The EU's trillion-euro question
Russia’s invasion of Ukraine has thrown the European Union into yet another full-blown economic and political crisis
But while the war is the immediate cause of soaring gas, fuel, and electricity prices, the roots of Europe’s current pain run much deeper. The vulnerabilities of the European energy system have been evident since at least 2008. But the EU has been too slow to respond, failing to take the necessary measures to ensure greater resilience.
Our current age of «permacrisis» underscores the need for Europe to respond faster and more decisively to shocks. In recent months, European governments have significantly reduced their dependence on Russian gas imports, which plummeted from 45% of the total last year, to just 5-6% currently. But substituting Russian imports is not enough; Europe must also reduce consumption. To offset the severe impact on member states, households, and industry, EU-wide solidarity mechanisms are needed.
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So far, such efforts have been lackluster. Germany’s much-criticized €200 billion ($201 billion) rescue package, which aims to shield companies and households from skyrocketing energy prices, is a prime example of the prevailing go-it-alone attitude. Germany’s attempt to gain a competitive advantage over its neighbors may spark a subsidy race that could increase energy prices further. Given the interdependence of EU member states and eurozone economies, this fragmentation is economically and politically toxic.
Europe faced a similar threat to its cohesion, stability, and prosperity during the 2010-12 sovereign-debt crisis. Then, as now, European governments were highly indebted and fiscally constrained. In the summer of 2012, then-ECB President Mario Draghi famously saved the euro by pledging to do «whatever it takes», including «unlimited» government-bond purchases. But rising inflation has severely limited the ECB’s ability to respond to the current crisis in a similarly aggressive manner.
In the coming months, EU leaders will debate the European Commission’s recent proposals for a review of Europe’s economic governance. The debate appears technical, but it is a defining political test. Governments face the daunting task of ensuring national fiscal sustainability through tax increases and spending cuts while allowing for wartime economic measures and facilitating future investment. A reckoning is in order: there is no way to achieve these goals simultaneously other than at the EU-level.
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European productivity has been declining since the 1990s, coinciding remarkably with the development of the EU’s single market and Stability and Growth Pact budget rules. While there is no single explanation for this, the gap between Europe and the United States suggests that the EU’s falling productivity may reflect smaller contributions to growth from investment in technology and innovation.
Since the end of the Cold War, European policymakers have focused on creating a level playing field by deregulating markets and harmonizing standards and policies. Although they have often been breached, debt and deficit limits have curbed national spending and restricted governments’ willingness to undertake ambitious long-term projects. The EU has not rushed to fill this strategic vacuum, preferring to act as a market arbiter rather than develop a shared vision or industrial policy.
The emerging wartime economy and escalating rivalry between the US and China have compounded the EU’s industrial weakness. As the Americans and Chinese vie for control of critical technologies and value chains, Europe faces massive investment gaps that impede its clean-energy transition and adoption of artificial intelligence and other foundational technologies.
As it stands, neither the EU’s €160-180 billion annual budget nor lending initiatives like InvestEU can deliver the scale of change that Europe needs. The 2021 Recovery and Resilience Facility, which aimed to mitigate the worst effects of the COVID-19 pandemic by providing €338 billion in grants and €385.8 billion in loans, has greater firepower. But it is a one-off instrument, most of which is already tied up in various post-pandemic national plans.
Europe faces a triple challenge. To increase EU-wide solidarity, encourage investment, and bolster economic security, we propose that the EU establish a new €1 trillion financing mechanism based on permanent fiscal capacity. This new facility could be financed through a common EU borrowing scheme and built on three main pillars: resilience, sovereignty, and geopolitics.
An emergency fund would provide quick financial firepower during crises. In today’s context, it could offer grants and loans to the member states hit hardest by soaring energy costs. But such a fund could also back critical investments to speed up the renewable-energy transition, such as North Sea wind power.
A sovereignty fund would seek to boost Europe’s technological and industrial development by supporting public-private partnerships and industrial alliances. One way to do this is to take high-risk, high-reward equity positions in European startup ecosystems that need to scale up in areas such as biotech and quantum computing.
The third pillar of this proposed financing mechanism would help the EU pursue its geopolitical interests by providing critical resources to reconstruct Ukraine and advance its integration into the Union. But it would also direct funds to initiatives like the Global Gateway – Europe’s answer to China’s Belt and Road Initiative – which aims to invest up to €300 billion in sustainable technologies, climate-change mitigation and adaptation, and critical infrastructure in the Balkans, the Caucasus, Africa, and elsewhere.
To be sure, the notion of a fiscal union remains controversial in Europe. But the history of fiscal federalism in America is instructive. Before World War I, US federal spending hovered between 2-3% of GDP. Upon entering the war in 1917, however, President Woodrow Wilson established a wartime economy and created special agencies to oversee supplies of food, fuel, and critical technologies. After the war, many of these agencies and wartime programs ended. The federal government shrunk again and remained small until the 1930s and 1940s, when Depression-era New Deal programs and World War II significantly, and permanently, increased its size and scope.
Admittedly, the EU is not the US. Nonetheless, the American experience illustrates how quickly central capacities can develop when external shocks require them. If historical analogies are anything to go by, the current crisis presents European governments with the circumstances to embrace economic federalism. They can no longer afford to go it alone.
Georg E. Riekeles is Associate Director and Head of Europe’s Political Economy Program at the European Policy Centre.
Philipp Lausberg, a former Marie Curie fellow at the University of Antwerp and the Hertie School of Governance in Berlin, is a policy analyst at the European Policy Centre.