In this year’s European Union (EU) elections, far-right parties made gains across many Member States, while the conservatives held their position in the European Parliament. Ursula von der Leyen has been re-elected as Commission President. She had presented political priorities designed to ensure support from a wide-ranging coalition from the Greens to the Conservatives. However, can she achieve these priorities within the straitjacket of EU fiscal rules or will her failure fuel further far-right gains? Katy Wiese calls for economic transformation in the European Union to avoid a swerve in the wrong direction.
This article was previously published by The Mint Magazine.
On 22 April this year, Roberta Metsola, president of the European Parliament, opened the last plenary session before the European elections in Strasbourg. Many proposals were approved during this session, including the EU Economic Governance Framework reform, also known as the EU ‘fiscal rules.’ After more than four years of debate and delays, the European Commission, the Council of the European Union, and the European Parliament finally struck a deal.
The deal – struck or blown?
Germany and France found a middle ground during the Economic and Financial Affairs Council (ECOFIN) meeting. Berlin and Paris had held opposing views for months with Berlin pushing for mandatory fiscal benchmarks to decrease debt levels and Paris advocating for more flexibility and fiscal space for certain strategic sectors. But in the end, Germany’s finance minister Christian Lindner, a well-known fiscal hawk, won the battle.
The victory was not just down to Germany but also to “frugal countries” (those reluctant to increase debt spending) such as the Netherlands, Austria, Sweden, and Denmark. From the start of the discussions, they had supported Germany’s demand for numerical benchmarks to guarantee annual reductions of debt and deficits.
It would be surprising if highly indebted countries did not get anything for agreeing to this. At least in the case of France and Italy, these benefits will be short-lived. France will be able to exclude interest payments from the minimum fiscal adjustment requirements until 2027. Italy received an extension of the adjustment period from four to seven years only by agreeing to implement reforms and investments as part of the Recovery and Resilience Facility (RRF). It remains unclear how these countries will follow the new rules.
The changes were long overdue, as the existing fiscal framework had been overly complex, arbitrary, and based on outdated and flawed economic assumptions. Still, one can hardly see the proposed rules as an improvement. They came as a real blow. With the Fiscal Matters partners, the European Environmental Bureau (EEB) has been fighting for the past four years for the adoption of rules that allow for green and social investments. Ultimately, the “frugal countries” prioritised short-term debt consolidation over supporting Member States in achieving a just transition.
Why is the deal so bad?
The new rules will demand significant budget cuts for most Member States to meet the fiscal consolidation requirements. These cuts could jeopardise crucial investments for a green and just transition. While the initial proposal by the European Commission did not represent a significant change, it did offer some much-needed flexibility. For example, the Commission suggested debt-reduction pathways that were country-specific. These were to replace the current debt rules with their one-size-fits-all solutions and debt-reduction plans that were unrealistic for many Member States. The idea was that the Member States would follow the proposed four-year plans to reduce debt with the possibility of extension for three more years if the countries committed to undergoing reforms.
However, due to the insistence of Germany and other “frugal states” on stricter rules, the final deal doubled down on strict annual debt and deficit-reduction goals. The arbitrary debt (60% debt-to-GDP) and deficit (3% of deficit-to-GDP) limits remain, but the annual budget targets have been scrapped. The idea of Member States following four-year plans remains, too. If Member States breach the limits, they will receive a so-called ‘’technical trajectory’’ from the Commission. Despite these tailored trajectories, countries with debts over 90% of GDP must reduce their debt by 1% per year on average. If their debt is between 60% and 90% of GDP, they must reduce it by 0.5% per year on average.
The added numerical safeguards mentioned earlier are particularly problematic, especially the deficit-resilience margin. This requires countries with deficits above 3% of deficit-to-GDP or arbitrary debt above 60% debt-to-GDP to reduce their structural deficit to below 1.5% of GDP. The combination of different requirements leads to very varied and demanding fiscal adjustments for Member States. Initial calculations by the European Trade Union Confederation (ETUC) and Bruegel indicate that following the new rules will require large deficit reductions that will impose severe constraints on public expenditures.
