HomeCoronavirusEurope’s big two kiss and make up for pandemic rescue deal

Europe’s big two kiss and make up for pandemic rescue deal

From champion of austerity to Europe’s biggest spender – Germany has travelled a long way in just a few months. The notoriously frugal ministry of finance has agreed to spend €130bn – a sum equal to 4% of national income – on more than 50 initiatives to promote growth across the country.

This breathtaking investment programme comes on top of the almost 30% of GDP the government has so far spent on rescuing businesses and protecting jobs during the coronavirus crisis.

The sums have shocked onlookers, dwarfing as they do the funds Germany deployed in the wake of the 2008 financial crash. Yet they are consistent with a broader push by European institutions to co-ordinate more than ever the recovery from recession of the EU economy.

The effort was already under way last year, aimed at counteracting a slowdown in GDP growth: after accelerating through 2017 and 2018, it had started fizzling out. The pandemic has turbocharged the response and brought the EU’s main actors together in a way not seen since the days of François Mitterrand and Helmut Kohl.

German chancellor Angela Merkel has buried her grievances with French premier Emmanuel Macron to produce €500bn of grants for hard-pressed business across the EU. The move circumvented the Bundestag’s refusal to countenance debt sharing across the euro area and, said Macron, overcame the bloc’s failure earlier in the pandemic to show sufficient solidarity.

He said: “What is sure is that this €500bn will not be repaid by the beneficiaries … We are proposing to do real transfers [of money] … that’s a major step.”

Macron, who, to the annoyance of many in Merkel’s conservative Christian Democratic party, is a supporter of greater financial integration, has seen his tepid relationship with Germany’s chancellor revived somewhat in the past few months.

Last Thursday, the European Central Bank stirred the pot with a generous increase in lending to sovereign nations and the banking sector, joining the US Federal Reserve, the Bank of Japan and the Bank of England in making sure the cost of borrowing remains at all-time lows for years to come.

Stock markets climbed on news of the combined funding packages, and analysts said they expected the financial markets to accelerate back to pre-pandemic levels during the rest of this month.

The German Dax was among several European stock markets to make notable gains. The Dax jumped 3.4% last Friday, taking the week’s increase to more than 10%, and more than a quarter since mid-March.

Helped by surprisingly positive US jobs data last Friday, this jump in stock prices was nevertheless underpinned by an announcement from EU home affairs commissioner Ylva Johansson that travel restrictions were about to be eased.

“I personally believe that we will return to a full functioning of the Schengen area and freedom of movement of citizens no later than the end of the month of June,” she said.

Some countries, such as Austria, are ahead of the pack: after cutting the number of coronavirus cases and deaths dramatically, it has now eased its lockdown so far as to include travel to and from neighbouring Germany and Hungary.

gdp forecasts

The Schengen security area, which allows free movement among its 26 member states, is often cited as the cornerstone of European economic activity, so the prospect of it reopening was always going to excite investors. All eyes, though, are on Merkel’s Germany, which is the first to go beyond the rescue phase and bring forward a fistful of measures to aid the recovery.

The €130bn package, far from inciting either a rightwing backlash or condemnation from the left for being too weak, has received unexpected praise. The Green party called it “better than we had feared”, though economists did criticise the stimulus package’s short-term thinking.

After spending two days hammering out a deal, Merkel said that because society was facing a “profound upheaval” shaped by climate change and digitisation, “we couldn’t just introduce a traditional stimulus package”.

She added: “It also had to be done with an eye to the future, so that is what we especially emphasised.”

Across Germany, the recovery package is seen as a defeat for the once all-powerful car lobby, which had reportedly spent weeks urging the government to include a subsidy not just for electric vehicles but also for those with internal combustion engines.

In 2016, Germany launched an inventive scheme that was meant to drive up demand for electric cars: with each purchase of an electric vehicle the buyer would get a €4,000 rebate, half of which was paid for by the government, with the rest funded by carmakers.

Instead of extending the scheme to diesel and petrol cars, as lobbyists had demanded, Merkel’s government decided to increase the rebate for electric vehicles to up to €9,000.

News magazine Der Spiegel cited industry insiders calling the package a paradigm change: “Truth is, the times in which the government fulfils every wish of the car sector are over”, it added.

Both the Green party and Merkel’s junior coalition partner, the Social Democratic Party (SPD), claimed the change of tack as a victory. Saskia Esken, the SPD’s joint leader, had defied car industry supporters in her own party and rejected plans for a subsidy for petrol and diesel cars earlier in the week.

“The package is better than we expected”, said Green party joint leader Robert Habeck. “The government has managed to turn a corner just in time and given up on a subsidy for combustion engines.”

Other countries, including the UK, are still drawing up their recovery packages. The Treasury is known to be circumspect about following in Germany’s footsteps given that Britain’s public finances are in a much weaker position.

