It’s not easy being green: Breaking Europe’s climate spending deadlock

Summary

• European industry needs to decarbonise, or it risks falling behind in green technology while countries like China race ahead.
• The EU has invested in clean technology and decarbonising heavy industry, but current spending is insufficient for Europe to remain competitive and meet its climate targets.
• The European Commission has proposed increasing funding for green industry in the EU’s next budget, the “multiannual financial framework”, to be approved in 2027 at the latest.
• Member states are divided over funding sources and priorities. The “frugal” states argue for no increase in overall EU spending, while the “friends of cohesion” want more money for agriculture and development. All states agree that defence and competitiveness are key priorities.
• To secure broad agreement, the budget should be underpinned by efficient and well-governed policy. Investing in green industry now can generate long-term benefits for Europe’s security and economy—not least for the frugal states of northern Europe.

Making power moves

The sun shines in a blue sky over Gliwice in south-western Poland as the technical university’s head of development explains research plans for low-carbon technologies. Close by, in Rybnik, a new centre for renewable energy and hydrogen is being built. It will help transform a region that has been heavily dependent on coal for decades.  

Meanwhile, in the far north of Sweden, steel companies SSAB and Stegra are investing in low-carbon processes, bringing change to one of the most polluting industrial sectors. And in Cluj-Napoca, the manager of the Cluj IT cluster explains how innovative Romanian companies are using information technology to modernise and green the economy, for example by making industrial processes less carbon-intensive.

These are just some of the hundreds of European green industry initiatives. But while the sector is growing, long-term success is far from guaranteed. Global competition is getting tougher. Even if the United States has changed course under President Donald Trump, companies in China and other parts of the world are quickly transitioning to a low-carbon economy. To remain among the leaders, the EU needs to do more.

To this end, the European Commission proposed a Clean Industrial Deal in February 2025, which is now under debate by member states. Yet investment remains too low to decarbonise European industry, and much of the funding depends on the NextGenerationEU programme, which expires in 2026.

This leaves it mostly up to the next EU “multiannual financial framework” for 2028-2034, the MFF. But since the commission put forward its proposal for the budget in July this year, member states have been divided by competing demands for funding. The main antagonists are the “frugal states” and the “friends of cohesion”. The frugal four include Austria, Finland, the Netherlands and Sweden, while Germany also takes a broadly restrictive position on spending. The “friends of cohesion”, on the other hand, want more money for agriculture and regional development. This includes Portugal, Spain and most central and eastern European countries. All member states agree that defence needs more funds. In other words, spending on the green industrial transition—especially through the budget’s proposed Competitiveness Fund which is designed to boost clean-technology investment and Europe’s industrial base—is under pressure from all sides.

Last year, an ECFR paper analysed the state of European green industry, including the positions of different member states, and set out proposals for a more forward-looking industrial policy. This year, ECFR’s research in several member states explores the national priorities for the upcoming MFF. Alongside publicly available material, this is based on interviews with key figures in EU institutions and national capitals, particularly of the “frugal” and “friends of cohesion” countries, and on meeting notes from the negotiations so far, obtained through requests for public access to documents.

Building on this research, this paper argues the next MFF must prioritise green industrialisation if the EU is to attract private investment, reduce energy dependencies and boost its competitiveness. It begins by situating Europe in the global green technology race, highlighting the need for more and smarter EU investment. It then sketches the often-opposing positions of member states. Finally, the paper recommends ways to align member state positions around an ambitious green agenda by showing how this reinforces Europe’s security and competitiveness, rather than detracts from them. Ultimately, without greater flexibility from member states, the EU will pay a higher price for falling behind in the green industrial transition, with repercussions extending far beyond climate alone.

The green technology race

The climate emergency and the need for a secure energy supply have pushed governments and industries around the world to move towards renewable energy, electric vehicles and low-carbon industrial production. Demand for these technologies has ballooned, and the battle is on for the market shares of the future. After several years of OECD country leadership in this field, the EU’s geoeconomic position is coming under challenge from China’s rising dominance in clean technology.

Europe still has a decent head start. European companies remain global leaders in green industries such as wind power, electrolysers, grid technologies, heat pumps, biogas, and sustainable aviation and shipping fuels. The EU also sets the standard in circular-economy technologies such as recycling and is strong in advanced manufacturing, with European companies supplying much of the machinery that keeps global production lines running.