The agreement is a disaster from an environmental, climatic, or social perspective. The EU fiscal rules do not account for climatic, environmental, and social investments or any other future-oriented expenditures as separate costs differentiated from socially harmful ones. This is the key reason the Fiscal Matters coalition advocated for excluding those future-oriented investments from the deficit and debt limits (preferential treatment). The coalition also stressed that no investments should be directed towards the economy’s environmentally and/or socially harmful sectors. In support of these demands, they advocated for applying the “Do No Significant Harm to Climate and Environment (DNSH)” principle as an assessment criterion for all national investments and reforms. While the Greens, some Member States and other parties were supportive, none of these demands are part of the new deal.
Austerity is back
The overall outcome of the deal will likely be damaging to crucial environmental efforts and social improvements. Budget cuts can severely weaken initiatives to fight the climate crisis, making it impossible for Member States to invest in a just transition. A recent study shows a need for around €40 trillion in investments by 2025 to achieve climate neutrality. To reach this goal, public investment must double from €250 billion to €510 billion per year to encourage private investment. The trouble is that these ambitious targets clash with new fiscal rules that require some countries to cut their budget deficits down to the previous 3% limit and 1.5% of GDP. This poses a big challenge for heavily indebted countries and those most vulnerable to climate impacts. According to a study by ETUC and the New Economics Foundation, Denmark, Ireland, Latvia, and Sweden are the only EU countries that can close their green funding gap under the proposed EU fiscal rules in 2024.
Research shows that austerity measures are linked to increasing anti-EU sentiment and, at times, even support for right-wing extremist groups. For example, one recent study found that a 1% reduction in total public spending resulted in a 3% increase in the vote for extreme parties. In short, austerity hinders progress and makes people resentful, causing them to lose trust in their governments. We are already seeing a growing number of protests against the unfair impact of climate action, as most of the burden falls on ordinary people and not enough on the very rich.
Cutting public services and safety nets would also cause the greatest hurt to the most vulnerable people, such as single parents, the elderly, and low-income families. This would further widen the gap between the rich and poor, increasing public anger and frustration towards governments and institutions. A fair green transition would mean that governments were required to help low-income households access energy-efficient homes, renewable energy, community energy, and low-carbon transport. Also, electric car-sharing programs and public transport would need to become affordable and accessible to everyone.
How to escape the tyranny of fiscal rules?
While we will need to discuss the feasibility of these new rules in the future, it is unlikely that the process will be reopened soon. That is why other solutions are urgently needed to plug the social and green investment gap.
One possible solution is for the EU to establish a permanent EU Transformation Fund to follow the end of the Recovery and Resilience Facility in 2026 to finance a socially-just transformation of our economies. Such a fund should support all Member States equally. It should focus on directing strategic investments into public infrastructure, green industrial policy, social investments, and environmental protection. The use of the funds needs to be well-targeted and tied to strong social and environmental conditions.
There is much support for such new investments. While some countries are strictly opposed to new EU-joint borrowing (hello Germany again), other countries such as Belgium are in favour. The current Commissioner for Economy and Finances, Paolo Gentiloni (Presumably no longer be Commissioner when this is printed), and institutions such as the International Monetary Fund (IMF) have called for implementing a permanent EU fiscal capacity. Mario Draghi highlighted the need for common funding in his long-awaited report on future EU competitiveness.
Public support for joint EU investments is also present. A recent study by the Jacques Delors Centre shows widespread support for green industrial investments financed by borrowing if coupled with social conditionalities.
Another solution is for the EU to adopt new progressive taxation. Many ideas and suggestions exist regarding how the EU could implement this. Examples include a tax on extreme wealth, a frequent-flyer levy, an excess profit tax on fossil fuels, and a financial transaction tax. All would support European governments in plugging green and social investment gaps.
While we need another revision of the fiscal rules, an EU-coordinated approach through an EU Transformation Fund may be the only way to close growing investment gaps in the short term. Inadequate investment prevents us from achieving a just transition, reaching our climate targets, and reducing social divergence.
