• Grant Hillyer

The European Union's Debt Crisis

The spread of coronavirus has led to a number of problems. Aside from its health implications, one of the biggest threats posed by coronavirus is how much it affects the economies of countries worldwide. As employees are sent home due to lockdowns and companies suffer, each nation has had to develop economic stimulus packages in response.

Determining who gets aid and in what form is always a complicated issue in the European Union. The European Union has to deal with competing interests from multiple nations jockeying for relief, and larger nations such as Germany have massive influence over the process due to their status as an economic power. There is a history in the European Union of richer nations tying recovery efforts to austerity and spending cuts, such as the measures seen during the 2008 financial crisis. There has long been a reluctance to spend money on other nations or to pool debt as the United States does, in part because it can be a tough sell for politicians and also due to those richer nations not wanting to tie their debt to that of the lower-performing countries.

However, that attitude might be changing in the face of the coronavirus threat. In the United Kingdom, Prime Minister Boris Johnson unveiled a budget that would spend $387 billion, or 15% of GDP. This is unprecedented spending for peacetime, especially coming from a Conservative government. This budget includes not only tax-breaks for companies, but government-guaranteed loans, relief from mortgage payments, and a nationalization of the UK’s rail system for at least the next six months to protect them from a loss of income.

Earlier in the year, in April, European finance ministers agreed to spend more than half a trillion euros in a package that included a €100 billion loan plan for unemployment benefits, €200 billion in loans for small businesses, and access to €240 billion in loans for euro-area countries to draw on from the eurozone bailout fund. This signaled a massive change in how the European Union is thinking about this crisis, as did the European Central Bank’s decision to massively increase spending on bonds when it announced it would be buying an additional €120 billion in bonds on top of the €20 billion it buys a month. The ECB also plans to keep its interest rates on borrowing in the negatives, and has increased the maximum a bank can borrow from 30% to 50% of the bank’s outstanding consumer and business loans.

Germany and France have proposed similarly drastic measures. Chancellor Merkel and President Macron proposed a budget worth €500 billion, a signal from the two largest economies in the European Union (post-Brexit) to the rest of the bloc that they are willing to spend enormous amounts to save the economies of the region. The money would not have to be repaid and isn’t tied to budget cuts. Germany and France have proposed tying their proposal to the MFF, the European Union’s long-term budget, to ensure funding would last beyond the immediate future. The proposal came after Germany’s parliament refused to agree to the pooling of European Union debt. Germany has already spent 30% of GDP on recovery efforts, though how much further they are able to go may be determined by other European Union nations.

The “Frugal-Four” of Austria, Denmark, the Netherlands, and Sweden are the main obstacle to more European Union spending and the pooling of debt. They have submitted a counter-proposal to Germany and France which creates an emergency fund financed solely by loans. This complicates matters a great deal as any recovery fund needs approval of all 27 member states. Their proposal is similar to how the European Union responded to the 2008 crisis, tying receiving loans to reductions in spending and economic reforms. It also has a sunset clause, ending funding after two years, in contrast to the long-term plan of Germany and France. Such a clause allows the European Union to cut funding after a certain point and re-negotiate the agreement.

For those who want to avoid spending, this is perfect, while France and Germany would probably argue their idea of tying spending to the MFF ensures the countries that need help will get it and won’t be cut off or hurt by another round of slow deal-making. Committing funding to the long-term MFF budget would also be a sign to the rest of the European Union that Germany and France are committed to helping the recovery efforts, and that they realize this recovery requires a large commitment. The adoption of the proposal from the Frugal Four would signal that the European Union isn’t fully committed to using all its resources for the recovery, at least not without strings attached and the assurance of a re-negotiation.

Another possible tool that the European Union could employ is the creation of Eurobonds which would collectivize the debt of European Union members. Proponents of the creation of Eurobonds point out they would allow rebuilding economies to avoid strict austerity measures, buying time for them to re-invest in industry and reducing the risks of recession. This would be beneficial to the whole European Union as it would prop up Eurozone economies. Additionally, it could help avoid Euroscepticism some argue was caused by the last round of austerity cuts when larger European Union economies were criticized for the lack of support they provided to Italy and Greece. Germany and France and other countries who want to ensure a stable European Union and avoid another Brexit situation are likely aware of this dynamic, which might be an explanation for their large budget and swift response.

Pooling debt and creating Eurobonds would also allow the European Union to have a new, safe asset. Having a bond backed by the whole European Union could lead to more investors seeing it as a smart investment, much like they view United States bonds. It could also stop the bank-sovereign loop. The loop was caused by banks’ reliance on debt issued by their home government. This created a cycle in which concerns about the creditworthiness of indebted European countries colored investors’ view of their banks and vice versa, amplifying market tensions. Having Eurobonds could break the dependence banks have on their home country as debt would no longer be tied to individual countries.

There are some downsides to having a shared European Union debt as well. One is the obvious loss of sovereignty countries would suffer, leaving individual countries without much control over their fiscal plans. It could also lead to the feared “free-riding,” in which some governments who are more prone to spending are continuously bailed out by more frugal nations. Opponents of debt pooling argue that the creation of a shared debt would allow governments to overspend and accumulate debt with the assurance they will be bailed out no matter what. This could lead to increased budgets across the board in the European Union and a total aversion to austerity. The creation of such bonds would also need the approval of all 27 European Union members.

Whatever the European Union decides, the need to act swiftly is obvious. Economists predict the European Union’s economic output is likely to shrink this year by around 10%. The recession caused by the last financial crisis caused a 4.5% decrease in output at its worst. If European leaders hope to keep the European Union together and stable, their best bet might be to pool debt, continue spending on recovery efforts, and offer relief quickly. Otherwise, countries which are most affected by the coronavirus might succumb to another recession, creating a fresh source of Euroscepticism that could propel more countries to attempt their exits from the European Union.

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