A green economy requires more than subsidies
7 Dec 2023|

In recent years, many policymakers thought they had found the perfect formula for implementing climate-friendly policies without facing difficult political trade-offs: massive subsidies. This strategy, often associated with US President Joe Biden’s Inflation Reduction Act, has influenced several Western countries.

Historically, mainstream economists believed that the best way to facilitate a green transition was to establish a carbon price through taxation or quotas and then leave the relevant economic decisions to private actors. Unsurprisingly, many economists have criticised the US Inflation Reduction Act as a less efficient method of allocating resources. But they missed important aspects of policies based on green industrial subsidies.

Such policies managed to overcome some of the political obstacles that have hindered climate policymaking. They raised hopes that industrial interests, security concerns and environmental priorities could be aligned. They balance voters’ deep concerns about climate change and workers’ demands for reindustrialisation, and even serve some purely economic objectives.

From a macroeconomic perspective, when interest rates were at historically low levels, debt-financed programs could provide economies traumatised by the Covid-19 crisis and the fear of protracted secular stagnation with a much-needed boost in aggregate demand. From a microeconomic perspective, such programs can be expected to accelerate innovation in specific fields.

But the limitations of this doctrine are becoming increasingly apparent. First, financial conditions have changed. The green investments France needs to make by 2030 are estimated at 2% of GDP, half of which is expected to come from the public sector. These figures are in line with other estimates for similar countries. Given the rise in interest rates, additional fiscal scrutiny is needed to accommodate these investments.

Second, subsidies alone can’t bring our climate targets within reach. The risk lies in potentially increasing the use of clean energy without dramatically reducing the use of fossil fuels. Regrettably, this is the current global trend.

Third, from a political standpoint, while green industries are necessary, they don’t immediately create a constituency large enough to counter the public backlash against new restrictions. This challenge is evident in Germany, where the government recently had to moderate its plan to phase out fossil-fuel heating systems, and in the Netherlands, where a plan to cut nitrogen emissions triggered a similar reaction.

A revised doctrine is needed. While key aspects of green industrial policies should be maintained and even enhanced, amendments and additions are essential. Crucially, fiscal policy must be reformed. In an age of monetary tightening, public debt related to climate policies should be differentiated. France is set to do this at the local level, but progress is also needed at the national and European levels. This could involve either additional European Union investment or amendments to the EU’s fiscal rules.

To generate additional resources, it’s necessary to reduce ‘brown’ subsidies and raise certain taxes, through international coordination. Potential measures include expanding carbon border adjustment mechanisms and increasing contributions from the maritime and air transport sectors.

By publicly committing to a long-term strategy to finance and deliver climate investments, governments could more easily influence the investment decisions of private companies and households and facilitate coordination of fiscal and industrial policy across national borders. Annual budgets don’t provide the visibility we need. The French parliament has already passed a bill mandating such a measure.

A detailed roadmap is also needed. To reconcile climate objectives, economic sustainability and political support, all policy instruments must be harmonised. To this end, French President Emmanuel Macron’s second term has been marked by the introduction of a new approach: environmental planning.

This strategy emerged from recognising the shortcomings of relying too heavily on carbon pricing, especially after the 2019 increase in gasoline and diesel taxes sparked the ‘yellow vest’ protests, driven by people who were dependent on petrol- and diesel-powered vehicles and felt abandoned. While acknowledging that market forces can’t produce alternatives quickly enough to meet social needs, environmental planning also recognises the limitations of relying solely on subsidies.

The French approach is based on meticulously mapping out all the necessary actions to cut the country’s greenhouse-gas emissions by 55% (compared to 1990 levels) by 2030. When it comes to areas like housing renovations, electric cars and industrial decarbonisation, feasible solutions already exist and primarily require scaling up or incremental improvements. There are only rare cases where breakthrough innovations are required. Clean electricity production will be boosted with nuclear and renewables, while energy efficiency will also play an important role.

Achieving climate goals requires a combination of instruments. For example, in the housing sector, the French government has provided poor and middle-class households with massive subsidies to insulate their homes. It has incentivised others by gradually introducing a ban on rental properties that need urgent renovations. It has also set ambitious industrial policy targets, particularly for the domestic production of heat pumps.

To be sure, there’s still a long way to go to achieve a greener economy. The coming year will serve as a crucial test for many Western countries, with elections in the US, the EU and the UK occurring amid escalating political tensions over environmental issues.

Several factors are crucial to preventing popular opposition to climate policies and encouraging take-up of clean solutions, such as electric vehicles. While the negative impact of policy changes is often explicit, positive outcomes remain implicit. For example, European governments announced that new petrol-and diesel-powered cars will be banned by 2035 but have struggled to provide even an estimated price for electric vehicles. Clearer commitments must be made, given that citizens comparing the current prices of petrol- and diesel-powered cars to electric vehicles are understandably concerned.

Moreover, public engagement must play a central role, as the phaseout of fossil-fuel vehicles will require extensive plans for retraining automobile workers and supporting small businesses. Geographic differentiation and renewed urban planning are also needed to reduce long commutes that force people to depend on cheap fuel.

Lastly, we must strive for fairness. To counter the populist narrative of elites evading restrictions imposed on the middle class, the super-rich should contribute more than the general public. As a symbolic gesture and proof of concept, the EU could announce ambitious plans for regulating the private-jet industry and hastening its clean-energy transformation.

This is just a small part of the broader reinvention we urgently need. By focusing solely on carbon prices and industrial subsidies, policymakers had hoped to sidestep tough political choices. But both approaches have proved inadequate, both socially and economically. Climate policies must move away from the ages of green taxes and subsidies and enter the age of politics.