Bruegel’s Darvas: ‘We need much higher carbon prices in Europe’

Bruegel's senior fellow Zsolt Darvas expects a limited expansion of the current investment clause as part of the Stability and Growth Pact review. [Bruegel]

In a paper discussed by EU finance ministers on 11 September, Bruegel, an influential think-tank specialing in economics, made the case for protecting green investment as part of the upcoming Stability and Growth Pact review. 

Bruegel’s senior fellow Zsolt Darvas, one of the report’s authors, told EURACTIV.com in an interview that most of the investment needed to reduce CO2 emissions would come from private sources, making carbon pricing the main instrument to incentivise the transition.

He also said he expects a limited expansion of the investment clause included in the Pact as a possible outcome of the reform of the fiscal rules.

Q: There is a need to reconcile the reduction of the high levels of public debt resulting from the pandemic, with the big expenditure required for the ‘green’ transition. The balance is even more complex to achieve because governments need to consider the social cost of these adjustments but also the impact of sustainable policies on citizens’ pockets. What would it be the right formula?

It is really difficult to find a good trade off among these three issues. First of all, in order to reach the climate goals, massive increase in climate-related investment is needed. Most of it has to be private, but around 25% or 30% of the total has to come from the public sector. At the same time, when the Stability and Growth Pact will be reactivated, countries will have to start cutting budget deficits and public debt. That will be a challenge. And if you look at the history of public deficit, budget reduction was done at the expense of investment. 

What about the social impact?

The third point you mentioned is absolutely important. Many economists, including myself, argue that good incentives should be provided for the private sector, by increasing carbon prices for everything, including household gas. But a massive increase in carbon prices will lead to major social tensions. Many households will not be able to invest in solar energy or renovate their houses. Therefore, there are major limitations on how much and how far carbon prices can increase. In addition, from the corporate side, we should not forget about impact on the global competition.

What about the carbon border adjustment mechanism?

I am not really sure whether this will actually happen. Moreover, I think that it cannot fully compensate for a much higher carbon price in Europe.

Europe looks for investment to spur its ailing recovery

Difficulties never come alone in the EU. The German Constitutional court’s decision to halt the ratification of the EU’s recovery fund on 26 March is the latest challenge faced by the EU in the battle against the Covid-19 pandemic.

You said most of the investment will come from private sources. Do you see the private sector ready to play this major role? Are there enough incentives?

It very much depends on public policies, taxes and regulations. For example, we already see that the emission standards for the car industry are going higher and higher and that will continue. When it comes to carbon pricing, I think our prices are not high enough in Europe. That has to change. 

Do you think the EU has all the elements in place, or at least in the pipeline, to channel private investors’ money towards sustainable goals? I am referring to the green bond standards or the taxonomy, for example. Are new proposals needed?

All these initiatives go in the right direction. But ultimately, the most significant factor will be carbon pricing. In order to reach a very fundamental reduction of CO2 we will need much higher carbon prices. The question is how fast we get there. And how we compensate those that are really unable to cope with higher prices, including unemployed people or vulnerable households.

But current prices are already sparking social unrest, and part of the current costs are due to the carbon price hike seen in recent months.

Public support is important. The recent huge spike in energy prices happened certainly too fast. But I would expect high energy prices to correct back in a few months, quarters or years from now. I think it is a more temporary phenomenon. Some households cannot really afford much higher energy prices in the long run, and they need public support. But many do have lots of financial savings and they could spend more on the environment and the fight against climate.

Commission hints at quick fix of fiscal rules in 2022

The European Commission said on Friday (10 September) that it will explore options to improve the Stability and Growth Pact by the end of next year, as member states are preparing for a bruising battle over the reform of the EU’s fiscal rules.

On the Stability and Growth Pact review, we could already see a trade off between speed and ambition. The Commission said there will not be a legislative proposal in place by early 2023, when the Pact will be reactivated.  An option is to publish a new interpretation of the fiscal rules. Should it include new debt reduction paths?

A fundamental change of the Stability and Growth Pact would be politically very difficult. Many countries don’t want it, and in other cases it would require changes in national Constitutions. There is a very low probability of major changes. The Juncker Commission already exploited the flexibility as much as possible, so I don’t think there will be a major reinterpretation either. We proposed a special treatment for ‘green’ investment [the so-called golden clause], excluding this type of expenditure from the Pact. The Commission is currently looking at what legal changes are needed, but I expect something along these lines.

Do you think climate concerns could help narrow the differences between the Northern bloc, in favour of fiscal stability, and Southern countries, which champion more investment? Will the two sides agree on a limited golden clause, based on the finance ministers’ discussion on your paper you saw last weekend? 

I think some little changes will happen related to green investment, but not as bold as we proposed. There is an investment clause already in the Stability and Growth Pact, but it is  extremely narrow. First of all, the conditions to activate it are very tight. I could imagine that this investment clause could be revised, and since it does not require legislative changes, it would sufficient with an agreement by the Ecofin.

It could exclude in the eyes of the Pact not only national co-financing of EU programmes, but any public expenditure for ‘green’ projects. In addition, the investment clause allows for maximum half percent deviation only over a period of four years. Perhaps this period could be revised to give a little bit more time, for example six years.

[Edited by Zoran Radosavljevic]

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