Sustainability and HM Treasury Contents

3Understanding of environmental sustainability

Short-term vs. long-term

18.The Treasury has an obligation to support interventions designed to meet the UK’s overarching environmental targets. Dimitri Zenghelis and Rob Lambe highlighted that it was also the Treasury’s job to “arbitrate against competing demands on the public purse”.34 It must be satisfied that a particular intervention is cost-effective: i.e. that the benefits of intervention will exceed the costs.35 The Treasury’s Green Book sets out a process for assessing the costs and benefits of an intervention to determine a Net Present Value (NPV) from which interventions can be compared and ranked.36 The NPV is, therefore, one important criterion for deciding whether government action can be justified. Another criterion is affordability.37 Even if an intervention has a positive NPV the Government could still deem it to be unaffordable because of its up-front cost or because another intervention is cheaper.

19.Solving environmental problems and meeting environmental targets often requires sustained action over a long period, and/or large up-front, and sometimes expensive, investment with long payback periods.38 These interventions could help to avoid higher costs in the future and could therefore represent savings to the economy in the long-term. The long timeframes involved, however, can cause problems for both project appraisal and ministerial priorities, which can prioritise the short-term over the long-term. The Financial Secretary to the Treasury described a “tension” in environmental policy-making between affordability and value for money.39

Taking account of long-term issues

20.In its report, the NAO looked at whether the Treasury fully took into account the best available evidence on long-term environmental risks, and the UK’s legal commitments on biodiversity, air quality and carbon emissions. For both resource and capital bids, the Treasury expected departments to follow Green Book guidance in all appraisal and evaluation. This included valuing environmental impacts. The NAO reported that for capital bids, departments showed clear communication of environmental impacts that formed part of the primary purpose of a project, and a range of environmental impacts were monetised and factored into NPV calculations and therefore the Treasury‘s decision-making processes.40

21.A number of respondents were, however, concerned that the Treasury was not adequately taking account of wider impacts, especially economic benefits, of proposals.41 This was supported by the NAO’s report which highlighted that secondary impacts were not always highlighted in the bid summary submitted to the Treasury. For example, DEFRA’s capital bid for floods monetised benefits from preventing flood damage to environmental sites, but did not assess the potential impact on overall biodiversity, landscape or water quality. Similarly, DfT’s bid for local rail electrification did not highlight the potential benefits for carbon or air quality. This is a concern we highlighted in our report Sustainability in the Department for Transport.42 The NAO suggested that greater clarity over the secondary impacts may have helped the Treasury to develop its assessment of cumulative environmental impacts across government.43

22.Respondents were also concerned about the use of models to support policy interventions. In particular, they were concerned that models used to assess climate and energy policy interventions were unable to account properly for the full range of long-term costs and benefits associated with decarbonisation. We heard that the Treasury may have relied too much on one particular model–Computable General Equilibrium (CGE) model–to assess the impact of the fourth carbon budget on the economy.44 Witnesses maintained that despite the limitations of models–including taking account of long-term issues–they were useful for providing a range of evidence to support policy appraisal.45 Treasury officials said that they were aware of the limitations.46 Matthew Bell suggested that the most important thing was that the Government was able to “intelligently interpret” the results of the models.47

23.In the recent case between ClientEarth and DEFRA on the Government’s air quality plans, the Judge said that Ministers knew that over optimistic pollution modelling was being used to justify their plans.48 Justice Garnham stated:

“In my judgement, the [the Government’s Air Quality Plans] AQP did not identify measures which would ensure that the exceedance period would be kept as short as possible; instead it identified measures which, if very optimistic forecasts happened to be proved right and emerging data happened to be wrong, might achieve compliance. To adopt a plan based on such assumptions was to breach both the Directive and the Regulations”.49

24.The NAO’s report stated, ‘aspects of HM Treasury’s methodological approach to evaluating the relative merits of bids during the spending review favoured projects that deliver benefits in the short-term rather than the long-term, though for rational reasons’.50 These related to the discount rate used by the Treasury and the NPV method it used to rank capital projects. As is the case with all discount rates, future costs and benefits are considered to have less weight than present ones. The Treasury has a long-established ‘discount rate’ which it applies when assessing NPV. The NAO stressed that this approach was well established. There is considerable academic debate about what discount rate is most appropriate to use when assessing environmental and climate related projects.51 The NAO highlighted that in addition to the Treasury’s technical evaluation, the Treasury also considered other factors when determining allocation of capital budgets. It was concerned, however, that there was no consistent framework by which those factors were assessed.

