The contradiction in the EU between deficit targets and green investments

The fiscal rules proposed by the European Commission endanger the public investments necessary to combat climate change and, if they were applied, our country could increase its allocation for green investments by only 1%, without jeopardizing the budget deficit target, shows in a study carried out by the New Economics Foundation.

"The inclusion of uniform debt and deficit rules, supported by Germany and other powerful countries, would maintain the same economic principles that have kept Europe on the brink of poverty for the past decade. In addition, these rules would lead to the need for some countries to introduce austerity measures, which have not had the intended effect in the past. (...) The fiscal rules proposed by the EU will also lead to greater economic divergence between countries. Richer countries, which have a greater ability to borrow within fiscal rules, will be able to allocate considerable sums to green public investment and to the efficient stimulation of economic growth. Instead, the rest of the EU member states will know restrictions on the projects financed. The EU's fiscal rules are built on the so-called Maastricht criteria, which require governments to keep budget deficits and public debt below 3% and 60% of GDP, respectively. However, the Commission's proposal on fiscal rules introduces a new approach to classifying countries based on a debt sustainability analysis (DSA), dividing them into high, medium and low risk groups. High- and medium-risk countries must reduce their debt and/or deficits, while low-risk countries are expected to keep debt levels below 60% and deficits below 3%. This country-specific approach, which suggests negotiated adjustments with governments, replaces the previous uniform reductions imposed, which required a 0.5% reduction in debt for exceeding 60% of GDP debt," say experts from the New Economics Foundation.

According to the analysis carried out by them, based on the criteria proposed by the European Commission regarding debt sustainability, 10 of the 15 EU member states that have a debt level exceeding 60% of each state's GDP should reduce their deficit annually with a minimum of 0.5% of GDP.

"To meet the EU's climate targets of cutting emissions by 55% by 2030, the proposed borrowing rules would leave 13 countries, accounting for half the bloc's GDP, unable to invest enough. In practice, deficit rules stand in the way of European climate goals. The strict 3% deficit limit makes it harder for the EU to meet its own climate goals or meet the targets set out in the Paris Agreement. This tight deficit limit stops governments from investing enough to limit the harmful effects of climate change. In addition, fiscal rules are likely to lead to economic divergence between richer and poorer/more fiscally constrained EU countries, as richer EU countries will be able to spend much more than others," the authors state the study.

According to the quoted source, at the moment only four EU countries can meet the 3% increase in green spending needed to meet the high emission reduction scenario: Ireland, Sweden, Denmark and Latvia, while Germany, the Czech Republic and Austria increase by over 1% spending on green investments. Romania can increase them by a maximum of 1%, while Bulgaria can increase them by 2% without jeopardizing European rules on the budget deficit, just like Estonia, Lithuania and Croatia.

However, the states that exceed the limited deficit of 3% of GDP, which includes Romania, in order to receive allocations for green investments, will have to reduce that deficit by at least 0.5% annually, claims the quoted study.

"This rule involves quick discounts. In 2024, this rule would require cuts worth euro45 billion in 14 EU member states. This would involve austerity measures at a time when the EU needs to rapidly step up public investment in climate and nature conservation, as well as spending in areas such as health, education and social sectors," the authors of the study state.

Regarding the need for fiscal consolidation in the 14 states, the document states that national budget deficits/surpluses are not independent of economic growth.

"If governments increase the budget deficit to finance investment projects to combat climate change or in public services, that financing can attract greater economic growth. Conversely, if governments cut spending on social care, schools and hospitals, this can lead to lower economic growth, and those cuts can lead to higher debt as GDP growth is lower. There are numerous studies showing that these tax rules have reduced economic growth. On average, fiscal consolidation does not reduce the budget deficit but increases total debt, according to a recent analysis by the International Monetary Fund, a fact recognized by the European Commission. And our analysis illustrates this: countries that made more drastic fiscal adjustments saw an increase in the budget deficit, not a decrease," say the authors of the study published by the New Economics Foundation, which believes that the European Commission's uniform rules for reducing the deficit can increase the debt of EU member states.

"However, they believe that the EU member states with the highest degree of public debt could invest a total of 135 billion euros annually in the ecological transition, provided that officials in Brussels relax the rules on the budget deficit of each state member.

To create more fiscal space and address spending gaps, three strategies should be pursued:

- expenses regarding investments that combat climate change should be excluded from the calculation of the 3% deficit;

- the "do no significant harm" principle should be applied to gradually eliminate harmful public investments;

- the establishment of a European investment fund, financed from new common loans, a fund to develop ecological industrial policies, public infrastructure and investments and reforms to increase resilience", the authors of the analysis say.

We note that the New Economics Foundation is a non-political British think-tank that promotes "social, economic and environmental justice" and regularly provides analysis on various economic issues in the UK, the European Union and beyond.