European policy-makers have a golden opportunity to address two major issues in one go this year. By amending the European Union’s fiscal rules in favour of green investments, they can make a critical contribution to meeting climate goals and help to increase the potential growth of the union by laying the foundation for higher productivity.

If such a programme is large and credible enough, it could have two bonus outcomes. It could stimulate more private green investments, which are already growing rapidly but require these kinds of long-term political signals, and it would solidify Europe’s role as the premier actor on the most critical issue of our time.

Debt levels are uncomfortably high in many parts of the world. Europe is not an exception, although the level of indebtedness varies considerably across the continent. Fiscal rules are prudent policies, and any relaxation, amendment or abandonment should therefore be carefully analysed. Such analysis should consider three broad factors. First, the level of debt sustainability is not static and may change over time. Second, country-specific factors and initial conditions matter. Third, the reason for the change of rules and the ‘use of proceeds’ should be taken into account as well.

In a paper published in September 2021, Brussels-based think tank Bruegel concluded that ‘there are substantial investment needs that will be very difficult to achieve in the current fiscal setting’. The paper therefore recommends the ‘introduction of a green golden rule that excludes net green public investment from the deficit and debt calculations under the EU’s fiscal rules.’

This recommendation is complemented by three caveats. ‘Beyond the new green golden rule and the most flexible application of existing fiscal rules, a further relaxation of deficit adjustment paths is not necessary; Fiscally weak countries should, for the moment, rely on NGEU for their green investment and cannot ignore risks to budget constraints; [There should be incentives] for private investment through appropriate taxation and regulation.’

This is a sobering and compelling argument, and even fiscally strong countries with domestic fiscal rules – such as Germany and Sweden – should seriously consider additional national programmes. The new chancellor and prime minister in Berlin and Stockholm, Olaf Scholz and Magdalena Andersson, both former finance ministers known for fiscal zeal, have opened up for increased green investments. This is a welcome development but, given the scope of the investment needs, there is a risk these initiatives will be underwhelming, especially if they are expected to fit within current fiscal rules.

Rating agency Scope argues that the investment gap in Germany amounts to 12% of gross domestic product and that ‘the focus over the next years should be education and supporting Germany’s transition to a digital and green economy through targeted spending and supportive policies.’ Similarly, economists in Sweden argue that the country has a unique opportunity to finance necessary climate infrastructure through borrowing that is not allowed under the current fiscal rule.

An ambitious green investment programme has the potential to increase output in Europe. The general rule that borrowing for productivity-enhancing investments can be motivated still applies. Bruegel argues that ‘the impact of green investment on growth is uncertain’ but that ‘investment in green technology can certainly create economic growth opportunities if new products are exported globally.’ The paper emphasises that ‘green investment can have positive multiplier effects in an economy of demand shortage.’

Finally, a public green investment drive that is credible and long term in nature also has the potential to stimulate more private investment by laying the foundation for a low-carbon economy. This is a golden opportunity given that other large regions are lagging – Europe can cement its dominance over the US in arguably the most important issue for decades to come – while $130tn worth of institutional capital have net-zero ambitions that need to be filled with real investments.

There is a clear risk though that any national or regional ‘green pact’ will be the result of bargaining and ultimately underwhelm expectations even if it is agreed upon. That would be unfortunate, because when it comes to action on climate and growth, governments will find it difficult to overwhelm markets.

Marcus Svedberg is Investment Strategist, Fourth Swedish National Pension Fund (AP4).