It's possible to finance the ecological transition with public debt
It's the economic version of squaring the circle: how can we both invest massively in the ecological transition and control debt 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 infrastructures: all this comes at a cost. The transition to a low-carbon economy is a major technological and financial challenge. To achieve 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 this essential expenditure, the 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 the issuance of green bonds - public debt securities specifically designed to finance environmental projects. In 2024, these bonds reached 61.9 billion euros. At 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.
At a time when budgetary room for maneuver is limited as a result of the European deficit and debt thresholds being exceeded, the idea of using public borrowing to finance green investment is obviously generating 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 under what conditions an economy can sustainably resort to borrowing to finance public spending on the environment, without jeopardizing either economic growth or fiscal balance.
Their analysis is based on a model in which economic growth, pollution and public debt evolve together. Pollution is seen as a cause of productivity deterioration. It acts as a factor in the degradation of the productive environment: air quality, workers' health, equipment efficiency, agricultural yields. The higher the stock of pollution, the more it reduces the ability of companies to produce efficiently.
Mitigation and adaptation expenditure
To counter these effects, the State has two public policy levers: mitigation spending, which reduces pollution levels (for example, by investing in cleaner technologies or carbon capture), and adaptation spending, which limits the harmful consequences 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 the link between taxation, debt and the environmental efficiency of public spending.
The originality of this analysis lies in the fact that the level of debt is not imposed as an exogenous constraint. Instead, it 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.
Debt can be sustainable
Over 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 sustainable.
In these favorable cases, a virtuous circle of debt can emerge: by financing effective environmental policies, the State improves the productivity of production factors, which in turn stimulates investment and growth, generating additional tax revenues.
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Sustainability remains fragile
Firstly, the vulnerability of productivity to pollution must not be too great. If the adverse effects of pollution on the economy are too pronounced, even ambitious policies are not enough to avoid a continuing deterioration in economic, fiscal and environmental conditions. The economy can 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.
Last but not least, appropriate taxation is important. A sufficient tax rate on income from work and capital is necessary to avoid an explosion in debt. A lax tax policy compromises stability. Indeed, too low a tax burden compromises the financing of adaptation and mitigation expenditure, leading to an unsustainable accumulation of debt.
Eviction effect or windfall effect?
The model also reveals that, in certain configurations, an increase in public debt can coincide with an improvement in economic growth and well-being.
This is what the authors call a "windfall effect": far from crowding out private investment, debt actually stimulates activity by financing effective public policies.
This result contrasts with the traditional view that public debt has a " crowding-out effect " on growth, by mobilizing financial resources to the detriment of productive investment. Here, the social return on environmental spending justifies increased indebtedness. 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 efficient to offset its budgetary cost. This is an essential point: not all debt is virtuous, even if its label is "green". Sustainability is based not only on the level of debt, but also on the quality of public investment.
The study also shows that certain policies can improve consumer well-being along sustainable growth trajectories. This is the case with higher taxes, which can reduce pollution without slowing growth, as long as productivity remains modestly sensitive to pollution. Indeed, consumers benefit from a reduction in pollution accompanied by greater economic growth, and therefore income.
Debt with conditions
Public spending on adaptation, such as infrastructure to protect against flooding or heat waves, is particularly recommended if it can significantly limit the impact of pollution on productivity. In this case, they promote both economic growth and debt sustainability.
On the other hand, mitigation expenditure must be sufficiently effective to produce positive effects. Otherwise, their cost may exceed their 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 confirms that debt can be a tool for ecological transition, provided it is used within a precise technological, budgetary and environmental framework, with well-targeted policies and appropriate taxes. Under these conditions, debt can be a lever for economic and environmental sustainability.
Mouez Fodha, University Professor, Economist, University of Paris 1 Panthéon-SorbonneLéa Dispa, Scientific Mediation 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. Read theoriginal article.