Why Fostering Socio-economic Convergence in the EU Is Necessary for Successful Climate Change Mitigation

Download the study "Making the great turnaround work: Economic policy for a green and just transition"

Introduction

With the European Green Deal, the European Union (EU) has set itself an aspirational agenda to address the climate crisis. The Corona Recovery package underlines this intention, as 37% of the funds provided have to be spent for the green transition. Similarly, the recently adopted “Fit For 55” package includes policies that aim for a 55% reduction in emissions by 2030. These are only two examples that underline the ambition of the EU for a green transformation – an ambition that is supported by a majority of EU citizens, who wish for a green European economy that guarantees sustainable employment and business opportunities.^[1]

However, while indeed many EU citizens perceive the green transition as an opportunity, for others it appears as a challenge that may undermine their economic status and threaten their material prospects. For people who are currently employed as miners, for firms that make their profits in the steel sector, and for countries whose main energy sectors are fossil fuels, a green transition is often not perceived as a necessary step towards a modern and sustainable EU, but rather as a menace to their socio-economic future.

The problem underlying these concerns on the national level is that EU member states follow different development models. Whereas the economic development models of some countries are compatible with – or even built on – a green transition, the economies of others are very emissions-intensive. In effect, the prospects to gain from a green transition are distributed unequally among member states. This applies particularly to Eastern European countries, which managed to catch up in economic terms to other European countries, but did so with a very emissions-dependent growth model. In other words, their socio-economic development path rests to a considerable degree upon non-sustainable activities. Many people in these countries fear that once the opportunity to pursue these activities is taken away, they will suffer socio-economic consequences and become – again – left behind in terms of wealth compared to the richer member states. What they are lacking is an alternative and more sustainable but equally attractive economic avenues to close the income gap with the rest of Europe.

As long as this remains the case, important ecological reforms are likely to be blocked by these countries for political economy reasons. They fear the end of the economic catching-up process that they experienced in the previous years. Their wish to catch up is built upon one of the fundamental economic promises of the EU, which was first formalised in the Treaty of Maastricht: the promise of an economic convergence among member states. But without adequate policies, the green transition bears the danger of fuelling economic polarisation within the EU, and of forfeiting political support from short-term losers of the necessary reforms.

Therefore, it is vital to take these concerns seriously and address them^[2] for both political reasons – many of the green reforms must be adopted unanimously by the member states – as well as normative reasons, since the promise of a convergence of living standards was one important argument for convincing many Eastern European countries to join the EU in the first place. This requires the EU to develop both a new narrative of socio-economic convergence as well as an economic policy agenda that supports the countries in developing a green economy. If it fails to do so, the necessary political support for the green transition will crumble – with devastating long-term effects for the EU and, most likely, our planet. In other words, the challenges of climate change mitigation and socio-economic convergence in the EU are inextricably linked and must be addressed together.

This paper explores the interrelations between climate change mitigation and socio-economic convergence in the EU as well as the underlying political and scientific controversies. Based on that, it is argued that a multi-level industrial policy can be utilised to deliver on the promise of a green economy that fosters socio-economic convergence.

Socio-economic convergence and climate change mitigation

The challenge of climate change mitigation is well known. Despite the EU reducing its CO₂ emissions in the last 13 years, the speed and scale of the EU’s policy agenda are not sufficient to meet the self-set targets of a 55% reduction by 2030 and net zero by 2050, even under very optimistic assumptions about the implementation of promised climate policies of member states.^[3] Inevitably associated with this is the challenge of socio-economic convergence within the EU: There is an increasing gap among the various member states in terms of their socio-economic well-being. The deeper reasons for this persistent gap lie in the different economic and political situations of the member states and their distinct starting positions when they joined the EU. Economically speaking, member states developed different engines of economic development by specialising on distinct economic activities – that is, they are following different development models, some of which are, unfortunately, incompatible with each other.^[4]

