NextGenerationEU

Never waste a good crisis: How the EU Covid19 recovery fund can fix the reform backlog in the Member States

Today the President of the European Commission Ursula von der Leyen unveiled her NextGenerationEU funding strategy to finance the recovery plan for Europe. NextGenerationEU is the official name of the up to 800 billion € EU Covid19 recovery fund. The funding strategy can be summarized in one term: temporary common European debt.

A unique instrument for a unique situation

The EU recovery fund is an unprecedented health spending and economic stimulus package in this unprecedented health and economic crisis. This one-off instrument is funded by a one-time issuance of common European debt. Currently, the EU is waiting for the German Federal Constitutional Court to clear the way and the remaining EU Member States to ratify the so-called Own Resources Decision that will allow the EU to temporarily take common debt.

672.5 billion € to motivate reforms in the Member States

The key element of the EU recovery fund is the Recovery and Resilience Facility (RRF), that will disburse 312.5 billion € in grants and up to 360 billion € in loans to the Member States.

In order to benefit from the RRF, a national government has to submit a national Recovery and Resilience Plan detailing what national reforms and investments the government will execute with the RRF money. Since autumn 2020, the governments have been working in weekly meetings with the Recovery and Resilience Task Force of the European Commission on their Plans. Some Member States initially showed up with drafts that were only a few dozen pages long, that merely consisted of investments and that irresponsibly neglected reforms. The European Commission has made clear that it expects only detailed Plans of over 1 000 pages each with substantial national reforms to be submitted before the deadline on 30 April 2021. Reforms like increasing the speed of civil claims court cases, the introduction or expansion of a vocational training system, an up-to-date land register, or a pension system that withstands demographic change.

But what is the connection between fighting a virus and reforming a land register?

The purpose of the Recovery and Resilience Facility is to improve the Member States resilience against the next economic shock - be it caused by novel viruses, junk mortgages, or something else. A state’s key instrument in a crisis is its ability to borrow money on the financial market. Money that it then spends to fight the crisis, e.g. by funding hospitals, vaccine research and purchases, short-time work schemes, and economic stimulus measures. Everything that defends the ability of a state to instantly borrow hundreds of billions of euros at any time effectively is part of crisis resilience.

If national court procedures for civilian claims are too lengthy, then property rights are not effectively defended. This leads citizens and companies to invest less, harming growth. The size of a national economy influences how much debt a state can bear - and therefore the willingness of creditors to let this state borrow their money.

Vocational training systems have proven to reduce youth unemployment and provide companies with the skilled workers they need. Those who work create value, adding to the size of the economy. This in turn enables a state to take debt.

An up-do-date land register enables a state to collect property taxes and prosecute tax fraud. An effective tax collection system is a prerequisite to pay back the loans of a state.

If a pension system relies on everybody having four babies and dying at 70, then the reality of demographic change will either require pensions to shrink and drop pensioners into the public welfare system - or will require the pension system to be fed by other tax revenue in order to maintain fair living standards for pensioners. Both options appear as costs in a national budget - and thereby reduce a state’s room to pay back its debt.

A pension system reform that responds to demographic change avoids this. In the 1990s, Sweden introduced the AP7 Fund that invests pension contributions in a well-diversified way. The return on this investment pays for the pensions. This eases the burden on public coffers.

In conclusion, speeding up court procedures, building up vocational training systems and land registers, and reforming pensions all improve a state’s ability to borrow vast sums of money when the next pandemic or economic crisis hits us - and its ability to save lives and overcome the crisis.

This is why the RRF demands reform plans from the Member States.

Lessons from the last financial crisis

This is also the lesson from the financial crisis in the early 2010s. Back then, some Member States had lost the ability to keep borrowing on the financial market. They had accumulated high debt levels before the crisis - partly because they had skipped necessary reforms. When the crisis hit, creditors regarded it as too risky to keep lending to them. In this situation, the Eurozone Member States used taxpayer’s money and guarantees to found the European Stability Mechanism (ESM). The ESM steps in when there is no other lender available to a Member State.

In order to avoid over-indebtedness in the future, a mechanism of oversight of the European Commission over the national budgets was introduced in 2012: The European Semester. In this annual exercise, the Commission analyses the budget and reform needs in every single Member State. Unfortunately, the Commission’s reform recommendations (like the four reforms discussed above) had not been binding upon the Member States so far. Therefore, the Member States did not implement many reforms that would have strengthened their individual ability to borrow money on the financial market during crises. Hence, the risk that a Member State would need help from the ESM, that is funded and guaranteed by taxpayers’ money from all Member States, remained.

The RRF - if it is implemented correctly - will correct this: A Member State only receives money in return for reforms. This means: A Member State only receives money if it improves its resilience against future crises, and thereby also reduces its risk to need a bailout from the ESM.

The RRF has the potential to fix a long-standing mismatch: We as European have vouched for each other’s debts via the ESM for a decade. But we as Europeans were unable to prevent one of us from conducting a national policy that would lead the latter of us to need an ESM bailout.

The decisive moment is now

The European Commission now needs to be firm in the final days of negotiations with each Member State to push it to include as many reforms as possible in its national Recovery and Resilience Plan until 30 April. After all, 675.5 billion € need to deliver as many reforms as possible, which means as much resilience as possible.

Moritz Körner is member of the German FDP and a member of the liberal Renew Europe Group in the European Parliament, Jonas Roleder is Policy Advisor at the Renew Europe Group on the Committee on Budgets of the European Parliament. The opinions expressed in this article are personal views.