Session 2010-12
Green Economy
Written evidence submitted by Grantham Research Institute on Climate Change and the Environment, London School of Economics and Political Science.
Alex Bowen is principal research fellow at the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science. Simon Dietz is co-director of the Grantham Research Institute on Climate Change. Dimitri Zenghelis is Visiting Senior Research Fellow at the Grantham Research Institute and Senior Economist at Cisco.
This submission addresses the following issues identified by the committee:
"The Committee will examine the concept of a green economy in the UK, what it should look like, and how it will help deliver sustainable development. The Committee also wishes to examine the barriers preventing the transition to a green economy and the Government’s role in tackling these and creating the conditions necessary for a green economy to thrive."
In particular the following questions have been addressed:
1. What are the economic, social and environmental outcomes that a green economy should aim to deliver?
2. What are the appropriate tools and indicators to monitor progress towards such outcomes?
3. What is the nature of the barriers preventing the transition to a green economy?
4. What approach is required to deliver a green economy, and what aspects of the current economic model require development, eliminating and/or new approaches to be found? What tensions might there be between economic growth and the green economy? Would ‘greening’ the economy deliver the outcomes needed?
5. What policy and institutional ‘framework’ is required to create the right conditions for the green economy to thrive, and does the Government’s Green Economy Roadmap provide this framework? Does the Roadmap deliver a clear vision of the green economy?
6. Do any models that more closely resemble a green economy exist elsewhere that the UK should aspire to?
7. What is the role of consumers, businesses, non-government organisations, and international bodies in delivering, and stimulating demand for, a green economy?
8. Do any models that more closely resemble a green economy exist elsewhere that the UK should aspire to?
9. How do the UK’s policies to deliver a green economy relate to actions needed to deliver a the global green economy (a theme of the June 2012 Rio Summit)?
The arguments set out in the paper are those of the authors and not necessarily of the Grantham research Institute for Climate Change and the Environment. In preparing this submission we have drawn particularly on work carried out by the Institute though other authors are referenced.
Submission summary
- Current economic activity is causing unsustainable environmental damage due to multiple market and policy failures. A green economy should take proper account of the factors which lead to these market and policy failures, to deliver not only better environmental outcomes, but better social and economic outcomes also.
- Measuring progress toward the economic, social and environmental outcomes that a green economy could deliver requires a range of supplementary indicators in addition to GDP.
- Multiple barriers prevent the transition to a green economy: an inconsistent approach to carbon pricing, patenting difficulties for entrepreneurs, technological uncertainty and resulting uncertain returns for lenders and investors etc. Overcoming barriers needs careful analysis. Successful action requires transparency and credible commitments from policy-makers.
- In order to ensure the full benefits of the transition to a green economy are realised, we need to enhance understanding of long-term economic growth and the scope to kick-start a new Industrial Revolution centered around a clean-energy economy and renewable resources.
- A ‘long, loud and legal’ framework is needed for policy. The government should also shoulder some of the policy and regulatory risk by entering into pre-commitments entailing financial or reputational penalties for backsliding.
- It would be worth considering whether the Committee for Climate Change should be given more power to set policy instruments, such as the new carbon price floor, tariffs, and carbon-related changes such as the Climate Change Levy and CRC EES payments.
- Building-up international collective action to bring down GHG emissions is a priority. Across-the-board carbon pricing should be a part of that action. The second imperative is to stimulate green innovation. Carbon pricing is part of this, but there is a need for policy action particularly in the energy, transport and construction sectors.
- Better public understanding of environmental dangers and risks, and a resulting values shift in civil society, is likely to drive the transition to a green economy.
- The UK should continue to work closely with EU partners to ensure a level playing field for green investment, without discriminating between countries, firms or regions.
1. What are the economic, social and environmental outcomes that a green economy should aim to deliver?
1.1 The answer to this question depends on people’s values and the interpretation of the term ‘green economy.’ The simple response that we offer here is that a green economy, compared with the current UK economy, should deliver better environmental outcomes and thereby offer scope for better economic and social outcomes too. The opportunities are enormous but taking advantage of them will require collective action sustained across borders over the long term as well as changes in UK government policies. Better environmental outcomes would include lower and declining greenhouse gas emissions, less damage to environmental assets from which people derive wellbeing directly, such as air quality, and less erosion of so-called ‘natural capital’ – finite natural assets in their role of providing natural resource inputs and environmental services for economic production (OECD glossary, http://stats.oecd.org/glossary/detail.asp?ID=1730 ). Achieving better environmental outcomes would also allow more sustainable economic development over the long term and attain greater fairness between generations. This is particularly evident with respect to stopping climate change (Stern, 2009). Moreover, without policy intervention these environmental stresses are likely to mount with time as a growing global population and rising per-capita consumption put increased pressure on resources.
