Are the Germans Edging Closer to True Fiscal Union?
In a striking reversal, Merkel joins with France in recommending a euro fund that could be a timid first step toward greater integration.
For the second time in the last three years, France and Germany have teamed up on an ambitious plan to rescue Europe—but this time their big road map looks likely to actually go someplace. The Franco-German declaration this week, “A French-German Initiative for European Recovery From the Coronavirus Crisis,” comes as the European Union finds itself immersed in a political and economic crisis in the wake of the COVID-19 pandemic and just a week before the European Commission is set to unveil its own blueprint for recovery.
The headline part of the Franco-German plan is a bold, 500 billion-euro fund (about $550 billion) to help out ailing economies that are struggling to rebuild after the economic carnage from months of near-total shutdowns. The big question is whether naysayers like Austria and the Netherlands, which have long opposed picking up the tab for what they see as profligate Southern Europeans, will be persuaded to go along with such an ambitious, pan-European rescue.
And an even bigger question is whether the powerful endorsement of Germany, along with France, could edge the EU closer to the sort of fiscal integration that the more frugal Northern European countries, led by Berlin, have resisted in the past. The Franco-German proposal for the European Commission to issue debt and then give grants where needed isn’t quite the straight-up debt-sharing that southern countries had asked for, dubbed “coronabonds”—but it’s a step in that direction, marking a turnabout for Germany. And proposing to offer troubled regions grants rather than loans is a way to make the recovery less painful—another important departure that brings Europe a little bit closer to fiscal transfers, another taboo subject.
“You can call it what you want, but it’s large-scale mutualized debt, it’s a different form of coronabonds,” said J.H.H. Weiler, an expert on the European Union at New York University Law School. “It crosses a certain line.”
What exactly are the French and the Germans proposing?
The proposal is a four-pronged recovery plan, including more pan-European health measures, and a repackaging of plenty of big ideas that have been kicking around Paris, Berlin, and Brussels in recent years, including speeding up the green and digital transitions and getting tougher about screening Chinese and other non-EU investment in strategic sectors such as energy and ports. But the heart of the proposal is a 500 billion-euro “recovery fund” which would allow the European Commission to borrow huge sums from the market, then channel that money in the form of grants to sectors and regions most in need of money for rebuilding.
“They’re basically using something the EU has done before, but putting it on steroids,” said Mij Rahman, the managing director for Europe at Eurasia Group.
Why is this such a big deal?
Even though it’s just a proposal by two of the EU’s 27 member states, it’s a huge step for many reasons. First, it’s a Franco-German proposal—and when those two giants at the heart of the European Union row in the same direction, it’s hard for other member states to resist their pull.
“There are very few projects that have been backed by Germany and France that are rejected outright,” Weiler said. And the joint proposal lays down a marker for just what Europe’s recovery plan should look like, and how economic aid should be structured and handed out, right as the European Commission prepares its own plan.
“The French and Germans are nudging the commission in that direction. There’s a lot of good stagecraft and choreography going on here,” Rahman said.
Importantly, the idea for the recovery fund also offers a possible way out of an impasse that has divided Europe since the outbreak of the pandemic. More indebted, hard-hit Southern European countries including Spain and Italy pressed for some form of pan-European debt, or “coronabonds,” to help finance their economic recovery. But less indebted Northern European countries, including the Netherlands but also Germany, flatly rejected that idea—leaving Southern European countries seething with anger at the north and souring on the whole idea of Europe.
Why is Germany doing this, if it just shot down the idea of eurobonds?
There are several reasons for the new direction. Earlier this month, in a shocking ruling, the German Constitutional Court opened the door for legal challenges against the European Central Bank’s big bond-buying programs. That meant Europe’s biggest single financial tool to deal with the ravages of the pandemic could be made unavailable altogether, which would create an even bigger North-South crisis in Europe. By joining France with this new proposal, German Chancellor Angela Merkel can make amends for the German court.
“The court ruling was ultimately the catalyst,” Rahman said. “It changed her calculation.”
But there’s also the immediate economic ruin that needs to be dealt with, something that is increasingly tough for budget-strapped countries with higher borrowing costs than Germany. By joining France to propose a huge, debt-funded grant program, Germany is taking aim at the biggest short-term danger to the EU.
“Merkel looked at the situation in Europe and said, something has to be done, there needs to be a way to channel funds to the south that does not add to their deficit,” said Eileen Keller, an expert on European economic integration at the German-French Institute.
But there’s plenty of self-interest in Germany’s move, as well. It’s by far the biggest economy in the EU and has benefited greatly from the common currency and single market. Protecting that over the long term—even at the cost of angering some frugal German voters in the short term—fits Merkel’s strategic view, Weiler said.
“What’s good for the country may not be popular politics. She is head and shoulders above her counterparts in terms of statesmanship, in terms of protecting the real German national interest,” he said.
So what are the real prospects for this big proposal?
There are still plenty of questions—above all, what the details are of just how the recovery fund would work, and how the commission would distribute money. The immediate challenge is to get countries like Austria (which has already criticized the Franco-German proposal and said it would pitch its own), the Netherlands, and some Scandinavians to drop their objections to something that looks a bit like shared debt and smells a lot like fiscal transfers from rich to poor.
“Now it’s up to the ‘frugal four,’ can they afford not to go where Germany has gone now? How long can the Austrians, Swedes, and Danes hold out if Germany is no longer backing them?” Rahman said.
Most likely, the Franco-German proposal will get whittled down and reshaped as the commission puts its own package together. The “frugal four” will want to see more loans than grants in the relief package, while Southern European countries will seek in vain for even more than 500 billion euros. The outcome will most likely be a “typical European compromise” that pleases nobody but at least moves the ball forward, Weiler said.
And one big question will determine not just the political viability of the new proposal, but also its real effectiveness at disbursing funds where they are needed: the strings that come attached to recovery money. Europe already has almost half a trillion euros in funds available for pandemic relief under the European Stability Mechanism. But tapping money in that fund traditionally came with strict conditions about economic policy, budget management, and economic reform, as Greece discovered during the last big crisis a decade ago. As a result, the funds have a deep stigma—such that Spain, Italy, Portugal, and Greece have refused to use even the pandemic funds that have hardly any onerous conditions at all.
“Conditionality has become a very bitter pill, especially for Greece,” Keller said.
In their proposal, France and Germany alluded to some form of conditionality, noting that access to the recovery fund “will be based on a clear commitment of member States to follow sound economic policies and an ambitious reform agenda.” Figuring out just what strings to attach to the next big recovery fund will be a big part of the upcoming tussle between member states.
“We will see in the negotiations what conditions they attach to the grants—it won’t be a totally free lunch,” Weiler said.