Macro Focus: An analysis of the European Commission’s Next Generation €750 billion recovery plan

Key takeaways:

• The European Commission unveiled a €750 billion “Next Generation” temporary recovery programme (€440 billion grants, €60 billion guarantees and €250 billion loans) over the 2021-2024 period that would come in addition to the €1.1 trillion allocated to the EU’s budget over the 2021-2027 period. The total funding (Budget+ Next Generation plan) will represent 1.5% of the EU-27 GDP over the next seven years period.
• The Next Generation will prioritise the green and digital transitions as well as additional cohesion funding targeting the EU’s most deprived regions. The bulk of the financing (Grants+ Loans) would be pre-allocated directly to the Members States that were the most severely hit by the pandemic. Three countries (Italy, Spain and Poland) would get €376 billion or half of the total proposed extra financing. Greece, Romania and Portugal would share an additional €100 billion between them.
• The novelty of the proposal resides mostly in the fact that for the first time in EU history, fiscal expenditure in the form of grants would be financed through the issuance of debt by the European Commission that would be backed by the Member states, along the line of the French-German initiative unveiled a few days before the Commission’s proposal
• However, the disbursement of the grants would be split across the 2027-2027 with most of the payments concentrated over the 2022-2024 period. This does not fit with the idea of a massive and concentrated fiscal stimulus package in a classical Keynesian sense. As such, it will perhaps increase potential growth in the MT/LT but it will not – per se – close the gigantic output gap that some countries like Italy will face in the coming years as a result of the coronavirus recession.
• Hence, while the additional funding is most welcome, the countercyclical policies needed to close a massive output gap will still have to be conducted mostly at the Member State level and will require a quasi-permanent relaxation of the EU fiscal compact rules.

Detailed analysis:

After some soul-searching, the initial collective response of the European Union to the coronavirus pandemic took the shape of an emergency support plan comprised mostly of loans for a total of up to €540 billion, to provide immediate financial resources to the EU countries that needed them for the treatment of the pandemic and for the mitigation of its immediate adverse consequences on workers and businesses (cf. the table below). Among these three instruments, the ESM Pandemic support credit line is the most controversial as it reminds investors of the Euro sovereign crisis and carries with it some stigma. In addition, the Commission relaxed states aid rules and activated the general escape clause in the Stability and Growth Pact giving in effect a “licence to spend” to the Member States.

Institution	Programme	Purpose	Amount
European Commission	SURE (Support to Mitigate Unemployment Risk in an Emergency)	Temporary wage supplementation and income support for the self-employed	€100 bn
European Stability Mechanism (ESM)	Pandemic Crisis support credit line (interest-free loans for up to 10 years and 2% of GDP)	Prevention, treatment and healthcare linked to the pandemic	€240 bn
European Investment Bank (EIB):	Pan European Garantee Fund (EFG)	Support lending to small and medium-sized enterprises	€200 bn

The Next Generation proposal unveiled on May 26 by EU Commission President Ursula Van der Leyen goes further with a €750 billion recovery fund consisting of €440 billion grants, €60 billion guarantees and €250 billion loans over the 2021-2024 period (at 2018 constant prices). This goes further than the French-German initiative unveiled ten days earlier, calling for €500 billion EU recovery fund that would be financed by market funding. The financial resources for this plan would be raised by the European Commission on the market and assigned to the countries that are most hardly hit by the crisis within the multi-annual financial framework of the European Union. The novelty of the proposal resides in the fact that for the first time in the history of the European Union, this would be financed by issuing a common debt that would be backed by all the EU member states, through the Commission’s ability to draw additional funds above its budget ceiling, in line with the recent French-German initiative. In a way, this is an implementation of the concept of eurobonds that has been floated in European policy circles for a decade since the outbreak of the Euro sovereign crisis in 2010.

