ESG & Policy Research

Next Generation EU: how does it work and what does it mean for Europe?

After four days of heated discussions, the European Council finally agreed on a EUR 750 bn recovery plan (Next Generation EU) and the EUR 1,074 bn seven-year budget covering the 2021-2027 cycle. It is a historic and major step for European integration, but some aspects of it are bound to trigger

The total amount of funds available under Next Generation EU plan remains unchanged from the original proposal put forward by the European Commission (EUR 750bn), but the composition was changed significantly during the negotiations. The grants component – which is where the degree of fiscal solidarity implicit in the package is more evident – was reduced from EUR 500bn to EUR 390bn, while the loans component was increased from EUR 250bn to EUR 360bn.

It is also interesting to look at what grants have been cut (Table 1). The grants in the Recovery and Resilience Facility (RRF) have remained broadly unchanged at EUR 312.5 bn. Next Generation grant top up to HorizonEU –financing EU research programs – has been cut by 62%; InvestEU, for investment in EU internal policies, has been cut by more than 80%; the allocation to the Just Transition Fund, to help support local communities in transition to a green economy, has been decreased by 2 thirds. Three programmes have been defunded, among which the Solvency Instrument, which would have allowed for EU-level solvency aid to firms in countries that could not afford the rescues.

Overall, it seems that the political compromise has been found on cutting allocations to those programmed would have been administered at the central level and would have financed truly European public goods. As Next Generation EU will be funded through EU issuance, it would have been a powerful signal for European integration going forward if some of that issuance had gone towards EU-level long-term programmes – as this could have increased the chance of bridging Next Generation into a permanent framework.

Table 1

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The concentration of cuts on centralised programmes has allowed keeping the national allocations of grants within the RRF broadly unchanged compared to previous estimates. As a simplification, we can calculate the grants allocation by applying the key proposed by the European Commission for the RRF instrument (which constitute 80% of all grants) across the whole EUR 390bn. This proxy calculation yields Italy and Spain as the top-2 beneficiaries (receiving EUR 80bn and EUR 78bn in grants respectively). To calculate the net transfer that countries will end up getting from these grants (Figure 1), we assume that each will be liable to repay according to their share in the EU budget.

In a way, this is a worst-case scenario assumption: the final repayment will in fact crucially depend on whether an accord will be found on increasing the EU own resources, which would decrease the national contribution accordingly. The own resources discussion will be a difficult one, and the deal approved this week only includes a weak commitment on the subject. The new non-recycled plastic waste tax that will be introduced as of 2021 is a national contribution, not a genuine EU fiscal capacity. This discussion will start in earnest in 2021, following a Commission’s proposal. It will likely be dominated by a struggle on the need to harmonise corporate tax rates – of which there is unsurprisingly no mention in the Council’s conclusions.

Moreover, the allocation of 30% of the grants will actually be re-assessed in 2022, based on ex post countries’ share in the EU real GDP loss observed over 2020 and the cumulative loss in real GDP over the period 2020-2021. This was proposed by European Council President Charles Michel as a way to take into greater account the actual impact of the COVID-19 economic crisis, and it may eventually result into a larger share going to those countries that were hit the hardest by the health emergency and hence implemented stricter lockdowns (such as Italy and Spain).

Figure 1

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The degree of fiscal solidarity implicit in the Next Generation EU package is best exemplified by looking at the position of Italy. With a grant entitlement of about EUR 80bn and a liability (based on its EU budget share) of about EUR 50bn, Italy would get about EUR 30bn in net transfers from the grant component of Next Generation EU – equivalent to  the EU returning to Italy about 7 years of net contributions paid by the country into the EU budget. Italy is the only net contributor to the EU budget to be a net recipient of the Next Generation EU grants, and this switch in the sign is a very important signal of a change of mindset about EU fiscal solidarity (more than the size of the transfer).

The counterpart of this, however, has been the increase of budget rebates for Austria, Denmark, the Netherlands and Sweden, while the German rebate has remained constant. Over the next budget cycle, rebates will total EUR 53bn. In the past, France, Italy and Spain have been paying for respectively 30%, 22% and 15% of the rebates. If things remained the same, Italy and Spain could be liable for EUR 11bn and EUR 8bn respectively, which would decrease the effective net transfer. More generally, the compromise on rebates perpetrates a problem of transparency that dates from long before this budget cycle.

Coming to allocation, 70% of the grants provided by the RRF will be committed in the years 2021 and 2022 and decided by the Commission based on countries’ national spending plans. The assessment of the national plans will then have to be approved by the Council by qualified majority voting (QMV), requiring 15 countries for at least 65% of the population. Here the news is that countries will need to finally start paying attention to the Commission’s Country Specific Recommendations (CSRs) – which have been so far largely ignored. Consistency with CSRs will in fact be a benchmark against which the assessment of national spending plans will be based, with an eye out for reforms strengthening the growth potential, job creation and economic and social resilience of the Member State, with contribution to the green and digital transition as pre-requisites. Hopefully, this will help coordinate domestic reforms efforts in a way that fosters a balanced and even EU-wide recovery.

The governance of disbursements was one of the most contested issues. The Initial Commission proposal was for a very slim process that would have given the central role to the Commission. The final compromise will see the Commission producing an assessment of the “satisfactory fulfilment of the relevant milestones and targets” and then seeking the opinion of the Economic and Financial Committee (EFC, a committee of technocrats from the Finance Ministries). There will be the faculty for one or more members to request that the assessment be discussed by the Council. This “emergency brake” was introduced to bridge the gap between the Commission’s initial proposal and the request of a Council veto by the ‘frugal front’. All considered, while the brake can slow down disbursement up to 3 months, ultimately the Commission’s assessment would prevail.

Overall, this deal is symbolically a major step for the EU because it overcomes two historic taboos of European integration, i.e. long-term opposition to large size EU common issuance and staunch opposition to explicit fiscal transfers across countries (even if temporary). As such, it also provides a long-awaited political underpinning to the ECB’s action and it sets he bases for a discussion on increasing the EU’s own resources. This will be the start of a number of very difficult negotiations that will unfold in the coming months, in which it will be key for France and Germany to preserve the alignment of views and the ambition they demonstrated in May, when they started this revolution. If they will, at the end of the road we will turn back and look at 2020 as the most important year for European integration.