THE WARSAW INSTITUTE REVIEW
Date: 31 August 2020
The Third Crisis of the European Union
The outbreak of the COVID-19 pandemic and its spread to Europe is the third crisis since 2008, after the Eurozone debt crisis and the migration crisis, which has had a significant impact on the economic, social, and political situation in the European Union, and has posed a challenge to its stability. The economic impact of the coronavirus pandemic as a political test to the European Union’s cohesion will be presented in this article.
The WHO report of January 25, 2020, informed of the first three cases of COVID-19 disease on our continent. On March 13, the same organization recognized Europe as the “epicenter” of the global pandemic. The scale and terror of the spread of infection varied from country to country. However, the pandemic affected all EU Member States, what makes this crisis different from the two previous ones.
At different scales and points of time, each country took steps to prevent the pandemic’s spread – the side effect of which was freezing their economies. Consequently, COVID-19 caused not only human casualties but serious economic problems. What will be analyzed in this article is the response of the European Union to this challenge and the consequential political overload. The sanitary and medical dimension of the EU response to the coronavirus epidemic will not be addressed because the European Union does not have the capacity to respond to public security emergencies per se, not including programs such as the ‘RescEU’ initiative. This organization was simply not inherently designed for this purpose and, therefore, expecting the effectiveness of its actions in this area is wishful thinking and proof of being attracted to the almost-perfect image of this organization shaped by mainstream EU propaganda.
The area in which the EU really takes functional and tangible action is dealing with the economic consequences of the pandemic. Such actions are likely to be effective, and, what is equally important, no other organization will intervene more efficiently in this matter. This is why this topic is addressed in this article.
We would be interested in answering the following questions about the challenges of the crisis:
What are the proposed ways of facing these challenges? How are the axes of political division between EU member states shaped considering these proposals? What are the interests behind the positions of the opposing parties? Are there any chances of getting out of this situation; what are these chances, and what will be their effect?
The text is written in the midst of a dynamically changing negotiating situation involving discussions on the financial support system from the EU budget for the member states’ economies. The general subject of debate is the problem of the so-called “coronabonds,” and source of disagreements is their consolidation (whether they should be in the form of easy-access non-reimbursable loans, or loans that are difficult to access, with political control over the recovery programs of borrowers’ economies). For this reason, the article presents the state of affairs in the last ten days of May 2020.
When the European Union got surprised by the outbreak of the pandemic, the situation of this organization was determined by three fundamental factors: the finalization of the debate on the EU’s Multiannual Financial Framework (MFF) 2021-2027, the scale of indebtedness of the countries of the South, and the experience of the immigration crisis. The first of them was characterized by the pressure of the so-called “frugal camp” (Austria, Denmark, Finland, the Netherlands, Germany, Sweden) aiming at a profound reduction in the scale of the EU budget and cuts in transfers of funds to poorer countries. This demand resulted from electorate pressure inspired by the rhetoric of anti-system parties – in Germany: Alternative for Germany(AfD), in Finland: The Finns Party, in the Netherlands: The Party for Freedom – PVV, etc.), which criticized the EU as a “transfer union spending the hard-earned money of hard-working Germans (Finns, Dutch, and so on) onto lazy Southerners or the backward, ungrateful, and unreliable poor people of the East”. This stereotype was formed in 2008-2012 in relation to the sovereign debt crisis in the South of the Eurozone, and in Ireland. This created tension between the South (according to this point of view ‘exploited and despised’ or ‘lazy and wasting subsidies’) and the North (‘arrogant and striving for dominance’ or ‘treated like an ATM’).
The atmosphere worsened during the immigration crisis, mostly suffered by the South (like in the previous case). It should be reminded in this context that immigration from Ukraine to Poland – indeed of a different type (legal, easily integrated) but not less numerous, is not taken into account in this narrative. The elections to the European Parliament in 2019 convinced the establishment parties – which, despite their final victory, suffered very serious losses – that ignoring the pressure of the anti-system parties in a situation of economic downturn may lead to the further reduction of their popularity. The marginalization of the French political scene’s traditional parties in 2017 and the Italian ones a year later was a dangerous memento.
