to reach 95% of GDP by the end of 2021, an increase of 15 percentage points since the start of the pandemic. With the fiscal rules of the European Union’s Stability and Growth Pact temporarily suspended and interest rates expected to remain very low, constraints on public spending are still limited. Nonetheless, as the global financial crisis demonstrated, times of strong fiscal stimulus have very often been followed by periods of sharp fiscal correction that tend to impact public investment disproportionately.
Post-pandemic, Europe’s digital and green transformation will be even more pressing, yet the investment needed to drive that transformation is at risk. Europe faces a critical decade for the success of the climate transition and for maintaining its ability to complete technologically. The pandemic has even intensified pressure for digitalisation and for innovation to adapt supply chains and product portfolios to the “new normal” that will prevail. Yet, the pandemic has also created severe obstacles to the investment surge that is needed for recovery and transformation. These obstacles include uncertainty and the legacy of the pandemic lockdowns on firms’ ability to finance future investment. Decisive, forward-looking intervention will be needed.
Action for a green, smart and cohesive Europe
Long-term vision is needed to lead Europe out of the crisis. The pandemic represents an almost unprecedented shock to European and world economies. A massive short-term emergency response was needed. In Europe, policymakers have done well to limit the immediate economic ramifications of the shock, partly by ensuring short-term liquidity is available to help businesses to survive. Going forward, however, Europe needs to enact a long-term vision on the green and digital transformation. The pandemic and its effects are an opportunity to address the long-term challenges that Europe faces. Not doing so would be counterproductive, potentially undermining the immediate economic recovery.
Overcoming policy uncertainty is essential to unlocking investment, particularly for the climate transition. The recovery of corporate investment will depend, in part, upon a concerted policy response that instils confidence in European businesses about the trajectory of the recovery and the constancy of policy support. Firms see uncertainty about regulation and taxation as the greatest obstacle to climate-related investment. An ambitious yet predictable carbon-pricing (or taxation) regime would do much to provide businesses with the reliable information they need to invest. The surge in R&D in renewable energy during the global financial crisis – driven in part by the EU Climate and Energy Package – demonstrates how concerted policy could spur innovation while also acting counter-cyclically to help the economy recover.
Greening and digitalisation present opportunities to create new jobs – even in the short-term. One fear is that the digitalisation and climate transitions will destroy jobs, just when Europe is trying to recover. The transitions will drive a shift in the kind of skills demanded and lead to the reduction of some kinds of employment – more routine jobs via automation and jobs in carbon-intensive industries. Yet the transitions will also create jobs, and the overall impact on employment could be positive. In the shorter term, the urgent need for a surge of investment in building renovations, the adoption of digital technologies and infrastructure improvements, including at the municipal level, could provide the kind of counter-cyclical employment boost the economy needs.
Policy actions need to address regional disparities and promote social cohesion. Across Europe, differences in progress on digitalisation and climate-related investment are huge, with firms and municipalities in Western and Northern Europe often very advanced, and many cohesion regions at risk of being left behind. At the same time, job losses through automation and decarbonisation will not be felt equally across regions, with the risks of this twin transition tending to concentrate in Central and Eastern Europe. Policies that actively foster social cohesion are needed, such as measures to promote employment, facilitate the reallocation of workers, advance decent work and offer local opportunities for displaced workers. On the positive side, the most at-risk regions also tend to present some of the greatest needs and opportunities for investment for energy-efficiency improvements to buildings, other forms of decarbonisation and digitalisation. These are areas where Invest EU and the Just Transition Fund can play an important role.
Inclusion and cohesion will depend on active support for re-training and the propagation of digital skills. The digital and green transitions will drive the changing demand for skills. The limited availability of skilled staff remains the second most important barrier to investment (reported by 73% of European firms) in the EIBIS survey. With 42% of the EU population lacking basic digital skills, reforming adult learning programmes and broader participation are needed to deal with the risks of a growing gap in workers’ skills and further polarisation of the labour market. Online learning creates new opportunities, but it must be coupled with investment in quality education to address inequalities and provide a foundation for life-long learning.
Public investment is needed and should be sustained, despite the financial wound left by the pandemic. Public investment was on a mild upswing before the pandemic, but still below 20-year average levels. This upswing helped infrastructure investment to rebound slightly after years of contraction. Most European municipalities have increased infrastructure investment over the last three years and plan further rises, as they think the current level of investment is still inadequate. Public investment has a vital role to play in the green and digital transitions, complementing and facilitating private investment, but that spending could be jeopardised by the rise in public indebtedness caused by the pandemic. This time should be different, however. Ultra-low interest rates allow for very cheap public borrowing and have made debt cheaper to service, yet so far the savings generated have mainly supported current expenditure, not investment. Government investment is near a 25-year low, following years of fiscal consolidation. Years of underinvestment have caused a build-up in infrastructure investment needs. Above all, the challenges of decarbonisation and digitalisation require a boost to public investment that cannot be delayed without massive damage to Europe’s long-term sustainability and competitiveness.
Support for corporate finance will need to shift from short-term measures to funding that encourages investment and innovation, including more equity or equity-type finance. At the onset of the crisis, the key priority was to immediately help cash-strapped firms. With the summer reopening of Europe’s economies, support shifted to ensuring the proper flow of credit by providing funding and guarantee products for banks. This support has remained essential during the second infection wave. In the post-crisis environment, however, more equity-type products like venture debt will be needed. Equity finance is better adapted to absorbing losses and supporting risk-taking activities, including innovation. Continued support for the Capital Markets Union 2.0 project is crucial.
To spur climate investment, greater transparency is needed on the impact and risks of climate change. The climate transition will require the mobilisation of private finance on a massive scale. Initial interest in the private sector is promising, but limited. Funds focusing on environmental, social and corporate governance investment are in demand and some new markets, such as green bonds, are developing. However, growth remains slow and the premium paid for green investments remains tiny. Uncertainty surrounding true environmental risks and their impact on financial assets is preventing investors from being more discerning. Enhanced information, along with the development of simple and transparent standards, such the EU Taxonomy for sustainable activites, should help spur investor demand. At the same time, banks have a major role to play in Europe’s largely bank-based financial system. Central banks and national supervisors are pushing banks to better price climate risks into their loans, while also encouraging the investors to delve more deeply into the risk. Enhanced disclosure guidelines and the increased awareness of climate stress have led to a wider spread in borrowing costs between green and brown loans and bonds, which will increasingly support the greening of the economy.
A coordinated EU response could catalyse the transformation. Investment in one region or EU
