Between Austerity Europe and Keynesian Europe: The Politics of Debt and Growth

in the European Union

Cornel Ban
University of London (City)

Abstract
Have European policy makers reacted to the 2008 crisis with single-minded determination to
constitutionalize austerity or have they instead been reflexive and used the crisis to generate
EU-level buffer mechanisms against financial and macroeconomic crises? This paper argues
that this emphasis on austerity from the existing literature on the European governance of
the crisis can benefit from two consequential nuances. First, the EU established a full-
fledged lender of last resort function for sovereigns and banks (European Stability
Mechanism) that might soon morph into a consummate lender of last resort. Second, the
EU also acquired a Keynesian face in the form of a countercyclical and competitiveness-
boosting lending fund (European Fund for Strategic Investments) that strengthens the EU’s
investment state regime linking the EU with national development banks. However, the
paper finds that the first function comes at the cost of imposing pressures for pro-cyclical
fiscal policies on countries facing sovereign debt issues that are in excess of those demanded
by the IMF. Similarly, the countercyclical lending fund has had a patchy record at delivering
investment support to the countries that needed it the most.

Key words: ESM, EFSI, IMF, austerity, stimulus, monetary fund

1
Introduction
A rich body of literature associates the European Union institutions with self-defeating
austerity policies enforced through increased surveillance, legalization of decision marking
and a rich menu of coercive measures (Blyth 2013; Ladi and Tsarouhas 2014; Heinz and de
la Porte 2015; Pavolini et al 2015; Ban 2016; Bengtsson and de la Porte 2017). Extensive
empirical research demonstrated the pernicious effects of the EU management of the crisis
on all social services and particularly on health (Reeves et al 2014; Greer 2014; Kentikelenis
et al 2014). As a special issue on the topic concluded, austerity represents “a radical alteration
of EU integration, whereby the EU is involved in domestic affairs to an unprecedented
degree, particularly with regard to national budgets” (Heinz and de la Ponte 2014). Before
long, as social investments were all but neglected, the EU faced a political backlash
associating its crisis governance with the undermining of Europe’s social achievements
painstakingly built over many decades of social struggle (Matthias and Blyth 2017).

Other scholars have pointed out that Europe’s crisis was compounded as much by
institutional design issues (the well known poverty of the EU-level fiscal capacity) as it was
by two costly political choices. The first is the failure to generate sovereign debt pooling
mechanisms such as the ill-fated Eurobond, due to contingent political dynamics in the
creditor states (Matthijs and McNamara 2015; Matthijs 2016; Moschella 2017). The second
costly choice was the absence of a proper lender of last resort for sovereigns, which further
constitutionalized austerity at the EU level against the background of procyclical
transformations in the European sovereign bond market (de Grauwe and Ji 2013; Blyth
2013; Gabor and Ban 2015; Gabor and Ban 2016).1

How have European policy makers engaged with these early policy decisions and the

1
This choice is both self-defeating and financially costly for the EU institutions involved. As Paul de
Grauwe showed that “failure to provide lending of last resort in the government bond markets of the
monetary union carries the risk of forcing the central bank into providing lending of last resort to the banks
of the countries hit by a sovereign debt crisis and this lending of last resort is almost certainly more
expensive; the reason is that most often the liabilities of the banking sector of a country are many times
larger than the liabilities of the national government.”(2013: 521).

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constraints they left behind? With what consequences for the European economy? This
paper draws on Ilene Grabel’s concept of “productive incoherence” to argue that this
emphasis on austerity from the corpus of literature on the EU governance of the crisis begs
for two consequential nuances. Since 2013 the Eurozone (albeit not the EU as a whole) has
a full-fledged lender of last resort function for sovereigns (European Stability Mechanism)
and since 2015 it also acquired a Keynesian face in the form of a countercyclical lending
fund (European Fund for Strategic Investments). However, the paper finds that the first
function comes at the cost of imposing pressures for pro-cyclical fiscal policies on countries
facing sovereign debt issues that are in excess of those demanded by the IMF. Furthermore,
the countercyclical lending fund has had a patchy record at delivering investment support to
the countries that needed it the most. Furthermore, while the EU’s latest institutional
creations have been incoherent in that they failed to create a coherently countercyclical crisis
management regime, this incoherence has been productive via the incremental calibration of
their interventions and the acknowledgement of the idea that austerity has to be balanced
with publicly funded growth strategies across the EU.

The first section of the paper provides a succinct overview of the position of the EC and
ECB as the “usual suspects” of the scholarship on austerity and ends with the formulation of
specific research hypotheses. The next two sections make up the bulk o the paper and
provide a detailed empirical investigation of the cases of the ESM and EFSI as the newest
pillars of the EU crisis management regime. The findings are based on desk analysis and
semi-structured interviews with European Commission, ESM and EFSI senior staff carried
out between 2016 and 2017.

