The opportunity Europe should not waste

Do the NextGenerationEU funds hold up to their promise to make Europe’s economies stronger and more resilient? Two years into the lifetime of the programme, the European Central Bank (ECB) Blog assesses where governments stand and what risks there are for implementation.

NextGenerationEU (NGEU) can really make a difference for European economies. ECB staff estimate that, if fully implemented, NGEU may increase the level of real gross domestic product (GDP) in the euro area – on which this blog focuses – by up to 1.5% by 2026. This makes quite a difference as it will lift the growth prospects further on.

The potential boost comes via two primary channels:

  • Money for investment – euro area governments plan to draw more than €417 billion in EU grants and loans from the Recovery and Resilience Facility (RRF) – the cornerstone of NGEU – in the period 2021-2026. Around 80% of these resources are intended to fund investment projects.
  • Incentives for better economic structures – the RRF links its disbursements to qualitative milestones and quantitative targets, of which 1,620 are related to structural reforms in euro area countries.

Already today, the implementation of the national Recovery and Resilience Plans (RRPs) is producing material benefits to the European citizens. These include savings in energy consumption, additional capacity for renewable energy, promoting digital products and services, modernisation of the public administration, as well as the creation of new infrastructure for transport, healthcare, and education.

NGEU’s impact is expected to be larger in the main beneficiary countries, such as Italy and Spain. All European countries are expected to benefit through positive trade and confidence effects, greater economic resilience, increased convergence across countries and, very importantly, a significant boost to the green transition and digital transformation.

And yet, NGEU can only reach its full potential if all national reform and investment plans are implemented in a timely, efficient, and effective way. Hence the question: two years after its adoption, is NGEU delivering on its roadmap?

Timely implementation is at risk

The RRF disbursements to euro area countries have so far reached €130 billion. This amounts to more than 30% of the total envelope expected to be requested by these countries in the period 2021-2026. In 2021-2022, 14 euro area members made 22 payment requests under the RRF, of which 12 were approved. While by the end of 2022 only 7% of milestones and targets had been completed in the whole EU, this share reached 22% in Spain and France, and 18% in Italy.

While this shows that NGEU is making good progress, there are also some delays. Why is this?

First, several euro area countries have postponed their disbursement requests. In some cases the required structural reforms were delayed, and as these are preconditions for paying out the funds, there has been a knock-on effect on the schedule for payments.

Second, some countries have postponed their investments funded by the RRF. This is illustrated in Chart 1, which reports aggregate estimates of the annual deviation of NGEU-funded government expenditure compared with the initial Recovery and Resilience Plans (RRPs). Negative values indicate underspending. The chart shows that in 2021 and 2022 the NGEU expenditure plans were not executed completely. Forecasts for 2023-2026 indicate that Member States plan to catch up on investment objectives in the remaining years of the NGEU, notably in 2025.

Given the large amounts foreseen, the delays in the past two years will test the countries’ capacity to fully absorb the RRF funds by the end of the programme in 2026.

Two main categories of NGEU implementation risks are detected in virtually all euro area countries. First, the energy crisis and higher inflation have been raising new challenges. Procurement contracts and public tenders often need to be revised due to higher inflation. The persistence of supply bottlenecks – that is, problems to access the necessary materials, equipment, and skilled workers – has also created hurdles. The second key driver is limitations in administrative capacity and political hurdles, such as:

  • deficiencies in the coordination between central/federal and local authorities;
  • inadequate technical expertise in the public administration;
  • too complex administrative practices and insufficient fast track procedures when needed;
  • insufficient quality of monitoring and controls, auditing, and impact assessment; and
  • low political consensus on some critical measure.

Policymakers need to step up their efforts to address these shortfalls. The quality and capacity of public administration, including public financial management, is itself a key area for reform projects in the RRPs of Member States with lower administrative capacity.

Past country performances in the absorption of EU funds offer a cautionary tale. By the end of 2020, no more than 60% of EU funds under the 2014-2020 Multiannual Financial Framework had been absorbed in the four biggest euro area countries. In the previous period 2007-2013, a grace period of another three years was required before a share of funds closer to 100% could be absorbed (Chart 2, dotted lines). The question, therefore, arises whether the six-year horizon of NGEU will be sufficient to absorb much bigger – and by now to some extent already backloaded – EU funds along the foreseen path shown in Chart 2 (see solid lines).

It is, therefore, too early to draw any firm conclusions on the implementation of NGEU. To be sure, 2023 will be a crucial year to scrutinise on both fronts of investment and reforms.

NGEU as a test for further EU integration

A successful NGEU may reinforce the case for a permanent central fiscal capacity for investment in European public goods such as climate change mitigation, energy autonomy, security, and the digital transformation. A European fiscal capacity, if properly designed, could also play a role in enhancing macroeconomic stabilisation and convergence in the euro area in the longer run.

By linking EU funding to the implementation of nationally owned structural reforms, NGEU is also pioneering an innovative, more integrated approach to EU economic governance. This approach recognises that reforms, investment, and fiscal sustainability are mutually reinforcing and should be better incorporated in fiscal and macro-structural surveillance.

NGEU is a once-in-a-generation opportunity for Europe in a double meaning. Only a successful and timely implementation will keep the promise of making our economies stronger and more resilient. And at the same time and if successful, NGEU could become a role model for further economic integration in the European Union. It is an opportunity Europe should not miss.

Source: The ECB Blog