But if Europe keeps its current pace, it will quickly fall behind. The geopolitical challenges facing the EU’s clean technology industry are tougher than when the last MFF was negotiated. Chinese companies, driven by targeted industrial policy on an unbeatable scale, as well as cut-throat price wars in their domestic market, are posing intense competition to European companies at home and chipping away at European dominance in global markets. In some areas Chinese companies already have the upper hand. China makes up more than 80% of solar panel manufacturing capacity, for example.

Meanwhile, the US government’s climate scepticism is weakening the business case for European companies in the American market. And to top things off, unpredictable export controls and tariffs are unravelling globalised value chains. For example, China’s sudden export restrictions on heavy rare earth metals in April 2025 brought car production to a halt at several facilities in Europe. Beijing has since significantly intensified these restrictions as of October.

Europe’s economy is feeling the impact. Its electric vehicle industry stagnated in 2024, for instance, while China’s market share jumped by a quarter above its 2023 levels. In heavy industry, progress is slowing after major European companies such as ArcelorMittal postponed their investment plans, blaming energy costs and uncertainty around EU policies.

Safeguarding these industries requires political intervention, especially as new and innovative technologies, such as hydrogen-based steel, face a cost disadvantage before they get off the ground. EU policymakers also need to consider technology development five to ten years ahead if Europe’s industrial position is to be sustainable. This means high levels of public expenditure on research and innovation, especially as digital technologies and AI can be essential to improving energy and resource efficiency in manufacturing. The EU has global leaders in digital networks such as Ericsson and Nokia, and in AI solutions for industry SAP is a significant player.

Ultimately, even if China and to some extent the US are quickly advancing, Europe is in a good position to strengthen its clean industry—if its climate and digitalisation policies are well coordinated and financed.

What European industry needs

More funding

Between 2011 and 2020, EU investments to reduce greenhouse gas emissions averaged €764bn a year. The European Commission estimates that an additional €477bn per year is needed to reach the 2030 target of a 55% reduction in emissions, compared to 1990 levels. This would bring the total bill to €1.2tn annually, equivalent to 6.7% of 2024 GDP.

Public investment of between 0.5% and 1% of GDP over the next five years will be crucial, depending on how much comes from private sources. This means national governments and the EU itself must collectively provide an additional €130–260bn per year in public investment to bridge the gap. Not all of this investment directly supports low-carbon industries; much is for renovation of buildings and infrastructure for electric vehicles. Of the available funding for green industry, it will need to be allocated according to each sector’s financial needs—namely clean technology, heavy industry and general green modernisation of the economy.

Clean technology

The EU broadly defines clean technology as those that reduce emissions and increase energy efficiency, the key ones being wind power, solar, heat pumps, batteries and electrolysers for hydrogen production. The European Commission has estimated that promoting the production of these five technologies would require around €92bn from 2023 to 2030; of this around €16-18bn would need to be from public funding, or around €2.5bn annually. This is a prudent estimate considering the much higher level of state support in competing countries like China.

The MFF also includes 14 more technology areas defined by the EU as important for clean technology. While a full description of the public investment needs for all these areas is not available, it is reasonable to assume that it is significantly higher than the €2.5bn each year.

Heavy industry

Reducing the climate impact of heavy industry requires massive investment over the coming years. Some member states, together with the EU innovation fund, already provide substantial support for the decarbonisation of sectors such as steel, aluminium, cement and fertilisers. Once again, however, more is needed. The Institut Rousseau calls for an additional €7bn of public support per year, especially after 2030, to decarbonise by 2050 (if 43% is to come from the public sector).  

Connectivity and modernisation

The electrification of industry, which is essential for decarbonisation, also requires significant public and private investment in Europe’s electricity grids. Back in 2022, the commission estimated that meeting its 2030 energy targets would take €584bn.

Current investments are nowhere near enough: there is a gap at the national transmission level of €50bn annually over the next five years, according to Boston Consulting Group, while an extra €34-39bn is needed annually for more local distribution grids, estimates energy business organisation Eurelectric. In addition, expanding cross-border grids requires substantial direct EU support, more than €1.3bn a year according to a study for the commission. Public expenditure is also needed to avoid unreasonable increases in electricity prices for households in poorer regions.

