Economics of Climate Change—how economics can enable the transition to net zero

We face a number of barriers to reaching net zero. This includes scarce access to finance, slow policy and regulatory coordination, and insufficient adoption of decarbonisation solutions by businesses and consumers. In this article, we reflect on the session chaired by Oxera on the Economics of Climate Change at COP26 on one of the World Leader’s Summit days, to explore how economics can help to remove these barriers, as well as helping to make any net zero transition a fair one.

It was with these words that we concluded our panel discussion on the Economics of Climate Change at COP26 on 2 November. We spoke to investors and representatives of GreenTech start-ups about how economics can provide the toolkit for harnessing the multi-disciplinary skills that can ultimately make decarbonisation possible.¹

Figure 1   Oxera’s panel discussion at COP26

Economics lies at the heart of understanding if—and what—interventions are needed, in the form of policy, market and regulatory measures, to help the world deliver the goal of a net zero future. A number of barriers lie in the way of reaching our climate change targets, and economics can help to address some of the key questions lying in our path to net zero—including the following.

• How do we ensure that green innovations have access to finance?
• How do we enable these innovations to reach, and be adopted by, businesses and consumers?
• How do we establish a just transition towards a green economy?
• How do we coordinate policy and regulation to assist in these areas of finance, uptake and fairness?

The idea of policy and regulatory coordination is crucial as it is linked to all the other questions. During our session, our live poll highlighted this as the largest barrier to reaching net zero.² In this article, we discuss some of the key themes and takeaways from the event.

Ensuring that adequate financing is available

Our panel included the founders of five GreenTech start-ups, with the proposed solutions ranging from worldwide geo-mapping of climate risk exposure to land and buildings, to developing a battery that does not need to be recharged for decades. Our panel demonstrated that there is no shortage of ideas to tackle the problem of climate change. These ideas, however, need financial backing—as access to finance can remain a key barrier in developing these ideas, as well as achieving commercial deployment and economies of scale.

We previously highlighted the upward trend in environmental, social and governance (ESG) funds, with the potential for them to outnumber their conventional counterparts by 2025.³ This is an encouraging trend in assessing the prospective adequacy of capital for investments in sustainability and highlights the changing preference of investors, accepting potentially different risk–return trade-offs. This trend was re-emphasised as part of our panel discussion by Michael Naylor, Chairman of Jupiter Green Investment Trust, who highlighted just how much the green investment landscape has changed in the last few decades. Currently, investors are more ready to invest in GreenTech start-ups, which Michael Naylor refers to as ‘innovators and accelerators’, which would previously have been considered to be much higher risk.

Policy and regulation can help to enable private investment in a number of ways—this support can be monetary and non-monetary in nature. Governments can help by directly funding research initiatives, for example, through the provision of grants. They can also help to signal support for certain technologies to the private sector, which can subsequently encourage private investment: in particular, the provision of stable policy and regulatory frameworks can facilitate investment by the private sector. Also, as noted above, the support of GreenTech does not necessarily need to be monetary in nature. As one example, policies can be designed in such a way as to discourage private investment in more polluting alternatives. For example, this type of policy can be seen in the UK’s ban on the sale of conventional diesel and petrol vehicles by 2030.⁴

Another factor that can help to boost the level of financing is the plugging of information gaps. A lack of information, or misleading information, can lead to mispricing of risk and inefficient allocation of investment expenditure. Some of our panellists are working on solutions that would improve the quality of information available. Cervest’s main product, EarthScan^TM, aims to measure climate risk, such as the risk of flooding, at an asset level—be it a multi-national hotel or a garage. By breaking down this risk to such a granular level and communicating it in a clear way to decision-makers, Cervest aims to empower users to make more informed decisions and invest in solutions to better manage the climate risk that they face.

Sylvera, which provides objective quality ratings on offset projects, is also aiming to close an information gap. Its intention is to increase the level of trust in the offset market with its quality ratings. Sam Gill, co-founder and COO of Sylvera, highlighted that more trust means that people are ready to pay more for quality offsets, which can ultimately translate into better quality offset projects being delivered. As a result, more businesses and governments can look to rely on the offset market without a fear of being labelled as greenwashing. The provision of better information about the varying quality of offset projects can facilitate the green transition by shifting capital towards the higher-quality projects.

Ensuring that adequate uptake is reached

Delayed uptake of innovative technologies is another major barrier that innovations can face for their benefits to be fully realised. In our panel discussion, we explored options for educating stakeholders, managing uptake through pricing decisions, and using policy and regulation as further potential ways to facilitate the uptake.

Educating stakeholders means disseminating the message that the product exists, and clearly showing its environmental benefits. As an example, in Oxera’s panel discussion we heard from Phill Davis, co-founder and commercial director of Magway, a company that is developing a low-carbon freight delivery system, and is focusing on educating potential investors about the benefits that their product could have. For example, they are creating a ‘digital twin’ of their product that allows investors to visualise the network before investing. They are also rolling out a 16km prototype to show the benefits and efficiency of their system.

An appropriate pricing of innovative products is another way to incentivise businesses and consumers to adopt technologies. Infinite Power, which is developing a battery that does not need to be recharged for decades, are aware of the importance of the price point of their product and how it would compare to more conventional energy sources. Ultimately, having a cheaper product would encourage uptake both among environmentally conscious users (who might even be willing to pay a premium for green solutions) and among those who need the cheapest solution possible.

Finally, policy and regulation can play a multi-faceted role in the uptake of decarbonisation technologies. An obvious example is implementing subsidies for new technology to encourage initial take-up at an early stage in the product lifecycle to help generate scale benefits to eventually compete with old technology. This will help in cases where newer technology is originally more expensive than older technologies (as the new technology may get cheaper as uptake increases), to provide a financial incentive for the consumer to choose the greener option.

