Covid-19 and the Search for an Ambitious EU Recovery Fund

May 1, 2020

This piece is the second in a two-part commentary series on the European Union’s recovery from the economic impact of Covid-19. Read the first part here.

Since the beginning of the Covid-19 crisis, Italian prime minister Giuseppe Conte has repeatedly warned of the risk of a political emergency and the European Union’s potential collapse in the absence of a comprehensive, European approach to economic recovery. The challenges facing leaders in this recovery are both structural and political, and there are different paths out of the current debate, all of which carry risks and opportunities.

During the April 23 European Council meeting, leaders agreed to the €540 billion ($583 billion) package of measures drafted by Eurozone finance ministers and asked the European Commission to develop a recovery plan to be published by May 6. In parallel, the European Central Bank (ECB) has continued to maintain financial stability, and its firepower will remain crucial until the recovery fund is agreed and becomes available.

Given the unprecedented nature of Europe’s economic contraction, the European Union will need to use all the tools currently at its disposal as well as come up with new ones to address the crisis. European leaders will need to be flexible to resolve structural shortcomings in the absence of future treaty changes and be given the time needed to create new financial instruments.

So, what are the paths forward?

Two Significant Recovery Plans on Offer

The Spanish Plan. Spain, supported by France, has put forward an innovative plan to use grants (not loans, an important distinction for highly indebted countries) worth €1.5 trillion ($1.62 trillion) backed by “perpetual” (non-maturing) bonds to fund the recovery in the countries hit hardest by the pandemic. (Similar bonds have been used before in dire times by Britain and the United States, for example, during the World Wars.) The debt would rely on legal mechanisms that already exist to fund the EU budget, thus removing the need for a political debate (or potential vote in the German parliament). The grants would be allocated according to clear criteria, such as drop in GDP and size of the affected population, which would be a concrete embodiment of EU solidarity. Because this plan is tied to the seven-year EU budget (multiannual financial framework or MFF), which would begin in 2021, each EU member would be responsible for its own share of the disbursement following existing burden-sharing arrangements. However, the use of grants rather than loans remains a stumbling block for some northern countries that worry about financial transfers across the bloc.

The Brussels Plan. The Commission’s draft recovery blueprint, leaked ahead of the leaders’ meeting, foresees a roughly €2 trillion ($2.16 trillion) effort, €323 billion ($349 billion) of which would be a dedicated recovery fund, and some of which would be raised on capital markets using the Commission’s triple-A rating. It would then lend to member states for the riskier parts of an investment, leveraging the private sector for the rest—the draft plan foresees the lending being leveraged ten-fold. The Commission’s proposal will include a balance of loans and grants, and the recovery fund will be frontloaded in the 2021-2027 MFF to address the most acute needs. The size of the plan is impressive but matches the magnitude of the economic crisis (recent worst-case estimates from the ECB show a potential 15 percent drop in Eurozone GDP) and includes the €540 billion package. The Commission has suggested it would need to increase the EU budget to 2 percent of EU gross national income (from 1 percent currently) for the first two or three years. This last part will reopen the debate between members who prefer a smaller EU budget—particularly after the United Kingdom’s departure—and those who want an ambitious budget to address such issues as climate change and the digital economy.

Notably, both plans place the recovery fund under the umbrella of the MFF, which extends support and solidarity to all 27 members of the European Union and not just to the 19 members of the Eurozone. Doing so also ensures existing EU rules will apply for fund allocation and that the fund will be aligned with EU political priorities. It will also require approval from all EU member states. France has proposed placing the recovery fund outside of the EU budget as a special purpose vehicle that would be focused on future investments, but as of yet, there is little appetite in the rest of the bloc for this.

There Are Drawbacks to Both Plans

The recovery fund as currently envisaged depends on EU members finding agreement on the size of the new MFF, on the conditions attached to those resources, and on finding the right balance between loans and grants. However, even pre-pandemic, they were struggling to reach any sense of agreement on the next budget, debating along several fault lines: 

• How big is big enough? All EU members will have to agree on increased contributions to the budget if a bigger portion of it is not raised through capital markets. German chancellor Angela Merkel has signaled that Germany will agree to contribute more, but it is unclear by how much. Other members, such as Austria or the Netherlands, may not agree to this. Should the latter countries call for reduction in other EU funding areas, France and other members that receive significant funds from the Common Agricultural Policy could resist any such reduction or reallocation.

• With strings attached? Conditionality on rule of law and democratic standards is a significant bone of contention, but a larger budget under current allocation formulas means more money will go to countries that receive and need important levels of cohesion and structural funds—some of which have flouted these standards. In a telling example, on the day the Hungarian government declared an open-ended state of emergency, Budapest received €3.8 billion to support its response to the coronavirus—dramatically more than Italy even though Hungary has suffered far less, reinforcing concerns about rule of law and the Commission’s allocation processes. Central European nations such as Poland and Hungary—already under EU pressure for their anti-democratic reforms—will resist receiving less funding under existing regional cohesion funds and will be more willing to use their veto.

• Corrosive capital? More spending means a higher risk of waste. The European Union has already suffered from the misallocation of resources, either through corruption or inefficiency. There are encouraging efforts underway to prevent the disbursement of recovery funds to companies registered in tax havens, but the European Union will need to significantly empower the European Anti-Fraud Office.

• Loans or grants? Allocating funds through loans or grants seems to be the new version of the “pooling debt or not” debate, though the Commission could come up with a creative (and legal) way to find a balance. Spain’s suggestion to fund grants through “perpetual” debt is another creative way, with only the interest on these bonds being repaid—though countries could elect to pay back the principal down the line, and EU resources levied through a new tax could be used to pay the interest rather than member states’ contributions. Common debt issuance among some but not all Eurozone countries and outside the MFF, as floated by France, remains a remote possibility, but creating such an instrument could weaken the European Monetary Union.

• One man’s solidarity is another man’s resentment. The debate over the budget and the recovery fund may be highly technical, but public perception will be one of the most significant factors in finalizing any agreement. There has been a significant rise in anti-European sentiment in Italy, leading populist leaders to call for a referendum on Italy’s membership in the Eurozone. Northern EU members face similar public pressure not to transfer greater amounts of wealth to the south. It will be increasingly difficult to strike a balance between and retain public support from both sides.

The Solution Will Show EU Leaders’ Resolution

A decade ago, during the euro crisis, some EU members pushed to implement austerity and incremental economic measures, with some of the political and economic consequences we know today (e.g., populist waves and lackluster growth). The European Union’s economic response to the global pandemic has thus far been more dramatic and substantial, with the European Central Bank’s measures having the most powerful effect. How EU leaders resolve the issue of the recovery fund—and what ultimately propels them to take significant decisions—will tell us a great deal about the future strength of the European Union.

Donatienne Ruy is an associate fellow with the Europe Program at the Center for Strategic and International Studies in Washington, D.C.Heather A. Conley is senior vice president for Europe, Eurasia, and the Arctic and director of the CSIS Europe Program.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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