New EU debt rules 'risk undermining climate goals'

The commission's proposal includes a one-size-fits-all rule that would mean countries would have to reduce their deficits by a minimum of 0.5 percentage points of GDP per year when deficits exceed three percent.

According to the report, this would translate to €45bn worth of cuts in 2024 — at a moment when Europe should scale up investment and would force indebted countries to reimplement the austerity measures, described by researchers Sebastian Mang and Dominic Caddick as "failed economic principles" that have "made Europe poorer."

This would "likely contribute to further economic divergence between the US and the EU, especially as the US is scaling up public investments in green industrial policies," they added.

In a previous paper published in April, the NEF researchers found that only four EU countries (Sweden, Ireland, Denmark and Latvia) would be able to meet their climate commitments if uniform spending limits were to be reimposed.

In June, the European Court of Auditors also warned that the EU is at risk of failing to meet its 2030 climate change targets due to insufficient public spending.

Political impasse?

Fiscal rules have been suspended until the end of this year to help countries deal with the effects of the coronavirus pandemic and the consequences of the Russian invasion of Ukraine.

These limits, which are widely deemed too strict, will kick back into force automatically at the start of next year if no new rules are in place.

Countries are scrambling to find a middle ground but have so far failed to reach an agreement, with highly indebted countries like Italy and France insisting on more leeway in deficit rules to allow for more investments, and Germany insisting on uniform and binding limits.

Like the existing rules, the proposed commission compromise also adheres to the 1991 Maastricht criteria. These limit debt to a maximum of 60 percent of economic output and deficits below three percent.

The commission wants to allow countries more flexibility in reducing debt ratios but still envisions a hard deficit limit of three percent. The researchers argue that the commission fails to consider the cost of spending cuts.

Previous NEF findings show that Portugal, Greece and Spain, the countries that cut their budgets the most between 2009-2019, saw the largest increases in their debt-to-GDP ratios.

If countries are forced to reduce spending on green infrastructure and public services, it would undermine growth and force future governments to spend more on adapting to the impacts of climate breakdown.

Boost growth instead

Recent analysis by the International Monetary Fund (IMF) also shows that green investments have an above-average positive effect on economic growth compared to other public investments. It also found that fiscal consolidation historically does not reduce the debt-to-GDP ratio but increases it.

Partly based on this, the authors find that even a one percent green stimulus above projected growth could lower debt levels in the medium term due to the so-called 'multiplier effect.'

In a conservative estimate, this translates to at least €135bn per year, which could be spent on green investment by the EU's most indebted countries, including France, Portugal, Spain, Belgium, Hungary, Italy and Greece, with debt still falling by the 2030s because investments in social and green services boost growth.

"The EU is missing the big picture by focusing on arbitrary debt reduction targets that constrain green spending instead of boosting green investment," Mang and Caddick argue, adding that policymakers should reject numerical benchmarks on debt and deficit limits.