21 April 2020

Covid-19, Corona Bonds and “Kicking the can down the road”: Federal Trust

What I see is European construction drifting towards a free-trade zone, that is to say an English-style Europe, which I reject. If we do nothing, this will lead in 15 years to a break-up. I reject a Europe that would be just a market, a free-trade zone without a soul, without a conscience, without political will, without a social dimension.

Jacques Delors Interview (c. 16/17 October 1993), quoted in The Times (19 October 1993), p. 11

It is a curious thought that while Britain has opted to leave the EU, so it has managed to infect the EU with its own free market virus. A virus that Jacques Delors thought would lead to the collapse of the EU by 2008 – the year of the Great Financial Crisis (GFC). The EU, and more particularly the Eurozone, survived that crisis, only to limp on into the next one, caused by the Covid-19 virus.

As the various countries in the Eurozone (EZ) moved into lockdown mode, so they enacted a variety of national measures designed to alleviate the economic pain caused by Covid-19. A rapid survey of existing measures revealed that the sum total of designated fiscal measures to prop up the economy (including Germany, France, Italy, Spain and the Netherlands) amounts to around € 500 billion. This represents the addition of those measures announced as having some kind of financial ceiling. Most of these countries have also entered into what are open ended and in some cases unlimited commitments to subsidize the cost of wages and salaries, both for larger companies as well as for SMEs and for the self employed. These could amount to a similar total, suggesting that combined support on offer by EZ countries could be in the region of € 1 trillion. Before thinking that this looks like a generous sum, consider that the USA (federal government) has currently offered US$ 2.8 trillion (€ 2.57 trillion) to support personal incomes and company liquidity through the Covid-19 crisis. This is wrapped into a single piece of legislation, called the Coronavirus Aid, Relief and Economic Security Act, or CARES for short. This was passed on March 27^th with bipartisan support by Congress, and shows that federations can act swiftly when needed.

Managing Covid-19 the EZ way

The EU/EZ is not known for rapid decision making, and the confederation does not generally react well in crises, as will be shown below. After long meetings and considerable disagreements, the Eurozone finance ministers achieved a compromise/consensus for an emergency rescue package on April 9^th 2020. While this succeeded in creating some fiscal space for member states to gain some financial support for dealing with Covid-19, the negotiations were conducted in a mean spirited way, with continuing deep disagreements about the future. Moreover, the scope of the measures was largely limited to supporting medical emergencies, leaving measures to deal with Covid-19’s economic consequences to another day.

A €500 million package of ‘palliative economic measures” has been assembled, involving revised credit lines from the European Stability Mechanism (ESM), set up after the GFC. These credit lines will be available two weeks following the agreement. They will be accompanied by increased European Investment Bank (EIB) lending. This involves €25 billion, designed to create loans to SMEs in the Eurozone. This, it was argued, can be leveraged up to €200 billion.

It was also agreed that member states facing difficulties can spend up to 2% of GDP from the ESM, without there being any conditionality being applied. Woe betide any member state that might be tempted to spend these funds on anything other than health related items. Since, according to the Dutch Finance Minister, Wopke Hoekstra, the debtor would have to undertake reforms after the crisis and pay back these monies to the ESM.

All of which is highly reminiscent of earlier difficulties with the Greek financial crisis, and circumstances back in 2012 when the PIIGS (Portugal, Ireland Italy, Greece and Spain) were obliged to accept, to them, humiliating conditions in order to gain any support from the EZ at all. The patent distrust shown by mainly northern EZ members towards their southern partners being such as to make outsiders wonder how long the EZ could realistically remain together.

The Covid crisis provided a reminder of an even earlier debate around the issue of Eurobonds, something backed by the ECB. These were proposed by advisors from the German Economic Council, as well as in a paper called “A Modest Proposal” by Holland, Varoufakis and Galbraith (2012), pointing out that mutual debt instruments issued by the EZ as part of a more integrated monetary bloc would be a good way to resolve the sovereign debt crisis, by effectively reducing the debt refinancing costs of heavily indebted member states. The Covid crisis led to a proposal, backed by 9 EZ member states, for Corona bonds, following along similar principles. These would be issued and backed by the EZ, with the ECB managing the secondary market. And just to show how little was learned from the earlier crisis, the northern creditor nations, mainly the Netherlands and Germany, again refused to countenance their introduction, thus jeopardizing the foundation of a European Recovery Fund. No agreement was reached about how large should the fund be, when should it be set up (was it urgent or not?), and neither was there agreement on how the funding costs should be shared between the fiscally stronger and weaker member states.

The peculiarity of this situation being that the Coronavirus is quintessentially an external factor or event. No one can be blamed for it. It represents an external threat, to which one might think EZ members could rally around and produce a combined, timely, and effective solution.

Federal Trust article

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