Corona recovery plan

July 1, 2020 Souwie

Covid 19 is expected to result in the worst economic recession since the European Union began. Capital Markets Union (CMU), begun in wake of the last economic crisis, could help to significantly counter some of the worst long term effects of this recession. But harmonizing the capital markets of 27 separate member states, is no simple task. The loss of London’s more developed markets, post-Brexit doesn’t help. A recent report from high-level working group led by Thomas Wieser at the request of the European Commission has been well-received by experts. But the American Austrian economist warns of watering down by the EU Council and the Parliament. .

Capital markets provide deep pools of liquidity that act as a spare tyre for the economy in times of crisis. They also help nurture innovation and economic growth by facilitating optimal distribution of savings to investment-hungry businesses. The world’s first stock market developed in Amsterdam. But today, Europe is highly dependent on bank lending, which is almost twice as high as in the US and amplified the scale of the 2008 crisis. This is partly because European capital markets are underdeveloped compared to the US. What this means in real terms is that European SMEs receive five times less funding from capital markets compared to their US counterparts It also means that innovation and growth of small to medium size enterprises in Europe are stifled.

The advantages of Capital Markets Union are many.

In Europe, there are dozens of small, relatively undeveloped capital markets. It is difficult, for example, for a young tech entrepreneur in Slovenia to find financing at home. Yet there may well be investors in the Netherlands or France who would be eager to risk some of their spare cash in his start up. Although riskier, such investment options provide better returns than simply leaving your money in the bank, particularly when interest rates are low. They also provide investors, large and small, with a wider range of investment options, for example small green start-ups. Portfolios can thus be diversified, lowering risk levels.

Although some progress on Capital Markets Union has been made in the last 5 years, Wieser agrees that Europe still has 27 capital markets rather than just one. With Brexit, the more liquid capital markets of London can no longer be used as a hub around which to work. However, it also means that the field is now open for what Wieser terms a more ‘polycentric’ financial landscape. The former Eurogroup Working Group President predicts that if all of their 17 clusters of suggestions were implemented, Europe would see ‘a significant increase in capital market supply and demand’ within 5 years. European citizens wouldn’t be confined to the small national markets but would have a wide range of options spanning the Union. This in turn, would stimulate additional demand as will the recent move toward mutualized debt post-corona.

What are the major obstacles to Capital Markets Union?

These fall into three major categories – technical, of which there are many requirements, cultural and political. The first forms the central focus of the high-level group’s report although many of the technical adjustments needed will require political input. Wieser highlights the need for improvements in national solvency laws, including the process of refunding withholding taxes. He also highlighted the need to improve access to information on both listed and unlisted companies. This would also help reduce listing costs for SMEs, currently very high in Europe.

There is also the issue of regulation. Some countries have weak audit quality, overly complex procedures and unduly high tax rates. Both Wieser and member of the Board of Appeal of the European Supervisory Authorities, Professor Niamh Moloney, agree that smart supervision at both national and pan-European level is crucial. A balance between adherence to the law and nimble, flexible supervision is key. As is the need to ensure the independence and increased authority of the European Securities Market Authority (ESMA). At present, ‘the governance of ESMA is not conducive to hard-nosed European supervision’ states Wieser, citing a lack of independence and supervisory powers.

Europe must aim for ‘new digital age Capital Market’ – Thomas Wieser.

Bringing about convergence of national legislation is no easy task. Apart from the obvious political obstacles, there is the problem of varying levels of implementation. A single European law can result in several different versions in practice at Member State level. Wieser explains that, for this reason, a move away from directives to regulation, which are more binding, would be beneficial. Although the latter run the risk of becoming more politicized.

This is where digitization can play a useful role. Thomas Wieser proposes the creation of ‘a new digital age capital market’. ‘If we do it all together, we can make Europe the leading jurisdiction for all of these future initiatives’, he emphasises. Digitization can significantly help reduce the cost of information sharing and streamline many of the technical procedures that are vital to the smooth running of efficient capital markets.

Europeans need to be less risk averse and invest in capital markets rather than leaving it in the bank.

Equally important are the political and cultural aspects of this initiative. Thomas Wieser points out that in order for Capital Markets in the EU to grow, the public has to become more interested in investment. At present, most Europeans opt for the safer bank deposit option or low risk funds recommended by investment advisors. A culture that is more open to risk taking needs to be nurtured. At the same time, a wider range of cross-border financial products need to be monitored for quality and the public educated as to their risks.

Back in Brussels, Wieser is hopeful that the Commission will be supportive of his recommendations. But he is less optimistic about the Council and the EU Parliament. Drawing on 25 years of EU working experience, the economist sagely describes the progress of many such reports. They move from the Council, where ideas are often ‘sliced away like pieces of salami’ across the road to the Parliament where ‘it might finish looking like a great cheese!’ He laughs, but it is a working reality. Finding consensus among 27 Member Sates is never easy but when time is of the essence, it becomes imperative.

