Impact of the European Economic Recovery Plan

The objective of the EU’s economic recovery plan is to drive a co-ordinated EU response to the economic crisis, which builds on the unprecedented level of co-ordination shown in response to the financial market crisis. The priority is to treat the symptoms of the economic crisis and protect jobs and purchasing power in the short-term while also investing in Europe’s long-term economic health and in boosting the fight against climate change.

The package is not a ‘one-size fits all’ proposal. It takes account of the differences between member states in terms of their budgetary situations and outlook, their exposure to the financial and economic crisis, and whether or not they have to correct macro-economic imbalances, etc.

Main elements of the plan

The Commission’s Recovery Plan combines co-ordinated national action with EU policy measures in a mutually reinforcing way. It includes a timely, targeted and temporary fiscal stimulus of around 1.5% of EU GDP or €200bn, within both national budgets (around €170bn, 1.2% of GDP) and EU and European Investment Bank (EIB) budgets (around €30b, 0.3% of GDP). The Plan falls inside the Stability and Growth Pact (SGP) but uses all of its flexibility.

The fiscal stimulus is complemented by proposals to speed up structural reforms under the Lisbon Growth and Jobs Strategy in all member states and, in particular, those who most need to act in order to make their economies more competitive and ensure medium-term budgetary sustainability. This fiscal stimulus and accompanying structural reforms are complemented by ‘smart investment’ measures at both European and national level, with the priority being to preserve and create jobs now and in the future while accelerating the transition towards a knowledge-based and low carbon economy.

The Recovery Plan sets out a framework for how funds should be used to stimulate investment, ‘green’ Europe’s economies and boost energy efficiency. It proposes mobilising existing funds – including social and cohesion funds, where up to €6.3bn of payments will be brought forward – to help unemployed people, as well as help with training and retraining. A key part of the Commission’s Plan is a ‘smart mix’ of regulation, research and development (R&D), national investment, Commission funding, EIB support and public private partnerships for forward-looking investments in key sectors, such as cars and construction.

The Recovery Plan also includes proposals to stimulate labour markets and increase demand for energy efficient goods and services through innovative use of taxation. It includes further concrete measures to help small- and medium-sized enterprises (SMEs), as well as calling for rapid progress on the Small Business Act initiative already presented by the Commission.

The Commission will be asking EU leaders to endorse the Plan at the European Council on 11-12 December and to implement it immediately. The earlier this is done, the better the Plan will work. There will need to be close co-ordination at both political level, notably through finance ministers, and at a technical level throughout the implementation of the Plan.

Why is co-ordination of fiscal measures important?

The benefits of individual member states’ fiscal measures will be much greater if they are part of a co-ordinated European response that will create multiplier effects. Equally, countries who try to ‘go it alone’ tend to run into problems; they get punished by capital outflows; some of their stimulus leaks into imports from other countries and they get nothing in return. A co-ordinated approach will avoid these difficulties.

Why do we need a fiscal stimulus and why not a bigger one?

The fiscal stimulus is timely, targeted, temporary and co-ordinated. It is large enough to have a major impact in boosting demand and purchasing power and thus in protecting jobs. Without such a stimulus, there is a risk that demand, investment and employment could spiral downwards in a lasting and deep recession, leading to a major fall in tax revenue and increase in spending on social benefits, with a resulting threat to public finances in the medium-term.

The fiscal stimulus will help avoid such a downward spiral but limits borrowing to a level that member states will be able to pay back without compromising medium-term budgetary sustainability – provided the right accompanying policies are implemented in line with the Recovery Plan. Taking on excessive levels of debt would result in further – and possibly worse – economic crises and unemployment in the future.

How does the proposed fiscal stimulus take account of the fact that member states have different starting positions?

Co-ordination does not mean that all member states should adopt the same approach. This would make no sense. Those who took advantage of the good times to achieve more sustainable public finance positions have more room for manoeuvre now. For member states, particularly those outside the euro area, facing significant external imbalances, the aim of budgetary policy should be to correct those imbalances. This is not a one-size fit all Plan.

Neither is the fiscal stimulus a zero sum game where member states make payments into a central ‘pot’ and one euro less paid in by one country means another has to pay one euro more. Instead, this is about a co-ordinated fiscal response where each member state, within an overall European framework, takes the taxation and investment measures, which suit its economic situation and strategy, thus supporting its own economy to the maximum and also helping others.
The fiscal stimulus is not a measure in isolation. It is intrinsically linked with the rest of the Plan. The Commission is proposing using the funds to finance investment in key strategic areas, to create jobs now and build the basis for a dynamic and sustainable 21st century economy. And under the Plan, the fiscal stimulus is accompanied by strong provisions to make sure it does not jeopardise medium-term budgetary sustainability – including stepping up structural reforms especially in those member states whose budgetary position most demands it.

