EU leaders have reached an agreement on the €750 billion Recovery Fund. However, it seems that no detailed explanation has been provided on what the Fund actually does and how one could leave it once it is ratified in the parliaments of all 27 member states.
In this article, we will attempt to explain what the Recovery Fund is, what it claims to do, what it actually does and how one could leave it. The main points are as follows:
• The Fund totals €750 billion of which 390 billion will be distributed as grants and 360 as loans.
• The funds including interest costs will be repaid primarily through higher EU dues and joint EU taxes (maybe called “fees”) during the period 2028-2058.
• The recovery effects of the Fund are likely to be insignificant since it funds marginal projects of unknown quality and, furthermore, is too small to achieve its aims as marketed by its supporters.
• The Fund is contrary to several Articles of Agreement in the EU basic charter.
• If parliaments accept the Fund as is, the EU will enter into an income transfer union.
• Thereafter, the Fund cannot be exited except by exiting the EU as a whole.
• If the reader wants to avert this, they should urgently protest to his representative in Parliament.
The EU will, through a Fund outside its budget, borrow a total of €750 billion to be distributed to its members as grants and loans in 2021-2023. Grants will total €390 billion and loans €360 billion. Most of the funds, €672.5 billion, will be channeled through the Recovery and Resilience Facility. The remaining €77.5 billion will be distributed through different funds, like the European Social Fund.
Each member state must produce a plan, to be supervised by the EU Commission, for using the received funds. Unless this plan is followed, funding may be interrupted.
It is yet unclear how the loans will be structured and what the interest rate will be. Member states guarantee repayment of the loan through the EU budget. This budgetary funding requires unanimity while the Fund can be created through majority decision.
Member states’ ultimate guarantees have been capped at double the calculated total (in Finland’s case some €13 billion). However, it must remain true that Fund and EU liabilities remain regardless of any repayment difficulties of individual member states. In reality, caps on solvent states’ repayment obligations cannot therefore be truly permanent or credible.
Assistance granted by the Fund
Despite the Fund being nominally created to combat the effects of the coronavirus, its distribution criteria show scant relationship to this. Of all grants, €77.5 billion are distributed through already existing EU programs. Of the remaining €312.5 billion, about 70% are distributed among member states according to population size, size of GDP per capita and unemployment during the (pre-Covid) period 2015-2019. Criteria for distributing the remaining 30% are population size, real GDP per capita, and loss in real GDP in 2020 and the absolute decline in real GDP during 2020 and 2021 calculated in equal portions.
Grants are thus primarily distributed to states with economic problems having nothing to do with the coronavirus. The Fund can therefore be characterized as an income transfer fund serving primarily countries which have had permanent problems with their economic policies. The largest recipients, from the Recovery and Resilience Facility, are:
– Italy: €65 billion (approx. 7% of 2020 government budget)
– Spain: €59 billion (approx. 11% of 2020 government budget)
– France: €37 billion. (approx. 3% of 2020 government budget)
– Poland: €23 billion. (approx. 10% of 2020 government budget)
– Greece: €16 billion. (approx. 18 % of 2020 government budget)
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In some countries, the size of the funds is massive, when we note that 70% (€218.75 billion) will be distributed in 2021 and 2022 and the rest (€93.75 billion) in 2023. As this will come on top of already huge debt stimulus enacted by practically all European countries, it will diminish the stimulative effect of the Fund considerably. It’s also highly questionable whether the funds will find their way into productive investments (see below).
Many countries can already access markets at lower interest costs than the Fund. Interest in Fund resources therefore primarily concerns the grants. Since grants represent only about half of the Fund, it is not unlikely that demands for more or even permanent grants will emerge in the near future.
What does the Fund try to do?
The Fund is marketed as the Next Generation EU as it aims to stimulate investment primarily in projects supporting climatological and digital developments. These investments are supposed to increase growth, reduce unemployment, improve economic and political stability, raise welfare and thus ensure easy repayment of the debts now incurred.
Funding has not been a problem for corporate investments in recent years. The main problem seems to have been general economic uncertainty which has been prolonged by the economic consequences of Covid policy and increased political stresses. At the same time, extremely easy monetary policy together with continued weak bank performance in Europe has increased the number of zombie companies incapable of meaningful investment activity.
The Fund is based on the idea that public funding and control is needed to increase socially and politically acceptable investment by the private sector. However, private companies in any case conduct the investment in projects considered profitable. The Fund will therefore ultimately fund projects which companies deem unprofitable or too risky. Their value will depend on whether politicians have judged the future economic and other needs of society correctly or not.
