Building on Macron-Merkel initiative, Commission proposes €750 billion of borrowing for recovery

On April 23, the European Council, the heads of state or government of the 27 member states of the European Union, approved a €540 billion package of assistance for workers, firms, and euro area member states that the Eurogroup, the finance ministers of the euro area, had approved two weeks earlier. The package consists of three elements: The first, designed as a safety net for workers, involves a new program—SURE (Support to mitigate Unemployment Risks in an Emergency)—that will provide up to a total of €100 billion of temporary assistance to member states in loans on favorable terms to help cover the costs to firms of national short-time work schemes in which the firms continue to pay workers after their hours have been reduced. The second, designed as a safety net for firms, involves a new €200 billion loan guarantee program of the European Investment Bank to support ailing firms, especially small and medium enterprises. And the third, designed as a safety net for the euro area member states, involves a new Pandemic Crisis Support program, based on the Enhanced Conditions Credit Line facility of the European Stability Mechanism, that will provide precautionary credit lines up to a limit of two percent of the member state’s end-of-2019 GDP, which, if all 19 euro area members were to make use of the maximum amount available, would involve €240 billion.

The Eurogroup package was an important initial response to the pandemic. But as the full magnitude of the economic contraction caused by the COVID-19 pandemic became apparent, it was clear that much more was needed if the member states were to recover. Addressing the European Parliament several days before the European Council meeting, Commission President Ursula von der Leyen said, “We need a Marshall Plan for Europe’s recovery and it needs to be put in place immediately. There is only one instrument we have that is trusted by all Member States, which is already in place and can deliver quickly. It is transparent and it is time tested as an instrument for cohesion, convergence and investment. And that instrument is the European budget. The European budget will be the mothership of our recovery…We will use the power of the whole European budget to leverage the huge amount of investment we need to rebuild the Single Market after Corona. We will front-load it, so we can power that investment in those crucial first years of recovery.” One way to do that, she said, would be to increase the “headroom” in the budget between the amount raised through member state contributions and spending, thereby increasing the amount the Commission can borrow in order to finance additional spending.

At their April meeting, the leaders agreed “to work towards establishing a recovery fund, which is needed and urgent.” The fund, they said, “shall be of a sufficient magnitude, targeted towards the sectors and geographical parts of Europe most affected, and be dedicated to dealing with this unprecedented crisis. We have therefore tasked the Commission to analyze the exact needs and to urgently come up with a proposal that is commensurate with the challenge we are facing. The Commission proposal should clarify the link with the MFF [Multiannual Financial Framework for 2021-27], which in any event will need to be adjusted to deal with the current crisis and its aftermath.” The leaders didn’t identify a target figure, or even a range, for the fund. But when asked in the press conference after the meeting about its size, von der Leyen said, “We are not talking about a billion. We are talking about a trillion.”

Yesterday, von der Leyen addressed the European Parliament and outlined the Commission’s proposed recovery plan. The stage for the announcement was set by several important developments over the past two weeks—most notably, a resolution approved on May 15 by the European Parliament regarding the form, size and financing of the recovery fund; a video press conference last Monday in which French President Emmanuel Macron and German Chancellor Angela Merkel called for creation of a €500 billion recovery fund that would extend grants to member states needing assistance; and an alternative proposal Saturday by the so-called ‘frugal four’ (Austria, the Netherlands, Denmark and Sweden) that called for loans rather than grants.

On May 15, the European Parliament passed, by an overwhelming majority—505 in favor and 119 opposed, with 69 abstentions—a resolution calling for a new “Recovery and Transformation Fund” that should be €2 trillion in size, should be financed “through the issuance of long-dated recovery bonds,” and should be “disbursed through loans and, mostly, through grants, direct payments for investment and equity.” The recovery plan, it said, must provide funds on top of the next MFF and not to the detriment of existing and proposed programs and they should go to programs within the EU budget, in order to guarantee parliamentary oversight and participation. The Parliament said it should be fully involved in the shaping, adoption and implementation of the recovery fund and warned the Commission to refrain from “any attempt to design a European recovery strategy that is outside the community method and resorts to intergovernmental means.” And it warned it would use its veto powers if its demands weren’t met.

