Hit hard by the COVID-19 pandemic and the war in Ukraine, the EU needs money. Given that European Commissioner for Economy Paolo Gentiloni cannot get it directly from the EU’s member states, he wants to borrow it.
The purpose does not seem to matter. What matters is that the commission receives money — lots of it — even if that means amassing a mountain of debt.
In 2020, Gentiloni played a key role in creating NextGenerationEU (NGEU), the emergency program that enabled the EU to borrow more than 800 billion euros (US$855.8 billion) to deal with the effects of the COVID-19 pandemic.
In May last year, he wanted to raise funds to aid Ukraine, and in October he suggested issuing joint debt to help European citizens with their gas bills.
Now, amid a wave of common debt issuances, the European Commission plans to compete with US President Joe Biden’s US$369 billion Inflation Reduction Act, which includes subsidies for clean-energy projects. While the new plan might not involve new borrowing, it proposes a new “European sovereignty fund” to invest in green technologies.
It is doubtful that the benefits of these programs justify their costs. For example, there seems to be no correlation between the distribution of NGEU funds and the severity of local COVID-19 outbreaks.
However, there is a negative correlation between NGEU aid and GDP per capita, with some of the poorer countries that were less affected by the virus receiving staggering amounts of money.
The problem with the commission’s borrowing spree is that the EU’s own rules bar it from taking on debt. Article 311 of the Treaty on the Functioning of the European Union clearly states that the EU must finance itself “wholly from own resources.” That is why member states needed to agree unanimously to NGEU’s creation.
Another major problem is the lack of clarity about who might bear the cost of this debt. Politicians and economists often say that the EU’s debt burden would inevitably fall on future generations of taxpayers, who would be required to service it. While there is some truth to this, today’s savers are certain to pay the highest price.
Like most of the developed world, Europe is reeling from the return of stagflation. In a stagflationary environment, unexpected events, such the war in Ukraine or the COVID-19 pandemic, create supply shocks that translate into rising prices due to excess demand. Issuing new debt creates more demand, thus further fueling inflation.
While price growth seems to be slowing, eurozone inflation is still at 8.5 percent — four times higher than the European Central Bank’s 2 percent target — and could spike again. Even the most recent core inflation rate, which excludes volatile food and energy prices, stood at 6.2 percent, much higher than anticipated.
During the stagflationary decade of the 1970s, it took a while for a wage-price spiral to take hold. With no end in sight for the Ukraine war and the steady exit of baby boomers from the workforce, high inflation is likely here to stay.
The persistence of high inflation makes pensioners who saved diligently for old age, together with savers who put their money into nominal-value secured assets such as life insurance, the real victims of Europe’s indebtedness. The distributional effects could turn out to be profound, if not disastrous.
In his memoir The World of Yesterday, the Austrian writer Stefan Zweig vividly described how hyperinflation in the 1920s impoverished and radicalized the petty bourgeoisie. Nothing, he wrote, made the Germans so “hateful and ripe for Hitler” as inflation.
The historian Gerald Feldman corroborated this observation in his seminal 1997 book on German inflation, The Great Disorder.
To be sure, today’s inflationary surge is nothing like the hyperinflation crises of the early 20th century, but every inflationary episode starts small. The trick is to nip it in the bud before it spirals out of control. As the Romans said, principiis obsta — “resist the beginning.”
The European Commission’s plans to raise billions by issuing long-term EU bonds are legally questionable and economically irresponsible. This borrowing, for which new justifications are constantly being sought, is clearly inflationary.
Moreover, the commission’s approach could undermine European stability and endanger the euro.
If it continues on its current path, the EU would harm the creditworthiness of European government bonds.
When former British prime minister Liz Truss similarly ignored all warnings and sought to increase Britain’s already-elevated national debt with her disastrous tax cut proposal last year, she spooked investors, crashed the pound and was quickly shown the door.
Central bankers in Europe and the US have been raising interest rates aggressively over the past 18 months to tame inflation. Following through on Gentiloni’s plans would undermine these efforts. Any new debt is now inflationary and thus potentially devastating for the stability of the euro.
All of this is not to say that policymakers should not pursue worthy causes, but in a stagflationary environment, the way to do so is through taxes or other expenditure cuts — not debt.
If the European Commission needs money, it should ask the national parliaments of its member states. If they refuse, the EU must not borrow it. To do otherwise would put the dream of European unification at risk.
Hans-Werner Sinn is a professor emeritus of economics at the University of Munich, a former president of the Ifo Institute for Economic Research, and serves on the German Ministry for Economic Affairs and Climate Action advisory council.
Copyright: Project Syndicate
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