May 13, 2020 Souwie

This EU budget will include an economic recovery plan for the pandemic. Traditional divisions between north and south, east and west may prove even more stark than usual. Many also question whether Von der Leyen’s much publicised Green Deal will survive a post-corona world. But what if the Green Deal could be re-purposed to drive economic recovery in Europe and bridge political divides? Many wealthy northern European nations are deeply committed to going green and may well be more willing to fund a Green corona recovery plan.

EU Commission president, Ursula Von der Leyen has spoken of a one trillion euro corona recovery fund. As yet, however, it is unclear where this money is coming from. The EU has a variety of so-called instruments or economic tools at its disposal. It uses them to collect and re-distribute funds to countries and industries most in need. However, it is not able to collect taxes like a nation state. So its revenue is entirely dependent on donations from Member States. At present, each Member State transfers approximately 1% of its national budget to the EU. The EU in turn allocates this money in the form of grants to selected Member States, foreign countries, farmers, researchers etc. The EU budget must balance each year, this means that the EU cannot borrow money. If it wants to make more grants, it needs more revenue.

The question of loans versus grants has been a vexed one. In general, the Northern member states led by the Netherlands and Austria, have pushed for loans, which will require repayment, with interest. The more hard hit southern member states, including Spain and Italy, have called for more grants or money transfers which will not require repayment. Italy even raised the idea of issuing coronabonds – mutualized debt, provided through the European Stability Mechanism (ESM). These differences are not new.

European Stability Mechanism credit lines to come with minimal strings attached.

The financial crisis of 2008 raised similar divisions between the more frugal, debt-wary north and the less stringent south. It took much wrangling and negotiation last month to reach agreement on the terms of the credit lines associated with the ESM. All member states will now have access to 2% of their GDP for corona related costs including prevention. The loans will come at very low cost, around 0.1% with maturities of 10 years. This €240 billion package should be available from 15^th May. The Commission has proposed that these loans be free of normal conditions such as debt sustainability. Brussels will simply check that the funds are used for coronavirus related health spending and no more.

But what of post-corona economic recovery measures? Eurozone economies are expected to shrink by 7.4% this year – the worst recession in the Union’s history. National politicians will come under increasing pressure from their respective electorates to deliver, as unemployment rises and businesses close. Whatever the final amount and mix of the EU corona recovery plan, the issue of how exactly this money will be spent is crucial.

No discussion thus far about how exactly corona recovery funds will be spent.

Director of the Bruegel Institute, Guntram B. Wolff, points out that there has been little discussion and no agreement thus far on which companies and industries will benefit from EU support in the recovery period. Wolff worries that member states will support different companies and industries based on political rather than economic concerns. The result, could be fragmentation of the single market. This in turn will weaken the EU economy, just when it needs all the strength it can muster. Belgian economist, Andre Sapir, agrees that ‘coordination is absolutely central to all economic solutions to this crisis.’

The EU Green Deal is Von der Leyen’s flagship initiative. Upon launch in December last year she described it as ‘Europe’s man-on-the-moon moment’. Described by some as ambitious and others as merely a set of targets, nothing similar has been attempted before. Economic progress since the industrial revolution has been heavily reliant on fossil fuels. It is as Jeffrey Sachs says, ‘the first comprehensive plan to achieve sustainable development in any major world region.’

‘Going green might be less painfully done now’ – Guntram B. Wolff.

The New Green Deal will involve an overhaul of nearly every major aspect of the EU economy, including energy, food, transport and manufacturing. Clearly this is not going to be easy. But a comprehensive response to the economic effects of the pandemic will require similar attention to all aspects of the economy. Under the circumstances, ‘going green might be less painfully done now’ says Wolff, as switching costs may be lower.

The Green Deal is going to cost money. The plan involves allocating 25% of the EU budget to climate action. In order to pay for this, the EU wants to reallocate funds from the Common Agricultural Policy (CAP) and infrastructure toward environmental protection. The plan also makes mention of various initiatives designed to make future EU financing for Member States dependent on compliance with Green practices.

The European economic governance framework, for example, may be strengthened in order to incentivise green public investment. Further, the European Investment Bank will be supported in its efforts to become a climatebank. A Just Transition Fund has also been proposed to provide assistance to companies and regions to go green. Countries like Poland, Hungary and the Czech Republic have thus far pushed back against the plan. They are all heavily dependent on fossil fuels and their economies less developed than those of Western Europe.

Why not make it Green?

Tying the corona recovery package to the Green Deal would not be easy. But given that large amounts of EU funding is going to have to be distributed and accounted for in the wake of the pandemic, why not make it Green? So far discussions have been largely economic, but the EU suffers from a lack of political unity. The real question then is, could a Green corona recovery plan, provide that much needed unity? A goal behind which the majority of Europeans and their Member States could get behind?

Would Northern states be more willing to put their hard earned money into the communal pot, knowing that it would be used to help further Europe’s green transition? Would this idea be one that national politicians could sell to their voters? This time last year Greek economist and politician, Yanis Varouvakis, suggested that a radical Green New Deal has the potential to unite progressives across Europe. Could a green corona recovery plan prove to be the great leveller across north and south, east and west?