Deal on EU recovery fund and EU budget: Breakthrough or disappointment?

29 July 2020

The agreement on the “EU recovery fund” is ground-breaking in important dimensions and will contribute to recovery in hard hit countries, but it comes at a high political price.

By Philipp Heimberger
Photo credit: European Union

The "EU recovery fund" is the core building block of the fiscal policy response at the European level to the Corona crisis. The heads of state and government reached an agreement on 21 July after four intense days of EU summit negotiations. The EU recovery fund was negotiated together with the new EU budget for the period 2021-2027. As a consequence, some countries were able to link their approval of the EU recovery fund to rebates concerning their national EU budget contributions and budget cuts in the new Multiannual Financial Framework (MFF).

The agreement reached at the July summit of heads of state and government provides for a total of €750 billion in the "recovery fund", with €390 billion in grants and €360 billion in repayable loans. The European Commission will issue bonds on behalf of the EU. This will finance a temporary increase in the EU budget over the period 2021-2023. The grants will be channelled through several EU spending programmes.

Of central importance is the so-called “Recovery and Resilience Facility” (RFF), through which 312.5 billion of the grants are set to flow. 70% of these funds will be distributed in the years 2021 and 2022, the remaining 30% (93.75 billion euros) in 2023. However, the key to the distribution of these approximately 94 billion euros will be the loss in GDP in 2020 and 2021; therefore, it is not yet exactly known how the money will be distributed. Countries such as Italy or Spain, which have been particularly hard hit by the pandemic, should in any case be able to get significantly more money from the EU recovery fund than less affected countries such as Germany and Austria. However, all EU Member States will have to submit national recovery and resilience plans to the European Commission, outlining investment and reform projects for which the planned EU funds can then be retrieved.

Breakthrough aspects of the agreement

The agreement is ground-breaking in important respects. Anyone who takes a look at the positive side must first acknowledge that before Corona it would certainly have been unthinkable for the EU to take on so much additional debt based on guarantees from Member States in order to temporarily launch additional EU spending programmes to combat an economic crisis. This is the first time that an EU-wide "safe asset" will be created, enabling investors to avoid different risk levels attached to bonds of EU Member States and to invest directly in EU bonds.

The implementation of the agreement on the EU recovery fund could significantly improve the functioning of the common economic and monetary area, as it builds on issuing EU bonds and includes plans to service these debts over the period 2028 to 2058 also through additional "own resources" - i.e. through EU taxes and levies instead of direct contributions from EU Member States. The Council agreement states that the European Commission will be able to introduce a new levy on plastic starting in 2021. And there is the goal of agreeing new taxes on carbon emissions and digital commerce before the start of 2023, although it remains highly speculative whether these taxes can be successfully introduced and whether they will bring a significant amount of funds.

Nevertheless, issuing common bonds and introducing new own resources are elements that constitute a common European fiscal policy. In the past, one of the most serious weaknesses of the euro area has been that it operates a common monetary policy (via the ECB), while fiscal policy remains in national hands, the coordination of which (within the framework of European fiscal rules) is fraught with major problems.

With the agreement on the EU recovery fund, there is now an important element of a common fiscal policy to combat the Corona crisis. The issuing of EU bonds to finance joint spending programmes to combat a crisis could also be used again in the foreseeable future beyond the EU recovery fund now agreed, if the instruments prove effective. Grants of €390 billion represent around 3% of EU GDP; even if spending will stretch until 2023, the macroeconomic impact of this fiscal stimulus will be significant and contribute to economic recovery in EU Member States particularly hard hit by the macroeconomic fallout from the pandemic.

This macroeconomic stimulus is based on temporary expenditure programmes; it does not constitute a permanent fiscal capacity. However, the political debate on a sizeable budget to cope with crises could also take a new direction for the eurozone with the experience of debt-financed fiscal policy in the Corona crisis.

It is also noteworthy that 30% of the available money in the EU recovery fund must be used in the spirit of the "green and digital transformation". This establishes a link to the European Commission's longer-term policy agenda regarding the "Green Deal" and digitisation - even if there is still considerable room for interpretation as to which measures promote the green and digital transformation.