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Beyond this, there are several other areas requiring public support. Decarbonisation of the economy requires significant investments in research and innovation. By 2023, most member states were still far below the 25-year-old EU target of 3% of GDP on research and development spending while the EU as a whole spent just 2.2%. Skills development is another important factor that will need to be supported by public money.

While the EU has relaxed state aid rules to facilitate support to green industry, member states have different financial capabilities. To avoid fragmentation of the internal market, EU-wide action is necessary. But as the European Commission notes, the current EU budget is insufficient to reach its target of reducing greenhouse gas emissions by at least 55% by 2030. For this, using some EU funding to derisk private investment, as is done under the InvestEU programme, will be important. To encourage investors and give European industry the necessary boost, however, significantly more public resources are needed than those currently available.

Good regulation

It is not just about money. The right regulatory conditions must be in place for public funds to be efficient and for private investment to thrive. Investors must be able to trust the EU’s climate neutrality target and the basic design of the emissions trading system, the ETS, whereby polluters must purchase carbon emission permits which they can then trade. If political uncertainty arises, public spending under the MFF will not be able to compensate for a lack of private funding.

German ministers want to delay the phase-out of free allowances for carbon-intensive industries, such as iron and steel, which are set to decrease from 2026 and end in 2034. Any delay would reduce the economic incentive to invest in low-carbon technologies and deter greatly needed private investment.

The same is true if the ETS price drops drastically (as has happened in the past), for example if international credits are included in the system. If companies can buy cheap permits abroad instead of investing in decarbonising their European facilities, the price of permits would decline, weakening incentives for transition within the EU.

The EU therefore not only needs to allocate budgetary support to green industry, but it also must give private investors political certainty through well-designed regulation. This will provide the right guardrails for economic support, ensuring that EU money is not misused or that more EU money is needed to make up for a lack of private investment.

Thus, member states—“frugals” and “friends of cohesion alike”—must agree both on more spending and on keeping a high level of climate ambition in EU legislation.

The proposed budget

The commission’s proposal for the new long-term budget marks a serious effort to confront these challenges. It breaks with the past in merging earlier programmes and attaching more conditions to payments. Three elements are particularly relevant to the green industrial transition:

First, the budget’s new Competitiveness Fund will roll 14 different EU programmes into one, easing access to EU monies for companies that have had to navigate a maze of application procedures. According to the commission, €67bn will be available for clean transitions and decarbonisation of industry. Of this, €26bn will come from the fund itself, and the Innovation Fund, financed by the ETS, will generate around €41bn. The Horizon Europe research programme would also nearly double in size to €175bn, with €25bn set aside for clean transitions and to be coordinated with the Competitiveness Fund. (For comparison, €131bn is earmarked for defence, space and resilience.)

Second, a large new fund will replace existing agricultural and regional programmes. Spending will be guided by national and regional partnership plans, subject to commission approval. This broadly follows the model of the national recovery and resilience plans in NextGenerationEU, the bloc’s economic response to the covid-19 pandemic. The national plans can be key instruments for supporting industrial transitions at member state and regional levels.

Third, climate financing will remain woven throughout the EU budget. Under the MFF proposal, 35% of total expenditure should contribute to climate and environmental objectives, and no EU expenditure should cause significant harm to the environment (with some exceptions, notably for defence). The MFF proposal also contains a significant increase for the Connecting Europe Facility, which funds cross-border infrastructure, allocating €30bn more for energy and €52bn for transport and military. Some of this money would go towards improving electricity grids, where there are big investment needs.

These are meaningful steps. But analysts have still criticised the commission’s proposal for not being ambitious enough when it comes to the green industrial transition, risking not just Europe’s climate targets but its front-runner position in global green technology markets. And there is a significant risk that member states will cut the proposed expenditure during the MFF negotiations.

Footing the bill

Paying for all of this will be another battle. Member states must agree on how to fund the EU’s budget—and, as ever, there will be wrangling over national contributions. Other sources of income are equally controversial, especially among the frugal countries. Traditional revenue is mainly member state gross national income-based contributions, some of the value added tax, and custom duties.

