Blog Post

Europe’s Dysfunctional Growth Compact

Recently, a €10 billion ($13 billion) shortfall in this year’s European Union budget came to light. As a result, the EU cannot reimburse member states for recent unexpected expenditures, including emergency outlays, such as aid to Italian earthquake victims, and spending aimed at boosting economic growth and employment, such as the accelerated absorption of unused […]

By: Date: November 29, 2012 Topic: European Macroeconomics & Governance

Recently, a €10 billion ($13 billion) shortfall in this year’s European Union budget came to light. As a result, the EU cannot reimburse member states for recent unexpected expenditures, including emergency outlays, such as aid to Italian earthquake victims, and spending aimed at boosting economic growth and employment, such as the accelerated absorption of unused Structural and Cohesion Funds. Member states have refused the European Commission’s request for extra contributions to cover the shortfall, causing talks over next year’s budget to collapse.

Meanwhile, negotiations over the 2014-2020 Multiannual Financial Framework (MFF), the central-planning instrument for the use of EU funds, have broken down, owing to disagreement over key issues, including the size of the budget and the composition of expenditure. The decision has been postponed until early next year.

The situation has highlighted the ambiguity surrounding the EU budget’s role in European integration. While all EU leaders have advocated using the budget to stimulate economic growth, little action is being taken. This raises doubts about the so-called “growth compact” launched by the European Council in June, particularly about the political commitment to mobilize €120 billion quickly by reallocating unused Structural and Cohesion Funds and increasing the European Investment Bank’s lending capacity.

Indeed, although European governments have agreed to encourage faster absorption of EU funds in crisis countries, they have refused to pay into the EU budget to enable the funds’ disbursement. This contradiction signals that national interests continue to prevail in EU budget negotiations, which are often exploited for domestic political gain in member states. Unless a mechanism is introduced that facilitates the rapid disbursement of EU funds, thus insulating the budget from destructive politicization, these funds cannot be used to stimulate growth in times of crisis.

Not all member states contribute equally to the EU budget; some are net contributors, while others are net beneficiaries. At the end of EU-financed investment projects – payments for which are agreed and executed in the annual budget framework – the money is transferred to the beneficiary. Cash to net beneficiaries is paid in by net contributors.

One country’s inflow of EU money is thus another country’s outflow – and these are grants, not loans. As a result, agreement every seven years on overall expenditures is inadequate to preclude conflict on annual budgets.

Nonetheless, steps can be taken to prevent political deadlock in budget negotiations, while increasing the budget’s flexibility so that it can be used to stimulate growth. For example, some leveraging of the budget could be allowed, although this would spark controversy, given that EU treaties require that the budget remains balanced at all times.

But the EU budget has already enabled an indirect form of leveraging: the European Commission’s use of implicit budget guarantees to raise capital on financial markets. These funds are used to provide financial assistance to non-eurozone EU countries through the Medium-Term Financial Assistance Facility, to eurozone countries through the now-expired European Financial Stabilization Mechanism, and to partner third countries.

Between the MTFA, the EFSM, and payments to third countries, the total exposure this year is €70.5 billion. Some borrowing over the seven-year MFF period may be possible, while upholding the medium-term objective of a balanced budget.

Such leveraging of the EU budget would complement the recently established European Stabilization Mechanism (the successor to the EFSM) and the MTFA. Countries receiving assistance should be given the option of applying for an anticipated disbursement of EU funds. Following a request by a member state, the Commission would be entitled to borrow on capital markets under the implicit EU budget guarantee, with the maximum amount determined by the size of the country’s unused (pre-allocated) Structural and Cohesion Funds. The capital would be repaid in annual installments as the funds become available through the EU budget, while the national co-financing rate would apply to interest payments.

This framework would reduce incentives for using annual EU budget negotiations to advance political agendas. Net contributors would be locked into a relationship with the markets – a convincing creditor. At the same time, imposing conditionality on this kind of disbursement would enhance legitimacy, as opposed to the current framework, in which beneficiaries seek entitlements. Indeed, all EU countries – not just eurozone members – would benefit from such a framework.

Such an initiative could co-exist with European Council President Herman Van Rompuy’s proposal to create a risk-sharing mechanism only for eurozone countries. The revamped growth compact would more effectively allocate European resources and increase the flexibility of permanent transfers from rich to poor countries – provided that the money is used for productive investment. Van Rompuy’s budget would also help to stabilize the eurozone in the event that asymmetric shocks require temporary transfers from unaffected to crisis-stricken countries.

In fact, the two instruments may well be complementary in eurozone countries. Crises are typically associated with a drop not only in actual growth, but also in a country’s growth potential, owing to deferred investment. A risk-sharing facility could limit the decline in actual growth after a crisis, while prompt EU-financed investment would prevent a country from shifting to a lower growth path.

A version of this article was originally published in Project Syndicate


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic
 

Blog Post

Three macroeconomic issues and Covid-19

COVID-19 raises a number of serious issues of a sanitary, social and economic nature. While recognizing the difficulty of giving definitive answers at this early stage, we attempt to shed light on three critical macroeconomic topics.

