Debt mutualisation: the new norm?

Debt mutualisation: the new norm?

This article seeks to offer a retrospective analysis of the NextGeneration EU package, agreed in principle by the European Council in the summer of 2020 and formally adopted in December of that year. Focusing on NextGen EU’s historical novelty and particularly Germany’s role as a surprising proponent, this article will also assess the prospects of future debt mutualisation within the EU. 

NextGen EU amounted to 750 billion euros and was designed to support states during the pandemic as public finances were stretched by increased spending needs as well as strained tax revenues. This package was lauded as signalling a significant change in EU policy for two reasons: firstly, the majority of it would be dispersed in the form of grants, and secondly, the whole package was to be funded through a joint EU debt instrument. Previously, Germany, alongside a group of countries tagged the ‘frugal four’ (Austria, Denmark, the Netherlands, and Sweden), had raised their opposition to grants from the EU to member states, as well as their aversion to any form of common debt issuance (Bergsen, 2020). 

This opposition reflects a stylised division between Southern and Northern European countries within which the former are cast as profligate, and the latter are unwilling to underwrite the frivolity of others (Baccaro et al, 2020). Despite this, in May 2020, Germany, alongside France, announced what became NextGen EU, reflecting a meaningful shift from its previous steadfast opposition to common debt issuance (Amaro, 2020). Germany continues today to be the decisive figure in these discussions. This paper will argue that while NextGen EU reflects a paradigm shift in many ways, it is not the ‘Hamiltonian moment’ some hoped it would be (Kaletsky, 2020). Instead, it seems the EU will continue to be plagued by its inability to move backwards and the lack of desire to move forward with integration (Guiso et al, 2016).  

The Eurozone crisis and the initial hopes for shared debt

The 2010 sovereign debt crisis was a crucial test for the Eurozone and it demonstrated the tensions inherent to the euro, which has been aptly described as ‘a currency without a state’ (Issing, 2020). The common currency had given investors the illusion that euro area states were converging in their creditworthiness (Blyth, 2015).  Once this illusion broke, there was a swift selling-off of Greek, Italian and Spanish bonds in particular, which prompted major fiscal crises in these countries as they struggled to service this debt (Blyth, 2015). From 2010 onwards there were calls by some policymakers and academics for ‘Eurobonds’ or any kind of mutual debt instrument which could be used to facilitate fiscal transfers between states, but these were rejected (Tooze, 2018). The ECB was late to mount a meaningful response, and it was not until 2012 when the crisis had already significantly escalated, that it began its open market transactions programme. The ECB only pursued a more radical quantitative easing programme in 2015 (Tooze, 2018).

The idea of common debt instruments was stopped in its tracks by the aforementioned Northern countries, who argued that they would create moral hazard (Tooze, 2018), whereby Southern countries  — who had thus far refused to rein in their spending – would be bailed out by their more careful Northern counterparts. This effort was largely spearheaded by Germany, with German Chancellor Angela Merkel saying in 2012 that there would be no Eurobonds ‘as long as I live’ (Isenson, 2012). Although no common debt was issued, the ECB’s bond-purchasing can be understood as ‘fiscal integration by stealth and default’ (Howarth & Schild, 2021). This is because the ECB’s shareholders are euro area member states, so their balance sheets are on the line when the ECB undertakes bond purchases (Georgiou, 2022).

Despite the ECB eventually interfering in order to safeguard the cohesion of the Eurozone, the sovereign debt crisis was concerning insofar as it demonstrated a lack of willingness of certain European countries to engage in the solidarity that a currency union requires (Blyth, 2015). Even the ECB’s quantitative easing programme (which ran from 2015-2018, restarting in late 2019) generated significant discontent from certain actors. This included the German Constitutional Court, which, in May 2020, argued that the ECB had gone beyond its mandate in purchasing government bonds at that scale. It went on to critique the German government itself for not sufficiently protecting the interests of its citizens from the potential adverse economic impacts of the bond-buying programme (Amaro, 2020). 

The COVID-19 shock, which hit southern European countries first, had the potential to create a much larger crisis of European solidarity (Baccaro, 2022). In this context, the NextGen EU package was surprising: it was both more radical and much faster in giving support to Southern countries than the measures taken during the Eurozone crisis. Thus, two questions arise: why was the response so different in the two crises, and why did Germany move away from radical opposition to strong advocacy of grants as well as shared debt? 

COVID-19 and NextGen EU 

The COVID-19 pandemic hit Italy, in particular, earlier than other European countries. A tense situation quickly arose within the EU whereby some member states blocked the export of personal protective equipment (PPE) in the knowledge that they would likely need it themselves (Tsang, 2020). This led to anger among populations who were the earliest victims to the pandemic: a survey from April 2020 indicated that 79 percent of Italians felt that Italy had been abandoned by its European partners (Baccaro et al, 2022). It was in this context that NextGen EU was justified, particularly in Germany: the EU itself seemed under threat from the pandemic, not only because of the stresses it placed on member states but also the acrimony it had created between them.

