The Legacy of the Pandemic: How Covid-19 Is Reshaping Economic Policy in the EU

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April 2021

The Legacy of the Pandemic: How Covid-19 is Reshaping Economic Policy in the EU

Marco Buti and George Papaconstantinou1

ABSTRACT

The economic policy response to the Covid pandemic broke new ground, in terms of its ambition, the tools used, and its institutional characteristics. This paper argues that three sets of factors explain this: our evolving understanding of macroeconomics; the nature of the current crisis; and the policy learning from the financial crisis. It also reviews the emerging institutional landscape at EU level, with its combination of rules-based and institutional features, and assesses the critical factors for successful implementation of the Recovery and Resilience Plans at national level. The paper finally contends that four sets of issues will be important in shaping the legacy of the pandemic for European integration: redefining the new boundaries between state and market; revisiting the nature of subsidiarity; reconnecting the EU domestic with the global agenda; and learning to respond to longer term structural shifts.

1. The EU: A History of Resilience

The EU is navigating its third crisis in the space of a single decade, following the eurozone financial crisis and the migration crisis. Jean Monnet famously stated that ‘Europe will be forged in crises and it will be the sum of solutions adopted for those crises’. Indeed, as in previous crisis episodes, the policy solutions are to be found at the intersection of what economic policy suggests and political reality and institutions allow, and reflect a combination of principles, flexibility and pragmatism. But every crisis has its own characteristics, and prompts its own response. This crisis is different, and the policy response, with the Next Generation EU initiative at its heart, is breaking new ground.

Successful crisis response needs to pass what could be called the ‘Monnet Compatibility Test’ (see Figure 1). It needs to be economically coherent, marshalling the policy tools and mechanisms that provide for an effective crisis response, addressing root causes,

1 European Commission and European University Institute, respectively. Marco Buti writes in his personal capacity. We

CEPR POLICY INSIGHT No. INSIGHT POLICY 109CEPR thank Moreno Bertoldi for useful comments and Oscar Polli for excellent research assistance. CEPR POLICY INSIGHT No. 109 April 2021 2 Figure 1 task. difficult avery be to proves three all combining Unfortunately, periods. divisive and traumatic be to tend what in support citizens’ maintaining coherent, politically be to it needs EU Finally, Treaties. the and subsidiarity both respecting while mechanisms governance common leveraging coherence, have institutional to needs it also framework, complex EU institutional the In damage. the minimising recover, while to economies European allowing and into 2021.into over carried effort the of (see Table part response euro 1), asignificant 2,5 trillion with in toa substantial 2020 added provisions, liquidity the as as well effort, fiscal overall thetogether, taken that so crisis, theeurozone in than prominent less significantly however, differences, were Such conditions. fiscal underlying diverse in part reflecting instruments, policy of mix their in and generosity in both differed EU member states to facilitate the recovery. policies followed by first, relief on disaster focus to was The logic young businesses. and amongsmall especially and to suppliers, pay workers flows cash have firms ensuring insolvencies, mass time preventing thesame off;at laid temporarily or if quarantine in even pay-checks workers receive and delay payments, households can ensuring guarantees, debt and cash, through liquidity maintaining at aimed It was decisive. and swift generally was of level EU the at Member States response policy economic the systems, economic in shock supply demand and simultaneous the and lockdowns of the because a‘sudden activity to of economic stop’ amounted what with Faced 2. The Covid Economic Policy Repsonse integration. for European pandemic of the legacy the shape will that factors the examine we section, 7, EU 6and (sections final Generation the In respectively). under Next- Plans Resilience and Recovery national of the for success conditions the and in governance EU thechanges 5). (section crisis thenreview We financial the from learning (section policy 4), the and crisis current of the (section 3), nature the macroeconomics of evolutionthe understanding of our crisis: financial the to response policy the than ambitiousand more different is response current why the reasons the out sketch sections of Covid-19. three fallout The economic following the tackle to level national EU at and taken decisions policy 2reviews Section pandemic. the to response Test paper, policy economic the (loosely) we this apply to In Monnet Compatibility the