There is certainly reason to doubt the ability of politicians to do this, as well as the ability of the EU Commission to effectively monitor which marginal projects the Fund actually makes possible. In practice, companies will seek grant funding for all projects likely to be accepted. A number of these would have been realized in any case, making the Fund grant simply another general income stream for the company. If the increased income is used for repayment of debt or for dividends, effects on employment will be minimal.
A more pressing issue than inducing companies to selectively invest is the need to support ailing banking systems in Europe. Jose Manuel Campa, Chairman of the European Banking Authority, suggested in May 2020 that Fund financing (then proposed to be €500 billion) should be used in its entirety to recapitalise EU banks. Last summer, the recapitalisation needs of the Italian banking system were estimated at €300-400 billion, and the sum is now probably even larger. The EU appears to be on the verge of a new banking crisis.
The Fund has been marketed as an effective part of the economic recovery from the coronavirus in Europe. It is nothing of the sort and its primary effect is elsewhere.
What is the real aim of the Fund?
The Fund profoundly changes the way the EU functions.
It increases joint debt of the member states and the income transfers between them. Greater joint financial responsibilities strengthen ties to the EU which is important particularly to constrain countries not willing to accept the new emerging principles and aims. Finally, it changes the role of income transfers in the EU, where they have previously consisted primarily of farming subsidies.
Moreover, existing agreements on the functioning of the EU (SEUT) are effectively ignored.
Article 125 forbids the EU from assuming commitments of member states. Measures by the EU to reduce budget deficits of member states, for instance through grants, are accordingly not allowed. The Article also restricts member states from taking responsibility for each others’ liabilities, thus disallowing any development towards a fiscal union.
Article 310 requires that the EU budget be in balance, and that expenditures are financed exclusively by current income. However, the Fund means that part of EU expenditures will be debt-financed.
Article 122 allows the above principles of the Agreement to be put aside in the case of severe difficulties. Such difficulties are usually exemplified by natural catastrophes or other exceptional circumstances. For example, German legal experts have questioned whether a rule referring to single member states can be used as a basis for the Fund or for building a debt-financed EU budget.
Since the criteria used for distributing Fund resources don’t reflect the effect of a “natural catastrophe” i.e. the coronavirus, the Fund reveals itself as a pure income transfer instrument. Its use means the unlawful introduction of elements of a fiscal union. It is useful to note that the Finnish Parliament has previously rejected accepting instruments that obviously go against existing EU Articles.
How to exit the Fund
There is little doubt that the Fund or similar instruments will grow in the future. There is nothing indicating that member states will change their economic policies in a direction which reduces the need and wish for financial support. New crises will therefore arise, and grants will be demanded referring to the Fund as precedent.
The German Social Democrats as well as Christine Lagarde, the President of the ECB, have already suggested that the Fund become a permanent part of the EU. This is no surprise as the Fund does very little to fix the main problems of the Eurozone: the over-indebtedness of Italy and Spain. They will, most likely, also demand more income transfers in the future.
For those not wishing to take part in the growing fiscal union the question arises of how to exit the Fund.
The Fund itself is created through an EU Commission regulation which automatically enters into force and binds member states until rescinded or changed. National parliaments have no say in the matter.
The financing of the Fund, however, requires unanimity among member states and acceptance by national parliaments. If even one member state opposes financing of the Fund, the instrument must either be discontinued or created among willing members using a separate agreement outside the EU framework. This was discussed at the time when Hungary and Poland opposed some of the support criteria of the Fund.
It is thus impossible for a member state to exit from the Fund if its Parliament, together will all others, has accepted the financing of the Fund. The only way to exit from the Fund would be to exit from the EU as a whole. Even then, it is likely that the EU would insist that the country must fulfill the financial obligations it has entered into while a member.
The safest way to “exit” from the Fund is therefore to never accept its financing in the first place.
Until his retirement in 2010 Dr Peter Nyberg worked at the Finnish Ministry of Finance as Director General of the Financial Markets Department. He joined the Ministry in 1998, having previously worked at the Bank of Finland in various capacities, finally as an Adviser to the Board. After his retirement he was retained for various tasks related to financial crises, among them work for the Irish government to evaluate the causes of the banking crisis there. He also worked for the IMF as a Senior Economist in the 1980s.
Dr Tuomas Malinen is CEO of GnS Economics Ltd. and an Adjunct Professor of Economics at the University of Helsinki. He is also a Vice-Chairman of EuroThinkTank, a group of professional research group studying the future of the eurozone. His research interests include economic growth, economic crises, monetary unions and income inequality.