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Together with a €1.1 trillion budget of the European Union for 2021-2027 this would bring the financial firepower at the disposal of the EU Commission to €1.8 trillion, or 1.5% of EU-27 GDP per year over a seven year period. As per the Commission plan, most of the financial resources packaged in the proposed recovery fund would be channelled through The Recovery and Resilience Facility (Budget: €560 billion of which €310 billion for grants and €250 billion in loans) . The RRF is intended to support national recovery and resilience plans which will have to be submitted by individual EU Member States to the European Council, the European Commission and the European Parliament for review and approval. These national plans will need to prioritise investments aimed at accelerating the digital and green transitions.

The rationale for concentrating two thirds of the Next Generation funding in this facility is that it would be channelled to support public investment where it is most needed while alleviating the burden on the national budgets. We reproduce the pre-allocations of funds from the Recovery fund retrieved by Bloomberg – including the RFF and other instruments and facilities described below – by country and we compare them with each country’s share of EU-27 GDP. The fiscal transfers implied in the EU proposal are obvious as a few countries would receive a significant share of total distributed funds (grants+loans) – excluding the guarantees made available to the EIB and the mutualised facilities – which represent between two and three times their share of EU-27 GDP (cf. table below).

	Grants in billion euros	% of 2019 GDP	Loans in billion euros	Grants+Loans in billion euros	Share of total programme (%)	Country’s Share of EU-27 GDP (%)
Italy	81.8	4.5	90.4	172.2	26.2	12.8
Spain	77.3	6.2	63.1	140.4	21.4	8.9
France	38.7	1.6		38.7	5.9	17.4
Poland	37.7	7.1	26.1	63.8	9.7	3.8
Germany	28.8	0.8		28.8	4.4	24.7
Greece	22.5	12.0	9.4	31.9	4.9	1.3
Romania	19.6	8.8	11.6	31.2	4.8	1.6
Portugal	15.5	7.3	10.8	26.3	4.0	1.5
Bulgaria	9.2	16.5	3.1	12.3	1.9	0.4
Czech Republic	8.6	3.9	10.6	19.2	2.9	1.6
Hungary	8.1	5.6	6.9	15	2.3	1.0
Slovakia	7.9	8.4	4.9	12.8	1.9	0.7
Croatia	7.3	13.5	2.6	9.9	1.5	0.4
Netherlands	6.7	0.8		6.7	1.0	5.8
Others	34.9	13.8	10.5	45.4	6.9	18.1
Total	405*	2.9	250	655	100	100

However, according to data released by the Commission and compiled by Zolts Darvas from the Bruegel Institute, the disbursement of the grants included in the RRF would be split across the 2027-2027 with most of the payments concentrated over the 2022-2024 period. This means that there could be a significant time lag between the full outplay of the crisis and the receipt of EU funds. This does not fit well with the idea of a massive and concentrated fiscal stimulus in the Keynesian sense, although the EU budget has never been intended for macroeconomic stabilisation and its overall very modest size would not qualify it for that purpose anyway.

In addition to the above mentioned flagship recovery facility, €190 bn of additional market funding would be used to enhance the EU’s existing programmes, instruments and facilities:

• The green transition would also be supported by a substantial increase of the Just Transition Fund from €14 bn to €40 bn.
• The REACT-EU facility (Recovery Assistance for the Cohesion of the Territories of Europe) would add up to €55 bn of additional cohesion policy funding between 2020 and 2022, without national co-funding required.
• An additional €15 bn extra funding for the European Agricultural Fund for Rural Development (EAFRD)
• EU guarantees to the European Investment Banks (EIB) and to national development banks will be raised to €60 bn, in order to support investments made by the private sector . This instrument is mostly a rollover and an extension of the Junker Plan which will expire by the end of 2020.

Taking into account the Next Generation proposal, the new EU financial architecture for 2021-2027, including the EU Budget (MFF) and the Recovery Fund, would look approximatively like this against the previous proposals (cf. the right column in the chart below):

To finance the recovery programme, the Commission will issue bonds on the financial markets on behalf of the EU. As per the Commission’s wording:

The Commission will borrow up to €750 billion, the bulk of it concentrated in the period 2020-2024 and:

– channel the funds to one of the new or reinforced programmes or finance the grant component of the Recovery and Resilience Facility,

– or lend the money to the Member States in need under the new Recovery and Resilience Facility under the terms of the original emission (same coupon, maturity and for the same nominal amount).

