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Europe’s overreach with the Recovery Fund may spell the end of the euro ǀ View

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Barely two months ago, the European Commission delivered a soaring vision of a stronger, more united, and more integrated European Union. The painted landscape – “a union of vitality in a world of fragility” – reflected confidence built upon the July summit agreement of EU member states; an agreement which established a €750 billion Recovery Fund to finance Europe’s economic revitalisation.

This was, the EU believed, an “achievement that we should take collective pride in”.

Alas, pride usually comes before a fall. And even the beautiful vista of a more temperate EU may not survive the coming pandemic-plagued winter.

And while the shocking delay of the EU to agree sanctions against the autocratic government in Belarus was bad enough (owing to classic politicking by the Cypriots), it is the fundamental disagreements at the heart of Europe’s Recovery Plan that risks compromising the Eurozone’s stability in 2021.

And I'm not just talking about the current impasse on the Rule of Law provisions with Hungary and Poland.

The Recovery Plan was supposed to be about saving Europe’s economies from pandemic-inspired stagnation and ruin. Instead, the European Commission has doubled down on joint borrowing and long-term debt as the drivers of further fiscal integration.

And therein lies the problem. For in seeking to go big (and stay relevant), the EU has fatally overreached.

Think about every single dispute the EU has endured on fiscal rules over the past two decades. Then multiply it by ten for the probable impact of these inevitable Recovery Fund disagreements on EU cohesiveness.
Dr Eoin Drea
Senior Research Officer, Wilfried Martens Centre

Quite predictably, Recovery Fund discussions are now stuck in the middle of the street catfights about governance mechanisms, assessment criteria, anti-corruption provisions, and basic rule of law principles. Remarkably, the EU has managed to turn the Recovery Fund into another bone of contention between Brussels and national capitals. It is exacerbating every internal EU disagreement, magnifying every unresolved policy tension.

Even if an agreement is reached in the coming weeks on the Rule of Law mechanism, Brussels will ultimately become the arbiter of how Recovery Funds are distributed to member states. What will follow is years of further disagreements about eligibility and national capitals blaming Brussels for slow and inconsistent decision making.

Think about every single dispute the EU has endured on fiscal rules over the past two decades. Then multiply it by ten for the probable impact of these inevitable Recovery Fund disagreements on EU cohesiveness.

But, the real danger for the euro is that in progressing the Recovery Fund without the more important complementing measures (such as completing a Banking and Capital Markets Union), the EU risks compromising the entire Recovery Fund concept, further eroding trust between EU members and weakening the wider credibility of the eurozone.

In addition, a poorly functioning, ineffective, or biased Recovery Fund will undermine the principle of working towards deeper European integration. It also risks lumbering the next generation with sizeable financial debts for very little in return.

This isn’t free money, even if the EU doesn’t yet know where the actual cash will come from.

For the euro, the critical point will come when the financial markets begin to question the longer-term prospects of the Recovery Fund framework. The serene comfort of the euro’s stability in 2020 was predicated on the Recovery Fund becoming a successful (and permanent) feature of the EU’s financial armoury.

Such a view – “it’s the first step down the road of burden-sharing and fiscal unity” - remains widely held by the wider financial community. However, this view has always ignored the real political cleavages at the heart of the Recovery Fund concept.

Many member states, as represented by Finnish prime minister Sanna Marin, still regard the Recovery Fund as a “one-time, short-term crisis response measure”.

No ifs or buts, no room for compromise.

In a post-pandemic environment, these divergences - between market expectations and political realities - will eventually spark a full-blown eurozone crisis. Less pandemic infused markets will realise that further fiscal integration remains politically unachievable in Brussels. And the collateral political damage arising from the Recovery Fund is actually making such a goal even more unattainable in the long run.

The Recovery Plan has been rebranded “NextGenerationEU” by a Brussels bubble keen to highlight its transformational scope. But just like the Iraq invasion of 2003, the real problems are only about to begin.
Dr Eoin Drea
Senior Research Officer, Wilfried Martens Centre

While economic growth and employment levels may rebound, the much more relevant indicator for currency stability will be eurozone debt levels. With a projected debt to GDP level of over 100 per cent in 2020 (up from 84 per cent in 2019), the eurozone will eventually face a reckoning from the markets. An Italian debt projected at over 160 per cent of GDP still remains the most likely starting point.

Instead of concentrating on the incremental (and much more boring) steps needed for deeper fiscal integration, the EU has bet the house on a Recovery Plan designed to shock and awe the Brussels doubters. And just like President Bush’s invasion of Iraq in 2003, this strategy has achieved its immediate objective. The EU, for a brief summer, seemed to rise to meet the moment.

Alas, the autumn and winter have shown that the Recovery Fund’s impact on restarting Europe’s battered economies will be dwarfed by many longer-term political costs. The denouement will be increased public debt, increasing divisions between EU members and the markets realising that Europe remains as politically divided as ever.

The Rule of Law provisions aren't even the Recovery Fund's biggest problem.

The Recovery Plan has been rebranded “NextGenerationEU” by a Brussels bubble keen to highlight its transformational scope. But just like the Iraq invasion of 2003, the real problems are only about to begin.

  • Dr Eoin Drea is a Senior Research Officer at the Wilfried Martens Centre for European Studies and a Research Fellow in the School of Business at Trinity College Dublin

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