The commission wants to use 30% of the total ETS revenue from industry and power plants directly for the MFF, equivalent to around €9.6bn. This would leave member states with 6% less than they currently receive. To support low-carbon transitions, it will be crucial that this extra cash is used by the Innovation Fund and the possible Industrial Decarbonisation Bank. This will be a big topic in the council negotiations—both on the MFF and in the ETS review, due to begin in mid-2026.

However, the council has previously balked at a proposal for the EU to use ETS revenue directly. Member states are wary of any new sources of income that can be perceived as taxes on their citizens and companies. The commission’s proposal to make the ETS an “EU tax” is therefore contentious. It could also weaken the link between carbon revenue and climate spending in the long run, as the money would no longer be earmarked solely for green projects.

The EU’s planned revision of its Fit for 55 climate package in 2026 adds another layer of complexity. The review could reshape the ETS—both ETS1, which covers power generation and heavy industry, and ETS2, the new system for buildings and road transport—as well as the carbon border adjustment mechanism (CBAM). Some member states may link these issues to the MFF talks, creating an intricate puzzle and increasing the risk of convoluted climate-policy negotiations at the European Council. Any changes to the amount of ETS revenue at the EU level would directly affect what cash is available to finance green industrial transitions. Income from CBAM and from a new tax on unsorted electronic waste are also among the commission proposals for new sources of income, but will likewise be controversial.

Other creative ways to free up funding have yet to be proposed. Budget negotiations will determine how the EU’s current debt will be repaid, for instance. The commission has proposed a set amount per year, but this could be changed to allow for higher spending in the MFF’s first years, for example, given the current crises. Yet frugal states are likely to object to such measures. Another question is how the unspent money from the Recovery and Resilience Fund and the regional development funds of the current MFF might be used going forward.

Finding the money will therefore be a fraught process: every potential source—traditional contributions, ETS revenue, CBAM, new taxes or unspent funds—faces political hurdles, with frugal states ready to push back. As a result, MFF negotiations are likely to be long, intricate and full of snags, leaving the EU’s green spending plans dependent on delicate compromises.

Divided we falter

The political ruckus over the next MFF began before the proposal was even presented, with a European Commission communication in February, a European Council discussion and a European Parliament resolution. Since the proposal’s July 2025 unveiling, ministers have held an initial debate while experts from member states have dived into the details in council working groups. More recently, governments have begun weighing in on how the Danish presidency should design a “negotiation box”—a draft document outlining the structure and key unresolved issues—to facilitate agreement.

Member states roughly land in two camps: the “frugals” back spending on competitiveness and innovation, but oppose any overall increase in the budget; the “friends of cohesion” support competitiveness measures but oppose cuts to agriculture and regional policy.

In previous MFF negotiations, such dynamics have led to deep cuts to forward-looking investments in research, innovation and skills spending. There is a risk this could recur, reducing money for areas crucial to green industrial transitions such as the Competitiveness Fund, the Horizon Europe research programme and the Connecting Europe Facility. This time, it is also clear from the public debate and from ECFR interviews that defence and security are overriding priorities that will get extra spending, and could further crowd out climate priorities.

When the commission proposal was first discussed by ministers at the General Affairs Council on July 18th, these divisions were already apparent. Dutch and Swedish ministers were vocal that the proposal is too large, with those from Austria and Finland concurring. German ministers also stated the amount proposed is far too high. In the other camp, several governments, including those of Poland, Romania and Spain, defended spending on agriculture and regional policy and want to keep these areas as separate parts of the MFF, not merged into a single fund.

Previously, the Franco-German axis has been decisive for final agreement on the MFF. For now, however, a compromise between French and German ministers is a long way off. At the July 18th meeting, Berlin prioritised competitiveness and defence, while calling for cuts elsewhere. Paris, on the other hand, was adamant that agriculture and regional development support remain priorities.

During the interviews for this policy brief, ECFR gained further insights into the thinking of member-state policymakers. First, the groups are not clear cut. For example, the Czech Republic is with the “friends of cohesion”, but is close to the frugals on the size of the budget and taking on new debt.[1] Meanwhile, civil servants in Sweden are aware that the government’s tough frugal line could isolate it, although this has not yet been reflected at the political level.[2] More specifically, no government is strongly arguing against spending more money on greener industry and other parts of European competitiveness. The question is rather where the money will come from given that the overall budget is likely to be reduced during negotiations.

