Can Europe’s recovery fund live up to expectations?

12 August 2021

5 minute read

The €800bn European recovery fund aims to kick-start the Eurozone’s economy in an ambitious response to COVID-19. Can the plan lift long-term growth prospects while prompting closer fiscal integration?

Key points:

  • The European Commission’s €800bn European recovery plan aims to repair the initial economic damage caused by the coronavirus
  • A minimum of 37% of the funds given to states should focus on climate challenges and 20% on fostering digital transition
  • The European Commission will start issuing bonds and by the end of the year plans to issue €80bn in long-term funding
  • Italy will be the chief beneficiary of EU recovery funds in absolute terms, obtaining €205bn (12.4% of 2020 GDP) from the Next Generation EU facility
  • We forecast that the national plans will contribute around 1.2 percentage points to the bloc’s real growth by 2023, growth being particularly pronounced in Italy and Spain.

Can the pandemic help put the European Union on the path to fiscal integration, following the recent financial framework that targets coordinating stimulus efforts? 

The European Commission (EC) has devised the €800bn European recovery plan known as Next Generation EU (NGEU) that, when coupled with the EU’s financial framework, aims to repair the initial economic damage caused by the coronavirus, while creating a greener and more digital and resilient Europe.

The route to fiscal union

After a period of tense negotiations, an agreement was reached to embrace the idea of debt mutualisation. Ratification of May’s own resources decision paved the way for the EC to start issuing bonds. By the end of the year the Commission plans to issue €80bn in long-term funding.

The NGEU’s main component is the funding of the six-year Recovery and Resilience Facility (RRF), funds being distributed in grants and loans. In an effort to assist the least developed nations, 70% of grants depend on a member state’s population, the inverse of gross domestic product (GDP) per capita and average unemployment rate over 2015-2019. The remaining 30% is calculated by the rate of gross domestic product (GDP) decline since 2020. 

Promoting European objectives

To receive funds, countries submitted their National Recovery and Resilience Plans (NRRP) to the EC. Each addresses the challenges around coordinating economic and fiscal policy. They were encouraged to focus on key areas for investment and reform, including clean energy, sustainable transport, digitalisation of public administration, data cloud capabilities and reskilling/upskilling. A minimum of 37% of the funds should focus on climate challenges and 20% to foster the digital transition.

Following the money

Italy will be the chief beneficiary of EU recovery funds in absolute terms, obtaining €205bn (12.4% of 2020 GDP) from the NGEU facility. The Italian government aims to target tax credits to groups moving to high-productivity technologies. A high-speed railway is also planned between the north and south along with tougher labour market policies.

German policymakers aim to “future-proof” hospitals, digitalise administration, support replacing private vehicle fleets, fund more energy-efficient buildings and upgrade supply chains with the funds.

Meanwhile, French authorities pledge to modernise the railway network and develop public transport. They aim to use the funds to invest in improving energy intensity of public buildings and to support research in industrialising electrolysis and fuel cells technologies.

In Spain, the focus will be on reducing traffic levels and developing sustainable-mobility alternatives.

Collective debt

The establishment of debt mutualisation may help reshape Europe. The issuing of joint debt can reduce the risk of fragmentation, lower borrowing costs for several states and improve policy coordination in the bloc. There are potential challenges, especially around enforcement of the fiscal rules, but this is a worthy goal. 

Lifting productivity and growth

The RRF should provide a sizable fiscal stimulus to eurozone demand from the middle of this year. We forecast that the national plans will contribute around 1.2 percentage points (pp) to the bloc’s real growth by 2023, growth being particularly pronounced in Italy and Spain. The EC estimates that projected growth will be lifted by 0.5pp at the 10-year horizon.

Indeed, these estimates exclude the likely positive effect of structural reform on potential growth. However, execution will be the key to obtaining the best possible return on investment.

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