EU: Stage Set for Clash

The Hague is expected to deploy the biggest gun available to EU member states and roll out its veto to derail a Franco-German plan that introduces eurobonds under a different name. Last week, the Dutch were said to have succumbed under pressure from Germany and ceased their opposition to the issuance of common debt.

Slipping into the role vacated by the United Kingdom and leading the Frugal Five – Finland has now apparently joined the original four – The Netherlands is leading an open revolt to the Berlin-Paris axis that tried to reclaim its former prominence by setting the union’s response to the economic fallout of the corona pandemic. Fellow ‘frugals’ Austria, Denmark, Finland, and Sweden may also threaten to use their veto to torpedo the French proposal, seconded by Germany, to funnel €500 billion in grants to Italy, Spain, and other hard-hit countries via the EU budget.

In a surprise move, German Chancellor Angela Merkel early last week announced her backing of a plan first suggested by President Emmanuel Macron of France and that includes raising the required funds via a one-time bond issue by the European Commission and guaranteed by all member states. Whilst Berlin may publicly disapprove of the Frugal Five’s revolt, the German government is not likely to be seriously displeased and may, in fact, have used The Hague to (again) stage a ‘good cop, bad cop’ scenario which allows it to scupper the French plan without being seen to do so.

In a secret policy document leaked on Saturday, the original Frugal Four clearly state that they cannot accept any ‘instruments or initiatives’ that lead to shared debt or a larger EU budget. Already before the corona outbreak, the Dutch had voiced their strong opposition to an increase of annual remittances to Brussels, arguing that the departure of the UK offered an opportunity to reappraise and streamline the EU budget. The ‘frugals’ have now expanded their line of argument and note that a ‘thorough modernisation’ of the premises that guide EU spending may allow for the creation of a European Recovery Fund to help member states improve their resilience to the next crisis.

The Frugal Five intent to throw down the gauntlet when EU leaders meet next month by formally proposing that the European Commission rearrange its spending priorities to free up funds for the necessary post-corona recovery effort. This implies a sharp reduction in the monies available to the EU’s cherished farm subsidy programme as well as the reassignment its structural support budget. The former is certain to offend the French whilst the latter may encounter stiff opposition from eastern member states.

The Dutch-led group will also propose to offer Italy and Spain economic support in the form of plentiful cheap credit instead of the grants envisioned under the Franco-German plan. The recipients must, however, ´strongly commit’ to an agenda of structural economic and administrative reform. According to the leaked document, countries taking up credit must also promise to adhere to the rule of law. This is considered a direct and rather crude warning to the governments of Poland and Hungary which have limited the independence of their judiciaries.

Both Rome and Madrid argue that now is not the time to tinker with policy and say that the austerity measures suggested by the Frugal Five may prolong the Corona Recession and cause great harm to the social fabric. The countries of southern Europe have asked for €1.5 trillion in financial support. Earlier this month, the European Parliament urged the Commission to provide up to €2 trillion to member states and adopted a resolution to this effect.

A compromise solution may be in the works after Poland, Hungary, and others indicated a preference for a recovery package with a mix of loans and grants tied to economic and social reforms. Slovak Foreign Minister Ivan Korcok said that a future ‘recovery instrument’ should include fiscally responsible ‘elements’. His comments were echoed by government officials in Poland, Hungary, and elsewhere.

Chairman Wolfgang Ischinger of the Munich Security Forum, a leading forum on foreign policy, says that opposition to the Franco-German plan is to be expected but notes that the proposal only provides broad outlines with details to be hammered out by EU leaders later on. Mr Ischinger suggested that the plan could become a catalyst for ‘sweeping changes’ and possibly even a new EU treaty that would seal the legacy of Chancellor Merkel: “Existential challenges call for extraordinary measures.”

Pointing to Germany’s upcoming presidency of the EU Council, Mr Ischinger expects the plan to add to the momentum for change. Last week, Chancellor Merkel hinted that she may lend her country’s considerable weight to push for changes in the way the union operates and reaches decisions in order to enhance the EU’s role in world affairs. However, such a radical reform agenda is unlikely to receive support from smaller member states that have previously resisted all attempts at limiting their ability to use a veto to check the ambitions of France and Germany. The loss of this prerogative is considered by many EU members a ‘no-no’ as it would undermine their sovereignty.

It is now up to Commission President Ursula von der Leyen to soothe resentful southern member states and placate the northern ‘frugals’ – and keep the EU together. This week, Mrs Von der Leyen will present the Commission’s own proposal that runs for almost 2,000 pages. The Commission is expected to include key elements of the Franco-German plan but limit grants to public health programmes only and underwrite economic recovery efforts with loans. EU diplomats are not too concerned over the red lines drawn by the Frugal Five and expect the group to yield on some issues.

Over the weekend, former German Finance Minister Wolfgang Schäuble, a notorious budget hawk and president of the Bundestag (federal parliament) since 2017, came out in favour of non-refundable grants and said that his country has a vested interest in the economic recovery of southern member states: “If Europe wants to have any chance at all, it must now show solidarity and prove that it is capable to act.”

Thomas Wieser, who presided the two principal advisory committees of the Eurogroup during Greece’s banking crisis, also favours grants: “If we get this wrong, it will ruin the political atmosphere for decades, literally decades. Loans are easy because they are free. But when it comes to true solidarity and help, nothing is free. And true solidarity is what is needed now.”

Spanish Prime Minister Pedro Sánchez signalled that his government will not agree to any recovery plan that includes loans, arguing that a higher debt load will only add to the problems his country faces.

According the latest economic outlook for the Eurozone published by the International Monetary Fund, debt levels are rising in all countries of the group though disparities remain large. Whilst The Netherlands has added ten percentage points to its national debt as a result of the pandemic, the country keeps its prized pole position in the bloc with a debt-to-GDP ratio of 58.3 percent. Spain (113.4%), Belgium (114.8%), France (115.4%), Portugal (135%), Italy (155.5%), and Greece (200.8%) dwell on the opposite end of the scale. For 2020, the average indebtedness of the euro area is forecast to rise to 97.4 percent of GDP (2019: 86.1%) – well above the 60 percent agreed to in the 1997 Stability and Growth Pact.

The stage is now set for a major north-south clash when EU leaders convene by video conference next month. Though some pundits predict the imminent demise of the union, common sense will probably prevail as it has before. The EU is unequalled in finding compromise solutions and exploring commonalities whilst ignoring the rhetoric of leaders playing to home audiences. Whilst their bravado sometimes does momentarily spill over into summit meetings, it is more often than not checked at the door.