The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic.
The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.
Increasing
green public investment while consolidating budget deficits will be a
central challenge of this decade. The EU has set the ambitious goal of a
55% greenhouse gas emissions reduction by 2030 compared to 1990 and
zero net emissions by 2050. This will require a major increase in green
investments, of which is a sizeable part should be public investment. At
the same time, major fiscal consolidations are needed after the
extraordinary fiscal support during the Covid-19 crisis. The
consolidations will be framed by European fiscal rules. Past
consolidation episodes resulted in major public investment cuts. How can
the EU ensure that public investment will increase when fiscal
consolidation is implemented?1
The fiscal rules debate
A buoyant academic
and policy analysis literature has assessed the EU fiscal rules. We see a
broad consensus on the fact that the current rules face technical
problems (measurement of potential output and structural balances) and
are not well implemented, but not on other questions, including on the
role of judgement, country-specificity, and the degree of centralisation
in fiscal surveillance (e.g. Martin et al. 2021).
A comprehensive and
broad-based reform will hence take time and is unlikely to be completed
by the reinstatement of fiscal rules in 2023, but the need to increase
green public investment is imminent. In this column, we assess the
scope for adapting the rules to make room for increased public green
investment.
Green investment needs to meet EU targets
European Commission
scenarios suggest an immediate expansion of annual investment in clean
and efficient energy use and transport by about 2% of GDP in order to
reach the EU’s climate targets (European Commission 2020). This estimate
is in line with those of D’Aprile et al. (2020) for the EU and the
International Energy Agency (2020) for the world, among others. It does
not include the cost of flanking social policies which cannot be
regarded as green investment.
The share of the public and private sectors in green investment needs
Most of the new
investment has to be private, but the public share will be significant.
For overall climate-related investments in energy and transport, the
2019 National Energy and Climate Plans foresaw an average 28% public
funding share in the EU (European Investment Bank 2020).2 If
one assumes that the new additional green investments were in line with
this 28% public share, an annual additional public investment of about
0.6% of EU GDP would result. This is a major fiscal effort that will
need to be financed.
The share of public
funding can be reduced by appropriate government regulation, taxation
policy and, in particular, a higher carbon price. However, a drastic
carbon price increase might not be socially sustainable and the European
industry might not cope with that either. Moreover, some green
investments cannot be done by the private sector because of market
failures.
It is also crucial
to remove distortions in the taxation and subsidisation of the energy
system to incentivise more private investment. But the updated estimates3 of
Coady et al. (2019) show that they amounted to a mere 0.15% of GDP in
the EU in 2020. Eliminating explicit subsidies could cover about
one-fourth of the new public investment need.
Lessons from the past
Public investment
was a victim of fiscal consolidation in previous episodes (Figure 1).
Gross public investment fell by 0.8 percentage points of GDP from 2009
to 2013 in the EU, and fell even further by 2016. Even in the group of
long-standing EU members that did not face market pressure, the real
value of public investment was slightly lower in 2013 than in 2009,
while overall primary expenditures increased by about 5% in this period.
There were only a few countries where public investment as a share of
GDP remained unchanged or increased (Belgium, Denmark, Finland, Hungary,
Sweden). In countries under market pressure, investment cut was more
dramatic. Other more future-oriented spending items, such as research
and development and education spending, were also cut.
Figure 1 Gross public investment, 2009 and 2013 (% GDP)
Source: November 2021 AMECO dataset.
There are reasons
why politicians prefer cutting investment over current spending. First,
in ageing societies, the interests of future generations have less
electoral support. Vote-maximising politicians are likely to decide
against the future, as seen in previous fiscal consolidation episodes.
Second, fiscal rules disadvantage investments by treating them fully as
current expenses, even though the benefits of investments accrue over
long periods. This biases the political economy further against
investment. Basic accounting logic would allow net investments to be
funded by deficits as they increase the stock of assets (Blanchard and
Giavazzi 2004).
Options for dealing with the trade-off between fiscal consolidation and increased green public investment
Fiscal consolidation
will have to start when EU fiscal rules are reinstated from 2023.
According to our simulations (Darvas and Wolff 2021), the speed of
consolidation can be moderate – half a percent per year – under a
flexible interpretation of current EU fiscal rules. This flexible
interpretation would neglect the 1/20th debt reduction rule (a rule that
de facto has not been implemented on account of other relevant factors
such as the implementation of structural reforms).
However, to increase
climate spending by 0.6% of GDP, governments would need to cut other
spending by 1.1 percentage points, so that the 0.5% overall
consolidation is achieved. Such deep cuts to non-climate spending simply
will not happen given our political systems.
