Hungary, Poland and the rule of law: Follow the money

Since Vladimir Putin invaded Ukraine a year ago, economic sanctions have been at the forefront of EU policy making. But Brussels has also discovered the power of the purse closer to home, in its fight to arrest democratic backsliding in Hungary and Poland. On December 12th  2022, the EU froze €6.3 billion of cohesion funds that were due to Hungary because of rule of law concerns. The EU has still not disbursed Poland’s post-pandemic recovery money for the same reason.  

With soaring inflation, slow economic growth and swelling budget and trade deficits, Hungary, and to a lesser degree, Poland, have  become even more reliant on EU money than usual. Until 2026, EU cohesion funds and the grants and loans from the Union’s post- pandemic recovery fund represent annual transfers worth a staggering 4.3% of Hungarian and 3% of Polish 2022 GDP, funding a hefty chunk of public investment. A freezing of even a portion of these EU funds would further compromise public finances and economic growth. It may also erode investors confidence in financing Hungary and Poland’s deficits, putting more downward pressures on their currencies or even leading to a balance-of-payments and financial crisis.

The worsening economic outlook is not the only problem for Hungary’s Viktor Orbán and Poland’s ruling Law and Justice party.  Orbán won a landslide election in April, but his ability to govern the country without much opposition hinges heavily on a complex network of cronies and political allies who he generously funds, often with EU cash. In Poland, Law and Justice is facing an election in the autumn that depends on its ability to deliver its hallmark ‘Polish Deal’, a massive tax break and benefit hand-out part of which would be financed through Poland’s share of the recovery fund.  

The EU shrewdly pressed these advantages to extract rule of law concessions from the pair of countries. To unblock (or unfreeze) EU money, Orbán has passed a litany of anti-corruption laws, and Poland’s Mateusz Morawiecki is trying to undo the controversial judicial reforms that his coalition has pressed for the past seven years and that the EU consider illegal. Hungary’s reforms are not earth-shattering, and Polish President Andrej Duda has referred Morawiecki’s ‘un-reform’ bill to the country’s politically captured constitutional court. But, for the first time, both governments will need to show some tangible progress to get EU cash. The EU is no longer merely rubberstamping pro-forma commitments from the Polish and Hungarian governments. Brussels has got more out of Budapest and Warsaw in the past year alone than at any point in the seven years it has been playing by the legal book. While the EU purse is a powerful instrument, the need for consensus in EU machinations mean it cannot always be brought into the fray. The EU could harness its money power for three reasons, none of which is likely to stay constant over time.

First, the Commission was able to push ahead with freezing EU funds to Hungary despite pressure from the member-states in the Council partly because Ursula von der Leyen is powerful enough to disregard the views of some countries, particularly if has the European Parliament behind her. But the Parliament is mired in its own corruption scandal and von der Leyen has alienated some of her partners with what they perceive to be concessions to Poland on account of the war.

Second, the war in Ukraine has exposed fractures in the friendship between Budapest and Warsaw that the EU was able to exploit. But the Polish government is being less honest about its friendship with Orbán than it may appear. Morawiecki has given no indication that Poland will unblock an ongoing disciplinary action against Budapest that requires unanimity to succeed. And Poland did not agree with the Union’s decision to freeze Hungary’s cohesion money. Third, and most critically, the Union has been able to use the carrot of its post-pandemic recovery fund to extract rule of law concessions from both Budapest and Warsaw. Unlike EU cohesion funds, the Commission decides whether to approve national recovery funds, and, crucially, when to unlock the money. The recovery fund makes the Commission much less dependent of wrangling in the Council, where Poland and Hungary may be able to gather support or at least divide opinion.

But the recovery fund is not a rule of law tool by design, and, most importantly, it is time-bound. As its funds are paid out and disappear into the rear-view mirror, the Commission’s leverage will unavoidably decrease. And rows over money and vetoes will return, possibly every six months, as recovery money tranches need unlocking.

For now, the benefits of withholding EU funds outweigh the risks for Brussels. Neither Poland nor Hungary are eurozone members and their economies comprise only 4 and 1 per cent of the EU economy, respectively. But if the situation deteriorates there could be a balance-of-payments or financial crisis in either country.  This is not good news for the EU: financial crisis could spill over to other eastern-European countries and some pockets of the wider eurozone financial system that are vulnerable to instability in the region, possibly forcing the ECB to intervene to stop any contagion. The threat of an economic crisis is more useful for the EU than actually having one.

Vetoing decisions in exchange for concessions is a practice as old as the EU itself. So is using money to increase one’s leverage in EU decision making. But, in the long-term, it is in nobody’s interest to resort to blackmail as it could easily morph into political and economic brinksmanship. The EU’s goal has always been to engineer improvements in the rule of law, not cause an economic meltdown in the region.

Eventually, the EU will have to reckon with a bigger, more important question: what is the point of having members of the club who think rights are compulsory, but obligations are not?

Both the internal market and the area of freedom, security and justice work because there is an implied trust that all national courts follow the same standards. Once this is no longer the case, membership of not only the single market, but also the EU’s borderless area of Schengen become endangered. The Union should make that link clear. The one single long-term answer to the EU’s rule of law crisis is about redefining the way the EU thinks about its common legal space.

Whereas EU sanctions failed to floor the Russian economy immediately, they may starve it from high-tech imports and choke off its growth over time, particularly if the EU can sustain them. The reverse holds true for using EU money within its own ranks: it is a good short-term strategy to defend the rule of law, but will not be effective in the long run.

Camino Mortera-Martinez is head of the Brussels office and Sander Tordoir is a senior economist at the Centre for European Reform.