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Why the recovery fund won’t work


Mujtaba Rahman is the head of Eurasia Group’s Europe practice and the author of POLITICO‘s Beyond the Bubble column.

European leaders convening in Brussels next week have pinned their hopes on a €750 billion recovery fund to rescue the Continent from the coronavirus crisis.

It won’t be enough.

When it comes to the mission for which it was primarily designed — to help Rome deal with the economic shock of the coronavirus and alter the trajectory of Italian politics to better guarantee its long-term membership of the eurozone — the recovery fund is unlikely to succeed.

To be sure, the recovery fund represents a big step forward in the evolution of the EU. It will allow for significantly more borrowing at the EU level and substantial redistribution, via grants, to countries in Southern Europe disproportionately affected by COVID-19. Italy, for example, could receive 8.5 percent of its GDP in grants and long-term loans — an unprecedented sum in the EU’s 63-year history.

In the medium term, as recovery takes hold more quickly in Northern Europe, pressure on Brussels will build to re-enforce fiscal rules.

And it’s looking like it’s going to be implemented.

European Council President Charles Michel has been engaged in a series of intense bilateral talks with EU leaders. Senior officials in Brussels involved in the process say the atmosphere around the talks “is better than expected.”

This is partly because Michel’s efforts have been flanked by active diplomacy from German Chancellor Angela Merkel and French President Emmanuel Macron. Senior French officials say there are “conditionally positive indications” coming from The Hague, the key opponent of the plan.

And yet, those hoping the recovery plan will make all the difference will almost certainly be disappointed.

It won’t be possible to convince Northern Europe to agree to such considerable borrowing (and granting) without a robust process of reform, implementation and peer review — a process Brussels is just now beginning to set up.

This will take time to put in place. Under current plans, Italy won’t see money from the fund until late 2021. Meaningful amounts won’t flow until much later, in 2023 — too late to prevent Italy from experiencing a deep recession and rocketing levels of public debt.

Meanwhile, the pandemic and politics will continue to move forward. As well as dealing with the risk of a second spike, Italy’s Prime Minister Giuseppe Conte will also have to contend with difficult regional elections, a constitutional referendum after the summer, as well as his possible indictment over his government’s handling of COVID-19.

If Conte is forced to tap the European Stability Mechanism to address short-term funding gaps, the resulting uproar will certainly not contribute to domestic political stability. The 5Star Movement, the government’s senior coalition partner, is totally divided on the question. It could face meaningful defections from the government if a vote on the ESM were forced through parliament soon.

In the medium term, as recovery takes hold more quickly in Northern Europe, the narrative there will change from stimulus to adjustment, and pressure on Brussels will build to re-enforce fiscal rules.

Frustration will also likely grow in Northern Europe, as there remains very little political appetite to meaningfully reform in Rome.

It’s true that Italy’s government has held multiple daylong meetings with economic stakeholders to build consensus around new reforms. But little tangible has emerged. As of now, the most promising proposal involves a reduction in the tax burden on labor, such as social security contributions.

Meanwhile, while Matteo Salvini’s far-right League has lost some traction in the polls, it remains Italy’s most popular party. In addition, the League’s losses have mainly benefited the smaller, far-right Brothers of Italy.

Matteo Salvini’s far-right League party remains Italy’s most popular party | Tiziana Fabi/AFP via Getty Images

Together with the more moderate Forza Italia, they collectively retain a solid lead — enough to form a government if elections were called today. Over the longer term, a Euroskeptic League-led government remains a very real possibility.

This is a key event risk for markets — something the recovery fund was meant to reduce, but in its current form, will not.

The outlook for Spain’s government isn’t much brighter. The coalition in Madrid is a minority government and requires the support of several small parties to pass legislation. Building consensus on reforms is an almost impossible ask. In fact, going backward is more likely, as Podemos, the Socialists’ senior partner, is committed to unwinding labor market reforms introduced in 2012.

In this context, it would be wrong to count on support from the European Central Bank indefinitely — even if inflation is unlikely to pick up anytime soon.

So yes, the recovery fund does represent an important step for the EU and the eurozone, underpinning it with a more robust fiscal architecture. But it will do little to prevent an uneven recovery, and will not fundamentally improve the short, medium or long-term trajectory of Italian politics — its ultimate goal.

For that, serious money is needed in the second half of this year. That is the ambition Michel, Merkel, Macron and European Commission President Ursula von der Leyen should set themselves for their EU summit in two weeks’ time.



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