Why does a fiscal stimulus in one member state also help others? Why should member states with strong budgetary positions do more than those who have not?

In a single market, boosting domestic demand in member state X also boosts demand for imports in member state X, which in turn boosts demand in member state Y (and all the others). If that stimulus can help return member state Y to the growth path, there is a secondary effect whereby demand in member state Y for exports from member state X is also boosted. In time, and once multiplied across all 27 member states, this can create a powerful virtuous circle, boosting overall growth and helping pay back the borrowing, which has financed the fiscal stimulus in the first place.

Conversely, no member state has an interest in others funding a fiscal stimulus by taking on unsustainable levels of debt: they would risk jeopardising their public finances and triggering a spiral of debt, recession and unemployment, which would drag other member states down while undermining confidence in governments. In the euro area, this would be particularly damaging for other member states. Outside the euro area, it could lead to pressure on the national currency and to large rises in inflation.

What are the main differences in member states’ starting positions?

Growth for 2009 is forecast to vary from around or over 4% in Slovakia, Bulgaria, Romania and Poland, to a contraction of 2.7% in Latvia. Negative growth is forecast also in UK, Ireland, Spain and Estonia, with France, Italy and Germany at standstill.

Commission forecasts for government deficits for 2009 vary from nearly 7% in Ireland to a surplus of 3.6% in Finland with among the biggest member states, the UK deficit predicted at 5.6%, France at 3.5%, Italy and Spain at just under 3% and Germany at 0.2%. Some economists in some member states have expressed concern about deflation unless a fiscal stimulus is quickly injected, while there is double-digit inflation in others (Bulgaria, Estonia, Latvia, Lithuania).

What tax cuts does the Plan propose?

The Commission will propose reduced VAT rates for green products and services, related to the building sector. It has already proposed a Directive to make permanent reduced VAT rates for labour intensive services; the Council should now adopt this proposal as soon as possible (before the 2009 Spring European Council). However, taxation is largely a national, not a Community, matter. The plan makes a number of suggestions for tax cuts, for example, reduced social charges on lower incomes to promote the employability of lower skilled workers. It is up to member states to decide whether or not they wish to take up these suggestions though.

How does the Commission propose to ensure that banks re-open credit lines for businesses?

It is very important that banks resume their normal role of providing liquidity and supporting investment in the real economy. Member states should use the major financial support provided to the banking sector to encourage a return to normal lending activities and to ensure that central interest rate cuts are passed on to borrowers. This is primarily a matter for member states, however, the Commission will take it into account when reviewing state aids to banks. More generally, the Plan will help to create a climate of confidence, which will encourage banks to return to normal lending activities.

Why does the Plan place so much responsibility on Member States? What is the Commission’s role? Why does the Commission itself not do more?

Responsibility under the Recovery Plan is shared so that the Commission and all member states play mutually reinforcing roles. No one can tackle this crisis unilaterally; co-ordination is the key.

Without the Commission’s key contribution, there would have been no possibility of agreeing and implementing the measures taken to support banks. There would be no chance of coherently reforming Europe’s financial markets. And there would be no way to implement a co-ordinated European Recovery Plan for the real economy. The Commission must always be both a driving force and a ‘honest broker’ acting in the common interest of all 27-member states, large and small. In tackling the financial crisis, and now in implementing the Recovery Plan, the Commission’s role is central and it is essentially fourfold.

1. The Commission drives agreement on measures to be taken at national level within a co-ordinated EU framework, to avoid one member state’s actions damaging others.
2. The Commission proposes modifications to EU law and budgets, and works with the European Parliament and member states to adopt and implement those changes. It has recently made proposals on, for example, deposit guarantees, capital requirements, credit ratings agencies and in the context of the Strategic Energy Review. Under the Recovery Plan it will propose further measures on among other things structural funding, greener taxation and energy efficiency.
3. The Commission monitors the implementation of both new measures and existing EU law to ensure that member states meet their commitments and that a level playing field is maintained. In recent weeks, it has approved key state aids in record time, sometimes within 24 hours.
4. The Commission represents the EU as a whole in international negotiations, both in established fora, such as the WTO and the G8, and in specific crisis meetings, such as the Washington summit and those that will follow it. But the Commission only has the powers attributed to it by member states under the Treaties. The main legal and budgetary instruments for stimulating demand and employment are in the hands of the member states. The Commission cannot replace their actions or attribute further funds to itself. Its own budget is of great strategic importance but, at around 1% of EU GDP, it is a tiny fraction of the EU public spending as a whole and around half the government budget of the Netherlands or one-eighth that of France.

