Bill Gates’ Green New Economy
Can we afford it, and who will pay the cost?
In his recent book, “How to Avoid a Climate Disaster,” Bill Gates cuts to the chase: Civilization currently emits 51 billion tons of greenhouse gasses every year; we need to reduce emissions to net-zero to avoid climate disaster and to do so, we will need to decarbonize every facet of society: manufacturing (31% of emissions), electricity (27%), agriculture (19%), transportation (16%), and buildings (7%). A central focus of the book is the projected cost of decarbonization, which is characterized in terms of “Green Premiums,” the excess cost of zero-carbon energy, processes, and products in relation to their fossil-fuel counterparts. For example, the Green Premium is currently estimated at 15% for utility electricity, 16–29% for manufactured steel, 75–140% for cement, and 141%-296% for sustainable jet fuel.
The emphasis on Green Premiums is somewhat different from contemporary policy thinking, which is grounded on the concept of the “social cost of carbon,” a measure of the cost of emitting greenhouse gasses into the atmosphere. Green Premiums represent the cost of not emitting greenhouse gasses into the atmosphere. (Think of Green Premiums as the “social cost of decarbonization.”) A policy of damage avoidance, as opposed to damage remediation, sensibly focuses on decarbonization costs.
Gates highlights Green Premiums as a central focus of climate policy, but on the question of how to reduce Green Premiums, he echoes old-school, “pay-the-damages” economic orthodoxy: “… we need to reduce Green Premiums to zero. Some of that we can accomplish with innovation … But we can also raise the cost of fossil fuels by incorporating the damage they cause into the prices we pay for them.” (Chapter 10) An alternative approach would be to incorporate the cost of decarbonization (Green Premiums) into fossil fuel prices and use the pricing revenue to finance decarbonization. The difference between these two policy approaches is not just semantic; they represent diametrically opposing conceptual frameworks and strategies for tackling the challenge of climate change.
Carbon pricing versus “decarbonization pricing”
Climate regulations are premised on a social cost of carbon, even though economists can’t agree on the future costs of climate change. For example, the Nobel laureate economist William Nordhaus has recommended an economically “optimal” target global temperature rise of 3.5°C in 2100, which would be catastrophic according to climate science. Other economists have estimated the present-value damages of that level of temperature rise at over 500 trillion dollars, more than total worldwide wealth. But whether or not the economic models are believable, a more fundamental question is this: Why do we base economic policy on prognostications of future climate damages when we have no way of actually paying for damages that will be incurred by future generations for centuries and millennia henceforth?
President Biden’s newly appointed “Interagency Working Group on the Social Cost of Greenhouse Gases” will be using tools such as the Nordhaus model to recommend a social cost of carbon for regulatory purposes. The group’s efforts could probably be spent more productively on evaluating the social cost of decarbonizing the U.S. economy. Case in point: According to a recent study by the Lawrence Livermore National Laboratory, California could achieve net negative emissions by 2045 (minus 125 million metric tons of CO2 per year) at the cost of less than 0.4% of the State’s current gross domestic product. That is the cost that we would incur to protect the welfare of future generations, not the cost that they would bear from our inaction. The discounting calculus underlying the social cost of carbon favors deferred action on climate change (procrastination), whereas a focus on reducing Green Premiums — Gates’ approach — would favor early action to maximize compounded future returns from proactive investments in clean energy.
However, Gates favors traditional carbon taxes, based on estimated damages from climate change, as the most effective way to reduce Green Premiums. Quoting from Chapter 11 in his book, he makes the following recommendation:
Put a price on carbon. Whether it’s a carbon tax or a cap-and-trade system where companies can buy and sell the right to emit carbon, putting a price on emissions is one of the most important things we can do to eliminate Green Premiums.
In the near term, the value of a carbon price is that by raising the cost of fossil fuels, it tells the market that there will be extra costs associated with products that emit greenhouse gas emissions. Where the revenue from this carbon price goes is not as important as the market signal sent by the price itself. …
This staid economic doctrine overlooks alternative approaches such as price subsidies, which have been more successful at bringing Green Premiums down through technology innovation and economies of scale. A simple illustration shows how feeble and ineffectual carbon taxes are in comparison to the alternatives:
Suppose, for example, that carbon pricing had been applied to make solar photovoltaic (PV) power competitive with coal in the U.S. utility electricity market. In 2009 coal power was selling for $111 per megawatt-hour (MWh), while PV was at $359/MWh. The price difference between PV and coal was $248/MWh, the Green Premium, which created a market barrier to the substitution of PV for coal. Putting a price on carbon emissions equivalent to $248/MWh would, according to Gates, have been “one of the most important things we can do to eliminate Green Premiums.” Any lesser carbon price would have been insufficient to eliminate the premium.
