Green investment as a catalyst for economic growth?

Green investment as a catalyst for economic growth?

Reported by Carmen Smith, Engagement Coordinator, Centre for Science and Policy

On 18 June, ahead of the election of the new Labour government, Nick Godfrey, Distinguished Policy Fellow at the Grantham Institute and institutional partner of the Coalition of Finance Ministries for Climate Action, chaired a panel at our Annual Conference in London.

The panel included Dimitri Zenghelis, a founding member of the Stern review team and lead author of a Cambridge Zero Policy Forum report to be launched this October on whether green investment for the UK is really a growth strategy. He was joined by Niva Thiruchelvum, who led the Net Zero Review in HM Treasury and is now a director at strategic advisory firm Hakluyt, and Anna Valero, Director of the Growth Programme at LSE’s Centre for Economic Performance and member of the UK Government’s Economic Advisory Council.

Coming at an important time for UK politics, the discussion focussed on investment in green technologies as a way of securing future green growth for the UK. This timely and pertinent discussion also coincided with an open letter by 400 experts from across academic institutions in the UK calling on all parties to drive climate action at the pace and scale required to deliver on the UK’s growth and prosperity objectives.

As well as agreeing that unmitigated climate change is a significant economic risk, the panellists also shared the opinion that there is now sufficient political impetus and targets to ensure that a green transition is underway. The panel unanimously agreed that we will continue to see the pace of innovation and investment increase in the coming years as large global investors deploy their capital in green industries where there is sufficient policy certainty and opportunity, however the question is of pace. For this, policy makers have an important role in maintaining political credibility by implementing stable policies that work with the market mechanisms at play.

Reinforcing feedback: The market mechanism underpinning the green transition

A key economic driver of the green transition is the falling cost of clean technologies. For example, there has been an 80-90% fall in the cost of solar PV. Wind generation has seen a 40% drop in costs, storage costs have fallen, and lithium-ion battery costs have fallen by 80%, none of which was predicted in scenario testing 10 years ago.

The reasons for these dramatic cost reductions are that these sectors are replicable, modular and technology-based. Costs to investors therefore come down because of ‘learning by doing’ in production, distribution, and maintenance. They also come down because of economies of scale e.g. the gigafactories in southern China, and because of spillover effects as technologies are combined, promoting innovation. Furthermore, when technologies become market ready, politicians are more likely to push for decarbonisation, and if the politics becomes easier there is more deployment, and this brings the costs of production down further i.e. reinforcing feedback.

By contrast, the equivalent cost of generating a joule of energy from burning coal and fossil fuels has not changed in more than a century. This is because fossil fuels are a commodity and are resource and labour-intensive with diminishing returns i.e. it requires ever more exploration and costly labour for digging, shipping and refining. A recent study at Oxford University found that the extractive intensity of fossil fuels is up to 1000 times higher than green energy. Conversely, the marginal cost of maintaining a renewable energy plant is zero. Renewable energy plants exhibit increasing returns to scale which have important economic consequences as current models require diminishing returns to reach equilibrium. This means that economic forecasts for this type of mechanism are inaccurate, and when used for policymaking, not only make incorrect predictions, but change expectations that limit investment. Consequently, because investment is one of the main drivers breeding innovation, efficiency and productivity growth, false narratives delay decarbonisation and make it more costly.

But what does this mean for the UK economy?

As clustering and the conglomeration of green industries are developing at economies of scale, early movers are developing the supply lines, knowledge clusters and skills that will allow them to set that global direction and establish themselves as leaders. For example, China has cornered the market in some of the most important and fastest growing industries in the world: batteries, EV and solar PV. It is estimated that with the decline in China’s construction and property sectors, around half of China’s GDP in 2023 was in exporting clean goods and services.

While the UK has now lost first mover advantage in these industries and does not have the industrial capacity of China, it would also not be profitable over the next four years of government, to lock further into fossil fuel infrastructure and miss out on investment opportunities e.g. in manufacturing, finance, design and engineering. The UK needs to transition to keep up. If not, we will see fossil fuel price volatility and will be managing the decline in what will be yesterday’s industries. But rather than just trying to keep up, the aim of the Treasury’s Net Zero Review, was to ensure that the UK is at the forefront, taking advantage of opportunities to bring clean growth to businesses across the country, whilst avoiding the doom loop of lack of investment and lack of growth, leading to a fall in tax revenues and further rounds of austerity.

The UK has existing comparative advantages which are difficult to replicate, that is, a highly skilled English-speaking workforce, world leading research institutes and universities, natural and coastal infrastructure, and highly developed industries with transferrable skills. Furthermore, with right-wing parties playing a dominant role in Europe and the possibility of Donald Trump winning the US presidential election, it was suggested by one panel member that we may see a slowdown in green policies by the US and EU, players that have been so far driving the global energy transition. In this case there may be a role for the UK to take more of a leadership role in the coming years.

What is the role of government?

There was agreement among the panellists that ensuring green growth is a joint endeavour between private sector innovation and the government, whose role it is to address the multiple market failures that we see. This might be by setting price signals to incentivise investment and innovation, and designing targeted regulation where price signals don’t affect demand. Crucially, the government also has funds that it can deploy in highly defined and targeted ways e.g. to drive down the cost of technologies and to make technologies commercially viable. The Net Zero Review looked at a range of ways to deploy public capital at every stage of the innovation cycle from research to early-stage deployment, through to scaling up and commercialising proven technologies. Here, there may be too much risk for the private sector to invest because of uncertainties around revenue streams, so the government has an important role in designing schemes to enable green innovation, reducing the risk of locking into devalued and stranded assets. The government can also coordinate different market actors and large-scale infrastructure, making it easier to crowd in private capital.

As one panellist highlighted, the incoming government needs to be strategic, flexible and have functional policies so that, as the world changes, they have the flexibility and adaptability to cope with those changes. They may then not be caught by surprise by the pace, scale and economic consequences of the transition taking place, as well as the global race to manage and build those future markets.

The panellists argued that although cost-benefit analysis (CBA) is used widely to assess the cost-effectiveness of policies, it would not, for example have resulted in the development of electric vehicles, batteries, or renewable energy because these technologies were very expensive 10 years ago. It required strategic vision, including from government ministers, to invest in something that was inefficient in a static cost benefit framing but efficient in a dynamic increasing returns framing. While the wider fiscal picture means that it would not be possible to fund all green innovation, panellists noted successful examples such as that of Elon Musk, Wan Gang and Bill Gates, who have taken big strategic bets on new technologies and industries.

What does an inclusive and resilient growth strategy for the UK look like?

Headline GDP growth in the UK is poor compared to pre-financial crisis (currently 0.7%), but this occurs against a long-term stagnation in productivity. Under conditions of slow growth, it is harder to invest and do all the things we know we need to do for net zero as well as restore infrastructure. Therefore, the route to sustainable growth is through increasing productivity through investment, and this is quickest within the capitalist system with the appropriate regulations and incentive structures for both innovation and behaviour change.

A green growth strategy for the UK will largely depend on private sector investment, and therefore having political stability and strategy that businesses can understand over time is key. There is also room for strengthening institutions to enable this. Similar to the UK’s independent Climate Change Committee, panellists suggested re-establishing the Industrial Strategy Council. The Council would identify green growth policies, highlight trade-offs and hold government to account. The Council would be important in maximising synergies between growth and net zero as well as working with other institutions on regulating growth.

The UK will also need to align policies with the EU or risk facing barriers to our supply chains and export markets. EU environmental laws are nevertheless strict, and it should be straightforward for a new UK government to level up given that the EU is such a large market. In many cases the UK will have to comply to EU standards to compete in the market.

With innovations in satellite monitoring, aerospace and AI/digital technologies, there is also scope for the UK to make some integrated supply chain issues more transparent and to hold multinationals to account, for example, by monitoring scope 3 emissions. A farmer in Vietnam might then want to serve markets in Europe that have tighter scope 3 emissions, therefore breeding competition along the supply chain to meet stricter environmental and carbon targets. Panellists also suggested targeted industrial policies, not only in industries related to net zero, but in guiding industry in a whole range of areas to becoming more sustainable.

To conclude, one panellist described this challenge as ‘kickstarting the clean innovation machine’, which testifies to the limitations of cost benefit analysis. As will be highlighted in the Cambridge Zero Policy Forum report due out in October, green innovations are at first difficult, expensive and disruptive, but once kickstarted, will ultimately result in a win-win-win scenario, in which rapidly transitioning to clean energy, infrastructure and technologies results in lower energy system costs and green growth. The UK has a profitable role to play in leading that competitive race.

To listen to a recording of the panel discussion, please see below.

Photo by Lisa Baker at Always Finance News