Europe’s prospects depend on more than beating the pandemic

A resurgence of the pandemic is threatening to tip the eurozone into a double-dip recession, cutting short the recovery that took shape from the middle of this year. Few if any economists expect a slump as severe as the 11.8 per cent quarter-on-quarter contraction recorded between April and June. But services, which account for about three-quarters of economic activity in the 19-nation eurozone, are bearing the brunt of the tight restrictions on people’s movement that governments are reimposing in an effort to control Covid-19.

A larger, long-term question for the eurozone is whether the pandemic will turn out to be the moment when political leaders finally take decisive steps to address the vulnerabilities of the monetary union created in 1999. From the start the eurozone lacked several core features of other currency areas, such as a central treasury, a finance minister, a countercyclical fiscal capacity, common bond issuance and a comprehensive banking union.

The euro area has also fallen behind the US and China in the development of artificial intelligence and other digital technologies. In certain ways, the pandemic is stimulating efforts at closer eurozone integration. But it is less obvious that European governments and businesses will emerge from the crisis better placed to compete with their US and Chinese rivals in the most advanced industries.

According to the OECD’s latest forecasts, the eurozone economy will contract by 7.9 per cent this year, almost twice as much as during the financial crisis of 2009. The OECD predicts a return to growth of 5.1 per cent in 2021, but even a rebound of that size would not heal all wounds incurred this year. Economists at the Centre for Economic Policy Research, a think-tank, say small and medium-sized businesses are particularly at risk, with many bankruptcies likely in sectors such as accommodation, the arts, education and recreation.

However, if the magnitude of the economic crisis has no precedent in post-1945 Europe, neither do the countermeasures of eurozone governments. In size and design, these go further than the emergency steps taken during the sovereign debt and banking crises a decade ago. National governments are leading the way with extensive deficit spending measures, but the most eye-catching step is a €750bn recovery fund approved by EU leaders in July.

The fund breaks new ground in that the EU will for the first time borrow money on financial markets to finance transfers to its member states and other expenditures. Some €390bn are intended to be allocated as grants, and €360bn in loans.

Jean Pisani-Ferry, an economics scholar at the Florence-based European University Institute, calls the recovery fund “a high-risk gamble”.

“If the plan succeeds, it will surely pave the way to further initiatives, and perhaps ultimately to a fiscal union alongside the monetary union established two decades ago,” he says. “But if the programme fails to deliver on stated goals, if political interests prevail over economic necessity, federal aspirations will be dashed for a generation.”

Three big questions about the fund are first, how quickly will it swing into operation, secondly, will governments make use of the entire €750bn package, and finally, to what extent will the money be spent on genuinely useful investments. According to the European Central Bank, less than 10 per cent of the total sum is likely to be paid out next year. The rest is due to be disbursed mostly between 2022 and 2024. It will therefore be important for eurozone governments not to withdraw national fiscal stimulus programmes next year, Mr Pisani-Ferry cautions.

Individual countries will be allocated funds on the basis of income per capita, unemployment trends and, in 2023, the falls in real gross domestic product they suffered in 2020-21. By these measures, Greece — which received three emergency financial rescues from 2010 to 2015 — is expected to be the largest net recipient of EU recovery funds. Cyprus, Italy, Portugal and Spain will also be net beneficiaries, as will the three Baltic states, Slovakia and Slovenia.

However, it remains to be seen if the programme — undoubtedly, one of the boldest economic initiatives since the EU’s founding Treaty of Rome in 1957 — will narrow the longstanding gap between the eurozone’s wealthiest and less well-off states. According to a study by the Brussels-based Bruegel think-tank, the pandemic has struck hardest at those countries where tourism accounts for a large share of the economy and where the quality of governance, in areas such as the rule of law and business regulation, is below the EU average.

The eurozone’s resilience will be enhanced if its leaders tackle long-overdue reforms such as completing the single European market for services, setting up a capital markets union and promoting the digitalisation of business. These serve as a reminder that Europe’s long-term economic prospects will depend on more than conquering Covid-19.