Thus, policymakers
will face a hard choice between scaling back climate ambitions, amending
fiscal rules to make public climate investment possible, or designing a
new redistributive EU climate fund to circumvent fiscal rules. In our
view, climate targets must prevail, for two main reasons. First,
European backtracking on emission reduction targets might be followed by
similar backtracking in non-EU countries, which would risk irreversible
deterioration of the environment. Second, for most EU countries, there
is negligible risk of fiscal unsustainability. For these countries,
financing public climate investment by debt is sensible.
This leaves the EU
with three options for fostering green public investment. One would be a
general relaxation of EU fiscal rules. However, this would not provide
incentives to increase public investment, and additional fiscal
resources could well be used for recurrent consumptive spending given
the political economy reality.
A second option
would be to centrally fund all EU climate expenditure, possibly via EU
borrowing. In our simulations (Darvas and Wolff 2021), we show that this
is already the road undertaken for a number of southern and eastern EU
countries via the Recovery and Resilience Facility (RFF) until 2024. An
advantage of continuing with this approach and widening it to all EU
countries would be the approval of national green investment plans by
the Commission and the Council. This could help ensure consistency with
EU goals and prevent greenwashing. However, such a fund would need to
have a much larger capacity than NextGenerationEU (NGEU) and would need
to be in place for decades.
The treatment of the
RRF in EU fiscal indicators and fiscal rules provides lessons on how a
new EU climate fund would be treated. In line with the European System
of Accounts and a Council legal option, in September 2021, Eurostat4 concluded
that national spending financed by RRF grants will not be included in
national deficit and debt indicators, but spending financed by RRF loans
will be (Darvas 2022).
The justification
for excluding RRF grants is that EU borrowing to finance these grants
should not be counted as member-state debt because “there is no
match between the grants received from the RRF by the individual Member
States and the amounts that potentially will have to be repaid by each
individual Member State, as the two elements are calculated on the basis
of different criteria” and “there is great uncertainty on what amount each Member State will be liable for” (para. 38 of the Eurostat guidance). Thus, EU debt used to finance the grants constitutes only “a contingent liability for the Union budgetary planning”,
but not a national debt (para. 42). RRF grants do not matter for
deficits either. RRF grants are thus exempt from EU fiscal rules.
It is different for
spending financed by RRF loans. A country that borrowed from the EU is
liable to repay the full amount of the loan (along with its interest) to
the EU. Thus, spending financed by RRF loans is not exempt from fiscal
rules.
An EU climate fund
would be recorded the same way as the RRF. If it entailed major
cross-country redistribution, its political feasibility looks difficult.
Yet, without any re-distributive elements, spending by this fund would
not alleviate the constraint coming from fiscal consolidation
requirements.
The third option,
which we favour, would be a green golden rule: allowing green investment
to be funded by deficits that would not count in the fiscal rules. This
would provide incentives to undertake them, because such investment
would be excluded from the consolidation requirements. The critical
issue is the definition of green investment. A defining criterion of
climate investment should be a direct reduction of harmful emissions.
National fiscal councils and audit offices, the European Commission, the
European Court of Auditors, and the Council should play a role in
assessing compliance with the green golden rule.
A further advantage
of a green golden rule is that it could be utilised by all EU countries.
In contrast, a non-redistributive EU climate fund offering only loans
might not incur significant demand, partly because some EU countries can
borrow at a cheaper rate than the EU, and partly because demand for RRF
loans was also moderate, suggesting that borrowing from the EU is not a
popular action.
Contrary to public
investment, where the positive growth effects are well established in
the literature (e.g. Tenhofen et al. 2010), the impact of green
investment on growth is uncertain as many green investments would only
replace functioning ‘brown’ infrastructure. A green golden rule can
therefore be problematic in countries with debt sustainability problems.
Such countries should, initially, rely only on NGEU for their green
investment as they cannot ignore risks to budget constraints. Only after
NGEU expires after 2026 will the question of a green golden rule become
relevant for these countries.
Legal options
Ultimately, certain elements of the 2011 Six-Pack legislation5 and the 2012 Treaty on Stability, Coordination and Governance (TSCG)6 should
be revised to include a green golden rule in the EU fiscal framework.
This might take years. But until that is achieved, there are pragmatic
options for fostering such a rule in the preventive arm of the SGP,
though not in the corrective arm. This requires a revision of:
- the existing ‘investment clause’ to alter the adjustment path in the next years, and
- the medium-term objective (MTO) to change the long-run anchor for the structural balance.
A Council decision would be sufficient for these changes.
