On March 4, 2020, as Italy was battling the first wave of COVID-19 in Europe, the German government announced a ban on exports of all protective medical equipment. Coupled with Germany’s refusal to consider joint bond issuance to support the bloc’s economy, the move seemed to indicate a country acting in its own interests rather than those of the European Union (EU) as a whole.
Germany wasn’t alone. In those first weeks of the coronavirus outbreak, countries across the EU unilaterally closed borders and tried to secure medical and protective equipment for themselves, ignoring calls for a joint response and support to the hardest-hit states, Italy and Spain.1 The period was reminiscent of the European sovereign debt crisis that emerged at the end of 2009, fuelling speculation as to the EU’s survival.
But, as in 2012, the bloc eventually reacted to the pandemic and pulled together. In July 2020, the EU announced it would create a €750 billion ‘Next Generation EU’ pandemic recovery fund that will issue common debt, and a new seven-year budget, under which the bloc will be able to run a deficit during economic shocks and channel money to countries in need of support. The agreement was hailed as a landmark moment for European integration.
“The period of division was mercifully short and very quickly morphed into a more unified approach to the COVID-19 crisis. Those countries that suffered most began to receive reassurance assistance would be provided,” says Stewart Robertson, senior economist at Aviva Investors. “Europe is always one to make the best of a crisis, and it has swiftly transitioned into a much more joined-up way of thinking, including on monetary and fiscal policy responses. Both are effectively in maximum stimulus mode and will continue to be so.”
The European project has its origins in the European Coal and Steel Community of the 1950s, an inward-looking project between a small number of countries that gradually transformed into the broad but incomplete union we know today. Despite the promising steps forward in the collective response to COVID-19, the bloc still needs to find the political will for greater coherence to prosper over the long term.
Towards a more complete union?
As the world begins to think about post-pandemic reconstruction, the EU is at a defining moment for its future. The way it comes together – or not – to decide on its ambitions and how to achieve them will shape the continent, and global geopolitics, for decades to come. Two key issues to consider are inequality and the environment.
Post-COVID rebuilding has to consider the green agenda and a renewed look at inequality
“As we look forward, dealing with COVID-19 but also believing there is a post-COVID world, Europe has gone to great lengths to stress that the rebuilding has to consider the green agenda and a renewed look at inequality,” says Robertson.2
On climate change, Europe is ahead of the game. Robertson compares the growing political consensus to the asset management industry where, after being an afterthought for many years, environmental, social and governance considerations are now integral to client expectations and the overall investment offering.3
“I find it interesting that, every time they talk about the future, senior European Central Bank officials like Christine Lagarde or Olli Rehn, governor of the Finnish central bank, mention the green agenda. It is clearly part of their programme, in a much more substantive way than in the past,” he says.
Striving for a just transition
Inequality has been similarly prioritised, forming part of Europe’s Green Deal, an ambitious package of measures designed to make the EU carbon neutral by 2050. While inequality has been on the agenda for years, institutional attitudes only began shifting a few years ago, after the wake-up call of populist electoral victories across the EU and elsewhere. The disproportionate impact of COVID-19 on the most vulnerable has further increased the urgency to act.4
As Stephen King, senior economic adviser at HSBC Holdings and specialist adviser to the House of Commons Treasury Committee from 2015 to 2017, explains: “Thirty or forty years ago, west Wales was considerably richer in terms of per capita incomes than say, Bratislava. Bratislava today is considerably richer than west Wales.
Regional inequalities have undoubtedly connected with some of the support for populist isolationist politicians
“Massive regional disparities have opened up. It is true in the UK and the rest of Europe, and those regional inequalities have undoubtedly connected with some of the support for populist isolationist politicians”, add King. The idea globalisation was the reason people have been left behind has had significant resonance.
King also believes this feeling of having been left behind creates a sense that the supranational bodies setting the rules, including EU institutions, do not represent people or their interests, particularly when their inner workings lack transparency.5
“You can see why some of these international organisations lose political support and lose the trust of their constituents in different parts of their member countries,” he says.
In its October 2020 Fiscal Monitor, the International Monetary Fund (IMF) underlined the need to support the most vulnerable and bring back a sense of cohesion within societies: “New investments in healthcare, social housing, digitalisation, and environmental protection would lay the foundation for a more resilient and inclusive economy.”6
The IMF’s approach is not just about fiscal support and welfare protection; it is about creating an environment that provides more opportunities for everyone to thrive. The Fund has also highlighted that a premature withdrawal of fiscal support is one of the biggest dangers to the recovery.
