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The green politics of Europe’s fiscal debate

Stability, growth and climate action

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The photo shows the sculpture of an euro symbol from behind, so the symbol appears reverted. The sculpture is placed at the headquarters of the European Central Bank in Frankfurt, Germany.
Behind the Euro symbol at European Central Bank headquarters in Frankfurt, Germany. Photo by Farah Almazouni on Unsplash.

The European economy faces inflation, a cost-of-living crisis and recession. In response, Member States consider reforming Europe’s restrictive fiscal rules to avoid a return to devastating austerity. This debate offers a chance to chart a way out of the current crisis – and holds the key to unlocking investment in Europe’s decarbonisation.

Russia’s invasion of Ukraine has sent gas prices to record levels, and inflation is sweeping Europe. In response, governments have already spent €500bn protecting citizens, who face the worst cost-of-living crisis in decades. As the European Central Bank hikes interest rates, the bloc nears recession. Member State budgets are already strained by the pandemic and the first seven months of the war. Despite this, governments will need to spend even more to soften the blow – or face a new winter of discontent.

The suspension of Europe’s tangled fiscal rules (made up of the Stability and Growth Pact and a host of other regulations) in 2020 has allowed for this continental effort of state support. The rules as they stand are not fit for purpose. Instead, they constrain government spending, encourage austerity and slow European growth. Reactivating these rules in 2024, as expected, would prolong the bloc’s economic pain, slow the recovery, limit Europe’s crisis response and stifle vital future investments.

Investing in the green transition

The most pressing of these investments is in the green transition. The EU leads the world in its commitment to net zero by 2050. Yet the implementation of this ambitious promise poses a funding challenge. Fresh investments are needed in transport infrastructure, building renovation, renewables deployment, skills training, and elsewhere to drive a societal transformation not seen since the industrial revolution.

For EU Member States to reach the promised 55% emissions reduction by 2030, the average investment need is €360bn annually. Of these, €100bn must come directly from government budgets. These urgent public funds come on top of all other state spending.

On Your Marks…

Reforming the fiscal rules is firmly on the EU’s agenda for 2022. President von der Leyen has committed to it in her State of the Union speech. Moreover, the Czech Presidency is clear that the rules have “reached their limits” and will lead the Council discussions on an update. Beyond Brussels, the International Monetary Fund has called for reform, while the ECB advocates for considering inflation dynamics in any solution. Nonetheless, fundamental disagreements exist on the shape of reform.

The so-called ‘frugal’ Member States— including Austria, Sweden and the current holder of the EU’s Presidency, Czechia — favour reform, but not increased investment. Instead, they want to toughen the punishments meted out to European countries whose debts are judged unsustainable. Such an oppositional coalition could block any proposal which explicitly supports green investment.

In contrast, Member States supporting progressive reform present less of a united front. While the unlikely alliance of Spain and (ex-arch frugal) the Netherlands may seek to join forces with France, Italy, Greece and Portugal in the ECOFIN Council, they have so far failed to coordinate in facing the Frugals. These Member States have a unique opportunity to forge a new fiscal consensus, one which supports Europe’s climate commitments. The moment to seize this opportunity is fast approaching.

All eyes on Germany

Much of the debate hinges on Germany. The Ministry of Economics, led by the Green Robert Habeck, published their proposal in August. The plan shows the new coalition government is open to a future-fit reform. They even mention the need to support the green transition.

Yet, Liberal Finance Minister Christian Lindner, who sits on ECOFIN and will lead negotiations, has taken a more hawkish tone. He is pushing for fiscal discipline and bashing any kind of support for green investments. Whether determined by internal coalition wrangling or a hard-fought compromise in Brussels, Germany’s final position will greatly influence the deal and Europe’s fiscal future.

Seizing the opportunity

Against the background of the ongoing informal debate, the Commission will present its orientation in October. This marks the start of the formal process that could lead to significant rule change. Supporters of ambitious reform must use this process to push for a deal that equips governments to face the cost-of-living crisis and unlocks vital investment in Europe’s decarbonisation. It is an opportunity that we cannot miss.

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