25.It is apparent that the Treasury has made efforts to incorporate evidence on long-term environmental risks into its guidance. In 2011, the Treasury updated the 2003 version of the Green Book to include sections on valuation of non-market goods which included environmental assets, such as air quality and environmental landscape features.52 Furthermore, the Treasury has been working with stakeholders such as WWF and the Natural Capital Committee (NCC) to incorporate new evidence on natural capital.53 This is something our predecessor Committee encouraged in the last Parliament.54 Rob Lambe and Karen Ellis argued that it was not necessarily that policy appraisal failed to take account of long-term environmental risks but that, in some cases, the relevant guidance in the Green Book was simply not being used.55 The NAO highlighted the example of the Treasury’s recent decision to cancel the carbon capture and storage (CCS) competition (something we discuss more in the next chapter). It highlighted that DECC did not have time to quantify all the costs and benefits of delaying CCS deployment, which meant that the risks of cancelling the competition were not factored into the decision.56

26.The NAO also suggested that the Treasury could have done more to make use of the expertise of independent advisory bodies (such as the CCC and the NCC). Bodies could be involved in scrutinising the bids and sense-checking the initial high-level assessments prepared for Ministers to inform their decision-making.57 This idea was supported by the CCC. Lord Deben, Chair of the CCC and Matthew Bell emphasised the knowledge and expertise held within the CCC and expressed a desire to help the Treasury to assess, in confidence, the impact of specific decisions on the ability of the UK to meet its long-term climate targets cost-effectively.58

Political priorities

27.It was not clear on what basis an intervention was accepted or rejected once it had been subject to appraisal and achieved a positive NPV and therefore considered to be cost effective. Michael Jacobs highlighted how the “conceptual frameworks” used by Treasury (and described above) were important in helping to “frame” decisions, “help guide policy” and could “push them in certain directions”. But in the end he said, “those [frameworks] are never determinants of the decisions”, “it is Ministers who make the decisions”.59 Susan Acland-Hood Director of Enterprise and Growth Unit at the Treasury supported this telling us that civil servants used NPV and other analysis to help Ministers make choices but emphasised that ultimately it was ministers who made the decisions.60

28.The Government’s macro-fiscal and economic objectives in recent years have focused on trying to keep aggregate public spending and borrowing at economically sustainable levels. Treasury officials told us that the recent spending review was “tight” and “challenging” and that the Treasury had to “make a range of quite difficult decisions”. They highlighted however that “through that process we spent a lot of time making sure we were thinking hard about the environmental impact of the decisions we took”.61 Neil Kenward, Deputy Director of Energy, Environment and Agriculture at the Treasury, said that ultimately there were “trade-offs” between interventions and associated costs to the economy.62

29.Respondents to this inquiry were concerned that these trade-offs had gone too far in relation to the environment. The number of environmental policies that have recently been changed or removed by the Treasury because they were deemed too expensive has led the UK Sustainable Investment and Finance Association to argue that the Treasury’s financial outlook has been too short-term.63 They and others argued that this could lead to greater long-term costs to the economy. They argued that this represented a failure by the Treasury to properly consider long-term business investment needs, environmental risks and the Government’s wider long-term strategy to meet legally binding carbon reduction targets and international environmental agreements, such as the Nagoya Protocol.64 Karen Ellis argued that the Treasury had a responsibility to think about what these risks meant for the economy and to start to manage them better through appropriate policy levers.65 The Committee on Climate Change noted that, while long-term targets set out under the Climate Change Act 2008 would not be affected by the vote to leave the EU, the referendum result poses questions for “each of the individual sectoral levels in the power sector and in transport”, and that the “mechanisms are intertwined with European mechanisms, the EU Emissions Trading Scheme, fuel standards for cars, product standards, the Common Agricultural Policy, a whole range of mechanisms are tied up then with Europe”.66

30.Some witnesses argued that the Treasury had made a number of perverse decisions which were not necessarily cost effective. Alan Neale, a retired academic in business economics and environmental policy, highlighted comparatively expensive, glamorous low carbon technologies (e.g. offshore wind, wave, tidal and nuclear) had received more attention than cheaper alternatives (e.g. onshore wind and energy efficiency) which might represent better value for money.67 Lord Deben explained the lack of focus on energy efficiency specifically:

“[ … ] I think it is to do with boys’ toys. I think it is fundamentally that politicians want to have things that you can point at and say, “We have done that” or, “We have built that”. The problem with energy efficiency and with these things that are much deeper in their impact, but slower in their impact, it is very difficult to say, “Do you know, I have been responsible for a 22.2% increase in the efficiency of light bulbs”. It just is not good on a platform. I think it is a real problem of how you articulate those kinds of things. You can see the audience turn off as you get on to the subject of not boiling as much water in your kettle, more than you need”.68

31.The Treasury’s technical and political framework for assessing environmental interventions is geared towards favouring short-term priorities at the expense of long-term environmental sustainability, even when it could lead to higher costs to the economy in the future. In part, this is because its framework does not take account of long-term benefits adequately. Ministers cannot make well-informed decisions unless they have access to all relevant information including long-term costs and benefits.