The current
investment clause allows for temporary deviations from the MTO (or from
the adjustment path towards it), amounting to at most 0.5% of GDP under
rather strict conditions, such that a negative GDP growth or a level of
GDP more than 1.5% below its potential. When all conditions are met,
only national co-financing of projects co-funded by the EU under certain
EU funds can be considered. The temporary deviation must be corrected
by the fourth year. These conditions are not specified in any EU
legislation, but are based on a Council decision, informed by a
Commission proposal,7 a Council legal service option and an EFC compromise agreement.8
Possible revisions
of the investment clause could include the removal of the GDP condition,
extending the scope to new green public investment, increasing the 0.5%
maximum deviation, and allowing a longer time to correct the temporary
deviation.
The determination of the MTO is codified in Article 2a of Regulation 1466/97,9 and
public investment is explicitly mentioned as a consideration for the
MTO. We propose that a first calculation of the MTOs follows the
procedure described in the latest (2017) version of the Code of Conduct
of the Stability and Growth Pact,10 and then in a second
step, these MTOs are lowered by the increase in the net green investment
the country aims to implement. Fiscal surveillance should ensure that
the extra fiscal space provided by a lowered MTO is solely used for net
green investment. A limitation of the proposed MTO correction is that
the floor of the MTO is minus 1% for euro-area and ERM2 members with
public debt below 60%, and minus 0.5% when debt is over 60% of GDP.
Conclusions
Increasing green
investments in periods of budget consolidation will prove politically
close to impossible if these investments are undertaken by cutting
current expenditures or raising taxes. It is also not recommended that
long-term capital investments be funded from current revenues. Instead,
economic and accounting logic suggests that net capital investments be
funded by deficits, reflecting the long lifetime of green
infrastructure. A green golden rule would provide the right incentives
for this. A major and justified worry is ‘greenwashing’, or the desire
of governments to declare current spending as green capital investments.
This needs to be addressed through a narrow definition of green
investments and strong institutional scrutiny. A second worry is that
green investments have uncertain growth effects. In countries with debt
sustainability concerns, such investments should therefore not be funded
with national deficits. And indeed, until 2026, it is the EU recovery
fund that will provide for that funding. Until a green golden rule is
agreed on and legally implemented, there is scope to allow for some of
such investment to take place by using the existing flexibilities.
References
Blanchard, O and F Giavazzi (2004) “Improving the SGP through a proper accounting of public investment”, CEPR Discussion Paper No. 4220.
Coady, D, I Parry, N P Le and B Shang (2019), “Global Fossil Fuel Subsidies Remain Large: An Update Based on Country-Level Estimates”, IMF Working Paper 19/89.
Darvas, Z (2022), “A European climate fund or a green golden rule: not as different as they seem”, Bruegel Blog, 3 February.
Darvas Z and G Wolff (2021), “A Green Fiscal Pact: climate investment in times of budget consolidation” Bruegel Policy Contribution 18/2021.
D’Aprile, P, H Engel, G van Gendt et al .(2020), Net-zero Europe: Decarbonisation pathways and socioeconomic implications, McKinsey & Company.
European Commission (2020), Impact
assessment accompanying the document ‘Stepping up Europe’s 2030 climate
ambition. Investing in a climate-neutral future for the benefit of our
people’, SWD/2020/176 final.
International Energy Agency (2021), Net Zero by 2050. A Roadmap for the Global Energy Sector.
Martin, P, J Pisani-Ferry and X Ragot (2021), “A new template for the European fiscal framework”, VoxEU.org, 26 May
Tenhofen, J, G Wolff
and K H Heppke-Falk (2010), “The Macroeconomic Effects of Exogenous
Fiscal Policy Shocks in Germany: A Disaggregated SVAR Analysis”, Jahrbücher für Nationalökonomie und Statistik 230(3): 328-355.
Endnotes
1 This column was written before the outbreak of the war in Ukraine.
2 The EIB (2021)
reported a 45% unweighted average public share in the EU. We calculate
the weighted average at 28%. IRENA’s (2021) 1.5°C scenario estimated a
22% public share at the global level in 2019, which would decline to 17%
beyond 2030.
3 https://www.imf.org/en/Topics/climate-change/energy-subsidies
4 https://ec.europa.eu/eurostat/documents/10186/10693286/GFS-guidance-note-statistical-recording-recovery-resilience-facility.pdf
5 https://ec.europa.eu/info/business-economy-euro/economic-and-fiscal-policy-coordination/eu-economic-governance-monitoring-prevention-correction/stability-and-growth-pact/legal-basis-stability-and-growth-pact_en
6 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex:42012A0302(01)
7 https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52015DC0012&from=EN
8 http://data.consilium.europa.eu/doc/document/ST-14345-2015-INIT/en/pdf
9 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:01997R1466-20111213
10 http://data.consilium.europa.eu/doc/document/ST-9344-2017-INIT/en/pdf
Senior Fellow, Bruegel; Senior Research Fellow, Corvinus University of Budapest
Vox
© VoxEU.org