Amid all the other stories of the west’s annus horribilis, it’s easy to miss the fact that the eurozone is likely headed, once again, for a crisis.
The coronavirus pandemic has exposed problems that have, for years, been swept under the rug. For the euro, that issue is basic economics. From the beginning, economists have warned that a shared currency without a common fiscal policy is prone to collapse when faced with a crisis, as it leaves individual governments unable to respond to economic downturns. Efforts to create such a fiscal union, however, have been met with stiff pushback from member states wary of subsidising their poorer neighbours.
The euro survived the financial crisis – just about – after officials found creative loopholes in EU rules. But the economic challenge posed by the pandemic is likely to be much more serious than in the past, requiring stimulus far beyond what current rules allow. Covid-19 will either prove to be a catalyst for greater integration or accelerate the currency union’s slow, fraught decline. What is certain is that the eurozone will not emerge from the pandemic in its present form.
The latest blow to the single currency came from Germany’s federal constitutional court (BVG), which ruled on 5 May that the European Central Bank’s €2 trillion quantitative easing program violates Germany’s basic law. Although the ruling specifically excludes the ECB’s much smaller bond-buying program for Covid-19 relief, it is likely to hamstring the EU’s ability to respond to the coming economic fallout from the pandemic, as governments take on unprecedented peacetime debts and struggling enterprises depend on cheap credit to stay afloat.
The compatibility of the single currency and German law has always been tenuous, and the legal ping pong between Brussels and Karlsruhe is nothing new. Although Germany is one of the most enthusiastic supporters of European integration, the constitutional court has maintained its right to review steps toward integration and determine their compatibility with German law. Where it has been most defensive has been on issues around the single currency, particularly regarding direct monetary stimulus.
In its ruling, the BVG found that the ECB’s bond-buying program is unconstitutional because there is insufficient German oversight in the purchases to ensure compliance with the “no bailouts” clause of the Maastricht treaty. To get around this issue while still providing the stimulus needed to keep the euro afloat in the financial crisis, the ECB began indirect bond purchases and pledged to maintain “proportionality” in economic impact.
As a result, the issues behind the eurozone crisis are poised to bubble up once again as hopes for a “V-shaped recovery” increasingly sound like “home by Christmas.” European governments are currently subsidising businesses on an unprecedented scale to make up for disruptions due to the ongoing lockdown measures.
Many of them already have tenuous public finances. But the efforts to prop up businesses during the pandemic are more likely to postpone, rather than prevent, a wave of Covid-induced bankruptcies across Europe, according to forecasts by the Institute for Economic Research in Halle, published in the Economist.
Furthermore, the economic shocks from Covid are likely to hit some countries harder than others. Southern Europe’s economy depends heavily on tourism, hospitality, and culture. Travel restrictions and social distancing requirements mean these industries are likely to lose much of their business in the coming year.
These countries also struggle with much weaker public finances than their northern counterparts, running deficits far above the EU average. The Covid recession has seen calls from the south for the EU to step up and provide relief, and the Brussels mandarins believe their moment has come.
In May, Ursula von der Leyen, the commission’s president, unveiled a €1.9tnn spending plan, €750 billion of which is dedicated to Covid-19 relief. Part of the funding will be drawn from the EU’s normal seven-year budget, but the proposal leaves a large portion to be funded through borrowing and new EU-wide taxes.
President von der Leyen’s proposal is not just an emergency stopgap. It is the biggest push towards a United States of Europe in a generation. Under its current laws, the EU’s budget is funded through contributions from member states, import duties, and a harmonized VAT. The EU cannot borrow to finance its own budget, nor does it levy its own taxes.
However, the road to a fiscal union remains rocky and uncertain. For one, Germany and France have yet to convince other sceptics of a fiscal union like the Netherlands, Austria, Denmark and Sweden to accept it. Like Germany, these countries have strong economies and tame public finances, and would likely end up as net payers into a common European tax system.
Meanwhile, the pandemic is causing many countries to turn inward, nationalising politics and economic policy. Convincing Denmark to fund relief to Italy, to prop up a currency it does not even use, while nearly 200,000 Danes are out of work will not prove easy.
Covid-19 has struck at a time when European faith in the single currency and even the idea of further integration itself remains shaken from the financial crisis. Last time, the EU turned out to be better suited for spreading problems than resolving them. For its part, the eurozone is finally facing its demons and confronting what economists have warned for years – that a monetary union without a fiscal union is a house of cards waiting to collapse.
The current pandemic will either be a catalyst for greater federalisation or an accelerator of the monetary union’s long and anguished demise. The outcome will depend on Brussels’ ability to get the troops in line and convince its members that the plight of French and Germans, Italians and Swedes, Danes and Dutch are, in fact, a single European challenge that only the EU’s manifest destiny of “ever closer union” can take on.