Members' Research Service By / May 16, 2022

Future Shocks 2022: Promoting economic recovery and resilience

Following a deep recession in 2020 of -5.9 % and further contraction in the first half of 2021, the EU economy recovered faster than expected, with growth of 5 % in 2021.

Written by Magdalena Sapala, Alina Dobreva and Martin Höflmayer.

This paper is one of 11 policy responses set out in a new EPRS study which looks first at 15 risks facing the European Union, in the changed context of a world coming out of the coronavirus crisis, but one in which a war has been launched just outside the Union’s borders. The study then looks in greater detail at 11 policy responses the EU could take to address the risks outlined and to strengthen the Union’s resilience to them. It continues a series launched in spring 2020, which sought to identify means to strengthen the European Union’s long-term resilience in the context of recovery from the coronavirus crisis. Read the full study here.

The issue in short: the challenge and the existing gaps

Following a deep recession in 2020 of -5.9 % and further contraction in the first half of 2021, the EU economy recovered faster than expected, with growth of 5 % in 2021. However, expectations are that Europe is at an early stage of an adverse economic shock to its economy – just when the recovery from the pandemic had become more firmly entrenched – as the economic implications of Russia’s invasion of Ukraine are likely to be significant. As a consequence, the post-Covid recovery will almost certainly be significantly delayed, with a clear downside risk. While the overall economic costs are still difficult to predict, they will differ between EU Member States, whose economic vulnerability to the invasion is very unevenly distributed.

At the time of writing, growth rates vary across EU countries, as the impact of the pandemic on economic activity continues to weaken over time and supply-side constraints ease. So far, the strong economic recovery has been aided by a rapid and substantial fiscal and monetary response. That response was possible through the activation of the general escape clause in March 2020 by the European Commission and the Council, allowing Member States to undertake appropriate budgetary measures in exceptional circumstances. The clause was extended by the Commission in March 2021, and is likely to be extended to 2023 in light of the conflict in Ukraine.

The severe economic impact from the pandemic led to a substantial shift in EU fiscal policy guidance. An unprecedented budgetary package was adopted, which combined the €1 210.9 billion multiannual financial framework (MFF) for 2021 to 2027 with the €806.9 billion Next Generation EU (NGEU) instrument. This package was made possible thanks to an agreement on an unprecedented scale on borrowing at EU level to fund it. The debt will be repaid through the EU’s own resources (OR), which necessitates an expansion of the OR portfolio. Even before the NGEU-related borrowing, there had been an ongoing debate on the reform of the EU system of own resources, a key goal being to limit the share of GNI based on own resources and to align the OR system better with EU policies. Making the NGEU a permanent instrument had been mentioned as a possible option even before the outbreak of the war in Ukraine; the debate on new joint borrowing to fund common strategic goods, such as energy security or defence, is now likely to intensify.

Existing policy responses

The European economy is undergoing unprecedented transformation towards a more sustainable, green economy, while at the same time driving the digital transition. Both require ambitious investments and reforms. The recovery from the Covid-19 pandemic has been supported by new EU instruments, including the European instrument for temporary Support to mitigate Unemployment Risks in an Emergency (SURE), the Coronavirus Recovery Investment Initiative (CRII), and NGEU. According to the 2021 stability programmes, a majority of Member States are planning to enhance the resources available for government investment as the share of public investment in GDP is set to surpass pre-pandemic levels in 2022.

The European Semester, with its broader scope and multilateral surveillance, will be at the heart of the EU’s fiscal, economic and employment policy coordination. In light of the policy changes after the Covid-19 crisis, the European Semester is being adapted to take into account new instruments and facilities to drive forward the Member States’ reform and investment agendas.

In July 2020, to help repair the immediate economic and social damage caused by the pandemic, and at the same time to bring lasting change and make Europe more resilient and sustainable, the Member States created NGEU as a temporary recovery instrument (€806.9 billion in current prices, to be paid out by the end of 2026). Together with the 2021-2027 MFF, it represents 1.8 % of EU GNI, the largest investment package ever implemented through the EU budget, and provides a much- needed catalyst for public investment. Furthermore, with the new, unfolding crisis caused by the war in Ukraine, the role of NGEU has been de facto extended, but within its agreed maximum financial capacity. The Member States were encouraged to use it as the ‘first line’ reaction, and to cover, in particular, the growing need for investment in energy security (see below).

