It’s the Economy, stupid!

Every month, TEPSA Secretary-General Jim Cloos writes a newsletter editorial on the news of the day, the future of Europe, and the work of the TEPSA network. To receive every upcoming editorial direct to your inbox, SUBSCRIBE to the TEPSA Newsletter here.

The economy will be one of the two big themes at the special European Council of 9 and 10 February. The Russian war in Ukraine is not only about geo-politics, it is also about geo-economics. Coming after the global COVID-19 crisis, it has had far-reaching consequences that need to be tackled. The leaders will hold a much-needed in-depth discussion on the inter-linked challenges facing the EU in this respect.

The first one relates to the impact of the higher energy prices on our productivity (measuring the economic output per unit of input, including energy) and competitiveness (measuring a country’s export ability compared to imports). Spiraling energy prices affect the capacity to attract investment and will keep Europe at a competitive disadvantage both vis-à-vis China and the US. China benefits from discounted prices offered by the Russians, while the US is self-sufficient in energy and exports increasing amounts of LNG to Europe, at prices that are much higher than what the Europeans used to pay for Russian gas.

The good news is that Europe has managed to bring demand down: efforts by European households and businesses to use less gas — encouraged by the voluntary 15% reduction target set by the EU — have helped. Moves by industrial consumers to switch fuels and find efficiencies have also paid off, leading to a 20% cut in demand in the latter half of 2022, compared with the same period the year before. Europe has rapidly learned to live with dwindling amounts of Russian gas after Moscow slashed its pipeline exports last year. As a result, natural gas prices are today nearly 80% below their all-time August high of €346 per megawatt hour; this is far below the triggering level of €180 euros/MWh for the recently adopted “market correction” mechanism to kick into action.

The bad news is that even so, they remain historically high, which shows that the problem is a more structural one. Switching producers and products will remain cost intensive. A pipeline outage in Norway, or a drop in US exports caused by extreme weather, could feasibly trigger a price spike. A strong recovery in demand in China, which recently ditched its strict zero-COVID policy, could also push prices higher again. It is still difficult to see how alternative gas supplies in anything like the volumes Europe used to take from Russia will be available at affordable prices. New LNG export capacity and LNG infrastructure in Europe will take time. A recent report from the IEA found that Europe could face a natural gas shortage of twenty-seven billion cubic meters in 2023; that is equivalent to some 7% of the region’s annual consumption. The IEA stress test assumes that Russian pipeline gas flows to Europe stop completely from the start of 2023, that China’s imports of liquified natural gas return to 2021 levels and that Europe’s storage facilities are just 30% full at the end of this winter. That means Europe could face severely constrained growth prospects for years to come.

The problem is compounded by the American IRA (Inflation Reduction Act). This act is a welcome development in that it highlights the need to fight climate change, but the manner is problematic, since it excludes, at least for the time being, European-based companies as potential beneficiaries of the subsidies and could promote industrial relocation from Europe to the States. There is no easy solution to this: taking retaliatory measures could lead to a damaging trade war, while imitating the American approach may cause a race towards subsidies that will distort the world economy even further. Various Member States have differing views. We have a long tradition of opposing camps when it comes to economic governance and trade. This will be a difficult debate.

The second challenge has to do with the level playing field within the EU. As a result of the various crises that have hit us over the last 15 years, the Commission, supported by the Council, has repeatedly softened the anti-State aid rules, using Article 107 (3) (b) TFEU; the latter enables the Commission to approve national support measures to remedy a serious disturbance to the economy of Member States. It adopted a first State aid Temporary Crisis Framework at the time of the subprime crisis in 2008. The same happened again in March 2020. The new framework led, according to public figures provided by the Commission, to the approval of national aids amounting to a staggering 3 trillion euros or 21% of the EU’s annual GDP. Germany alone accounted for 53% of all the State aids authorized (44,4% of its GDP!), France for 14,5% and Italy for 15,4 %. The Russian invasion of Ukraine triggered the set-up of a yet another Temporary Framework, linking it to the RePowerEU plan objectives and allowing to tackle the issue of high energy prices. So far, the amounts mobilized represent 672 billion euros, out which 356 billion in Germany, 162 in France and 51 in Italy.

The rationale behind this approach is compelling. The problem though is that State aids create imbalances between countries. Heavily indebted countries have far less margin of maneuver: if they follow suit, their debt levels explode, and if they do not, their economy takes the hit. There is also a problem for ‘liberal’ countries that could afford giving State aids but do not believe that this is the best way to manage the economy; hence the low figures of State aids compared to their respective GDPs of countries like Austria (0,0% under COVID and 0,30% under the latest framework), the Netherlands (4,55% respectively 1,36%), and Sweden (3,64% and 0,03%). It is crucial to avoid jeopardizing the level playing field within the EU as a result of hugely differing national State aids. During the COVID-19 crisis, one of the key measures to counter this threat was the creation of the Resilience and Recovery Fund of EUR 750 billion. It is entirely logical to reflect on a possible new Investment Fund to counter the damaging effects of the Russian war in Ukraine. It will not be easy, however, to achieve unanimity on such a new fund. The Dutch Prime Minister has already voiced strong opposition to the idea, and other ‘frugals’ are likely to follow.

The debate in February will focus on those two challenges. But there is a third major issue that needs addressing. It is closely linked to the preceding one; it concerns economic governance and the future of the Stability and Growth Pact (SGP). As a result of the crises since 2008, the SGP has over the years been applied with increased ‘flexibility’. Over the past twelve months, hundreds of billions more funds have been provided to help shield consumers from painful rises to their energy bills.  The general escape clause of the Stability and Growth Pact, in place since the spring of 2020 at the time of the outbreak of the COVID-19 pandemic, has been prolonged until the end of 2023.

Everybody understands the need to take extraordinary measures in a time of crisis. But sooner or later you must revert to a more fiscally responsible position if you do not want to risk damaging long term effects. All the major financial crises of the past have erupted as a result of excess borrowing in some countries, the rapid increase in vulnerability hidden by easy financing conditions, which then spread even to countries with a less profligate approach. Maybe the US, because of the predominance of the dollar, can afford to defy the laws of financial gravity, we cannot. That is why recurrent escape clauses from fiscal discipline cannot continue indefinitely. The EU is right to reflect on making the SGP both more flexible and more enforceable. It is also important to advance more decisively towards a full Banking and Capital Markets Union. While the EU has drawn the lessons from the subprime crisis and reacted much faster and more decisively this time, much remains to be done to ensure sustainable growth and finances and increase our resilience.

The leaders will have a lot on their plates in a few days’ time. The more so since on top of the issues mentioned here they will no doubt touch on related major themes like the search for more strategic autonomy across all policy areas and the future of our trade policy. One meeting, even a special one, will not be enough to tackle such an array of issues. This is an ongoing process. Expecting spectacular breakthroughs at each meeting of the EUCO is either very naïve, -failing to understand the magnitude of the challenges-, or very cynical, -looking for easy arguments to rubbish the EU. We should be neither.

Jim Cloos, TEPSA Secretary-General