‘The EU recovery fund is too little, too late’

Ashoka Mody on the vast economic crisis facing the EU.


Topics Politics World

The EU is facing the largest economic crisis in its history. As the Covid crisis first began to ravage Italy, the EU struggled to offer a unified, coherent response. Earlier this month, Angela Merkel and Emmanuel Macron launched a joint proposal for a €500 billion recovery fund. European Commission president Ursula von der Leyen has turned that into a €750 billion fund, financed by joint EU borrowing, which has been widely lauded as a historic step for EU integration. But also in the past few months, the German courts have caused a lot of trouble for the European Central Bank, questioning the legality of its quantitative-easing programme, which could also have major implications for the EU’s ability to steer Europe’s recovery. Ashoka Mody teaches economics at Princeton and is author of EuroTragedy. spiked caught up with him to find out more about the crisis.

spiked: How bad is the current economic crisis in the European Union and the Eurozone?

Ashoka Mody: We know, for example, that in the first half of 2020 the Italian economy will contract by about 15 per cent. That is pretty much data, not just a guess. The big question is going to be how much more it will deteriorate in the rest of the year. As a benchmark, I would say that the United States, despite all the fumbling it has done in its management of the health crisis, is probably going to see less of an economic contraction than any of the European countries.

The European countries have a set of additional problems. One is that they trade a lot more than America does. What we are seeing right now is that this crisis has affected pretty much every country around the world. When trading partners do not function at a normal operating capacity, they import less from each other, which weighs down each other’s exports.

Another issue for European countries is that Europe comes into this crisis with a larger debt burden. In Germany, the government itself does not have a large debt burden, but companies do. For the rest of Europe, even the government debt burdens are extraordinarily high. Household debt levels are also high.

The third problem for Europe is that European banks are much more fragile. These three factors are relevant, both in terms of thinking about how deep the crisis will be and thinking about what the recovery will look like.

Altogether, my view is that Europe is worse off than the United States, and within Europe, Italy and probably Spain are worse off than the others. What I am also noticing is that France is doing rather poorly. The major countries in the south of Europe are going to face an economic shock that is both deep and potentially long lasting.

spiked: What does the economic shock in Italy mean for other European countries?

Mody: It depends a great deal on what the policy response is going to be. Again, this is seen as a moment of hope, because the somewhat frightening judgment of the German court on the limits of the European Central Bank (ECB)’s operations has been dismissed by most commentators as not having any teeth. And there is a proposal for the European Commission to borrow and give grants.

My concern is twofold on that front. Number one: starting with the plan for grants, Italy and Spain are wounded now, and this is like promising a bandage to someone which will arrive in six months’ time. The wound has to be treated now otherwise the bleeding will cause a lot of distress, both humanitarian and economic.

Italy in particular is in a weak situation because it comes into this crisis as a country that has not grown for 20 years. The idea that it might get some grant money in six months’ time is no consolation, because Italy probably needs something like 10 to 15 per cent of GDP stimulus now. The US is going to do a fiscal stimulus in that range. It has a much stronger economy, and a lesser impact from Covid. If the US needs that level of stimulus, then Italy certainly needs a stimulus of that order of magnitude. Therefore, in preventing contagion in Europe, the bottom line is going to be how active the ECB will be.

spiked: You say the German court’s ECB judgment has no teeth, but a lot of people are concerned that German courts have hobbled the ability of the ECB to act, in ruling past quantitative easing illegal. But you don’t think that judgment is cause for concern?

Mody: No, just to be completely clear, I was only reporting what others have so far responded. Many commentators, particularly those who style themselves as pro-Europeans, have been too quick to dismiss the German court’s decision, for two reasons.

Firstly, they have ridiculed its economic analysis, which I think is somewhat misplaced. In the end, the court is asking one basic question, which is that if the Eurozone has to have a unified monetary policy, how far can it go to supporting the monetary and fiscal interests of one individual member country? In other words, monetary policy for the Eurozone is one matter, and monetary policy for Italy or for Spain is another matter. This central question translated into operational terms is what share of Italian bonds can the European Central Bank buy before it becomes legally and politically unacceptable?

