National and European policymakers have put together an exceptional fiscal response to the coronavirus crisis. The Next Generation EU (NGEU) fund, together with a reinforced European budget (MFF) for 2021-2027, should be one of the main tools to shape and boost the bloc’s recovery. In particular, the establishment of the Recovery and Resilience Facility within the NGEU is a major step in this direction.

Figure 1: How the NGEU spreads its grants around

Among the main eurozone countries, Italy and Spain will be the major beneficiaries of the European funds in nominal terms. In GDP terms, their grants will be around 5% and 6%, respectively

 

With an overall capacity of €672.5bn in grants and loans, the fund will support the recovery of European countries, focusing especially on those that have experienced the most severe downturns during the pandemic crisis.

To access those funds, member states are now preparing their recovery and resilience plans, setting out a credible package of reforms and public investment projects. These schemes aim to use the investments to boost potential growth and address structural issues that should create jobs and growth, focusing on green and digital transition. The plans will be submitted to the European Commission in coming months for evaluation and then be sent to the Council for approval. Disbursement of funds will likely start next summer.

 

Looking at the European Commission timeline (Figure 2), grant commitments will be concentrated in 2021-2023, and the loans should be disbursed not later than 2026. This will pose enormous pressure on the national decision-making bodies to allocate the funds and on administrative structures to coordinate and monitor implementation.

Figure 2: When the process' main steps will happen

Given the large economic contractions expected in 2020, Italy and Spain will be among the major beneficiaries of the European funds. According to the first estimates, which will be recalibrated next year, Italy could receive around €87bn in grants (5% of 2019 GDP) and potentially €120bn in loans. while Spain could benefit from €70bn in grants (6.5% of 2019 GDP) and other €70bn in loans.

In the draft budgets for 2021 that the two Mediterranean countries just submitted to the European Commission, Italy and Spain foresee fully using the allocated grants. Italy also plans to use the full amount of loans (€125bn), while at this stage, Spain expects to cover its funding needs for 2021-2023 with the grants. Only later (in the biennium 2024-2026) will it eventually apply for the loan facility.

 

Italy and Spain have had trouble planning and spending EU funds

Given historical evidence on public spending and investment dynamics and some structural characteristics, we have serious concerns about Italy’s and Spain’s capacity to first efficiently allocate and then properly spend the significant resources available.

First, history suggests that both countries have struggled to plan and spend the European funds accessible during the usual multiannual budget period. During the last MFF started in 2014 and ending this year, they used only a small part of the European Structural Investment Funds (ESIF) (Figure 3). In particular, they spent as little as 10% of the funds in the first four years, trying to catch up at the end of the budget period. This clearly signals a lack of a proper planning process and possibly a scarcity of viable investment opportunities.

 

Figure 3: Italy and Spain have often lagged in spending EU funds

Italy and Spain showed very similar dynamics in committing and spending European funds during the last MMF period. The amounts allocated were €75bn and €56bn for Italy and Spain, respectively, a smaller amount than foreseen in the Recovery Fund and also spread over a longer investment horizon. In contrast, Germany and France proved to be more proactive in allocating the funds over the entire budget period.

It follows that government investment has been declining steadily in both countries since the aftermath of the sovereign debt crisis (Figure 4). Italian government investment dropped by 35% in the last 10 years, falling from 3.7% of GDP to 2.1%. In Spain, spending declined by a staggering 54% over the same period, from 5.2% to 2.1% of GDP.

But if higher spending is desired to boost long-term growth, the OECD says, “it must be accompanied by reforms to improve the effectiveness of spending by enhancing the infrastructure governance framework, expediting project delivery and improving project quality.” As the 2019 OECD Economic Survey for Italy reports, poor project quality, disorganised evaluation processes, and delays in delivery have been major obstacles to good infrastructure development as much as low spending. An analysis of 20 strategic transport projects indicates that from the start of the planning process, it takes more than 15 years to deliver large projects (above €2bn), while smaller projects take around six years. Planning and public tenders account for about two-thirds of the total time, suggesting that Italy doesn’t have an appropriate administrative structure. Spain is plagued by similar issues as well.

Figure 4

Government investment has declined both in absolute terms and compared to GDP for Italy and Spain during the last 10 years. Also, investment as a share of total government expenditure has dropped from 7.2% in 2009 to 4.4% in 2018 in Italy and from 11.2% to 5.1% in Spain

The poor planning capacity is also reflected in government spending figures when compared to the two countries’ official economic projections. Indeed, European Commission forecasts of government investment for Spain have often been missed in recent years (Figure 4), while Italy’s performance has been mixed.

 

Figure 5: A history of missing forecasts

Official estimates often overestimated the countries’ planning ability, as in the case of Spain. The EC spring forecasts have been constantly missed in recent years, and government investment started to pick up only in 2019

Finally, the decision-making and spending processes depend highly on the capacity of institutions and national administrative bodies. According to the World Economic Forum’s 2019 Global Competitiveness Index, neither country excels in institutional quality, although the problems look much more severe in Italy. While Spain’s public sector performance ranks 37^th out of 141, Italy has a much worse score (127^th). Moreover, Italy ranks 130^th on government long-term vision and 126^th on government responsiveness to change. All these elements add to the view that both countries are unable to follow a clear long-term view, partly due to political instability of their governments.

We conclude that even if the current crisis has put huge pressure on government actions and both political willingness and institutional commitment are better this time, we still believe a full and proper absorption of the funds will be unlikely. It would mean managing an unprecedent amount of resources in a relatively short time, and previous experience shows both countries’ inability to fully benefit from these funds. They’ll still benefit from the funds available at the EU level, but most likely at a slower pace than what governments are currently assuming, or they’ll use part of the funds to finance already planned projects, leading to a diminished impact on potential growth.

This would mean, especially in 2021 and 2022, fiscal support won’t meet government estimates and, therefore, the impact on economic activity will also be more spread out over the forecast period.We estimate that if Italy and Spain would follow the same spending path observed during the MFF period ending this year (Figure 3), 2022 GDP in Italy and Spain will be 0.7% and 0.4% below, respectively, what we estimate in our baseline, which already accounts for some delays in implementation compared to the official government projections. The current baseline instead includes positive effects coming from grants in 2022 amounting to 0.9% of GDP for Italy and 0.65% for Spain

 

Figure 6: Will Italy's grants be front-loaded or delayed

 

In Italy, the government foresees a large proportion of grants disbursed in 2021 and 2022, while we think a more realistic scenario would spread the resources over a longer period. This partly explains why OE forecasts for 2020 remain below government ones. We expect most of the macroeconomic effects of the NGEU to be seen later.