The postulate to limit financial transfers within the EU has, therefore, a strong political foundation, and every government in the North seeking to renew its electoral mandate in the future must take it into account, whatever the economic sense or nonsense of such a step might be.
Coronavirus pandemic outbreak and national responses
The pandemic in Europe started with France, and it culminated in Italy, Spain, and the UK – a country that is no longer an EU Member State but is in the transitional period for Brexit, and, therefore, is still covered by a number of EU policies. The national responses varied over time in their intensity, scale, nature, and results. It should be said, however, is that the number of infected and deceased people does not translate into the scale of the economic impact of a pandemic. On the contrary, a superficial, and let us add straight away, a false logic could lead to the opposite conclusion that those governments that have frozen the economy faster, deeper, and for longer have saved their citizens from an epidemic and deepened its economic impact. It turned out that the sanitary and economic situation of individual countries is not such a case. The real picture is presented in the chart below, prepared by Prof. Luis Huete, a IESE Business School lecturer. Although it illustrates the situation on a global scale, it can also be interpreted from the European perspective.
Source: This Graphic Speaks Volumes, “The Corner,” May 15, 2020.
First EU reactions and policy implications
The EU was late with the political response – it did not warn the Member States. Its specialized agency, the European Centre for Disease Prevention and Control (ECDC), ignored the threat, following the WHO, and did not raise the alarm in time. Therefore, in this initial stage of the pandemic, the countries reacted individually. This resulted in uncoordinated border closures and, in the cases of France and Germany, the requisitioning of equipment and medical supplies necessary to combat the pandemic, and the ban on their export abroad. The latter was quickly withdrawn, but the damage done to mutual relations between the EU member states decreased mutual trust. In fact, the EU single market was actually suspended for medical equipment from 4-15 March by decisions of Paris and Berlin.
Consequently, Italy had the impression of being cut off and abandoned by the other EU member states. For Italy, which experienced frequent and, according to the Italians, hasty border closures by its neighbors already during the immigration crisis, and whose crucial economic branch is tourism, it was particularly painful.
It was only at the beginning of April that the EU took several key actions to respond to the economic impact of the pandemic. It set up the CRII (Coronavirus Response Investment Initiative) and CRII+ (Coronavirus Response Investment Initiative Plus) programs, basically suspended the EU’s ban on state aid, and launched a discussion on how to use the EU budget to finance economic recovery programs following the damage caused by COVID-19. Each of these steps turned out to be a source of further tension between the member states.
The division lines: North – the frugal camp, South – the victims of the pandemic, East – the camp of the friends of cohesion policy
The funds used in the CRII and CRII+ programs did not consist of new money from the EU budget, but of redirected money from cohesion funds already allocated between the Member States. Therefore, the rationale behind their distribution was the logic of cohesion policy, not of a response to the coronavirus epidemic. The countries that were allocated the money were allowed to spend it on fighting the economic consequences of the pandemic, and not on objectives defined by regional policy rules. Various restrictions on obtaining these funds have also been removed, such as the need to make a certain percentage of one’s own contribution. The decision was taken, and the plan was launched quickly. However, its arrangements caused political tensions, which was most visible in the Dutch Parliament.
With the Netherlands as its most active member, the frugal club managed to achieve its political goal, which was to avoid allocating new sums to both programs. It also introduced a rivalry for EU funds between the “unjustly endowed” and the “disadvantaged” South. Under CRII, the largest amounts were received by Poland, Hungary, and Romania – in absolute terms, and Hungary, Lithuania, and ex aequo Latvia and Slovakia – as a percentage of GDP; and not Italy, Spain, and France, which recorded the highest number of infections and fatalities. The deliberate situation has attracted Italy and Spain to the “frugal club” to such an extent that its objective remains to reduce EU transfers to Central Europe’s member states. However, neither Italy nor Spain seems to be interested in cutting cohesion policy budgets, while France, due to its strong farmers’ lobby, cannot agree to a reduction in the Common Agricultural Policy budget. The two policies are the biggest fund transfers of EU funds to the East. Emotions are not a good basis for making economic calculations, but they are part of a natural electoral game. As indicated above, the number of coronavirus victims is not the unit of measurement of economic losses resulting from the pandemic. In attracting the electorate of both the North and the South to support the idea of reducing “excessive” transfers of funds to the East, the slogan of “unfair” distribution of funds to fight the effects of COVID-19 is very useful.
