Our money, our rules: the EU budget and conditionality go back a long way

Once again, negotiations on the upcoming EU budget seem deadlocked. Hungary and Poland are blocking the ratification of the next multiannual financial framework as they are opposing the new rule of law mechanism. We have taken the current conflict as an opportunity to take a closer look at existing conditionalities in the EU’s budget. 

As Hungary and Poland are opposing the new rule of law mechanism as part of the next EU multiannual financial framework (MFF), negotiations on the upcoming EU budget face another stand-off. Coupling the rule of law mechanism with the EU budget intends to sanction rule of law breaches in member states financially and to safeguard the EU’s democratic principles. The mechanism was introduced during the budget negotiations in the Council in 2020 – which were awarded the title of the longest budget negotiations the member states ever held. Fearing interference with internal politics and cuts in EU funding, some member states such as Hungary and Poland are threatening to veto the current proposal which is negotiated between the three EU institutions. In June 2020, Sara Kikić took a closer look at the demise of basic democratic principles in Hungary and the power grab of president Victor Orbán and the Fidesz party during the Corona-crisis in an insightful REGIOPARL blog-post.

In today’s post, we take the current quarrel over the EU budget as an occasion to trace the introduction of conditionalities to the payouts from the EU’s financial resources more closely. Such conditionalities have already been adopted in previous funding periods and are therefore far from new occurrences in the EU’s budgetary rules. However, the rule of law mechanism introduces a new level of politicization to the EU’s financial framework, and therefore, to some extent, represents a novelty in EU budget negotiations. For our analysis, we will focus on cohesion policy, one of the most significant budgetary items of the EU budget and the EU’s tool for combatting regional inequalities.


Europe’s financial solidarity: The cohesion policy framework

The founding members of the European community already declared to balance inequalities between European regions within the preamble of the Treaty of Rome. After the European Social Fund was established in 1957, the European Agricultural Guidance and Guarantee Fund (EAGGF) was subsequently set up in 1962. In order to demonstrate a notable benefit of the EU accession of Great Britain in 1973 to her voters, Thatcher demanded to set up the European Regional Development Fund (ERDF) in 1975. The ERDF redistributes funding from more developed member states to less developed regions to finance various projects.

Yet, it took another ten years until the funds were put under the roof of the cohesion policy framework. This policy field really took off with the adoption of the Single European Act in 1986. Cohesion policy was established as a corrective measure for the expansion of the internal market. 1988 saw the creation of the legal basis for cohesion policy in its present form, doubled the financial resources and strengthened the role of the European Commission as a managing actor of cohesion policy. Since then, the overall aim of European cohesion policy is to reduce “disparities between the levels of development of the various regions and the backwardness of the least favoured regions” (TFEU Art. 174). However, cohesion policy has always been accompanied by conflicts between net contributors and the main financial beneficiaries of the policy.

The ratification of the Maastricht Treaty in 1992 and the subsequent adoption of the Economic and Monetary Union (EMU) marked the next step in the European integration process. In this context, the Cohesion Fund was set up in 1994 to finance infrastructure investments within Southern member states. Yet, it also introduced first conditions for payments under the newly established fund. The Commission was granted the right to suspend financial resources under the Cohesion Fund if member states did not comply with the budgetary deficit ceilings defined under the EMU.

The Berlin Summit in 1999 already indicated significant forthcoming changes concerning the specific usage of EU allocations. While investment in the development of infrastructure and social programmes had formed the basis of cohesion policy for years, there was now an increased demand for investment into ‘intangible assets’. These comprise investments into small and medium-size enterprises and aim at fostering innovation and entrepreneurship within European regions, thus supporting the transformation of the EU into a (predominantly) knowledge-based economy.


