Not (yet) up to the task: how eurozone members are gambling away post-Covid economic recovery

The Eurogroup needed a highest-common-factor agreement to match the coronavirus crisis but intergovernmentalism left it with the lowest common denominator.

After the Eurogroup meeting on April 9th, its president, Mário Centeno, announced that the eurozone finance ministers had ‘answered the call from our citizens for a Europe that protects’.

Action at the European level is key to rein in the economic shockwave following the Covid-19 outbreak. As the former president of the European Central Bank, Mario Draghi, recently affirmed, economic recovery will be easier the more public treasuries step in and relieve the private losses of workers and firms. The goal is to ‘keep the lights on’— to prevent the production system sinking under the accumulating burden of debt and losses until workers can get back to work and consumers can buy again under safer conditions.

For governments to absorb private losses, credibly, speedily and efficiently, they must be sure financial markets will have confidence in their continuing solvency. This requires that European monetary and fiscal institutions backstop governmental efforts.

Institutional guarantees

Some key institutional guarantees have been provided over the past weeks. The ECB’s Pandemic Emergency Purchase Programme commits €750 billion to sustaining public debt in the eurozone where it is most needed.

The European Commission has activated the escape clause of the Stability and Growth Pact, thus allowing governments to take all necessary budgetary action to fight the pandemic. Likewise, it has adopted a temporary framework for state-aid rules, thus allowing member states to pump liquidity into reeling businesses. Additionally, it has created a fund aimed at preventing job losses by supporting short-time work schemes and encouraging firms to keep their staff.

The European Investment Bank has mobilised a €25 billion guarantee fund, which complements national liquidity schemes to (partially) balance out member states’ different financial firepowers, thus allowing a more homogeneous safety net for firms across the euro area.

Final safety net

While these measures allow public and private debt to increase, the Eurogroup was supposed to provide a final safety net for public finances as the linchpin of the package. Such a safety net would have to meet two bottom-line requirements.

First, it ought to make sure that spiking public debt remains sustainable over the coming years. Secondly, it ought to guarantee that investment will be sustained in an exhausted fiscal space—in particular as regards the most affected member states—to fend off economic stagnation and macroeconomic divergence.

The Eurogroup meeting failed to do either.

On condition

Participants agreed on a ‘Pandemic Crisis Support’, a credit line from the European Stability Mechanism, according to which member states will be able to apply for funding of the order of 2 per cent of gross domestic product. This is on condition that funds provided are committed to ‘direct and indirect healthcare, cure and prevention related costs’, while applicants ‘remain subject to the EU’s economic and fiscal co-ordination and surveillance frameworks’.

This is the statement no one wanted to hear. Centeno’s bold assertion disguises the substantial failure to deliver an effective response to the medium- to long-term economic consequences of the Covid-19 crisis. In particular, it remains unclear how European institutions will deal with (substantially increased) public debts in the coming years.

Will they prioritise debt reduction despite the adverse economic environment? Or will they strengthen investments to boost growth and make debts sustainable? As it stands, the first option seems more likely, with the ECB being once again the only institution to pledge continuing support to hobbled public finances, as it has done since Draghi’s 2012 ‘whatever it takes’ London speech.

Necessarily unequal

As long as member states are able to rely on their own national budgets only, recovery measures will necessarily be unequal across the euro area, due to the varying durations of the lockdown and the differing states of public finances. In the absence of commonly supported measures, the hardest-hit countries will have to endure private and public deleveraging in the presence of an economic downturn.

Stagnation and further macroeconomic divergence will be the most likely outcome. Besides the predictable upsurge of political discontent and populist temptations, financially weaker members will likely be subject to speculative attacks, and therefore be even more dependent on long-term ECB support than before.

Without a solid political agreement on the side of the member states, however, such support cannot be taken for granted in the long run, as shown by the recent pressures on the ECB to change its monetary policy—despite unequal and unsatisfactory growth and overall deflationary tendencies in the euro area. Indeed, although both the ECB and the European Commission have been quick to steer the right course to tackle the crisis, their initial reactions (see also here) testify to the frailty of the political consensus on which their action rests.

Not up to the task

While supranational institutions now seem to be aware of what is at stake, as reflected in the call by the commission president, Ursula von der Leyen, for a post-Covid Marshall Plan, intergovernmental institutions are clearly not up to the task. Not only did the Eurogroup agree once again only on the lowest common denominator—this time, not even its president knew what exactly had been agreed, as became evident when he tried to spell out on what the Pandemic Crisis Support could actually be spent.

Understandably, Centeno’s words leave it to the heads of state and government to cast light on whether the credit line’s soft conditionality applies to recovery expenditures generally or to sanitary costs only. But his statement also shows how far member states’ expectations diverge as to the goals to be pursued within the economic and monetary union—whether it is about monetary stability alone (if this is realistic at all under the given circumstances) or whether it includes fair growth chances too.

The Eurogroup agreed to start working on a Recovery Fund without being able to make any headway on whether it will include common debt issuance, which remains the only way to smooth growth chances across the eurozone and fend off the risk of a politically or financially motivated breakup. The heads of state and government will be called upon to flesh out the proposal in the coming weeks.

This might be a decisive window of opportunity for all those who are interested in a fair and growth-oriented European economic policy—to press policy-makers into doing what is needed to prevent another, and more dangerous, decade of unequal and fragile growth.