A Hamiltonian moment for Europe? Demystifying Next Generation EU and the EU’s recovery funds

The Next Generation EU (NGEU) programme represents a milestone towards fiscal mutuality against common shocks in the EU, changing the way the Union finances itself. This is why the LSE European Institute hosted a panel event aimed at bringing together experts from a wide array of experiences to explore the design and implementation of the NGEU, weighing the positives against the negatives.

In this blog, Renato Giacon and Corrado Macchiarelli give an account of the discussion that took place on March 9, 2022, at LSE.

The Next Generation EU programme is changing the way the EU finances itself as never had the European Commission borrowed at such large scale and long maturities on financial markets. Meanwhile, six EU Member States (Italy, Greece, Romania, Portugal, Slovenia and Cyprus) have decided to make the leap of faith and have included a formal request for concessional loans in their adopted Recovery and Resilience Plans, counting to overcome their large funding needs post Covid-19 but also a decade of low investment expenditure.

The LSE European Institute organised a panel discussion, focussing on how NGEU and the EU Recovery Fund (EU-RRF) should be designed and implemented to (i) better focus on effective, efficient, equitable and sustainable ways of spending EU and national money for bankable projects; (ii) successfully mobilise private sector funding from institutional investors, International Financial Institutions (IFIs) and commercial banks; and (iii) deliver the promised medium to long-term benefits in terms of economic convergence, complexity and higher growth patterns that EU countries can derive from it.

The national Recovery and Resilience Plans (RRPs) - that each EU Member State (MS) is asked to compile and stick to - are embedded in the European Semester, the EU’s framework for economic policy coordination, with grants and loans’ payments to EU MSs released only upon the successful implementation of performance-based milestones. These are defined both in terms of investments and reforms, with the additional request to achieve ambitious green and digital targets. Such an enhanced policy steering at the EU level must balance different national agendas driven by often competing political economy needs. The mechanism represents a strong external market discipline both in the funding and the investment framework, which finds a precedent only in the experience of some EU countries such as Greece under the Enhanced Surveillance Framework post-2010.

The discussion opened with the remarks of Ines Rocha (EBRD) who built her intervention on the operational insights provided by the active role of the European Bank for Reconstruction and Development (EBRD) in the implementation of the NGEU programme and the deployment of the Recovery Funds. She made the point that large RRF grant-funded projects are usually included ex-ante in countries’ RR Plans, while smaller projects that are part of broader investment programmes might be selected through public tenders or similar procedures. Private sector projects to be financed via RRF loans mainly depend on the IFIs, national promotional banks and commercial banks’ pipelines, creating an important private sector-led investment stream in the implementation of the programme.

Furthermore, EU countries - which have requested EBRD engagement in the delivery of their RRPs - have recognised that EBRD is strategically aligned in its own priorities and country strategies with the national Recovery Plans. The EBRD can assist the countries in delivering policy objectives and leverage the EU recovery grants and loans by attracting other private co-financiers to facilitate successful programme delivery.

The most typical sectors of EBRD intervention include the areas of:

  • Green growth (such as financing renewable energy, electricity storage projects, hydrogen production, green cities, clean mobility and energy-efficient buildings’ renovation)
  • Accelerating the digital transformation (5G, gigabit networks and fibre optic networks, broadband projects, digital upskilling and reskilling programmes, support for the digitalisation of businesses with a particular focus on SMEs, start-ups & greater cloud usage) 
  • Financing R&D and innovation projects outside the digital sector such as in the field of climate innovation (i.e. fertilisers, cement sectors).

She ended her intervention by pointing out that the most concrete EBRD engagement under the Recovery Funds so far has been in Greece through the Corporate Loan Facility. The programme will combine up to €500 million of RRF concessional loans managed by the EBRD, up to €500 million of EBRD commercial own-resources financing and financing from private investors and commercial banks. The EBRD signed an Operational Agreement with the Greek Ministry of Finance in November 2021. From the point of view of project structuring, the Greek RRF Facility is unique insofar promotes financial discipline by private sector final beneficiaries which have to pay back the loans, encourages proper risk assessment by market players in the absence of Greek state guarantees and leverages RRF funds through co-financing with private sector funding sources.

Some of these points were picked up by Professor Anthony Bartzokas (LSE Hellenic Observatory and the University of Athens), who singled out the NGEU as a new important tool to support investment recovery in the EU, funded through the Commission’s borrowing on the capital markets. Furthermore, he emphasized the early positive signals from markets with NGEU-related announcements already demonstrating a significant spread-compressing effect on euro area sovereign borrowing costs. In addition, Bartzokas recognised in his intervention that the investment stimulus provided by the EU recovery funds includes fine-tuning opportunities in response to concerns about European resilience, especially at a time of elevated geopolitical risk and green transition uncertainties such as the current one.

He continued by identifying a few possible implementation gaps in the EU Recovery Funds linked to the focus on thematic clusters with limited microeconomics considerations, the need for detailed cost justifications during project cycles, and overlaps vs. complementarities with the European Structural and Investment Funds (ESIFs) and EU cohesion policy. Particularly, he highlighted how the experience of ESIFs and other existing EU funding programmes has already driven the evolution of investment decisions of different policy institutions at different governance levels (i.e., European Commission, the EU member states, IFIs and private sector’s financiers) and advocated a similar learning process in the governance processes of the EU-RRF. Finally, he underlined some legacy issues identified from the EU Cohesion Policy experience in the academic literature, including the lack of timely implementation, limited project upstreaming capacity and a funding substitution effect for the national budgetary component, as important priority areas for the monitoring function of the EU-RRF in the implementation phase.

