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What is the price of EU solidarity?

As Europe tries to find a way to boost moribund economies, will the deficit countries finally get access to an EU chequebook?

Euro notes

John Redwood

in Features


Germany has €935bn deposited at the European Central Bank. Italy, Spain and Greece between them have borrowed €936bn from the same source. Both sides enjoy a zero-interest rate on these positions.

They are held through the Target2 balances, originally designed as a way of handling short-term imbalances in payments between the various countries of the Euro. It has become instead a de facto way of transferring large sums from the rich surplus countries to the poorer deficit countries of the zone, with no formal repayment date and on interest cost. It's a neat solution to one of the fundamental flaws of the Eurozone's architecture, the absence of a mechanism to transfer large sums by way of a grant from rich to poor, from a surplus area to a deficit area.

There are varied surpluses and deficits amongst the other members of single currency scheme, so my presentation of the simple symmetry between the German surplus and the deficits of three of the deficit countries is designed to bring out the stark underlying reality that effectively Germany is financing the most financially stretched. In a similar vein, the Netherlands deposit account almost equals the Portuguese overdraft at the ECB.

Economy hit hard

The EU economic forecasts for 2020 do not make good reading. They report without comment the likely ballooning of the annual deficits of EU countries to 8.5% of total GDP, way above the 3% ceiling laid down in Treaty, and well above last year's 0.6% led by a German surplus. They anticipate unemployment rising to 9%, inflation falling to 0.2%, and a substantial fall in GDP.

Commissioner Gentiloni says: "Both the depth of the recession and the strength of the recovery will be uneven, conditioned by the speed at which lockdowns can be lifted, the importance of services such as tourism in each economy and by each country's financial resources. Such divergence poses a threat to the single market and Euro area." 

The Commission is willing to share its deep worries about the EU and Eurozone, partly to put more pressure on the member states to undertake more collective action to limit the damage of antivirus policies and to speed recovery.

It appeared for some time as if Germany – along with the Netherlands, Sweden and Austria – would continue to block all attempts to raise more money at EU level to spend in the vulnerable deficit countries struggling with the virus. Covid-19 has been unkind to the Eurozone, doing far more damage to Spain and Italy than to Germany. Both countries relied on tourism and hospitality for an important part of their earnings, only to see those sectors prevented from trading by lockdown, and then kept low by a reluctance for people to travel and the need for social distancing.

Recently, France and Germany stirred into action and brokered a bilateral deal to support a new €500bn fund of money to be spent on green policies and recovery from the pandemic. This fund is designed to go out and borrow Euros based on the collective covenant of all EU member states. The interest will be provided for in the European budget should there be a positive interest charge to meet. Eventual repayment will be at the expense of all the member states.

Wealth transfer coming?

The deficit countries have long wanted access to an EU cheque book to boost spending in their countries whilst enjoying the credit status of the whole EU backed by super-prudent Germany and the Netherlands. At last, for €500bn, they might achieve it. In order for it to work, a number of hurdles still remain. All member states have to agree to this, as it is currently just a Franco-German proposal.

Then those spending money from the fund need to spend proportionately more in the weak deficit countries than in the stronger-financed states. Were the fund to pay out in strict proportion to the size of each economy in the EU, or in the ratios of each country's share of ECB capital and risk, there would be little improvement over the deficit countries raising the same sum nationally to spend. They need to get a bigger share to get more fiscal stimulus from this package. The EU as a whole has to make sensible arrangements over the duration of these debts and over the impact they may have on the size of the rest of the EU budget. 

Some think this might be the first of several such moves, implying the EU is well on the way to accepting mutual financial obligations on a large scale. Others see this as a one-off response to a unique crisis, where the surplus countries will move to ensure it does not happen again and its impact is limited.

Germany key

Angela Merkel felt strong enough to brandish her pro-EU credentials again thanks to a relatively good outcome for Germany from the pandemic which has strengthened her popularity. As often with the EU, it is probably enough to get them through the next few months, but not enough to sort out the underlying imbalances in the EU economy.

Bulgaria has an average GDP of around €10,000 a head and parts of Greece around €14,000 a head compared to €53,900 in the Ile de France. Italy has not grown overall since 2007, even before the virus hit. The EU often talks about solidarity, but the iron rules of the German-led currency scheme have, up to now, prevented large tax cuts or spending boosts in the poorer parts of the area to try to help them catch up.

The €500bn may be spread around quite a lot, on the basis that all should have prizes, even if the south gets relatively more. Given the overall size of the EU economy and the possibility this spending will be spread over more than one year, this is a helpful stimulus, but not a large one in relation to the pandemic damage to the economy or the scale of response seen in the US, UK, Japan and elsewhere.

With the German Constitutional Court judgement still causing disagreements and the Germans still reluctant to countenance large scale fiscal sharing, the stresses remain in the system. Using the EU budget as the mechanism for this proposal entails some delays in getting the money out to the places that need it and means future arguments about how far this approach can go. Agreement today on such a fund is helpful but does not in itself resolve the issue of whether the Euro area becomes a full transfer union with the richer countries supporting the poorer countries.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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