Marshall's Thoughts

Promoting a Green Transition: A Discussion of Potential Unspoken Hindrances

Benjamin Choo

Last year saw Putin’s invasion of Ukraine, resulting in high price levels which marked the end of an era of low and stable inflation and created a global energy crisis. However, perhaps a silver lining underlying this is the acceleration towards the green transition. Indeed, supply chain disruptions in energy prompted governments across Europe and Asia to reopen coal mines and keep polluting power plants alive. But it also spurred investments in renewables to diversify away from these energy sources. 2022 saw an unprecedented rise in global investment in wind and solar assets, which exceeded that of oil and gas wells for the first time. Governments in America and Europe have committed long-term spending worth billions on subsidies for clean energy, while China is also offering attractive incentives.

Amidst this rosy picture, however, this article seeks to analyse hindrances to the green transition people typically do not mention – that is, ironically, some government policies that have the unintended consequence of slowing down the green transition:

1. Red tape: This has long been an impediment to new projects in America and Europe, preventing firms wanting to invest from doing so. Denmark possesses a comparative advantage in offshore wind power. But it recently stopped processing all applications for such projects, upon realising this potentially breaches EU law. Meanwhile, in America, it takes over ten years to obtain the required permits to connect a renewable project in Wyoming to California.

2. Government intervention in energy markets: Governments are increasingly intervening in power markets to keep prices low. The EU has imposed a maximum price policy on renewable generators, and many European countries have implemented a windfall tax on their profits. Moreover, lowest-cost bidding for renewables contracts is often practiced to keep electricity affordable – to the extent that generators face difficulty in staying profitable. The current environment of higher interest rates does not help, in particular for green energy plants which require more capital than those operating on fossil-fuel. Renewable providers are rethinking their investments, as such projects are now constrained with limited revenue in the face of increasing costs. This problem is fundamentally driven by time inconsistency – governments want to keep energy prices low today, but this could have adverse long-term effects if this limits necessary spending on renewables for the future.

3. Policies intertwined with protectionist objectives: The Inflation Reduction Act (IRA) in America contains $400bn in subsidies for green tech over a decade, such as tax breaks for electric vehicles made with the US. But the money allocated comes a “fine print”, containing a multitude of rules and regulations ranging from requirements that components must be produced domestically, to restrictions on tech imports and exports amid concerns regarding national security. Interlaced with protectionism, the IRA is likely to result in a large sum of inefficiently spent money. Requiring jobs to be in America artificially supports manufacturing that has a comparative disadvantage, making the green transition more expensive, and limits the scope of efficient producers overseas to reap economies of scale. Moreover, this also sparks the potential for tit-for-tat subsidies by other economies to avoid companies from relocating to the US, with such a possibility being discussed among finance ministers in Europe. Interestingly, looking at this from a game theory perspective, it could be argued that it may the dominant strategy in this “new normal” to be offering such subsidies to attract firms to engage in this green transition. Yet collectively, countries are worse off, requiring governments to set aside funding for these subsidies which also reduces global productive efficiency, thus illustrating a prisoners’ dilemma.

This is not to say this has undone any progress made in the green transition. Even in this state of the world, forecasters estimate that current developments would still help accelerate the energy transition by five to ten years. The increases in investment and tighter targets would likely produce significant renewable-generation capacity. The International Energy Agency (IEA) expects global renewable-energy capacity to rise by 2,400GW between 2022 and 2027, an amount equivalent to China’s entire installed power capacity today. Compared to before Putin’s war on Ukraine in 2021, this is almost 30% higher than the agency’s forecast. Moreover, renewables are expected to account for 90% of the increase in global generation capacity over this duration.

However, this process can be further accelerated compared to the state today. The gains from cutting red tape are significant, with the IEA estimating that renewable energy production would rise by an additional 25% by 2027 if bureaucratic and financing barriers were removed. Green power should also be allowed to be sold at a higher price that governments would like for better long-term outcomes, possibly with competition agencies ensuring this is not used unfairly to extract surplus from consumers. For instance, in Netherlands the Authority for Consumers & Markets (ACM) published sustainability guidelines setting out its approach towards the assessment of sustainability initiatives under competition laws. Lastly, multilateral trade deals regarding the clean energy should be formulated. This would enable diffusion of knowledge and technology, thus helping to speed up the development of green technology. This would then pave way to global productive efficiency in green energy. Like-minded countries should be building an open transatlantic marketplace for innovators and investors. Yet, the world’s leading economy which once championed free trade is now resorting to protectionist measures which risks hurting both countries it views as adversaries and allies alike.

The world has begun a historic shift in energy generation, but it is not happening fast enough to avoid the dangerous effects of global warming. Crucially, governments around the world must take a pure, long-term view towards decarbonisation centered on international cooperation for this to happen.

This week's thought was by Benjamin Choo

Benjamin is an Economics undergraduate at Christ’s College, Cambridge. He is interested in the testing of economic theory using empirical data and thus the field of econometrics.

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