Get Out: The EU’s COVID-19 Exit Strategy

Authors: Ashwin Vijay Srinivasan & Jacob Tran Vu Son Tung

Editor: Harsh Didwania

Less than a month after news of severe cases of pneumonia in Wuhan, China, linked to the city’s seafood market, broke out, the European Union (EU) received its first reports of SARS-CoV-2 from member states on January 24th, 2020. Since then, the COVID-19 pandemic has led to the emergence of a multifaceted global crisis that is not only medical, but is also economic, social, humanitarian, and political in nature. Stories of burgeoning cases and healthcare teetering on the edge of systemic failure in countries like India, the U.S., and Brazil have been dominating the news. That said, the EU’s struggle and roadmap to recovery will provide history with a valuable account of the benefits of collaborative partnership that is enabled through regional economic integration, especially when contextualised in today’s growing populist and protectionist rhetoric. More pertinently, it speaks to how an able leadership and deft handling of an unprecedented calamity has paved the way for a structured and potentially transformative recovery by capitalising on the opportunity provided by the pandemic-induced reset.

Among the world’s largest and most developed nations, the general consensus is that the brunt of the effects faced by the EU have taken a larger toll on its economy which will prolong its recovery. With a GDP growth rate of 4.8% forecasted for 2021 (European Commission, n.d.), it lags most noticeably behind China and the U.S., which are on track for an 8.5% (The World Bank, 2021) and 7.0% growth respectively (Mutikani, 2021). What does not bode well and is more worrying, however, is that the EU’s real GDP levels are expected to surface back to pre-pandemic numbers only by mid-2022, which is an indication of below-par growth. Prior to exploring what lies ahead for the union, it is crucial to have a comprehensive understanding of the EU’s immediate response to the onset of the pandemic, and the adoption of the much more deliberate and methodical NextGenerationEU (NGEU) recovery plan.

The EU’s long-term budget is determined in cycles of seven years and is encapsulated in its Multi-annual Financial Framework (MFF), which is funded by national contributions based on each country’s Gross National Income (GNI)[1], customs duties on imported goods and services, a proportion of the value-added tax (VAT)[2] collected by each country (capped at 0.3% for the 2021-2027 MFF), and as of 2021, a contribution of €0.80 per kilogram of non-recycled plastic packaging waste in order to move closer to achieving a circular economy (European Commission, n.d.); the Directorate-General of the Budget under the European Commission determines the distribution of these funds.

It was the prerogative of the 2014-2020 MFF to allocate financial resources for the EU’s reactionary response to mitigate the pandemic’s effects, which included plummeting demand and production, major losses of income and economic activity, widespread unemployment, and a healthcare crisis. This included €200 billion to fund European Investment Bank (EIB)[3] loans to enterprises, €240 billion of financial support for countries from the European Stability Mechanism (ESM)[4], €100 billion for the Unemployment Risks in an Emergency (SURE) instrument, and €800 million for the healthcare sector (De Vet et al., 2021). By June 2020, roughly €3.5 trillion worth of fiscal support was sanctioned by the EU’s member states, which is equivalent to 27% of the region’s estimated GDP for 2020 (De Vet et al., 2021). Further, due to a significant variance in each member states’ level of economic development, prosperity, and crisis-handling capability, there was an inherent disparity in the size of individual countries’ stimulus packages.

While throwing money at the problem was a widely adopted strategy across the world, further recovery would need to be fuelled by a plan that focused on short-term recuperation while laying the foundation for enabling and achieving the EU’s longer-term objectives and priorities. This resonated with the EU’s leaders and materialised in the form of the NGEU plan, which is the crown jewel of the region’s 2021-2027 MFF and is akin to the Association of Southeast Asian Nations’ (ASEAN) Comprehensive Recovery Framework (ACRF). The NGEU will be funded by the capital markets through the issuance of bonds that will be fully repaid by 2058, 30% of which will be green bonds.

The 2021-2027 MFF will provide a monetary injection worth €2.018 trillion to rebuild a “greener, more digital, and more resilient Europe” (ec.europa.eu, n.d.). Of this, the Recovery and Resilience Facility (RRF) accounts for €723.8 billion under the NGEU (which is worth €806.9 billion), and entered into force in February 2021 and “will finance reforms and investments in Member States until 31 December 2026” (European Commission, n.d.). The funds set aside through the RRF have the sole priority of aiding the alleviation of the socioeconomic externalities of the pandemic and to work towards preparing the region for its transformation over the next decade.