The problem of liberalization of state aid rules to combat the effects of the coronavirus pandemic – a threat to the EU single market
On March 20, the European Commission radically relaxed the restrictions on the rules for granting state aid from member states’ budgets to private companies. This was a commonly expected step, making it possible to start any serious fight against the pandemic’s economic consequences. The isolation measures introduced by the governments froze the economy and deprived many companies of the opportunity to operate, and thus of income. Leaving them alone would translate into a threat of mass bankruptcies, unemployment, and social rebellion.
However, the rules limiting state aid in the EU that had been in force up to that point were not a whimsy but had their cause – maintaining fair competition within the European single market. The four European freedoms (free movement of people, goods, services, and money) would not have been possible if the governments of individual member states had been left free to decide on subsidizing with public funds companies owned by their indigenous capital. Strong countries with large budgets, in the absence of customs barriers, import quotas, etc. within the single market, would, without these bans, always be able to outbid the poorer countries in their subsidies and destroy their businesses to guarantee their monopoly position. The pandemic has not eliminated this problem. The deep liberalization of bans and the simplification of procedures for applying for public funds, which the European Commission agreed to, resulted in both the desired, necessary positive effects, i.e., enabling governments to rescue national economies ruined by the effects of the epidemic, and negative consequences. It placed the wealthiest EU countries in a privileged position, drastically increasing the differences between members of the EU. As long as there were strict restrictions on state aid, at least in theory, Polish, Portuguese, Greek, or Romanian companies competed within the single market with German, French, Dutch, or Scandinavian companies. Once these restrictions have been lifted, this is not even theoretically possible.
There are two ways to solve this problem. The first is to provide more generous support from the recovery fund for poorer countries, and the second is to revise the rules on state aid, taking into account the different financial capacities of Member States. This problem is confirmed by the data on state aid approved by the EC at the end of April 2020 in the EU’s individual countries. It amounted to a total of €1.95 trillion. Central European countries outside the Eurozone allocated considerable funds (according to their resources) to fight the pandemic’s economic consequences. However, since no one can compete with Germany and France in terms of their budgetary power, the German package represented at the end of April as much as 56% of all EU state aid approved by the EC; the French one accounted for 18%, the Italian one for 11%, and the Belgian one for 3%. Among the other packages of individual member states, none exceeded 1% of the total EU state aid. The EC’s acceptance of this situation entails the risk of creating a tremendous competitive advantage for companies from the richest EU countries over those from poorer countries, the budgets of which do not allow for competition for subsidies with the EU giants, and the destruction of the single market.
The problem of the Economic Recovery Fund and ‘coronabonds’
Euroland ministers, who met in an inclusive formula (i.e., with the participation of ministers from EU member states outside the Eurozone), agreed on 7-9 April on initial financial support programmes for member states in the context of the pandemic. However, they only cover financing health care and the fight against unemployment. They did not decide to set up an economic recovery fund, but they promised to do so. One of the subjects of the dispute was the question of the loans provided as part of the fund.
The “frugal camp” demands that the funds made available to those in need be “difficult money.” This means that they would be subject to political control by the EU institutions especially in terms of borrowers’ economic recovery programs and their implementation. It is also about avoiding the accumulation of expenditure over time, meaning guaranteeing that the money will be paid back. Southern countries (including France), already heavily indebted, are calling for the communitarization of “coronavirus debts” – non-reimbursable loans (grants) with easy eligibility conditions.