“The IMF used to be this bastion of balancing budgets at all costs; that has changed,” says Robertson. “One of the casualties of COVID-19 is the European Stability and Growth Pact, which used to stipulate 60 per cent debt, three per cent budget deficit. The EU may revisit some fiscal rules in future, but I would be very surprised if we returned to anything remotely resembling those.”
Monetary and fiscal commitment
While not necessarily a ‘Hamiltonian’ moment, the Next Generation EU recovery fund is a key signal, despite ongoing discussions on its details.
“It is a very important step towards closer integration across the euro zone and Europe more widely,” says Robertson. “It opens the door towards full debt mutualisation, a unified fiscal approach and common debt issuance at the EU level; in some places in Europe, that has often been shut. A lot of the building blocks are now in place or being constructed to move in that direction.”
Giovanna De Maio, non-resident fellow at the Brookings Institution’s Center for The United States and Europe, agrees. “Most importantly, this tool signifies the acknowledgment that the nature of this crisis will affect Europe as a whole, not just weaker EU economies. While details still need to be defined, this achievement and collegial effort should not be underestimated because its existence speaks to a sense of unity and a vision for the future towards further integration,” she says.
In fact, October 2020 saw another emblematic event for the euro zone, with the first debt issuance related to its unemployment relief scheme, Support to Mitigate Unemployment Risks in an Emergency (SURE). The issuance of €10 billion of ten-year bonds and €7 billion of 20-year bonds were oversubscribed to the tune of €230 billion, showing the appetite for a European ‘safe asset’.7
The next few years will likely see ongoing fiscal and monetary support
Whatever happens, the next few years will likely see ongoing fiscal and monetary support. Getting the recovery fund working effectively will be a priority, as will gaining acceptance for it as part of the institutional infrastructure – and a building block for the future.
“At some stage, we will have to return to sustainable public finances in every country, particularly the ones that look most vulnerable. But I think the EU and organisations like the IMF will take a more enlightened and slower approach to putting public finances back on sustainable paths,” says Robertson.
Ongoing support should be possible if, as expected, interest rates remain low; the European Central Bank (ECB) has already said it will keep monetary policy loose for as long as necessary.
“I don’t think it will explicitly adopt yield curve control like Japan, but de facto that is what its policy will mean,” says Robertson.
The ECB is also conducting a strategic review under which it is widely expected to implement a symmetric two per cent inflation target, similar to the one recently adopted by the Federal Reserve, to replace the current inflation target of “close to but below two per cent”.8
“Effectively, the bank will allow inflation to happen more than in the past. That means interest rates can stay lower for longer. The hope is that it will allow the longer end of the yield curve to stay low, keeping financing affordable,” Robertson explains.
Figure 1: Policy rates in major regions
Time for optimism?
Closer cooperation and ongoing policy support should be welcome news to investors, especially those who have been underweight the region for a long time.
“Investors need to start seeing Europe differently from the fractious, potentially insolvent problem-child of the last decade. Despite the serious current challenges, there is growing recognition among member states that these would be much greater were it not for the existence of the EU,” says Sunil Krishnan, head of multi-asset funds at Aviva Investors.
Figure 2: EU citizens increasingly optimistic about the bloc’s future
“Added to the EU’s greater willingness to share the fiscal burden around and consider closer integration, all of these are big differences from how we have looked at Europe over the last ten or 15 years. It’s a change to be looking for opportunities in Europe rather than deciding what to avoid or where to go short,” he adds.
De Maio, meanwhile, sees opportunities for progress in political areas. “In future, there may be more frequent use of the ‘enhanced cooperation tools’ through which smaller groups of states can decide to cooperate on certain issues, or potentially a reform of voting procedures to reduce the scope of subjects to be voted unanimously. On migration, the European Commission has presented a new proposal for a ‘migration pact’ bridging security and solidarity,” she adds.
Nationalist and populist movements seem to be somewhat suppressed for now
Robertson is also optimistic. “While nationalist and populist movements could easily bounce back in a coronavirus-driven recession, for now they seem to be somewhat suppressed. And although Hungary and Poland have moved against European ideals in recent years, their desire to join the euro zone gives the Union a powerful bargaining chip,” he says.
There may be room for compromise there, although De Maio believes a discussion on the respect for democratic values within the EU is urgent and needs to be addressed carefully but decisively.
