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Europe’s quandary – net zero or fiscal discipline
The European Union aims to achieve carbon neutrality by 2050 and establish itself as a global leader in green industries while maintaining fiscal discipline. But accomplishing these objectives simultaneously is impossible, and the bloc must decide what it is willing to sacrifice
Jean Pisiani-Ferry 3 Jun 2023

As Europe sets its sights on becoming the world’s first carbon-neutral continent, it must perform a delicate balancing act. Can the European Union transform its economy while enhancing its competitiveness? And can it achieve these goals while maintaining its status as a shaper of global standards and adhering to its principles of fiscal responsibility?

The answer to these questions is a resounding no. Trade-offs are unavoidable, and identifying the concessions required to strike the right balance could prove more challenging than policymakers may think.

In 2019, when the EU unveiled its Green Deal and pledged to achieve carbon neutrality by 2050, its primary goal was to bolster the 2015 Paris climate agreement and help limit greenhouse gas emissions. But policymakers had a second, clearly defined objective: to turn the EU into a green industrial leader. This is why European Commission president Ursula von der Leyen described the policy framework as Europe’s “man on the moon moment”.

Whether the Paris accord would have collapsed without Europe’s commitment to carbon neutrality is anyone’s guess. Nevertheless, the EU deserves high praise for devising a comprehensive legislative package within a few years, which many had considered impossible. The European Green Deal relies on a vast array of tools, ranging from regulation (like the prohibition of sales of new internal-combustion cars after 2035) to carbon pricing (through the expansion of emissions quota trading).

But things have changed since 2019. First, China has emerged as a global leader in various green technologies, including solar panels and electric vehicle (EV) batteries. The scale and speed at which it has pursued green industrial policy may have solidified its comparative advantage.

Second, former US President Donald Trump’s tariffs on Chinese imports, which remain in place under his successor, Joe Biden, have resulted in lasting damage to the multilateral system. For all intents and purposes, the World Trade Organization is now a shell of its former self.

Third, Russia’s invasion of Ukraine has deprived Europe of unrestricted access to Russian natural gas, which had previously given it an edge in the global scramble for energy resources.

Lastly, the United States has joined the global fight against climate change, albeit in its own way. The Inflation Reduction Act, Biden’s landmark climate legislation, excludes carbon pricing, does not cap subsidies, and conditions access to them on distortionary local-content requirements. These characteristics make the IRA a game changer, leaving the EU’s consistent and carefully planned strategy increasingly vulnerable.

Despite these challenges, the EU has remained steadfast in its commitment to achieving carbon neutrality by 2050. While seeking to position itself as a global player in emerging green industries, it is also determined to uphold multilateral principles and rules. Moreover, the bloc plans to do all this while maintaining its existing fiscal framework. In fact, it is currently exploring reforms that barely provide flexibility in accommodating the expected budgetary consequences of the net-zero transition.

The new reality, however, may soon force the EU to reassess its stance. Given the substantial political capital that has been invested in pursuing carbon neutrality, it is hard to envision the bloc explicitly renouncing it. But it could maintain the pretence of working toward it, fail to meet its 2030 targets, and then gradually accept its new position as a follower rather than a leader. This scenario seems increasingly likely, as the EU has not established the internal governance mechanisms needed to ensure member states’ compliance.

While the EU retains direct control over some measures, such as the ban on sales of new carbon-emitting vehicles and the allocation of emissions quotas, supporting policies still largely fall within the jurisdiction of member states. Unless European governments implement policies to discourage the continued use of aging combustion-engine cars or subsidize investment in new EVs, for example, such cars could remain on the road for many more years.

In order to reduce the costs of achieving carbon neutrality, Europe may be tempted to sacrifice its competitiveness. If Chinese EVs prove to be more affordable than those manufactured in Europe, ardent climate advocates may argue in favour of buying Chinese cars. But Europe cannot afford to squander the opportunity to revitalize its auto industry.

Since 2019, the EU seems to have become more willing to sacrifice its global role as a shaper of rules and standards in the interest of enhancing its competitiveness. But the EU’s commitment to a rules-based global order is part of its DNA, and it has no substitute of comparable weight. By relinquishing its role as a rule-maker, the EU could hasten the demise of multilateralism. Given that a weakened EU would lack the resources needed to save the existing global system, this outcome seems increasingly likely.

The most prudent course would be for the bloc to ease fiscal constraints through a green carve-out or a common-debt scheme, backed by an agreement to increase its own resources. Admittedly, such a move would risk triggering macroeconomic instability. But it would be less harmful than sacrificing competitiveness or letting the multilateral system crumble.

Unfortunately, these policies do not have sufficient support within the EU. Germany’s finance minister, Christian Lindner, recently reaffirmed his country’s commitment to the existing fiscal rules. But insisting on fiscal rectitude may confront the EU with significant losses on other fronts. Contrary to what some European policymakers may believe, the transition to clean energy will not be costless. The choice facing European policymakers is straightforward: act now to address these costs, or pay a much higher price later.

Jean Pisani-Ferry is a senior fellow at the Brussels-based think-tank Bruegel, a senior non-resident fellow at the Peterson Institute for International Economics and holds the Tommaso Padoa-Schioppa chair at the European University Institute.

Copyright: Project Syndicate

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