Economics
Opinion Article
December 22, 2020

Europe at the darkest hour

As I write, finance ministers are still meeting to decide the future of Europe. The crisis caused by the pandemic advanced across the continent at breakneck speed, threatening a devastation that had not occurred since the Spanish flu of 1918. The courageous response of health professionals and European citizens' responsible attitude in confinement made it possible to avoid more pessimistic scenarios.

The economic cost of the confinement will be high but certainly justified by the lives saved. I do not think that another approach would have less economic costs. If it had not been for temporary confinement, it would have been the prolonged loss of confidence that destroyed the economy. The budgetary costs resulting from the health and social crisis, from support to the economy and tax revenue loss, will be high, predicting an explosion in debt. Thus, we risk a new sovereign debt crisis, as the rating agencies are beginning to warn. To remedy this additional suffering, it is time for European institutions and politicians to rise to the challenge. And the answer is not enough to be positive - it must come with the size and urgency required to prevent the pandemic from reaching debt markets.

Unlike the sovereign debt crisis, there are no people responsible for the pandemic - except for the coronavirus. There are only victims. Some, like Italy or Spain, suffered first and therefore suffered more. Others, such as Portugal or the Netherlands, have benefited from the warnings and teachings to take more timely and effective measures. On the other hand, some economies will suffer more than others because they depend on more vulnerable sectors such as tourism. On the other hand, a crisis solution is an event without moral hazard since the pandemic hit countries at random. There is no risk that the measures adopted will facilitate opportunistic behavior since this event will not be repeated (it is expected).

If ever there was a time for solidarity in Europe, it is the pandemic we are experiencing. Failure will generate mistrust that will lead citizens of the Member States to a greater divorce with Europe. As a convinced European, I understand those who demand this from Europe and its institutions - after all, it was in this condition that sovereignty over budgetary and monetary policy was conceded. Furthermore, the risk of a new sovereign debt crisis will entail even greater economic costs in the future, as we are well aware.

However, the imperative need for solidarity should not serve as a back door to introduce politically difficult topics and have high moral risks, such as the mutualization of debt. Regard less of what we think about Eurobonds, this is a sensitive issue that divides Europeans and their representatives, and the urgency of the crisis is not the time for complex debates with long-term structural consequences. It is essential to recognize this crisis's exceptional character and that the solutions of solidarity that arise are not seen as precedents for “normal” times. The mutualization of coronavirus costs should quickly replace the message about the mutualization of debt. The policy measures adopted should apply only to the unique situation we are experiencing, and no country should fear that they may set a precedent for the architecture of the euro. The introduction of the term “coronabonds” in the lexicon helps the debate, but many, including the Spanish prime minister, insist on considering the two terms as substitutes. For countries concerned with the moral hazard of “euro bonds”, this confusion only generates distrust and makes consensus difficult.

In my view, coronabonds should be an exceptional instrument in European economic policy, a recognition of the specificity of the pandemic we are experiencing. These “coronabonds” could be issued by a European entity (such as the European stability mechanism, which has the authority to go into debt). Revenues would be distributed to Member States on a non-refundable basis, according to the budgetary costs of health systems, the support and relaunch of the economy, and tax revenues loss due to the fall in economic activity. These would be calculated using exogenous indicators such as the incidence of infection, the exposure of economies to the sectors most affected in the short and medium-term, or the drop in GDP and tax revenue. The bonds would be issued at very long maturities (e.g. 50 years) and, if there was no market, they would be financed by the ECB at a rate calculated on the basis of 30-year rates. The debt payment would be distributed among the Member States using a formula similar to that of sharing the costs of the Community budget. If a country did not fulfill its commitment, European procedures would be initiated, as is the case with excessive deficits. In the case of a country's default, the losses would be for the ECB and, therefore for all of us, but the country would risk sanctions.

One point to note is that “coronabonds” must also involve the ECB. According to the Financial Times, the exceptionality of Central Bank direct financing to help withstand the consequences of the pandemic has already been approved in England. The German constitution's difficulty, which prohibits direct ECB financing, has already been overcome in the "quantitative easing" policies. For those who fear that ECB financing may be inflationary, I note that a little inflation in the European context would not be undesirable and that the exceptional character of ECB financing would not affect agents' expectations of future monetary growth and would only generate a temporary increase effect on inflation.

It is difficult to account for the uncertainty we are currently experiencing. Still, if we assume a 20% financing of European GDP at Germany's 30-year real rate (0.1%) and divide it over 50 years (with the European economy growing in terms of 2% per year), this would imply an annual payment of 0.2% of GDP. If the financing is 40%, the payment will be 0.4% per year. With rates close to zero, the current monetary environment helps to reduce the costs of European solidarity. It seems to me to be a low cost to save Europe.

The positive effect on European confidence of a solidarity response to this crisis could be the ray of light in the darkness of so much suffering.

But to get here, each must listen to the other, without doctrine or ideology. No insults or recriminations. Without secret agendas to create precedents or to gain negotiating power, but with the responsibility and sense of commitment that the situation requires. The positive effect on European confidence of a solidarity response to this crisis could be the ray of light in the darkness of so much suffering.

This content was originally written in Portuguese and published in Jornal de Negócios.

Daniel Traça

Dean at Nova School of Business and Economics

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