Second, a common view in northern member states like Belgium is that funding mechanisms should support the most promising low-carbon industries—no matter where they are—based on objective criteria.[3] In contrast, those in central and eastern Europe often stress that programmes should support low-carbon industries spread across the EU. The Competitiveness Fund “should give equal opportunities for all parts of the EU”, explained a Czech official, a view echoed by Polish and Romanian civil servants.[4]

Central and eastern European officials are also sceptical of the Innovation Fund, as it has mainly promoted green investments elsewhere as shown in the figure below. “There is a need to guarantee a fair share of the ETS revenue”, one official said. These countries also want to keep the Modernisation Fund, or a similar mechanism, to support carbon-intensive regions in their transition to clean energy. Reconciling these views on the geographic distribution of funding will be crucial for agreement on the Competitiveness and Innovation Funds.

Each state’s position is rooted in national needs and economic priorities, rather than obstructionism. The frugals have a point in saying that savings on other parts of the budget such as agriculture could create fiscal space to support green industries. The friends of cohesion are in turn correct that the EU has stay unified and equitable, and that this requires support for regions lagging behind in economic and social development. Cutting agricultural support could be a potential solution, but appears politically unfeasible due to strong resistance from large member states such as France and Poland.

In this situation, all camps need to compromise to preserve the modernisation aspects of the budget; otherwise the EU will fall behind in the global green technology race and miss its own climate targets—both of which would entail far higher economic costs than a smaller MFF. Just this summer’s extreme weather cost the EU €43bn, and its collateral effects €126bn.

What’s next

Member states will likely reach a final agreement on the next MFF around 6 to 12 months before the new budget period begins on January 1st 2028. That leaves a lot of time for disagreement between now and then.

Denmark will play a key role as holder of the rotating council of the EU presidency until the end of this year, chairing meetings of ministers and budget experts, and drafting the first negotiation box. This will be especially important considering the MFF proposal radically changes the budget structure, and Denmark’s draft will indicate how much support there is among member states for these reforms. Danish officials will therefore have to act as impartial mediators, but will influence the structure of the budget and the range of expenditure proposed for further debate in the Council of Ministers. Cyprus and Ireland will follow as rotating presidencies in 2026, and Lithuania in the first half of 2027. Judging from previous budgets, European Council president António Costa is likely to be decisive in the endgame and he has already signalled he intends to play a leading role.

Together we advance

Negotiations on the MFF will be tough. Several elements of the commission’s proposal are at risk of getting watered down or dropped altogether. Past experience, like in 2020, suggests efforts to modernise the economy—through spending on measures such as research and innovation—tend to lose out when the final compromises are made. If that pattern repeats itself, the proposed Competitiveness Fund is likely to be scaled down, with negative consequences for the greening of industry.

In addition to the traditional divisions between frugal states and those in favour of regional policy and agricultural support, the need for increased defence spending and repayment of pandemic loans complicates negotiations further. A rising “greenlash” against the ambitious climate policies set out in the European Green Deal, coupled with a more right-leaning parliament and council than during the last MFF negotiations, adds another layer of difficulty.

Nevertheless, compelling arguments for climate action could be key to maintaining and even enhancing the next MFF’s contribution to industrial decarbonisation. While EU leaders remain broadly committed to combating climate change and supporting low-carbon industry, they disagree about the most effective measures, what to prioritise and what trade-offs are acceptable. To resolve these contentions, this paper argues that a greener European future does not have to come at the expense of other key priorities, namely defence and competitiveness. Rather, they support each other. A greener EU is also a safer and wealthier one.

Greening defence and security

Across both the frugals and friends of cohesion, defence and security are a top priority, with the commission proposing significant increases in spending. However, the current debate largely pits defence and climate priorities as mutually exclusive. The topics are quite separate in the MFF proposal and are sometimes contradictory, such as the wide-ranging exemption from the “do no significant climate harm” principle for defence and security—without a precise definition of what “security” means. What this approach gets wrong is that the two areas are mutually reinforcing: climate action will bolster European security and resilience.

First, investments in energy grids and transport, such as electricity transmission and railways, serve a dual purpose: advancing the green transition while strengthening defence. This makes a strong case for the proposed increase in the Connecting Europe Facility part of the budget. The 2024 Niinistö report on the EU’s defence preparedness described how climate resilience underpins Europe’s overall security, highlighting flood protection, climate adaptation and resilient infrastructure as vital for civil resilience and military logistics. Innovation in this area can also enhance Europe’s industrial competitiveness.