The Monnet Compatibility Test CEPR POLICY INSIGHT No. 109 April 2021 3 response with that of the United States. 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The Different Features of theCovid Crisis the Keynesian spillovers dominate the spillovers via public debt sustainability via spillovers the dominate spillovers Keynesian the shortfall, demand large of avery presence the in that, awareness on the based is this adjustment: policy of the brunt bearing banks to avoidcentral as so policy up fiscal ECB) by the step (repeatedly to governments to call their -is related -and The second both the short run and in the medium to long to run. medium the in and run short the both in a coherent framework in post ex result to need will independent, institutionally whilst Commission, by the launched framework surveillance macroeconomic of the review the and ECB by the undertaken review strategy ongoing monetary The in Europe. authorities fiscal and monetary between relations evolution the in 2021) al. et an underpins (Bartsch mix policy a‘congruent’ ensure to The need sector. financial the from emanating disruption avoiding in valve asafety as acting role in important increasingly their is third the arithmetic’ (Sargentarithmetic’ andWallace Buti(2020a). 1981). See fiscalprudence,thereby via excessive achieved turningonitsheadSargent and Wallace ‘unpleasantmonetarist the ELB,fiscaldominanceisactually ispushedagainst policy spilloversprevail andmonetary When Keynesian 2 . And . And CEPR POLICY INSIGHT No. 109 April 2021 7 Table 2 RRPs below). (see the theroll out andof process ratification of the lap final of the phase present the in not incurred are delays that It important is years. three and two between wouldtake process that 2021; circumstances, under normal Spring in completed be to markets) planned is in borrow to Commission the allow fragile fiscal conditions frantically searched for a fiscal space they objectively did not have. did not have. they objectively space fiscal for a searched frantically conditions fiscal fragile with countries whilst use it, to andrefused situation domestic their on focused space fiscal with countries crisis, eurozone the During difficult. exceedingly is policies of national coordination via horizontal only stance fiscal area euro appropriate an achieving Third, retrenchment. fiscal sharp in embark and ‘declare victory’ to quick too were countries EU shock, the negative stem in helped 2009which expansion fiscal strong a after retrospect, in Again, bound. lower effective the approaches policy monetary if especially gaps, output negative under higherlarge are much multipliers fiscal that 2013, 2014) Leigh showed and (see Blanchard Blanchard pioneered by Olivier Analyses costly. is very stimulus of fiscal withdrawal early shock, severe avery after Second, supply. short in was this for atime –yet sheet balance ECB the via or indirectly budgets, national via Union openly either (EMU), Monetary and Economic the in needed is sharing of risk amount Acertain eurozone. of the integrity the behind fully standing as markets the by perceived be to came ECB the that Draghi, by Mario statement it takes’ ‘whatever of the 2015, summer aftermath in the only in It was purchases. on asset embarking and stance monetary the relaxing in banks central other to compared more hesitant was it dislocations, market of signs first the at provisions of 2007, liquidity with summer the in quickly very reacted ECB the Whilst equilibria. of negative realisation the or dynamics, self-fulfilling stop to forceful very be to has policy monetary First, 2020b): Buti (see following also the are crisis Covid the to response the for devising relevant are which crisis eurozone the from lessons main view, the our In sub-optimal. was crisis eurozone the to response the conclude to that fair it is exercise, atreacherous rationalisation ex-post make time the at conditions political and institutional the Whilst possible. as quickly as again rules implementing the start and support fiscal the withdraw normality, to return to urge an was there countries, creditor in plans rescue However, justify to earnest. in started governance EU of economic the overhaul an and created, were institutions new devised, were tools policy new reinterpreted, be to had old rules aresult, As question. into called was area currency common of the existence very the as test, stress in a institutions and rules put governance EU crisis financial The eurozone 5. Policy Learning from theFinancialCrisis Recovery Timing Impact Source Nature Comparing Crises Full economic shockfelt over Endogenous andasymmetric Fiscal shockand/or financial Severe; asymmetrical on sector imbalances Slow, butdurable Eurozone Crisis countries 1-2 years in origin Combined supplyanddemand Immediate economic shock Exogenous andcommon in Severe; asymmetrical on Fast(er), butfragmented countries (and sectors) over 1-2 quarters Covid Crisis shock origin CEPR POLICY INSIGHT No. 109 April 2021 8 eurozone crisis. eurozone the public opinion during marred which divisiveness political the to compared round, time this met be to more likely also is compatibility political the conclude