The main advantage and innovation of NGEU is the way it is financed, and its focus on the climate and digital transformation. To finance the instrument, the Member States broke with a taboo that the EU cannot borrow on a larger scale to finance its expenditure, and agreed to base it on collective borrowing on the international capital markets. As a result, in the past 12 months the Commission has moved from being a small issuer, raising funds to finance relatively small lending programmes like the European Financial Stabilisation Mechanism (EFSM) and macro-financial assistance (MFA), to being one of the biggest issuers in euro.

The first assessments of the implementation of the Commission’s borrowing strategy were positive and recommended making it a permanent solution, mentioning among its benefits the enhancement of the international role of the euro. The optimistic views of the NGEU are amplified by estimates of its substantial macroeconomic impact. By 2024, it is expected to trigger at least a 1.5 % increase in the EU’s real GDP compared to a baseline scenario without NGEU investments, and to increase employment by up to 1 % during its period of operation.

The centrepiece of NGEU is the Recovery and Resilience Facility (RRF) (some 10 % of NGEU’s resources are channelled through six other budgetary programmes: React-EU, Just Transition Fund, InvestEU, Rural development, Horizon Europe, and RescEU). Worth €723.8 billion, the RRF is a mix of grants and loans, to be invested in line with six pillars representing policy areas of European relevance, in a package of reforms and investments based on national plans. These plans have to take into account the 2019 and 2020 country-specific recommendations of the European Semester. Thanks to the introduction of compulsory targets for spending on green transition and digital transformation under each national plan (at least 37 % and 20 % respectively) much of the RRF financing supports projects in the areas of decarbonisation, renewables, energy efficiency, resilience of key infrastructure, and sustainable transport.

At the beginning of March 2022 – i.e. less than a year since the first national recovery and resilience plans (NRRPs) were submitted for assessment – the Commission reported that RRF implementation was firmly underway. With 22 national plans approved, and with payments at the level of 18.6 % and 13 % of the approved grants and loans respectively, the Facility seemed to be operating according to the timeline agreed with the Member States.

The 2021-2027 MFF was adopted in a package that included NGEU and linked to the Own Resources Decision, whose application would secure sufficient revenues to continue existing EU programmes without limiting their funding under the next MFF and to repay the NGEU-related debt. The Own Resources Decision was ratified by all 27 Member States by 31 May 2021 and entered into force in June 2021. The Interinstitutional Agreement (IIA) that introduced the principles and criteria for new own resources confirmed the link to NGEU repayments and established an own resources roadmap with regular dialogue.

Figure 40: Ensuring economic recovery and resilience
Figure 40: Ensuring economic recovery and resilience

With a delay to the roadmap established in the IIA, on 22 December 2021 the Commission proposed the next generation of own resources to establish some new resources, namely the revenues from emissions trading (ETS), resources generated by the carbon border adjustment mechanism (CBAM), and based on the recent OECD/G20 agreement on a re-allocation of taxing rights over multinational corporations (‘Pillar One’). If the proposal is adopted, the revenues included in it are projected to start flowing into the EU budget from 1 January 2023 and to generate up to €17 billion on average annually after the initial introductory period.

A proposal for a second basket of new own resources is currently planned by the Commission for the end of 2023. Other new own resources options are also included in the IIA. If these proposals are not adopted and implemented, or if they do not deliver the expected and needed revenues, some policy options are either to increase the GNI-based own resource, or to limit the funds of the next MFF compared to existing EU programmes. Furthermore, as the Russian war in Ukraine evolves, the option of further borrowing is also being discussed, including by the current French presidency.

Obstacles to implementation

In the context of heightened economic and geopolitical uncertainty, the relaunch of the review of the EU’s economic governance framework has put the spotlight on the underlying question of how the economic governance framework can ensure enough investment to support the twin transition while preserving public debt sustainability. For instance, to reach the targets set in the Green Deal and the digital transformation, the EU will need to increase annual public and private investment by around €650 billion in the coming decade (2021-2030), compared to the previous decade. As previously highlighted, the geopolitical ramifications of this investment gap, for instance through reducing the transition time towards renewable energy sources to reduce dependency on fossil fuel-based energy sources, are in a dynamic stage and will need to be reassessed.

While the economic consequences of the conflict in Ukraine are still unclear, the current fiscal framework compels Member States to adopt pro-cyclical fiscal policies. The underlying fiscal rules remain complex, rely on unobservable variables, lack transparency and have failed to sufficiently preserve the level of public investment during periods of fiscal consolidation. Furthermore, since the containment of the pandemic led to a heavy deterioration of public finances, the current framework does not sufficiently differentiate between Member States with markedly different fiscal positions, sustainability risks and other vulnerabilities.