Austerity Europe and Beyond

After a Keynesian interlude, in its June 2009 Quarterly Report, the EC asked all EU govern-
ments to “prepare a credible strategy for fiscal policy so as to be able gradually to withdraw
the stimulus,” stressing, however, that the withdrawal should take place only gradually, once
the recovery takes hold, and avoid “excessively tight budgetary policies choking the nascent
recovery” (25). In October, the call to withdraw the stimulus grew a bit louder, but it was
only in the March 2010, after the EU heads of state meetings in the European Council failed
to produce a strong response to the Greek debt crisis, that the EC argued austerity should be

3
pursued “urgently.” It was also in the March report that the EC defined its solution to the
predicted increase in unemployment in countries showing high current account deficits:
harsh and immediate “internal devaluation” packages executed through extensive spending
cuts and structural reforms.

The doctrinal turn to austerity was translated into practice via a combination of legalistic,
and coercive governance modes of governance. The coercive mode was first activated when
the Commission embedded its ideas in bailout agreements concluded in 2008 and 2009 with
the crisis- ridden countries in the eastern “periphery” (Lütz and Kranke 2014). The legalistic
mode kicked into gear in 2010, when the Commission pushed for the adoption of an even
stricter set of fiscal rules than the Stability and Growth Pact (SGP) that effectively outlawed
discretionary fiscal policy by shifting compliance with an enhanced SGP away from peer
pressure and toward outright sanctions and fines for public debt and deficits out of line with
new, more demanding numerical targets (Hodson 2011, 242). The stress on rules-based and
eventually constitutionally hamstrung fiscal policy was unprecedented and was steeped in the
Commission’s own research apparatus (Deroose et al. 2008; Iara and Wolff 2010) and
reflected a particular Ordoliberal diagnosis of the European macroeconomy (Ban 2016).
Thus, in 2010 the Commission published a research paper finding that “stronger fiscal rules
in euro area member states reduce sovereign risk” (2010 EC Economic Paper 433, 1) and
“the legal base turns out to be the most important dimension for the perceived effectiveness
of the rules” (1). In the same year, the Commission also initiated the European Semester, a
framework that combined nudging and coercion. Every year since 2011, the Commission has
written a report for each member state detailing its position on domestic macroeconomic
and structural reforms to be adopted, naming and shaming rule- breakers along the way and
applying sanctions on member states found in violation of deficit targets (Zeitlin 2016).

If the EC had a relatively gradual transition from stimulus to austerity, the ECB went for
austerity early on. An overarching picture of the European Central Bank’s fiscal policy
standpoint between 2009 and 2012 can be pieced together by looking at the views expressed
in the ECB Monthly Bulletin reports. A year before the Greek fiscal scandal erupted and the
Commission’s about- face, the ECB was already on offensive against expansionary fiscal
policy. Indeed, as early as January 2009, the ECB’s Governing Council demanded the

4
reversal of the fiscal stimulus measures adopted by EU member states in the fall of 2008,
arguing that “if not reversed in due time, this will negatively affect in particular the younger
and the future generations” (ECB 2009, 7).

By September, the ECB asked for “a swift return to sound and sustainable public finances.”
This entailed higher- than- usual fiscal consolidation efforts that would “exceed significantly
the benchmark of 0.5 percent of GDP per annum set in the Stability and Growth Pact”
(ECB 2009, 7). Removing any doubt as to who should pay for all this, the ECB stated clearly
that “the focus of the structural measures should lie on the expenditure side, as in most euro
area countries tax and social contribution rates are already high” (ECB 2009, 7).2

By 2014, the conventional wisdom in the EC and ECB began to enter a more fissiparous
stage. High-level figures in both institutions began to admit that austerity did not work and
sought the loosening of fiscal adjustment packages. This became patently obvious in the
Juncker Commission, where fiscal rules have been interpreted by stealth (Schmidt 2016) and
whose top technocrats now admit the failure of austerity without hesitations.3 Contrary to
popular knowledge, even the ECB began to modulate its strong pro-austerity voice as well.
In his 2014 speech before central bankers and private financiers at Jackson Hole pleaded
that demand side fiscal policies play “a more supportive role” to the reflationary attempts of
central banks (Draghi 2014). Moreover, as Manuela Moschella showed, even in the second
Greek program both the EC and the ECB relaxed their opposition to debt restructuring and
fiscal accommodation (Moschella 2016).