Second, the green transition will drastically reduce Europe’s energy dependencies. Europe’s swift transition away from Russian gas in 2022 highlighted the security benefits of previous climate investments. Continued support for renewables and efficiency is therefore crucial to reducing reliance on authoritarian regimes and freeing up more room for manoeuvre on diplomatic instruments like sanctions.

Third, supporting border regions, including those undergoing low-carbon transitions, will strengthen European security. Several central and eastern European member states emphasised this during the ministers’ first MFF debate, and it is telling that commission president Ursula von der Leyen began the autumn with a visit to the EU’s eastern border. Governments in Finland and Sweden recognise the sensitivity of decarbonisation in the Baltic states, which have Russian-speaking majorities along their eastern border where polluting industries have traditionally provided employment.[5] Economic development is also important in countries such as Slovakia, Romania and Bulgaria with heavy industries near Russia that have to become greener or face closures. Otherwise, poorer regions on the border with Russia would become ripe for political interference and anti-EU sentiment.

Furthermore, many aspects of the evolving Clean Industrial Deal, which will become a major component of the next MFF, are directly relevant to the defence industry, and vice versa. Securing access to critical raw materials, for instance, necessitates robust international partnerships, while new materials can reduce both dependencies on China and the carbon footprint. Digitalisation, AI, cybersecurity and skills development are likewise central to both defence and climate action.

Herein lies an opportunity to deepen cooperation with third countries. Implementing the Clean Industrial Deal through greater international cooperation would allow Europe to forge new partnerships and enhance its global positioning. According to the MFF proposal, the Global Europe part of the budget will “offer comprehensive mutually beneficial partnership packages”. Yet the proposed preference for European companies in the Competitiveness Fund risks alienating the very partners the EU wants to engage. Allocations of money will need to reflect statements about partnerships in Global Europe and demonstrate the EU can provide a better offer than it does today.

Finally, with member state governments already committed to taking on new debt for military equipment through the SAFE instrument, a wider definition of security and resilience strengthens the case for some new debt for infrastructure such as electricity grids. Convincing sceptical states such as the Netherlands will be difficult, but if France and Germany can agree, it might not be impossible. Germany has financed such investments in its domestic policy outside its so-called debt brake. This way, it has been able to create a €500bn fund for extra spending on infrastructure, earmarking €100bn of this for climate-related investments. Berlin could also agree to a similar degree of flexibility on the EU level. In addition, NATO’s commitment for members to spend 1.5% of GDP to “ensure civil preparedness and resilience” should motivate EU leaders to find ways for all member states to rapidly invest.

Greening competitiveness

The competitiveness of green industries is another priority for decision-makers, as evidenced by their glowing responses to the Draghi report. Yet the very states who back the report’s findings seem unwilling to take the necessary steps to implement its recommendations—including funding them.

Several parts of the commission’s MFF proposal would economically benefit the frugal states and Germany. Their innovative companies are already thriving in the European green transition, in part thanks to climate-orientated funding. For example, a study by commission experts found that the EU Resilience and Recovery Facility, which prioritises green and digital transitions, has led to an economic benefit of €66bn—twice the size of Germany’s recovery and resilience plan. “This reflects both the direct impact of the RRF and significant positive spillovers, driven by the strong integration within the EU Single Market”, explained the report. This funding has benefited sectors that are both critical to the German economy and essential for the green and digital transition, such as the renovation of buildings and the manufacturing of electric vehicles. An increase in green financing in the budget would have a similar effect. Adequate resources for low-carbon competitiveness in the next MFF will therefore be essential for innovative European companies to compete with China in next-generation technology. Moreover, without a robust European industrial base, it will not be possible to finance regional and agricultural policy in the long term.

The governance of the proposed Competitiveness Fund and the broader budget conditions will be important for convincing frugal states. ECFR’s interviews in countries such as Sweden, for example, confirm they are sceptical of industrial policy that tries to “pick winners” by supporting individual companies.[6] Independent analysis, however, can inform work plans for different industrial sectors, ensuring that economic support is based on minimum objective criteria and that there is the most efficient and even allocation of industrial support across the bloc.  

