The EU’s new fiscal challenges

In its next task, the EU will need to set clear rules for private investment in the green transition, to avoid the mistakes of the past.

There is agreement that financing a just environmental transition will require both private and public capital. However, there is less agreement on the regulatory framework.

The Capital Markets Union pursued by the previous European Commission aimed primarily at mobilizing private capital through financial deregulation, but paid little attention to tackling the European-wide deregulatory agenda. Rolling out the red carpet for private capital risks distributing windfall profits without contributing to sustainable investment goals, while increasing inequality. Instead of continuing on this path, the next Commission, which will be formed after the European Parliament elections in June, will need to reset the rules for private investment to guarantee a socio-ecological transition.

short-term concentration

While the deepening of European capital markets is certainly desirable, it does not correspond to the short-term focus of listed companies. At a time when there is an urgency to invest in sustainable digital business models, capital is often distributed to shareholders instead.

In the Netherlands, dividends of public companies increased by nearly 60% between 2019 and 2022, but profits only increased by 36%. A similar pattern can be seen in Germany and France, where profit sharing has increased at the expense of investment. According to the Climate Change Disclosure Project, if French companies listed on the CAC 40 had distributed just 30% of their profits in 2018, their retained earnings would have covered their sustainable investment needs for that year. Share buybacks are also prioritizing “shareholder value,” with German DAX companies planning more share buybacks this year than ever before.

In line with orthodox economics, restrictive fiscal rules and reliance on “efficient” private enterprise have led to significant privatization in systemically important sectors in recent decades. There was an argument that private finance could fill the funding gap and manage offloaded companies more efficiently. This is the orthodoxy invoked today to mobilize private capital for the green transition. So what actually happened?

British water companies are a perfect example of financialisation gone wrong. It was privatized in the late 1980s when Margaret Thatcher was Prime Minister, but has since been restructured by various financial investors and has become deeply in debt. In the past, huge profits were distributed rather than investments in physical infrastructure, but now concerns ranging from excessive water loss to catastrophic environmental pollution are making headlines. .

Thames Water, which serves 15 million households, faces insolvency from mid-2023 due to insolvency. Renationalization of the company appears to be the only solution. However, this means that taxpayers will have to pay the price for individual investors who have been siphoning off large profits.

significant impact

The pandemic has highlighted the urgent need for investment in health and social care. For many years, the government has withdrawn from this sector, paving the way for the entry of private finance. But instead of this leading to increased investment, a survey of elderly care homes across Europe found profit exploitation and debt accumulation. This increased the risk of bankruptcy, while profits were now routed to investors through offshore financial centers to avoid taxation.

This has a serious impact on the quality of service provided. A Harvard Medical School study found serious health risks for patients treated at U.S. hospitals owned by private equity firms. A Swedish study showed that financialized nursing homes provide lower quality services than housing with other ownership types. Vulnerable people are directly affected, as evidenced by the numerous caregiving scandals in Spain, Germany, France and the UK. These include high billing costs due to substandard care, resident malnutrition, and even higher mortality rates in nursing homes with private equity owners.

Similarly, as governments and other non-profit providers have retreated from housing over the years, financial investors such as public companies and private equity firms have moved in, exacerbating social problems. From 2009 to 2020, the amount of capital invested annually in residential real estate in Europe increased by more than 700% to over €60 billion. However, the housing supply shortage has increased significantly and rents in city centers continue to rise, reaching record levels in some areas. This trend is further exacerbated by financial investors, as shown in a recent study by the European Central Bank.

Once again, financialized companies are focused on the short term, not housing development. The latter could actually lower the housing company's stock price, as German housing giant Vonovia noted in its 2019 annual report. Investments in maintenance and energy-related renovations are short-term costs as well. And here too the profits are distributed rather than invested. In 2021, 41 percent of the rent paid to German listed housing companies was paid directly to shareholders as dividends.

growing inequality

A system that promotes the distribution of profits while discouraging investment will exacerbate inequality. According to Oxfam, the world's billionaires are already $3.3 trillion richer than they were in 2020, while the poorest 60 percent of humanity are $20 billion poorer. This is problematic for the green transition, as research suggests that rising inequality is associated with declining support for climate policies.

Rising inequality has been particularly evident in recent crises and policy responses. During the global financial crisis, banks were bailed out with public funds. Whereas gains were previously private, losses have become socialized. The rise in public debt was then judged to warrant severe austerity across Europe.

During the pandemic, businesses and the financial sector once again benefited from generous crisis policies, including central banks' asset purchase programs. While hedge funds and banks' profits have increased, countless workers across Europe have been forced to cut back on hours and suffer wage losses.

The track record of unregulated private finance involvement in public services is thus rather bleak, with a tendency to prioritize value extraction over value creation in essential sectors. Relying on private finance to facilitate the green transition could further widen inequalities, thereby jeopardizing societal support for climate policies and even strengthening support for populist movements. There is even.

Regulation is essential

There is no question that private capital must play an important role in this transition. However, effective regulation that not only directly regulates financial markets but also influences other elements of economic policy is essential.

Conditions need to be attached to industrial policy to ensure that government subsidies are not used for dividends or stock buybacks. Dividend distribution caps could be introduced in certain sectors at European level to limit the squeeze out of public services by financial investors. This has the potential to prevent exploitative practices while ensuring that companies realize adequate returns over the long term.

EU regulations covering alternative investment funds (AIFMDs), such as private equity, focus primarily on protecting investors, ignoring protections for the real economy. Fundamental changes to the Directive could make financial investors liable for risky business models, for example by introducing liability provisions for portfolio companies.

Last but not least, financial stability is essential for a successful socio-ecological transition. The March 2023 financial crisis showed how volatile the sector remains. Future rescue efforts may divert much-needed attention from the transition. There are many reasons for a financial reset.

This is part of a series on progressive “manifestos” for the European Parliament elections.