That said, no fundamental and systematically enforced change on agenda setting has taken

2
The justification for this stance was anchored in the New Classical argument that places a heavy reliance
on rules- based fiscal consolidation to be introduced immediately and paired with structural reforms to
reign in public spending and reduce labor costs. To the extent that countries are judged to have “fiscal
space” (no one other than Germany and Sweden was judged to have it), the ECB Governing Board
encouraged them to allow existing levels of automatic stabilizers (mostly welfare payments) and new
targeted reductions in corporate income taxes and in labor taxes to take effect. But even for these countries,
the ECB cautioned against more “Keynesian” options such as government purchase of goods and services,
public investment, and increased social transfers to credit-constrained households. In the view of the ECB,
such measures were deemed to have rapidly fading impacts on economic growth. Even if one lived in the
best of all fiscal worlds, what one should aspire to were Reagan- style tax cuts and the same levels of social
spending, with the private sector remaining the hero of recovery.

3
Author interview with Marco Buti, October 2016.

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place, with reorientation being a more apt word (Savage and Verdun 2016; Bauer and Becker
2014; Dunlop and Radaelli 2016). This is particularly the case in the Commission’s “flexible
austerity” paradigm (Seikel 2016: 1398). Although the rules of the SGP upgraded the
Commission’s policy autonomy (Bauer and Becker 2016), structural power rests in the hands
of creditor states (Seikel 2016). As a consequence, economic and social policies that conflict
with budgetary discipline are subordinated to the primacy of creditor states. But, as Mark
Blyth (2016) and Matthias Matthijs (2016) showed, for a variety of material and ideational
reasons the preference of these states was austerity (Howarth and Rommerskirchen 2013;
Blyth 2016; Matthijs 2016).

The ESM: Europe’s Lender of Last Resort

From the EFSF to the ESM
The European Stability Mechanism (ESM) is an intergovernmental institution established in
2012 as a permanent bond market support mechanism (“bailout fund”) for the Eurozone.4 It
mobilizes funding and provides stability support under strict conditionality to the benefit of
contracting Member States5 experiencing, or being threatened by severe financing problems.
The ESM intervenes to the extent that its funds are judged to be indispensable to safeguard
the financial stability of the euro area as a whole and of its Member States. 6

The origin of the ESM and of its predecessors reflects a compromise between the
institutional constraints posed by hard-to-change treaties and domestic political possibilities.7
Institutionally the ESM exists in a ‘Catch-22’ – it is a bail-out policy instrument in a
European Union treaty that prevents bail-outs. Article 125(1) of the Treaty on the
Functioning of the European Union (TFEU) states that loans should not be provided to
members that cannot honor their payments.

The logic here reflects the German position that the member states are not obliged to
provide assistance to other members, which prevents moral hazard. But given that principal
lenders are likely to be within the Eurozone the costs of a member state becoming insolvent

4
For a comprehensive overview of its functions see Micossi, Stefano, Jacopo Carmossi, and Fabrizia
Peirce. On the tasks of the European Stability Mechanism. Centre for European Policy Studies, 2011.
5
Recital 7 ESM Treaty.
6
Article 3 ESM Treaty.
7
Author interviews with European Parliament members, 2016.

6
and defaulting on their obligations are not only economic turbulence for the region but also
the possibility of members leaving the single currency (Cloosa and Maatsch 2014). When the
crisis hit, the European Union needed a mechanism to provide stability funding to members
while not violating the treaty. In 2012, the Council established the European Financial
Stability Facility (EFSF), a special purpose vehicle playing the role of a financial assistance
instrument specially designed for Greece. These temporary sovereign bond market assistance
funds were replaced in 2013 with the permanent European Stability Mechanism (ESM). 8
However, it is important to point out that the establishment of the ESM required the
softening of the “no bailout” clause in the treaties and the addition of a third paragraph in
Art 136 TFEU.

Like the EFSI, the ESM has senior management whose previous professional positions were
what they should be by virtue of their institutional design. As the network analysis below
shows, the EIB senior management is drawn overwhelmingly from the public sector of the
member states and while the ESM’s has a stronger contingent of senior management deeply
embedded in the private financial sector (including US-based financial firms). This is not
surprising considering that even the IMF has recently embraced the value of private market
professional in order to deal more effectively with the opacity of modern finance (Seabrooke
and Nilsson 2015).

Figure 2: Previous employment of senior management at EIB and ESM

8
ESM, Annual Report, 2013.

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The first international intervention jointly organized by the Eurozone member states and the
IMF began in May 2010, at the request of the Greek government. The intervention was
launched shortly before the launch by the European Council of the European Financial
Stabilization Mechanism (EFSM). A public limited liability firm under Luxemburgish law,
the EFSM had been tasked to provide financial assistance to the Greek government, reduce
the country’s foreign debt and bring Greece back on private sovereign bond markets.

