Blog Post

The EU Budget’s Outsize Political Role

The European Commission is now in the process of formulating the next Multiannual Financial Framework (MFF), a medium-term budget framework that fixes the European Union’s revenues and expenditures, including how much should be allocated annually to each objective and each country. The next one starts in 2014 – and much more than money is at […]

By: Date: June 27, 2011 Topic: Macroeconomic policy

The European Commission is now in the process of formulating the next Multiannual Financial Framework (MFF), a medium-term budget framework that fixes the European Union’s revenues and expenditures, including how much should be allocated annually to each objective and each country. The next one starts in 2014 – and much more than money is at stake.

The debate over the next year will be significantly influenced and constrained by national interests. Member states, facing serious fiscal problems of their own, are unlikely to agree to pay more to the EU budget, which will thus probably remain at 1% of EU-wide GDP, as in the previous MFF. But this is no excuse to give up on overhauling the budget’s role in EU governance.

The EU budget is unlike any other. First, size is not everything. The budget’s potential goes well beyond its face value. For example, under the Medium-Term Financial Assistance (MTFA) facility, the EU provides liquidity to non-eurozone members in balance-of-payment difficulties and, more recently, also to eurozone countries. It does so by using implicit EU budget guarantees to raise capital on financial markets. Thus, indirectly, the budget has enabled leveraging of financing in order to support crisis countries – an expression of European solidarity that has gone fully unnoticed.

Second, size relative to the recipient country’s GDP is far from trivial. Over 2007-2013, the new member states receive funds equivalent to about 20% of their GDP, while Greece and Portugal receive close to 8% and 12% of GDP, respectively. At the country level, EU funds – if appropriately employed – are a powerful instrument for growth-enhancing reform.

Finally, the destination of EU funds, not their size, affects their capacity to deliver economic growth. Certain types of projects are more growth-enhancing than others, depending on starting conditions. The crucial issue is how EU funds are used and the extent to which the projects they finance complement each other.

The next MFF should answer three questions: What is the budget’s role in times of crisis? What are the policy priorities, and how should they be fixed? How does the EU budget relate to the emerging new economic governance framework?

The EU budget played an important role in the recent economic crisis. The size of advance payments was increased to finance the European Economic Recovery Program in each country, and feasibility studies of large infrastructure projects were suspended. But these measures were merely palliative; the next MFF should be much more ambitious in identifying the role of the EU budget in the management and prevention of crises.

For example, the MTFA facility is not funded, so the budget’s implicit-guarantee function should be strengthened. The MFF could require that unused funds (so-called “de-commitments”) be pooled to create a guarantee fund in case of sovereign default. Doing so might improve credit ratings, thereby facilitating the European Commission’s efforts to raise financing on favorable terms.

Moreover, given current fiscal constraints, the EU budget should be used more systematically to leverage financing of strategic private-sector investments with the support of the European Investment Bank (EIB). Indeed the creation of EU project bonds for this purpose has already been proposed.

Finally, the European Commission should be allowed to administer funds directly in countries that are under conditionality, mainly to finance large infrastructure projects – ranging from transport to telecommunications to energy. Financial markets might very well interpret this as a guarantee of solvency.

As for priorities, the EU has clearly indicated that Structural and Cohesion funds should be used to implement the “EU 2020” strategy, according to which member countries are asked to focus resources on a small number of high-return projects – so-called “thematic concentration.” For example, one important suggestion is to increase the number of selectable objectives in step with each country’s allocation of EU funds.

This would be a mistake. Why not give countries and regions full freedom in choosing their objectives, rather than imposing some unnecessary or irrational criterion to fix the maximum number?

Consider, for example, that the countries that receive the most funds relative to their GDP have the lowest regional disparities in employment rates. In Poland, Greece, and Portugal – where the regional disparities averaged roughly four percentage points in 2009, compared to the EU average of 11.8 – a higher degree of thematic concentration would deliver the strongest results.

Finally, one should not lose sight of changes in the EU’s economic governance. One of the more problematic is the new European Semester, a cycle of economic-policy coordination that requires member states to submit early in the year their fiscal and structural reform plans, EU-funded and not, choosing from a menu of EU priorities. There is full discretion in the identification of priorities, and plans are revised every year. But the Semester appears to be inconsistent with the EU budget’s rigid structure and time horizon.

Some flexibility in the use of EU funds was already introduced during the crisis, when member states were allowed to readjust their agreed Operational Programs. Unfortunately, very few took advantage of this opportunity. Under the next MFF, this special derogation should become the norm – or even a requirement – in order to strengthen the effectiveness of the Semester.


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