‘Net Zero’ and the innovation-policy nexus

The adoption of radical policies and targets to combat climate change can speed up the process of innovation and reduce costs associated with emissions reductions

Theresa May’s decision to adopt a ‘net zero’ target for greenhouse gas emissions has rightly been recognised as a historic milestone in the accelerating task of tackling climate breakdown. But it is also a useful reminder about both the limits of economics and the potential of economic policy.

The decision itself is a straightforward one. Under the 2008 Climate Change Act, UK governments are required to reduce national greenhouse gas emissions (GHGs) by 2050 to a level 80% below those of 1990. Under the Act this long-term goal can be amended by secondary legislation, which is why (given Labour and other parties’ support for the proposal) May can strengthen the 2050 target to ‘net zero’ before she leaves office. The phrase ‘net zero’ acknowledges that some emissions may be allowed if they are offset by emissions captured and stored in vegetation or underground.

In a classic Cabinet fudge the Government has placed two caveats on the target. Contrary to the advice of its independent Climate Change Committee (CCC), the government has not ruled out the option of buying ‘carbon credits’ to meet the target – that is, paying other countries to reduce emissions on the UK’s behalf. And there will be a review of the policy after five years, to see whether other countries are also playing their part in cutting global emissions.

Both caveats are nonsensical. Since (as the 2015 Paris Climate Agreement recognised) the entire world has to achieve net zero emissions by the middle of the century, no country will wish to sell the UK emissions reductions it will have to make to meet its own target. And if in five years’ time other countries are not doing enough to combat climate change this will only make global action more necessary not less, so it would not be credible for the UK to abandon its effort at that point.

It is of course easy for Theresa May to claim a ‘legacy’ through a policy dated over thirty years hence. But in fact it will have immediate consequences. Under the Climate Change Act, governments must adopt five-year ‘carbon budgets’ consistent with meeting the long-term goal, and then produce plans and policies to meet them. So changing the 2050 target will force a revision of the UK’s current climate plans, which (as the CCC has noted) are already off track.

Much has been made of Chancellor of the Exchequer Phillip Hammond’s warning – carefully leaked – that the net zero target would cost the UK economy “well in excess of £1 trillion” by 2050. This figure was derived by adding up the estimated annual costs to the UK’s GDP from now until 2050. But it is absurd, a wild example of Treasury hubris. For we simply have no idea how much reducing emissions will cost over a thirty year period. To achieve the goal will require huge technological and structural changes to our economy, many of them, in the 2030s and 40s, using methods not yet fully invented and whose costs cannot be known. And of course, the figure takes no account of the damage to our economy which allowing climate breakdown to continue unchecked would cause. So it is frankly ludicrous to claim we have any knowledge at all of the net monetary costs (or indeed benefits) of setting ourselves on this path. Economists really must have more humility than this.

Of course the underlying question is a real one: can net zero actually be achieved? And here the response is more profound. For the act of setting the target will help determine the answer.

The Treasury’s approach treats the target and the costs of reaching it as independent variables. But technological development is not an exogenous factor: it is influenced by policy choices. Setting a target and directing policy to meet it will speed up the process of innovation. Knowing that the government is legally obliged to achieve its target, companies will have market incentives both to develop new emissions reduction technologies and to cutting what they cost. The existence of the target, in other words, will change the costs of meeting it ex post from what they might have been calculated ex ante.

We have direct experience of this. The cost of solar power is now less than one-tenth of what it was a decade ago, and wind power less than half, leading to a huge expansion in their use around the world. (Global investment in renewable energy now comfortably exceeds that in fossil fuels.) Not only were these reductions not predicted in 2009 – meaning that the targets which various countries set in that year have been vastly exceeded in the decade since. They were also the direct result of those targets. As countries set renewable energy targets they drove demand for new technologies, which led to innovation in both their performance and cost. In turn this allowed those targets to be increased in subsequent years, with further innovation occurring. The entry of China into large-scale renewable energy manufacture has greatly accelerated this cycle.

The same innovation-policy nexus is now apparent across a wide range of emissions-reducing technologies, from electric vehicles to building construction. And it is now being directly driven by industrial strategies – including in the UK – specifically designed to make it easier, and cheaper, to meet stronger environmental targets. As the economist Mariana Mazzucato points out, innovation has a direction as well as a rate, and governments can do much to focus support on innovation which drives emissions reduction.

In doing so they will have a wider economic effect, which is the creation of business expectations. As Keynes noted, investment depends on what businesses expect future demand to be like. But this can be heavily influenced by policy. By setting radical and legally binding targets to cut emissions, the government is signalling what kinds of products and technologies will be profitable in the future, and which will not. This is why – in what might have been thought to be a surprising reaction – the Confederation of British Industry has come out in support of the government’s net zero legislation. The policy creates a degree of certainty in investment expectations which businesses strongly welcome. (Compare Brexit.)

So there is every reason to think that net zero will turn out not just to be achievable, but at less cost, and more quickly, than currently imagined. The much more uncertain question is how the transition will be managed. For whatever the overall benefits, there will undoubtedly be costs to certain sectors of the economy. Environmentalists and politicians are fond of claiming that climate policies will create new green jobs. And so they will. But they will also destroy some (such as in the oil and gas sector) and require the transformation of many others (in motor manufacturing and chemicals, for example). So achieving a ‘just transition’ will require a much more imaginative approach to industrial restructuring and regional economic policy than anything we have managed to achieve in the last forty years. That is the real policy – and political – challenge.