that one can 2021), Parliament European and Commission 2021, Parliament European European (see countries’ ‘frugal so-called in also NG-EU to support large Judging by the criteria. institutional and economic the meet not fully did crisis eurozone the during response Test, policy the Monnet of Compatibility the prism the through sum, In expansions. fiscal national complemented and the coordination policy of vertical adegree ensured EU) initiative EU (NG- Generation Next the much. of Finally, doing too that outweighed largely little of doing too risk the that who stressed Atlantic, of sides the on both authorities policy and by monetary communicated clearly was This long it takes. for as as economy the to support 2021b),Commission of maintaining awareness showed the 2022 SGP to of the (European Clause Escape General the 2022, helped by extending in 2021 and stance fiscal asupportive keep to commitment the addition, massively. In and swiftly reacted policies fiscal national and ECB the both above, recalled As crisis. theeurozone of the lessons from learning benefitted pandemic the to The response of subsidiarity. afailure meant which at either level, EU eurozone or response, fiscal out of acentral ruling the to led time, forma mentis intergovernmental The to duelower multipliers. effectiveness lower meant also which distribution, country wrong the via usually was this attained, was level aggregate the at stance fiscal appropriate when the aconsequence, As success and large access by member states compared to the ESM pandemic facility. pandemic ESM the to compared by member states access large and success for market the one reasons is of the this indeed and instrument aCommunity public as the and markets the in However, identified budgets. clearly it is by national provided of guarantees onback the place takes Commission by the borrowing since component, intergovernmental an has SURE, work, time NG-EU. for short The support within Facility, Resilience and for Recovery the case the is this status: supranational clear a very had pandemic the to response the during innovations main the contrary, the On under discussion. or EDIS still –is system guarantee deposit single –the pillar third necessary the time, same the at (SRB) Board Resolution mixed; -was Single -the pillar but second the supranational, instead (SSM) –was Mechanism Supervisory theSingle Union – theBanking of former. ofpillar the adoption The first for the acondition was latter of but the adoption the nature, in intergovernmental were – not only Compact Fiscal the – rules of fiscal strengthening important most the and – ESM the – institution new main the complexion: both specific a very Table in took 3, this However, illustrated building. as institution and coordination rules-based of strengthening a was there crisis financial the To during sure, be 2019). (Draghi response and coordination policy fiscal to policy of monetary effectiveness the comparing in forcefully point this made has Draghi Mario system. rules-based apurely to relative building institution of importance the emphasised has debate agrowing years, several past the Over 6. Getting theEU Governance Right at the the at CEPR POLICY INSIGHT No. 109 April 2021 9 consistent with overall EU objectives (Table EU objectives 4). overall with consistent 2021a)narrative Commission a and offering (European guidelines on specific based agenda investment and reform out adetailed (RRPs), Plans setting Resilience and Recovery national their Commission the with finalising currently are Member States Key rules-based coordination Table 3 completing the payments by the end by the of 2026 ( payments the completing end by the of 2023 and resources the committing require funds EU’ Generation ‘Next as ahuge challenge, represents prescribed horizon time the in involved sums large the of use but effective out, the set now is fully process Plan for Recovery the The timeline well. as EU governance evolution of overall for the anarrative provide will they economies; on member state impact positive the beyond goes funding on EU based efforts of national of success degree the that implies doing so. This as seen widely are and better’, back ‘build economies European helping in successful indeed are pandemic Covid the from fallout economic the address to place put into currently tools and novel the mechanisms that precondition: one is essential there more conduciveEU integration, to be to For politics the at MemberStates 7. MakingSure theCovid Response Works -Looking policy framework. themacroeconomic EU of the the ongoing of review outcome in reflected be also should landscape institutional evolving This situation. current the in satisfied better be to appears coherence, Test, institutional notably most Monnet Compatibility the again, Once coordination. vertical more effective to lead to potential the has which features, institutional and of rules-based combination amore robust with landscape institutional amore balanced is emerging is What crisis. eurozone the during that prevailing to different very proving is 19 crisis Covid the to response the sum, In Rules-Based Building Insititution Coordination : Intergovernmental mode Coordination processes in the EU: institution-building vs. vs. EU: the institution-building in processes Coordination • • • • • • • Mixed / Supranational / Imbalances Procedure Imbalances Macroeconomic Strengthened SGP Compact Fiscal (NFCs)Councils Fiscal (EFB)/National Board Fiscal European (SRB) Board Resolution Single (SSM) Mechanism Supervisory Single (ESM) Mechanism European Stability Stability Facility (EFSFS)/ European Financial Financial Crisis European Council 2020 Council European • • • • • Two-Pack] Six-Pack and [Review the of Clause Escape General SGP (PCS) Support Crisis Pandemic ESM emergency (SURE) an in risks unemployment tomitigate Support Facility (RRF) Resilience and Recovery Covid-19 Crisis ). To end, this CEPR POLICY INSIGHT No. 109 April 2021 10 Table 4 number of issues will be critical for success: critical be will number of issues a implementation the move phase, to and RRPs their complete member states As Source: General objectives Narration • • • • transition green/digital the to Contributing cohesion social and economic to Contributing creation job and resilience growth, Stengthening Semester European the of priorities and challenges the Addressing • • • • implementation should prove useful. prove should implementation in practices best from learning and of peer-exchange aprocess countries, across similar be will projects digital and anumber of green as addition, In projects. investment private not simply and displacing leveraging areas, these in of EU funding additionality the ensuring be will as respect, this in important be will principle ‘do-no-significant-harm’ the guaranteeing and targets climate and digital the (andplans methodology/metrics) their attain national the Ensuring of RRPs. put heart the at have been transitions green and digital twin the transform’, and ‘recover order In to climate. and Digital governance. of EU future the more broadly as well as cases, individual in of funds use the of efficiency the both to way, it rigorous relates and as asubstantive in conditionality this reflect to need will process review the setup, new this respecting While resilience. and for recovery relevant are that Semester the European of context the in made recommendations country-specific of subset or a significant all addressing adequately to linked and lighter is conditionality where Plan, Recovery found under the be to needs balance new A effort. reform the undermined countries individual of in ‘ownership’ lack cases many in that meant countries on programme imposed conditionality ownership. and Conditionality transitions. on green/digital based country each in strategy growth overarching on an these ground to and rules, to adherence aformal and implementation, going simple beyond ‘box-ticking’ their in as well as of RRPs design the both in substance in present be to investments elements and of reform complementarity for this important be It will interventions. national in reforms with of investments ‘twinning’ the reforms. plus Investments crisis. eurozone the during programmes support from experience with for countries easier proving be to seems transition this Interestingly, structures. administrative different of flexibility required the with direction, central under astrong approach a‘whole of government’ embody to need will they vary, will arrangements and all not fit does onesize While effort. national adefining cases many in be implementation will of and what for design the arrangements governance new place in putting have been EU Member States aresponse, As disbursement. for funds targets and milestones as well as rules, conditionality new embody tools funding new The structures. Governance Adapted from Buti and Messori (2020) Messori and Buti from Adapted Recovery and Resilience Plans: content and processes content and Plans: Resilience and Recovery • • • From objectives to indicators acheivement and Implementation timeframes investment and projects Individual objectives intermediate & Final projects A crucial element of the new Recovery Plan is is Plan element Recovery new of the A crucial Internal Consistency of NRRPs During the eurozone crisis, the heavy heavy the crisis, eurozone the During • • • funding funding EU other Possible economy the and employment on impacts and costs between Correspondence Total costs Cost estimation • • procedures Monitoring investments) (reforms, measures Accompanying Monitoring CEPR POLICY INSIGHT No. 109 April 2021 11 and policy-making to deal with longer-term structural shifts taking place. taking shifts structural longer-term with deal to policy-making and for EU need economies the and EU/domestic agenda; the international/global the with reconnecting environment; new the in notion the of subsidiarity revisiting market; and state between boundaries emerging new the headings: distinct under four grouped be out could stand that issues Some of the response. policy economic of the factors success critical the beyond go that a number of areas across policies and attitudes rethink to Covid-19 us forcing toll, is social and economic human, its to addition In 8. Conclusions –Post-Covid ShapingFactors 1. • • • •