Before we went into this crisis, the ECB, through its prior quantitative easing purchases, already owned about 23 per cent of Italian sovereign debt. Now, we can expect that through the course of this crisis, over the next six to nine months, if the ECB is going to have a material impact on sustaining Italy, it will need to buy another 20 per cent of Italian debt. This means it is entirely possible that by the end of the year, the ECB will hold something in the range of 40 to 45 per cent of Italian debt. At that point, the ECB effectively owns Italy.

Remember, the ECB is not a normal central bank – it is not a central bank for a nation state. The ECB is the central bank of a confederation of states. As a consequence, the Italians will owe money indirectly to the Germans. Any time a foreigner like you or me sells an Italian bond, takes the money out of Italy, and puts it into a German bank, that money effectively becomes owed to the Germans, through the ECB.

The Germans keep a very watchful eye on those numbers because they know that if at any point the Italians are near to defaulting on the debt, either the ECB itself will need to somehow repay that debt on behalf of Italy, or the Italians will have to default. If you combine a scenario in which the Italian GDP remains 15 to 20 per cent below its level at the start of the year, its debt burden increases, its revenues decrease sharply, and the ECB now holds a lot of that debt, there will come a certain point at which the Italians will have to repay that debt, either to private investors or to the ECB.

And the political question that will then arise – and this is what the German court is essentially asking – what will happen to the claims of other member states? That is an unanswered question. For that reason, dismissing the German court is way too premature, because, either as a legal question or as a political question, it is very likely to reappear before the year is out.

spiked: Do you think the EU is in some way trying to downplay or deny the political faultlines here?

Mody: Yes. I always come back to this one anchor: the EU is a confederation of states. In a confederation of states, each nation will act in its self-interest. Solidarity and European sovereignty and political camaraderie are all lovely phrases, but they do not have any operational content.

I find that a number of my pro-European friends are now pointing the finger at the Dutch and others who are protesting against this bond initiative Merkel and Macron have announced. They are describing them as miserly and stingy. This sort of name-calling is unbecoming, but it is also completely besides the point, because the notion of what constitutes solidarity has to be embedded in a social contract, and there is no social contract. In fact, the social contract is the opposite.

For that reason I remain very pessimistic, even though, today, there is a great deal of optimism about this latest fund initiative. Not only do we now know for certain that it will come too late, but even when it does come it is not clear whether it will have any meaningful quantitative impact.

There are several problems that are already written into even the Merkel-Macron agreement, such as who will receive the money and who will repay the bond. We know, as we discussed, that France will receive money, so the question then becomes: who will not receive money? If there are so many claimants on the money, will Italy and Spain get the large sums that they need? And the biggest question is, who will repay the money?

This is where the French angle becomes particularly important, because if the French say that they want to be net recipients, then all we are left with is the Germans, the Dutch and the Austrians, and maybe the Danes and the Swedes, to pay for France, Italy and Spain. People are very excited about this initiative but I do not think anyone has done those sums. These are all very large countries whose needs are huge.

There are two key terms in the European terminology – net contributor and net recipient – and the question is going to be: if this bond does materialise, who is going to be net contributor who is going to be net recipient? That is going to be a very contentious debate in the months to come, which is why I have very little hope for this bond initiative. This is why the ECB becomes the only game in town, and hence, the German court’s judgment and the break it applies on the ECB, either directly or indirectly, becomes crucial to the evolution of the crisis in Europe.

spiked: We have seen a lot of nations, even within the European Union, act unilaterally to try to save their economies. For example, the trillion-Euro package that Germany has created for itself, which is well outside the usual rules of the European Union. Are countries other than Germany naturally hobbled in their ability to deal with this crisis by virtue of being in a monetary union?

Mody: Not simply by virtue of being in a monetary union, because I think even the Europeans at this moment understand that trying to apply their fiscal rules now would be so egregious that everyone would disregard them.

That said, what is more significant is whether countries other than Germany can do the kind of fiscal stimulus that Germany is able to do. It becomes very important also in the discussion of the European bond that even Germany is currently stretched by the stimulus policy it is enacting.