The relaunch of the Lisbon Strategy

However, mechanisms to enforce such shifts of investments were only introduced with the Lisbon Strategy adopted in 2000. Against the backdrop of rising competition from the US and Japan, the strategy aimed at turning Europe into “the most competitive and dynamic knowledge-based economy in the world […]” (European Council, 2000). After an initial failure, the relaunch of the Lisbon Strategy in 2006  regarded cohesion policy as the main instrument to achieve higher competitiveness. This had far-reaching implications for the policy field:

Most importantly, all regions became eligible for EU funding for the first time under the newly introduced objective of Regional Competitiveness and Employment. The objective’s wording reflects the policy’s growing focus on competitiveness and supply-side oriented investments. To meet the demands of the Lisbon strategy, the EU introduced the so-called Lisbon earmarking mechanism. In spending plans, member states and the sub-national regions had to lay out in advance how they planned to achieve the Lisbon goals, reserving at least two thirds of the overall budget allocations to do so. Less developed regions under the convergence objective were obliged to channel 60% of their funding into the Lisbon goals. Regions falling under the newly introduced objective of “regional competitiveness” had to earmark 75% of EU allocations. These spending plans had to be approved by the EU Commission. Even though the Lisbon goals were regarded as leaving ample room for regions and member states to incorporate their own priorities, this set new regulatory conditionalities to secure a paradigmatic shift within the Union’s cohesion policy. Reflecting the growing focus on innovativeness and an increase in economic productivity, Hubert Heinelt and Wolfgang Petzold have described cohesion policy as the “‘conditional investment arm’ of the EU’s broader strategic orientations” (2017, p.134).


Europe 2020 and beyond

The following funding period (2014-2020) continued such reform ambitions and introduced two new conditionalities. Back in 2012, negotiations over cohesion policy were shaped by the turmoil of the financial crisis and the subsequent European debt crisis. Both left their mark on the policy field: in light of rising government debts and growing demands for austerity policies, the European Semester attained a greater influence over cohesion policy. Although complying with the macroeconomic rules spelt out in the Stability and Growth Pact had already been established for the Cohesion Fund, these conditionalities were now expanded to the EU structural funds.

In theory, funding can be withdrawn if member states continue to display excessive public debts. Critics have pointed to the potential counterproductivity of such measures, as decreasing public funding within times of scarce public financial resources might neither lead to economic recovery nor to a decrease of outstanding public debt. Yet, so far the Commission has been hesitant to enforce such economic and monetary conditionalities. Although an excessive deficit procedure was triggered in 2016 for Portugal and Spain, the withdrawal of cohesion funding was ultimately not ordered. To increase the completion of regional projects funded by EU resources, the Commission introduced a second control mechanism. Since the 2014 funding period, member states have to keep a performance reserve of 6% of EU allocations. Thus, a certain amount of the EU funds is only paid out, if projects are successfully implemented according to predefined targets. This reflects the development towards a results-based approach of cohesion policy in recent years.


The upcoming MFF: increasing politicization of EU funding

The EU will continue most conditions within the upcoming funding period. Moreover, in its 2018 proposal, the EU Commission called for even stronger links between the European budget and the macroeconomic conditions of the European Semester. As we have seen, cohesion policy has a long tradition of conditionalizing EU payments .

However, conditions have so far focussed on the adherence of questionable spending priorities and prudential macro-economic considerations. Tying EU funds to the rule of law mechanism, therefore, introduces a new quality of conditionality. It can be seen as a direct response to the rise of a populist radical right within many European countries, and increasingly authoritarian governments in some member states. Although the European Commission has documented the ongoing deterioration of human rights standards and democratic principles in Poland and Hungary, it has so far been unable to counteract such developments meaningfully. Thus, an adoption of the new rule of law mechanism could prevent the continuous abridging of minority rights and help to safeguard the judicial independence in member states, for example, by imposing significant financial constraints.

To what extent Orbán’s veto to the mechanism will be successful is highly questionable. Even though the obstruction could result in the adoption of an EU budget emergency package instead of the full MFF, both the European Parliament and the Commission have re-emphasized their commitment to the rule of law mechanism. With the negotiations still ongoing, the next weeks will tell which road the EU takes for the upcoming funding period.