However, Britain’s chancellor, Rishi Sunak, was urged last week by a thinktank that has strong connections to the Tory party to take bold action and bring forward a stimulus package that includes tax cuts alongside huge infrastructure spending.

The thinktank, Policy Exchange, said cuts to stamp duty and VAT should be part of a scheme designed to spur spending by both businesses and consumers.

Merkel also put forward a cut in VAT, in a move that made the recovery package a more palatable compromise for many of her MPs.

Economists, though, were more sceptical. “It is completely unclear whether businesses will pass on the VAT reduction to customers at all,” said Sebastian Dullien, director of the Macroeconomic Policy Institute. “In retailing, you already have a lot of threshold prices: items that currently cost €99 are hardly going to go on sale for €97.50.”

Christian Odendahl, chief economist at London thinktank the Centre for European Reform, cited the temporary cut in VAT the UK government introduced in 2008, pointing out that only “75% of businesses passed [the cuts] on to consumers”.

Clemens Fuest, president of the Leibniz Institute for Economic Research in Munich, said the VAT cut risked not providing a lasting stimulus: “It’s a measure that allows you to drive up turnover in the short term. But after that period the whole thing doesn’t work any more, of course. So you could have a problem in 2021 when consumption collapses.”

France will be keen to follow in Germany’s footsteps. And doing so will be much easier now that every country in the EU is on course to breach the strictures of Brussels’ 3% deficit rule.

The free flow of government funds will not be held up by eurocrats worried by claims of governments spending beyond their means. Borrowing is cheap for all developed countries and few of them are likely to spurn the opportunity.

Ursula von der Leyen, the EU commission chief, has called for restraint from governments that may be considering offering bailouts to ailing businesses and perpetuating huge zombie companies.

But Macron is unlikely to worry too much about that. He has already ditched his stance as champion of private-sector knowhow for a more nuanced approach that embraces the stability of the public sector and businesses that rely on state aid.

It would help him hugely if France could regain its status as the world’s favourite travel destination. Without the return of packed flights and trains full of tourists, thousands of small businesses will go bust, and larger companies will struggle to rebuild their revenues.

Last Friday, Macron called on unions to reform the 35-hour working week. The government expects GDP to drop by 11% this year, in the worst recession since 1944, with the budget deficit expected to rise above 10% of GDP. Unions immediately opposed the idea, saying it represented a pay cut.

Macron, though, understands that his European project will fail if France is dragged back by infighting. He needs to keep pace with Merkel, or many of the gains made in the past three months will be lost.

Spain’s prime minister, Pedro Sánchez, called for a European-style Marshall plan. Photograph: Alberto Di Lolli/AFP/Getty Images

The race to rescue the EU

EU leaders have worked to make sure that Europe’s haphazard response to the 2008 financial crisis – which set the north against the south and almost caused its disintegration – is not going to be repeated. Bailout operations have been larger and more coordinated, but continued resistance in some more conservative quarters to sharing Europe’s wealth and income has persuaded some leaders to battle openly for deeper solidarity.

5 April The Spanish prime minister, Pedro Sánchez, called on Europe to produce a Marshall plan to rebuild the continent’s economies. Referring to the US-funded investment programme put together in 1947 by secretary of state George Marshall, Sánchez said failure to act in solidarity could imperil the union’s future.

“Europe must build a wartime economy and promote European resistance, reconstruction and recovery. Europe was born out of the ashes of destruction and conflict. It learned the lessons of history and understood something very simple: if we don’t all win, in the end, we all lose.”

6 April Germany’s chancellor, Angela Merkel, warned that the EU faced the biggest challenge since its foundation as she spoke about the economic and political consequences of the coronavirus pandemic. “Everyone has been hit equally by this and it must be in the interest of everyone, and of Germany, that Europe emerges stronger from this test,” she said.

16 April In an interview with the Financial Times, the president of France, Emmanuel Macron, said: “We are at a moment of truth, which is to decide whether the EU is a political project or just a market project. I think it’s a political project … We need financial transfers and solidarity, if only so that Europe holds on.”

13 May Paolo Gentiloni, a former Italian prime minister and now the EU’s economy commissioner, said that an uneven economic recovery from the coronavirus crisis posed an “existential threat” to the EU. He said: “What is clear is the uneven level of the recovery and the risks this creates to our single market and the necessary convergence, especially within the euro area. This is something that I could even define as an existential threat to the building of the union,” he told a group of European newspapers, including the Guardian.

27 May Ursula von der Leyen, the president of the European commission, called on EU countries to back a €750bn (£671bn) recovery plan, saying the union was facing a moment such as it had never seen in its 70-year history. “The crisis has huge externalities and spillovers across all countries and none of that can be fixed by any single country alone.”

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