Denmark has already recalibrated its position on the next MFF. Prime minister Mette Frederiksen declared earlier this year that her government would not remain part of the frugals. “You’re not going [to] hear us say that we want a budget of 1% [of annual GDP], that we will not accept budget increases at all, and that we exclude sources of financing such as common debt from the beginning”, the EU ambassador said in June. Such flexibility could inspire others to follow, especially neighbouring states such as Sweden and Finland due to the close Nordic cooperation on many topics.

The hour of compromise

In 2020—when the last MFF was finalised—Europe was facing a pandemic and governments agreed on extraordinary budgetary measures. Today’s moment is no less exceptional. Frugal countries need to be more flexible on expanding the budget, while the friends of cohesion group should be prepared to accept less agricultural and regional development financing.

The “negotiation box” the Danish presidency is set to present in December will reveal member state priorities. There is a significant risk that frugal states will water down forward-looking reforms designed to promote green innovation and competitiveness. This would be a grave mistake given the tremendous challenges facing the EU over the next seven years and, as this paper has shown, could undermine other key priorities like defence and competitiveness. This is the moment for leadership, to rise above trench warfare over traditional budget positions and instead strengthen the union in difficult times.

The following recommendations suggest ways the budget can be designed efficiently and clearly to secure the broadest possible support from member states.

Making every euro count

The level of expenditure supporting industrial decarbonisation in the MFF proposal—particularly through the Competitiveness Fund, Connecting Europe Facility and Horizon Europe—is a solid start, but it is insufficient. Alongside governments with strong climate ambitions defending the commission proposal in the Council of Ministers, other sources of financing are needed. This could take several forms. For example, the European Investment Bank could contribute more to clean industrial transitions. Following its recent decision to encourage risk-taking, governments should agree to an increase in the bank’s capital—a measure that, while still challenging, could be more easily accepted by some frugal states.

The EU could also make use of flexible repayment schedules for EU debt and draw on unspent funds from the current budget. Moreover, governments should agree to frontload investments financed by the ETS for 2026 and 2027. Inspired by national policies in Germany, current EU agreement on joint borrowing for defence could be extended to climate and energy investments promoting European security such as better electricity grids.

Moreover, governments can make sure that additional EU emission trading revenue is used for the Innovation Fund and the proposed Industrial Decarbonisation Bank, and not for other, non-climate, purposes. To facilitate this, the budget could allocate a certain proportion of the Competitiveness Fund, the Innovation Fund and the Industrial Decarbonisation Bank to each member state if projects fulfil certain minimum quality criteria, provided governments agree to allocate additional emission trading revenue to the EU.

Finally, to boost green competitiveness, a portion of Horizon Europe funding could be earmarked to foster stronger innovation ecosystems in member states that are lagging, provided these states invest more in research and development. Over the course of the next budget, there will be huge technological developments. To ensure the bloc stays ahead of the curve, budgetary regulation should align the next Horizon Europe research and innovation programme more closely with commercial interests. Currently, too many research projects remain detached from the market realities of European companies. The German Fraunhofer Institutes with their close connection to industry offer an example for others in the EU to follow.

The art of good governance

The commission has proposed that 35% of the total budget (excluding defence and security) should be allocated for climate and environmental objectives. But similar commitments in the past have been criticised (notably by the Court of Auditors) for lacking strategic direction and for “creative accounting”. Such critiques could apply to the current proposal, for example regarding agricultural spending where what counts as “green” is lenient.

How criteria are defined will be crucial to ensure money is spent on the most impactful climate policies. Most of the money will be allocated according to national plans designed by each member state in consultation with its regions. According to the MFF proposal, this plan must contribute to the EU’s climate and environmental objectives, and governments must ensure conformity with their national energy and climate plans via a steering mechanism. While this is a step in the right direction, the proposal is less explicit than NextGenerationEU on what each member state should achieve. Governments with significant climate and industrial ambitions should therefore work towards strengthening the budget’s criteria for integrating climate and environmental considerations. From an industrial decarbonisation perspective, priorities should include upgrading distribution grids, developing the necessary skills, strengthening innovation ecosystems and promoting just transitions.

