26 September 2024

Towards Shared European Finances

The Next Generation EU Template and Its Afterlives

The EU is once again eyeing a workaround to address an emerging challenge. A few days ago, former ECB President Mario Draghi issued a landmark report to stem the EU’s decline, calling for a massive investment of 800 billion euro annually. While political agreement may prove elusive, Draghi’s proposal is in line with an emerging post-pandemic pattern in EU policymaking. This pattern is characterized by flexible, ad-hoc measures that are implemented outside of the bloc’s treaty framework. The pandemic recovery package Next Generation EU (NGEU) initiated this pattern even though it was billed as a one-off measure. The EU has subsequently applied the NGEU approach to supporting Ukraine. NGEU has already effectively doubled the EU’s budget. If the Draghi plan is implemented, the EU budget will be at least four times as large as it was before the pandemic without a change to the treaties. We celebrate the boldness and effective design of this important template, even as we recognize some legal creativity necessary to carry out bold moves.

The European Union’s crisis strategy

The European Union has not always mastered effective crisis governance. The 2009 sovereign debt crisis, the border closures of the 2015–16 refugee crisis, the 2016 Brexit referendum, and the rule-of-law crisis in Poland and Hungary all highlighted the limits of Europe’s postwar experiment in supranational governance. And during the early weeks of the pandemic, too, a common European response seemed unlikely. But a few months later, the European Union issued over EUR 750 billion in debt to address the effects of the pandemic and rebuild a more resilient bloc.

This Next Generation EU recovery package was billed as a one-off, but it has since become a blueprint for EU crisis governance and global competitiveness policy. While Draghi’s proposal is in its early stages, the EU has already issued major common EU debt financing for a non-EU member state – Ukraine. Like the EU recovery program, programs in support of Ukraine were funded by issuing common EU debt, were distributed as a mix of grants and loans, and bound to specific reform goals. Like NGEU, too, support of Ukraine has often taken the form of instruments outside of the regular EU budget. Together, NGEU and the Ukraine Facility are part of a new form of EU governance by workaround in the face of crisis, likely to be further imitated in the near future (see a symposium on NGEU, An Ever-Stronger Union).

What exactly is the Next Generation EU template?

Next Generation EU is impressive in size, but that is not all. The money is allocated through a simple formula that benefits South European states, avoiding the byzantine process of the multi-annual financial framework. Two priorities, climate change and digital transformation, occupy over 50% of the funding for a project that arose in response to the Covid pandemic. And money has been and continues to be withheld from countries that violate the rule of law. Victor Orbán is clearly paying attention now that billions, rather than millions, are being held up.

We consider that three elements are central to the NGEU template and can be replicated in other issue areas and by other organizations. These are (1) extensive, debt-financed spending; (2) grants in addition to loans and (3) sensible conditions. The first element, debt-financed spending, is important because while agreement on issuing common debt is hard politically, the alternative of raising taxes would be impossible. The second element, the distribution of grants, makes it easy for governments to accept financial assistance; by contrast, IMF financing, which almost entirely takes the form of loans, is sometimes turned down and often very unpopular when accepted. Finally, the funding is conditional. NGEU disbursements required important institutional reforms in each Member State; Hungary’s delay in implementing reforms to the judiciary held up EU funds. But of course conditions differ by country and situation. Notably, sensible spending for a country at war, like Ukraine, is very different from sensible spending in peacetime Europe.

Is any of this legal? Treaty reform explicitly authorizing joint borrowing would probably be the best path forward. Arguably, massive spending programs violate key provisions of the EU treaties, notably the enumerated competences of the EU, the no bailout provisions, and, when used for arms purchases, the common defense policy provisions. That said, the strongest check on extraordinary European initiatives, the German Constitutional Court, reluctantly found NGEU to pass muster, while at the same time declining to send the question to the Court of Justice of the European Union. The CJEU, after all, tends to interpret EU powers broadly on diverse issues. We have written extensively elsewhere on the tension between the Karlsruhe and Luxembourg courts on this question. One of us, Katerina Linos, along with Elena Chachko, has also developed a novel legal theory, “emergency powers for good”, to justify NGEU and other transformational emergency measures. Practically speaking, while NGEU itself seems legally safe, the Karlsruhe court reasoned that NGEU was a one-off, and thus invited challenges to similar future projects.

EU common debt to support Ukraine, a non-member state.

