Coronavirus will deal a much stronger economic blow to the EU than Brexit

In Italy in particular, but also in Greece, Spain and many eastern European countries, people feel they have been left to fight the virus on their own, writes Hamish McRae

The EU will this year become a smaller economy than China, whereas at the end of 2019 it was still larger (Reuters)

Which is the bigger threat to the European Union: Brexit or Covid-19? It is four years since the UK voted to leave the EU and four months since the terrible toll of the coronavirus in Europe became fully evident. Deaths in Italy, the first European country to be attacked, hit their peak on 27 March.

We are still not sure of the future relationship between the UK and the EU, and the financial effort to rescue the European economy has only just begun. But there is a strong case to be made that Brexit will matter much less to the EU’s future than the blow from Covid-19.

On paper, the departure of the UK does serious damage to the EU. It has lost its second largest economy and second largest net contributor to its budget. It also means that the EU will this year become a smaller economy than China, whereas at the end of 2019 it was still larger – the EU slowdown is due to the effect of China’s faster growth and the UK’s 16 per cent of the EU’s GDP. But as the negotiations with the UK have demonstrated, Brexit has made it more politically cohesive, and since all major EU economies use the euro, more cohesive in economic terms as well.

If the EU has stuck together over Brexit, however, Covid-19 threatens to blow it apart. The reason is that in Italy, in particular, but also in Greece, Spain and many eastern European countries, people feel they have been left to fight the virus on their own. In the immediate medical crisis this was inevitable because public health is a national rather than an EU matter. There was also practical cooperation between member states: for all the headlines about borders being closed, which they were, there were less noticed stories about the French health service sending patients across to Germany, where hospitals were less stretched.

As the virus recedes, the focus has shifted to the financial support available to get economies moving again. But while the European Central Bank has provided huge monetary support of a similarly broad magnitude to that of the Federal Reserve and the Bank of England, fiscal action is a national matter. Inevitably, however, the ability of governments to loosen the fiscal tap depends on the state of national finances. Germany can do a huge amount because it was running a surplus ahead of the emergency. Italy and Spain, harder hit by the virus, have much more modest firepower; the focus switches to Europe.

Europe can move only slowly. A summit last week broke up without agreement on the Commission’s plans for a €750bn (£678bn) recovery fund. That sounds huge and in headline numbers it is, but when you put it in the context of the EU’s GDP this year of around €17 trillion, it sounds less impressive. Dig further and the numbers shrink. The most important part of the fund is the €560bn Recovery and Resilience Facility, which has €310bn of grants and €250bn of loans. Loans are rather pointless, however, in a world awash with money at very low rates: both Greece and Italy can borrow at a bit over 1 per cent.

As for the grants, well, consider this. First, they are not yet agreed and the numbers will probably come down further to get agreement, quite possibly not until the autumn. Second, countries that receive them will still have to put something into the pot, so the net amount they get will be lower. Third, the grants are equivalent to only about 1.6 per cent of the EU’s GDP. Fourth, only 10 per cent of the total is proposed to be paid out next year. And fifth, the final payments would not be until 2027.

Now that the UK is outside the EU and therefore not paying into this pot, it is not helpful for Britons to comment on how the rescue scheme is being put together, but it is fair to note that the response within Europe has been mixed at best. The strongest opposition has come from Italy.

An Italian politician, senator Gianluigi Paragone, has just announced plans to form a new party with the explicit policy of taking Italy out of the EU. Again, while it is not helpful for Britons to have strong views on Italian politics, it is impossible not to note that since it adopted the euro 20 years ago, the Italian economy has barely grown. It is also impossible not to note that the most recent poll on EU membership, in April, suggested that 42 per cent of Italians would like to leave the bloc. That is up from 26 per cent in November 2018.

Things may settle down; the glue that holds Europe together has proved remarkably strong. However, the British experience has shown that nothing can be taken for granted. If, as is quite likely, Europe has a less successful recovery from Covid-19 than the US, then the glue becomes a little weaker. Maybe the European high command will handle potential secession by Italy better than it handled actual secession by the UK. Maybe the fact that Italy can borrow so cheaply, thanks to its euro membership, will curb its desire to break away – but these are difficult times.