Pluses and minuses of the EU recovery fund

Welcome back. Four years ago, the Covid pandemic prompted EU leaders to devise an economic recovery programme that looked like Europe’s biggest common investment and stimulus initiative since the US-inspired Marshall Plan of the late 1940s. What’s the verdict — is the recovery fund a success, a failure or something in between? I’m at [email protected].

First, the result of last week’s poll. Asked if a far-right candidate will win France’s 2027 presidential election, 41 per cent of you said yes, 29 per cent said no and 30 per cent were on the fence. Thanks for voting!

Fiscal integration or pork-barrel spending?

At its launch, enthusiasts and sceptics made contrasting predictions about the recovery fund. Supporters portrayed it as potentially the EU’s “Hamiltonian moment” — a bold step towards fiscal integration, recalling the decision of Alexander Hamilton and other founding fathers in 1790 that the new US federal government should assume the debts of the states.

This description now seems as exaggerated as an earlier claim that the Convention on the Future of Europe, which met in 2002-2003 to write a constitution for the EU, would be a “Philadelphia moment”, akin to the drafting of the US constitution in 1787.

At the other end of the spectrum, Wolfgang Münchau, then an FT columnist, wrote in September 2020:

The big danger now is what the Americans call ‘pork-barrel’ spending, a fiscal splurge crafted for the sole purpose of generating political support for those who spend it. This is exactly what I expect to happen in this case.

It is clear today that the recovery fund hasn’t put the 27-nation EU on an irreversible path to a full fiscal union. On the other hand, it hasn’t degenerated into a pointless, over-politicised spending spree, either.

Off-budget borrowing

Putting polemics to one side, we can say that the recovery fund has broken new ground, and created potential future difficulties, in two ways.

First, it’s financed by common EU borrowing on capital markets on a scale without parallel since the 1957 Treaty of Rome that set up the European Economic Community, the EU’s ancestor. This isn’t supposed to set a precedent, but I wouldn’t be surprised if it does — pressures are growing for new, large-scale investments in areas from climate change to defence.

Second, the recovery fund resorts to off-budget borrowing, so EU leaders will face some awkward decisions when they negotiate the bloc’s next long-term budget. This normally lasts for seven years and would run from 2028 to 2034.

Iain Begg sets out the problem lucidly in this article for the Centre for European Reform think-tank. Somehow, the EU must repay the debt incurred under the recovery fund. But will national governments be willing to pay more into the EU budget to do that? Will they approve the European Commission’s proposals for the EU to raise new forms of revenue on its own?

Among the commission’s most controversial suggestions is that of levying a tax on the gross operating profit of corporations, as Margit Schratzenstaller writes for Social Europe. 

In any event, some claims on the fund’s behalf remain overblown. The commission and much of the media persist in referring to the recovery fund as an €800bn programme (equivalent to almost 6 per cent of the EU’s GDP in 2019). However, it is likely that much of this money won’t have been allocated or spent before the programme’s scheduled end in 2026.

Delays in using the money

“Recovery fund” is the loose term used for NextGenerationEU, the overarching instrument designed in 2020 both to help the EU recover from the economic shock of the pandemic and to build a stronger future, and for the Recovery and Resilience Facility, which lies at that instrument’s heart.

The RRF consists of up to €338bn in grants and up to €385bn in loans to EU member states. Repayments of the borrowing required to finance this expenditure are supposed to start in 2028 and carry on until 2058.

As of February, about €225bn in RRF funds had been disbursed, according to commission figures. More will be paid out before 2026, but probably not the full amount foreseen at the plan’s launch.

Two examples explain why. In Poland’s case, disbursements were held back on account of the commission’s concerns about the rule of law under the former conservative nationalist government.

After Poland’s elections last year brought to power a more pro-EU coalition, the money started flowing — but, according to one analysis, some 43 out of 56 investments listed in the Polish recovery plan may not be implemented before the end of August 2026, making them ineligible for the funds.