Alternatively, policymakers can nudge or even require consumers to make greener and healthier choices. A nudge is an intervention designed to change the way people are presented with choices without restricting choices. This can be operationalised by either making the desired choice (i.e. the greener choice) more attractive, or making the undesired choice (i.e. the more polluting choice) less attractive. For example, adding a meter to houses to show real-time energy use would make the consumer more aware of the cost of their energy use, and they may choose to reduce energy consumption as a result. Alternatively, limiting the amount of free car parks makes the use of private transport less attractive.⁵ Governments and policymakers can also go one step further by requiring a certain behaviour. For example, the UK ban on new conventional petrol and diesel cars will send a clear signal to businesses and consumers that they should buy electric.

Ensuring a just transition

In our panel discussion, we considered how climate change can produce winners and losers across a wide range of different dimensions. Certain jobs will be phased out, but others created. Economics provides a toolkit to help us assess the challenging trade-offs we will face in meeting the global targets we have committed to.

In a previous Agenda article,⁶ we discussed how policymakers can ensure a just transition, detailing the impact that the green transition could have on the number of jobs. Analysis by the European Commission showed that this transition should not result in net job losses because, on average, renewables activities are more labour-intensive than their fossil-fuel counterparts.⁷

Loss of jobs is one of the dimensions to consider in designing a just transition, but others also exist—for example, some communities are more vulnerable to the increased risk of natural disasters and extreme weather events that occur due to climate change.

Simply Blue Group are trying to promote coastal revival, as they view coastal communities as one of the worst-hit communities. They see an opportunity to promote sustainable economic growth in coastal communities, by channelling investment in different solutions such as floating wind, wave power and sustainable agriculture, all ready for investment. This will require reskilling of labour, as well as reallocation of capital, which can be a long process but which ultimately can have a number of additional knock-on effects, such as a potential rise in blue tourism due to increased biodiversity.

In Oxera’s panel discussion, we considered that another mechanism to support the delivery of a just transition is the choice of product pricing models. As an example, by using a freemium model, Cervest will be offering some level of its EarthScan^TM service on a free basis, for all users. By allowing the product to be free, it ensures that the most vulnerable communities can also access and act on this critical information.

Although market-driven solutions can contribute to achieving the just transition, it is uncertain whether it is possible without governmental support. Well-designed policy and regulation is critical to ensure the transition is fair. This is a multi-faceted problem. For example, the implementation of a carbon tax would need to be carefully designed in order not to be regressive, as we previously discussed in an earlier article.⁸ In terms of apportioning funds, governments of richer countries must also decide if and how to subsidise the green transition of poorer countries, due to the global nature of climate change.⁹

The role of economics

In this article, we have reflected on Oxera’s panel discussion at COP26 on the Economics of Climate Change, to highlight a number of the key barriers to reaching net zero. Innovations need to be financed, with private and public sources becoming more widely available. Consumers and businesses have to adapt to the use of decarbonisation technologies for their benefits to be realised. On top of everything, the green transition must be delivered in a way that is seen to be just. At all stages, policy and regulatory coordination is a driving force. Economics provides the practical toolkit to tackle barriers in the delivery of the green transition. As a study of trade-offs, it is at the heart of understanding and designing the interventions that are needed to reach net zero in the form of policy, market and regulatory design, and reform.

¹ Our panel, chaired by Oxera Partners Jostein Kristensen and Sahar Shamsi, CFA, consisted of: Iggy Bassi, Founder and CEO, Cervest; Sam Gill, Co-founder and COO, Sylvera; Steve Whitehead, Founder and COO, Infinite Power Company; Michael Naylor, Chairman, Jupiter Green Investment Trust; Sam Roch-Perks, Co-Founder and Managing Director, Simply Blue Group; and Phill Davies, Co-Founder and Commercial Director, Magway.

² At the time of writing, on 11 November 2021, nearly 60% of respondents saw ‘Slow regulatory and policy coordination’ as the largest barrier to achieving net zero, while 28% saw ‘insufficient adoption of solutions by consumers and businesses’ as the biggest barrier. On the other hand, just 6% of respondents viewed each of ‘scarce access to finance’ and ‘lack of innovative solutions’ as the largest barriers.

³ Kristensen, J., Shamsi, S. and Duffy, J. (2021), ‘The economics of climate change: a signal in the noise’, Agenda, 21 February.

⁴ See Department for Transport (2020), ‘Government takes historic step towards net-zero with end of sale of new petrol and diesel cars by 2030’, 18 November.

⁵ We discuss behavioural economics and the form these nudges can take in more detail in an earlier Agenda article. See Hogg, T. and Fields, L. (2021), ‘Working from home: shove or nudge?’, Agenda, 8 April.

⁶ Slomka, M., Kristensen, J. and Shamsi, S., (2021) ‘How do policymakers make the climate transition just?’, Agenda, 28 September.

⁷ European Commission (2018), ‘A technical analysis on decarbonisation scenarios – constraints, economic implications and policies’, p. 24.

⁸ As we previously discussed, if governments charge a per-unit carbon tax to all consumers, it would mean that wealthy and less wealthy consumers pay the same amount per unit of goods purchased. For the less wealthy consumer, this tax would take up a larger proportion of their income, making it regressive. See Slomka, M., Kristensen, J. and Shamsi, S., (2021) ‘How do policymakers make the climate transition just?’, Agenda, 28 September.

⁹ This issue was also discussed in a recent Oxera podcast featuring Dr Luis Correia da Silva, Sir Philip Lowe, Jostein Kristensen and Sahar Shamsi, CFA (released 29 October 2021), available here: https://www.oxera.com/insights/agenda/articles/the-economics-of-climate-change/ (last accessed 11 November 2021).