Poisonous politics lurk behind the EU recovery fund

The writer is director of the centre for economic policy at Esade business school in Madrid and former economics spokesperson for Ciudadanos

A friend working at a city council on the coast of southern Spain wrote to me the other day. “The whole management of the European funds is going to be a nightmare . . . we have too much money!” she said. “I have been told to spend €10m on the installation of photovoltaic plaques in 100 public buildings. But I don’t think we have 100 public buildings! This is a small city!”

This example is a microcosm of the problems surrounding the €750bn in spending to be unleashed under the Next Generation EU (NGEU) fund to aid economic recovery after the pandemic.

The initiative is a unique chance to transform Europe’s southern economies. But there is a risk that the money will be wasted in boondoggle projects. Given the poisoned politics across the continent, this poses dangers for the EU. Europe’s currency union was conceived as a way to reduce competitiveness gaps among countries. But progress on structural reforms has been slow. In terms of productivity, the gap between the core and the south is widening. The Covid-19 crisis will just accentuate these diverging trends.

Reforms in the south have failed in the past because too little attention has been paid to how to make them actually happen. Without a better understanding of this problem, NGEU is likely to repeat previous failures.

At present, the incentives for reform could hardly be worse in the south. Governments are fragmented and weak. More political parties have a veto power over reforms. Populist forces on the extremes will reduce the ability to reach agreements through the centre.

Moreover, thanks to the European Central Bank’s actions, market pressure on governments has disappeared. Low borrowing costs will make it easier for them to postpone reforms. The Recovery and Resilience Facility, through which 90 per cent of NGEU funds will be channelled, lacks teeth on economic conditionality. 

The debate on conditionality has been misleading. Nobody argues that, having been hit by a pandemic, populations in southern Europe should be exposed to fiscal austerity or more social suffering. But that does not mean we should forget about reforms.

Money alone will not solve structural problems. Think of Spain’s active labour market policies. Spain has the EU’s highest school dropout, youth jobless and temporary employment rates. It already spends more than €6bn a year on ALMPs.

However, according to Spain’s independent fiscal authority, there is no evidence that this money is improving employment opportunities for workers. Throwing more money into the system without reforms will simply reinforce the system’s flaws.

In the coming months, it will not be hard for the European Commission and national capitals to agree on a 50-point reform plan. The problems will start after agreeing to that plan.

Without a governance framework for NGEU that makes reforms actually happen, governments will spend the money satisfying their short-term electoral needs rather than implementing politically costly reforms. Why would they behave differently this time?

To ensure good governance, consider a proposal made 15 years ago by Harvard economists Ricardo Hausmann, Dani Rodrik and Andrés Velasco. They called for a strategy that would set policy priorities for governments “in a way that uses efficiently the scarce political capital of reformers”. Rather than trying to implement long laundry lists of reforms, which are “seldom helpful”, they proposed a framework for identifying the most binding constraints for economic growth in a given country.

EU governments and the commission should follow this framework, engaging in an honest conversation that results in a smaller set of structural reform goals. These should focus on two or three truly binding constraints for growth in areas such as human capital or institutional modernisation, where reform is necessary and politically achievable.

If nothing changes, it is not unrealistic to imagine that five years from now Dutch retirees, for instance, will be asked to take pensions cuts, while their newspapers are full of stories of EU money wasted on useless projects in southern Europe. Such an outcome could prove fatal for the EU. 

In 2020, the EU has done the hardest part, putting together an extraordinarily generous package as a response to the crisis. In 2021, Europe’s priority should be to make it work.