Industrial Policy and Budgetary Constraints: The Financial Agenda for the EU After the Elections

The economic policy issue that seems to have the highest priority at the European level is the return of industrial policy, modulated across overlapping narratives and objectives. These include competitiveness, the green and digital transitions, along with strategic autonomy that has now also expanded to encompass security and the defense industry as a result of rising geopolitical tensions.

Instead of focusing on industrial policy, however, the Economic and Financial Affairs Council (ECOFIN) – which brings together finance ministers – will discuss its financing, governance and macroeconomic repercussions.

The Risks of Industrial Policy

The International Monetary Fund published a survey of the world's industrial policies in 2023, indicating the risks that deserve attention. The first is that global economic fragmentation of trade and production creates inefficiencies and negatively impacts overall growth potential.

Another risk is misallocation of resources, especially if public funds are not used to remedy market failures. These are easy to spot for the green transition, for example, but less so for the digital transition, with the exception of public administration digitalization.

In addition, industrial policies adopted in retaliation for the choices made by other countries can trigger an escalation of costly measures, which end up canceling each other out in terms of relative competitiveness.

Various interest groups can also exert pressure to influence the allocation of funds, diverting them from actual economic and industrial revitalization purposes. The aim is to favor political consensus purposes, often to the benefit of already established companies.

In addition to these globally relevant issues, there are also the specific implications of the return of industrial policy for the European Union and the Eurozone. It is by no means certain that reducing economic interdependencies will diminish geopolitical tensions. On the contrary, it could be argued that interdependencies, which are rarely unidirectional, enhance shared interests and make dialogue and agreement-seeking more fruitful than open confrontation.

If, however, the direction of economic policy aims to reduce interdependencies, the extent to which the European economic model works towards that objective would also need to be analyzed. 

Consider the Eurozone's trade balance, which increased after the sovereign debt crisis of 2010-2012 and has been in constant surplus. Then it recorded its first significant deficit in 2022, due to the war in Ukraine and the increase in energy prices. In 2023, the Eurozone already returned to its traditional surplus, which will grow sharply in 2024. 

Systematic surplus implies a dependence on foreign demand, which can become a vulnerability at a time of rising geopolitical tensions. However, the overall surplus of the Eurozone, although significant (about 2.5-3% of GDP in the years 2015-2019, before the pandemic and the energy crisis), does not reflect the scale of the magnitude of risk. It is greater than it appears due to the very differentiated situation of the countries and the institutional weaknesses that do not allow a timely and effective management of asymmetric shocks that can then infect the entire area.

The overall vision at the EU or Eurozone level does not convey the complexities to be faced in the upcoming season of economic policy, which will focus on public spending to govern changes in industry and manufacturing.

The EU’s economic policy in the 2000s and up to the pandemic crisis was based on containing public expenditure, accompanied by pressure to adopt structural reforms to increase competitiveness. The discontinuity with the new attitude is marked.

As the laborious management of the Next Generation EU (NGEU) plan demonstrates, countries do not always have the institutional and professional resources to develop and then implement these kinds of spending programs, and even European institutions struggle to make up for shortcomings in activities that are new even to them.

But above all, the institutional infrastructure – made up of rules, processes and responsibilities – is weak. 

ECOFIN’s Dilemmas

ECOFIN's field of view includes financing spending policies and related governance.

It is inherently doubtful whether starting a season of fiscal activism – with a marked increase in public spending on industrial policies – is a recommendable choice, both in general and for Europe. Managing public spending with the same tools that Europe has today could produce dangerous side effects for the very stability of the EU.

The lack of common fiscal capacity is the first issue that emerges. With decentralized fiscal resources alone, it is difficult to imagine a coherent and functional industrial policy program for the whole of the EU. Each country would claim a strong autonomy in identifying the priorities for which to use its budget resources, to the detriment of coordination at the European level.

In addition, the strong asymmetries between EU countries in terms of competitiveness (needs) and fiscal space (means) are well known. In addition to incoherence and dysfunctionality, this would entail serious risks for the functioning of the internal market and the stability of the Eurozone, and therefore of the EU itself.

What to Make of Next Generation EU

The common fiscal capacity that was created during the pandemic to manage the risks associated with asymmetries between countries expires in 2026. ECOFIN therefore has to face two political issues: whether the 2026 deadline can be postponed, and whether a new joint spending and redistribution program can be configured as a follow-up to the NGEU. The latter has much broader implications than the former. With the NGEU, an institutional infrastructure has been created that can certainly be improved upon, but it is also necessary for the medium- and long-term prospects of the EU. 

After years of inconclusive debate on economic policy, with traces of financial engineering (does anyone remember the "blue/red bonds"?), the European Union has a permanent presence on the capital market with its own safe asset or Eurobond, if it can be called that. 

This is only one component of the NGEU that conveys the extent of the institutional investment that has been made, and, consequently, the squandering of political capital, credibility and resources that would occur if the infrastructure built up with the NGEU were dismantled. The debate on this point has the greatest degree of political difficulty, as it always does when it comes to the mutualization of risks and burdens. In some so-called frugal countries, political and legal constraints were already in place at the time of the approval of the NGEU to prevent the experiment from being repeated in the future. The German Constitutional Court has set stringent limits, including quantitative limits, for debt-financed programs such as the NGEU. Moreover, public opinion in the various EU countries has distant and even opposing trends.

The European Investment Bank (EIB) is one of the EU’s instruments for sharing resources and redistributing them to pursue common goals. The new President, Nadia Calviño, has proposed increasing the so-called "gearing ratio", the ratio between the EIB's capital endowment and the size of its balance sheet, or, in other words, the EIB's ability to borrow resources for financing. Even this proposal, which is important but less demanding than the renewal of the NGEU, is currently nowhere near achieving the necessary political consensus. 

Debt Is Not Enough 

The unavoidable complement to common spending capacity is the finding of resources. It would be a serious mistake to assume that common debt solves the problem of resources, without clarifying how the debt is to be repaid and what responsibilities it entails for taxpayers, countries and institutions. For example, assuming that common debt can simply be added to domestic debt, including for the countries with the most fragile fiscal situation. However, it would be not only a mistake, but – more importantly – it would be a way to block any political discussion. 

Common spending capacity, with necessary flexibility due to the use of debt, must be supported by the resources of the EU budget. This in turn is fueled by transfers from Member States, which are divided between net contributors and net beneficiaries. 

Even a possible increase in so-called own resources, i.e. taxes collected directly by the EU, would in any case call into question national resources. This is because these taxes would affect the tax burden and, depending on their amount, would lead to a reshaping of the countries’ tax revenues.

The issue of rebalancing public finances will therefore remain central even after the European elections. 

translated by Jenna Walker