On May 19, Germany and France announced a joint project to establish a €500 billion recovery fund. It is politically and economically beneficial for the North and the South, but entirely unacceptable for the East. It is not yet clear what will be the basis for calculating the support provided – the number of COVID-19 victims, economic losses, or a combination of the two. However, the general wealth of a given country (GDP per capita) is not mentioned in this context, and the problem resulting from the liberalization of public aid rules, i.e., the ability of individual national budgets to finance recovery is completely ignored. The loan repayment system is based on the proportionality of a country’s contributions to the EU budget. As a result, the poorer countries in the East of the EU would finance the recovery of the wealthier South, the governments of which reacted less effectively to the challenge of the pandemic, and which suffered greater damage as a result. However, this would satisfy the North’s political goals – to reduce or even reverse transfers to the East, reduce their own contributions by partially replacing them with funds from the countries of the East, and gaining support from the South for such a scheme.
The European chessboard of pandemic and its economic and political consequences continues. Satisfying demands of the North requires discrediting the countries of the East so that they can be “punished” for failing to “comply with EU rules.” Attacks on Poland and Hungary are, therefore, a logical strategy. That said, the EU budget is decided by the European Council unanimously and the EU Council also unanimously, unless the former also unanimously allows the latter for a majority procedure. Either way, no legally binding decision on the subject can be made without the consent of the East. Politics, however, is not a fair trial. The powers can do much to bend the law.
Aside from the ideological dispute between the progressivist EU mainstream and the conservative governments of Poland and Hungary, but also from the fundamental conflict of financial interests, the problem for the entire EU is even more profound and probably unsolvable. It lies in a rhetorical question: are the first EU economy (German) and the relatively small Dutch, Austrian and Scandinavian economies able to credit the second EU economy (France), the third (Italy) and the fourth (Spain), not knowing whether, when and on what scale the next wave of the pandemic will occur, what will be the consequences, who will be most affected – and if it will be the last one. To be effective, financial aid must be substantial. Using resources on a strategic scale requires the consent of their ‘makers’, i.e., the voters. Germany already knows this, and the ruling of its Constitutional Court has given a clear signal that Berlin will retain control over the spending of money coming from its taxpayers regardless of the decisions of EU institutions. Will this consent be obtained, and in which countries? What political actions will it trigger? Which parties in the North will gather political capital from the disputes surrounding this, and will governments not give in to this pressure? In other words, is the North going to rebel? If the aid is ineffective, the South will fall into a deep economic crisis, which will ultimately also lead to social turmoil and strike at the interests of the North, the voters-taxpayers of which are forgetting that financial transfers within the EU serve to maintain the European single market. They are compensation for the removal of customs barriers and import quotas and expose weaker economies to the competition with the stronger – and not charity. Their liquidation will eliminate the market for goods and services produced in the North and quickly make the taxpayers from these countries “sacrificing” themselves unemployed. This is not a good scenario for anyone. The same reasoning can also be repeated for the East. The attempt to exploit it by reversing the direction of fund transfers is, in the short term, attractive for the whole Western (both Northern and Southern) political class. However, it will eventually push the East of the EU out of the common market and generate unemployment in the West. This is certainly not a good scenario for anybody either.
The EU is now facing a tremendous challenge. It is fighting its third crisis, while the effects of the two previous ones – both financial and mental (growing mutual mistrust and reluctance to show and not just to declare solidarity) – still overlap, creating negative synergies. Governments are now going through a minefield because electoral politics is not an academic seminar, nor an area for weighing the coldly calculated arguments. The chance that no one will step on a mine and detonate the neighboring mines is low. Nevertheless, this is only part of our reality. The world outside the EU still exists and will continue to show itself – and, most of the times, not in a friendly way. Our life, however, is not the state of nirvana, and the time granted to us to solve our problems is not unlimited.
This article was originally published on The Warsaw Institute Review quarterly, issue no. 13, 2/2020.
Author: Przemysław Żurawski vel Grajewski
 In the fourth quarter of 2019, just before the outbreak of the epidemic, the debt of Italy amounted to 134.8% of the GDP, the one of France to 98.4% of the GDP, and of Spain to 95.5% of the GDP. General government gross debt – quarterly, Eurostat, 23/04/2020, https://ec.europa.eu/eurostat/databrowser/view/teina230/default/table?lang=en.
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