Understanding Green Transformation

The Green New Deals that are underway and being contemplated on both sides of the Atlantic entail major investments intended to reduce the environmental impacts of economic activity. Many reliable studies including McKinsey & Co. have estimated that reaching net-zero greenhouse gas (GHG) emissions by 2050 will require about $275 trillion of cumulative spending on physical assets over the next three decades. No equivalent estimate of costs is available for addressing other globally significant environmental problems, but we can be confident that they would be very substantial. Successful mitigation of and adaptation to the climate crisis, biodiversity loss, shortages of fresh water, and more will be determined by the kind of investments made today and their relation to macroeconomic objectives. Some of these objectives have recently received increasing attention, such as inflation and public debt, both in the European Union and the United States. Some other important constituents such as full employment, income inequality, and private-sector debt remain matters of concern. A green transformation of the economy will require a major commitment to green investment to reduce and respond to environmental degradation. Therefore, it is immensely important to explore the macroeconomic implications of green investment in the transformation to a green economy. However, for green energy policy to be successful, three main conditions need to be ensured: e?ciency, effectiveness, and legitimacy.

The requirements for effectiveness and e?ciency, and the resulting roles of the state and the market, have been discussed in industrial policy literature.  An effective policy first and foremost needs an institutional setting that balances the autonomy of governments against the private sector. Policy e?ciency can be improved by integrating market mechanisms in policy design. However, for an undertaking as complex, long-term, and overarching as green energy, transformation should also have legitimacy. The nature of legitimacy can be manifold, calling for a societal consensus on a long-term vision. In the broader sense, effectiveness, e?ciency, and legitimacy are interconnected and cannot be implemented in isolation. They all require the interaction of the state with non-state actors largely in the economic sphere. Furthermore, they share four key factors: broad societal agreement on the direction of change, change alliances, systematic policy learning, and the use of market mechanisms to manage policy rents and political capture. These factors contribute to legitimacy, effectiveness, and e?ciency in more ways than one. Societal agreement on directionality lends legitimacy to transformative policy and increases its effectiveness. Change alliances can strengthen these chances since less powerful actors can join forces to support the transformation. Openness to policy learning enhances effectiveness and also e?ciency. The inclusion of market elements does improve e?ciency by eliciting information on optimal prices and optimizing the allocation of resources. At the same time, it can help to avoid political capture, which would inherently be ine?cient. The resources spent on lobbying or outright corruption could be spent more productively elsewhere. Reducing the likelihood of capture, in turn, increases the effectiveness and legitimacy of green energy policies.

Green energy policy is implemented in a context of both high uncertainty and long-time horizons. What is more, economic and social reality is inevitably characterized by winners and losers and hence by conflict and controversy based on often irreconcilable objectives of different societal groups. For these reasons, action toward the green transformation needs to have a high degree of legitimacy. A broad agreement across stakeholders is needed with respect to the long-term vision of the transformation. For example, closing down certain options and supporting new industries. Germany’s decision to exit from nuclear energy and invest heavily in renewable energy technologies is a case in point. Such an agreement should establish a su?cient degree of policy directionality and manifest in long-term policy frameworks. When policies in favor of renewable energy change entire markets, bring down prices and create profit opportunities for future investments, they increase pressure on future governments to continue along the same path. The long-term certainty of institutional frameworks, in turn, is crucial for investment. As Evans has rightly put it, ”without a predictable environment of political rules and decisions, long-term investment is foolish.”

The green transformation is an undertaking involving exceedingly high levels of ambition, uncertainty, and complexity. As such no single actor has the resources to bring about the green transformation. It calls for public-private civic alliances which are critically essential for fostering the transformation. Such alliances can be seen as vehicles for bundling diverse interests for a particular purpose such as influencing legislation, policies, or technological projects. Heterogeneous change alliances are certainly di?cult to organize and often operate in loosely connected networks. Yet, in highly conflictual negotiation situations, the discovery of previously unknown ‘win-win solutions’ may make all the difference between a policy impasse and effective action. Thus, the anticipation of benefits from the green transformation would actually facilitate cooperation. For instance, the German energy transformation has been driven by civil society advocacy groups with a genuine green agenda, enlightened business circles anticipating the growth of green markets, employers and trade unions alike in sectors benefiting from new jobs or in electronic and chemical industries exporting specialized components to green industries worldwide, and regional governments and municipalities seeking to strengthen decentralized power structures.

It must be kept in mind that policy experimentation is increasingly recognized as critical for tackling complex development problems. To a great extent, this is due to the rise of emerging economies, which inter alia has been the result of applying unconventional policy approaches that combine market forces with state leadership. The openness toward experi-mentation is particularly pronounced in an attempt to shape future sustainable development patterns. For instance, model cities experimenting with new low-carbon infrastructures are spreading in emerging economies and exploring new forms of energy-e?cient buildings, public transport, infrastructure for scaling up the use of electric vehicles, or waste recycling. In the absence of homogeneous and binding global environmental policy frameworks, international networking and knowledge-sharing among pioneers of change can make important contributions in terms of developing and testing sustainable alternatives and increasing their appreciation in society. It is pertinent to mention that despite the policy experimentation successes in the global South, learning from Southern approaches is only gradually taking place in industrialized countries. One specific field that lends itself to such South-North policy learning is the use of renewable electricity feed-in tariffs. Although conceptualized in the context of rich economies, the tool has come to be applied widely and improved in emerging economies.

In the final analysis, the time has already come for a substantial increase in green investment in developed economies that can help bring about a green transformation that will achieve a range of environmental, social, and economic objectives while economic growth slows, possibly ceasing completely. Indeed, if priority is given to the pursuit of economic growth, it will be an obstacle to a green transformation, since productive investments in the private and public sectors will take priority over essential non-productive green investments. All investment adds to GDP, but if green investment simply displaces other investments, the net effect on aggregate demand will be zero. This holds whether the green investments are productive or not. However, over the longer term, if a substantial proportion of green investments are non-productive, in the sense that they do not add to the economy’s capacity to produce marketed goods and services, the rate of economic growth in a green transformation will be sharply slowed. This is to be expected since much of the investment required for a green transformation for mitigation and adaptation is likely to be non-productive. However, growth in GDP should not be a goal. GDP is an inadequate indicator of well-being, not least because it ignores environmental damage and other costs.