The review of economic governance, launched in February 2020 and updated in October 2021, further raises the question of how ‘the design, governance and operation of the NGEU/RRF provide useful insights in terms of economic governance through improved ownership, mutual trust, enforcement and interplay between the economic and fiscal dimensions’. This is particularly pertinent, since potential obstacles to implementing NGEU can concern both financing and spending.

On the financing side, the provision of support under NGEU would not be possible without successful borrowing operations conducted by the European Commission on behalf of the EU. This is a relatively new and challenging role, particularly given the unprecedented scale of the issuing operations and the record time in which the infrastructure for it had to be set up. Therefore, any disruptions or delays to implementing the EU borrowing strategy could have an impact on achieving NGEU’s objectives. Although the borrowing has been successful so far, the situation could change if the war in Ukraine escalates, market conditions deteriorate, or if doubts arise regarding how NGEU funds are used and governed.

Another financing aspect, the repayment of NGEU-related debt, has been projected in the context of an upcoming reform of the OR system. Over the years, such reforms have proven to be a difficult process, which indicates there is a risk of a delay or blockage of the reform of the OR system this time as well. Apart from the complexity of the adoption process, the need for a unanimous decision by all Member States when negotiations happen in the spirit of juste retour, rather than that of common interest and European added value, makes the process inherently difficult and even more so when discussing projections of the impact of novel policies. A potential delay or blockage of the introduction of new own resources could threaten the EU’s investment and policy implementation capacity, especially at a time of additional demand for policy responses created by Russia’s war on Ukraine. It could also intensify political debates on the EU budget, as it could lead to an increase in the share of GNI-based contributions. A potential delay or blockage would be even more problematic in the event of increased interest rates on NGEU debt, considering its magnitude, or other unforeseen external shocks.

On the spending side, the risk is mainly related to the possibility of misusing or wasting resources under the NGEU. Concerns relate to the limited budgetary scrutiny over the borrowed funds, and to the transparency of the performance-based implementation and disbursement method of the RRF, which differs to the approach used for EU budgetary instruments so far. Analysts raise the issue that speedy implementation of such large amounts should not take place at the cost of quality of reforms and investments, and proper control of spending, also in the context of rule of law conditionality. They highlight a risk of fraud and corruption. These concerns are all the greater with the off-budget character of NGEU resources and, consequently, limited transparency and democratic scrutiny of spending. Treated as external assigned revenue, NGEU resources are not part of the usual budgetary procedures and are not subject to the same control as the MFF programmes. Moreover, the involvement of the European Parliament as the budgetary authority is restricted.

Policy proposals by experts and stakeholders

The required total investment levels will remain high (see ‘In focus’) to pave the way towards a green, digital and resilient economy (€650 billion a year until 2030 according to the European Commission). Hence, an effective policy framework that incentivises and enables investment is crucial to sustain the level of investment needed for the green and digital transition. The ongoing review of the European economic governance framework provides an opportunity to reform the EU’s fiscal rules to ensure that they enable Member States’ investment and reform policies, while safeguarding sound public finances.

Various reform proposals have been outlined, from simply increasing the debt ceiling to 100 %, to a country-specific debt anchor or a simplified two-tier framework that consists of an expenditure rule linked to a debt anchor, to abandoning fiscal rules entirely and instead suggesting a set of fiscal standards. Other proposals argue for a fiscal policy anchor related to government interest payments or emphasise the need for a ‘green golden rule‘ tailored towards necessary (green) public investment.

The successful launch of NGEU and the RRF is seen as a turning point for the EU. It has demonstrated that joint borrowing as a way of financing the EU’s common needs is politically and legally possible, and has added a new dimension to the debate on a fiscal capacity for the euro area, reforming the European Semester, and financing the EU’s common needs, for instance related to the green and digital transformations. Some analysts consider transforming NGEU into a permanent facility to be a key priority for reinforcing the EU’s economic policy framework. They see it as a way to solve many challenges that the EU is facing. Some experts offer scenarios on developing NGEU into a permanent instrument.

It is emphasised by some experts that a positive evaluation of the implementation of NGEU and the RRF, in particular, will be crucial for a decision on using it as a template for any future instruments. Among the aspects that need improving, analysts mention anti-fraud measures, transparency, control mechanisms, broadening the accountability of RRF management and better involvement of national parliaments, the European Parliament and social and regional partners.

