Climate change is an urgent threat to living conditions on Earth. It can only be slowed down by drastically reducing greenhouse gas emissions. A vital contribution to this can be increasing resource productivity.

A higher emissions price is an excellent way to trigger such productivity increases. It strengthens companies’ incentives to develop and use low-emission technologies. However, this will not work without support from industrial and innovation policy by the state.

The effect of a higher carbon price is quite simple: The increase in the price for the emission of one ton of CO2 leads to a reduction in the volume of carbon dioxide emissions. (CO2 used here to denote all human-created greenhouse gases that are harmful to the climate.)

Carbon price and decline in production

In the short term, a higher CO2 price reduces the demand for and supply of products and activities containing CO2. Government CO2 pricing means that the companies affected by it, in turn, increase their prices, which consumers then have to pay.

The result is a decline in the quantity demanded for goods containing emissions. The net price that companies receive also falls because they can generally only pass on part of the increased carbon price to consumers.

This causes a reduction in the supply of goods made by those companies. In addition, the production volume of the economy decreases because domestic emission-containing products are less competitive internationally, and therefore exports decrease.

The result is that production, real gross domestic product (GDP), and employment decline in the country that introduces a higher carbon price. On the positive side, the volume of production-related emissions in this country is reduced.

Carbon price and technological progress

The second way companies respond to higher carbon prices is they adapt their production technologies, generating technological advances that increase resource and energy efficiency.

By the term “resources,” I mean natural resources whose use by humans leads to greenhouse gas emissions – i.e., primarily fossil fuels. The terms “resource efficiency” and “resource productivity” also refer to these raw materials. Higher resource productivity makes it possible for a given quantity of goods to be produced with a lower input of resources – and therefore with a lower volume of emissions.

One shortcoming of technological changes, however, is that they take a long time. They require research and development activities as well as investments to adapt production capacities. Technological progress toward lower-emission products and production processes is not a short-term but rather a medium- or long-term consequence of increased CO2 pricing.

Ideally, this means the real GDP of an economy increases. However, the emissions associated with GDP production decrease to a level that is ecologically compatible – ideally, sustainable growth or green growth even occurs.

However, a limiting factor is that technological advances reduce production costs and, so; as a result, market prices. The consequence is a higher demand for emission-containing products – and thus an increase in the volume of emissions.

This phenomenon is known as the rebound effect. Under certain circumstances, it can be so strong that technological progress ultimately leads to a higher volume of emissions, which makes nonsense of the intention of CO2 pricing. In this case, further government intervention would be necessary, e.g., a quantity restriction of the overall economic emission volume (cf. Petersen 2021: 187-200).

Need for industrial and innovation policy support

Companies are the main drivers of technological progress. A higher carbon price provides an incentive for them to take actions that reduce their emissions. Consumers support this incentive through a desire to buy lower-emission products, thereby reducing consumer spending.

Thus, much of the technological progress needed to reduce greenhouse gas emissions can occur through the market and competition if companies and consumers face higher government emissions prices and respond as outlined. However, not all necessary technological innovation will be able to occur entirely without government support.

An active role of the state is necessary, for example, in the so-called basic technologies. These technologies are spreading in many sectors of the economy, becoming better and cheaper over time and facilitating the invention and manufacture of new products.

Examples of such technologies include space travel, nuclear power, and green technologies. Private companies are often unwilling to invest in such technologies because the uncertainties surrounding their commercial success are too great. In addition, the time it takes to reach market maturity and generate profits is too long (cf. Mazzucato 2014: 52, 85, 112).

Basic technologies have positive externalities because they spill over to many other sectors. A positive external effect requires government intervention. Economic actors will not bear all the costs of developing a basic technology without receiving a return for all the societal benefits. If they do not receive compensation, their research and development will activities fall short – measured against the optimal level to achieve emissions’ goals.

In addition, some lower-emission technologies and products are characterized by network effects. For example, the increased use of electric vehicles requires an efficient network of charging stations. Public investment or government subsidies should provide charging infrastructure. (cf. SVR 2020: 264 f.). From a regulatory point of view, this would be justified as these network effects represent a positive external effect that requires state support.

Finally, there is the matter of existing physical infrastructure with a long remaining lifetime and high capital expenditure. Even if there are new technologies with lower emissions, it can make business sense to hold on to the more emissions-intensive infrastructure for many years to come.

Only in this way will the capital used for the investment flow back into the company through annual depreciation. Without government support, the changeover to the lower-emission technology desired by society as a whole will not take place.

Public policies to promote lower-emission technologies

As a consequence of the special features described above, the government should – in addition to introducing or increasing the carbon price – take an active role in the overall economic promotion of low-emission technologies. Various interventions are possible in this regard, e.g.

  • state-funded basic research, primarily to promote the development of new green basic technologies,
  • the payment of subsidies for technologies or production processes with positive externalities,
  • state investments that provide the public infrastructure necessary for the deployment of new green technologies,
  • long-term purchase guarantees by the government for companies that want to introduce innovative climate-friendly technologies and products,
  • the promotion of private innovation activities through innovation-related corporate tax cuts or corresponding write-offs, or
  • a vertical industrial policy with which the state promotes selected industries or sectors that are considered particularly relevant for the ecological transformation of the economy.

Conclusion

A comprehensive ecological transformation of the economy toward low-emission production technologies requires not only a higher carbon price but also government support.

Opinions in science and politics differ as to whether this should be technology-neutral support or whether targeted support for selected technologies makes more sense. If society has a preference for certain technologies based on scientific findings, this argues in favor of an industrial policy that specifically promotes these technologies.

For example, a “Council for Industrial Policy” (cf. Südekum 2020: 15) could be established to allocate state aid and public investment and to select initiatives that the state supports as part of this industrial policy. Based on scientific findings, this council would make recommendations on government technology support and thus provide important impetus for climate protection.

 

Literature

Mazzucato, M. (2014). Das Kapital des Staates: Eine andere Geschichte von Innovation und Wachstum. München.

Petersen, T. (2021). CO2 zum Nulltarif? Warum Treibhausgasemissionen einen Preis haben müssen. Bertelsmann Stiftung (Hrsg.). Gütersloh 2021.

Südekum, J. (2020). Neustart für die Wirtschaft in Deutschland und Europa – Stellungnahme zur öffentlichen Anhörung des Ausschusses für Wirtschaft und Energie des Deutschen Bundestages, Ausschussdrucksache 19(9)628. Düsseldorf.

SVR (Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung) (2020). Corona-Krise gemeinsam bewältigen, Resilienz und Wachstum stärken – Jahresgutachten 2020/21. Wiesbaden.

Note: This blog post appeared first in German on the blog “Inclusive Productivity” on June 11, 2021 (https://inclusive-productivity.de/co2-preis-und-ressourcenproduktivitaet-im-zeichen-des-klimaschutzes/).

 

 

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