As a symbol of Europe’s ambitions, Princess Elisabeth Island is hard to beat.
The concrete platform off the coast of Belgium is unlikely to win awards for beauty. But the project, billed as the world’s first artificial energy island, is quietly revolutionary — an energy hub designed to connect offshore wind farms in the North Sea to Belgium’s electricity grid, and one day deliver clean energy across the continent.
Named after Belgium’s future queen, it is a piece of energy infrastructure that fulfils the European Union’s aspirations to innovate and invest in a greener future, with backing from the bloc’s unique post-pandemic recovery fund that came into force three years ago.
However, the funding from Brussels is being held up by a dispute between Belgium and the EU over pension reforms — making Princess Elisabeth island an emblem not just of Europe’s ambitions but also of the bureaucratic and logistical problems that are hampering its showpiece fund and limiting the bloc’s long-term ambitions.
The Next Generation EU fund, which includes the Recovery and Resilience Facility, was agreed in 2020 but came into force in February 2021 at the height of the Covid-19 pandemic.
Member states unanimously agreed to jointly underwrite €800bn of debt to meet two broad objectives: to both jolt their ailing economies out of the lockdown-induced recession and also to invest in shared priorities such as climate change and digitalisation to kindle sustainable growth.
Ursula von der Leyen, president of the commission, described the flagship policy as a unique opportunity “to invest in a collective recovery and a common future.”
But the funds came with a countdown clock. Reaching an agreement to issue common debt at an unprecedented scale was only possible on the premise that the fund would be a one-off, time-limited experiment that would end in 2026.
The first objective was by most measures a success. The agreement, alongside an emergency bond-buying programme by the European Central Bank and the relaxation of spending and state aid rules, had an immediate calming effect on markets, avoiding an economic meltdown.
As a result, the EU reached pre-pandemic levels of growth in under two years. In 2022, the bloc grew faster than the US and China and the fund’s largest beneficiaries, Italy and Spain, outperformed the EU average.
The ratio of public investment to gross domestic product increased on an aggregate level from 3 per cent in 2019 to 3.2 per cent in 2022, according to the commission.
“We saved our economy especially from the threat of what could have been a great divergence,” EU economy commissioner Paolo Gentiloni says. “The rebound was impressive.”
But as the fund reaches its halfway point, the second objective of stoking future growth is looking less and less likely to be met. The fund’s implementation is lagging behind: disagreements between capitals and Brussels over reforms have held up payments, and investments were delayed or downsized due to inflation. To date, only a third of the funds have been disbursed.
Back in 2020, the commission estimated recovery support would add an average of 1.9 per cent to GDP in 2022. But the boost was much smaller at 0.4 per cent, according to a midterm report by the commission to be published on Wednesday.
Analysis by Goldman Sachs suggests that, for the top four EU economies — Germany, France, Italy and Spain — the impact on output of recovery grants is in the range of decimals, and will turn negative as the fund tapers out. The challenge would be to turn the immediate impact into permanently higher levels of growth.
“This is a very important plan,” says Filippo Taddei, senior European economist at Goldman Sachs, pointing to its potential to increase long-term growth by investing in things that have an impact on the level of productivity. But, he cautions, “that’s it. We’re talking about an increase in decimals.”
The extent to which the funds can be unlocked is likely to determine whether common EU funding is a one-off experiment, as some member states hope, or if it will become a tool that its advocates believe will secure Europe’s place among top world economies.
In recent years, Europe’s economic engine has failed to keep up with those of China and the US. The Biden administration’s Inflation Reduction Act, which was passed after the Next Generation EU fund, allows for $386bn investments in climate change and decarbonisation mostly through tax credit and has fueled a global subsidy race. The recovery fund was intended to give Europe the means to keep pace in that contest — but some question the desire.
“For the longest time, the discussion in Europe was about how a lack of funding would prevent structural change,” says Taddei. “Now that funding is available, it remains to be seen whether there’s a will to commit to its execution.”
Naturally, the commission has defended the fund’s performance, arguing that the lower than hoped for boost is to due to Russia’s full-scale invasion of Ukraine and the ensuing energy crisis.
“Eleven out of 27 member states were in recession [in 2023], not because Next Generation EU was not helpful, but because the war changed everything in the economic environment in Europe,” says Gentiloni.
In response to the war, the EU repurposed its recovery fund to accelerate energy independence from imports from Russia, and allocated an additional €20bn in grants for green infrastructure, such as the Belgian energy island.
Another reason is that many governments backdated investments, in effect replacing national expenditure with EU funds — something allowed under the fund’s rules as long as these comply with its objectives, but which reduced the additional growth effect.
“Some of the projects allowed in the recovery fund are investments that governments would have done anyway,” says Peter Vanden Houte, chief economist for Belgium and Luxembourg at ING.
“If it would have been completely additional investments, then you would have had a somewhat bigger growth impact.”
A further reason lies in the way the fund is structured. Countries would receive billions in grants and loans only if they met reform and investment targets — negotiated with the EU — ranging from upgrading public infrastructure to overhauling pension systems, with those hardest hit by the pandemic benefiting the most.
Conditioning payouts on such reforms proved successful in obtaining long-delayed policy changes such as an overhaul of public administration in Italy, and the labour market in Spain.