a medium-term perspective, it will be crucial that the renewed emphasis emphasis renewed the that crucial be it will perspective, a medium-term In States. United the and Kingdom United the in as well as EU nations, most across evident is shift policy This forces. by market mainly determined is what and by states provided is what between balance of the arethink is underlying is what areas, these all In case’). in ‘just to time’ in ‘just from shifts the EU in (encapsulated level and national at resilience would increase that sectors/products autonomy key in on strategic debate the orsystems) to tax more progressive income, basic auniversal wages, minimum higher compact (with social to a new mix, policy and balances for fiscal paradigm emerging an from ground: new break may which ongoing discussions, or shifts, anumber of policy in translated concretely is simple realisation This Europeans. protect to EU collective the and governments of national ability the as well as systems, health of well-functioning importance the of it realisation a new it brought with societies, European through ripped pandemic the As market. and state between boundaries the new Defining Fiscal sustainability. Fiscal aspects. public goods European and value-added European forward push to opportunity important of an loss the in result will level national at projects of appraisal the in these Neglecting spillovers. network and externalities however (and those), beyond even strong areas are there climate and digital the In not EU-wide. national, be will ‘ownership’ their and investments, Transnational spillovers. (from central to local), of national administrations and government. and administrations of national local), to (from central levels different at operating and process, the accompanying in important be therefore will stakeholders involvement of the of national quality and The timing acceptance. societal in embedded on being hinge will success their transformation, towards investments and combine reforms will RRPs Stakeholders. phase. implementation a successful to of RRPs design the links that of granularity type It this is EU other funds. with complementarity and estimates, cost and assessment impact economic arobust controls, and proper audits adopting targets, well-defined setting milestones, clear having ofon factors: ahost rests efforts investment implementing large such that shows Experience economies. national their reset to opportunity aone-off represent will Granularity. expenditures. recurrent from one-off distinguishing clearly and medium-term, over the sustainability fiscal support thereby and of public and expenditure taxes of quality improve the that include measures to for RRPs important it is whyis This positions. fiscal current reverse have to will debt and national of levels higher with left be will states members withdrawn, carefully and For many EU countries, the funding linked to their RRPs RRPs their to linked funding the For EU countries, many Despite their technical elements, and especially since the the since especially and elements, technical their Despite Once the pandemic is over and support is gradually gradually is support over and is pandemic the Once By design, the Recovery Plan prioritises national national prioritises Plan Recovery the design, By CEPR POLICY INSIGHT No. 109 April 2021 12 4 3 common euro-denominated bonds. hugeThe successofEUdebt issuanceundertheprogramme SUREshowsthe large for infinancial markets appetite andthestate aremarket explored byCollier(2018) andRajan (2019). the balancebetween infindinganew pillar’ roleofcommunitiesin breakingThe therural-urban divideandthe‘third 4. 3. 2. regulation and competition in digital platforms, as well as issues around around issues as well as platforms, digital in competition and regulation regarding issues policy new raises of digital dominance the time, same the At transitions. green and digital twin the with transform’ and EU ‘recover help to the supposed is Plan EU Recovery the indeed -and digital to push a European requires clearly this level, afirst At thrived. digital everything pandemic, the In shifts. structural longer to term respond to need the concerns take-away policy Covid The final shifts. longer to term Responding the euro the of attractiveness the help increase to also EU will Generation under Next Union EU of economy. debt common global on the European