionist and "beggar thy neighbours" types of policies. It has led countries to prioritize resilience and autonomy in production over cost savings and efficiency through global outsourcing. The same powerful German production platform, so disproportionately export-oriented and dependent on imports of intermediate goods, finds itself vulnerable to a type of shock (the Covid-19 pandemic) that disrupts GVCs and threatens to change the existing economic order through permanent disruption of the patterns of demand and production. Although transition from an industrial platform designed for export to one for the internal market (a sort of transition from a war to a peace economy) is a formidable challenge, this transformation would benefit Germany itself, considering the winds of trade war and the growing uncertainty about the future developments of the global value chains.