Why the EU must reset its Green Deal – or be left behind

Through its Green Deal, the European Union shows its ambition to be a world leader in the fight against climate change. Approved in early 2020, this comprehensive package of policies — spanning clean energy, buildings, farms, transport, industry and more — aims to achieve ‘net zero’ for EU greenhouse-gas emissions by 2050.

Since then, further goals have been bolted on. The 2021 European Climate Law stipulates that, by 2030, EU greenhouse-gas emissions should be at least 55% lower than 1990 levels1. The Nature Restoration Law passed in February this year aims to restore 20% of the EU’s degraded ecosystems by 2030 and at least 90% by 2050, to reduce emissions and achieve biodiversity objectives.

Yet, changing political and economic winds risk blowing the Green Deal off course. This year’s elections to the European Parliament saw gains by populist parties that are opposed to the Green Deal. And trends in the global economy have shifted markedly since the package was agreed — before the pandemic and wars in Ukraine and the Middle East.

Here, we highlight what these changes mean and call for a reset of this crucial green policy package. The Green Deal can be saved if the EU adopts a fresh mindset and realigns its policies to work with global trends.

Carbon taxation is not global

The Green Deal was predicated on three presumptions, each of which has not been borne out.

First, it was widely expected that a global carbon tax would emerge, and it has not. Most economists view carbon taxation as the optimal policy for pushing carbon-intensive industries to lower their emissions2. Carbon taxes also bring in revenue to help finance the green transition. Yet Europe now stands alone in implementing carbon pricing on a large scale.

The EU Emissions Trading System has introduced sizeable carbon prices. But big polluters are still offered exemptions. For example, free permits for emitting carbon dioxide have been granted to the EU’s domestic steel, aluminium and oil-refining industries. These are intended to avoid importing more carbon-intensive products from outside the EU (known as carbon leakage) and to support the bloc’s global competitiveness.

However, most countries worldwide do not levy carbon taxes. And those that do put a relative value of at most a few dollars on each tonne of emitted carbon dioxide equivalent, once they have corrected for the many firms that are exempted. That low value doesn’t reflect the real damage done, now and in the future — the ‘social cost of carbon’3.

Why has carbon taxation not taken off? International coordination of climate policies has fallen victim to geopolitical fragmentation and technological rivalry. The United States and China are competing fiercely over green technologies — each has issued massive subsidies for research and development (R&D) and manufacturing in areas such as batteries, solar panels and wind power.

To protect itself from unfair competition, in 2023 Europe began to institute a Carbon Border Adjustment Mechanism, which will be fully in place by 2026. This mechanism aims to ensure that imports that have not been subjected to a carbon tax (or have paid one that’s too low) will be taxed at the EU border. It effectively widens the coverage of EU carbon pricing and will eventually enable free permits for the biggest polluters to be scrapped. However, this would be achieved by hitting exports from low- and middle-income countries, slowing their economies.

Such offshore policy impacts might yet be exacerbated by another law — the EU Deforestation Regulation law. This was adopted in 2023 and was set to come into effect by 2025, but has been delayed. In some circumstances, it would ban imports of particular commodities if they were found to be linked to deforestation — including coffee, cocoa, soya, palm oil, rubber and wood. The aim is to induce partners to stop deforestation in their territories by submitting their imports to stringent EU verification processes and mechanisms.

Through such policies, the EU is, in effect, promoting global environmental regulations and standards through instruments that will mainly penalize its trading partners. It is perilously abandoning its conventional position as a defender of free trade and emerging economies. This stance might be perceived as insensitive and unfair, especially by low- and middle-income countries, and could result in conflicts and even diplomatic isolation.

The financial climate has cooled

Second, the Green Deal was designed and adopted at a time when long-term interest rates were historically low or even negative in real terms, and when levels of public debt were moderate. These economic conditions were conducive to financing the massive investments necessary to accomplish the transition to net zero, especially electrification. The aim was also to extend financial support to help European populations to bear the early costs of the green transition4.