As stunning as the Parliament’s resolution was, not only in terms of the size of the proposed fund, the method of financing it, and the form of disbursement but also in the extent to which it claimed for itself a significant role in shaping, approving, and implementing the fund, it was overshadowed by the Macron-Merkel videoconference in which they announced a joint initiative to create a €500 billion recovery fund that would be financed by the Commission borrowing on the financial markets and disbursing the funds through its budget as grants to the sectors, regions and countries hardest hit by the crisis.  

For Merkel—who had said in April, in response to Macron’s statement that there would have to be “real budgetary transfers,” that, while Germany would support a recovery fund in the €1 trillion range “because things can only go well for Germany if they go well for Europe,” grants “do not belong in the category of what I can agree”—the proposal constituted an exceptionally important change in her position. €500 billion isn’t nearly as much as Macron and other leaders such as Italian Prime Minister Giuseppe Conte and Spanish Prime Minister Pedro Sánchez would like, and not even as much as Merkel indicated last month Germany would support. But for a German chancellor to support a fund of that magnitude that would be financed and disbursed in that way is nothing less than historic.

Many commentators have assumed that Merkel’s turnabout was prompted by the German Constitutional Court’s May 5 decision that the government and the Bundesbank had failed to obtain an adequate explanation from the European Central Bank of the rationale and expected economic effects of its 2015 Public Sector Purchase Programme (PSPP). That may have had some effect on her willingness to agree to Macron’s proposal—not least because in March the ECB launched a new Pandemic Emergency Purchase Programme (PEPP) under which it will purchase up to €750 billion of private and public securities this year, has already purchased €180 billion of such securities, and may, at the June 4 meeting of its Governing Council, increase PEPP by another €500 billion, all of which could bring those who objected to the 2015 program back to the court with objections to PEPP. The possibility raised by von der Leyen several days after the court’s decision—that infringement proceedings might be in order because of the court’s disregard for EU law—might also have had some effect.

But at its core, Merkel’s decision was prompted by her realization that, without a sufficiently robust recovery effort, the EU’s Single Market, and perhaps the EU itself, could be imperiled. As she said in her videoconference with Macron, “the pandemic crisis…is the severest crisis the European Union has ever faced. A crisis of this type requires the right kind of answers…. We need to take action. We need to take action at the European level so that we emerge sound and stronger from this crisis….The goal is that Europe will emerge united and mutually supportive from this crisis. We know that the virus affects our countries in different ways and that this is why we face a risk that the economic impact of this virus will undermine EU cohesion and that the cohesion we actually need no longer exists. That is why the recovery fund must play a part in enabling all countries in Europe to respond in the right way. This requires an extraordinary, one off exertion, one that Germany and France are willing to make. Europe needs to stand together.”

Two of the most influential voices in Europe on such matters immediately endorsed the proposal. Christine Lagarde, the president of the European Central Bank, who, from the day she took office last fall, has consistently urged the euro area members to play a larger role in stimulating growth through a coordinated and expansive fiscal policy rather than relying, as they have, on the ECB’s monetary policy, described the proposal as “ambitious, targeted and welcome…..They pave the way for the European Commission to borrow funds over the long term and above all, they allow a substantial amount of direct support to be provided to the countries most affected by the crisis.” And Wolfgang Schäuble, who served as German finance minister from 2009 to 2017 and since then has been president of the Bundestag, also endorsed the proposal: “If Europe wants to have any chance at all, it must now show solidarity and prove that it is capable to act. Germans have an overarching self-interest that Europe gets back on its feet. Additional loans to the member states would have been stones instead of bread, because several are already heavily indebted.”