The initial mission of the EFSF was to address the wider contagion of the sovereign debt
crisis from Greece to other Euro area member states such as Ireland and Portugal (Gocaj
and Meunier 2013). 9 Both institutions have emerged as large players in the Euro area

9
Gocaj, L., & Meunier, S. (2013). “Time will tell: The EFSF, the ESM, and the euro

8
sovereign bond market, with outstanding bond volumes similar to that of a small euro area
economy. Research suggests that the sovereign bond markets trusted the guarantee structure
of the EFSF, treated it as core issuer of bonds and consequently reattached the periphery to
the core, relegating Greece to a “special case” area of high risk.10

The scope of the ESM interventions includes macroeconomic loans (the most used with
Greece, Portugal and Ireland), primary and secondary market purchases (developed but
never used), precautionary programmes a la IMF (developed but not used), as well as direct
and indirect bank recapitalization assistance (the latter was used for Spain).

Table 1: ESM financial support instruments

These interventions are financed by the issuance of bonds and other debt instruments on the
capital market. In short, the ESM emerged as a lender of last resort for distressed Euro area
sovereigns and banks facing serious bond market pressures.

crisis.” Journal of European Integration, 35, 239-253.

10
Author interviews with ESM senior staff, 2016.

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The ESM and the EFSF are managed by the same Managing Director and are operationally,
albeit not legally, identical. The EFSF was a temporary bailout fund (June 2010-June 2013)11
with pari passu (“equal footing”) creditor status that was incorporated as a private company
under Luxembourg law. In contrast, the ESM is a permanent (June 2012-) intergovernmental
institution under public international law that can claim a preferred creditor status (after the
IMF).12 The EFSF’s capital structure is backed by the guarantees of the Euro area member
states while the ESM’s is backed by the subscribed capital of €704.8 bn and the €80.5 bn in
paid in capital of the Eurozone Member States. Both are bailout funds but the maximum
landing capacity of the ESM is more than double (€500 bn) that of the EFSF (€192bn). Both
institutions have had very high credit ratings.

Legally speaking, the ESM is an entity that emanates from the sovereign will of the Member
States and delegates critical forms of intervention in the domestic policy arena of the
program countries to the Commission and the ECB. Article 3 of the ESM Treaty reads:

the Board of Governors shall entrust the European Commission – in liaison

with the ECB and, wherever possible, together with the IMF – with the task of
negotiating, with the ESM Member concerned, a memorandum of
understanding (an "MoU") detailing the conditionality attached to the financial
assistance facility.

Furthermore, article 6 (g) of the ESM Treaty stipulates that the BoG “gives a mandate to the
European Commission to negotiate, in liaison with the ECB, the economic policy
conditionality attached to each financial assistance.”

Yet despite being an emanation of the main EU subjects (the Member States), the ESM was
placed by them outside the EU legal framework, a fact certified by CJEU in the Pringle case.13

11
The EFSF assistance to Greece was extended to February 2015.
12
The one exception is the ESM recapitalization of Spanish banks, for which the ESM could only claim
pari passu status. Author interviews with senior ESM staff, 2016.
13
This legal arrangement was challenged in CJEU almost as soon as the ESM was established. Thomas
Pringle, an Irish national, asked Irish courts to clarify of the ESM Treaty was incompatible with the Irish
constitution and whether a referendum was not required to validate Irish ratification. Critically, Pringle
argued that the Troika conditionalities could have an adverse effect on the rights guaranteed by the Charter.

10
In effect, the EU created a private body that is controlled by the informal consensus of the
ministers of finance of the Eurozone but which leaves the adjustment program design (the
Memoranda of Understanding) and their enforcement to the Commission, the ECB and the
IMF (the so-called Troika/the Institutions). In effect, “the Member States ‘borrowed’ the
EU institutions for the use by the ESM”(Salomon 2015).

The ESFS/ESM as bond market fire brigade

The ESM’s interventions in the Eurozone sovereign bond markets and the ECB’s policy
turn after Mario Draghi’s “whatever it takes” moment can be credited with the first
successful attempt to arrest a systemic sovereign bond market crisis in the Eurozone (Figure
2). Indeed, the fact that the ECB and ESM acted in tandem was critical for this success
(Jones et al 2016).

Some scholars noted that at the time the EU could have given the ESM a “banking license,”
so that it could leverage its working capital more aggressively to bail out larger member
states but this option was rejected because “European Commission officials worried quietly
that any attempt to rely on EFSF or ESM financing would soon reach the limits of resources
available and so lack credibility in the markets. And the German government was unwilling
to allow the ESM to obtain a banking license because any increase in leverage would impose
unacceptable risk on ESM capital and because having the ECB as a liquidity backstop looked
too much like the monetary financing of governments.”

