The economy of the European Union is emerging from the worst recession since World War II and economic growth forecasts have been revised upwards for 2021 and 2022. And while the energy crisis does put a brake on the recovery, the strategy for exiting the fiscal support of the pandemic will be paramount. Moreover, the medium-term stance of fiscal policy will be crucial to ensure sustainable public finances. The European Commission has now issued a request for public consultation.

One important aspect of the consultation concerns the investment needs. The European Commission points to substantial annual investment needs in digital and green infrastructure. It is clear that achieving the goals of the Green Deal and the “Fit for 55” package will require significant additional investments as well as regulatory and tax measures.

In order to achieve the target of net zero greenhouse gas emissions in the EU by 2050, an immediate increase in annual investments in clean and efficient energy use by around 2 percent of GDP is necessary. In the middle scenario of the European Commission’s impact assessment, an additional annual investment requirement of EUR 360 billion on average (to EUR 1040 billion on average at 2015 prices) was estimated in order to achieve the intermediate target of a 55 percent reduction in emissions by 2030 compared to 1990. Even higher investments will be required after 2030. In relation to GDP, this means an increase from 5.3 to 7.0 percent, according to the Commission.

A significant portion of this additional investment will have to be financed by the public sector, with the public-private sector ratio estimated at 1: 4, as we have pointed out in a recent paper with my colleague Zsolt Darvas. Given that some of the investments required are public goods and given the existing policy choices, we estimate that public spending needs to be increased by around EUR 100 billion per year. This means a great effort that needs to be funded.

The main political challenge for European finance ministries in the coming years will be to consolidate deficits while increasing green investment. In the midst of the euro crisis in the early 2010s, budget consolidation in the EU took place very quickly. This rapid consolidation was a major contributor to the 2012 recession. In addition, almost all countries cut public investment. This needs to be avoided in the coming years.

However, a general relaxation of fiscal rules would not provide direct incentives to increase green investment and it would also risk excessive deficits in good times. It is, therefore, not a suitable approach to reforming the rules. Financing green investments through deficits that are not taken into account in the budget rules would, on the other hand, be an incentive to maintain and increase them during the consolidation phase. As such investments would be exempt from the consolidation requirements, green investments can be preserved in the coming decade.

We, therefore, recommend a “green fiscal pact,” which introduces a “green golden rule” that excludes net public investment in climate protection from deficit and debt calculations under the EU fiscal rules. We advise against a general relaxation of fiscal rules as debt sustainability concerns need to be taken seriously and climate change in itself may well reduce growth. Finally, incentives are needed to trigger private investment through appropriate taxation and regulation.

Such a green fiscal pact would create incentives for the necessary public investments in climate protection. Without the possibility of deficit financing, the EU will not achieve its goal of climate neutrality. Due to political and economic constraints, budget consolidation would come at the expense of investments.

While exempting investments from the deficits to be taken into account has been rejected in the past, there are now good reasons to justify deficit financing for green investments. The established green infrastructure will be used for decades and the net investment requirement is enormous. The restructuring of the energy system and the transport infrastructure is an enormous effort, which, in view of the political and economic constraints, simply cannot be financed from current budgets. The need for climate investment is so great that it has a macroeconomic dimension.

The key to a successful green golden rule lies in a clear system to define and control what is an actual green investment and what is just “greenwashing.” This requires careful definitions and institutional oversight. By and large, a kind of green golden rule would make a useful addition to the existing fiscal framework.

About the author

Guntram Wolff is the Director of Bruegel. Over his career, he has contributed to research on European political economy and governance, fiscal, monetary and financial policy, climate change and geoeconomics.

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