What the EU should do for its citizens

_ Gabriel Felbermayr, President, Kiel Institute for the World Economy, member, Scientific Advisory Board of the German Federal Ministry of Economics and Energy. The article was originally published in German by the FAZ newspaper. Translated into English by Yuri Kofner. Kiel, 12 August 2020.

Muddling along is the unwritten building principle of the European Union. The most recent summit resolutions have not changed that. It will take more than temporary transfers and shared debt to prepare the community for the next big crisis.

Transfer union: for the first time in the history of the EU, the budget is also financed with debt.

The evaluations of the decisions of the most recent EU summit diverge widely: Is this the entry into a transfer or even debt union? Or the ground-breaking further development of the EU into a solidarity community, the completion of the economic union through real fiscal competence at the European level?

One thing is clear: for the first time, the European Union is trying to stabilize short-term economic activity instead of pursuing long-term growth or structural policy goals with its programs. This is intended to fulfil the principle of solidarity anchored in the EU treaties. It is also clear: for the first time, the joint budget will be financed with debt in addition to traditional own resources, to the extent of up to 750 billion euros as part of a development fund under the name “Next Generation EU (NGEU)”.

But the pimped-up EU budget is not the big hit that some top politicians seem to think it is. In principle, despite the biggest economic crisis in recent history, the EU is continuing as before. The heads of state and government have failed to focus the EU more on common European public goods or to install a real stabilization mechanism.

With the new budget the EU will not become a transfer union; she was before. According to the official figures of the EU, between 2009 to 2018 the 17 net recipient countries in Eastern and Southern Europe received a total of 364 billion euros from the multi-year EU budget in transfers from the 11 net contributing countries. Germany alone billed 115 billion of this, France and Great Britain around 65 billion each. Poland received more than 100 billion euros, Greece and Hungary more than 40 billion euros each.

The EU was a debt union even before the July 2020 summit. At the end of 2019, the European Stability Mechanism (ESM) had issued total assets of 820 billion euros and bonds of 110 billion euros. Additional credit lines were made available to deal with the corona crisis. The European Investment Bank (EIB) had total assets of 554 billion euros and debts of almost 450 billion. As owners of these institutions, the EU member states are jointly liable for these liabilities, which are close to the volume of the new Recovery fund.

At the summit the tough struggle for the budget, which recurs every seven years – for its size and structure, for discounts and the financial burdens on the member states – became evident once again. Even without the Corona crisis, the negotiations on the EU budget framework until 2027 would have been extremely difficult. The exit of the UK as a net contributor is tearing a void in EU revenue, while key new priorities such as decarbonisation and digitization require new spending. Strong cuts in existing programs or contribution increases or both seemed inevitable before Corona. But they are measures that are highly unpopular in Brussels as well as in the member states. The European Commission and Parliament demanded significantly more money to cope with new future tasks, the member states demanded reforms and restructuring of the previous programs.

In a way, in this difficult situation the pandemic came at just the right time: it justifies extensive additional expenditure and legitimizes the use of previously frowned upon funding schemes. Chancellor Angela Merkel and French President Emmanuel Macron recognized this in May 2020 when they brought a joint debt of 500 billion euros into play to deal with the economic consequences of the Corona crisis. After a tough struggle, the EU Council decided at the end of July 2020 on a financial framework of 1 074 billion euros by 2027, which will be supplemented by the debt-financed, 750 billion new Recovery fund. The taking on of joint debts allows the EU member states to break out of the double tight corset of the EU budget and to put the costs on the long run. Far-reaching adjustments and reforms are bypassed. Ultimately, this approach enables muddling along, one of the unwritten building principles of the EU.

Once again, the question remained unposed and unanswered as to what the EU budget should actually do for the citizens. Most economists would see three main tasks, perhaps in this order: firstly, the creation of public goods, secondly, the stabilization of short-term economic events, and thirdly, the achievement of certain distribution-political goals.

In accordance with the principle of subsidiarity, the EU should finance those public goods which, due to their strong cross-border benefits or economies of scale, are better to be made available centrally rather than at individual member state level. Unfortunately, this has never really convinced the governments, which are still oriented towards the nation-state, as it would entail giving up tasks and losing power. The latest summit compromise did not change that. The Corona crisis has given the nation states a boost.

It is therefore hardly surprising that almost 90 percent of the NGEU Recovery fund go directly to the member states, using a formula that is linked to the economic performance of the countries but does not force them to use the money for projects with European added value. The remaining 10 percent go into classic European programs, but here, too, common public goods – for example investments in common infrastructure, security or research – only play a minimal role. Just an additional billion euros are available annually for the EU’s successful Horizon 2020 research program, only a few million more are available for investments, and the development of a joint health program was thrown out of the development fund entirely.

The situation is similar in the “normal” new seven-year household. The large blocks of the EU budget – agricultural policy and cohesion policy to support poorer regions – continue to make up the lion’s share of expenditure, even if these items have been given creative names. An average of 4 billion euros per year are earmarked for infrastructure over the next seven years. For comparison: In Germany alone the federal government is spending 37 billion on traffic routes this year. For the joint protection of the external borders, between 2 and 4 billion euros are planned annually, the German customs administration alone devours more money. The budget for health tasks will be increased to 1.7 billion euros over seven years, which is only 50 cents per year and EU inhabitant.

