CER's Cornargo/Springford: Europe needs both fiscal and energy solidarity

14 March 2023

The EU should establish a climate fund to speed the energy transition, and finance it with joint borrowing, building upon the success of the NextGenerationEU fund.

• Putin’s invasion of Ukraine has raised energy prices and, in response, European governments are subsidising electricity and gas consumption. The European Commission has developed the REPowerEU plan to cut Russian gas out of the EU market. That plan involves energy saving targets, more imports of pipeline gas and liquefied natural gas (LNG) from countries other than Russia, and more renewable energy.
• European governments have cut energy taxes and frozen retail prices to protect consumers and businesses. So far, EU governments have allocated over €600 billion to such emergency measures (although outlays will probably turn out to be lower, given the fall in energy prices). In our analysis, we evaluate the emergency energy measures of a few countries: France, Germany, Italy, Poland, Spain, Greece, Bulgaria, and the UK.

• Some countries are targeting the subsidies better than others by making them more generous for poorer households and for small and medium enterprises. For example, Germany has provided some heating subsidies only to recipients of housing benefits, and Italy has provided more generous discounts on energy bills to households under a certain income threshold.
• In the member-states we focus on, governments have spent over four times more on price control measures like tax cuts and price freezes than on cash transfers. The latter are preferable because they preserve incentives to save energy.
• Compared to consumption subsidies, EU governments have been doing much less to reduce dependence on gas by cutting demand. In the past year, new incentives for energy efficiency investments have remained substantially below energy subsidies.
• While natural gas prices have come down from their highs, they are currently twice as high as they were before Russia’s invasion. The European economy needs to adjust to a prolonged period of higher gas prices. Smoothing the shock for household and firms in the short term is a good idea, but governments should not continue to subsidise energy consumption forever. Instead, they should reduce subsidies over time and support investment to reduce dependence on gas.
• Governments should devote more and better targeted resources to the retrofitting of buildings and to encourage businesses to invest more in energy efficiency. They should also invest in modernising the electricity grid and increasing renewable energy capacity, which will help to replace imported gas with domestic sources of energy supply. Reforming planning rules to accelerate investment in renewables is a good example of how removing administrative barriers can also boost investment.
• To finance the REPowerEU plan and help governments in these efforts, the EU is repurposing some unused funds to make about €300 billion in lending available to member-states. These are loans, not grants, which benefit governments whose borrowing costs are higher than those of the EU as a whole. According to our calculations, using these loans would provide an investment subsidy of only €6 billion a year to 2026 for the entire EU-27. This would provide some helpful support for countries whose national borrowing costs are far higher than the EU’s, such as Hungary, Romania and Bulgaria.
• However, to meet its 2030 emissions reduction targets, the EU needs to invest an additional €250-300 billion a year, so in aggregate terms REPowerEU constitutes a small subsidy for the energy transition. Without more EU investment support, poorer and more indebted countries might struggle to speed the transition away from fossil fuels. And as government borrowing costs rise, Europe might repeat the mistake of the 2010s, when investment was severely curtailed by austerity programmes.
• The response to the energy crunch has showed that richer and less-indebted countries can afford more generous energy subsidies to households and businesses. The divisions between member-states with low and high public debt are now affecting the debate on the EU’s state aid rules. In a world where China and the US are using massive public subsidies to support their green tech industries, not all EU member-states agree on how to respond. France and Germany would like EU state aid rules to be relaxed to allow governments to provide US-style subsidies to green industries. The European Commission plans to loosen these rules to make room for a more ambitious industrial policy in the clean tech sector, but is meeting the opposition of laissez-faire member-states such as the Netherlands and high-debt countries like Italy, which would not be able to subsidise their industries as generously....
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