Financing the ecological transition through public debt is possible
It's the economic version of squaring the circle: how can we both invest heavily in the ecological transition and control debt in order to regain financial leeway? Under certain conditions, both are possible simultaneously. Find out how.
Mouez Fodha, University of Paris 1 Panthéon-Sorbonne; Léa Dispa, Aix-Marseille University (AMU); Marion Davin, University of Montpellier and Thomas Seegmuller, Aix-Marseille University (AMU)
Reducing greenhouse gas emissions, adapting to the effects of climate change, investing in resilient infrastructure: all of this comes at a cost. The transition to a low-carbon economy is a major technological and financial challenge. To achieve the goal of carbon neutrality by 2050, for example, the European Union will need to mobilize investments estimated at around 2 to 3% of its GDP per year until 2030. Faced with these essential expenditures, a question arises: can we use public debt to finance the transition?
Some countries have already begun to explore this avenue.
France is a pioneer in issuing green bonds—public debt securities specifically intended to finance environmental projects. In 2024, these bonds reached €61.9 billion. At the European level, European Central Bank President Christine Lagarde has called for the issuance of green bonds to mobilize large-scale financing for the ecological transition.
In a context where budgetary leeway is limited due to exceeding European deficit and debt thresholds, the idea of using public borrowing to finance green investments is obviously sparking intense debate.
Pollution versus productivity
In a recent study, economic researchers propose a theoretical framework for understanding the sustainability of such a strategy. The aim is to examine the conditions under which an economy can sustainably resort to borrowing to finance public spending on the environment without jeopardizing either its economic growth or its budgetary balance.
Their analysis is based on a model in which economic growth, pollution, and public debt evolve together. Pollution is considered to be a cause of declining productivity. It acts as a factor in the degradation of the productive environment: air quality, worker health, equipment efficiency, agricultural yields. The higher the level of pollution, the more it reduces the ability of businesses to produce efficiently.
Mitigation expenditures and adaptation expenditures
To counter these effects, the government has two public policy levers at its disposal: mitigation spending, which reduces pollution levels (e.g., by investing in cleaner technologies or carbon capture), and adaptation spending, which limits the adverse effects of pollution on productivity (air conditioning, thermal renovation, adapted agriculture, coastal protection).
These expenditures are financed by taxes on labor and capital, but also by the issuance of public debt. Researchers are focusing on this link between taxation, debt, and the environmental efficiency of public spending.
The originality of the analysis lies in not imposing the level of debt as an exogenous constraint. It therefore evolves endogenously according to the financing needs of environmental policy and government tax revenues. This provides a better understanding of the complex interactions between fiscal policy, the environment, and long-term growth.
A debt can be sustainable
In the long term, the results reveal several sustainable trajectories: public debt, although high, remains stable relative to productive capital, pollution is under control, and economic growth is sustained over the long term.
In these favorable cases, a virtuous circle of debt can emerge: by financing effective environmental policies, the government improves the productivity of production factors, which stimulates investment and growth, thereby generating additional tax revenues.
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Sustainability remains fragile
First, productivity should not be overly vulnerable to pollution. If the adverse effects of pollution on the economy are too severe, even ambitious policies will not be enough to prevent a continued deterioration in economic, fiscal, and environmental conditions. The economy may then become trapped in a path of environmental degradation and economic stagnation.
Secondly, the initial level of pollution and debt plays a decisive role. Beyond a certain threshold, the economy can enter a tipping point where pollution grows faster than the capacity to create wealth, making sustainability impossible.
Finally, appropriate taxation is important. A sufficient tax rate on income from labor and capital is necessary to prevent debt from spiraling out of control. A lax fiscal policy jeopardizes stability. Indeed, too low a tax burden compromises the financing of adaptation and mitigation expenditures, forcing the accumulation of unsustainable debt.
Crowding-out effect or windfall effect?
The model also reveals that, in certain configurations, an increase in public debt may coincide with improved economic growth and well-being.
This is what the authors call a "windfall effect": far from crowding out private investment, debt actually stimulates economic activity by financing effective public policies.
This result contrasts with the traditional view that public debt has a "crowding-out effect" on growth, mobilizing financial resources at the expense of productive investment. Here, the social return on environmental spending justifies increased debt. https://www.youtube.com/embed/i-GSVaz-6tc?wmode=transparent&start=0 Citéco 2020.
Green debt is therefore sustainable if the expenditure it finances is sufficiently effective to offset its budgetary cost. This is a key point: not all debt is virtuous, even if it is labeled "green." Sustainability does not depend solely on the level of debt, but on the quality of public investment.
The study also shows that certain policies can improve consumer welfare along sustainable growth trajectories. This is the case with tax increases, which reduce pollution without slowing growth, as long as productivity remains moderately sensitive to pollution. Consumers benefit from lower pollution accompanied by higher economic growth and, therefore, higher incomes.
Conditional debt
Public spending on adaptation measures, such as infrastructure to protect against flooding or heat waves, is particularly recommended if it significantly limits the impact of pollution on productivity. In this case, it promotes both economic growth and debt sustainability.
On the other hand, mitigation spending must be sufficiently effective to produce positive effects. Otherwise, its cost may exceed its long-term benefits. This would be the case, for example, with subsidies for the deployment of electric vehicles without accompanying measures to decarbonize the energy mix.
This study therefore confirms that debt can be a tool for ecological transition, provided it is used within a specific technological, budgetary, and environmental framework, with well-targeted policies and appropriate taxation. Under these conditions, debt can be a lever for economic and environmental sustainability.
Mouez Fodha, University Professor, Economist, University of Paris 1 Panthéon-Sorbonne; Léa Dispa, Science Outreach Officer, Aix-Marseille University (AMU); Marion Davin, Lecturer in Environmental Economics, University of Montpellier and Thomas Seegmuller, Macroeconomics, Environmental Economics, Demographic Economics, Aix-Marseille University (AMU)
This article is republished from The Conversation under a Creative Commons license. Readthe original article.