Germany also has to worry about the fact that it is a diminished giant. Its car industry was already beginning to feel considerable stress, and this crisis has given it a further knock. Germans are not prepared for the technological revolution going on around the world. They have fallen behind not only America, but also East Asia. The Germans have to worry about themselves – both in relation to the crisis and in relation to the fact that they have been, in a longer-term sense, beginning to acquire some of the characteristics of a declining nation.

The other countries all come into this crisis with very high debt-to-GDP ratios. The Italians already had debt worth 135 per cent of GDP. The French and Spaniards had debt worth 100 per cent of GDP. We know that their ability to inject a stimulus of 10-15 per cent on their own is very much more limited than it is for the Germans – unless they get huge support from the ECB which, directly or indirectly, finances that stimulus.

We do not know if or when the point might come when markets look at a large fiscal stimulus in France and feel they do not want to finance it. Maybe that day will never come, maybe markets will give the French authorities some room for manoeuvre, and let them run up a large debt level. I do not know the answer to that. But I suspect that France, Spain and Italy will, at some point in the coming months, face a moment when markets begin to baulk. That is what creates the problem.

The main problem is that we have one monetary union with one monetary policy, but countries going in very different directions. In the United States, the states and the federal government have been at odds. Despite that, there have been significant fiscal transfers to states already, and I expect that those transfers will increase. In the European Union and especially in the Eurozone, those fiscal transfers do not exist, which is why this artificial construct of the bond is being created to somehow simulate those fiscal transfers. But I would be stunned if those numbers are in any way meaningful in the end. And in any case, they will come too late for this crisis.

spiked: It is obviously incredibly important to stabilise the economies with fiscal and monetary stimulus in the short term. But is there a longer-term danger that quantitative easing gets out of control, if it is no longer corresponding to real economic activity?

Mody: That is a very good question, but a very difficult debate. Not just in Europe but in Japan and the United States, central banks have gone out on a limb, and they have expanded their balance sheets hugely. The question is about how they are going to deal with those balance sheets in the long run, and whether they will ever pull them back. Those are very big questions, to which I do not know the answers.

But I will say that one long-term feature, which is relevant, particularly in the European context, is that starting some time in 2008, we began to see a divergence between Germany, France and Italy. Germany was doing relatively well, France doing modestly and Italy doing poorly. Covid has made that divergence much greater, and that will now persist for a number of years. In this crisis, the nation states have diverged even more than they had in the previous crisis, and the political tensions, anxieties and divides will correspondingly increase.

In a more medium-term, structural sense, I think we are in for a lot of anxiety over the future of Europe. These small initiatives like the European bond are going to get lost in that bigger picture – if they ever materialise. I think that, as a consequence, the future of Europe is a cause for great concern, because as the economic divergence inevitably increases, the political divisions will also increase.

There was no need for the Eurozone – it was a completely mindless idea. But once in place, it has these inevitable dynamics. In terms of solutions, I always have to come back to a primary question: can you have a monetary union for a confederation of states? The Europeans like to dismiss that fundamental problem. They claim to be a multi-level state and in so doing they try to obfuscate that basic question of who the ultimate political authority is, of who is accountable to the European people. They have never tried to answer that fundamental question, and they are finding it hard to answer even today, and so continue to bypass it.

Unless Europeans realise the time has come to take a serious look at an entity that has not just the look and the feel but the real characteristics of the United States of Europe, these problems are going to continue. I know this sounds a bridge too far at a moment like this when the immediate problems are already so acute, but my historical view is that unless that basic question is addressed, the technocratic fixes will never be sufficient.

Ashoka Mody was talking to Fraser Myers.

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jamie murray

29th May 2020 at 12:50 pm

Does anybody else get m o d e r a t e d for innocuous comments?

Jim Lawrie

29th May 2020 at 1:50 pm

Yes. Particularly those on Cathay’s economy.


29th May 2020 at 2:09 pm

Yes. I still think we should remove the Reli gi o n of P eac e from Europe though. And the lockdown thing appears to have been a grave error driven by hysteria.

