Beyond the immediate emergency, a radical change in European policies is needed. European fiscal policy should be based on a large common budget and greater autonomy for national governments, starting with a ‘golden rule’ excluding public investment and all emergency-related expenditure from spending limits. European policies on expenditure, taxation and deficits must allow the development of the welfare state that is typical of Europe’s model, favouring the convergence of member countries to high levels of performance. In parallel, European policy must promote and finance efforts of all countries for restructuring their economy to prevent and adapt to climate change. Along this road, Europe could become an international model, setting international standards on health, welfare and environmental issues, assuming a leadership in international organizations, identifying the most effective ways to face today’s pandemic and tomorrow’s climate emergency.
Unfortunately, there are no signals of change from the European Council, the European Commission and national governments; there is no political vision and capacity for action adequate to the severity of the current emergency. The coronavirus crisis may indeed become a crisis of European integration.
The economic crisis has arrived
The coronavirus pandemic is bringing us a major economic crisis. According to the last OECD Economic Outlook, annual global GDP growth is projected to fall to 2.4% in 2020, from an already weak 2.9% in 2019, with a possible contraction of GDP in the first quarter of 2020; GDP growth in China could be below 5% this year, with a marked downward correction. The spread of the pandemic in Europe and the US will make the fall in GDP much larger, with stagnation or recession in all of Europe, and a significant fall – maybe in the range of 5% – for the most fragile economies of Southern Europe.
The drivers of the crisis are the stoppages in production and consumption in the months of most acute diffusion of the pandemic (the first quarter in China and Italy, the months from March onwards in the rest of Europe and in the US). Whole sectors – such as air travel, transportation, tourism and restaurants – have completely stopped. As European economies are closely integrated in global value chains, they will probably suffer from a ‘supply-chain contagion’. Additional negative economic effects are associated with the loss of employment and wages, which can only be compensated to a limited extent by the much needed income support measures introduced by governments (guaranteed incomes, tax relief, etc.). The fall in demand will further slow down production, while the increase in health expenditure is unlikely to have significant expansionary effects on the economy as a whole.
Data on Italy – the first European country hit by the pandemic – may provide some indication of what may happen in Europe as a whole. According to Confindustria, the main business association, 20% of companies have had strong negative effects; some sectors – such as tourism – will be affected far beyond the most acute moments of the pandemic. Furthermore, income support measures may not translate into increased domestic production, but may lead to greater imports (as has happened in the case of face masks and respiratory machinery). After the 2008 crisis, Italy and Southern Europe experienced a 20% fall in industrial production, that has later became permanent. A similar, further weakening of ‘peripheral’ European economies could result from the coming crisis.
Facing the coronavirus crisis, traditional economic policy tools could be ineffective. European monetary policy has long had little effect on the real economy. The indirect stimulus of expansive fiscal policies or tax relief could have a modest impact in the short term. The most effective tool for containing the crisis could be a large increase in public spending for the provision of public services, the purchase of domestically produced goods, and investment in new production activities in the context of a ‘green industrial policy’.
The financial crisis is coming
Finance is an additional driver of the coming crisis. Between February 19 and March 12, 2020, at the Wall Street Stock Exchange the S&P500 index lost 25%; In London the fall of the FTSE100 index was 28%; in Milan the FTSE MIB index lost 40%. Major action has been taken by the US Federal Reserve, announcing $1,500 billion of new liquidity; the ECB, as usual, is trailing behind with €120 billion only of new liquidity announced for the whole of 2020, and without cuts in interest rates. These measures have temporarily slowed down, but not stopped financial instability.
Moreover, the ECB decision on March 12 to provide new liquidity was accompanied by a disastrous statement by President Christine Lagarde: “we are not here to close spreads”, taken from a phrase by the German Member of the Executive Board of the ECB. A major worsening of the spread in interest rates between Italian and German government bonds and a stock market fall immediately followed the statement. The President of the Italian Republic Sergio Mattarella, with an unprecedented intervention, immediately replied that “initiatives of solidarity and not moves that can hinder Italy’s actions” are expected from Europe, leading to a slight correction of Lagarde’s view: ‘I am fully committed to avoid any fragmentation in a difficult moment for the euro area’.
This unprecedented clash between Italy and the European Central Bank reveals the deep divisions in the ECB governing council and how far German and France strategies are from the interests of Italy and Southern Europe. European institutions are unable to face an economic emergency. Without a radical change, the ‘fragmentation’ of the euro area could become one of the effects of the pandemic.