Abolishing fossil fuel subsidies; Eurozone government debt; Interactive Debt Tool

We cannot solve our problems with the same thinking we used when we created them, said Albert Einstein. We have been dealing with very different problems this week. We analyzed the opportunities and obstacles associated with the global phase out of fossil fuel subsidies and we looked at sovereign debt in the eurozone with a report and with our interactive debt tool.

Abolishing fuel subsidies in a green and just transition

Fossil fuel subsidies account for 0.5% of global GDP, almost exactly the size of the funding gap needed to comply with the Paris Accord. Abolishing fossil fuel subsidies and directing the funds to renewable energy seems like an easy win for the climate: After all, estimates from the OECD and IEA put the total value of fossil fuel subsidies at USD468bn as of 2019 (for 81 countries). Fossil fuel subsidies outpace those for renewable energy in most countries, with the EU-28 and the US being notable exceptions. On the other hand, exceptionally high subsidies are paid in the MENA region (Middle East & North Africa) or in Venezuela, i.e. in countries with a large domestic fossil fuel industry, which tends to have strong political and lobbying power.

Getting rid of them comes with steep costs for consumers, particularly the poorest households. The richest 20% of households receive six times the subsidies of the 20% poorest households, but the poorest households still get hit harder as they spend around 7% of their income on energy related expenditures compared to about 3% that the rich households spend. Nevertheless, abolishing fossil fuel subsidies should free enough fiscal room for redistribution.

In this context, abolishing fossil fuel subsidies requires a holistic approach to secure a just transition. Abrupt measures will not work. What is required are comprehensive plans for phasing-in and sequencing price increases to enable the whole population to smoothly adjust. This has to be accompanied by targeted cash transfers to poor households, e.g. expanded safety net programs or increased spending on programs benefiting primarily the poor (targeted health, education or infrastructure expenditures).

You can find the full analysis here.

Eurozone government debt - Quo vadis from here?

The fiscal version of “whatever it takes” triggered a notable deterioration in public finances across the Eurozone in 2020. However, the picture has never proven more heterogeneous at the country level: Seven countries (Greece, Italy, Portugal, Spain, Cyprus, France and Belgium, together representing more than 50% of Eurozone GDP) now boast debt-to-GDP ratios close to or above 120% of GDP i.e. twice the Maastricht debt target.

The Covid-19 debt overhang will prove sticky: In 2021-22, the Eurozone debt-to-GDP ratio should largely stabilize at around 100% as deficits remain bloated. But what happens after 2022 is anyone’s guess, depending on a complex mix of assumptions. The key takeaway: Unless Eurozone heavyweights, including France, Spain and Italy, register notable increases in nominal GDP growth and/or improved primary balances, a return to pre-crisis debt-to-GDP levels by 2035 is clearly not on the cards. In particular, a return to a fiscal ‘business as usual’ – i.e. to the average nominal growth and primary balance observed over the period 2000-19 – would see sovereign debt ratios in key economies move largely sideways over the next 15 years. While Germany would get back to pre-Covid-19 debt levels by 2028, other Eurozone heavyweights would need a lot longer (France 67 years, Italy 26 years and Spain 89 years).

What are the implications for EU fiscal policy in a world where 90% could be the new 60%? The Covid-19 shock will leave a longer-term impact on the region’s public finances, not just in the form of a lingering debt overhang but also by reinforcing a paradigm shift when it comes to the thinking around public debt and fiscal policy. However, in a context where flows trump levels, debt is not only bad, active fiscal policy is the main game in town and the planning horizon is becoming increasingly more long-term, a common debt anchor – why not 90%? – is all the more important to ensure fiscal policy soundness and in turn debt sustainability. Meanwhile, cosmetic changes including separately disclosing the Covid-19 debt overhang from the remaining government debt stock, or more controversial proposals such as the cancellation of sovereign debt held by the ECB, will change nothing of substance and could in fact undermine fiscal credibility.

You can find the full report here.

Interactive Debt Tool

Our interactive Debt Tool provides a whole range of possible outcomes for the trajectory of government debt in selected Eurozone countries over a 15-year horizon. The tool allows you to simulate the development of government debt ratios in selected Eurozone economies by applying different assumptions for the various variables as well as to compare those figures with our forecasts.

Our Debt Tool can be found here.