By the end of 2022, meanwhile, Portugal had allocated only €1.4bn, or 8.5 per cent of its available funds, to spending projects. There, and in other countries, unexpected events have disrupted the recovery fund’s operations — Russia’s full-scale attack on Ukraine, the rising costs of raw materials and supply-chain bottlenecks.

Some governments would therefore like to extend the fund’s work beyond 2026. But that will entail the difficult discussions I’ve mentioned about the EU’s long-term budget.

Impact on growth

In this in-depth analysis of the recovery fund, the FT’s Paola Tamma explained that the initiative had a rapid, beneficial effect in 2020 in that it contributed to calming severe tensions in financial markets at the start of the pandemic.

However, the impact on economic growth is more debatable. Not only has the effect been smaller than the commission predicted in 2020, but for the EU’s largest economies — Germany and France — it has been close to negligible.

Against that, there is some evidence that the fund’s grants and loans have helped to narrow the gap in economic performance between prosperous northern European countries and their less well-off southern European neighbours.

But that probably owes something to Germany’s relative underperformance in recent years, rather than to lasting improvements in southern Europe’s long-term growth prospects.

Meanwhile, BusinessEurope, a pan-EU lobby group, says that 42 per cent of its national federations are dissatisfied with the implementation of their RRF-funded economic recovery plans. It adds:

For 88 per cent of our national member federations, having declined significantly between 2020 and 2023, there was no improvement in the attractiveness of the EU’s investment environment vis-à-vis our major competitors over the last 12 months.

There have also been some problems with fraud and waste, but not on so large a scale as to discredit the recovery fund in its entirety.

Structural reforms lacking

The recovery fund was supposed to do more than simply boost growth in the short term. It was billed as a project that tied disbursements to administrative and structural reforms, such that the European economy would be put on a stronger footing for the long run.

Measured by this yardstick, the picture is mixed at best. That won’t surprise anyone who remembers the unimpressive record of earlier EU initiatives such as the Lisbon agenda of 2000 — a plan to make the EU “the most competitive and dynamic knowledge-based economy in the world” by 2010.

In an article that explained why the EU missed that objective, the eminent economist Charles Wyplosz wrote in 2010:

To one degree or another, European countries support large bureaucracies that stifle risk-taking, their public sectors are often inefficient, and social policies usually protect jobs rather than people.

At the EU level, national interests prevent the creation of a unified research space and countless protectionist measures hinder competition in the services sector.

Have matters improved since 2010, and in particular since the recovery fund’s launch? In this blog for the European Central Bank’s website, four economists — Klaus Masuch, Wolfgang Modery, Ralph Setzer and Nico Zorell — suggest that not much has changed. They write:

There are still many structural weaknesses in our economies: e.g., too much regulation that hinders the entry of new firms and job creation, not enough competition and insufficient incentives to innovate and invest. In several euro area countries productivity growth has been weak for decades.

Another big investment plan in the works?

All these shortcomings suggest it would be wise not to make extravagant claims about the recovery fund’s success.

Nevertheless, I suspect that another large-scale EU investment plan will materialise over time. For one thing, new rules on fiscal discipline place tight conditions on national budgets that will create pressure to use the EU once more as a borrowing vehicle.

For another, two reports prepared by former Italian prime ministers — Enrico Letta’s on the EU’s single market (already published), and Mario Draghi’s on EU competitiveness (due later this year) — make clear the need for large-scale investments.

Draghi says the cost of greening the European economy will come to €500bn a year.

In the meantime, EU leaders need to decide how they will repay the recovery fund debt, and how to modernise the bloc’s long-term budget.

More on this topic

Broader border taxes: a new option for European Union budget resources — a paper by Pascal Saint-Amans for the Bruegel think-tank

Tony’s picks of the week

• Geologists are exploring whether deep pools of magmatic brine in volcanoes can be tapped for vital minerals such as lithium, copper and cobalt, science commentator Anjana Ahuja writes for the FT

• Media freedom declined over the past year in eastern Europe and central Asia, where authoritarian governments are following Russia’s example of cracking down on free speech, according to a new report from watchdog Reporters Without Borders