Is green growth sub-optimal growth?

Paul Johnson is the much-admired Director of the Institute of Fiscal Studies, noted for its analysis of UK tax and spend policies. On 24 June 2024, the IFS published an analysis of the commitments made by different parties for the UK General Election. Speaking at the launch, Paul Johnson said:

‘If you had £5 billion a year to put into the most growth-friendly policy, it is unlikely that green investment is what you’d choose. This might or might not be the right priority, but it is not the same priority as growth.’

This statement made me wonder. Does Paul Johnson’s statement stand up, in the UK, or anywhere else? What is the opportunity cost of green growth?

Stephane Hallegatte at the World Bank is a go-to person on this. I re-read his 2012 framework paper with Marianne Fay and others, ‘From Growth to Green Growth’ (here), and found the following.

‘Environmental policies can also increase conventionally measured economic output (GDP) if they

• Increase the effective quantity of production inputs: physical capital, human capital, or environmental capital. The impact of environmental policies on the environmental capital is obvious. But environmental policies can also increase human capital, for instance because better water and air quality improves worker health (Hanna, 2011). They can also increase physical capital, because well-managed natural risks lead to lower capital losses from natural disasters (Hallegatte et al., 2007; Hallegatte, 2011).
• Produce productivity gains by correcting the many market failures affecting the environmental sphere and enhancing efficiency of resource use, thereby reducing production costs and increasing productivity and competitiveness, or playing a stimulus role. Gillingham et al. (2009) shows how green policies targeting energy efficiency can achieve their objectives at negative cost. Zenghelis (2011) proposes the use of green policies as a stimulus in countries in recession.
• Shift the production frontier by accelerating the development and dissemination of innovations,and creating knowledge spillover in the entire economy. Since investments in knowledge tends to be lower than desirable in the absence of public intervention, policies targeting green technologies can usefully increase R&D investments, and therefore economic growth (Gerlagh, 2006; Otto et al., 2008; Fischer and Newell, 2008; Acemoglu et al., 2011).

But they also say:

The previous sections have shown that environmental policies can have costs, in terms of reduced output, consumption or welfare, as well as welfare or income benefits. The net impact will vary depending on the particular policy considered and the context.

So what does Stephane himself have to say about this now? I asked him, and here is his reply.

From Stephane Hallegatte

I would still stand by the theoretical discussion in the 2012 paper, but we have new evidence from a lot of country analyses. There are many more papers on this now, e.g. this review from 2022.

Even if you ignore some of the channels from the 2012 paper, for instance the effect through human capital or the impact on innovation, green policies can increase growth if they shift investments toward high-return capital. The World Bank is now producing Country Climate and Development Reports in all developing countries, to identify how best to achieve development objectives (poverty reduction, economic growth, access to health and education, access to energy, etc.) in the context of climate change. Based on the first 42 countries, covering about half of the population and two third of the GDPGross Domestic Product of developing countries, our CCDR Summary report says:

‘The impact on short-term growth of incremental investments in low-emission development scenarios depends on the economic returns of climate-related investments. GDPGross Domestic Product impacts differ depending on whether returns are lower, similar, or higher than other productive investments. When the returns on climate-related investments are high—as in the case of energy efficiency investments with payback periods of a few years, or low-cost renewable energy—higher investments will lead to higher short-term growth, even if they crowd out other investments. On the other hand, when returns are lower, such as when investing in green steel, where reducing emissions has higher operational costs, redirecting investments toward greener technologies will reduce short-term growth.

The impact on short-term growth also depends on how climate-related investments are financed, and how they impact other investments. Different assumptions on crowding out other investments lead to different results, as illustrated in the case of Türkiye. If climate-related investments crowd out other investments and have low returns, they will have a negative impact on growth. But climate action can also crowd in private investment—for example, when investments in a better, more affordable, or more reliable power system encourages investments in businesses and industries, as discussed in the Sahel, Philippines, and Bangladesh CCDRs—accelerating economic growth.

Overall, the CCDRs find economic growth to be similar or even faster in low-emission development scenarios than in the reference scenarios, when assuming well-designed policies, synergies between structural reforms and a supportive environment (Figure 11). Because low-emission development scenarios systematically require higher investments and lower operational costs, the short-term impact on household consumptions is larger than on GDP. This impact on consumption highlights the importance of how countries mobilize financial resources, with different sources of finance creating different trade-offs, opportunities, and challenges. It also shows importance of appropriate compensation and social interventions to protect poor people’s consumption and facilitate a just transition for the workers and communities affected by climate policies.’

Then, of course, you have to add the innovation argument: climate policies from the last decades have already delivered innovation and progress, with benefits that exceed the GHG emissions they avoid. Already, solar and wind are more productive technologies than fossil fuels, even without counting the effect of fossil fuel on air pollution and health. And already e-bikes and e-buses are cheaper (on a lifecycle basis) than motorbikes and diesel buses. Soon, EV will be cheaper than ICE. These technologies will increase productivity and help provide access to electricity and mobility to billions of people, and they exist because we invested in them. As with other technologies, like computers, vaccines, or planes, the public sector incentivizing more investments in emerging technologies is leading to accelerated productivity growth, and thus more rapid economic growth. This is ignored in the figure above, and most economic models, but will be a key part of the story in the future. 

If we had followed the logic implied by Paul Johnson, we would have focused all our resources and investments on the cheapest existing technologies only, good old diesel engine and coal power plants, and we would never have developed the best technologies we have today. China today dominates the market for EV and batteries, two key technologies for the future, only because it invested in them early. Sometimes, looking into the future does not hurt.

And all of that is without considering the health and climate change benefits of an environmental shift, which will only add to the value of these investments. These impacts are long-term and hard to estimate properly. It does not mean they are not there.