Over the past few years, the climate policy paradigm has moved from a view where the economy must be constrained to mitigate climate change to one where growth and a sustainable environment can coexist. This change in perspective is adding momentum to the energy transition. But ramping up investments quickly to limit the impact of climate change and drive growth is challenging in a more fragmented world.

New theories have broadened our understanding of the green transition

Green growth theories recognise that technology is not static and is key to achieving simultaneous economic and environmental efficiency. Improvements in energy efficiency are one example where mitigating climate change enhances growth. Another is radical innovation, such as renewable electricity generation, which is now cheaper than fossil fuels.

However, green technologies are costly and not competitive at first, mainly because of nascent research and development and a lack of scale. Technological change is driven by past investments and existing capital. Consequently, the market tends to cling onto existing technologies.

Policy can help accelerate the transition. There are two market failures to address: the negative externality of carbon emissions and underinvestment in green technology. Carbon pricing can correct the first of these, but it cannot address the legacy innovation bias towards fossil fuel investments. Subsidies are needed to redirect resources towards emerging green technologies and crowd in private investment in a greener economy. The fiscal multiplier for renewable investments is estimated to be double that of fossil fuel investments.

Green growth policies have already had success

Decoupling economic growth from emissions has already happened in developed economies (Figure 1). With evidence that climate mitigation can be associated with growth, the policy focus has moved from a purely costs-based view of transition to include opportunities for innovation and growth.

Public spending on ‘greening’ infrastructure and technology has surged (Figure 2). In Europe, one-third of the Next Generation EU Fund has been allocated to green spending, and the Inflation Reduction Act in the US has $369bn of subsidies earmarked for climate mitigation and adaptation. Following energy market disruptions after Russia’s invasion of Ukraine and a renewed focus on energy security, large energy importers like the European Union and China have also accelerated their transitions. Global renewable capacity additions in 2023 have once again led the International Energy Agency to revise its renewable energy growth forecast upward by 33%.

 

Figure 1. US carbon dioxide emissions per capita decoupled from GDP 20 years ago
% change relative to 1990 levels

Source: BP, World Bank, Global Carbon Budget, S&P Global Ratings

 

Figure 2. Public climate financing is attracting private investors
$bn

Source: Climate Policy Initiative, S&P Global Ratings

 

Building competitiveness in green product markets is also emerging as a way to grow international market shares. China has spent more on climate change mitigation than other countries, and Chinese firms are dominating solar panel manufacturing. China is now also disrupting more traditional markets, like auto manufacturing, overtaking Germany as the world's second largest car exporter thanks to significant progress in producing electric vehicles. Although enacted only in 2022, the IRA could help American companies catch up quickly in green technologies.

The relative attractiveness of carbon taxes is moderating as green growth models emphasise the ‘carrot’ rather than the ‘stick’. In almost every economy, carbon taxes are less popular than subsidies. Countries with a focus on carbon taxing but fewer green subsidies (such as the EU), are adjusting policies to prevent capital flight, with companies taking advantage of green subsidies elsewhere.

Time and money are not the only impediments

Expanding the renewables sector is a challenge and will take time. There's no doubt that more investments are needed to green the economy. Carbon dioxide emissions per unit of output have plateaued since 2010, but have not yet declined.

Financing sufficient green subsidies to speed up the transition may not be feasible for governments faced with higher interest rates, high debt and lower growth. Government budget constraints – and a lack of foreign (official) financing – are already hampering the green investment in developing countries, which seek a ‘just transition’. So far, the majority of investments in clean technologies have come from the EU, the US and China.

Trade frictions and geopolitical concerns are also affecting the energy transition, potentially making it more costly and slower at a time when scaling up green technologies is key to preserving the environment. For example, the EU has announced an anti-subsidy investigation into electric vehicles coming from China. China has raised questions over the compliance of the EU’s Carbon Border Adjustment Mechanism with the World Trade Organization’s rules. And the US has issued local content guidelines for companies to benefit from IRA subsidies. Meanwhile, critical minerals are becoming a strategic asset.

Distribution issues associated with the green transition matter too, and not just the size of the economic pie. Globalisation failed partly due to these concerns. If safeguarding the planet is not seen as making life better for all, political support for the green growth paradigm could be at risk.