Vedrana Jelusic Kasic (Privredna banka Zagreb) brought a private sector experience to the panel, both in her role in the Management Board of Croatia’s second-largest commercial bank and former regional Director at EBRD with the lead on projects in Croatia, Slovenia, Hungary and Slovakia. She shared her direct experience co-financing with the ESIFs and provided insights on how the new EU-RRF will be different in terms of effectiveness, efficiency and sustainability.

She highlighted how the past experiences with EU funds had not always delivered to the initial expectations due to a combination of various reasons, such as:

  • Cumbersome reporting requirements
  • Lack of coordination between EU co-funded programmes and the national programmes
  • A lack of bankable projects which would have required a need of technical assistance funding for project preparation and implementation support
  • A legacy of poor absorption capacity from Managing Authorities which would have required improvements in the quality of government and the enhancement of administrative capacity
  • A realisation that the type of expenditures under European Funds had often given priority to basic infrastructure projects, instead of also trying to prioritize the advancement and reconstruction of the productive environment and the support of investments.

However, she also offered a positive way forward in pointing out that the experience with EU funds in the previous EU budget has served as a lesson in the design of the new EU-RRF which have a few in-built advantages that need to be translated from design to implementation. The release of funds is performance-based with a clear set of reforms and investments’ milestones which create clear incentives for EU MSs to deliver on their EU-RRF commitments. Secondly, the funds focus on two clear strategic priorities, the green and digital agenda, which are aligned with the key implementing partners’ agendas and should avoid “spreading the funds too thin” on the ground. Finally, EU-RRF leaves autonomy to the EU MSs to set their own country-specific reform and investment priorities, while letting implementing partners set up their financial structures at the operational and implementation level.

Finally, Dr Frank Neffke (Complexity Science Hub Vienna, Growth Lab Associate) focused on economic complexity and the lessons of economic geography as a cornerstone of economic recovery and growth in the post-Covid-19 EU. He made the point that geography still matters, especially for trade and FDIs flows. He highlighted how "path-breaking growth" would often require the ability of attracting high-skill workers, as well as the ability to generate return migration: low skill workers that move from advanced to less advanced economies (e.g., Albanian return migrants from Greece; Yugoslavian returnees from Germany, etc.). FDIs could help the required investment in skills where foreign firms could help kickstart new tech hubs. In that sense, the mix of policy reforms and higher investment volumes through EU-RRF should be able to increase economic complexity.

He finally pointed out that lessons a sustained and sustainable economic recovery should include priorities such as:

  • A transition to a green economy that leverages the capabilities that currently exist and are used already in their economies
  • Investments in skills and skill ecosystems
  • An exploration of local economies’ "adjacent possibles"
  • Aiming for higher complexity
  • Focus on connectivity & digitization, return migration and smart inward FDIs

To conclude, there are a number of points worth emphasising about the status and design of Next Generation EU and the EU’s recovery funds. First, this new EU initiative brings together three relevant and interrelated dimensions of consensus-building (fiscal, rule of law, and policy priorities around green and digital). Second, it is innovative insofar as it is strictly tied to an ongoing monitoring and conditionality mechanism of tranches of EU funds being disbursed upon the achievement of clear milestones.

Third, it is timely as it opens the way to other future large scale European Commission borrowing plans, including as part of a response to current EU energy and defence investment needs following Russia’s invasion of Ukraine. Fourth, it highlights the agency and ownership of national authorities in the design and implementation of their national plans but also their reliance on international financial institutions such as the EBRD for co-financing with their own balance sheet, mobilising private financing, managing technical assistance and helping with unlocking policy reforms.

Fifth, it will help EU member states (like Greece) to achieve higher economic complexity, facilitate further integration in European supply chains, invest in skills and ecosystems, and to explore the appropriate green capabilities and attract foreign direct investment.

Sixth, it shows how policymakers in Southern European countries such as Greece, Spain, Italy and Portugal have reflected on lessons learned from the previous euro area sovereign debt crisis, taking reforms and investment milestones seriously and moving ahead of the EU pack in the implementation of their Recovery and Resilience Plans and further disbursements of Recovery and Resilience Facility tranches.

These countries have been the first cohort of EU member states whose plans have been approved by the EU Council. Spain, France, Italy and Greece have all also received the European Commission’s positive preliminary assessments of their second payment requests based on the achievement of several milestones which cover reforms and investments in various areas (energy efficiency, electric mobility, waste management, labour market, taxation, business environment, pensions, healthcare, public transport, and many others).

Finally, and as a counterpoint, special attention ought to be paid to some Central and Eastern European countries where investment needs are high but there are still some delays in the implementation of the plans and the flow of new funds into their economies. Given past problems of scarce absorption capacity and bankable projects, the role of international financial institutions such as the EBRD as well as the European Investment Bank and national promotional banks has become increasingly linked to the success of this new pan-European funding and policy initiative, at a scale unheard of in the history of the EU.

This blog was originally published on LSE EUROPP.