The European Commission calculates that the share of reforms recommended by Brussels that were taken up by EU countries rose from 52 per cent in 2021 to 69 per cent in 2023 as the fund started being implemented. “This common funding . . . added teeth to the commission’s co-ordination role,” says Gentiloni.
But in other cases, including in Belgium, reforms proved to be a stumbling block and held up payments.
The Belgian government agreed last July to bring in changes to its pension system to pave the way for the release of funds that would go towards projects including Princess Elisabeth Island. But the commission disputes whether they go far enough in reducing the weight of pensions on public finances.
“Whenever the commission is ready we will move ahead, even if it means getting a small amount [of funds] suspended”, Dermine says, under rules that allow for partial payments if the commission believes an objective hasn’t been fully met. “We don’t want this to be a roadblock anymore,” he adds.
For now, Belgium is proceeding with Princess Elisabeth Island and other projects in the hope that the funds will soon be unblocked.
In eastern Europe, Hungary and Poland’s share of recovery funds have been caught up in negotiations over the rule of law. The new Polish government led by Donald Tusk, former president of the European Council, is willing to enact the required changes to the judicial system in order to unlock €60bn of EU cash, but the time to put that money to fruition is running short.
“The big prize or the most important phase of the recovery and resilience facility is coming up, 2024 through 2026 are the capital-intensive years,” says Taddei. “Now it’s about putting in place the infrastructures and technologies that will foster long-run growth.”
The shift towards capital expenditure should have started already in 2023, but many countries asked to review their spending plans, leading to delays.
As inflation rose, the cost of everything from labour to construction materials blew past what had been budgeted, and most countries asked for revisions to take higher prices into account.
Changes in government also resulted in lengthy renegotiations of national plans, as was the case in Italy, delaying implementation.
In June 2022, the commission retroactively reshuffled 30 per cent of the fund’s grants based on countries’ actual output in 2020 and 2021: countries that outperformed expectations saw their share of recovery funds slashed.
That was the case for Belgium, which saw its envelope shrink by a quarter from €5.9bn to €4.5bn. To make up for the shortfall, Belgium requested €264mn in EU loans to finance projects that were no longer covered by grants.
Even so, a number of investments had to be downsized, such as EV charging stations, energy-proofing of buildings and updating the public bus fleet. Some were removed entirely from the plan.
“It was a mess,” Dermine says. “We wasted a lot of time and a lot of administrative energy revising the plan.”
As disputes rumble on, the recovery fund’s expiration date looms ever closer with no hard plan as yet for what, if anything, might come next.
The commission, however, is confident that countries can catch up and achieve near-full disbursement before time runs out. “The deadline is feasible . . . I am pushing all member states to keep in mind and work towards the deadline that we have in place, because it is quite possible to have 90 to 95 per cent of what we have allocated disbursed,” Gentiloni says.
But observers and officials worry that time pressure, while acting as an incentive for governments to keep on schedule, could negatively impact the quality of expenditure and, in some cases, increase the risk of fraud.
“The problem we have is timing. Everyone knows that in that timeframe it’s not going to be spent most effectively, everyone is thinking about it,” says a national official in charge of dealing with the fund.
Spain and Italy, which requested the total amount of loans available and together account for more than half of the fund’s total loans and grants, are often seen as the bellwether for its success.
But because they have the lowest absorption rates of regular EU funds, the amount of their entitled budget that they spend, it raises questions about their capacity to spend huge amounts of additional money efficiently and safe from graft.
“Even a very efficient public administration would not be able to spend all of this money, especially when it is investments rather than transfers, in a relatively short amount of time,” says Tito Boeri, a professor of economics at Bocconi University and co-author of a book on the Italian’s recovery plan.
Italy has used nearly €14bn of its recovery funds to partially finance a tax credit scheme for building renovation, which has a total price tag of €100bn to date. This caused a boom in the construction sector, but its long-term impact is doubtful, and the scheme was subject to fraud, according to the country’s tax authority.
To reduce the risk of graft, all EU countries have an audit system in place, but countries lament the high administrative burden this places on implementing authorities.
“This is not proportionate to the risk. There are important risks of fraud and corruption but we must use the right tools to fight this, and here we’re using a bazooka to control things that are very restricted in scope,” says a national official tasked with collecting feedback from EU countries.
The fund’s pay-for-results structure should mean less bureaucracy compared with regular EU funds, which are reimbursed on a cost basis. However, the authorities in charge of spending from both sets of funds are often the same and have found themselves navigating two different systems — with two sets of requirements — in a short amount of time.
“The mood is reluctantly negative towards the practical implementation of the instrument,” adds the official, describing sometimes “nightmarish” procedures.
The fund’s mixed record so far weighs on a budding discussion on what will come after it.
Advocates of greater fiscal integration see the EU’s joint-debt experiment as a prototype for future funding instruments. “In the new global race for clean technologies, in the new global race for competitiveness, we need to [be] providing common funding for common goods,” Gentiloni says.
“The discussion on what next or what else [after the EU recovery fund expires] is not something that we can discuss two or three years from now, this discussion should start with the new commission and the new parliament ASAP.”
But the willingness among EU countries to repeat such an exercise relies on the ability of member states to prove the instrument has been a success.
“Whoever wants funding to continue needs to deliver a convincing implementation,” says Taddei. “Nobody expects 100 per cent, just close enough.”