Philip Humphrey

29th May 2020 at 8:52 am

Where does that leave Britain? Britain has over the past four years suffered low growth possibly because of brexit uncertainty (but the disaster that remainers and their so called experts predicted utterly failed to materialize). Assuming we leave the withdrawal agreement at the end of December without having compromised or being bound by EU rules, can we build a more dynamic economy with growth rates closer to those of the U.S.? We have the advantage of our own currency and the ability to set monetary policy to best benefit the UK, so maybe if we make the right decisions. One thing I’m pretty certain about is that if we stay tied to the EU and bound by their rules, that will inevitably mean we have growth rates similar to the dismal EU average.

Mor Vir

29th May 2020 at 9:36 am

Do we even want GDP growth?

Without productivity growth, GDP growth depends on increased labour utilisation, through the further incorporation of workers from abroad. GDP growth does not improve the wages or the living standards of workers already here (us) without productivity growth. Surely we should want want is best for ourselves, and better lives, than simply what is best for British capital. GDP growth per se is not what is best for us.

We are not ants on some abstract group mission to make as much profit for British capital as possible. I could not care less per se whether British capital increases any more than I could care whether Portuguese capital increases, and I do not see why my fellow citizens should care either. All I care about, is what is in it for us? There is nothing in it for us in GDP growth without productivity growth.

UK productivity growth has been downward toward zero since the 1970s and it has flatlined since 2008. GDP growth has continued, through increased labour utilisation, but neither productivity nor wages or living standards have improved. I see no reason why that same pattern would not continue with increased trade after Brexit. They they will simply get more workers, but we will not be any better off.

So, who cares and why, whether UK GDP grows after Brexit? We have not benefited from GDP growth before Brexit, so why would we benefit from GDP growth after Brexit? I am not sure that many people understand the pattern of what is going on here. I have zero ‘loyalty’ to the British state or to UK Plc, and I could not care less whether British capital makes more money for itself. Why should I?

David George

30th May 2020 at 10:45 pm

Agreed, the GDP figure on it’s own can be misleading, population growth or government spending, for example, can inflate it.
What you need to look at is real household median incomes; they have increased significantly despite a reduction in household size. That is more what people care about, the GDP figure not so much.
Here is a graph of the situation 2008 to 2016, interestingly the bottom quartile look to have done the best and your assertion that ” neither productivity nor wages or living standards have improved” is complete nonsense.

The increase in MHI from the seventies is even more dramatic, adjusted for household size, real disposable income increased from 5,700 (1970) to 14,000 up to the GFC, stalled and then recovered with about a 10% gain from the 2008/2010 hiatus as per the Wiki link.
You can’t just make up your own facts and then assert an ideological position from a delusion; or is it the other way round.

Mor Vir

31st May 2020 at 12:30 pm

The source is ONS.

“What you need to look at is real household median incomes; they have increased significantly despite a reduction in household size.”

Firstly, ONS figures are already equivalised to household size, so a reduction in household size is neither here not there, that is already accounted for in the equivalisation.

Secondly, the line chart in that wiki article is for median income, which is simply the middle figure between the two poles.

The more telling average is the mean, which is all of the figures added up and divided by the number of figures. The mean shows the actual growth in national income wealth. The mean ONS chart shows that household income is actually lower than it was in 2008.


ONS 2020.

Wealth, livings standards and household income growth are all directly linked to productivity growth, not GDP, and UK productivity growth has flatlined since 2008. According, so have the rest.

That is not a controversial statement, it is widely accepted. Let us avoid personal comments and stick strictly to the ‘facts’ and their methodology.

Mor Vir

31st May 2020 at 12:53 pm

This is from the FT.

It explains that wealth, income and living standards are linked to productivity.

It then describes how UK productivity is substantially lower than that of other developed G7 peers; that the collapse of UK productivity growth has been worse than that of any other major economy; and that it has flatlined since 2008.

TP economic policies have been a complete disaster over the last decade.

The productivity growth of all ‘mature’ capitalist economies is converging toward zero but UK is at a lower level of productivity in the first place, and the collapse of productivity growth has been deepest and most sustained in UK.

UK GDP growth now depends entirely on increased labour utilisation, the mass incorporation of workers from abroad, and that does not increase productivity or wages and living standards for workers already here (us).

