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Greening the Recovery by Greening the Fiscal Consolidation

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Greening the Recovery by Greening the Fiscal Consolidation POLICYBRIEF ISSUE 2 | JULY 2020 GREENING THE RECOVERY BY GREENING THE FISCAL CONSOLIDATION Ben McWilliams THE ISSUE Research Assistant at The long road to economic recovery from the COVID-19 shock is just beginning. European Bruegel countries are considering how best to reboot their economies, with fiscal stimulus plans at the core of the consideration. Meanwhile, the European Commission has put forward its Simone Tagliapietra own stimulus plan. These stimulus packages will amount to several percentage points of Research Fellow at GDP, and can therefore influence the future orientation of the economic system. For this Bruegel reason, policymakers aim to incorporate long-term goals into recovery packages, most fundamentally a just transition towards a climate-neutral economy. Georg Zachmann Senior Fellow at Bruegel POLICY CHALLENGE Greening the recovery is a significant policy challenge. While there are clearly recovery policies that have positive effects on greening the economy, such as promoting energy renovation of buildings, there is a limit to the proportion of stimulus that can be explicitly greened. Beyond focusing on the explicit greening of stimulus policies where possible, greater emphasis should thus be placed on altering expectations, so that market agents anticipate higher future pay-offs from low-carbon investment. The European Union needs to announce today a significant increase in carbon prices after 2021, to be engineered through revisions of the Emission Trading System and the Energy Taxation Directive. Such reforms could provide annual additional revenues of €90 billion. This could make a major contribution to the post-COVID-19 fiscal consolidation requirements, which might be in the order of one percent of GDP per year. TWO PILLARS FOR A SUCCESSFUL GREEN RECOVERY • Some stimulus policies have dual benefits: quick, Green stimulus targeted, effective, while cutting carbon emissions packages • These must be at the core of stimulus packages Why? How? Green fiscal • Much stimulus spending • Price floor guarantees consolidation cannot be greened mean higher ETS price (by committing to • Major consolidation needs • ETD reform with stronger higher future • Carbon pricing makes big link to carbon content of carbon prices) contribution to both fuels and higher prices Recommended citation: McWilliams, B., S. Tagliapietra and G. Zachmann (2020) ‘Greening the recovery by greening the fiscal consolidation’, Policy Brief 2020/02, Bruegel 2 POLICY BRIEF GREENING THE RECOVERY BY GREENING THE FISCAL CONSOLIDATION 1 COVID-19: THE ECONOMIC POLICY Amid the chorus of voices calling for the RESPONSE post-COVID-19 recovery to be a green re- covery1, it is often overlooked that a sim- The economic policy response to ilar narrative was developed in 2008, as COVID-19 involves three phases: relief, Europe and the world designed their re- recovery and fiscal consolidation. covery plans in the aftermath of the great In phase 1, governments put in place financial crisis. The rationale for a green indiscriminate and national-based approach was clear then and is clear now: measures to keep firms and workers the disruption, in this case caused by the afloat in the face of near-universal pandemic, offers an opportunity to build cash shortfalls. As the economic crisis a new eco-friendly system, for the benefit becomes longer and bankruptcy risks of current and future generations. loom, governments will also have to But pursuing a green recovery might provide solvency support through direct not be as straightforward as one might recapitalisation to certain, selected, firms think. Trade-offs must be weighed (Anderson et al, 2020). between the need to provide a short-term In phase 2, governments – along with stimulus to the economy and the need to EU support – will put in place measures address the long-term challenge posed to reboot their economies from the severe by global warming. In the short term, contraction, with interventions aimed at there is a clear limit to the proportion of stimulating both aggregate demand and effective short-term stimulus that can supply. This can be attempted directly via be explicitly greened. Green conditions increases in government expenditure, or can be attached to public investment indirectly via incentive mechanisms to and the support given to companies, increase investment/consumption from but the experience of 2009-2010 in the the private sector (Bénassy-Quéré et al, euro area showed that about half of the 2020). As a second wave of the epidemic total stimulus comprised cuts to direct is possible, this phase might be at certain and indirect taxation, social security points be also accompanied by a return contributions, or direct income support – of phase 1 measures2. in other words, measures to keep current In Phase 3, governments will have activities going, rather than to give them to implement fiscal consolidation a new green direction. measures. Relief and recovery policies For this