Coal emits about 1 metric ton of CO2-equivalent greenhouse gasses per MWh (1 ton/MWh), so an energy tax of $248/MWh would equate to a carbon tax of $248/ton, which is far beyond the bounds of economic and political viability and is much higher than social-cost-of-carbon standards. The maximum carbon price recommended by Obama’s 2010 Interagency Working Group on Social Cost of Carbon was $65 per ton. The “market signal” from a carbon tax on coal at that level might have motivated the industry and consumers to marginally reduce consumption or do some fuel switching. However, it would not have motivated increased PV market penetration because even with the tax, coal power would have still been half the price of PV in 2009.
A doctrinaire economist would argue that we shouldn’t try to expand PV production through regulatory intervention; doing so would distort the marketplace by “picking winners.” The role of regulation should just be to establish an economy-wide carbon price and leave it to the free market to find the most cost-effective ways to reduce emissions in response to the price incentive. Why spend $248 per ton, the Green Premium for PV, when the same emission reduction could be achieved at the cost of around $20 per ton by planting trees?
That argument presumes that the $248 expenditure for expanded PV generation would not have been needed if $20 had instead been spent on tree planting. But it doesn’t work out that way because no matter how many trees we plant, it won’t be possible to achieve net-zero global emissions without decarbonizing heavy industries such as utility electricity. Diverting the industry’s resources from eliminating its own emissions to tree-planting would only kick the can down the road and delay the day of reckoning when electricity will eventually have to be decarbonized, potentially at a much higher cost and with much greater pain than would have been necessary if the decarbonization process had started much earlier. Market actors don’t anticipate those longer-term costs because carbon pricing policies (carbon taxes or cap-and-trade) only incentivize them to seek out quick and easy, near-term emission reductions required to comply with interim carbon reduction goals.
Regulatory support for PV would certainly be warranted, but a carbon tax of $248/ton would have been a non-starter. On the other hand, taxation policy could have been effectively used, not to “pay the damages” of climate change but to pay the Green Premium for PV. In essence, the carbon tax would be replaced with a “decarbonization tax.” In 2009 PV generation in the U.S. market amounted to 0.89 million MWh per year (only 0.03% of total U.S. utility electricity generation), so a Green Premium equating to $248/MWh would have required an aggregate annual subsidy of $221 million. The subsidy could have been financed by a mere 9 cents/MWh tax on natural gas and coal, having combined generation of 2.7 billion MWh. A 9 cents/MWh decarbonization tax could have leveled the playing field between PV and fossil fuels just as effectively as a $248/MWh carbon tax.
Of course, the only reason that the subsidization tax is so imperceptibly small in the above scenario is that PV generation capacity was minuscule 2009. As the PV market expands in response to the subsidy incentive, one might expect that the subsidization tax would have to increase to the point where it reaches and overtakes the social cost of carbon. But we now know “with 2020 hindsight” what actually happened.
Between 2009 and 2020, PV prices dropped like a rock to the point where unsubsidized PV has become the least costly power source at $37/MWh (a tenfold decrease from 2009). PV generation capacity has grown by over 100X relative to 2009 (although it is still only a little over 2% of total generation). Wind power costs have similarly fallen by over a factor of 3 since 2009, and generation has expanded fivefold (to over 8% of U.S. utility power). By 2030, prices are expected to fall by another 72% for PV and 43% for wind.
That did not happen because of carbon taxes, or cap-and-trade, or private investment. What really kicked the renewable power revolution into high gear was Germany’s feed-in tariff program in the early 2000s, at which time German ratepayers were subsidizing PV Green Premiums at a rate of about $450/MWh. The market expansion was also accelerated by a variety of U.S. state and federal policies, including R&D subsidization, renewable tax credits (which are basically government-financed subsidies), and renewable portfolio standards (which, in effect, mandate industry subsidization of renewables).
Other high-emission industries such as shipping, aviation, steel, and cement manufacturing can’t be decarbonized as easily or cheaply as electricity. Still, the clear lesson from PV is that decarbonization need not be exceedingly difficult or costly if each industry’s resources are channeled efficiently toward reducing its own emissions. Traditional carbon pricing does the exact opposite and isn’t really up to the task of transitioning the global economy to full carbon neutrality.
Policy innovation
Gates argues emphatically for accelerated technological innovation to meet the challenge of climate change (and he started a company, Breakthrough Energy Ventures, to do just that). But just as importantly, we also need innovative regulatory and business models to finance the clean energy transition. Policy tools that have been successful with wind and PV power have some shortcomings in efficiency, equity, and scalability, which could be remedied to adapt them for a scaled-up, full decarbonization program.