Grouping countries according to their development models results in the four-part taxonomy summarised in Table 1: First we have the so-called core countries, which are characterised by a strong industrial base and high living standards. The firms in these countries have accumulated a lot of technological knowledge (“capabilities”) that allows them to produce and export very sophisticated products few others can provide on the world market. Typical examples of these highly competitive and export-oriented countries are Austria, Germany, and Sweden. Periphery countries, on the other hand, lack this technological superiority, meaning that they cannot stabilise their economic development through exports. They are often forced to stabilise it via debt – a strategy that was rendered unfeasible during the financial crisis of 2008. Thus, countries such as Greece, Italy, and Portugal are experiencing persistent socio-economic calamities. The third country group encompasses so called catch-up economies such as Poland and the Czech Republic, which are mainly located in the east. These economies started off with much lower living standards when they joined the EU, but they were able to develop a strong manufacturing sector by attracting international companies with low factor costs (especially wages). The last category consists of states such as Luxembourg and Ireland, which lay their focus on financial services and high foreign investment inflows accompanied by high tax revenues (but low tax levels) from the financial sector. This model often works at the expense of other member states, since countries such as the Netherlands regularly serve as tax havens for transnational companies, which would otherwise have paid higher taxes in other EU countries. For instance, estimates suggest that the “Netherlands alone is responsible for other EU members losing more than $10 billion of corporate tax revenue every year.”^[5]

Historically, the emergence of these different development models can be traced back to the formation of the European Economic Community, the predecessor of the EU. Already in the 1980s, with the accession of Greece, Spain, and Portugal into the Community, countries with fundamentally different levels of technological capabilities were integrated into a common market. However, over time these discrepancies in their initial starting positions did not level out. Rather, they were self-reinforcing, culminating in an ongoing divergence. In other words, the accumulation of technological capabilities turned out to be highly path dependent. This means that because it is easier to accumulate more capabilities when one already has many of them – a the-rich-get-richer-like phenomenon – countries with fewer initial stocks of capabilities do not catch up to the others naturally.^[8]

This mechanism results in persistent differences in capabilities, which some scholars already in the 1980s expected would lead to recurring structural crises.^[9] At the very latest, the economic crisis of 2008 showed that these predictions were right. It uncovered the gross domestic product (GDP) growth of large parts of the Southern European peripheries in the years before the crisis as a phase of “growth without development”^[10]: Their GDP growth was based on debt-driven consumption and tourism rather than the development of economic capabilities.^[11] As a consequence, it is much more difficult for those countries to recover from economic shocks, such as the current Covid-19-induced crisis, than for countries that build their economic development on the accumulation of technological capabilities and the production of complex goods and services. Thus, just as with the economic crisis of 2008, the Covid-19 crisis is fuelling further polarisation between core and peripheral countries.^[12]

These divergence patterns show an intricate link to the challenge of climate change mitigation, and it is most visible for the case of Eastern European countries. As one can observe in Figure 2a, several Eastern European countries seem to be catching up economically, since their overall GDP growth in the period 1995-2020 considerably exceeds that of most other member states. Figure 2b confirms this impression, at least for catching up to the Southern European countries,^[13] but it also shows that this is partly due to the relative decline of incomes in the Southern periphery, and that the gap with the highly financial countries is widening.

The development model that allowed these Eastern economies to catch up at least to some extent, however, relies on an industrialisation that comes with considerable ecological costs. Eastern countries’ economic growth and their employment opportunities are more dependent on environmentally harmful activities than is the case in other EU countries. Moreover, these countries are more reliant on environmentally harmful energy sources. Figure 3a below illustrates this by showing the main sources for power generation in Germany, representative of the European core countries from Table 1, and Poland, representative of the Eastern European catch-up economies. The data points to a pronounced asymmetry: Poland is much more dependent on fossil fuels, indicating that the transition costs for putting Poland on a 1.5°C-compatible emission-reduction pathway are much more severe than for Germany, for instance. This is true for most economies in Eastern Europe. Figure 2c provides complementary insights by displaying the per capita number of patents in environmentally efficient areas. Again, the data points to a very unequal distribution of patenting activities, hinting at an unequal distribution of capabilities in these areas. In this context, countries such as Sweden and Germany are much more likely to benefit from a green transition at the EU level than, for instance, Poland or Greece.

