Calls have been coming from all sides for the EU to intervene in the COVID-19 crisis in the name of European solidarity. Although the Union has little room for manoeuvre in the public-health sphere, it can use the powerful lever of economic and monetary policy to counter the coming economic downturn.
The crisis triggered by the coronavirus is rumbling across the whole of Europe and paralysing the continent’s economy. As of now, the most affected countries – Spain and Italy – are also among those most hurt by the 2008 crisis and its aftermath. But the economies of Europe’s two heavyweights, France and Germany, are also coming to a standstill. If each country is left to face the situation alone, there is the risk (not to say certainty) that the weakest will weaken even further. What can (or must) the EU institutions do?
There is of course the monetary policy and the action of the European Central Bank (ECB). It had did things by halves and missed its communication on March 12, triggering a crash on the financial markets. It has just made up for it by deciding on 18 March to inject 750 billion euros into the European economy by the end of the year. This is obviously good news, but the ECB will not be able to continue to act alone and in an undifferentiated manner at the level of the euro zone as a whole.
We must also mobilise budgetary tools on a large scale and be able to provide more specific aid to individual countries. This was done very inadequately and too late during the eurozone crisis.
There are ways forward, as is shown by the work of Daniela Schwarzer and Shahin Vallée for the German DGAP, Lucas Guttenberg for the Jacques Delors Centre of the Hertie School, and Luis Garicano for VoxEU, among others. Here we present an overview of the debate and the main proposals on the table.
Right now, the question is not one of sustaining demand and kickstarting economic activity, as during a classic financial crisis. States have already decided to slow economies to the strict minimum in order to gradually halt the epidemic. The priorities are rather to avoid redundancies by means of widespread, properly paid, temporary unemployment benefit; to prevent small businesses and the self-employed from going bankrupt; to prevent banks from failing; and to finance an exceptional boost in health spending. And all this while limiting speculation in the financial markets, particularly against the debts of the most fragile states.
Strictly speaking, the European budget has extremely limited firepower. It weighs less than 1% of the Union’s GDP, its use is highly regulated, and the Union does not have the right to go into debt by issuing securities on the financial markets as member states do. On 11 March, the European Commission announced the setting up of a special fund of € 25 billion, 0.17% of the EU27’s GDP: a drop in the ocean. On 17 March, the Commission went a little further by increasing the amount to € 37 billion, via its unused structural funds, with a plan to release € 28 billion more later. But even € 65 billion (0.45 points of GDP) would remain a very insufficient amount.
Such a crisis could and should be an opportunity to lift the taboo on so-called eurobonds, or sovereign-debt securities issued by the European Union (or European states jointly) to finance public action. The subject was broached by Giuseppe Conte, the Italian prime minister, at an emergency summit on the crisis held by videoconference on 17 March. He was supported by Emmanuel Macron. And, surprisingly, Angela Merkel did not say no, passing the ball back to her social-democratic finance minister Olaf Scholz to look into the possible modalities. The coronavirus offers a good opportunity to break the taboo.
The main argument against eurobonds so far has been “moral hazard”: if joint securities are issued, nobody will any longer have an interest in maintaining budgetary discipline at national level. But in the case of the coronavirus crisis, the shock is clearly completely exogenous to the eurozone. Responding to it via eurobonds should not arouse suspicions of encouraging bad behaviour. The argument is still far from won, however. Unsurprisingly, Mark Rutte, the Dutch prime minister and leader of Europe’s budget hawks, has opposed it for the time being. So the idea is gaining ground, but it probably still has a long way to go.
For now, member-state budgets will be financing much of the effort to support European household incomes, to prevent business bankruptcies and to fight against the epidemic itself. More precisely, in the immediate future the burden will fall on states’ deficits and debts: their revenue will shrink with the tax and social-security exemptions given to companies and households, and their spending will grow due to temporary unemployment, credit facilities, healthcare and policing. It has already been established that, in such circumstances, the restrictive clauses of the Stability Pact no longer apply: states may overlook the 3% deficit rule and the obligation to reduce debt above 60% of GDP. The French government, through Gérald Darmanin, the Minister of Public Accounts, has already announced that it is forecasting a deficit of 3.9 points of GDP in 2020, a forecast that is likely to be revised upwards by the end of the year.
But this will not be enough. A significant part of the extra spending that member states will have to bear will consist of providing aid to their companies to prevent them from going bankrupt due to plummeting turnover. State aid to businesses is very strictly regulated by the European treaties: one of the European Commission’s main tasks is to root it out so as to avoid distorting competition within the single market. However, the European Commission has already announced that aid given to companies to deal specifically with the coronavirus crisis will not be considered as distorting competition.
Even if they cannot provide significant immediate help to the European economy, the European institutions have thus cleared the way for ambitious national policies in response to the crisis. As with the public-health response, there is still no real coordination of these policies. The summit of 17 March did show some progress: member states were encouraged to spend one point of GDP to support their economies and to grant credit lines to their companies up to a limit of 10 points of GDP.