Overall, she believes COVID-19 has been a turning point for Europe. Domestically, it has triggered broader support for the leaders in power. Internationally, China’s lack of transparency and ‘mask diplomacy’ – its policy of sending medical supplies to those countries with which it wanted to form closer ties – was viewed as cynical by many of Europe’s leaders and prompted the bloc to take a tougher stance against the country. Meanwhile, the lack of US leadership led EU countries to take independent initiatives on managing the pandemic, while also offering help to other countries in need.9
Brexit is giving the EU another reason to unify. “There were fears that, if the UK broke away from the EU, it might set an example to others; in fact, Brexit has strengthened the unity of Europe, and by and large the EU has stood firm,” says Robertson.10
Multilateralism remains under threat
Brexit may have unified political opinion within the EU, but on the world stage Europe remains caught in the middle of nationalist power plays that could undermine its cohesion and the rules-based multilateral order.
Europe remains caught in the middle of nationalist power plays
“Whether it’s Russia with regards to the eastern fringe of the EU, or the UK trying to negotiate the best deal in terms of Brexit, a number of actors are trying to peel member states away from each other and prevent coordinated responses,” says Krishnan. “Similarly, in wrangling over the use of Huawei technology in 5G, the US and China haven’t been lobbying the EU for a coordinated response, they have been pressuring individual countries to act.”
These pressures make it difficult for the EU to agree on a common response, although it is trying.11
Caught in the middle
As the US administration hardened its stance on China and eschewed resolution through bodies like the World Trade Organisation (WTO), countries were effectively being asked to pick sides. Joe Biden’s victory in the US presidential election could herald a return to a multilateral approach, however.
Michael Grady, head of investment strategy and chief economist at Aviva Investors, says the big question now is whether Europe chooses to side with the US or China.
“The Democrats’ approach would be quite different from the Republicans’. They would want to get the Europeans on board, working together to further isolate China,” he says. “Whether the Europeans would get on board is another matter, because they could be put in a difficult situation economically if they did. China is a key export market for Germany and other EU countries. The Chinese authorities have shown in the past they can strongly influence consumer demand for foreign products.”
Russia has been engaging in a disinformation campaign with the aim of exacerbating tensions
De Maio adds Russia has been targeting Western democracies since the Ukraine crisis in 2014, engaging in a disinformation campaign with the aim of exacerbating tensions and undermining trust in the democratic model.
The latest war of words between the EU and Russia centres on Belarus in the wake of disputed elections in the Eastern European country. The EU and Russia have each claimed the other has inflamed the crisis.
“On Belarus, the EU and the United States have imposed sanctions on Belarusian officials and called for new elections. The EU also adopted sanctions against Russian officials believed to be involved in the poisoning of opposition leader Alexei Navalny,” explains De Maio. “These actions underline Europe’s strong support for human rights and democratic values.”12
Nationalist politics are destabilising not just the EU’s cohesion, but the broader multilateral order on which the bloc was founded.13 King says when the institutions that uphold common standards are under pressure, as is the case today, the rules of the game begin to collapse and globalisation retreats.14
“Advances in technology certainly enable globalisation, but unless you have rules of the game, humanity has demonstrated time and time again it is more than capable, whatever the technology, to build walls and borders and barriers. We may be going through that process again,” he says.
Diplomacy backed by action
To resist these centrifugal forces, the EU needs to step up cooperation on defence and diplomacy, developing credible approaches to dealing with the US, China and Russia, differentiating its response but standing firm to defend multilateral principles, as well as EU values and interests. It also needs to back its diplomatic efforts with action, particularly with countries at its periphery.15
The EU needs to step up cooperation on defence and diplomacy
As Josep Borrell, EU high representative for foreign affairs and security policy and a vice president of the European Commission, wrote: “If we want the fragile truce in Libya to last, we need to support the arms embargo. If we want the Iran nuclear deal to survive, we need to ensure that Iran benefits if it returns to full compliance. If we want the Western Balkans to succeed on the path of reconciliation and reform, we need to offer a credible EU accession process delivering incremental benefits.”16
De Maio concurs with that view. “Europe needs to do more for its own security given US disengagement from the Mediterranean and Middle East region. In fact, Europe has scaled up talks and initiatives on European defence capabilities to be able to ensure security in its southern and eastern neighbourhood,” she says.
Building a new future
In a strange twist of fate, the nationalist forces trying to undermine Europe’s cohesion may be helping it gain more influence globally. With the rise of power politics around the world, Europe’s ‘soft power’ has increased by default.
On the one hand, although China has been effective in projecting hard power, some of its diplomatic initiatives have been less successful. On the other hand, America’s soft power has diminished as it has been unwilling to engage with multinational organisations, at times actively undermining their ability to function (although new president Joe Biden has signalled his support for institutions such as NATO, which his predecessor Donald Trump often criticised).
