EU leaders agree 1.8 trillion euro fiscal fudge to keep worst hit countries afloat

“We did it! Europe is strong, Europe is united!”, declared the President of the European Council, Charles Michel, just before 6am this morning.

Speaking to a press conference in Brussels, he had reason to feel relieved. After four long days and nights of negotiations, accusations, and compromises, the European Union now has a recovery fund worth €750 billion, alongside a new budget totalling €1.074 trillion, to provide relief to member states hit hard by the coronavirus pandemic.

The eventual compromise deal struck by EU leaders early this morning provides a framework for transferring funds to struggling states such as Italy and Spain. A total of €390 billion will be provided in grants – fiscal transfers which do not have to be repaid – alongside €360 billion in loans, which will. This has shifted significantly from the original proposals, which had set the target at €500 billion in grants and €250 billion in loans.

In an unprecedented move the European Commission will raise these sums on capital markets, and the debt incurred by this borrowing will be repaid in the next EU Multiannual Financial Framework (MFF) – the EU’s budget – for 2021-2027. Guntram Wolff, Director of the Breugel think tank in Brussels, said that the move “changes the contours of monetary union”, and represents “a game-changer in terms of how this monetary union, how this European Union works”.

This is historically significant. After the Maastricht Treaty, signed in 1992, several EU member states committed to monetary union, but fiscal policy remains the reserve of the states. This distinction has made many members resistant to measures which resemble fiscal policy at the European level, including debt mutualisation and fiscal transfers. Germany’s Constitutional Court recently judged that the European Central Bank’s emergency bond buying programme could infringe on the distinction, stepping beyond monetary policy and into monetary financing of the member states.

There is one crucial question which remains – will the fund, however ambitious, be enough for Europe’s struggling economies in Italy and elsewhere? And here, despite the jubilation at an historic compromise among EU leaders, there are reasons to be less than sanguine.

In a discussion I had with Helen Thompson, Professor of Political Economy at the University of Cambridge, and Matthew Karnitschnig, chief Europe correspondent at Politico, just before the EU summit, a less optimistic picture of the recovery fund emerged.

You can listen to their assessment of the relief in the latest episode of The New World Podcast here.

Both agreed that the size of the package is unlikely to help Italy out of the trap of low growth, low social mobility and high debt in which it has been caught since the financial crisis. Instead, it is the European Central Bank’s emergency €1.35 trillion bond-buying programme that still represents in many ways a more practically significant instrument than the recovery fund.

The EU is in default mode – it is muddling through the coronavirus crisis rather than setting itself on a transformative path towards fiscal union. The recovery fund is a symbolic act, but it is a far cry from what is needed to get the ailing Eurozone economies bouncing back after the pandemic.

The summit was the second longest in the EU’s history, and perhaps the most divisive. A toxic atmosphere hung over events as, in the heat of the negotiations, the French President Emmanuel Macron and German Chancellor Angela Merkel, voiced frustrations with the EU’s so-called “frugal” countries. A great number of trade-offs, including rebates to the frugal states in the European budget, were made to get the deal over the line. In return governance restrictions, fiscal targets and rule of law constraints attached to the recovery fund were significantly watered down.

For all the significance of the present moment, there are fears that the deep political and structural tensions in the EU have been patched over rather than resolved.

Eric Maurice, head of the Robert Schuman Foundation in Brussels, said that he is “more pessimistic about the atmosphere” among EU leaders in the wake of the summit:

“We see that with every new crisis it is very difficult to be on the same (wave) length, between, of course, north and south, east and west, and now between bigger and smaller countries”.

Having provided the vital impetus in getting the EU27 to endorse this deal, Chancellor Angela Merkel will, with some justification, see this as an important personal achievement. Her decision to back the recovery fund was a crucial moment in ensuring its success, shifting the balance of power away from the frugal states and towards French calls for fiscal aid. The conclusion to the EU summit is a testament to Germany’s premier place in the European project.

Yet her still-to-be-elected successor who will take over the reins as the German Chancellor in 2021 will not find it any less of a challenge to bridge the gaps between the continent’s conflicting capitals in the future. The past few days have shown an EU27 united mostly in indecision.