Nonetheless, countries are essentially advancing on their own, at their own pace. Germany has announced the implementation of a “bazooka” of € 500 billion (14 points of GDP). France intends to put € 300 billion (12 points of GDP) on the table, according to Emmanuel Macron. Earlier Italy had announced a plan to inject € 25 billion (1.4 points) into its economy, and Spain a plan of € 14 billion (1.1 points). Right now these plans, which are not very detailed, are difficult to compare because the nature of the sums is different. Commonly they are not public expenditure strictly speaking, but rather simple cash facilities offered to companies to prevent them from going bankrupt.
The figures highlight a major potential problem: in a purely national framework, governments’ room for manoeuvre varies widely. And the countries most affected by the epidemic so far – Italy and Spain – are also those that have the smallest resources of their own, because they had only barely recovered from the euro crisis when the coronavirus struck.
The coronavirus crisis has already pushed up the long-term interest rates at which European states, including Germany, can borrow on the financial markets. But it has also begun to widen the spreads, the interest-rate differentials between different countries within the eurozone. Italy now has to pay 2.6% more interest per year than Germany to finance its debt, compared with 1.3% a month ago: the spread has fully doubled. On a debt that currently equates to 137% of Italian GDP, this represents for Italy an additional cost of 3.6 points of GDP per year in public spending if the spread is maintained over the long term. The situation risks discouraging the Italian government from taking sufficiently bold measures in response to the crisis. Moreover, there is a serious risk that the gap could widen further in the coming weeks if the health crisis continues.
Hence the need to find collective solutions that make it possible to help the most fragile countries in particular. We should not be under any illusions: even the strongest will be affected if European solidarity is found lacking. As economist Shahin Vallée points out: “contrary to what happened during the euro crisis, even German rates have also risen in recent days”. But Europe is not without levers of action, thanks in particular to the new tools created in the wake of the euro crisis.
1. The European Investment Bank must grant massive loans to European SMEs.
All governments are set to grant credit lines to companies to prevent them from going bankrupt. They will generally do so via public banks such as the Caisse des Dépôts et Consignations (CDC) or the Banque Publique d’Investissement (BPI) in France. At the European level, the European Investment Bank (EIB) could provide some of these facilities to prevent them from affecting the financial quality of the debt of each of the countries concerned. The EIB has already agreed to grant € 8 billion in loans to SMEs and to increase this amount to € 20 billion at a later stage. But these levels remain low. Spanish economist Luis Garicano proposes that the EIB should grant € 275 billion in loans, the equivalent of 2 points of the Union’s GDP. It could raise such an amount by issuing securities on the financial markets, which would be de-facto equivalent to eurobonds. And if the EIB has insufficient capital to support such loans, governments should recapitalise it.
2. The European Stability Mechanism (ESM) funds should be used unconditionally.
The second lever that Europe could use is the European Stability Mechanism (ESM), set up after the 2010 crisis. This fund has an intervention capacity of € 410 billion, or 3.4 points of eurozone GDP. It is intended to provide conditional assistance to countries that can no longer finance their debt on the markets at economically bearable rates. The fund is also endowed with a hitherto unused capacity to grant emergency loans, even before a state has been placed under its supervision. In the present circumstances, the ESM should be strongly encouraged by European leaders to make use of this possibility as soon as the need arises. The ESM should also state that in the context of the current epidemic, the only conditions it will put on its aid will be that the money is used to support the health system and the victims of the coronavirus crisis.
3. The European Central Bank must buy the securities of the states most in difficulty.
Activation of the ESM would also allow the European Central Bank (ECB) to use a tool that was put in place during the euro crisis but is not yet in use: Outright Monetary Transactions (OMT). Provided that the ESM has decided to help a government, this mechanism gives the ECB the right to buy that government’s debt securities on the markets in order to lower the interest rates demanded by investors. This is something it is not allowed to do in normal times: it is obliged to buy proportionally as much German as Italian debt when it intervenes on the financial markets.
4. The resources of the EU banking union must be strengthened.
The fourth lever that Europe now has is the Single Resolution Fund (SRF). This was set up within the framework of Europe’s banking union to prevent a troubled bank from weighing down its country’s public finances and thereby encouraging speculation against the country’s sovereign debt. This vicious circle was observed in certain crisis-hit countries in 2008-2010. The SRF, which is financed by the banks themselves, remains modest for the moment: it still has only € 33 billion, a drop in the ocean to guarantee the € 35 trillion total balance sheet of European banks. But one of the reforms of the aforementioned European Stability Mechanism (ESM), under discussion before the coronavirus crisis, was to use the ESM as a “backstop” for the SRF: if the banks’ difficulties exceeded the SRF’s capacity, then the ESM would take its place to support the banks. In the current context it is important for this reform to be implemented as quickly as possible, so as to prevent the difficulties of an individual country’s financial system from being reflected in the quality of its public debt.
5. Short-time working must be financed at the European level.
Before the coronavirus crisis, the EU had made genuine progress on the idea of European unemployment insurance as a countercyclical tool of solidarity. The current crisis could and should be a way to start putting the plan into practice. A part of the short-time work entailed by the crisis could be subsidised through European funds. If the crisis goes on, it will probably also be necessary to consider the option of “helicopter money”, money paid directly to households by the European Central Bank.
In the face of the unprecedented economic and social crisis that the coronavirus epidemic is causing in Europe, we are not totally without tools to respond in a spirit of solidarity. But as in previous such crises, a race is on. Will Europe be able to act other than “too little, too late” this time?