Europe has become an arbiter of certain social values
“Europe has become an arbiter of certain social values. For example, when China wants to burnish its credentials on environmental commitments, its main interlocutor is the EU. Conversely, if the US was looking to build an international consensus to rein in China, the body it would turn to first is the EU,” says Krishnan.
The EU could serve as an arbiter of sorts between the two superpowers, not only in trade matters but also ideology. Rising in defence of the multilateral, rules-based global order, it could help restore the ability of bodies like the WTO to resolve disputes and encourage international cooperation.17
“The EU is making significant progress on regulating foreign direct investments and protecting crucial infrastructure. In this regard, Europe is well positioned to play a role in establishing high standards for trade with China and leverage its economic power, hopefully with the help of the United States, to push Beijing to play by the rules and engage in cooperation on global challenges like climate change, where Europe can also lead the way,” says De Maio.
Taking the lead on climate policy and data protection
Climate policy is a good example of where Europe can use its soft power to lead, and environmental policies could also spur it to drive technological leadership. Creating a more favourable environment for innovation is high up the region’s policy agenda, and it will be important to see whether that translates into the kind of support given to start-ups in the US.
“There are already leading green technology companies in Europe and there will be more. Whether the region can create a fertile environment for a broader range of technologies is an interesting question, and one which I think will reward investors to look at,” says Krishnan.
Europe has set the standard for data privacy rules
Europe has already taken a lead in regulation, particularly of technology. Whether future innovations emerge in the EU or continue coming from the US and China, EU rules such as the General Data Protection Regulation (GDPR) have given individuals unprecedented control over their personal data and set the standard for data privacy rules.18
In its current state, data protection is as much a question of politics as technology and will undoubtedly be one of the key battlegrounds for European values and freedoms in the years ahead. The way Europe defends its citizens will be critical to establishing its great-power credentials.19
However, before it can consolidate its lead, the EU must think hard about how and where to invest to achieve the green and inclusive economy it envisions after COVID-19.
Investing for the future
First, an ageing population in Europe will mean lower GDP growth, as is happening in Japan.
“We get used to the ‘natural’ state of economies being one where they grow, and Japan has shown us that may not be the case in this world where populations are ageing. But that doesn’t necessarily mean poverty. You can still be a wealthy economy, even if you are not growing,” explains Robertson.
Raising the retirement age and increasing immigration are difficult political sells in most of the EU.20 Therefore, to maintain per capita growth rates and keep Europe a wealthy economy, investment and productivity improvements will be crucial. Education, research and development (R&D) and infrastructure can all play a part.21
Europe is competitive with the best in terms of education spending per head today
“Well-targeted education spending is one of the most obvious ways to improve long-term productivity. There are disparities within the region, but Europe is competitive with the best in terms of education spending per head today,” says Krishnan. “The real question for the future will be how that is targeted; this is perhaps even more important when you move beyond education to infrastructure spending and R&D.”
The quality of investment will also determine Europe’s long-term success.22 Krishnan believes Europe needs to guard against the danger of transforming a potentially win-win situation into a white elephant by backing the wrong technology.
“It remains to be seen whether the governance structures in Europe are strong enough to limit that risk. A lot of the burden will fall on the European Commission and member states to maybe rein in the grander designs of the European Parliament,” he notes.
Some are in fact calling for the EU to seize the current opportunity to redefine the way Europe operates.23 Increasing support for local autonomy and decision-making is an interesting example. Localism has proven important in the daily management of coronavirus policies and could play a similar role in the longer-term reconstruction.
“Talking about the importance of avoiding misdirected spending, a localism agenda is very important as well. Most of the evidence suggests the more localised you make the decisions, the better they tend to be,” says Krishnan. “This shouldn’t start and end with the pandemic but apply to a much broader range of policies. Perhaps we are now going to create the dialogue and the structures to allow that to happen.”
Europe as a global power
Although open borders and free trade have increased wealth within the EU and globally, the world may never fully return to the post-war multilateral order as we knew it. Europe was not created to play but to abolish power politics, yet it is now in a unique position to use its leverage to defuse existing tensions and, eventually, build a new, fairer and greener rules-based order.
Europe can use its leverage to defuse existing tensions
Borrell contends that Europe’s trade and investment policy, financial power, diplomatic presence, rule-making capacities and growing security and defence instruments give the EU many levers of influence.24
The question is not Europe’s power; it is whether member states will be willing to wield that power jointly to create new possibilities for a more open future.