The idea of extending NGEU to cover new objectives or even to resort to new joint borrowing gained even more momentum after Russia’s invasion of Ukraine put the EU on the path to a new crisis. Although controversial, and probably insufficient to cater for the needs, the issuance of new joint debt remains one of the options under consideration. In the meantime, NGEU’s unused loans (so far, only seven Member States have asked for them and some €200 billion is still available) can offer some immediate flexibility and support for action on energy security, defence, humanitarian aid or migration.

Position of the European Parliament

Whereas a substantial share of the investment will be borne by the private sector, public investment will have to increase as well. To mobilise private investment more efficiently, a functioning Banking Union and progress on the Capital Markets Union are crucial, including action on sustainable finance. On the fiscal side, the Parliament stressed in its own-initiative report on the Annual Sustainable Growth Strategy 2021 that ‘the focus should be on forward-looking policies and investments, especially in those Member States that have fiscal room for manoeuvre to invest’ and ‘that the RRF creates a unique opportunity for delivering the reforms and investments needed for the EU to get ready to cope with the present challenges’.

The European Parliament’s role in the overall management and scrutiny of NGEU is bigger than with other intergovernmental tools created in response to various crises over the last decade, such as the European Stability Mechanism. Still, it is rather limited due to the legal basis chosen for the creation of the recovery instrument (Article 122 of the Treaty of the Functioning of the EU), the treatment of the resources borrowed as external assigned revenue (see above), and in comparison with the role it has as the EU’s budgetary and discharge authority. As a result, although the Parliament is a co-legislator for the biggest part of NGEU, the RRF, the scrutiny and discharge functions over spending are compromised. The Parliament sees it as a risk to central budgetary principles and calls for more transparency in the implementation process, and for relevant changes to the financial rules applicable to the general budget, in particular making external assigned revenue an integral part of the budget.

Other key aspects discussed and monitored by Members of the European Parliament concern the quality of the reforms and investments included in the NRRPs, risks and delays in the implementation process, assessment of the payment requests and verification of the milestones and targets that are the condition for payments. Also under discussion are equal treatment of the Member States, application of rule of law conditionality, and involvement of national parliaments and regional and local authorities in implementing the RRF.

In the draft report on the borrowing to finance NGEU, the Parliament underlines that further investment in EU policies will be necessary to strengthen EU competitiveness and strategic autonomy, in particular regarding industry and climate action, and considers that NGEU is a good example of a viable architecture for funding above the MFF ceilings. Moreover, notwithstanding its reservations on the functioning and scrutiny of NGEU, as mentioned above, the Parliament calls on all EU institutions to ensure that this instrument is given a longer-term political vision.

The European Parliament has demonstrated long-term commitment to the reform of the own resources system. It has acknowledged the necessity to conduct such reform and has called consistently for the introduction of a basket of new own resources, which will diversify revenues, unload the pressure on the GNI-based resource and guarantee the EU’s capability to repay NGEU-related debt without risking limitation of existing EU policies. In its resolution on the reflection paper on the future of EU finances, the European Parliament stressed that additional political priorities should be coupled with additional financial means and not be financed to the detriment of existing EU policies. There is an ongoing debate in the Parliament over whether the revenues collected under the newly proposed types of own resources should be assigned to particular policies, or whether the fundamental principle of universality of the budget should be observed.

In focus: the European growth model
The European economy is undergoing unprecedented transformation in the context of major uncertainties linked to the global and security outlook. As outlined in European Commission’s Communication on the European Growth Model, the transformation relies on two equally important pillars: investments and reforms. On the one hand, investments are pivotal for sustained and sustainable growth. On the other hand, our economic structures and the regulatory framework, such as the fiscal framework, should support the economic transformation and be conducive to investment. Coherence between fiscal surveillance and economic policy coordination will be an integral part in this endeavour in order to align investment and reform policies in the Member States as well as national and EU instruments and objectives.
In an environment of geopolitical instability and rising global challenges, doubling down on the green and digital transition has become even more urgent to ensure the phasing out of EU dependency on Russian gas, oil and coal imports. The informal European Council in March 2022 in Versailles proposed a pathway to a new growth and investment model to make Europe independent from Russian fossil fuels well before 2030. The European Commission is invited to propose, by the end of May 2022, a REPowerEU plan that should reduce fossil fuel imports by two thirds within one year, building on the extensive work that has been done already on national recovery and resilience plans.

Possible action


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