At the height of the crisis, in 2012, funding was insufficient to address all critical needs in the
Eurozone, with emergency funds for Greece, Ireland, and Portugal in play, while Italy and
Spain wobbled without dedicated support (Lane 2012). All in all, today, four of the five

The Irish High and Supreme courts rejected the claim but asked CJEU for clarifications regarding the legal
status of the ESM: (2) whether the Council’s amendment to Article 136 TFEU to include a reference to a
stability mechanism, was legal and (2) whether the ESM Treaty itself was not in fact incompatible with the
existing Union Treaties. CJEU passed its judgment on the merits on November 27, 2012 (case C-370/12).
CJEU ruled that (1) the establishment of the ESM was procedurally and substantively legal, that (2) the
ESM is not an EU body and (3) the Member States that constitute it do not implement EU law when
making decisions in the ESM. Therefore, the European Court decided that the Charter is not applicable to
the ESM and the Member States acting in the ESM (and therefore outside the EU). This interpretation was
based on article 51 (1) of TFEU requiring EU Member States to observe the Charter “only when
implementing EU law.” Since ESM was outside the EU law, the conclusion was as stated.

11
countries that received ESM assistance can borrow at sustainable rates and have exited their
programmes.

Figure 2: Select sovereign bond yields at critical junctures of the crisis

Source: ESM

Faced with ongoing bond market panic, the ESM showed flexibility in its lending practices.
It abandoned the EFSF’s initial and stricter, high margin, relatively short maturity (5-12
years) IMF-style sovereign lending paradigm used mostly in Ireland and Spain and
transitioned instead to a low-margin, long-maturity one (32 years) that greatly facilitates the
repayment for the programme country concerned. The Financial Times cited private sector
evaluations showing how drastic the consequences of this change were. Relying on long-
term maturity allows a much slower cycle of debt refinancing, meaning that Greece has to
raise fewer funds in the coming decades in order to refinance bonds that have to be repaid.

When calculating the repayment risk on a given bond, investors will not focus on the overall
stock of outstanding debt. Rather, they will need to know how much of the debt needs to be
repaid within the timeframe of the bond whose risk investors are seeking
to assess, i.e. a focus on flows. If this methodology were applied to the case of Greece, it
would lead to an estimation of “gross balance sheet debt of €118bn at the end of 2015 (67
per cent of GDP), rather than €314bn (178 per cent of GDP) as reported by the

12
International Monetary Fund (IMF) or €311bn as reported by Eurostat. Almost all of this
roughly €200bn in debt reduction had occurred by the end of 2012.” Further lending to
Greece by the ESM reduced Greece’s balance sheet debt by another €17 billion. The
changes in lending terms “effectively reduced the Greek government debt burden by
about 49 per cent of the country’s 2013 output, or about €88bn.” These dramatic changes in
the Greek outlook show the relevance of methodological tweaks and lending terms.

The transatlantic conflict over debt restructuring and austerity

In October 2015 the ESM’s Managing Director gave a long interview to Financial Times14 in
which he defended the case against a debt writedown (or nominal debt haircut, in technical
terms) for Greece that would be on the scale that the IMF (in their June and July debt
sustainability analyses) and the Greek government preferred. Regling clarified that the
difference was a different timescale for looking at Greek debt, with the IMF asking for their
money back within ten years and the ESM reducing the burden of debt thorough agreeing to
much longer maturities (32 years) and lower interest rates that the Fund.

The IMF’s prioritization of the overall debt burden (“stock”) in their debt sustainability
reports was not applicable to Greece, he argued, because Greek’s annual debt payments
(“flows”) were low relative to almost all other European countries. In effect, the argument
went, over the long-term horizon, the ESM member states gave Greece debt restructuring
without reducing the nominal value of Greek debt. In the same annotated interview he
reassured the public that the IMF’s view were beginning to converge with the ESM’s.

A year later it became clear that the IMF was reluctant to buy a less talked about aspect of
the ESM’s view: the size of the primary surplus expected in exchange for this long-term
financial assistance that acted as a de facto debt restructuring. In December 2016, Maurice
Obstfeld, the chief economists and Poul Thompsen, Director of the IMF’s European
Department of the IMF took the unusual step of disagreeing in public (on the IMF’s blog)
with this long term view of the ESM in December 2016. The two senior economists insisted
that the primary fiscal surplus of 3.5 percent Greece had to achieve by 2018 “ would

14
https://www.ft.com/content/f5de7464-8d83-3ee8-83bc-8a749c9f479a

13
generate a degree of austerity that could prevent the nascent recovery from taking hold,”
proposing instead a lower primary surplus of 1.5 percent in 2018.

