How Europe can boost growth and tackle climate change

In the coming months, European leaders will confront two major challenges. First, they will need to find a way to turn a fragile upturn in economic conditions – driven primarily by lower oil prices, a weaker euro, and unconventional monetary policies – into a lasting recovery. Then, they will need to push for real progress in the transition to a low-carbon future, ahead of the United Nations Climate Change Conference in Paris at the end of the year.

At first glance, these goals may seem contradictory. But they need not be. Indeed, one policy proposal could help achieve both: an accelerated depreciation scheme for investments, with special rates for green investments. The coming G-7 meeting in Germany would be a good moment to announce a new package of incentives that would boost investment in general, with a focus on energy efficiency in particular.

It is not yet clear that Europe’s return to economic growth is here to stay. Since 2010, its performance has lagged behind that of other advanced economies. Even in Germany, the European Union’s strongest economy, investment has not yet picked up strongly.

Similarly, there is an urgent need to intensify the fight against climate change. Every year that passes before we make the transition to a low-carbon economy carries with it mounting costs. The International Energy Agency estimates that for every euro not invested in carbon reduction before 2020, we will need to spend more than four euros afterward to bring climate change back under control.

European Commission President Jean-Claude Juncker’s bold €315 billion ($344 billion) investment plan is ill suited to address our environmental challenges. The headline figure is an impressive sum, but the proposed investments are unlikely to deliver what is needed. To be eligible, investments must be profitable. And, in the absence of an effective carbon price or other incentives, environmentally friendly investment very often will not qualify, even if the Commission has formally declared that such investments should be given priority.

There is a much more efficient way to ensure that investments benefit both the economy and the climate. Firms scale up investment in times of uncertainty when they are allowed to depreciate capital expenditure rapidly for a limited period of time. This is also true when special depreciation rates are offered for investments that increase energy efficiency.

Accelerating depreciation in general, while offering extra incentives for green expenditures, could benefit the business cycle and the climate alike. Companies tend to make the most concerted efforts to green their production when they are planning to invest in new machines or buildings anyway.

Similar schemes have worked in the past. The United States allowed bonus depreciation in 1985 and 2002, and from 2008 to 2013. According to a study by the American economists Christopher House and Matthew Shapiro, such policies were very efficient, as they provided strong incentives for investment in long-term capital goods.

The French government has recently adopted a similar measure, allocating €500 million to it this year. Firms will be able to subtract several years’ worth of expenses from their profits in the first year and, overall, write off more than 100% of their investment. While the French initiative does not represent a massive stimulus – private investment in France runs at about €250 billion a year – it could ignite a positive spiral, with a significant multiplier effect.

German Chancellor Angela Merkel would be wise to remember that she introduced a similar (non-targeted) scheme in late 2005, shortly after the start of her first term. After years of sluggishness, accelerated depreciation helped investments to surge in 2006, and the resulting upswing in the economy brought enough tax receipts to more than repay the initial loss to the public budget.

European governments should urgently extend this approach across the EU, adding to it a green dimension. Investments in heating systems, electric motors, so-called smart buildings, and other initiatives would help cut energy bills. Since 2008, Ireland has compiled a list of some 10,000 products with the highest energy efficiency standards. This could serve as a blueprint for a Europe-wide initiative.

Instituting an accelerated depreciation scheme that focuses on green investments would trigger an important new push toward a low-carbon economy and help to consolidate Europe’s recovery. Last but not least, it would also provide the EU with an opportunity to demonstrate global leadership once again.

This article is published in collaboration with Project Syndicate. Publication does not imply endorsement of views by the World Economic Forum.

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Authors: Xavier Timbeau is Principal Director at the Observatoire des Conjonctures Economiques (OFCE). Thomas Fricke is Chief Economist of the European Climate Foundation and runs the German internet Web site WirtschaftsWunder.

Image: Flags of European Union member states fly in front of the European Parliament building in Strasbourg, April 15, 2014. REUTERS/Vincent Kessler.