reason, in order to turn the will significantly increase public debts green recovery vision into practice, it across Europe. Darvas (2020) has shown is important in response to COVID-19 how European countries with higher to do what was not done sufficiently initial levels of debt might see alarming in 2009-2010, which is to have a clear increases. Typical measures would understanding of both the economic include increases in taxation or cuts to impacts and the economic policy public spending. Already in the relief response, and to then properly integrate and recovery phases, the expectations of the green component into the recovery. companies and households about future 1. See for example https:// www.europarl.europa. In particular, greening the recovery consolidation measures are important eu/news/en/press- needs to be thought of as a long-term and will guide investment decisions. room/20200419IPR77407/ project, and measures should be taken This is where the concept of ‘green eu-covid-19-recovery-plan- now to alter expectations so that market consolidation’, specifically commitments must-be-green-and-ambi- agents receive the clear message that made today to higher carbon prices in tious-say-meps. low-carbon investment will from now the future, will be pivotal for stimulating 2. Questions must also be on generate the largest pay-offs. In the green investments today. asked about how effective European Union setting, the main avenue As the economic policy discussion government stimulus can be at boosting aggregate via which a ‘green consolidation’ – or an advances towards the design of the demand in an environment embedding of the green recovery – can be recovery phase, it is important to in which agents suspect achieved would be to ensure a significant integrate the green element into the that another lockdown and and durable rise in carbon prices after complete set of criteria that policymakers stop to business might be 2021. will use to inform their recovery policies. around the corner. 3 POLICY BRIEF GREENING THE RECOVERY BY GREENING THE FISCAL CONSOLIDATION 2 GREEN, FAIR AND EFFECTIVE: also the highest employment multipliers. A SET OF CRITERIA TO ASSESS Furthermore, the multiplier also depends RECOVERY POLICIES on a variety of other factors, including A wide range of policies can contribute the specific situations in which recovery to economic recovery. The decision on measures are applied4, the speed the right policy mix will depend on which with which recovery programmes are policies are most effective at stimulating deployed5, the size of the measures6 and the economy, and on what other short- their eventual targeted nature7. and longer-term effects they might have. Although the main focus of stimulus Here, we list three criteria for policy- packages is to boost aggregate demand makers to consider when determining a through anti-cyclical stimulus, govern- portfolio of recovery policies: effective ments must consider the effects of stim- promotion of economic growth, fairness ulus on long-term sustainable economic and the green recovery. growth. In the same way that the Great Depression accelerated a large structural 2.1 EFFECTIVE PROMOTION OF ECONOMIC shift in the US automobile manufactur- GROWTH ing sector (Bresnahan and Raff, 1992) it The basic idea behind recovery poli- is likely that the current economic crisis cies is use of public money to stimulate provides an opportunity for structural aggregate demand. The expectation is supply-side shifts. As businesses rethink that each euro of public money will not value chains, and as governments inject only imply an increase in demand for stimulus into depressed economies, goods and services worth the exact same their role in shaping future growth is 3. See, for instance, Tenhofen euro, but that the suppliers of the goods larger than during normal times. In 2020, et al (2010) on the macro- economic effects of exoge- and services will use the extra income the key challenge for governments is to nous fiscal policy shocks in to themselves demand additional goods provide effective signals encouraging Germany. and services, and so forth. The greater supply-side restructuring and rationalisa- 4. Buchheim et al (2018) the impact on GDP of each euro of public tion, to be based upon a shift away from found that a solar spending (the so-called multiplier), the carbon-based production. photovoltaic installation stronger the recovery will be, given a programme created many fixed amount of spending. 2.2 FAIRNESS jobs in labour markets that But estimating the multiplier of Individual recovery policies can have featured a lot of slack, but individual recovery policies – let alone very different distributional effects. For close to none in empty labour markets. entire recovery programmes – is complex. example, lump-sum transfers to low-in- Theoretically, we know that the lower the come households are progressive, while 5. If the crisis runs too long share of money leaked from the domestic state aid to capital-intensive industries is then self-reinforcing cycles might draw the economy economic cycle in the form of savings regressive.
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