By Elizabeta Sabolek-Resanovic, Economic analyst at Raiffeisen Research
With the NGEU instrument (and here above all the Recovery and Resilience Facility, RRF), an (initially temporary) initiative was created to support the rather low long-term potential growth of some Western European EU countries (compared to peers) and at the same time enhance economic and social convergence within the EU in times of transformation (e.g. in the digital space or in regard to greening the economy). The NGEU instrument – although launched in the context of the COVID-19 pandemic – should therefore not be seen as a mere response to the pandemic, but as an initiative to strengthen the EU project as a whole. On the one hand, the NGEU instrument acts as a substitute for a (still) non-existent central fiscal stabilisation capacity in the EU/ euro area (that can induce substantive cross-country spillovers on top of stabilization at the national level). In this way, a so-called lost decade as in the aftermath of the global financial and euro area crisis (compared to the USA, for example) in larger parts of the euro area and EU economy should be avoided.
In addition, this move strengthened confidence in the EU and its perceived ability to manage crises inside the euro area and beyond. Furthermore, the European Commission has certainly been strengthened vis-à-vis the member states, while the receipt of funds from the RRF is linked to the implementation of reforms and the fight against corruption, mismanagement of EU funds and conflicts of interest, in addition to investment priorities along EU lines.
It was also intended to support less financially strong EU members in their modernization needs in order to counteract possible dividing lines in the digital and green transformation. For the CE/SEE countries, the NGEU instrument, together with regular MFFs, remains a key factor in their path to closing the gap and increasing integration with Western Europe. The climate transition is yet another challenge in this regard as the CEE counties are again lagging here, therefore the NGEU programme with the climate focus is of high importance. Also, digital transition (key pillar of NGEU) gains on importance as the CE/SEE countries are looking for a new competitive edge beyond the relatively cheap labour force and try to move up the value chain both within the well-developed manufacturing specialisation, and beyond it (in R&D in particular).
That said, distributing the NGEU/MMF money wisely and effectively is especially important with this entirely new focus, and the Member States should strive to avoid mistakes that have led to weak absorption or inaccurate allocation in the past.
Overall, in our opinion, the NGEU instrument is an important project to strengthen convergence in the EU – also between Western and Eastern EU members — and at the same time to counter the partly recognisable frustration in Western Europe with regard to democracy and the rule of law in some CE/SEE countries. From a broader perspective, the NGEU instrument also promotes the EU as an issuer on the capital market and should, in our view, make an important contribution to the further (institutional) development of the EU.
On a side note, the EU has to some extent mirrored the NGEU project in the Western Balkans, respectively in the (potential) EU accession countries (via the Investment Plan for the Western Balkans), which is important to ensure modernisation along with EU priorities and the accession readiness of these countries.
And even though the NGEU instrument contains noticeable redistributive elements between EU members, we see a good chance that many firms from countries with lower allocations (Austria, Germany, France) will benefit substantially. In terms of the overall economy, it will then be necessary to evaluate the national and pan-European (positive) effects of the NGEU instrument in the mid-2020s. (Gunter Deuber, Dorota Strauch)
RRF in a nutshell: CE/SEE and overall EU perspectives
• The Recovery and Resilience Facility (RRF) is the centrepiece of the NGEU. The 723.8 billion euro (in current prices) in loans and grants will support the recovery plan for Europe through post-pandemic reforms and investments across the EU while enabling a digital and environmental transition in a cohesive society throughout Europe.
• To access the RRF funds, Member States had to submit their national Recovery and Resilience Plans to the EC, which checked the alignment with EU priorities and the country’s specific recommendations.
• The Member States were required to allocate a minimum of 37% to climate investments and reforms and a minimum of 20% to digital transition.
• The EC has estimated the allocations, and the European Council has approved the plans before an prefinancing of 13% of the total amount was paid in 2021 to most countries. Subsequent payments will depend on the achievement of specific milestones and goals, which must be set in the plans.
• The scope of the RRF is structured around six pillars, all of which aim to support economic recovery, job creation and laying the foundations for a stronger, more resilient Europe.
• The main pillars of the RFF programme that must be represented in the financial frameworks of the
beneficiary countries are:
• Green transition;
• Digital transformation;
• Growth, jobs and cohesion;
• Social and territorial cohesion;
• Health, economic, social and institutional resilience;
• Policies for the next generation.
