Why Energy Subsidies Are Different from Defence Spending
Europe can justify fiscal flexibility for collective security. Using debt to shield countries from the costs of delayed energy transition is a different matter. A commentary by Lorenzo Bini Smaghi
Faced with mounting geopolitical tensions, the European Union decided a year ago to activate the safeguard clause under the Stability and Growth Pact, allowing member states to increase defence spending. The clause permits countries to deviate from the public spending ceiling set out in their national plans for a period of four years and by an amount not exceeding 1.5 per cent of GDP.
The decision forms part of the ReArm Europe plan, designed to increase the defence capabilities of European countries. It complements the SAFE programme, which provides €150bn in EU loans to member states to finance productive investment through joint procurement.
Nineteen countries have applied to use the programme, of which eight have so far received a positive assessment.
The conflict that broke out in Iran at the end of last February, together with the closure of the Strait of Hormuz, has confronted Europe with a new emergency: a sharp rise in energy commodity prices, particularly gas and oil.
Some countries, including Italy, have asked the European Council to activate the safeguard clause again — this time in addition to defence spending — to allow member states to increase public expenditure in order to offset the impact of higher prices on their economies, for instance by cutting fuel excise duties.
If it is legitimate to exclude defence spending, why not also exclude spending aimed at helping households hit by the cost of living? The question deserves an answer.
One must first recall why rules and procedures were established at European level to constrain member states’ deficits and debts.
Within a monetary union, in the absence of a common budget, national fiscal policies affect the stability of the system as a whole. If one country’s debt spirals out of control, contagion effects spread across the entire area, with consequences for the public finances and economies of other countries. This was evident in 2010-12, when the Greek debt crisis spilled over to other member states, endangering the sustainability of their public finances and triggering a recession across the union.
Moreover, monetary stability within the euro area tends to lower borrowing costs for all. One need only compare current interest rates on 10-year UK government bonds, at around 5 per cent, with those on Italian bonds, which are much lower despite Italy’s higher public debt. UK public debt stands at about 104 per cent of GDP. This reduces the incentive for member states to pursue rigorous fiscal policies.
Fiscal rules are therefore designed to preserve financial stability, which is a common good, and to prevent deviant behaviour that could harm other EU countries.
Defence, too, is a European common good. The external security of each country depends on the defence capabilities of the others. Strengthening one country benefits all, while one country’s weakness becomes a collective weakness.
In the absence of a European budget and a common military structure, Europe’s defence depends on the sum of national defence efforts and on their co-ordination, including within Nato. In this context, the risk of moral hazard must be avoided: each member state has an incentive to invest less than the others while still benefiting from their investments.
Activating the safeguard clause for defence expenditure is precisely intended to reduce the incentive for opportunistic behaviour — that is, shifting on to others the burden of contributing to a common good.
The situation is very different when it comes to measures designed to deal with the energy crisis. Each European country has remained sovereign in its energy choices, and few intend to give up that sovereignty.
Some countries have made substantial investments in electrifying their economies, mainly through renewable sources, and in reducing external dependence. Others, by contrast, have reversed course and stopped investing in the environmental transition. The rise in fossil fuel prices has mainly hit this second group of countries.
In this case, countering the effects of higher prices through public subsidies financed by additional debt would not only waste resources. It would also run directly counter to the need to accelerate the energy transition.
It would also endanger financial sustainability, both for individual countries and for the euro area as a whole.
A previous version of this article was published in the Italian daily Il Foglio
IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