Problematic aspects

While some aspects of the agreement at the July summit can therefore be seen as positive and may also open up new opportunities for the future of the European integration process, it must be noted that this is not the best possible agreement. First, the volume of grants could have been higher  in order to ensure a greater macroeconomic impact in the countries particularly hard hit by the pandemic. This was prevented by the alliance of the so-called "frugal" states - the Netherlands, Austria, Sweden, Denmark, occasionally joined by Finland- whose heads of government largely ignored that their own countries' export-dependent growth models would benefit from a stronger recovery of all EU countries and from a strengthening of the EU's single market. Second, the so-called "super emergency brake" creates a complex and burdensome governance structure that could slow down the process of disbursing EU recovery funds. The Netherlands, in particular, had insisted that a national veto be granted for the recovery plans of other EU countries.

The agreement reached is a compromise between the Dutch demand for a national veto and the administrative controls sought by the European Commission. All heads of state and government must agree to the EU countries' individual investment and reform plans – but by qualified majority, not unanimously, so that two conditions have to be met: 55% of member states vote in favour of approving national recovery plans, and the proposal is supported by Member States representing at least 65% of the EU’s total population). However, each Member State will have the national right to delay the Commission's decision to disburse money, although they cannot simply stop it unilaterally. While there is a dispute settlement process, the last thing the EU needs in the current situation is the interruption of recovery projects and deepened conflicts between Member States over the timely disbursement of EU funds.

Third, conditionality could have been stronger with regard to compliance with the rule of law. In order to bring the Central and Eastern European Member States on board for an agreement, the link between the principles of the rule of law and the EU budget were softened. This has strengthened the position of the governments in Hungary and Poland – with consequences for future negotiations. Fourth, the higher EU budget rebates for a few rich countries are an additional burden for those countries that have to pay these contributions instead. The European Commission originally wanted to abolish the rebate system, but the "frugal four" could only be brought on board for an agreement by making further concessions, thus actually strengthening the rebate system.

Fifth, the opportunity to modernise the EU budget structure was missed with the summit agreement. Due to the pressure of the "frugal four" for cuts in the volume of grants in the EU recovery fund, there were reductions – some of them drastic compared to the original Commission plan – in research (Horizon 2020), health (EU4Health) and the financing of a fair transition in the fight against climate change (Just Transition Fund). This means that top-up budgets with a future-oriented approach were lost, which could also have provided visible public goods for the EU.

The agreement is a mixed bag

Taking all this into account, the agreement of the July summit of heads of state and government is mixed. It is of course much better than the "no agreement" alternative, which would have sent the fatal signal that the EU is not capable of responding adequately to a serious common challenge. This mistake was avoided. And there could also have been worse results of the agreement: The agreed 390 billion in grants to the EU recovery fund is substantial and will contribute to economic recovery in countries particularly hard hit by the pandemic. Although the “frugal four” have managed to reduce the volume of grants, this does not change the fact that the eurozone and the EU have now been given a temporary version of a macroeconomic stabilisation instrument through the EU recovery fund.

In order to avoid having to hold marathon summits with uncertain outcomes in the future once a crisis is already in full swing, it will likely take several additional marathon summits in somewhat calmer times to put the institutional architecture for macroeconomic stabilisation in the European context on a sustainable footing. For the future, it would be important to get rid of strict net-position thinking when discussing the EU budget and focus more on increasing the EU added value provided by EU expenditures. Reforms in the system of the EU’s own resources through substituting a substantial share of national contributions by innovative own resources may help overcome net position thinking in “frugal” member states. Finally, maximising the positive impact of the EU recovery fund on economic recovery over the next couple of years will require that the positive impulse of EU funds is not counteracted by premature fiscal consolidation efforts at the national level.

The European Parliament has a binding say over the EU budget and will need to approve the deal reached by the EU’s heads of state and government. It has threatened that it will reject the agreement and does not accept it as it stands, demanding a more ambitious MFF, more clarity on the proposed new EU levies and stronger rule of law conditionality. It is urgent that money from the EU recovery fund can be made available soon, starting in early 2021. As the EU recovery fund was linked to the agreement on the MFF for the years 2021-2027, the European Commission and heads of state and government will need to find a way to bring the European Parliament on board. The time schedule is tight, as national parliaments will also need to approve the final agreement before it can be put in place.