Furthermore, it will be important to show how member states across the union can benefit from green financing—especially to get central and eastern European states on board.Current policy instruments should be improved to provide greater benefits for these countries. For example, a certain proportion of the Competitiveness Fund, the Innovation Fund and the Industrial Decarbonisation Bank could be allocated to each member state if projects fulfil certain minimum quality criteria. A portion of Horizon Europe funding could also be earmarked to foster stronger innovation ecosystems in member states that are lagging, provided that these states invest more in research and innovation themselves.

Similarly, the governance of the Competitiveness Fund will be critical to its effectiveness. Since the earmarked money for low-carbon transitions is rather small, agreeing the right priorities will be decisive. The governance model proposed in the MFF could increase the risk of policy capture by incumbents—where public policy decisions are steered towards the interests of specific groups rather than the public interest. To reduce this risk, the EU should, in parallel to budget negotiations, strengthen its capacity for independent analysis and use it to guide sectoral work programmes. This should include expanding the role of the European Climate, Infrastructure and Environment Executive Agency. Competence and integrity will be crucial in this regard—and is a reason to keep a strong role for the commission directorate-general for climate, DG CLIMA.

Finally, the EU can seek inspiration from other countries. In East Asian democracies like Japan and South Korea, the state has been more active in industrial policy than in the more market-driven Europe. In Japan, the ministry for economy, trade and industry has long developed plans for industrial sectors, supported by the New Energy and Industrial Technology Development Organization which has experts across fields. Japan’s current approach of analysing emerging technologies and publishing a regular Innovation Outlook report could provide inspiration for the EU. South Korea also offers lessons on how the state can best support industrial transitions. Seoul spends a large amount on research and innovation and green public procurement, and has developed long-term strategies by partnering with industry, the ministry of trade, and industry and energy organisations such as the Korea Environmental Industry & Technology Institute. Its environmental technology sector is growing rapidly, and South Korea has a high rate of green innovations per capita. In areas such as energy storage, Korean companies are world leaders. The EU could learn from South Korea’s long-term strategies and collaboration between public and private sector to speed up innovation. The European Commission has excellent experts, but for now they are not enough to be able to manage such extensive programmes as envisioned in the MFF.

A green grand bargain

MFF negotiations are always fraught, with member states haggling over every euro. Yet this is ultimately a positive-sum story. Properly funded, green transition projects can serve the interests of frugal states, friends of cohesion and everyone in between. They strengthen European defence and security rather than compete with them, and they raise competitiveness instead of weighing it down. The US may be turning away from these truths, but China and other global powers see the long-term payoff in social, security and economic terms.

The low-carbon projects spotlighted at the beginning of this paper—the renewable energy centre in Rybnik, decarbonising steel in Sweden and IT-driven green innovation in Cluj-Napoca—will either flourish or falter depending on the MFF’s final design. These are not abstract ambitions: they are tangible, complementary investments in Europe’s industrial and strategic future. There is a green grand bargain to be struck, if leaders have the vision to seize it.

About the author

Mats Engström is a senior policy fellow at the European Council on Foreign Relations and a former deputy state secretary at the Swedish Ministry for the Environment. His recent publications with ECFR include The power of partnerships: European climate leadership with less America and Eco-nomics: A green industrial policy for the next European Commission (both with Susi Dennison).

Acknowledgments

The author would like to thank the many interlocutors in several EU member states and in EU institutions who generously shared their views on the topic of this policy brief. He also benefitted greatly from the cooperation with programme colleagues in ECFR, including Susi Dennison, Carla Moll, Marissa Gillwald and Katrine Westgaard. Tobias Gehrke and Byford Tsang, also at ECFR, provided useful input on an earlier draft. Many thanks to Portia Kentish for an edit that greatly improved the clarity of the arguments, to Jeremy Cliffe for editorial support and to Nastassia Zenovich for creating the graphics. Any mistakes are the author’s own.

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[1] Interviews with civil servants in Prague, March-May 2025.

[2] Interviews with civil servants in Stockholm, March-May 2025.

[3] Public debate in the General Affairs Council July 18^th and interviews with civil servants in Brussels, March-May 2025.

[4] Interviews with civil servants in Prague, Warsaw and Bucharest, March-May 2025.

[5] Author’s research on Swedish and Finnish security and defence policy 1998-2025.

[6] Interviews with civil servants in Stockholm during 2025.