According to Obstfeld, this higher bar set by the European institutions entailed the adoption
of additional austerity measures than those agreed initially, with the Greek government
agreeing with the European institutions (and against the advice of the IMF) to cut spending
further. Furthermore, “cuts have already gone too far, but the ESM program assumes even
more of them, with an increase in the primary surplus to 3.5 percent of GDP achieved
through further cuts in investment and discretionary spending (…) if Greece agrees with its
European partners on ambitious fiscal targets, don’t criticize the IMF for being the ones
insisting on austerity when we ask to see the measures required to make such targets
credible.”15 ESM representatives expressed dismay at this unorthodox practice and hope for
a “return to the practice of conducting program negotiations with the Greek government in
private.”

Such ideas reflected a dramatic shift on fiscal policy that had started with Dominique Strauss
Kahn and Olivier Blanchard and had become the norm with Lagarde and Obstfeld. An older
emphasis on maintaining states’ credibility with financial markets
remained the primary goal of policy, but this goal now had to cohabit with greater
acceptance of discretionary fiscal stimulus programs and an emphasis on gradual fiscal
consolidation where fiscal space for stimulus was limited. Also, unlike the pre-2008 period,
the IMF now advocates more balance between revenue and spending measures in the
approach to fiscal consolidation (Ban 2015). After some initial resistance to reconsider the
Fund’s traditional hostility to debt restructuring, by 2014 change was under way and it
became part of the Fund’s doctrinal revisionism, affecting areas as wide as capital account
regulation and financial regulation (Gallagher 2015; Ban et al 2016).

This open conflict between the two institutions brings to the fore questions about the
different fiscal philosophies of the world lender of last resort for sovereigns and its
European counterpart while highlighting the more conservative fiscal theory of the latter.
The fact that the ESM attributes strict adherence to rules-based fiscal consolidation to the
preferences of sovereign bond market is puzzling in the light of the fact that “the alleged

15
https://blog-imfdirect.imf.org/2016/12/12/the-imf-is-not-asking-greece-for-more-austerity/#more-15842

14
preference of financial market participants for stricter fiscal rules is based on a handful of
articles whose generalizability and validity can be questioned” (Rommerskirchen 2015). As
the next section shows, the Juncker Commission has attempted to compensate for this
austerian face of Europe with a countercyclical lending fund: the European Fund for
Strategic Investments. To date, the results have been mixed.

Keynesian Europe
The European Investment Bank is the world’s largest public multilateral bank and brands
itself as the EU’s bank. Despite this, to date it has stayed below the scholarly radar. 16
Following a slow recovery from a deep economic crisis, the EIB has received two capital
increases, emerging as a central actor in delivering much-needed investment to the European
economy, which remains below pre-crisis levels. As a pillar of the EU crisis management
regime it has taken on ever more roles on behalf of the Union, leveraging limited EU budget
funds on financial markets via investment vehicles such as the Project Bonds Initiative, a
policy program from 2012 that was designed to promote investment in European
infrastructure.

What is more, in 2014, the EIB was chosen to deliver President Juncker’s landmark
investment initiative, the European Fund for Strategic Investments (EFSI), which the
Commission recently declared a success and doubled in time and money. Set under the EIB
umbrella, the EFSI went fully operational in 2015 as part of the Investment Plan for Europe
(the so-called “Juncker Plan”). Its establishment reflected concerns with stagnant
investment, a prolonged recession followed by a weak recovery, high unemployment
(especially among the young) and legal-political constraints that ruled out the general
stimulus favoured in 2008-09. In practice EFSI is an EIB-operated body. The involvement
of an independent Investment Committee and its prerogative to provide a project with a
loss-absorbing EFSI guarantee (based on the fulfillment of the requirements of the EFSI
regulation) are the critically new elements in what is largely an EIB-staffed operation.

Indeed, the bulk of the EFSI’s daily operations such as information gathering on projects,
due diligence, informing EFSI governing bodies about the applicability of the EFSI

16
For a notable exception see Marstens and Thiemann (2017).

15
guarantee, are run by EIB staff. 17 As the administrator of EFSI, the EIB is a hybrid
international financial institution: First off, it serves as the public bank for the EU. As such,
its main policy mandate has been to support socioeconomic convergence within the Union,
compensate for the effects of trade liberalization and facilitate the functioning of an
increasingly integrated market, mostly via integrated cross-border infrastructure. Secondly,
the EIB was designed to act as a commercial bank in its day-to-day operations. This means it
had to make choices that maintain its credit rating on international financial markets to keep
lending costs low. The tension between its policy and commercial identitity means that for a
project to be financed by the EIB, it has to be both financially sound and integrated into the
policy objectives of the day, as defined by the EU’s political institutions. The EIB resembles
international development banks, but it has to strike a balance between its status as a public
EU body making it accountable to a wide array of EU institutions, and its need to refinance
itself on financial markets.