In this way, Member States will indirectly borrow under very good conditions, benefitting from the EU’s high credit rating and relatively low borrowing rates compared to several Member States.

This is the debt mutualisation component of the new plan as it would de facto transform the European Commission into a conduit for credit enhancement of Member States debt for up to €250 bn. In this regard, the European Commission would mimic the action of the ESM, although the later is more akin to emergency financing in a balance of payment crisis, much as the IMF would do, whereas the former would evoke the practice of a development bank.

In order to ensure the sustainability of this debt representing 5.4% of EU-27 GDP in 2019, the Commission has proposed to the Member States an amendment of the Own Resources Decision – the legal text that sets the rules governing the funding of the EU budget – by increasing the Own Resources Ceiling – i.e. the maximum revenues that the Commission can raise every year (cf. chart below) – to 2% of EU GNI (versus 1.4% of GNI currently) and by adding new sources of own revenues:

• Extension of the Emissions Trading System– based own resources to the maritime and aviation sectors to generate €10 billion per year
• Carbon border adjustment mechanism to raise €5 billion to €14 billion per year
• Tax on large companies, which, depending on its design, could according to the EU Commission yield around €10 billion per year
• Digital tax on companies with a global annual turnover of above €750 million to generate up to €1.3 billion per year

It is difficult to evaluate ex ante the additional risk posed in the long term to the European Union’s Member States by this additional debt. This will depend on the evolution of the EU funding sources over the next thirty years as the debt is expected to be fully repaid only in 2058. Obviously, there will be redistributional effects from the debt mutualisation and net fiscal transfers implied by allocation rules that differ from the traditional GDP and population criteria. However, the EU has always functioned as an institutional mechanism to redistribute income and encourage convergence between its Member States. In the 1990s and the early 2000s, the Eastern European countries received subsidies amounting to up to 5% of their GDP. This is justified from a macroeconomic perspective by the spillover effects that the additional income in one part of the EU generates in other parts.

Zsolts Darvas from the Bruegel Institute has also outlined in a recent blog post that the overall measures announced miss the opportunity for a more fundamental reform of the EU Budget in a post-Brexit Europe – for more on this you can also read Gunthram Wolff’s policy paper published in 2018. As a matter of fact, the Common Agricultural Policy would still represent around 30% of the EU permanent budget.

The €750 billion financial instrument is deemed to be “exceptional and temporary” in the Commission’s very own wording. History shows however that often what is perceived as temporary eventually becomes permanent. Hence, overall this proposal is welcome as it builds on the French-German proposal and paves the way toward a proper fiscal Union backed by a mutualisation of debt. However, by blending the proposed recovery fund into the EU’s multi-annual financial framework, it does not acknowledge the inherent specificity and centrality of the Economic and Monetary Union (EMU). As a result, a few Non-Eurozone EU Member States – including Denmark and Sweden which have been granted a legal “Opt-Out” clause to remain outside the Eurozone – will continue weigh on the fiscal policies of the Eurogroup and will have their say on every major decision influencing the stability and value of the single currency.

Hence, the EU Next Generation proposal cannot be dubbed a “Hamiltonian moment” for Europe the way it has been framed by some commentators rushing to conclusions. The European Commission remains a supranational organisation with delegated powers, not the Executive Body of a Federal State. This has been strongly reasserted by the German Constitutional Court – Deutsches BundesVerfassungsGericht – in a landmark ruling pronounced in May, which overturned a previous ruling made by the European Court of Justice regarding the legality of the ECB’s Asset Purchase Programme (APP) (cf. our analysis of this ruling).

The EU proposal is likely to morph several times before a consensus is reached between the Member States on the 2021-2027 MFF and on the recovery fund. The total amount of the recovery fund, the mix between loans and grants and the allocation ceilings of the funds to the Member States will be the most contentious points in the expected heated discussions that will take place in the run up to the July EU summit.

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