Key takeaways

• A European Central Bank (ECB) paper says current EU policies will fall short of the 2050 net zero goal, requiring additional annual investment of up to 3.7% of GDP and comprehensive structural policies at bloc and national levels.
• The authors argue that a successful green transition in Europe must be supplemented with large-scale public investments, targeted subsidies for green research and development, and regulatory reform.
• However, critics say the paper fails to recommend specific policy options, such as the role that financial regulation and prudential policies can play, and that the energy transition requires “bold action” including massive investment in infrastructure and innovative companies.

For Europe to transform its economy to one aligned with the green transition, it must adopt structural policies at the EU and national level to overcome current barriers to investment, a recent paper from the ECB finds.

The EU has committed to reaching net zero by 2050 and while it has reduced its emissions by 37% since 1990, more is needed as current policies are only likely to result in a 55% reduction by 2030, the paper finds.

“Several interrelated market failures and structural barriers are hampering the transition, calling for enhanced policy intervention,” say the authors, Miles Parker and Susana Parraga Rodriguez.

Changing technologies from carbon-intensive to carbon-free equivalents requires new technologies, which require additional investments of 2.7% to 3.7% of the EU’s GDP each year until 2030.

“Delaying the green transition has direct adverse implications for potential output and competitiveness as well as indirect implications for inflation volatility,” the paper states.

Barriers and solutions to financing green technology

There are several barriers and market failures hampering the green transition, according to Parker and Rodriguez. These include an implicit subsidy for fossil fuels due to unpriced environmental impacts, financing constraints, complex and fragmented regulation across EU member states, and a lack of infrastructure.

While carbon taxation is often cited as the best way to account for environmental costs, it will not overcome all the barriers and will need to be supplemented with other policies.

That includes other large-scale investments, targeted subsidies for green research and development, better infrastructure, regulatory reforms to speed up permitting, and structural policies to ease financing constraints, the authors say.

“Many of the climate-friendly technologies needed to achieve net zero emissions already exist at the firm level, but adoption rates are still short of the trajectory needed to achieve a successful green transition”.

Addressing the barriers to this transition could also yield innovations and benefits to the broader econoy.

“By raising long-term growth potential and productivity, such policies can also create fiscal space to support public green investment or cushion the social costs of transition.”

‘Bold action’ needed

The analysis confirms what advocacy groups and researchers have been saying for years, namely that the market alone will not be enough to deliver on the investment needed for the green transition, said Calvin Vella, a researcher for Positive Money Europe.

This means there is a vital role for public institutions, including the ECB and European Investment Bank, he added. This means ensuring the ECB’s “monetary operations and lending frameworks unlock finance at more affordable rates for clean industries and technologies”, while development banks should support emerging clean technologies and “national governments must increase investment in research and development to maintain Europe’s competitiveness”.

Pierre Monnin, senior fellow at the Council on Economic Policies, said he appreciated the authors highlighting that the transition will require various measures, but that they fell short of recommending concrete policy tools that could be included.

“In particular, they do not mention the role that financial regulation and prudential policies play in these structural policies. Being more specific about the structural policies would be particularly useful for policymakers,” he said.

The current system is geared towards maintaining the status quo, which finances innovation and change slowly, researchers Mark Sanders and Friedemann Polzin, both members of the Sustainable Finance Lab, said.

A green transition requires “bold actions”, including “massive investments in infrastructure and investments into innovative companies which require a different mix of equity and debt financing”.

Central banks should switch from a systemic risk approach to a systemic investment approach, they say, meaning not only identifying inflation, but also “opportunities for facilitating capital flows with a vision on future states of the economy, including energy, mobility or industrial systems”.

If the ECB wants to encourage more equity and less bank debt, then it should argue for making equity and debt more on par by abolishing tax exemptions of interest payments and reducing the tax burden on profits and dividends, said Sanders and Polzin.

“We need to reduce, not increase, the reliance of European payments and savings on private bank deposits.”

While the ECB cannot push investments into certain sectors, it can help strengthen the banking system. The current EU banking system is weak because it was made safe through public guarantees and regulation, they said.

“Consequently, bank credit in Europe is cheap and abundant, as long as it is safe, secured and predictable. But that is the one thing [that] the energy transition, or any other worthwhile endeavour in the coming century, is not.”