Will the green transition help or hinder economic expansion?

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Although the recent COP26 global climate summit in Glasgow was met with disappointments, we remain hopeful that governments and businesses will avoid a negative impact from this transition by taking sufficient action as soon as possible.

A recent report by the International Energy Agency (IEA) concluded that annual investment in the energy sector will need to increase from $2 billion today to $5 billion by 2030 if we want to move to a net zero world. But you can’t just add that extra $3 billion a year to annual GDP and say “happy days, more growth.”

That would ignore the question of where that $5 billion came from. Capital does not grow on trees. It is very likely to come from capital that otherwise would have been invested elsewhere. If so, will this transition to net zero lead to less innovation, less productivity growth than if this capital were not diverted from elsewhere?

This is a really crucial question.

An optimistic view

We are optimistic for several reasons. First, some of this investment will likely be in public infrastructure, which encourages job creation and investment and increases productivity. The second reason is that the falling cost of clean energy technologies has exceeded even the most optimistic expectations of ten to twenty years ago. There is interesting evidence that the evolution of the cost of climate change technology assumed by many models used to determine economic impact is too slow.

If you assume that the cost of these technologies drops at a rate similar to what we have seen in many other technologies over the past 50 years, you may find that the transition is actually driving growth. Including the first industrial revolution, we had five major waves of productivity growth: energy revolutions were involved in four of them. So why can’t we have another industrial revolution powered by cheaper green energy?

This is the optimistic view.

Economists from the Bank of England (BoE) and the Network for Greening the Financial System (NGFS) suggest that the transition to net zero will likely reduce GDP by 2050, but only by 1 percentage point. So only a little less growth than if we do nothing.

A recent review of academic literature showed an inconclusive divide between studies that suggest it would help, hinder or make no difference to economic growth.

worth the cost

Our base case is a slight negative impact on growth by 2050, but we are optimistic. Eliminating the huge downsides of not tackling climate change, which don’t show up in GDP numbers but have a real impact on our well-being, are probably worth that cost.

However, policy makers must act now.

This is the best way to prevent the economic costs from outweighing the benefits over time. Economies and businesses can evolve and adapt to well-signalled and spread-out changes, but a more sudden imposition of a policy – ​​say in 2028 or 2029 – could pose huge transition risks.

And it’s not just about policy makers.

We urge the high-carbon companies we speak with to adopt robust decarbonization policies today, to reduce the risk that a more sudden and financially disruptive policy will be imposed by governments later. These same BoE/NGFS economists expect GDP in 2050 to be 5 percentage points lower if we delay the transition for ten years.

Ed Smith is co-CIO of Rathbone Investment Management

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