The European Commission budget: Old show with new twists

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Economics and politics, freely, 13 February 2020

Crunch time is coming in Brussels. Soon, the European Council – consisting of the heads of state and government – will have to decide on the Commission’s budget for the next five years. Because the Commission has few resources of its own, it relies on member governments for its income, and governments are keen to shape its spending as well. With so many players, there is wide room for high drama and late-night agreements. In addition to the usual issues, a few new ones are popping up.

Brexit means that there will be one less contributor. There will be one less receiver too, but the UK used to pay more than it received (to the tune of some €7 billion in 2018). Out of a total budget of €148 billion, this is a sizeable hole (which was dutifully noted, and sometimes vastly inflated, during the Brexit referendum campaign). In addition, the new president, Ursula von der Leyen, has staked her leadership on a big Green New Deal, complete with a stack of money. Less income and more spending is a recipe for trouble. In addition, in the wake of Brexit, EU membership has lost some of its shine and several Central and Eastern European countries are challenging old rules, including on judicial independence and solidarity regarding immigration.

These new issues will bring to the fore the older ones. The two classic sources of disagreement concern the size of the budget and who gets what. Quite naturally, the Commission wants more money and the member states want to keep their monies. For many years, the budget was capped at about 1% of EU GDP. The departing Commission has proposed to raise the budget to 1.1%; many governments think that 1% is enough. The debate is not really about the 0.1% difference. It is about creating a precedent – doing away with the 1% ceiling – and about what the money is used for.

Most spending goes to the Common Agricultural Policy (CAP) and to transfers from the richer to the poorer countries. Both are widely seen as inefficient, sometimes even subject to corruption. It would seem natural to reduce these programmes to adjust to the post-Brexit situation and to make room for the Green New Deal. That is not how things are done in Brussels, though. CAP has become an entitlement to both farmers and to those countries that benefit most from it. Don’t expect the beneficiaries to give up the money.

The transfers are meant to foster convergence of living standards in the poorer countries to those of the richer ones. Countless number of studies have failed to demonstrate success; some find success, others no effect and some a negative effect. If it clearly worked, it would have been detected. An unmistakable symptom of unease is the change in vocabulary. Initially labelled ‘structural funds’, then ‘cohesion funds’ and later “’sustainable growth’, they are now called ‘smart and inclusive growth’. No one is fooled.

The lack of effectiveness is not surprising, in fact. Why should the richer countries make gifts to the poorer countries, year after year? One argument is solidarity, which is understandable but unrelated to faster growth. The other argument is that the less-developed parts of the EU need to accelerate investment in public services, education and productive equipment. This is undoubtedly true, but it does not necessarily imply transfers among states. In principle, the Single Market is meant to promote convergence through the free flow of goods, people and capital. Thanks to the free flow of capital, a country that lacks the resources needed for investments can borrow what it needs from the rest of the EU. As a poorer country engages in trade and develops its economy, foreign financing should be flowing in, provided it is well used. Gifts could come on top, provided again that they are well used. An indication that resources are being put to wise use is that foreign borrowing and transfers go hand in hand. This is not what we observe.

Source: European Commission.

The figure above displays net transfers from the EU budget in 2018 (receipts over payments) on the vertical axis and, on the horizontal axis, the current account, both as a percentage of national GDP. The current account measures net national saving, the sum of private and public saving less public and private investment. As intended, the transfers go to the poorer EU member countries – those from Central and Eastern Europe as well as Greece and Portugal. The transfers are quite sizeable, reaching up to 4% of the recipient country’s GDP. With few exceptions, however, the current accounts of these countries are positive or nil. They do not borrow abroad. Some (those with current account surpluses) even lend to the rest of the world. Either they don’t need to borrow, as they struggle to absorb the mana from Brussels, or they are not attractive enough to external investors. Both interpretations – which they reject, of course – suggest that the transfers are not needed and, quite possibly, that this is not money well spent.

As long as significant chunks of the EU budget are likely to be wasteful, it is difficult to vouch for a budget increase and for new programmes. This is where politics come in. The transfers are officially not sent to countries, but to regions. All countries have managed to have some regions recognised as poor, so they all receive some gifts. Phasing out these funds, or just reducing their size, would pit countries against one another, regions against one another within countries, and all countries against the Commission, which draws power and influence from dishing out its money.

If the transfers remain, keeping money flowing your way is what drives negotiations. Always and everywhere, budget decisions are messy. Within the EU they are even messier because there are more interests to reckon with, most of which are directly present in the European Council. This year, it stands to be even worse than usual. The most likely outcome will be small variations around the status quo, which would be pretty awful.