Watch for (cross-border) spillover effects!
Beyond the direct impact of their own national envelopes, countries will also benefit considerably from the effects of NGEU investments in other member states, mainly through trade flows and exchange rate movements. This finding suggests that focusing only on the allocation of funds and ignoring cross-border spillover effects can substantially underestimate the macroeconomic impact.
OLAF, the Court of Auditors, the European Public Prosecutors Office and the Commission itself may access relevant data and investigate the use of funds if necessary.
Spillovers are central for small open economies with smaller grant allocations. In these cases, the positive effects coming from other member states’ plans account for the bulk of the GDP impact. According to European Commission Analysis (Quantifying Spillovers of Next Generation EU Investment (europa.eu)), in sum, the simulations underline the significant impact of NGEU and its potential to lift Europe’s economies onto a significantly better recovery path in terms of both GDP and labour market conditions.
If implemented swiftly, with a strong focus on high-quality public investment and additionality, NGEU gives a substantial boost to the recovery in all member states. At the same time, positive spillover effects appear, especially for small and open economies.
Moreover, the model analysis stresses that high-quality public investment can significantly boost potential output beyond the implementation period and thus also contribute to addressing medium-term challenges such as climate change and digitalisation. The EC analyses suggest that Next Generation EU investment can boost GDP by up to 1.5% and that the effects are around one-third larger when explicitly accounting for the spillover effects from individual-country measures. A simple aggregation of the national effects of individual investment plans would thus substantially underestimate the growth effects of Next Generation EU.
However, the analyses do not include the potential reform gains which is difficult to quantify, but which can add substantially more to the GDP and employment effects in the long run. For a fast NGEU scenario (four years), with evenly distributed spending between 2021 and 2024, the level of real GDP in the EU can be around 1.5% higher than without NGEU investments (in 2024). As public capital is productive, the additional investment boosts demand and increases potential growth. The latter supply-side effects last beyond the implementation and lead to large, long-run multipliers. Additionally, during its period of operation, NGEU investment is estimated to increase employment by up to 1%, compared to the no-policy change baseline.
In the medium-run, substantial and persistent real wage gains reflect improved labour market conditions and productivity gains.
A closer look at country-specific effects shows, given the allocation key, that MS with below-average GDP per capita levels are estimated to experience the largest boost to GDP levels. EC estimates, for a four-year stimulus and a high productivity calibration, that the increase in output reaches more than 4% in Greece, around 3¾% in Bulgaria, Croatia and Romania, and around 3% in Italy and Portugal. For these countries, the role of spillover is smaller because their trade partners receive smaller allocations, and the economies tend to be less integrated with production chains and trade. Especially for MS outside the euro area, the monetary policy reaction matters for the short run spillovers. There can be a negative short-run spillover for those countries due to the national currency appreciation (although the total GDP effects remain positive). However, this exchange rate effect is temporary and becomes positive in the second or third year of NGEU. Additional simulations show that if the monetary policy in these MS partially targets the euro exchange rate, NGEU spill over becomes positive immediately.
Summary
To conclude, NGEU with the RRF as its central piece should have a positive and long-lasting impact on the European economy as is created not only to mitigate the economic and social impact of the coronavirus pandemic but make Europe more sustainable, resilient, and better prepared for the challenges and opportunities of the green and digital transitions. RRF is designed to favour lower-income and vulnerable countries as well as those particularly hard-hit by the pandemic. Eventually, in the mid to long run, it might make additional fiscal space especially for relatively high indebted MS (like Croatia).
However, aware that the expected positive impact are based on models made under certain assumptions (that cannot be taken for granted) the final and real impacts will depend on the capacity of member states to absorb and properly use the financial support. Additionally, the functioning of industrial supply chains, the availability and skills of the workforce and other factors dependent on various policies (e.g. fiscal or labour market policies) are further challenges the final outcome will depend on.
All in all the plan is a very important step for the CE/SEE countries to continue the post-pandemic recovery, to build higher resilience to any future crises, and accelerate the transition in the areas that will shape Europe in the next decades.
*This text was first published as part of the publication: CEE Insights: NGEU as a generous source plus great opportunity for EU & CE/SEE (raiffeisenresearch.com)