Transitioning to Net Zero requires a strategic state
A s the COP26 conference begins this week, the world’s attention is focusing on which countries will pledge ambitious long-term climate mitigation targets. However, just as important as these pledges are the policy actions that governments take in the short-term to accelerate the transition to a green economy. As one of the first countries in the world to legislate a legally binding target to reach net zero emissions by 2050 and as hosts of the conference in Glasgow, the spotlight is upon the UK government to demonstrate leadership and galvanise ambitious action.
In the UK, rapid progress has already been made in decarbonising power production, and in particular in transitioning away from coal. The next challenge lies in rapidly electrifying industrial production, domestic heating, and transport systems — as well as reducing energy leakage through better efficiency measures. Climate adaptation measures are also critical: as well as decarbonising our infrastructure, it also needs to be upgraded to ensure it is resilient to climate impacts already locked in. Additionally, restoring nature must be embedded within the green transition. Not only does the UK have some of the most depleted levels of biodiversity in the world, but restoring critical ecosystems such as peatlands and wetlands would enable us to sequester more carbon, and protect our cities from extreme weather events.
In economic terms, such a transition represents nothing short of a structural transformation that will affect all sectors and all actors within the economy. The UK Government’s Net Zero Strategy, released this month, set out how the government plans to accelerate the transition in the timeframes remaining for transformative action. Whilst a step in the right direction towards proactive policymaking, the Strategy is by all admissions largely a ‘markets-led’ approach, preferring the use of microeconomic policy instruments to correct prices and improve information and incentives. For example, the new Heat and Buildings Strategy sets a target of 600,000 heat pump installations per year by 2028, but provides grant funding for only 30,000 installations per year for three years. Here, the government is taking the gamble that its stated ‘ambition’ of no new fossil boilers after 2035 will be enough to kickstart private sector innovation to lower costs, and so enable market forces to fulfil the installations target over much of this decade.
“In economic terms, such a transition represents nothing short of a structural transformation that will affect all sectors and all actors within the economy.”
Yet there are a number of reasons why relying on businesses to lead the green transition is unlikely to be effective. Firstly, many different forms of green innovation need to be rapidly deployed, but there are serious structural constraints impeding the deployment and diffusion of green technologies in many sectors. For example, the installation of low-carbon heat pumps and retrofitting buildings has been hampered by a lack of required skills in the labour force. Households also face significant upfront costs and there are still questions over who should pay to retrofit Britain’s sizeable private rental building stock. Secondly, a lot of the carbon-intensive infrastructure we have in place today will have to be retired ahead of its original projected lifespan, which will generate economic dislocations in terms of the reallocation of labour, capital, and resources. Both of these factors imply economy-wide uncertainty, and the private sector does not tend to take risks for innovation under such conditions — particularly in this post-pandemic era when both households and corporates are increasingly indebted.
To address these challenges, governments need to take a more proactive role to resolve the structural constraints that are preventing private actors from making the most sustainable investment choices. This requires strategic direction, but also significant public investment. Research from the UCL Institute for Innovation and Public Purpose has shown that ‘mission-oriented’ industry policy can rapidly accelerate the diffusion of innovation throughout the economy. It does this by defining a clear trajectory for innovation — directing the new rules of the game, so to speak — and thereby creating certainty through shaping and co-creating new markets with the private sector.
The UK’s cold and leaky homes make up around a fifth of our greenhouse gas emissions, so decarbonising our building stock is precisely the sort of ‘mission’ around which industrial policy should strategically orient. Critically, retrofitting is precisely the sort of green public investment spending that is estimated to have very high economic multiplier effects. This is because many of the projects are close to being ‘shovel-ready’ and are labour-intensive, whilst required training could boost UK productivity levels. Green retrofit jobs are also additional and well-distributed across the UK. From this perspective there are huge unrealised synergies with the UK government’s ‘levelling up’ agenda. It is estimated that a publicly funded retrofit programme would create at least 190,000 direct jobs in the UK by 2030, and could generate many more jobs indirectly from the feedthrough effects to new manufacturing capabilities and supply chains.
These ‘supermultiplier effect’ green public investment programmes — such as a Great British Homes Retrofit or nationwide EV charging network installation — could be funded and supercharged by the issuance of green government debt. UK Green Gilts have so far raised £16 billion for green spending, but investor demand for the most recent bond was 12 times oversubscribed, indicating significant private investor appetite. The new UK Infrastructure Bank should also kickstart the provision of subsidised green financial products to help households and SMEs with the upfront costs of the transition. Finally, to ensure that the private financial sector also aligns with the challenge, the Bank of England has a number of policy tools at its disposal that it could deploy to incentivise bank lending for green purposes. It could also use this toolkit to disincentivise lending to new development projects that do not meet the government’s ambitions on energy efficiency and low-carbon infrastructure.
Not taking the chance to lock into highly favourable borrowing conditions today would be an enormous shirked opportunity in terms of investing in a way that is least likely to incur a large debt burden on future generations. At the present juncture, the costs of inaction on the climate crisis are far greater than any debt burden we need to take on today. Furthermore, green public investment spending is not just a cost centre, there are significant economic co-benefits to gain from cleaner air, warmer homes that are cheaper to run, green employment generation, and the birth of new green industries in which the UK could become a market leader. The key question is not what governments can afford to spend, but where such investment spending is strategically directed. Instead of relying on markets to do the heavy lifting, it is time to recognise that a more proactive role for the state can accelerate the transition to the green economy of the future.
Katie Kedward recently gave evidence on these issues to the UK Trade and Business Commission. The full session can be watched here: