A low carbon future needs an industrial policy

The UK Chancellor (Finance Minister), George Osborne, presented plans for taxation and spending that pay homage to environmental concerns. But his measures rely on the mistaken belief that market mechanisms and other interventions are substitutes, not complements. (This article is part of an IPPR series more of which can be read here)
David Nash
31 March 2011

Last week’s budget was meant to be a budget for growth. Instead, George Osborne announced that GDP figures for 2011 and 2012 had been revised down by 0.4% and 0.1% respectively. It was also meant to demonstrate that this was ‘the greenest government ever’. But we didn’t exactly get that either.

At a time when countries worldwide are enacting government-led policies to stimulate low-carbon growth at home and take advantage of burgeoning clean technology market opportunities abroad, Britain is at best tiptoeing ahead. The Coalition’s commitment to making the Green Investment Bank operational by 2012-13 is welcome, but crucially it won’t be able to borrow during the lifetime of this parliament (and conveniently won’t place any further debt on the government balance sheet until after the next election). Plans to introduce a carbon floor price for electricity generation in 2013 are well intentioned but at only £16/tonne the floor price will fail to drive additional low-carbon investment and will merely act as a modest revenue generator for the Treasury. Cutting fuel duty by 1p might provide minor relief for hard-pressed families who happen to own a vehicle, but it hardly sends the right market signals for low-carbon alternatives.

Instead of succumbing to the characteristic tinkering that usually befalls the budget, we needed the Chancellor to outline a clear and ambitious strategy for low-carbon growth. Such a strategy would have needed to have been grounded in the reality that only through government activism can we decouple carbon emissions from growth, develop competitive clean-tech enterprise, and make the transition to a low-carbon economy.  

Of course, industrial policy is often seen as a dirty word in Western free-market economies – critics argue that government can’t ‘pick winners’ and when it tries it is left open to capture by private interests. Worse, government intervention distorts the efficient allocation of capital by market forces, or so the argument goes (as if even less regulation of finance would have ensured better capital flows and prevented the collapse of the banking industry). The reality though is that this is an outmoded reading of industrial policy and fails to recognise that governments everywhere – including in the UK - are usually engaged in some form of industrial policy, be it fiscal stimulus to boost manufacturing, export facilitation, free-trade zones, tax incentives to encourage foreign direct investment, or other levers that are designed to address externalities that inhibit growth.

With many countries facing a fragile recovery and soaring unemployment, industrial policy is in many respects back in vogue. But what can industrial policy teach us about government efforts to decarbonise growth and tackle climate change?    

Firstly, many governments are already wielding the classic instruments of industrial policy to support low-carbon sectors and climate-friendly industries, such as loan guarantees for clean-tech start-ups, infrastructure upgrading to support the connection of more renewables to the grid, and the setting up of low-carbon ‘clusters’. In the UK, the Coalition is pursuing Labour’s plans to introduce a Renewable Heat Incentive and finance four Carbon Capture and Storage demonstration projects (with the funds now coming from general taxation rather than a levy on energy companies). More will be needed and government will have to collaborate with the private sector – as part of what Dani Rodrik calls the ‘discovery process’ - to see what works and what doesn’t.
Yet, to address fully the scale of the climate challenge, policymakers will need to cast their net wider and take action across all sectors of the economy, affecting all industries and businesses, especially carbon-intensive firms. Low-carbon objectives will now have to be integrated into,  rather than thought of as a footnote or a separate endeavour entirely to, wider economic objectives: including sustained GDP growth with high levels of employment, export promotion and, in many countries, poverty alleviation. Forthcoming research by the Global Climate Network – the alliance of think-tanks which ippr founded – is exploring what such ‘low-carbon industrial strategies’ might look like in practice in major economies including the United States, China, India and South Africa.

With this in mind, a low-carbon industrial strategy should not only be about helping to cultivate winners, but also about working with potential losers through the transition, by encouraging them to adapt their business models and clean up supply chains. Despite the determination of some in the environmental movement, it is not possible to simply wish away whole industries. Rather, governments need to bring conventional industry on board with, or at least ensure they are not obstructing, their low-carbon industrial strategy if it is going to succeed. The influence of big oil and coal over the demise of federal legislation to limit emissions in the United States last year is a case in point.

In countries like Poland where carbon-intensive industries contribute a large proportion of GDP, it is even more important that climate policy takes the transformation or managed decline of these industries into account. Jobs will inevitably be at risk, and this will run counter to the core objectives of most governments: if support for cutting emissions for climate reasons is shallow, then job losses in the name of a low-carbon transition will undermine the strategy. It will be up to government, working with the private sector, to support and re-skill these workers and, where necessary, prioritise worker re-deployment to new growth professions. 

Secondly, it is important to recognise that a full toolbox of policy measures – ‘industrial’ and others – will be needed in order to make the transition to a low-carbon economy happen.

Among the industrial policy tools necessary, government investment in clean technology RD&D will be decisive in driving forward innovation and, in turn, bringing down the cost of deployment and increasing market competitiveness. It is often remarked that the private sector is reluctant to shoulder the risk of investing in unproven concepts because it considers the benefits of R&D to the wider economy (jobs, knowledge acquisition by competitors) to outweigh the private returns to the original investor. There is little reason to believe this will change and so targeted government support at each stage in the innovation cycle – from initial research to commercialisation – will be critical. 

But carbon pricing is also likely to be important as a means to encourage both innovation and efficiency in high-carbon firms, trigger changes in consumer behaviour, and raise new revenue, potentially for climate measures. The Coalition has plans to introduce a carbon floor price for electricity generation in 2013, to complement the much maligned EU emissions trading scheme, but at only £16/tonne the floor price will fail to drive additional low-carbon investment. There is also an argument to be made about whether putting a price on carbon would not be more effective (and politically appealing) if it were to happen once sufficient efforts have been made to crowd-in viable alternative low-carbon technologies, and then ratcheted up during the transition to lock out high carbon. But sequencing aside, as Robert N Stavins has argued, government support for clean technology R&D and carbon pricing should be seen as complements, not substitutes.

Finally, just as it would be mistaken to champion any single policy instrument as a silver bullet, it is also wrong to assume the existence of a ‘one size fits all countries’ solution. Indeed, the climate policy toolbox needs to be country-specific, grounded in domestic economic, social and political realities. What is more, any attempt to track and quantify progress at the international level – a prickly issue that came up again during the last round of UN talks in Cancun – must be led by governments from the bottom-up. Top-down pressure on countries to measure their emissions may, as Navroz Dubash argues, turn out to be counterproductive and encourage gaming – such as the inflation of emissions baselines – and creative accounting.

International cooperation is of course critical. Despite the burgeoning narrative on how countries risk forfeiting competitiveness if they do not embrace the low-carbon technological race, not every country can be good at everything – for instance, Britain is simply not going to acquire the same number of solar panel manufacturing jobs as, say, India. Therefore, governments should be realistic when choosing where to place the emphasis – especially when their objective is export market breakthrough or expansion – and be ready to collaborate: for instance, by establishing regional innovation hubs, embarking on joint technology ventures, striking collaborative intellectual property agreements and harmonising energy efficiency and product-labelling standards.

If countries are on truly on board with this cooperation agenda – recent developments in the G20, the Major Economies Forum on Energy and Climate (MEF) and the Clean Energy Ministerial process are certainly positive – then there is reason to be optimistic. The challenge however will be to accelerate this collaborative process, particularly in areas where cooperation on low-carbon development can help countries achieve their overarching national economic objectives – whether economic diversification, job creation or poverty alleviation.

In the meantime, the starting point for governments should be to draw up of a bold economy-wide strategy that marries plans for growth, industry and enterprise with low-carbon objectives. On the basis of this year’s budget, George Osborne and the Coalition Government have yet to show that they are ready to take the necessary first step.

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