Europe’s economic recovery effort should be smarter, not bigger

The writer is visiting professor in practice at the London School of Economics and a former director-general of the Italian Treasury

Is Europe doing too little, too late to support its post-pandemic economic recovery? The question hung in the air this week even after the EU conducted its most ambitious transaction on world financial markets. For the future, the essential point is that Europe’s fiscal, economic and monetary support need not be bigger, but it must be smarter.

Some respected policymakers, such as Wolfgang Schäuble, the former German finance minister, are in favour of the EU’s debt-fuelled stimulus programmes but nevertheless urge a swift return to fiscal and monetary discipline. Others warn about the risks of withdrawing support too soon and reverting to an inappropriate policy mix. In my view, the starting point is to frame the debate in a proper way.

The 27-nation EU and the 19-nation eurozone that is at its core, are both examples of unfinished business. Among the missing pieces are adequate tools of macroeconomic stabilisation. The vulnerabilities of the current set-up include the risk that fiscal and banking distress can be mutually reinforcing, as we saw 10 years ago. A lack of fiscal capacity at the centre leads to an excessive and politically contentious reliance on the European Central Bank’s unconventional monetary policies.

During the pandemic, all EU countries, but particularly the most economically fragile ones, benefited from the suspension of the EU’s fiscal rules and from the ECB’s protective umbrella. National policies involved state guarantees of bank loans, compensation for the lost incomes of workers and businesses, job retention schemes and the postponement of some taxes. Despite some difficulties and delays, these measures were by and large effective in stabilising EU economies and laying the groundwork for the recovery. A generous and multi-faceted EU plan played its part, too, in countering the downturn.

True, the policy response was less than perfect. It was cobbled together in an ad hoc, emergency fashion. It was geared towards fiscal transfers among member states, when what the eurozone really needs are European safe assets and a centralised fiscal capacity.

Still, even if the response of governments could have been more timely and efficient, it is difficult to argue that it should have been bigger. The European Fiscal Board, an independent advisory body of the European Commission, concluded this week that “policies adopted or credibly announced by governments to date appear to achieve an appropriate degree of fiscal support”. I concur with that assessment.

In any future crisis, it will be a matter not of doing more but of doing it better, and for that the European dimension must step in. With EU safe assets and a permanent fiscal capacity at the centre, the bloc’s policy responses would be at least as powerful as the current national ones, but would be more sustainable, automatic and timely.

The other part of the EU’s recovery plan concerns resilience. The aim is to enhance potential growth through public investments backed by structural reforms. Whilst most of the macroeconomic stabilisation effort was left to national initiatives, the resilience plan will draw heavily on jointly financed European money, like the 10-year, €20bn bond issue launched this week by the European Commission.

The plan is skewed towards those countries most in need. They include less well-off member states for which EU regional aid funds have long formed a sizeable share of their gross domestic product. But one of the two biggest beneficiaries will be Italy, which has so far been a net contributor to the EU budget. A quarter of a century of economic underperformance has caused Italy to slide into the EU’s bottom half in terms of per capita GDP.

Italy and Spain, the other big beneficiary, will bear an enormous responsibility as the EU’s recovery plan gets under way. The funds need to be put to work effectively. Concrete reforms must become visible to European governments and voters in other countries for the EU to consider future steps towards integration.

There is, of course, no excuse for the failure of some countries to have implemented structural reforms and made good use of public investments in the past. However, tight fiscal constraints made it difficult at times for some governments to co-finance projects benefiting from EU structural funds and to maintain a decent level of expenditure on public investments. This exacerbated their growth problems.

Moreover, misguided responses to previous crises and an unfavourable mix of fiscal and monetary policies were not conducive to achieving the political and social consensus needed for deep-seated, supply-side structural reforms. Instead, populist, anti-establishment movements grew in size, resulting in a rollback of some of the reform progress achieved in the past.

There is no doubt that fiscal discipline across the EU must be restored at some point. In the larger picture, however, the overriding goal is to reform Europe’s economies and prepare them for future challenges. This will require an improved fiscal framework and the right balance between budgetary policies, economic strategies and ECB monetary measures. Europe’s task is not to come up with a bigger response but a better one.