Note: Panel 2a highlights that Poland exhibits more than twice the dependency on fossil energy sources than Germany, which implies higher prospective costs during a transition towards renewable energy. Panel 3b points to a very unequal distribution of green technology-based patents. This detachment renders countries such as Poland practically incapable of elevating themselves to the same level as leading-edge performers in the green technology segment.

In effect, stronger regulations – and corresponding transformations – as envisaged by the European Green Deal represent a serious threat to the project of economic convergence in the EU. This means that especially countries whose industries are based on emissions-intensive production and that show a low level of innovation in green technology areas must be offered a new and optimistic narrative of socio-economic convergence, one that is not threatened but instead strengthened by ecological reforms envisioned by the EU. Otherwise, important ecological reforms are likely to be blocked by these countries for political economy reasons.

Synergies, conflicts, and the need for industrial policy

Although addressing these interrelated challenges represents an unprecedented difficulty for EU policy-makers, there are potential synergies in the solutions to those problems that so far have remained underexplored. For instance, relocating essential supply chains from other continents to European peripheries might not only improve upon the resilience of the European economy, but it could also create employment opportunities and sources of value added for the economies of the member states, thereby supplying a new avenue for catching up economically. At the same time, this strategy could reduce emissions, both domestically as well as abroad, by replacing outsourced production facilities with more emission-efficient production facilities in the EU and further reduce emissions through shorter transport routes.^[14]

However, such onshoring would come with considerable costs, and it would require active location policies as well as a trade policy that effectively puts a price tag on all social and ecological harm induced by imported goods throughout the overall production and delivery process. Without such a pricing scheme, it seems unlikely that goods produced (almost) entirely within the Union would be able to compete with international alternatives.^[15] If the consideration of social and ecological calamities increases the prices of goods on the European market, this could also incentivise producers to abstain from exploitative practices outside the EU, given that the European market represents a quite relevant sales area for many companies.

Another difficulty with such an endeavour is that, although it potentially allows for the construction of a new catching-up model, considerable transition costs are likely to occur: Workers in industries that need to be phased out because of the ecological damages associated with them (e.g. the coal-mining industry in Poland) will not immediately find jobs in the newly onshored industries – and might even have difficulties acquiring the skills required in the new industries.^[16]

This shows that only a coherent set of EU-wide policies with a strong multi-level governance component can address the challenge effectively. One key element of such a set of policies is a place-based, self-determined industrial policy that allows regions to develop resilient industries. Based on recent findings in the industrial policy literature,^[17] we suggest that such an industrial policy should account for the following three key principles (see also Figure 4):^[18]

• Adaptability of policies to allow for the flexibility needed to react to unforeseen challenges and to do justice to the nature of complex innovation processes.^[19] The Montreal Protocol on the ozone layer, the rise of electric vehicles, and Europe’s success in controlling water pollution, which are some of the biggest successes in environmental policy, were achieved with this experimentalist approach to policy-making.^[20]
• Context appropriateness to do justice to the fact that the same rules affect countries on different development trajectories differently, and different reforms are needed in core, periphery, catch-up, and financialised countries. This also allows for a better use of existing country-specific technological capabilities and institutional arrangements.^[21]
• Coherence to create policy packages that maximise synergies instead of focussing on single policies with the risk of creating unnecessary trade-offs.^[22] Here, it is important to also factor in long-run trade-offs such as resource depletion and climate trade-offs to make sure that established industries are resilient.

A coherent, adaptable, and context-appropriate industrial policy can support the accumulation of productive capabilities and the growth of green industries in peripheral European countries.^[23] Actively steering European economic development in this direction lays the groundwork for a successful green deal by offering peripheral countries economic development prospects that respect planetary boundaries.

Conclusion

If the EU is to tackle the climate crisis effectively, it must find new models for economic convergence, otherwise it will most likely fail on both fronts. This paper has argued that an active industrial policy that is context appropriate, coherent, and adaptable can be utilised to address this challenge. Nevertheless, one must acknowledge that the necessary green transition on the EU level comes with transition costs, challenges, and opportunities that affect distinct people, firms, and countries very differently, and hence bears the threat of rising inequalities, both within and among countries. Central to the success of a green transition is, therefore, the EU’s adequate reaction to this fact. This reaction can then enable and facilitate a green transformation that really leaves no one behind.