The pandemic has caused a very large increase in public and private debt all over the world. The G20 is deeply involved, in particular, in dealing with sustainability issues of poorest countries’ debt. In order to advance on this front, several measures are under discussion, including debt cancellation, various forms of restructuring, international risk sharing, and an increase in common debt issued via multilateral financial institutions. The European Union is dealing with the worryingly high debts of its member states by introducing a deeply innovative instrument, appropriately labelled “New Generation EU” (NGEU). NGEU implies the issuance of a substantial amount of common EU debt instruments across global markets. It is a temporary measure to cope with the pandemic; however, in coming years it could trigger an acceleration in the development of a more ambitious and integrated European budgetary policy.
That the pandemic would have wounded the European economy and led to (as elsewhere in the world) a substantial increase in both private and public debt, has been clear since it started. One of the first measures the Commission implemented was to suspend the application of the Stability Pact, which limits member states’ sovereign debt and deficit. At the same time, the European Central Bank has started to provide the additional liquidity needed to stimulate banks to lend to firms hit by the Covid-19 shock and by lockdowns, whilst governments have also gotten involved in providing guarantees for bank loans.
Covid-19 is a cause of debt mainly because of restrictions and blockages in production imposed to limit the spread of the virus. This type of measures hurts firms as well as household incomes. The latter shrink, triggering a weakening of aggregate demand. A demand shock is therefore added to supply contraction. Only a substantial injection of subsidies and emergency loans can then reduce the negative multiplier’s speed, which depresses the economy. Debt also rises and increases spontaneously as payments that should come due aren’t honoured. Firms’ unavoidable losses consume their net-worth, causing many of them to disappear, while others are kept artificially afloat by banks or public subsidies; ultimately becoming “zombies”.
Part of the debt required to support firms and households is temporary and can be directly recovered from debtors after the end of the pandemic. Some industrial production, real estate businesses, and infrastructure construction can then reach higher productivity than what they would have experienced without the Covid-19 shock; thus generating the income necessary to reimburse private and public debts incurred to support their activities during the pandemic. However, the largest part of Covid-originated debt will not be recoverable, even when owed by efficient firms. For instance, when a successful tourist business is impeded to sell its services during the pandemic, it will find it nearly impossible, when the crisis ends, to overwork in such a way as to compensate for lost cashflows. Even less recoverable will be the debt originated to support bankrupt or “zombie” firms, as well as those that prior to the pandemic were already showing inadequate productivity and competitiveness.
Covid is a common, symmetric shock, and it seems natural to try to cooperate to cope with the debt it causes and to share part of its risks. It is also an opportunity to reorganize production and relocate labour and capital across Europe in such a way as to favour the most efficient sectors and production, those that better interpret the new needs of the current times, ongoing technological progress, new forms of international competitiveness, the changing pattern of private tastes, and public needs. The stronger efforts to reallocate resources and innovate activities will be, the larger the debts needed to finance them. However, productivity will also increase more quickly; enhancing potential, future GDP and, therefore, the possibilities to reimburse the debt that were originally ignited to support such innovations.
According to the EU Commission’s Winter forecast, it won’t be until 2022 for the Union’s GDP to get back to pre-Covid levels , when it will be 2,7% lower than what it would have grown to be in absence of the pandemic. The loss is not impossible to recover with a euro-wide plan featuring the right mix of well-targeted investments and reforms to yield a sustainable increase in the potential growth rate of our economies. Sustainability also means that the green and digital features of this investment strategy must be stressed; that the plan must provide abundant financing for disease prevention, public health, research, and education; and that convergence of European national systems must be fostered by concentrating financial help in weaker and slower-growing member states. As a way to reach these results, the EU has decided to share a large part of Covid-induced debt and a portion of the financing of national recovery in order to strengthen member states’ economic resilience against future, unpredictable events and shocks. The degree of this sharing is unprecedented in the history of the Union. This sharing has taken place in two ways. The first is more immediate and precarious as well as the least transparent one: it entails a very large increase in the purchase of national sovereign securities by the ECB. The composition of the purchases of this Covid-related facility was designed to favour the weakest and most indebted countries. As a consequence of this policy, a big swelling of the quantity of money and of the balance sheet of the ECB has taken place, which will have to be somehow managed in coming years.
The second way to share debt and the plans to exit the pandemic will have a more deferred and gradual impact. It involves very innovative measures with powerful, potential consequences for the quality and intensity of the EU’s growth and integration. With the SURE and New Generation EU (NGEU) programs, the Union has decided to issue eurobonds, i.e. common debt on global markets used to finance loans and subsidies for member states to be used with aims and in ways jointly designed at the community level, also favouring countries that suffered most from the Covid shock. SURE has already issued its bonds and started its transfers to member states, specifically targeted to support national systems to help the unemployed. NGEU is currently finalizing the joint preparation of national plans for “recovery and resilience” with common guidelines to promote, in particular, the green and digital economy, youth, education, and research. While “recovery” means cyclical support to relaunch incomes, investments, and aggregate demand, the emphasis on “resilience” encompasses funding to support transformative reforms to make European economies more productive and better able at coping with the new challenges of the future. In the case of certain countries, such as Italy, planned reforms supported by NGEU include key/essential sectors, such as the judiciary and public administration. These transformative features of the use of funds provided by NGEU should enhance the perceived quality of the eurobonds that will be issued to finance the program. As such, common public European debt will increase significantly; its sustainability will also be enhanced by solidarity between member states; while its interest costs will be lower than those of most national debts.
It is important to note that NGEU, which has been planned and approved in strict connection with Europe’s Multiannual Financial Framework 2021-2027, could turn out to be the first step towards a permanent increase in the size of the EU budget, a standard habit of planning a deficit for EU public accounts, a regular supply of eurobonds for the global financial markets enhancing the international role of the euro and of EU capital markets. In fact, it appears that France and Italy are already planning to propose an increase of the NGEU fund, which is currently larger than 5% of the Eurozone aggregate GDP. New types of eurobonds could also be issued by creating baskets of national sovereign securities, thus averaging their riskiness, perhaps indirectly, via the European Stability Mechanism’s balance sheet, which could be deeply reformed. Such developments, which would require complex institutional and Treaty changes, are far from being under serious discussion among member states and are strongly fought by the many enemies of country risk-sharing, of the widening of EU public finance, and of its potential powers to enact regular cross-border income transfers. However, it is fair to say that the Union’s reaction in tackling the pandemic crisis has moved a few steps towards this highly controversial direction.