Europe’s ‘Green Deal’ Opens Door to Economic Renewal—And Risks

(Bloomberg) -- Europe is taking a green gamble for its economy.

The European Commission unveiled a plan this week to put its economy in line with the needs of the planet by imposing stricter caps on greenhouse emissions, changing taxation and creating new rules for companies.

With a target of being climate-neutral by 2050, Europe may even change how it taxes trade with states that don’t meet its new green criteria.

If the so-called Green Deal works, advocates say investment could deliver the kind of transformation not seen for half a century. But there are risks it stumbles below lofty targets, or even raises uncertainty, costs and trade tensions.

Going for Growth

In its plans to accelerate the reduction of greenhouse gas emissions, the commission said an extra 260 billion euros ($290 billion) in investment will be needed every year. That would be a significant boost, equivalent to 1.5% of 2018 economic output.

With euro-area growth and inflation stuck in a low gear, it’s the kind of systemic rethink that could change the economy’s course. Plus, record-low interest rates provide an opportune moment for massive investment.

Yet it’s not that simple. Changes to regulation and taxes will steer spending away from some industries. Jobs will likely be lost in some areas, with no simple transfer of workers to new sectors.

The key will be whether governments get on with structural reforms, particularly education and training so that workers can quickly retool with the necessary skills.

“In the short term we should expect it to be a headwind to growth,” said Societe Generale Chief Economist Michala Marcussen. “But that’s not to say we shouldn’t do it because the alternative of kicking the climate-change can down the road is that the cost to GDP will far outstrip any short term costs today.”

Belt Loosening

The climate plan could allow for a change to fiscal rules so states can unleash the kind of public investment the European Central Bank has championed. The commission said it will look at “green public investment in the context of the quality of public finance.”

However, the chance of a dramatic step, such as excluding green spending from deficit and debt calculations, seems unlikely. The document also noted the need for “safeguards against risks to debt sustainability.”

All of that will happen in a review by the commission and EU member countries.

“It’s postponing this decision, watering it down into a bureaucratic procedure. So basically, nothing is going to happen soon,” said Simone Tagliapietra, a research fellow at Bruegel.

ECB Action

Following their Governing Council meeting Thursday, ECB policy makers reiterated that contributing to fighting climate change is both an opportunity and a responsibility, arguing at the same time they shouldn’t be expected to be the main actors.

Vice President Luis de Guindos said the ECB will support the EU’s ambitions within its possibilities and include global warming in its upcoming strategic review. France’s Francois Villeroy de Galhau pointed to a raft of measures that could be adopted beyond the often-demanded green quantitative easing -- including changes to rules on the collateral accepted in exchange for loans. The ECB also has a role in ensuring commercial banks are taking climate risks into account, according to Austria’s Robert Holzmann.

Private Lever

With limited and uncertain margins of public finances, the key may be the private sector. Bloomberg Economics estimates that the additional annual investment to meet emission targets may be more like 400 billion euros a year, far higher than the EU estimates.

What Bloomberg’s Economists Say...

“Where will the money come from? As things stand, the spending commitments by EU leaders seem tiny relative to the scale of the task, placing a significant burden on the private sector to do the heavy lifting. That’s a risky approach.”

--Maeva Cousin and Jamie Rush. Read the full INSIGHT

To stand any chance of getting the level of investment needed, the EU will have to provide better visibility on regulation and carbon pricing. To that end, the promise of a climate law is crucial. For a sign of how uncertainty crimps investment, one need only look at the U.K. and Brexit, where business spending has fallen in six of the last seven quarters.

“There is macroeconomic potential that can be favorable,” said Jean Pisani-Ferry, visiting fellow at the Peterson Institute for International Economics. “But it’s not clear it’s possible to mobilize it if we are not credible.”

Trade Tensions

One of the most eye-catching shifts from the commission was opening the door to a “carbon border adjustment mechanism.” That could consist of taxes on imported products that do not meet the same stringent criteria as those made in Europe.

The idea is to prevent companies outsourcing production to avoid financial penalties, particularly to countries that, as the EU puts it, “do not share the same ambition” on climate change. Without such a tool, efforts to reduce emissions could come to nothing.

But such mechanisms could also be seen as protectionist. If any tariffs were to hit U.S. goods, that probably wouldn’t go down well with Donald Trump, who’s already pulling out of the 2015 Paris Agreement on climate change.

“It’s probably the most controversial thing because if the EU starts doing it then there might be a retaliation from other countries,” said BNP Paribas economist Raymond Van Der Putten.

--With assistance from Zoe Schneeweiss, Jeannette Neumann and Boris Groendahl.

To contact the reporter on this story: William Horobin in Paris at whorobin@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Jana Randow

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