EFSI is intended to crowd-in additional investment to the tune of EUR 315 bn7 over the
next three years. The funds to be leveraged stem from the EU budget (EUR 8 bn) and the
European Investment Fund (EUR 5 bn for SME financing) and are meant primarily for (i)
transport, energy and the digital economy; (ii) the environment and resource efficiency; (iii)
human capital, culture and health; (iv) research, development and innovation; and, (v)
support to SMEs and mid cap companies. For example, the EFSI funded health care
research in Spain, the expansion of Croatian and Slovakian road and airport infrastructures
and the technological updating of steel rolling in Italy. Merstens and Thiemann (2017) also
found that national development banks “received positions in EFSI as both stakeholders
and contributors”(p.2) and were enabled to use EFSI to expand their activities and
organizational capabilities, leading these authors to speak about the emergence of a
European investment state at the EU level.

But the EFSI is not only being promoted as a successful initiative to incentivize investment
in a depressed economic climate. It also has a higher standard in terms of transparency and
accountability to EU institutions. The main reason for higher standard of accountability to
the EU institutions is EFSI’s use of the EU budget. Given strong prior Member State and

17
Author interviews with senior EFSI staff, 2016.

16
Commission involvement, the novelty is a key role for the European Parliament.

In short, the EFSI is intended as a countercyclical lender a that increases lending in

recessions and weak growth economic cycles, when private banks retreat as well as a public
venture capitalist for high-risk special activities that must be ‘additional’18 in the sense that
“they point to a market failure or suboptimal investment situations and therefore would – in
principle – not have been financed in the same period by the EIB without EFSI support, or
not to the same extent.”

Given its critical importance and initial success in reaching the pre-set targets in terms of
speedy take-up of investment volumes, the Commission decided in September 2016 to
double its duration and financial firepower, extending the EFSI until 2020. Given the EIB’s
expertise, as well as the pressure on the Commission President to deliver on an election
promise without developing new structures, the EIB was chosen to leverage the EU’s limited
budgetary commitment into a meaningful investment programme.

In addition to EFSI, the EU’s Keynesian arm includes the European Investment Fund.
Established in 1994, and co-owned by the Commission and the EIB, this financial institution
acts as a risk and venture capital agent for the EIB. EIF is part of EFSI via the latter’s SME
Window, which is set to provide 75 bn in capital and loans guarantees to SMEs. For
example, it provides guarantee facilities, credit enhancement securitisation, social impact
funds and equity to Business Angels and other non-institutional investors for the financing
of innovative companies. EIF also raises funds from investors to provide risk capital to
growing SMEs. Via its recent EIF-NPI Equity Investment Platform, the EIF offers national
development banks the possibility to match the total investment budget of the EFSI SME
Window on a 1:1 basis.

But how Keynesian has EFSI been in reality? Figure 3 and 4 shows that two countries with
steep recessions (Italy and Spain) a country with average performance (France) and two
countries with strong growth (Poland and Germany) got the most EFSI loans and
guarantees, as adjusted per capita. Member states battered by steep recessions (Finland, the

18
Author interviews with senior EFSI staff

17
Baltics, Hungary, Romania) get dramatically less. In sum, the countercyclical pattern looks
quite patchy. Yet two distinct patterns emerge. First, France, Spain, Italy, Germany, but also
Poland have national promotional banks whose key role in mobilizing EFSI funds was
praised by the Commission. Also, it was only after Greece established its own development
bank at the request of the Commission that its absorption of EFSI funds increased
significantly.

Second, two-speed Europe is already a reality in the case of the EFSI. Of the operations
already signed, approved and pre-approved under EFSI in December 2016, most went to old
EU Member States with development banks and all East European member states but
Poland countries have not secured levels of EFSI funding secured by the average EU-15
member state.

When interviewed by thus author, the EFSI Secretariat noted that the number of eligible
investments is naturally higher in larger Member States and economies.19 In terms of EIB
Group financing relative to GDP, the breakdown is said to favour smaller EU countries. In
the case of EFSI, Estonia, Spain, Lithuania, Slovenia and Slovakia are expected to see the
highest investments. As of October 2016, EFSI funds administered by the EIB and the EIF
amounted to 361 projects in 27 out of the 28 member states, with 44% of the 315 bn euros
already used.85 This can count as a success.