In order to gain access to these funds, however, each member must submit their individual recovery plans to the European Commission, which lays out the relevant reforms and investments that they wish to undertake over the period during which they would be funded by the RRF. These plans “should effectively address challenges identified in the European Semester” (European Commission, n.d.), and “advance the green and digital transitions” (European Commission, n.d.) to improve economic resilience. Submission, approval, and translation of these plans into legally-binding documents will immediately unlock 13% of the funds that a specific country is eligible to receive.

(Source: European Commission, n.d.)

Disbursements have been made since 13 July 2021 for 12 countries. At the end of August, 25 out of 27 member states have submitted their plans, with 16 being endorsed by the Commission and 12 by the EU Council (BakerMckenzie, 2021). With the plans being underway, we want to examine how well the plan will fare in the current socio-economic climate, and what can be the next steps for the EU.

One problem is that there are certain obligations for countries receiving the package that can lead to friction in dissemination. A core tenet of the RRF requires the member state to spend 37% and 21% of the funding on “green” reform and digital transformation, respectively. While this can help move Europe in a common direction, it also dampens the immediate impact of the fund. As climate change is not as immediate a concern as COVID-19 recovery, it is questionable how the two initiatives can be done efficiently together. Worse, EU members might be incentivised to request for much more funding than they need for covid recovery simply because they have to meet the green and digital requirement - this will reduce accessibility to funding.

A less obvious facet to the obligations is that participating countries must resolve their conflict with the EU before receiving the aid. This includes those like Hungary and Poland, whose populist and nationalist governments have been designing policies conflicting with the EU’s general consensus. One prominent case is that of Hungary. While Hungary maintains that its plan is reasonable, the EU delayed approving its application, with speculations being cast over the country’s new “anti-LGBTQ legislations” (Liboreiro, 2021). With these conflicts not ending any time soon, we can expect transmission of funding to these countries being slow.

Secondly, the EU has been incurring huge debt through the COVID-19 pandemic, and its history with debt is by no means stellar. It did not manage to recover to pre-2008 recession level of GDP until six years later, being entangled in a debt crisis. Criticism has been placed on its obsession with a stable common currency and therefore unwillingness to resort to stimulus packages. The failure of these austerity measures means that this time, the EU is determined to spend to stimulate its economy.

With this new RRF package, funds are being financed by common debt. While member states appear confident in the EU’s ability to finance the funds, the shadow of the debt crisis lurks. With EU debt experiencing a sudden increase in 2020 (European Union, 2021), there is a possibility of another debt crisis. The union has to tread a fine line between not providing enough equity for the economy to recover, and providing too much equity, leading to another debt crisis should the recovery target not be met.

Furthermore, debt is concentrated in several vulnerable countries like Greece, Portugal, and Italy, the latter being a huge concern. Being the hardest hit by covid and the biggest beneficiary of the RRF, Italy has also not exhibited strong growth since the 90s, raising doubt for its successful recovery from the pandemic (Euronews with AFP, 2021). With Italy being such a big economy, the possibility of bailout in case of overwhelming debt as in the case of Greece in 2012 is low. If debt becomes overwhelming for Italy, it can be the downfall of the EU.

One final concern to the RRF’s efficiency is the pessimistic consumer sentiment. With the emergence of the new Delta variant, it is clear that COVID is here to stay. Consumer confidence has taken a drop since this new development (Amaro, 2021). Reopening and lifting of lockdowns are less likely to give rise to huge shocks in consumer spending, compared to last year when hopes of speedy recovery was still predominant. Certain important sectors, such as hospitality, might see growth as countries partly open up, but substantial increase in tourism spending is unlikely.

On the other hand, with living with the virus becoming the norm, EU consumer behaviour is exhibiting a sustainable transition to digital (Barchet et al, 2021). Member states might be in a position to take advantage of these while designing their digital transition plan under the RRF. Investments in better working-from-home support, as well as online entertainment and shopping, are all options that align with the general consumer sentiment.

Notes

[1] As defined by the Organization for Economic Cooperation and Development (OECD), gross national income (GNI) is the sum of a nation’s gross domestic product (GDP) and “net receipts from abroad of compensation of employees, property income and net taxes less subsidies on production” (OECD, n.d.). [2] “A value-added tax (VAT) is collected on a product at every stage of its production during which value is added to it, from its initial production to the point of sale” (The Investopedia Team, 2021).

[3] The EIB is the lending arm of the EU.

[4] The ESM “was set up as an international financial institution by the euro area Member States to help euro area countries in severe financial distress” (European Stability Mechanism, n.d.).

References

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