1.2 The argument that we can obtain better outcomes across all three domains –environmental, social and economic – is based on the observation that the existing economy suffers from many market and policy failures. These afflict environmental outcomes particularly badly because many economic activities damage the environment and use up finite resources without those responsible for the activities concerned taking this into account. If policy-makers, households, firms and other decision-making parts of civil society start to take proper account of factors leading to the market and policy failures, correcting these failures where they can, individual and social wellbeing can be enhanced over time.
1.3 In several areas, particularly with respect to the incentive to innovate, it has been recognised for a long time that laissez faire market arrangements (relying primarily on individuals pursuing their own self-interest through the market) are powerful in stimulating productive economic activity, but are unlikely to lead to the best outcomes for society as a whole. The recent financial crisis showed us what can happen when mounting risks are ignored. There is wide recognition that on its own, the market failed to adequately police the market; it is unlikely to be best placed alone to safeguard the environment. Growing awareness of the risks to the environment and future growth has alerted many policy-makers that the costs are in fact much higher than had been realised. The good news is that this awareness could lead to careful policy interventions that have big pay-offs. The composition of economic growth could be improved. There is scope for current welfare to be raised, too, especially while there is unusually high unemployment and underused plant, equipment and infrastructure. But at the moment, the UK may need to invest more – primarily in the preservation of natural capital, including the atmosphere – rather than consume more in order that many benefits accrue in the longer term.
1.4 This line of argument draws on conventional environmental economics and implies a rather modest view of what needs to change to make the UK economy more ‘green.’ It is consistent with the fairly broad definition of a green economy as one that supports sustainable development – "development that meets the needs of the present without compromising the ability of future generations to meet their own needs" (Brundtland Commission, 1987). As far as climate change is concerned, big changes in what households consume will probably not be necessary to reduce greenhouse gas emissions sharply. There is a larger issue of what sustainability means in the long term and how to bring it about (Neumayer, 2003; Atkinson et al., 2007) but we focus here on the sorts of policy changes that could command broad support even at a time when people are worried about low growth.
2. What are the appropriate tools and indicators to monitor progress towards such outcomes?
2.1 Multiple indicators are needed, as recognised, for example, in the OECD’s work on indicators for the green economy, the World Bank’s estimates of natural resource depletion and adjusted savings, the UNDP’s Human development Index and the UK government’s National Ecosystem Assessment. What is easiest to measure in the economy, society and environment may not be the most important. Social welfare cannot be reduced to a single dimension such as income or happiness. It requires a range of supplementary indicators in addition to GDP. Many of the issues have been laid out in recent reports, including President Sarkozy’s Commission on the Measurement of Economic Performance and Social Progress (http://www.stiglitz-sen-fitoussi.fr/en/index.htm ) and the international Economics of Ecosystems and Biodiversity Study (http://www.teebweb.org/Home/tabid/924/Default.aspx ). There remains much to be done in refining valuation methods, extending the scope of environmental and social measures and acknowledging the uncertainty around measurement. This reflects not only difficulties in gathering data but also differences in ethical perspectives and attitudes towards risk.
2.2 As far as climate change is concerned, improved data on energy use, both domestically and in industry, is needed. Public support for investment in smart buildings, smart grids and other monitoring and management technologies can help provide data to assess the carbon intensity of activities, helping people to make their energy use more efficient. A UK carbon reduction certification agency would be a helpful innovation ( Martin and Wa gner, 2009 a ). I t could take on the monitoring, verificati on and reporting requirements under the UK C limate Change Levy, CRC E nergy E fficiency S cheme and possibly the EU Emissions Trading Scheme (ETS) , promoting public and shareholder interest in firms’ success in cutting emissions and energy use. More information is also needed about the carbon footprint of goods and services for final consumption, whether produced in the UK or imported.
3. The nature of any barriers preventing the transition to a green economy
3.1 The key barriers are the market and policy failures that have to be overcome (Stern, 2007; Helm, 2010).
3.2 In economists’ jargon, ‘externalities’ abound. In the climate change domain, the damage done by greenhouse gas emissions is not taken into account unless policy-makers manage to impose a price, for example, through the EU ETS. Lots of waste products generate adverse spill-overs, if not on the same scale as carbon dioxide. But there are also good spill-overs, for example, when an entrepreneur comes up with a good idea that cannot be patented – and in those cases, the market incentive to engage in the activity is likely to be inadequate. Ecosystem services to consumers and companies are generally not priced. Private firms tend to undersupply infrastructure and networks. Access to information about the environmental consequences or monetary costs of actions is unevenly distributed. Technological and other uncertainties increase costs to risk-averse lenders.