The issuance weight of the the increasing thereby and role euro of the international the for bolstering essential also it is shocks, to resilience its increasing EU and the of functioning of better terms in important is crisis eurozone the with started that aconclusion reforms the to bringing EMU; the complete while to need the on one should reflect that context this in It also is of vulnerability. source a are surpluses account current persistent that acknowledging demand, external from dependency the reduce have to will policies macroeconomic of Europe’s chains; value robustness the enhance and of growth source amore ‘indigenous’ provide to need will Market Single the substantial: rolethe global of are Union assertive of a more ramifications The domestic or finance. trade as such areas in policies avoid as beggar-thy-neighbour well governance), as digital and climate but also pandemics, and (not health just publicglobal andgoods on European discussion the influence able be to to in order essential be will rolethe EU global of the upgrading flux, in blocs and relations trade difficult with re-ordering, of geopolitical a situation In relations. geo-economic new with but instead supply global chains not with autonomy one belongs -the dealing of strategic dimension other the where is This agenda. global the with domestic the reconnect EU to the pushing Covid-19 also is agenda. global the with EU domestic the Reconnecting 1949, Gigliobianco 2010) Gigliobianco 1949, (Einaudi enhanced be will bodies intermediate and rolethe of communities world, post-Covid the in cohesion, social and freedom economic of marrying Einaudi’s In tradition citizens. to closer level, local the to direction, opposite the in delivery policy moving wouldsuggest This state. welfare national the by delivered services the from not just and of belonging, asense through solidarity amore achieving ‘dense of rebuilding society’, importance the highlighted has pandemic the time, same the EU At level. to the to pandemics of future management prevention and the surrounding a number of issues ‘elevate’ to aneed be will there public good, aglobal is health As needed. be will supply atlevel EU direct others, on suffice; will policies of national coordination issues, not: on certain has what worked and has of what review a be will there Post-crisis, procurement. vaccine to rules travel from areas, a number of in cooperation forced EUat and level for coordination need the revealed The pandemic union. health on aEuropean proposals or the Plan EU Recovery the around decisions by the seen be already can as subsidiarity, on discussion the to twist anew gives This for EU collective. the matter a is what and member states in policy of national domain the belongs to of what balance the concerns issue Arelated subsidiarity. Revisiting challenge. akey be will protection in-the-market to on-the-job protection from Shifting of production. of factors reallocation – the enhances – but actually not hamper does protection social on strong 4 . 3 . 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Penguin London: , . . , 5(3): 1-19. . . , Serie , Serie . . , CEPR POLICY INSIGHT No. 109 April 2021 15 support programme and its associated economic, financial and structural W and structural and financial first Crisis economic, Greek the of Story Over -The Inside Game of author the is Greece’s He policies. associated of its implementation and and programme negotiation support the in role key a played he crisis, eurozone the of outset the at Minister Finance Greece’s OECD. As the at economist asenior as the served has and from Economics of School London economics in PhD a holds He Institute. University European the of Governance Transnational of School the at Education Executive of Director George Papaconstantinouand Economy Political of is Professor International October 2021. in published be will decade, past over the Europe in elaborations policy the to contributions his revisiting book, new His governance. global and reforms economy of European integration, macroeconomic policies, welfare state political the Union, Monetary and Economic on extensively published has He Europe. in universities various at professor visiting been has he Oxford, and Florence of universities the of G20. Agraduate and G7 at Deputy Finance Commission the been has 2019. 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