European leaders clash over economic response to COVID-19 crisis

April 1, 2020

The coronavirus pandemic has exposed longstanding divisions in the European Union (EU), with clashes over how to fund the response — and solidarity is in short supply. A European Council meeting on March 26 failed to agree on which economic tool the EU should deploy to combat a severe recession caused by the coronavirus pandemic.

The coronavirus pandemic has triggered a human catastrophe and economic crisis worldwide, with panicked lockdowns grinding the economic gears to a halt, and Europe sitting on an economic cliff-edge.

The initial response in Europe was led by national governments, closing borders and businesses - and in some cases initiating national spending programs to protect workers, jobs and businesses. However, appeals by hard-hit Italy for urgent assistance went unheeded by all but China and Cuba. It was beginning to look like “European solidarity” was an idea for fairer weather.

Playing catch-up, on March 12 the European Central Bank (ECB) announced an initial €120 billion package aimed at ensuring liquidity in the financial and banking sector, but the looming disaster presented a threat several magnitudes greater than first anticipated.

The ECB therefore called for massive direct government intervention in order to stave off a deep recession, and on March 18 announced its own “bazooka” response — a €750 billion package of Quantitative Easing named the “Pandemic Emergency Purchase Programme” (PEPP) — to allow a rapid expansion of easy debt and facilitate public spending.

The PEPP allows the ECB (and national central banks) to buy large amounts of government and corporate debt until the end of the year to keep the money flowing. State aid rules have also been loosened to enable heavy national spending to combat the downturn and the pandemic.

Crucially, the PEPP is also accompanied by the activation of the “general escape clause”, pausing the EU’s Stability and Growth Pact — a mechanism that imposes the straight-jacket of austerity through member states’ debts. The 33% limit on purchasing of national debt also been temporarily lifted, Greek government debt is included, and the ECB will target short-term debt maturing in as little as 70 days.

This unprecedented — and welcome — move from the ECB is nonetheless insufficient. The PEPP still limits debt purchases, which will still be allocated by the “capital key” of national central banks. Concerns also remain about what the short duration of the PEPP will mean for EU member states’ capacity to service increased debt while fighting an ongoing recession.

The global economy was already heading into a downturn when the coronavirus crisis struck, and it reaches deep into the productive sector of the economy, with the financial sector amplifying the impact. It is unlikely that a short term response in the eurozone will avert a global slowdown, especially in the aftermath of the coronavirus shock.

North versus South

On March 24, the Eurogroup — made up of the eurozone’s finance ministers — met to discuss creating a longer term “pandemic crisis support” tool. The meeting was a failure, with discussion focussing on whether to use the existing European Stability Mechanism (ESM) — the EU’s €410 billion bailout fund  — to offer loans to eurozone members.

Several EU countries, including Italy and Spain, are highly sceptical of the mechanism, which brings both austere “conditionalities” and a stigma of association with the controversial bailouts of the 2008 financial crisis.

As an alternative, they proposed creating a common debt instrument via special eurozone bonds — dubbed “eurobonds” or “coronabonds” — with long maturities These would share the debt and associated risk of borrowing by individual countries across the eurozone, allowing greater levels of borrowing and spending by national governments.

EU member states would thereby share liability for the debt incurred in preventing an economic meltdown, and countries spending heavily to avert economic and social crisis would not be punished later by being burdened with both high debts and onerous conditions. Eurobonds would represent a considerable step towards completing the EU’s “monetary union” and are, therefore, also frequently demanded by proponents of deeper European integration.

Nonetheless, a more fiscally conservative bloc led by Germany and the Netherlands oppose the use of eurobonds, unwilling to support supposedly “irresponsible” spending by the likes of Spain, Italy and Greece without the power to impose structural reforms on those economies.

Undeterred, on March 25, leaders of nine eurozone countries — France, Italy, Spain, Portugal, Belgium, Luxembourg, Greece, Slovenia and Ireland — co-signed a letter calling for the creation of such a mechanism. ECB president Christine Lagarde, her predecessor Mario Draghi, European Parliament President David Sassoli, trade union leaders and numerous economists have also lent their support.

Advocates argue that the coronavirus crisis is ideal for using eurobonds, as it is a textbook example of what economists call an “exogenous shock”. In particular, this means that the “moral hazard” argument against eurobonds — of not rewarding bad behaviour and giving irresponsible governments access to cheap credit — doesn’t apply.

There is no moral risk in helping Italy or Spain run up huge deficits to avoid coronavirus deaths and a recession, as no one “blames” Italy or Spain for this crisis the way Greece was blamed for theirs. It is difficult to moralise during a pandemic. Difficult, but not impossible. A bloc led by Germany, The Netherlands, Finland and Austria maintained their objection during the March 26 European Council.

The summit had begun with a fiscally cautious draft declaration limited to announcing a future “roadmap for an action plan” to restore the European economy – the only concrete measure was an emergency credit line from the ESM. Italian Prime Minister Giuseppe Conte refused to accept an instrument designed for a debt crisis, and — with Spain — demanded a better solution within 10 days.

The meeting dragged on for hours as leaders of the 27 EU member states re-drafted their joint communique and then re-drafted it again, locked in battle over one paragraph in particular. In the end, the outcome was a fudge. Italy and Spain succeeded in removing reference to the ESM, but no final decision was made, and the Eurogroup was tasked with drafting a new proposal in two weeks.

Eurobonds supporters argued that their proposal remained on the table, Italy’s Conte argued: “If Europe does not rise to this unprecedented challenge, the whole European structure loses its raison d’être to the people. We are at a critical point in European history.”

However, opponents insisted that the ESM was still the only game in town. German Chancellor, Angela Merkel immediately made it clear that for Germany “the ESM is the preferred instrument”. Dutch Prime Minister Mark Rutte was equally firm: “I cannot foresee any circumstances in which the Netherlands will accept eurobonds.”

Insufficient outcome

For many countries, the outcome was manifestly insufficient. It was certainly light years from the urgent “Marshall Plan” of coordinated spending that Spain’s Prime Minister Pedro Sanchez had called for in the “war against the coronavirus”.

Tensions were further heightened when Portuguese Prime Minister António Costa responded to comments by Dutch finance minister Wopke Hoekstra, who suggested EU member states claiming not to already have budgetary capacity to deal with the pandemic should be investigated. Costa lashed out, describing the statements as “repulsive” and “senseless”, and warning that this “recurring pettiness threatens the future of the EU”.

As the brutal impact of this crisis spreads through the EU, this attitude is likely to change — whether it is in time to avert disaster is less certain. If the EU fails to provide the framework, Italy and other member states may feel compelled to act independently. Conte has insisted that Italy would rather go it alone than accept loans under the ESM with further disciplinary terms.

If German and Dutch instransigence prevails, Italy could easily end up with a debt-to-GDP ratio of 200%, once the immediate crisis eases. With high unemployment, low growth, no fiscal sovereignty, and more than 10,000 dead from coronavirus, it would be fertile political ground for a neofascist far right that already enjoys 30% support.

For now, the EU has temporarily suspended its damaging obsession with austerity, allowing states to intervene in and bring crucial sectors — such as healthcare — back under public control, while protecting jobs and incomes. These moves are short-term, however, and aimed largely at protecting profit and short-term corporate viability.

Clearly, many more economic and political taboos remain to be broken before we can deal with the looming crises threatening people, democracy and the climate — rather than just the Euro and the banks. If they remain unbroken, however, the EU runs the risk of being broken itself — with potentially catastrophic consequences.

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