The world will have to undergo an unprecedented global economic transformation to achieve a zero-carbon economy. This has implications for investment, inflation and growth, as well as for policy decisions.
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Achieving net zero requires a collective effort – and a different way of thinking
The quest for a net zero future requires us to think differently about the cost of burning fossil fuels. In economic and industrial revolutions to date, carbon emissions were seen as a “free” by-product of progress. In the green transition, emissions are internalised:in government subsidies, in new infrastructure investment and in carbon pricing schemes for businesses and end-consumers.
Setting the policy signals to facilitate the transition to a net zero economy will affect all facets of the economy, manifesting through key macroeconomic indicators such as GDP and inflation.
Deemed ‘one of the most radical economic transformations in history ’, the 2015 Paris Agreement is the blueprint to reduce emissions by 46% by 2030 relative to 1990 levels in order to limit global temperatures to 1.5 degrees Celsius above pre-industrial levels. However, the world is nowhere near on track, with most countries showing a large gap between that ambition and what they have pledged in their international climate commitments.
To limit climate change, all sectors of the economy – energy, transportation, housing, agriculture, manufacturing and even services – will have to change quickly in the next two to three decades.
Huge investments are required
Breaking the link between economic growth and greenhouse gas (GHG) emissions will require historic levels of capital expenditure in clean energy, transport and industrial infrastructure as fossil fuels are replaced with low-carbon alternatives.
The predicted costs of the green transition vary significantly, with estimates ranging from $100 trillion to $300 trillion between now and 2050. On an annual net basis, this requires investment of 2-8% of global GDP, which is substantial but far from impossible.
But don’t forget the cost of inaction… The costs of the green transition will be high, but compared to a scenario where no action is taken, the choice is simple. A realistic comparison takes into account the consequences for the global economy of climate change over time, including increased extreme weather events and rising sea levels. If insufficient action is taken to curb emissions, in the long run
it is unlikely that the global economy would develop meaningfully as climatic tipping points are breached, bringing about large climate-induced costs.
And what it means for people… Human welfare has always been measured as “consumption” in GDP. But such a measure does not capture the value of leisure and health or the negative effects of pollution, extreme weather events and inequality on people’s wellbeing.
If the green transition fails to materialise and climate change accelerates, the negative factors not captured by GDP could increasingly affect people.
How much investment will it take to reach global net zero targets? We look at three considerations for economies going green.
Shock to the system: Impact on growth and inflation
The consequences of the green transition can be treated as a series of shocks to the economy: both negative and positive. For example, the increase in energy costs is a negative supply shock, whereas positive shocks include increased productivity created by investment in green innovation.
What could these green transition shocks mean for growth and inflation?
Growth could benefit from the multiplier effect: In theory, increased investment could lead to higher consumption demand, which in turn could increase production. Forecasts from the International Energy Agency (IEA) suggest that global GDP would be more than 4% higher by 2030, while the International Monetary Fund (IMF) estimates that the output multipliers for spending on renewable energy could range from 1.1-1.5, comparing favourably with the 0.5-0.6. of fossil fuel investments.
Inflation is probably inevitable: ‘Climateflation’ has to be weighed against the temporary inflationary effects caused by the green transition: ‘fossilflation’ from more costly fossil fuel-generated energy due to carbon taxes and ‘greenflation’ from the additional costs for firms to switch from carbon to renewable energy sources. But the green transition should eventually have a disinflationary effect as energy costs fall again once a carbon-free economy is achieved. Moreover, carbon taxes will generate revenue, which can be used to lower other taxes or to increase public investment.
Adjusting policy for the environment and the economy
The expected green subsidies in the US's Inflation Reduction Act (IRA) are of similar size to those of the EU, except in renewable energy production where EU subsidies remain far larger, but there are important differences
The EU GDIP and the IRA differ in their structure, conditionality and time horizon, making direct comparison on an apples-to-apples basis tenuous. On an annualised basis, the EU subsidy package is greater in magnitude than the IRA, but the IRA is more likely to have a material impact on the development of clean-tech manufacturing. This is because of the IRA’s slicker credit-based system which the EU cannot replicate due to its not having a pooled tax system, making access to subsidies a more laborious process. The IRA also contains an important protectionist element with the domestic contents requirement, in line with a wider desire to re-shore the manufacturing of next-generation clean-tech industries and preserve energy security. The EU package contains no trade-distortive measure, but sets benchmark targets for local production.
Opportunities and risks
The implications for investors are as complex as the green transition itself. There will be opportunities in certain technologies, firms, sectors and commodities that will benefit from the shift towards green energy generation and government subsidies. However, there are also significant climate-related risks, such as the costs associated with extreme weather events. Risks related to the green transition itself include the uncertainty around the implementation of climate policies and the public support they rely on, as well as the speed and scope of potential technological breakthroughs. Higher inflation in the first five to 10 years of implementation is unlikely to be offset by central bank action.
Cooperation will be key
The green transition is an unprecedented attempt to put a cost on global carbon emissions. This requires not only a large-scale transformation of the economy, but also collective action, which makes it more challenging than earlier industrial revolutions.
A green transition without proper global cooperation could lead to rising protectionism and ‘beggar-thy-neighbour’ industrial policies, where actions taken by one country could negatively affect its neighbours or trading partners, forfeiting much of the welfare gains the integration of the global economy has made possible over the past decades.
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Costing the Earth: What will it take to make the green transition work?
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About the experts
Head of Economics Research
Christian Keller is Head of Economics Research at Barclays, leading a global team covering both Developed and Emerging Markets. Mr. Keller is based in London and joined Barclays in 2007 from the International Monetary Fund (IMF) where he had worked since 1999. Based at the IMF headquarters in Washington D.C., Mr. Keller worked on IMF programs with Emerging Market economies in Europe, Latin America and Asia, and served as the IMF’s Resident Representative in Turkey from 2005-7. Mr. Keller graduated with a PhD in Economics from University of Köln, Germany, and holds a joined-MA in Economics and Finance from University of Köln and HEC, Paris.
Global Head of ESG Research
Maggie O'Neal is Global Head of ESG Research at Barclays. Based in London, she has been named in the top three of Institutional Investor European Fixed Income Research team for her coverage of Basic Materials and Industrials since 2016, including #1 in High Yield Basic Materials in 2021. Prior to joining the firm in 2015, she was at Deutsche Bank