What is new in the plan for SMEs?

The Plan aims to enhance access to financing for SMEs. The EIB has already put together an overall package of €30bn for loans to SMEs. In addition, an additional €1bn will be conferred by the EIB to the EIF for a mezzanine finance facility. The EIF will also accelerate the implementation of the financial instruments under the EU’s Competitiveness and Innovation Programme. Meanwhile, member states should make full use of the recently reformed rules for granting state aid, particularly for SMEs. To assist them, the Commission will put in place a simplification package, notably to speed up its state aid decision making.

In addition to this, the Commission will make it temporarily easier for member states to grant certain kinds of aid to SMEs (e.g. loans for investments in the manufacture of products complying early with, or going beyond, new Community standards which increase the level of environmental protection). The Plan also contains very concrete, specific measures to reduce administrative burdens on business, promote their cash flow and help more people to become entrepreneurs.

How much will the EU budget contribute to the Plan and how much will the EIB contribute?

In 2009, there will be up to €14.4bn from the EU budget in the form of €5bn of additional funding for Energy Inter Connections and Broadband, €6.3bn for advanced social and cohesion fund payments, €2.1bn in total redeployed from existing budgets for green cars, energy efficient buildings and factories of the future and high-speed internet, and €0.5bn of advanced funds for trans-European transport networks, as well as €0.5bn for various other projects.

Total intervention from the EIB will be €15.6bn in 2009 with a similar figure in 2010. This is in addition to the €30bn in EIB support for SMEs to 2011, already announced. EIB funding will also generate a positive leveraging of additional private investment. The European Bank of Reconstruction and Development will also add €500m a year to its current level of financing in new member states.

What is the role of trade and development?

Keeping trade links and investment opportunities open is vital – because Europe’s return to solid growth will depend on its capacity to export and because global recovery depends to a large extent on the performance of emerging and developing economies. The EU will therefore maintain its commitment to open markets across the globe, keeping its own market as open as possible and insisting that third countries do the same.

It will seek early agreement on a global trade deal in the Doha Round. A successful conclusion to the Doha Round would boost recovery worldwide and the G20 Summit in Washington agreed to strive to reach a framework agreement paving the way for that by the end of this year. It will also create a network of ambitious free trade agreements with a range of partners.

It will seek more effective regulatory co-operation, including through the Transatlantic Economic Council. The crisis will add to existing pressures on developing countries. It is, therefore, all the more important that the EU, and others, maintain their commitments to achieving the Millennium Development Goals.

Is the financial market crisis over – is it only the real economy that matters now?

No. The extensive and ongoing action on financial markets at EU and global level is closely integrated in the Recovery Plan. If it is implemented fully across Europe, the Recovery Plan, by bolstering the real economy, will make a major contribution to restoring confidence and to putting the financial markets back on an even keel, thus boosting lending to businesses and individuals and turning a vicious cycle into a virtuous one. Equally, if the Recovery Plan is to maximise effectiveness, member states will need to ensure that banks, especially those receiving support under the European programme for supporting the banking sector, free up lending and ensure that interest rate cuts are passed onto borrowers.

The EU programme for recapitalising banks, guaranteeing customer deposits and inter-bank lending has stabilised the situation. The steps already taken and in the pipeline, for example on credit ratings agencies, capital requirements, derivatives and hedge funds, will provide further reassurance and help get financial markets back on their feet and at the service of depositors, policy holders and investors. The global agreement and international work effort agreed in Washington on 15 November is of key significance.

But the financial market situation remains precarious. The current threat to the real economy represents a ‘second round’ threat to the financial markets, notably because if there were to be spiral of company failures and unemployment, that would lead to defaults on loans by both businesses and individuals. Such defaults would reduce banks’ capacity to lend, exacerbate the credit crunch and in turn further damage the real economy.

You can read the full report about the Europe’s Recovery Plan here:https://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/735&format=HTML&aged=0&language=EN