Performance standards are recommended by Gates as one important policy approach. These include clean electricity standards, clean fuel standards, and clean product standards. However, “clean” doesn’t mean zero-carbon; it just means “cleaner.” Standards generally only mandate an incremental step toward full decarbonization, which can be inefficient because industry is only incentivized to find cost-effective means for complying with short-term, interim targets. The most cost-effective strategy for full decarbonization might require a different technology path. For example, negative-emission, carbon-capture technology might be postponed indefinitely under a technology-neutral clean electricity standard, even though carbon neutrality might be unachievable without carbon capture.
Under a performance standard, the incentive for further emission reductions abruptly ends once the standard is achieved, whereas financial incentives such as subsidies are more stable and can be focused on a portfolio of complementary technologies to support a coordinated, long-term strategy for full decarbonization. Financing can come either from government or from industry. Deriving financing from industry makes sense under the “polluter pays” principle — except that the industry should be paying to stop its emissions, not to continue emitting. From an industry perspective, this approach could be more favorable than carbon pricing policies that seek to extract revenue from the industry. And from the standpoint of governmental politics, a policy that does not rely on deficit-financed government subsidization might find bipartisan support.
Germany’s feed-in-tariff program induced unexpectedly high growth in renewables, necessitating frequent regulatory revisions to balance the tariffs with available funding. Regulatory fees and subsidies could be indexed to market growth and emission performance to create more stable and predictable pricing incentives without regulatory intervention.
A more fundamental problem with subsidies is their potential effect on wealth distribution, inequality, and market competitiveness. Taxpayers or regulated industries and their customers finance the subsidization of new energy technologies before commercial equity markets are willing to invest, but they don’t generally get equity shares in return, and the profits resulting from those subsidies go to commercial investors.
The “charity” model of public finance could be replaced with an investment model, i.e., subsidies would transition to investment mandates. This could open the door to public and regulatory financing for decarbonization on a much larger scale. (Australia’s Clean Energy Finance Corporation exemplifies this approach.) If commercial equity markets don’t provide the capitalization needed for the clean-energy transition, then government regulations can pool the resources of taxpayers and regulated industries to make the necessary investments — and reap the dividends.
Several core investment objectives of public financing — or mandated industry investments — would be to ensure that (1) the financing goes to technologies that have commercial potential and meet established standards for emissions performance and sustainability, (2) clean-energy industries receive sufficient capitalization financing commensurate with climate stabilization goals, and (3) the costs and risks of clean-energy investments — and any investment gains — are distributed efficiently and equitably among investors and stakeholders across a broad jurisdictional scope.
This policy approach can be illustrated, for example, with the airline industry. Currently, air transport emissions are regulated by the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), which uses carbon trading to divert industry resources away from reducing its own emissions. The scheme has the oxymoronic goal of achieving “carbon neutral growth from 2020” when in fact, CORSIA allows aviation emissions to keep growing.
The airlines might be supportive of an alternative policy that does not seek to extract carbon pricing revenue from the industry but instead pools the resources of the global air transport industry to decarbonize aviation and ensure long-term security of fuel supplies via commercialization of sustainable aviation fuel. The policy would be especially attractive if it is structured as an investment mandate, which could yield future dividends from industrial production of green hydrogen, a feedstock for sustainable fuel, and a cornerstone of the zero-carbon economy.
The green gold rush
Once they have achieved market maturation and economies of scale, renewable energy technologies can be enormously profitable. Quoting Gates (from Chapter 11),
There are markets worth billions of dollars waiting for someone to invent low-cost, zero-carbon cement or steel, or a net-zero liquid fuel. … making these breakthroughs and getting them to scale will be hard, but the opportunities are so big that it’s worth getting out in front of the rest of the world.
Or it might be worth “getting with the rest of the world” in confronting a collective challenge that is too big for any one nation to tackle on its own. The opportunities are immense, but so are the technological and financial resources that must be brought to bear on global decarbonization. The task is too big for financial markets alone and perhaps also too big for governments that are laden with massive debt and immobilized by political polarization. But innovative public-private partnerships could leverage the enormous investment potential of green technologies to finance the clean-energy transition while ensuring that the benefits of decarbonization accrue equitably to all stakeholders. The transition to 100% clean energy could potentially save American consumers over $2500 per year for an average household while creating 25 million new jobs. With the fate of civilization in the balance, it’s an opportunity we can’t pass up.
Carbon neutrality won’t likely be achieved by playing carbon-trading shell games in which some players pay for the right to pollute while others profit from their emissions. To build a zero-carbon economy by mid-century, market players and stakeholders will need to concentrate their combined resources on clean-energy investments, which can continue to return “decarbonization dividends” for perpetuity long after carbon emissions have ceased.