The fact that a failure to cooperate in order to support the member states worst hit by the pandemic could have meant the breakup of the euro is largely what facilitated Germany’s u-turn on grants as well as joint debt. Surveys indicate that Germans are more amenable to debt mutualisation when they are aware, ‘there is a threat of breakup of the euro’ (Baccaro et al 2022). Chancellor Merkel was aware of this sentiment and consistently emphasised the extraordinary nature of the pandemic, which necessitated extraordinary measures. Indeed, she  repeatedly pointed out ‘the real dangers of European single market disintegration and the unravelling of the wider integration framework’ (Howarth & Schild, 2021). It is not just that the cost-benefit calculation shifted in the minds of German policymakers, but moral hazard was also a much less pressing concern since generous government spending during the pandemic was widely accepted as the appropriate response. NextGen EU was thus possible in the case of this unique crisis that both threatened the integration of the EU and lacked a convincing link to moral hazard (Howarth & Schild, 2021). 

The future – more integration? 

Where is debt mutualisation heading now? Europe continues to face crises on multiple fronts: the consequences of American protectionism (typified by the US Inflation Reduction Act); the war in Ukraine; and the rising cost of living, largely a result of increasing energy costs. In this context, there have again been calls for shared debt instruments – by individuals such as Thierry Breton, the EU’s Commissioner for the Internal Market –  which can raise money in order to provide aid to countries struggling to support their citizens (Kowalcze et al, 2022). However, the familiar divide between Northern and Southern countries has re-emerged (Kowalcze et al, 2022). Germany’s position in this debate has been ambiguous: Christian Lindner, the German finance minister and Federal Chairman of the free market-oriented party FDP, has made clear that joint debt was inappropriate in this situation (Chazan & Felming, 2022). At the same time, German Chancellor Scholz, representing the SDP (a social democratic party) has expressed more openness to more shared debt, as long as it funds loans, not grants (Burchard, 2022). 

Germany’s cautious position is, of course, not without precedent. At the time of NextGen EU’s inception Angela Merkel was eager to highlight its one-off nature, regularly briefing conservative policymakers on the negotiations and ensuring them that this would not become a sustained system of debt mutualisation (Schramm, 2021). It appears, then, that Germany’s support for NextGen EU did not represent a long term shift in its attitude towards debt mutualisation more generally. This makes the prospects of future moves towards debt mutualisation much gloomier since Germany’s support was so crucial to the passage of NextGen EU. 

Whilst NextGen EU was certainly path-breaking, it was also explicitly justified in its exceptionally dangerous context. By framing it in this way, the bar has been set for future efforts at open fiscal integration: it must be demonstrated that there is a serious threat to the breakup of the euro in order for radical action to be taken (Schramm, 2021). NextGen EU’s legacy is a concerning one insofar as it suggests that meaningful steps forward in fiscal integration require crisis situations to justify them. This condition is not without precedent: Jean Monnet famously prophesied that ‘Europe will be forged in crisis’, indicating an awareness of crises’ ability to stimulate further moves towards integration (Anghel & Jones, 2022). A reliance on crises to produce these sorts of outcomes is troubling, though, because crises are of course unpredictable and it is unclear they will always provide incentives to cooperate more. For example, Anghel and Jones argue that whilst the war in Ukraine has produced ‘manifest solidarity’ across the EU for the people of Ukraine, this does not ‘translate easily into solidarity between any one EU member state and another’ (Anghel & Jones, 2022). More specifically, national publics are becoming ‘more concerned with the direct costs they will face than with the world events that caused them in the first place’ (Anghel & Jones, 2022). 

This tendency is connected to a central debate about NextGen EU; namely, if it represented a ‘Hamiltonian moment’, referring to Alexander Hamilton’s late 18th century successful push for the mutualisation of debts, accumulated during the War of Independence, between the American states (Steinbach, 2015). This initial move towards the mutualisation of war debt created a much stronger fiscal union in the United States, giving the federal government both the responsibility of servicing debt, and the ability to raise taxes to do so (Steinbach, 2015). In light of this, there has been much debate regarding the similarities between this American context and NextGen EU, with some suggesting that NextGen EU represents a similar move towards long-term fiscal integration (Kaletsky, 2020). However, there is only a ‘shallow parallel at a very general political level’ between these two episodes (Georgiou, 2021). One of the key differences is that the fiscal regime instituted in America after debt mutualisation was an extremely slim one: oriented towards preserving sovereignty and paying down the debt from a one-off historical event (Georgiou, 2021). By contrast, a fiscal union in Europe would involve the EU taking on responsibilities such as massive welfare states and countercyclical spending (Georgiou, 2021). A fiscal union in the EU would thus imply changes of a different magnitude, compared to the ones which the early United States implemented. To institute such a union, there must be broad-based support rather than crisis-dependent agreements which do not alter the fundamental divisions between EU members, as exemplified with NextGen EU. 

In 2011, Paul Volker said, “Europe is at an Alexander Hamilton moment, but there’s no Alexander Hamilton in sight” (Georgiou, 2021). This statement is perhaps misleading in that it sees the issue as the lack of a single political figure or talent. However, the EU’s failure to adopt a fiscal union reflects much deeper fault lines. NextGen EU was certainly promising, but as long as measures of its size are tied to threats at the level of pandemics, sustained fiscal integration remains a distant prospect. NextGen EU did not end concerns over moral hazard and fiscal profligacy in certain states. Instead, the pandemic was a unique situation in which those concerns could be justifiably put aside. 

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