3.3 Overcoming such barriers need not be expensive, but it does need careful analysis. Successful action requires transparency and credible commitments from policy-makers to guard against some well-known pitfalls such as short-termism, rent-seeking and regulatory capture.
3.4 In addition to the long-standing barriers to the transition to the green economy, there are also particular problems at the current conjuncture. Real incomes have been eroded, private investment and innovation have slowed, and short-term economic prospects are dampening demand in the economy. The echoes of the recent banking crisis are inhibiting financial intermediation and hence investment. The propagation of macroeconomic shocks often reflects coordination, asymmetric information and other market failures, amplified in the macroeconomic swings in collective confidence or what Keynes termed ‘animal spirits’. In such circumstances, governments can usefully act opportunistically by increasing investment in environmental capital and clean technologies (Bowen and Stern, 2010).
4. What approach is required to deliver a green economy, and what aspects of the current economic model require development, eliminating and/or new approaches to be found? What tensions might there be between economic growth and the green economy? Would ‘greening’ the economy deliver the outcomes needed?
4.1 First, governments need to apply long-standing insights from public and environmental economics, for example about the use of corrective taxes and subsidies. For the UK, bodies such as the OECD
and the Institute for Fiscal Studies (http://www.ifs.org.uk/mirrlees/mrResearch/id/213 ) have made helpful suggestions. Second, the study of environmental economics needs to be encouraged, notably more empirical work evaluating specific policies, to understand better what works in practice. Third, we need to enhance our understanding of long-term economic growth and the scope to kick-start a new Industrial Revolution centred around the clean-energy economy and renewable resources. The potential is great (Romani et al., 2011). In the presence of such pervasive market failures, and with policy outcomes likely to yield long run, non-marginal economic and environmental effects, any analysis must be broad enough to cover the full array of policy impacts. This means recognising the shortcomings and limitations of some of the existing economic analyses, based on over-simplified or narrow modelling, or on models that take a limited view of the nature of innovation and learning. Though such models are informative, their limitations need to be recognised explicitly in order that policymakers are not misled.
4.2 There will continue to be tensions between economic growth and the promotion of the green economy. There are, for example, real problems in trying to promote ‘environmentalism in one country,’ such as carbon leakage, pollution havens and at least transitory impacts on competitiveness in a few industry sectors. Countries’ transitions are likely to proceed jerkily and at different speeds. Conventional measures of economic growth may register a fall, at least for a while, because of transition costs and the need to rebalance activities to give greater emphasis to non-marketed components of wellbeing. But as with any investment, a small early sacrifice of consumption is designed to yield substantial gains down the road.
4.3 However, in some respects now is a very good time to accelerate the greening of the UK economy because of high involuntary unemployment and low utilisation of plant and equipment. There is also a global excess of likely full-employment saving over prospective conventional private-sector investment needs, a characteristic common to severe economic downturns (Zenghelis, 2011). Standard macroeconomic theory and evidence suggest that in the current economic environment, if policy-makers were able to open up viable new markets by tackling market failures, they could unleash sizeable macroeconomic benefits by boosting private spending, creating jobs, generating tax revenues, and allowing the monetary authorities greater leeway to stimulate demand. Moreover, at the present time this private investment need not crowd out alternative capital expenditure or swell public borrowing. There are also likely to be big opportunities to get firms to improve their energy efficiency without hitting their profits or employment (Martin and Wagner, 2009b).
5. What policy and institutional ‘framework’ is required to create the right conditions for the green economy to thrive, and does the Government’s Green Economy Roadmap provide this framework? Does the Roadmap deliver a clear vision of the green economy?
5.1 A ‘long, loud and legal’ framework is needed for policy. To develop credibility over long time horizons, independent and trusted institutions need to be built up and clear and fair rules set out to guide policy revisions. To avoid time inconsistency, and to align the interests of policymakers with those of private investors, the government must be prepared to enter into pre-commitments entailing financial or reputational penalties for back-sliding – in other words, it must shoulder some of the policy and regulatory risk. To minimise rent-seeking and regulatory capture, policies need to be kept simple and transparent, without discriminating among private agents, and the incidence of costs and benefits carefully examined.
5.2 In the area of climate change, the Government could build on the promising example of the UK Committee on Climate Change, set up in 2008. It is held at arm’s length from the day-to-day pressures of government and has been able to maintain an expert and focused effort to guide UK climate-change policy. Drawing on an analogy with the constrained discretion and operational independence granted to the Bank of England in 1997 in the realm of monetary policy, it would be worth considering whether the UK CCC should be given more power to set policy instruments such as the new carbon price floor, tariffs and carbon-related charges such as the Climate Change Levy and the CRC EES payments (Bowen and Rydge, 2011).