UK workers have benefited zero from GDP growth before Brexit and they are likely to benefit zero from it after Brexit. The British capitalist state will simply get more workers to meet the demand due to any increased trade after new trade deals. It will be a nice earner for British capital but UK workers will not benefit from it.

> Britain’s productivity crisis in eight charts

Britain’s productivity crisis should be keeping the country’s politicians and civil servants awake at night.

This is because the UK has experienced a slump in productivity growth since the financial crisis that shows no sign of coming to an end. The slowdown has been more acute than any other western country.

It matters because achieving higher growth in productivity — or output per hour worked — is the way nations become richer, living standards rise and governments have the resources to improve public services or cut taxes.

Labour productivity is normally measured as the value of goods and services produced for each hour worked. The average British worker produced 16 per cent less on average than counterparts in other members of the Group of Seven leading economies in 2016, according to data from the Office for National Statistics.

The average French worker produces more by the end of Thursday than their UK counterpart can in a full week. However, British productivity levels are still higher than those in Canada and Japan.

Productivity growth has slowed in almost all advanced economies since the financial crisis.

But Britain’s slowdown has been more dramatic than any leading western economy. Annual growth in productivity has plummeted from average annual rates of about 2.3 per cent before the collapse of Lehman Brothers to 0.4 per cent in the past decade.

“Had the pre-crisis growth trend continued, then productivity would be more than 25 per cent higher today,” said the Resolution Foundation, a think-tank.


Mor Vir

31st May 2020 at 1:10 pm

The FT explains in another article how wages and living standards are lower in UK than in 2008 due to diminished productivity growth. It is the only country in which GDP has grown while wages have fallen.

UK GDP growth depends entirely on increased labour utilisation, and the mass incorporation of workers from abroad, as productivity growth is collapsed. Increased labour utilisation boosts GDP but it does not improve the wages and living standards of the workers already here.

In fact, UK wages and living standards have gone down, and they are 10% lower than in 2008, due to a lack of investment, inflation, monetary devaluation, the increase in part-time work and self-employment, decreased unionisation etc.

> How wages fell in the UK while the economy grew

Britain stands out among big economies with more people in work but in lower-paid jobs

Between 2007 and 2015, the UK was the only big advanced economy in which wages contracted while the economy expanded. In most other countries, including France and Germany, both the economy and wages have grown.

Italy and Portugal are yet to reach their pre-crisis levels on both measures, while in Finland and Spain real wages grew in periods of economic contraction.

The UK sits on its own as a rich economy that experienced a strong economic performance while the real wages of its workers dropped.

Britain’s GDP went back to pre-crisis levels in the third quarter of 2013 and it is now nearly 10 per cent larger than in the second quarter of 2008. Yet in 2014 wages were almost 10 per cent lower than seven years before. During the same period, salaries in France and Germany grew 7 per cent.

There are various reasons for the exceptional case of the UK, not least a shift towards lower-paid jobs, low productivity levels and growth, a strong rise in employment and higher inflation.

More people in work but with lower pay

Only the US and Canada have greater flexibility in labour market regulation than the UK, according to the OECD. Thanks to a more flexible job market, people were able to find jobs quicker than in other countries. Employment expanded by 2.4 per cent in the six years to 2013, while in France there was no job expansion and the EU as a whole experienced job losses.

After the crisis, labour supply increased, but these “unusual increases in labour supply” were absorbed by the market, writes the OECD in its latest country survey.

UK employment expanded at the expense of capital stock, which contributed to low (and falling) levels of productivity. In turn, lack of investment growth hampered productivity with negative effects on wages. “Whether pay drives productivity, or productivity drives pay, they go hand in hand,” as Sarah O’Connor, our labour correspondent, puts it.

Inflation and the dynamics of the labour market are pulling real wages in opposing directions. Ultimately further progress in living standards rests on boosting productivity growth, a challenge for the coming years.



29th May 2020 at 2:08 pm

A ‘more dynamic economy’ with fewer protections for workers, greater social and economic inequality and governed by a cabal of secretive, incompetent Old Etonians with total contempt for democracy and natural justice.

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