The EU’s steadfast support of Ukraine and repeated resort to joint borrowing are a new chapter in European integration not only financially but also in terms of EU defense policy. Conceived of as a project to maintain peace in Europe, European integration has had a halting relationship with providing military assistance. In this light, the bloc’s support of Ukraine with financial and military resources appears to be strikingly new. But while the kind and extent of the EU’s support of Ukraine is in fact new, supranational European institutions have played a role in military conflicts beyond its borders before. In the 1970s, the European Community created the first venue for the articulation of joint positions on security questions – the European Political Cooperation. Subsequently, the EC issued its first joint sanction on the basis of a UN resolution in the 1982 Falklands war. More recently, since the end of the Cold War, the EU has provided financial support to the African Union’s security efforts through the African Peace Facility (EUR 2.7 billion between 2004 and 2019) and has sent training missions to Mali, Somalia, and the Central African Republic. Currently, under the EU’s Common Security and Defense Policy (CSDP), there are 24 missions globally, both civilian and military.

What, then, is new about the Ukraine Facility? Here, both the scale of financial commitment, and the fact that money is given to a country at war to provide lethal equipment is worth nothing. Let us now turn to how the Ukraine facility borrows from NGEU. It has done so, first, by using funds outside of the regular EU budget to support Ukraine. Four days after the invasion, the EU approved EUR 500 billion to support Ukrainian armed forces under the European Peace Facility. This was the first time that EU support for a third country included the provision of lethal weapons. March and December 2022 saw increases of EPF funds by EUR 6 billion until 2027, and in May 2023 the European Council agreed on another EUR 1 billion under the EPF to support Ukraine. This is all noteworthy legally given key treaty provisions, such as Article 4(2) TEU, which reserve matters not delegated to the Union, including not most defense policy matters, to the Member States. Nevertheless, innovative ideas to combat the Russian threat, including financing weapons and using profits frozen Russian assets are developing, even as a Hungarian veto is feared. In March 2024 these were attributed to anonymous sources within the Commission, while in August some were publicized by the EU’s top diplomat. One legal question is how to interpret treaty provisions such as article 41(2) TEU, which seems to prohibit the use of the regular EU budget for “operations having military or defence implications.”

In March 2024, the Ukraine Facility entered into force and marked the further adoption of the pandemic playbook for the support of Ukraine. The Ukraine Facility’s goals include Ukraine’s reconstruction and recovery, mobilization of private investment, and facilitating Ukraine’s accession to the EU. Indeed, EU accession has been used in the past to try to resolve major geopolitical conflicts, some times successfully (e.g., former Yugoslavia) and other times unsuccessfully (e.g., Cyprus). Like NGEU, the Ukraine Facility disburses funds as a mix of grants and loans. The Ukraine Facility promises EUR 17 billion in grants and EUR 33 billion in loans to Ukraine between 2024 and 2027. Like in the case of NGEU, too, most of the funds are disbursed after Ukraine meets recovery and reform targets, but limited financial support (EUR 1.5 billion per month) can be made available immediately. These targets have broad overlap. Both programs incentivize the green transition, aim for social and territorial cohesion, and seek to address the social and economic consequences of the crisis. A key difference, meanwhile, is the preparation for Ukraine’s accession to the EU.

Joint borrowing for competitive industrial policy

The Draghi report arrived at a moment when European leaders broadly agree that they need to spend more on defense and more on industrial policy given geopolitical threats. However, there may, at present, be little consensus on whether common or national financing is the more appropriate route. It is here that NGEU provides a template.

Draghi argues that “the EU should continue – building on the model of NGEU – to issue common debt instruments, which would be used to finance joint investment projects that will increase the EU’s competitiveness and security” (p. 62). His report mentions NGEU five times, using language referencing “well-established precedent in the funding of the NGEU” (p. 61). Echoing the core themes of NGEU, clean energy and digital transformation, the report emphasizes the extraordinary hikes in energy prices across Europe, and the scarcity of European technology giants, among many other themes and detailed proposals.

Of course, this report is just a starting point for negotiations – whether any of its recommendations will be implemented is yet to be decided. But Draghi’s report can function as an anchoring mechanism to highlight both the size of the budgetary increase needed, and also the legal precedent the Commission believes it is building on. Here, we note a sharp contrast with the begrudging logic of the Karlsurhe Court, which greenlighted NGEU only as an extraordinary one-off-measure, not to be repeated.

Conclusion: crisis governance by workaround

In response to the sovereign debt crisis, the EU insisted on national fiscal liability; Member States remained responsible for their own debt. In response to the Covid-19 pandemic, the EU implemented a massive spending program. There was no European financial crisis following the pandemic, even as governments shut down business, closed borders, and paid out huge sums to unemployed workers. Spreads between German and South European debt, which grew after Covid hit, sharply declined once NGEU was announced. Neat legal solutions to deal with emergencies can be beautiful. Effectively dealing with the emergencies, be these related to pandemics, climate change, or military threats, is even more important. The significant success of NGEU is certainly worth replicating.