That, of course, didn’t mean the other EU leaders would immediately fall into line behind Macron and Merkel and endorse their proposal, and indeed Austrian Chancellor Sebastian Kurz and Dutch Prime Minister Mark Rutte soon made their opposition to the proposal known. And on Saturday, the ‘frugal four’ issued a ‘non-paper’ in which they proposed support for an “efficient and sustainable COVID-19 recovery.” Toward that end, they proposed creation of a temporary, one-off Emergency Recovery Fund “to support the economic recovery and the resilience of our health sectors to possible future waves” [of the coronavirus]. The fund would be based on a “loans for loans” approach. While the lending would be on “favorable terms,” the loans would be based on a thorough assessment of needs, would require a “strong commitment to reforms and the fiscal framework,” and would be directed toward “activities that contribute most to the recovery such as research and innovation, enhanced resilience in the health sector, and ensuring a green transition that underpins the EU’s ambitious climate, growth and digital agendas.” The financial scope for the fund would be provided “through savings in the MFF by reprioritizing in areas that are less likely to contribute to the recovery.” There would be an explicit sunset clause after two years and no mutualization of debt.

The European Recovery Plan proposed by von der Leyen yesterday has two components—a new €750 billion recovery instrument, called Next Generation EU, that will be embedded within the MFF, the long-term EU budget for 2021-27, and a revamped MFF, which will involve, aside from the Next Generation EU funds, €1.1 trillion of spending over the seven years, bringing the total over those years to €1.85 trillion. The money for Next Generation EU will be raised by temporarily increasing the EU’s ‘own resources’ ceiling to 2 percent of EU Gross National Income, which will allow the Commission to borrow €750 billion on the financial markets. The funds raised will be repaid through future EU budgets after 2028 and before 2058. To repay the funds, the Commission will propose a number of new ‘own resources’—i.e., additional sources of revenue—that could include a new one based on the emissions trading scheme, a carbon border adjustment mechanism, one based on the operation of large companies, a new digital tax, and a tax on non-recycled plastics.

All of the funds raised through the Next Generation EU instrument will be disbursed through existing or new programs in the EU budget, meaning there will be full transparency and democratic accountability for the Parliament as it insisted in its resolution of May 15. Importantly, given the dispute between Macron, Merkel and others who favor grants vs. the ‘frugal four’ and their like-minded colleagues who favor loans, the Commission proposes, following Macron and Merkel, that €500 billion of the €750 billion raised through the Next Generation EU instrument be disbursed as grants while €250 billion is disbursed as loans.

The funds raised with the Next Generation EU instrument and disbursed as grants or loans will be invested through three “pillars.” The first involves support to member states for investment and reforms to address the crisis and includes, in particular, a new Recovery and Resilience Facility with a budget of €560 billion that will involve grants or loans to member states to implement investments and reforms essential for a sustainable recovery. It also includes a new initiative that will provide a top-up of €55 billion for cohesion support, and additional funding for several programs supporting a green transition. The second pillar is designed to provide incentives for private investment that would kick-start a recovery and includes €31 billion to support a new Solvency Support Instrument, a doubling of the capacity of InvestEU, the EU’s flagship investment program, and €15 billion to support a new Strategic Investment Facility within InvestEU. The third pillar will include €9 billion for a new standalone EU health program to invest in prevention, crisis preparedness and procurement of vital medicines and equipment as well as a substantial increase in support for the EU’s Neighborhood, Development and International Cooperation Instrument and for its pre-accession partners in the Western Balkans.

The Commission’s Plan is immensely complicated, involving as it does the creation of a number of new instruments, programs and sources of revenue, as well as a revamping of the MFF, and it will take some time for the member states and the Parliament to digest and evaluate what the Commission has proposed. The plan will be the subject of extensive discussion when the European Council meets again on June 18-19 and, given its complexity, the discussions will no doubt continue for some time to come. But lest anyone forget how urgently Europe needs a recovery effort on the scale of the one presented yesterday, Lagarde noted the ECB’s estimate last month that the euro area economy might contract by only 5 percent this year is already outdated and it now appears it will contract by 8 to 12 percent.

David R. Cameron is a professor of political science and the director of the European Union Studies Program at the MacMillan Center.