The picture that accompanies this post is the visual rendition of the GDP Spring Forecasts of the European Commission. Darker colours indicate larger GDP losses in a range from 4% to 9%. The Covid pandemic is levying a heavy toll on all EU countries, but not evenly. A clear-cut cleavage is visible between South-West and North-East of the EU, with the former suffering worse human casualties and economic losses. If untamed, this SW/NE cleavage is going to generate powerful centrifugal forces and put the EU in jeopardy in the post-Covid age
The Frugal Four is the nickname of the leading NE countries (The Netherlands, Denmark, Austria and Sweden) who soon before the outbreak of the Covid pandemic blocked the timid attempt of the Commission to raise the EU budget of few decimal points. The Frugal Four remain faithful to their opposition to any enlargement of the common fiscal space of the EU, not to speak of the issuance of common debt, also in the face of the Covid emergency. At the first post-Covid European Council in March, they were prepared to pass nothing more than the emergency package of €540 billion proposed by the Commission – most of which coming from outside the EU budget - and, for the Euro Zone (EZ), the strengthening of "unconventional" monetary measures by the ECB.
The Frugal Four's claim that each country should take care of itself by its own fiscal means has been overcome in the course of subsequent hard negotiations leading to the Commission's new plan "Next Generation EU" presented on the 27th of March. This plan elaborates on earlier proposals of a European Recovery Fund put forward by France with a large group of countries (including Italy, Spain, Portugal, Belgium, Ireland and others), and more specifically by the joint Franco-German initiative of the 18th of May. The Commission's new plan, which does create a common pool of resources levered by common debt, is orthogonal to the Frugal Four's wishes, and in fact they have swiftly made public their counterplan based on a "loans for loans" approach.
It is fair to point out that, first, the Frugal Four have substantially retreated their line of resistance to the issue of the distribution of the resources - loans, not grants. Second, the real game changer has been Germany's move from backing the Frugal Four to backing the group led by France. It should therefore be considered that, until the German move, the Frugal Four were not speaking just for themselves, and were not representing a minor nuisance. Quite the contrary, their view is the orthodox view, widely shared in the NE countries, that de facto has governed the EU and the EZ so far with little, if any, alternative voices. Since this view is not dead, but temporarily silenced by the exceptional time we are living, it is important to point out and keep in mind that it would be conducive to major mistakes in the anti- and post-Covid policy strategy.
First, national debt burdens would explode, no matter how comfortable the national fiscal space may appear. The crisis is still on too an early stage; underestimation of its scale and costs, and overestimation of fiscal capacity to deal with it, are quite likely. In case of deeper and longer depression, country-by-country, piecemeal fiscal measures would lack credibility, triggering counterproductive market reactions that would increase risk premia.
Second, leaving each country's destiny to its own fiscal capacity hides acute moral hazard, since any country that will not be able to tackle the health and economic crisis with all possible means will pose a serious threat both to itself and to others. More than ever, no one can survive alone.
Third, even in case governments presuming to enjoy enough fiscal space were right, pushing more borderline countries towards their limits of borrowing capacity, or beyond, would disrupt European financial markets and – in the EZ – put an excessive burden on the ECB: a remake of the 2010-12 sovereign debt crises on an immeasurable scale. As that episode showed (uselessly?) relying on "market discipline" as a surgery knife is a tragic illusion.
Fourth, sovereign borrowing means sovereign spending whereas sharing borrowing means sharing responsibility over spending. Which is better in view of the best use of resources for stabilization and recovery of the EU as a whole?
Fifth, it is all about integration and interdependence. The Frugal Four's view of the EU is a competition union, a free market arena overseen by a few regulatory supranational institutions within which sovereign(ist) states compete. Economic and monetary integration create larger opportunities of benefits for all, but also bring mutual responsibilities, otherwise the system becomes untenable in the long run. Competition without cooperation is a zero sum game with winners and losers. Over time winners may become losers and vice versa. However, as long as the game takes place in a highly integrated area, even more so in a monetary union, the destiny of the winners cannot be untied from that of the losers, unless the tie is severed. If the EU, and the EZ in particular, want to have a future, the competition union view should be definitively dismissed, and the "Next Generation EU" plan should become what its name says, the EU of the next generation.