EU unveils €200bn plan for recovery

Even John Maynard Keynes himself, not an easy man to please, would have been impressed: a global implementation of the policies he prescribed three-quarters of a century ago to avoid a slump.

At their meeting in Washington on 15 November, the leaders of the G20, the world's largest and fastest-growing economies, committed themselves to "use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability". Ever since then they have been striving to deliver Keynesian boosts to the economies, as well as encouraging their central bankers to slash interest rates. China has injected the equivalent of 5 to 14 per cent of GDP (economists dispute the scale of the increase). On Monday we saw the Chancellor announce a £16bn boost for the British economy, equivalent to about 1 per cent of GDP. Yesterday it was the turn of the European Commission to call for "timely, temporary and targeted" action.

José Manuel Barroso, the president of the Commission, has proposed a comprehensive and ambitious recovery plan. He is hoping that, at the EU summit next month, the EU's 27 member states will agree to a co-ordinated new fiscal stimulus package said to be worth €200bn (£170bn) – or 1.5 percent of Europe's GDP. The aim is to encourage a mixture of increases in public spending and tax cuts to rebuild confidence amongst businesses and consumers. Some €170bn is to come from the 27 member states while the other €30bn would come from restructuring EU budget spending plans and in loans from the European Investment Bank.

Initiatives by individual governments are being taken into account, and a target fiscal boost of 1.2 per cent is being proposed, and seeks to take account of member states existing financial positions. So some states, such as Germany, have more room for budgetary manoeuvre than others, such as Britain, will be asked to do more, though this has prompted some grumbling from Berlin. In a joint newspaper article in Le Figaro and Frankfurter Allgemeine Zeitung, France's Nicolas Sarkozy and Germany's Angela Merkel said they could support fiscal stimulus packages worth 1 per cent of European GDP, although the programme recently announced by Merkel is worth only €12bn, or less than 0.5 per cent of German GDP. In the Bundestag yesterday, Mrs Merkel seemed unenthusiastic about a more radical approach: "We should not get into a race for billions," she said. "We should take the path of the middle ground, made-to-measure for Germany." Perhaps in response, Mr Barroso said that this was not a "one-size-fits-all" formula, but rather a "tool-box" for member states to make use of.

And, as in the UK, the eurozone's fiscal rules are also coming under pressure. Sarkozy and Merkel say the requirement to hold public deficits below 3 per cent of GDP in individual countries should be eased, to head off a "recessionary spiral". However, Mr Barroso said the Commission was not planning to revise EU budget rules: "We are not going to introduce greater flexibility. The stability pact already has flexibility in it. We are in... exceptional circumstances and in exceptional circumstances we should use the full flexibility the pact already provides. We are not proposing a revision of the pact. A credible euro demands a credible stability pact."

Most EU states have already announced quite substantial fiscal packages, in addition to the easing of monetary policy by the European Central Bank. In Germany, a package of measures has been announced to generate €50bn in new investment and contracts from the public sector. France has announced state aid of €19bn for certain key industries, Spain has seen a €40bn fiscal stimulus package, including €6bn in tax cuts, and Italy has announced an €80bn stimulus package.

The precise obligations of each EU nation remain undetermined. The Economic Affairs commissioner, Joaquin Almunia, said the Union could currently be divided into three types of country: those in relatively straitened circumstances who would simply be unable to make much extra effort; those who could make only a modest contribution, such as the UK, and those with "room for manoeuvre in their fiscal positions", which basically means Germany, the EU's largest economy. There was much more clarity about the sort of measures favoured by the European Commission, including lower taxes on jobs and the option of following the British example and cutting VAT (though not below the EU's floor of 15 per cent).

Concerns about the EU package focus on three main areas. First, the obvious worry that it may not work and will just leave the EU's member states with enormous budgets deficits and much higher levels of national debt to no discernible purpose. This is what happened to Japan from the early 1990s, when governments tried time and again to stimulate the economy through tax cuts and public spending on infrastructure projects. The tax cuts were by and large saved, while the Japanese countryside became littered with little-used motorways and bridges. It is a matter of timing. The Japanese boost – including near-zero interest rates – came too late, long after confidence had drained from the economy and deflation (a generalised tendency for prices, especially of assets such as houses and shares to fall and output to stagnate) had gained a firm grip.

The EU, and the wider G20, now hopes to avoid this fate by acting swiftly and decisively, hence the urgency of the initiatives such as cutting VAT, and their clear intent to persuade consumers to bring spending forward. Having seen interest rate reductions do relatively little good because of the failure of the credit markets and the banks to pass them on in full, governments are turning increasingly to boosting their economies though fiscal means. There are suggestions, not least from President-elect Barack Obama's advisers , that the next step may be "quantitative easing" – simply "printing money" to induce a return to economic growth.

On the record, Mr Obama has said he wants a stimulus package "enacted right away" with tax cuts and spending increases – passed by Congress ready for him to sign into law when he takes office on 20 January.

In the US, the bulk of the tax cut will be aimed at income tax paid by those on average and near-average earnings, and there is no federal consumption tax like VAT to be cut. A boost of between $500bn (£330bn) to $700bn is being discussed by some of Mr Obama's team: between 3.5 and 5 per cent of US GDP. Even after that the US government may have some extra "headroom" to inject more funding into their financial system.

After Mr Barosso's plans are approved, it is not clear that Europe, and the UK in particular, will have anything left to offer banks in trouble. That is a very worrying possibility.

The Commission's package

* Fiscal boost of €200bn, or 1.5 per cent of the EU's GDP, to be "timely, targeted and temporary".

* Commission urged EU states to commit €170bn to the package, while €30bn is to come from EU sources, such as the European Investment Bank (EIB).

* Member states urged to consider lowering employers' social charges on lower-income jobs.

* Countries may lower VAT, but 15 per cent minimum still applies.

* Commission to propose law on reduced VAT for labour intensive services.

* €5bn from EIB, EU and governments for private-public partnerships developing green technologies for cars.

* Commission will speed up payments, up to €6.3bn, of part of EU regional aid funds.

* €5bn to improve energy links across the EU and improve broadband access.

* EIB to increase annual lending in EU country by €15bn in 2009 and 2010.

* Easier access to €1.8bn in EU funding for job trainings.

* Some €1bn to develop energy-efficient houses and €1.2bn for similar technologies for factories.

* Structural reforms to be speeded up.

* Member states may have to breach the EU's budget deficit ceiling of 3 per cent of GDP in 2009 and 2010, but should cut deficits to below the limit once economies recover.