6. Priorities for action, including those sectors of the economy crucial for creating the conditions for a green economy
6.1 The priority is to tackle the biggest market and policy failures – they do not all correspond neatly to industry sectors. Human-induced climate change results from the biggest externality that the world has had to face. It follows that the most pressing need remains to build up international collective action to bring down greenhouse gas emissions (Stern, 2009). Implicit or, preferably, explicit carbon pricing across the board should be a part of that action. The UK has been showing leadership in this regard but needs to rationalise and simplify policies designed to make emissions more costly.
6.2 The second imperative is to stimulate green innovation – including, but not limited to, low-carbon innovation. Credible carbon pricing will send a clear market signal that should spur innovation. However, the presence of additional market failures in innovation suggests the need for supplementary policies. The energy sector is central as far as greenhouse gases are concerned but innovation in transport, the construction industry, land use and urban design is also needed. So is product innovation in consumer markets. The barriers to successful innovation differ across sectors so some industry-specific measures are likely to be needed, as recognised in the current UK policy mix. But policy-makers are unlikely to be very good in anticipating where and when the key technological breakthroughs are going to arrive, so the emphasis should be on policy instruments with broad application – another reason why carbon pricing is key, because it provides a pervasive incentive to introduce low-carbon technologies (Aghion et al., 2010). Road-maps for the transformation of specific industries and the reduction of greenhouse gases sector by sector, such as those provided by the Committee on Climate Change, are a helpful way of demonstrating what can be done given our current understanding of technological options, but they should not be regarded as sacrosanct. Similarly, although general support for more spending on research and development is desirable, ‘top down’ attempts to identify where comparative advantage will lie in international trade in the global green economy run the risk of picking losers.
7. What is the role of consumers, businesses, non-government organisations, and international bodies in delivering, and stimulating demand for, a green economy?
7.1 Policy-makers have a key part to play at international, national and sub-national levels, because of the central role of market and policy failures. But collective action does not need to rely entirely on statist solutions and legislative interventions. One also needs to encourage green entrepreneurship amongst businesses, as business organisations such as the CBI and shareholder corporate responsibility groups have recognised. Firms, trade unions and educational bodies can also help ensure that people acquire the new skills that will be required in the green economy. More generally, changes in values in civil society, as people understand better the environmental dangers and risks we face, are likely to drive the transition to a green economy. As with locking into the wrong physical infrastructure-which can have a long-lasting hard-to-reverse impact on emissions-so locking in mindsets that fail to recognise or limit carbon-intensive behaviour can make emissions reductions difficult to achieve later on. In both cases, early action to induce sustainable practices is required to avoid getting stuck on a carbon-intensive growth path in the long term (so-called ‘path dependency’ on policy choices).
8. Do any models that more closely resemble a green economy exist elsewhere that the UK should aspire to?
8.1 The Columbia/Yale Environmental Performance Index for 2010 ranks the UK 14 out of 163 countries, suggesting that UK performance is creditable but not the very best (http://epi.yale.edu/Countries ). In Europe, Iceland, Switzerland and Sweden all have a lot from which the UK can learn. The UK also rates quite highly with respect to the pace of green innovation, but it is well behind Japan, Germany and the USA and has not increased its efforts as rapidly as some emerging market economies – notably Korea and China (Dechezlepretre and Martin, 2010).
8.2 Quantitative measures risk giving a false sense of precision to international comparisons and the nations at the top of the various rankings are by no means ideal types whose policies for greening the economy the UK should emulate in all respects. Different countries will face different risks and opportunities as well as different institutional realities, so the most effective approaches and policies will differ correspondingly from country to country. But there is a lot to learn from best practices elsewhere.
9. How do the UK’s policies to deliver a green economy relate to actions needed to deliver a the global green economy (a theme of the June 2012 Rio Summit)?
9.1 The UK’s long-standing commitment to action against climate change and its innovative statutory framework for policy-making in this area have both been helpful in inspiring action in other countries. So has its recognition that climate finance for poorer countries is vital in building the foundations for global collective action. More needs to be done on this front (Bowen, 2011; Fankhauser and Burton, 2011). As this note has suggested, the UK could also do more to price carbon efficiently and stimulate green innovation. Further moves in these directions would have beneficial spill-overs to other nations. At the same time, the biggest stimulus to green investment and innovation would be private-sector anticipation of the growth of new markets.
9.2 The UK is not large enough alone to create the critical mass to drive global green innovation and investment, so it should join with other countries who see green policies as part of their broad growth strategies (including many developing countries) to stimulate market development. This nation and others need to avoid a mercantilist approach to new green industry opportunities. The government must work with EU partners to ensure that the inevitable linkage of trade and climate policies does not yield protectionism, but moves towards the establishment of a level playing field for green investment without discriminating among countries, firms or regions. The returns to collaborative action are great; going green is not a zero-sum game.
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25 August 2011