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Governments are increasingly turning to green industrial policies to avert ecological breakdown. However, the European Union’s restrictions on borrowing limit the ability of member states with higher debt and deficits to meet green spending needs, including green industrial policies, green public infrastructure, supporting households to roll out renewables and energy efficiency, and electric mobility and public transport. This could lead to increased disparities between countries and slow down necessary climate action. Green industrial policies and increased government spending should provide support for businesses in return for stronger social and environmental conditions as well as public equity stakes. This will help ensure that public policy goals are met as well as generate inclusive prosperity and reduced inequalities.

In response to the USA’s Inflation Reduction Act (IRA), the European Commission proposed a Green Deal Industry Plan, which includes production targets for green manufacturing, temporarily relaxing state aid rules, developing skills, and repurposing existing funds for a joint European sovereignty fund. But, the Commission’s plan has been criticised for including significant deregulation. In contrast, the USA’s industrial approach includes increased fiscal firepower, social conditions for companies to receive public support, and the sharing of excess profits.

Restrictions on debt and deficits mean governments need to keep their debt-to-GDP ratio and their borrowing arbitrarily low. Those with higher debt and deficits will not be able to benefit from green industrial policies as much as those that are less indebted.

Based on a range of assessments, our analysis looks at three different scenarios of spending increases to meet the EU’s agreed climate targets and to meet 1.5C aligned climate targets. It shows that:

• Only four countries (Ireland, Sweden, Latvia, and Denmark), representing 10% of EU GDP, would be able to muster sufficient fiscal space to practically undertake our 1.5 degree aligned scenario within debt and deficit limits.
• Five countries (Luxembourg, Bulgaria, Lithuania, Slovenia and Estonia) could increase spending at least enough to meet the lower end and higher end spending increases needed to achieve EU agreed climate targets, but not spending needed to meet our 1.5 degree aligned scenario.
• Five countries (Germany, Austria, Slovenia, Cyprus and Malta) are able to increase spending by at least the lower end of green spending needed to meet the EU’s agreed climate target but are classed as medium debt risk by the Commission and as a result may face limits on spending. Germany could increase spending by nearly enough to meet our 1.5 degree aligned scenario but are classed as medium risk.
• Eight countries (France, Spain, the Netherlands, Poland, Belgium, Finland, Czech Republic and Romania) would not be able to achieve our limited green spending scenario, which represents minimum investment needs to meet the EU’s agreed climate targets, without breaching the 3% deficit limit, or having to cut other spending or increasing taxation. An additional five countries (Italy, Croatia, Portugal, Greece and Hungary) are classified as having high debt risk by the Commission and would be under pressure to reduce debt levels in the next four to seven years. This would mean countries that represent 50% of the EU’s GDP are unable to meet the lower end of green spending needs that the Commission estimates are needed to meet EU agreed climate targets.

This analysis shows that current fiscal rules limit many governments from making necessary green investments, which will likely increase economic divisions between member states and slow EU climate action.

The political objective to keep debt arbitrarily low is not shared by other major economies. The eurozone is expected to borrow almost half (in terms of % GDP) as much as other G20 countries in 2027, and less than a fifth of what China is expected to borrow. The USA is expected to be consistently above a deficit of 3% of GDP throughout 2023 – 2027.

Transformative green industrial policy also requires a new social contract with businesses, to ensure it doesn’t become corporate welfare and increase inequality, but instead creates value for us all. The IRA takes some steps to push corporations to act more socially responsibly, particularly around wages and apprenticeships. The US Chips and Science Act goes further, requiring excess profits to be shared with the government and discouraging stock buybacks. The EU should put in place similar measures to ensure that businesses achieve social and environmental public policy objectives. By retaining equity stakes in companies receiving support, governments can ensure that value is created and that transitioning to a green economy benefits us all.