However, if the European Investment Fund operations through the SME window are
subtracted, a different picture emerges. Half of the EU’s Member States have five or less
EIB administered projects each (loans, guarantees and equity type operations). A small
number of Member States received a much larger number of funded projects. Although
some of the winners are countries that struggle with an extreme dearth of investment (Italy,
Spain, Portugal), or are generally larger economies with far more projects eligible for EFSI
financing (Germany, France), it is nevertheless an issue that the new Member States are
grouped towards the low end of the spectrum.

19
Author interviews with senior EFSI staff, 2016.

18
Figure 3: Economic growth rate and EFSI loans and guarantees (adjusted by per capita GDP)

Figure 4: EFSI loans and guarantees (adjusted by per capita GDP)

19
Source: Eurostat, EFSI and author’s calculations

While this situation has complex causes, one could argue that it could have been be
remedied by a more developmentalist mindset in Luxembourg. This means that the EIB
could have deployed not only conventional, targeted and sustained efforts to ensure
availability of information in these states but also through the provision of expertise for the
establishment of national promotional banks.

20
The EIB is the equivalent of a development bank at the EU level, while promotional banks
are the equivalent of development banks at the domestic level. To the extent that the
Commission currently favours the establishment of national promotional banks for the
delivery of EFSI funds across the EU, the EIB should ensure that its expertise and best
practices are made available in the setting up of “sister” institutions to national authorities.
The EFSI has detailed guidelines on how to avoid geographical and sectoral concentration,
but nothing stands in the way of structurally well-positioned (and lower-risk) applicants from
wealthier Member States to lodge successful applications.

Moreover, beyond gross flows of loans and guarantees, it is difficult to probe deeper into the
effects of EFSI as a prop for aggregate demand. This is because the EIB does not make
publicly available on its website information relating to all EFSI financing and investment. A
Transparency International report shows that this should include information regarding
financial intermediaries (financial institutions whose names are made publicly available by the
EIB) and information relating to the manner in which EFSI financing and investment
decisions contribute to the general objectives set out in the Regulation (Ban and Seabrooke
2017). There are good reasons to be wary. For example, existing research by the NGO
Bankwatch asserts that in Eastern and Central Europe, “many intermediaries appear to be
making very few allocations to SMEs despite the fact that they have often received the entire
global loan amount and have had, in some instances, over two years to find SME
beneficiaries.”

Conclusions
The conventional wisdom is that since 2010, austerity has been the dominant policy coming
from established EU institutions. This paper shows that that entry of the ESM and EFSI in
the governance mechanisms of the crisis has put some wrinkles on this common perception.
Most importantly, these new institutional arrivals in the EU crisis management regime have
contributed to a productively incoherent arrangement where the calibration of interventions
to provide more accommodation for the member states’ and the balancing between austerity
and stimulus became central to the regime.

Specifically, the evidence suggests that the ESM has proved to be a lender of last resort

21
whose creative reduction of the debt burden over long time horizons for debtor states has
been matched by its insistence on contractionary fiscal policies that exceed those of the IMF.
In that sense, the ESM has been a rescue operation for a version of the Washington
Consensus that the Fund has grown out of since the Great Recession.

As in the Janus of legend, the EU’s flexible austerity face represented by the ESM was joined
to the EU’s Keynesian face represented by EFSI, which was designed to be a countercyclical
lender and booster of aggregate demand in countries facing steep recessions. However, in
addition to making available loans and guarantees that are far below the needs of Europe’s
national economies, this institution managed to fulfill its mandate only in countries with
strong public development banks, irrespective of their output performance.

Going forward, the findings of the paper highlight the importance of regional monetary
funds as well of regional and national development banks for rich countries. In the case of
the former, more comparative research is needed on how the ESM differs from other
monetary funds and why. One avenue for the further exploration the latter is to synthesize
the structuralist tradition in development studies (Wade 1990; Woo-Cummings 1998; Wong
2004) and the constructivist political economy of development banks (Thurbon 2016) to
look for analytical leverage outside the realm of conventional public financial institutions and
explore the long overlooked role of these financial institutions as investor in socially
cohesive competitiveness strategies and provider of countercyclical finance. Indeed, it is a
fact that the world’s most powerful industrial exporters have development banks
(government-sponsored financial institutions concerned primarily with the provision of
long-term capital to industry) owning between a fourth and a third of the total liabilities of
national financial systems. These banks’ countercyclical lending also works as the quasi-fiscal
arm of the state by running off balance sheet stimulus programs in the form of increased
lending volumes in times of recession (Barbossa 2010; Ban 2013), when private banks
typically tighten their purses. This is of significant public policy importance as the ideational
and material networks linking domestic and EU-level public financial institution constituting
the emerging European public investment regime may gives governments the fiscal space to
channel resources at competitiveness strategies that do not entail socially punitive internal

22
devaluation of wages while providing long maturity, low interest and more socially conscious
loans to high value added activities and sectors.

23
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