By: Leonardo Cadamuro and Francesco Papadia Topic: European Macroeconomics & Governance Date: March 10, 2020
Read article Download PDF
 

Policy Contribution

European Parliament

How good is the European Commission’s Just Transition Fund proposal?

On 14 January 2020, the European Commission published its proposal for a Just Transition Mechanism, intended to provide support to territories facing serious socioeconomic challenges related to the transition towards climate neutrality. This brief provides an overview and a critical assessment of the first pillar of this Mechanism, the Just Transition Fund (JTF).

By: Aliénor Cameron, Grégory Claeys, Catarina Midões and Simone Tagliapietra Topic: European Macroeconomics & Governance, European Parliament, Finance & Financial Regulation Date: February 26, 2020
Read article Download PDF More on this topic More by this author
 

External Publication

Factors determining Russia’s long-term growth rate

This paper’s main conclusion is that Russia’s economy cannot grow at the pace recorded in the early and mid-2000s because of the different external environment, the different stage of development and serious demographic headwinds.

By: Marek Dabrowski Topic: Global Economics & Governance Date: January 16, 2020
Read article More on this topic More by this author
 

Opinion

Could the U.S. economy be experiencing a hidden tech-driven productivity revolution?

In the last decade, most advanced economies have grown more slowly than before. Slower growth has frequently been seen as a legacy of financial crises, especially that of 2007–2009.

By: Marek Dabrowski Topic: Innovation & Competition Policy Date: January 6, 2020
Read about event More on this topic
 

Past Event

Past Event

Improving regulatory policy formulation and institutional resilience in Europe

Are large differences in the resilience of individual economies related to differences in the quality of country-level institutions that shape the absorption and response to these shocks? At this event we'll discuss the evolution of labour markets, and the role of institutional design and good process.

Speakers: Arup Banerji, Maria Demertzis, J. Scott Marcus, Céline Kauffmann and Rogier van den Brink Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 13, 2019
Read article More on this topic
 

Opinion

Upbeat outlook from Chinese banks' profits masks growing problems for small banks

The performance of Chinese banks has been resilient so far, despite decelerating growth. While the performance of large banks remained steady, the rebound came from small banks. Why have small banks rebounded and is the rebound sustainable?

By: Alicia García-Herrero and Gary Ng Topic: Global Economics & Governance Date: November 12, 2019
Read about event More on this topic
 

Past Event

Past Event

Russian economy at the crossroads: how to boost long-term growth?

Russia’s convergence to advanced economy income levels has stalled. Long-term growth prospects are still obstructed by sluggish productivity growth, low capital accumulation and shrinking labour inputs. The new government has articulated a set of ambitious policy objectives for the next six years. But are additional reforms necessary to further boost productivity and investments in line with government targets?

Speakers: Marek Dabrowski, Markus Ederer, Elena Flores, Alexander Larionov, Dmitry Polevoy, Niclas Poitiers and Alexey Vedev Topic: Global Economics & Governance Location: Kadashevskaya Naberezhnaya, 14, Moscow, Russia, 115035 Date: November 7, 2019
Read article More on this topic More by this author
 

Podcast

Podcast

Deep Focus: Making a success of EU cohesion policy

Bruegel senior fellow Zsolt Darvas talks to Sean Gibson in this Deep Focus podcast about how the EU can improve its cohesion policy, citing the best examples of its implementation and stressing the methodological difficulties in measuring its effectiveness.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 20, 2019
Read article Download PDF More on this topic
 

External Publication

Effectiveness of cohesion policy: learning from the project characteristics that produce the best results

This study by Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza, and Catarina Midões analyses the characteristics of cohesion policy projects that can contribute to successful outcomes. Their analysis is based on a literature survey, an econometric analysis and interviews with stakeholders. About two dozen project characteristics are considered, and their association with economic growth is studied using a novel methodology. Based on the findings, the study concludes with recommendations for cohesion policy reform.

By: Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza and Catarina Midões Topic: European Macroeconomics & Governance Date: June 11, 2019
Read article More on this topic
 

Blog Post

A European atlas of economic success and failure

Economic growth was diverse across EU regions, yet it is crucial to control for region-specific factors in assessing growth performance. We find that there are rather successful regions in many EU countries, suggesting that the EU can provide a good framework for growth. Yet the worst performers are more concentrated in some countries, suggesting that country-specific factors can play a major role in regional development.

By: Zsolt Darvas, Jan Mazza and Catarina Midões Topic: European Macroeconomics & Governance Date: June 3, 2019
Read article Download PDF More on this topic
 

Policy Contribution

How to improve European Union cohesion policy for the next decade

This policy contribution investigates the performance of the design, implementation and effectiveness of cohesion policy, the most evaluated EU tool for promoting economic convergence. By analysing the effects of cohesion policy on economic growth through reviewing literature, conducting empirical research by comparing regions, as well as considering attitudes and expectations collected through interviewing stakeholders, the authors provide reform recommendations.

By: Zsolt Darvas, Jan Mazza and Catarina Midões Topic: European Macroeconomics & Governance Date: May 23, 2019
Read article More on this topic More by this author
 

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 20, 2019
Load more posts