Broadly speaking, southern European countries, most notably Italy and Spain, have been the hardest hit by the coronavirus. These are also the nations that came into the crisis with weaker economies and higher levels of debt and unemployment. The European Commission — the EU’s executive arm — has warned that the unevenness of contractions and recoveries will deepen divisions within the bloc and could put at risk stability in the euro area, whose 19 members share the common currency. Deep-pocketed member states such as Germany have showered their firms with state aid, while others such as debt-addled Italy can’t match that spending power. That is distorting the level-playing field between companies in the EU’s vast single-market. Social discontent could destabilize governments and fuel anti-European sentiment in countries that are struggling the most. In short, the EU’s future is at stake.
2. What’s the problem with joint action?
The EU is not a country. It doesn’t have a common treasury that’s expected to support regions in need, the way the U.S. Treasury pours funds to states hit by hurricanes. Nor does it have anywhere near sufficient funds in its relatively meager common budget to deal with a crisis on this scale. Even in the euro-using core, the monetary union is not backed by real economic or banking unions. As the EU’s devastating debt crisis of 2010 showed, in tough times money tends to fly to the continent’s safe harbors, exacerbating liquidity crunches in the economically weaker countries as their borrowing costs surge.
3. What do people want to do now?
During the debt crisis, countries in the bloc’s south proposed what they called eurobonds, in which member states would pool their borrowing power and spread the burden of additional debt. The idea was that by issuing jointly backed debt, the financial solidity of countries like Germany and the Netherlands would allow all countries to borrow more cheaply, and dispel dounts about the sustainability of weaker members’ finances. This year, that idea has been revived in proposals for what have been termed coronabonds. But a group of richer, northern leaders were firmly against that, refusing to put their taxpayers on the hook for the liabilities of their southern neighbors.
4. What is the Franco-German plan?
The EU’s initial response to the crisis came mainly in the form of making cheap loans available, a strategy that countries in the south argued would only increase their debt burden and weigh on future economic growth. In response, German Chancellor Angela Merkel and French President Emmanuel Macron agreed to support a 500 billion-euro ($550 billion) aid package financed through the issuance of bonds by the European Commission on behalf of the EU as a whole. If the package is approved by EU states, proceeds from the so-called Recovery Fund would be distributed to countries most affected by the crisis in the form of grants. Repayments would come from the EU budget, where Germany contributes the lion’s share. The proposal marked a dramatic shift for Germany, which initially opposed any form of mutualized borrowing.
5. That sounds like eurobonds. What’s the difference?
Germany says the recovery fund does not represent debt mutualization. First of all, it’s a one-off concession for the duration of the crisis. Second, if coronabonds were issued, the danger for Merkel could be like that faced by someone who signed a lease when a roommate can’t pay their share of the rent — Germany could be on the hook for a bigger chunk than it expected. But in the Merkel-Macron plan, Germany wouldn’t be liable for the entire 500 billion envelope, only for its share of the budget, an amount that corresponds to its share of EU economic output. On the other hand, Germany is the main contributor to the EU budget, so it will repay most of the funds, whatever the debt instruments are called. “The Franco-German deal is a real step towards creating the first meaningful EU debt,” said Guntram Wolff, director of the Brussels-based Bruegel think tank. “The debt service of federal debt always depends on contributions from all regions but those contributions are relative to the economic size of the regions.”
Debt mutualization is not. Article 125 of the Treaty on the Functioning of the European Union says that neither the EU nor individual member states can be liable for the debts of other governments. A so-called “Hamilton moment” — as happened in the U.S. in 1790 — whereby obligations across the 27-nation bloc are mutualized would require treaty changes adopted by national parliaments and in some cases referendums. In a nutshell, sharing more risk can only come when countries agree to cede more sovereignty on their finances. So far, there’s no sign of a majority backing for a reform that would give a central authority the power to raise taxes and decide how money is spent throughout the EU or even the euro area.
7. But doesn’t this come close?
In practice, the bloc’s members are progressively sharing increasing levels of risk and have bailed each other out in times of need. For example, the European Stability Mechanism — the euro area’s crisis fund — has raised hundreds of billions on debt markets, which it then lent to Greece on terms normally reserved for countries with AAA credit rating, allowing the EU’s most indebted state to make billions in savings from interest payments. The same arrangement is also available now for countries wishing to draw up to 240 billion euros from the fund to finance costs related to the pandemic. Also, the European Central Bank has been buying massive amounts of debt under its bond-buying programs. While much of that is held by national central banks, a good chunk is on the ECB’s own books, making its shareholders — euro-area members — in theory liable for any losses.
8. So it’s the form of the borrowing that matters?
In a way. The EU, through the European Commission, has long been able to borrow, as have other European institutions. This ability rests on the backing and commitment of member governments to the EU project. All European institutions have a stellar credit rating, on the assumption of such backing from the richer Northern European nations. In essence, these nations lend their fiscal muscle to the EU, allowing its institutions to carry out transactions on concessional terms for the benefit of weaker members. It may not be debt mutualization, but it’s European solidarity in practice.
9. Will the Franco-German plan be accepted?
It’s unclear. A group of rich nations nicknamed the Frugal Four — Austria, the Netherlands, Sweden and Denmark — strongly object to joint debt issuance, even if it’s a temporary thing. They argue against disbursing money in the form of grants, instead insisting on loans, as happened when the European institutions borrowed to bail out nations in the debt crisis. They proposed an alternative plan ahead of the commission outlining its own proposal Wednesday. A compromise might involve a mixture of grants and loans. Separately, Eastern EU members are worried that the proposed recovery fund will channel cash to the pandemic-hit south and they will be left out, since their healthcare crisis was contained. Tough negotiations will follow, and unanimity is required for any decisions to be taken. Meanwhile, Europe will rely on asset purchases from the ECB to keep borrowing costs low, and on national spending measures to keep its businesses afloat while economies nosedive.