By Zsofi Bajnai,

In the wake of the Covid-19 crisis, EU countries have been forced to adopt strict measures to minimise health risk that are instead very likely to cause severe economic recession. The majority of Europe – trying to learn from Italy’s disaster and some successful tackling models in Asia – opted for strict containment measures. The UK and the Netherlands’ first instinct was to pursue ‘herd immunity’, but adjusted to similar quarantine tactics after massive political backlash. Most countries are now in a phase called “economic hibernation”, suspending all non-essential work. As a consequence, the European Commission is already estimating a deeper recession than that of the 2008 crisis, pointing to an underlining need for a rapid co-ordinated policy response across the Eurozone.

Models attempting to measure the seemingly inevitable economic setback are greatly affected by the uncertainty of the situation. The Netherlands’ Central Planning Bureau found that the relationship between the duration of restrictive measures and the corresponding impact on GDP, the labour force and public finances is not directly linear, which eases some of the pressures on the lockdown time-scale. An analysis by Bank of America Global Research has forecasted a 2.7 percent recession in Europe for this year, replacing a previously anticipated 0.3 percent economic growth, an outlook grimmer than the downturn accompanying the financial crisis a decade ago. Peter Altmaier, Germany’s Federal Minister for Economic Affairs estimated on Thursday that the biggest economy of the EU will also drown into recession after ten years of continuous growth, with a GDP decrease likely exceeding 5,7 percent. Economists at Deutsche Bank reckon the Eurozone to suffer an 11.4 per cent GDP decrease in the second quarter of 2020, and expect GDP to be, “Running 3-4% below pre-virus levels even by mid-2021 in Italy and Spain”. The economic turmoil is already triggering a sharp increase in unemployment, and despite some countries’ efforts to maintain non-essential production and services, manufacturing activity in the Eurozone has suffered its largest fall since the 2008 financial crisis.

On an EU-level, gazes are turning towards the institution to see if it can manage the crisis effectively. In recent years, wide-spread scepticism over whether the EU will remain (or rather, truly become) a leading player amid global geopolitical power shifts have been amplified by inner struggles to strengthen its scale and scope of co-operation, and an increasing rise of anti-EU sentiments – most prominently resulting in Brexit. This crisis brings a great challenge for the EU, but also an opportunity to show its true utility and the safety-net it can provide for its members, strengthening its position and legitimacy for the long haul.

In the last few weeks, EU leadership has been deeply divided over how best to finance economic recovery after the crisis. The European Commission has set up a €37bn Coronavirus Response Investment Initiative to support the health care sector and provide liquidity to small businesses. Italy, Spain and France –amongst six other Eurozone governments – have been pushing for the output of so-called “coronabonds”, whilst Germany and the Netherlands are wary of the further mutualisation of debt. Chair of Société Générale Lorenzo Smaghi has questioned in the Financial Times the suitability of these bonds, contending the methods of generating a triple-A rating for them without direct EU fiscal authority, or the feasibility of granting this authority which would require a level of integration that so far has been – although advocated by President Macron amongst others – seemingly out of scope. Mr Macron has proposed a common EU fund focused on economic recovery with a limited timeframe (five to ten years) to address fears over mutualisation, with French finance minister Bruno Le Maire hoping that “a limited timeframe and the possibility of having common debt but only within that fund” might be a more acceptable solution to other countries. Germany, on the other hand, is focused more on utilising the existing European Stability Mechanism (ESM), which already has a total lending capacity of €410bn at its disposal and a triple-A rating. Klaus Regling, managing director for the ESM, has estimated the setting up of a new European institution to issue “coronabonds” will take up to three years. As he put it simply, “one cannot create bonds out of nothing”.

The European Commission, in the meantime, is turning to re-write its proposals for the upcoming seven-year EU budget to focus on the economic recovery phase seemingly indispensable now, Commission President Ursula von der Leyen has confirmed. To address the alarming increase in corona-consequent unemployment, the Commission is now also working to raise funds for a €80bn to €100bn reinsurance scheme, under the SURE initiative. This measure models Germany’s Kurzarbeit mechanism, essentially facilitating governments with financing short-term working schemes. These loans would be partially backed by unallocated EU funds, but may also require guarantees from the national level. The draft proposal declares the new mechanisms would only come into force once all member states had put up their economically proportionate share of guarantees, collectively worth €25bn. Commission President Ursula von der Leyen said that the temporary scheme was an example of, “European solidarity in action”, which –if successful – can strengthen the faith in the institution both internally and on a global scale.

Another challenge for the EU at this time comes from a political angle, with fears that strongman leaders may exploit the situation to gain political advantage. Hungarian Prime Minister Viktor Orban has already granted himself emergency powers that go far beyond even what this extreme situation would require. This move has precedence by years of power-abuse under Mr Orban’s self-proclaimed “illiberal democracy”, prompting the EU to trigger it’s slow and seemingly less than efficient Article 7 proceedings, on which Hungary and Poland have vowed to back each other. While the move has captured global attention, with US Presidential candidate Bernie Sanders calling it an example of an authoritarian leader using the crisis to “seize unchecked power”, the EU has only addressed the situation in a reserved tone, claiming to “closely monitor” the situation in the near future. However, already facing criticism for its inability to keep these anti-democratic tendencies in check, Alexander Stubb, former Prime Minister of Finland and leading EPP-figure (in which Mr Orban’s Fidesz party has been recently suspended) might be right in stating that this move “is in many ways a test of leadership” for the EU, and it is now more crucial to be effective both on an economic and political level than ever.

The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.

Image Source: Reuters