32.The Treasury needs to improve the way it captures and takes account of long-term environmental costs and benefits. It must ensure that it has the best available evidence when making decisions about specific interventions, for example, by including wider costs and benefits and establishing a consistent framework with which departments can provide supplementary evidence in addition to NPV calculations. It should also make more use of relevant independent advisory bodies during spending reviews to scrutinise bids and green-check – a systematic environmental stress test – initial high-level assessments prepared for Ministers to inform their decision-making. The Treasury should, after a spending review, make public who it has consulted with and how they incorporated any feedback into their decision-making.

33.We welcome the Treasury’s work to incorporate new evidence on natural capital into its decision-making processes. A natural capital approach has the potential to help account for the long-term environmental risks. However, we want to see evidence of how the Treasury will take this work forward. In its response to this report, the Treasury should set out concrete proposals about how, and by when, it intends to take forward and incorporate new evidence on natural capital into its policy appraisal process.

34 Q12 [Rob Lambe], Q13 [Dimitri Zenghelis]

36 The Green Book defines Net Present Value (NPV) as the discounted value of a stream of either future costs or benefits. The term NPV is used to describe the difference between the present value of a stream of costs and a stream of benefits.

37 The Green Book defines affordability as an assessment of whether proposals can be paid for in terms of cash flows and resource costs.

38 National Audit Office, Sustainability in the Spending Review (July 2016), p22

39 Q101 [Jane Ellison]

40 National Audit Office, Sustainability in the Spending Review (July 2016), p18-20

41 Qq15–20, WWF-UK (SAT 0003), Aldersgate Group (SAT 0030), Renewable Energy Association (SAT 0035), Renewable Energy Systems (SAT 0036), Institution of Environmental Sciences (SAT 0037), Centre for the Understanding of Sustainable Prosperity (SAT 0039), EEF (SAT 0041)

42 Environmental Audit Committee, Third Report of Session 2016–17, Sustainability in the Department for Transport, HC 184,

43 National Audit Office, Sustainability in the Spending Review (July 2016), p18-19

44 WWF-UK (SAT 0003), Friends of the Earth (SAT 0006), Green House Think Tank (SAT 0013), Grantham Research Institute at the London School of Economics (SAT 0027), Aldersgate Group (SAT 0030), Christian Aid (SAT 0033)

45 Q28 [Dimitri Zenghelis], Q31 Karen Ellis], Q61 [Matthew Bell], Q62 [Lord Deben], Centre for Energy Policy, University of Strathclyde (SAT 0074), Grantham Research Institute at the London School of Economics (SAT 0075)

46 Q187 [Neil Kenward, Susan Acland-Hood]

47 Q61 [Matthew Bell]

49 As above, para 86

50 National Audit Office, Sustainability in the Spending Review (July 2016), p23

51 Qq17-20

53 Q14 [Karen Ellis], Q172 [Jane Ellison], Q174 [Susan Acland-Hood]

54 Environmental Audit Committee, Fifteenth Report of Session 2013–14, Well-being, HC-59, para 24

55 Q15 [Rob Lambe], Q17 [Karen Ellis]

56 National Audit Office, Sustainability in the Spending Review (July 2016), p34

57 As above, p22

58 Q48 [Lord Deben], Q65 [Matthew Bell, Lord Deben]

59 Qq5-6 [Michael Jacobs], Q182 [Susan Acland-Hood]

60 Q182 [Susan Acland-Hood]

61 Qq104-110

62 Q120 [Neil Kenward], Q130 [Neil Kenward]

63 WWF-UK (SAT 0003), Friends of the Earth (SAT 0006), Green House Think Tank (SAT 0013), Carbon Tracker Initiative and Sandbag Climate Campaign (SAT 0020), Grantham Research Institute at the London School of Economics (SAT 0027), Independent Renewable Energy Generators Group (SAT 0028), UK Sustainable Investment and Finance Association (SAT 0032), Christian Aid (SAT 0033), Alan Neale (SAT 0040)

64 Q15 [Dimitri Zenghelis, Michael Jacobs], Q66 [Matthew Knight], UK Sustainable Investment and Finance Association (SAT 0032)

65 Q2 [Karen Ellis]

66 Q53 [Matthew Bell]

67 Alan Neale (SAT 0040)

68 Q54 [Lord Deben]

16 November 2016