Almost half of the Recovery fund, 360 billion euros, is to be extended to member states as a loan and must be repaid in full by the recipients themselves. The loans must be related to the Corona crisis, but contain at least 30 percent climate policy measures, but the EU Commission does not really have a say in the use of the funds. Even so, they will probably not be accessed. The ESM’s credit lines, which have been available since May 2020 to combat the economic consequences of the pandemic, have not yet been drawn, even though they are only associated with very weak conditions

For one simple reason: even Italy and Greece, the EU countries with the highest levels of debt, currently have no difficulty in getting loans on extremely favourable terms. Italian government bonds with a ten-year term are yielding just under 1.1 percent, significantly less than before the outbreak of the Corona crisis. Their interest rate had risen to more than 2.5 percent for a short time in mid-March 2020, but the European Central Bank was able to depress interest rates and the interest rate spreads to German debt instruments sharply by announcing massive bond purchases.

The situation is very similar for Greek bonds with the same maturity. The Spanish and Portuguese yields on ten-year bonds are currently only 0.3 percent. That is more than the negative 0.5 percent that is due on German bonds. But the gap to the interest on joint bonds, such as those of the EIB investment bank, is so small that the countries will hardly be willing to make use of European instruments if they can borrow themselves on the markets at very modest additional costs.

The EU budget will therefore only increase by 390 billion euros over five years due to the new Recovery fund, not by the 500 billion targeted by Merkel and Macron. On the one hand, this means that the repayment, which should start in 2028 and take place over 30 years, will hardly limit the EU’s financial leeway. The central European budget remains far too small for it to have a real economic stabilization function. Over the next five years, it will account for around 230 billion euros per year or the equivalent of 1.8 percent of the common gross domestic product (GDP) expected for 2020 and will fall as planned to around 1.1 percent of GDP from 2026, when net borrowing has been completed.

In order to really prepare the economic and monetary union for the next big crisis, it takes more than temporary transfers and shared debts. The EU needs a budget that relieves the member states of previous tasks in the long term, that is large enough to fulfil an automatic stabilization function and that also successfully pursues distribution policy goals. In theory, this would not be difficult because the stated goals are compatible.

If the EU really wants to be a political union, then it has to take on common public goods such as national defence, cross-border infrastructure and essential tasks in research policy. This does not just mean a coordinating, co-financing function, but full planning, provision and financing. To fulfil these tasks, such a union would probably have to have a budget of around 5 percent of the EU’s economic output, which the members provide proportionally to their gross domestic products and which would only have to be balanced over the economic cycle, but not every single year.

If the EU took over the financing of such public goods, it would relieve the member states of a higher amount than they have to pay to Brussels. This is because the joint provision would by definition be more efficient than the small-scale approach that has prevailed up to now. Together one would get more security, more efficient infrastructure and more streamlined research results for less money. The European taxpayer would be relieved. The impression that Europe is a bottomless pit would be avoided. The losers would, however, be the nation states and their politicians, who have lost their policy power.

Such an EU budget of this size, which is primarily focused on the creation of public goods, could also fulfil distribution and structural policy functions. Communalizing the protection of external borders would naturally relieve the peripheral countries in particular. Better road, rail, electricity, and data networks would primarily help the structurally weak regions, which are often close to inner-European national borders. New top universities or European research institutes, perhaps based on the model of the German Max Planck Society, could be located where top mobile researchers like to move, for example on the Mediterranean coast. And even if the public goods in the EU were distributed completely equally geographically, there would be an effective redistribution from rich to poor: richer countries pay more per capita into the EU budget than poorer ones, but all countries benefit equally from public goods. The most important advantage: If it is primarily about public goods for all Europeans and not about easing funding restrictions in the budgets of the member states, one would finally get away from small-minded nit-picking around national net transfers.

After all, such an EU budget would also have important stabilizing functions. Instead of inventing new instruments in every crisis, the members could rely on the effect of automatic stabilizers at the EU level, both in the case of symmetrical and asymmetrical shocks: If an individual country gets into an economic crisis, the falling gross domestic product also means payments to EU budget would roll back, while the benefits of continued provision of public goods remained. If a symmetrical crisis occurs, as in the current pandemic, the central European level would continue to fulfil its tasks and finance the deficits caused by falling national contributions through borrowing.

This mechanism would be immediately ready for any crisis; it would be self-dosing because the implicit transfers would depend on the height of the recession. The stabilization function of the Recovery fund decided in July 2020, however, is minimal. Even if 70 percent of it is spend 2021 and 2022, the money will only flow late and will probably have a procyclical effect. It will then reinforce an upswing that is already underway instead of softening the downswing that has already largely been behind us.

The economic advantage of the EU for the member states does not consist mainly of the Community’s spending program. That would not be any different after the fundamental reform of the EU budget outlined above. Because it is regulatory requirements that make the EU so valuable: rights such as the free movement of goods, people, services and capital, or common rules, for example on subsidies or monopoly control.

The many quantitative studies on the effects of European integration show that even without public goods and transfers, all countries benefit economically from their EU membership. However, they benefit to different degrees, and the political costs of relinquishing national sovereignty rights are perceived differently. In addition, behavioural economics research shows very clearly that it is not enough if the absolute net benefits of membership in a club are positive. It is also about a distribution of the advantages that is perceived as fair. Therefore transfers – one would speak of side payments in the economic theory of negotiations – may be necessary to stabilize and advance the European integration project. However, since the costs of relinquishing sovereignty are difficult to determine objectively, a politically toxic negotiation process for transfers, including blackmail attempts, always arises. This could be avoided with implicit transfers through the provision of public goods.

The new financial framework of the EU and the new construction fund still have to go through the parliaments. This opportunity should be used to finally discuss the finality of the European project again. Debt or transfer union can never be an end in itself. The European Union must generate tangible added value for all citizens in all member states. If it does not succeed in ensuring this, its existence is in danger in the long term.

Source: https://www.faz.net/

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