Challenging the accepted wisdom: why economics isn’t ‘up to the job’ of tackling climate change

Finance leaders are key to the economic and governmental changes required to reach net zero – but the Global Government Finance Summit heard fears that they have not yet understood the flaws in their models or the challenge they face

“This is the number one topic – not only in this conference but in public policymaking, and for this and the next generation,” said Jakob Wegener Friis. Speaking to fellow finance and economics leaders at the Global Government Finance Summit, Friis – who is deputy head of cabinet for the European Commissioner for Economy, Paolo Gentiloni – was referring to the topic of the first daytime session: ‘The path to sustainable growth: finance departments and the climate crisis’.

Asked by event facilitator Siobhan Benita why countries are not moving more quickly to curb carbon emissions, Friis cited ‘conventional wisdom’: economist John Kenneth Galbraith’s term for ideas seen as self-evident during a particular period of history. “I think there’s a lot of conventional wisdom in terms of what you can and cannot do in public policymaking,” he said: even civil servants and elected leaders who recognise the scale and immediacy of the threat doubt their ability to move at the pace required.

Inherent in the notion of conventional wisdom is the idea that it will, ultimately, become outmoded: rendered redundant as the situation changes. “As Galbraith stated, the answer to conventional wisdom is not a new theory: it’s events,” Friis commented. “And events are unfolding. I think that we are somewhat behind the curve.”

A ‘make or break moment’

For countries on the climate change frontline, this is already obvious. More than 75% of respondents to a survey carried out in 16 African countries reported personally experiencing the effects of climate change, said Ahmed Reda Chami, president of Morocco’s Economic, Social and Environmental Council. Noureddine Bensouda, general treasurer of the Kingdom of Morocco – currently in the grip of its worst drought in 40 years – argued passionately that sustainability “is not just an option, or a fashionable phenomenon. It represents nothing other than our very ability to survive in future”. The world is, he said, “at a make or break moment. We are no longer looking at if, but at how we can best achieve a just transition to a sustainable economy that leaves nobody behind”.

Just across the Mediterranean, Spain is also feeling the heat. “According to the data the Spanish government holds, climate change is impacting us already, with droughts, floods; it’s impacting our economy,” said the Spanish delegate, a senior advisor to Spain’s secretary of state for finance. To help tackle the problem the government has introduced new taxes, including levies on non-reusable plastic packaging and on waste sent for landfill or incineration.

However, efforts to address the problem have been slowed by more immediate crises: “In the last three years, we’ve been suffering unexpected events – COVID-19 and the Ukraine war – and worrying about how to tackle the pandemic and protect our economy,” she commented. With those threats waning, now “it’s a priority for the Spanish government to think in the long-term and to tackle climate change”.

Some major players are now moving quickly. The USA’s Inflation Reduction Act programme is ploughing hundreds of billions into green energy; meanwhile the European Commission (EC) has, said Friis, established “the European Green Deal as the number one policy for Europe for this five-year period”. Its goal is to achieve net zero by 2050, with a 55% cut from 1990 emissions levels by 2030; and it’s backed by €800bn (US$875bn) of support to help countries decarbonise their economies. The EU is promoting carbon pricing as a key policy tool here, Friis added, but “I would not blame different jurisdictions for deploying different tools”. What matters is that everybody moves forward; and that there’s transparency over methodology and metrics, enabling people to compare performance across different jurisdictions.

The EC is, for example, developing a Carbon Border Adjustment Mechanism: essentially an import levy on the embodied carbon of carbon-intensive goods entering the EU. “To do that, we need a lot of data,” said Friis. “But we also need some sense that other jurisdictions can show that they have policies that are equivalent” – enabling EC administrators to determine the appropriate level of tax for each import.

Sustainable accounting

Meanwhile, EU member states are improving their understanding of their own greenhouse gas emissions. “We now have to publish a carbon budgeting document each year to try and assess the carbon impact of each Budget,” explained John McCarthy, chief economist of Ireland’s Department of Finance. As Friis noted, governments need to know “how public finances and budgetary policies are benefiting – or not – the green transition”; the EU is helping here with guidelines and technical assistance.

Steve Barr, an industry digital strategist with Microsoft Worldwide Public Sector, warned of a “lack of skills and capability” in this field. Many governments “create the policies, but they don’t have the capability to implement them,” he said. “They don’t know where the data is or how to collect it. There should be more investment in the people to implement these changes”.

Certainly, some carbon-reduction policies require complex metrics, accounting structures and analytical capabilities. That’s not always the case: Ireland’s carbon tax, for example, is a straightforward market mechanism. A steadily-rising emissions charge on energy bills, it incentivises a shift to greener power while raising money to tackle fuel poverty and fund the zero carbon transition. “Finance ministries don’t like hypothecation,” commented McCarthy. “But we think by ring-fencing the revenues, we’re getting more buy-in.”

Other policies, though, are more demanding. Valentina Ion, Microsoft’s director of public finance industry, highlighted “tokenisation”: a mechanism for “connecting those who are emitting carbon with those who are capturing carbon and making the world greener”. So farmers who introduce policies that absorb carbon, for example, can receive payments from carbon-emitting businesses – incentivising both sides to invest in greener practices.

To understand their own emissions, Ion explained, public bodies need to look right down through their supply chains: “How are your suppliers contributing, and how are they themselves applying greener criteria in their own selection of suppliers?” Effective, standardised metrics are also required in the green finance sector, she added; and there’s a need to identify fraud and “greenwashing” in the claims companies make about their own environmental credentials. “We see fraud in every industry,” she commented.

The power of information

‘Internet of things’ technologies can help here, said Ion – providing accurate, real-time data flows that free organisations from the need to depend on estimates and declarations. This information can also provide a detailed picture of how different behaviours and policy decisions shape emissions, informing decision-making on investments and service provision. “You can understand who’s emitting carbon, how it evolves through the day, and what drives that behaviour,” she said. “Then you can understand if differential taxation is required, or what infrastructure should be put in place.”

Microsoft is developing open services to assist public servants with these issues, Ion explained: its “planetary computer” brings together data on land use, carbon emissions and other topics, offering organisations live data feeds via APIs. The development of quantum computing will provide the analytical power required to process the vast quantities of data available, while cloud offers the capacity to hold and store it – and to do so in a greener way. By minimising redundant capacity and centralising computing processes in renewables-powered cloud centres, Ion explain, cloud systems offer big emissions savings relative to on-premises capacity.

So there are routes through these challenges around carbon metrics and accounting. The shift from carbon-based wealth creation to a sustainable future, though, presents more substantive obstacles. “I don’t think we have the toolkit yet in finance ministries to understand the economic impact,” said McCarthy. “Probably it will be relatively small in aggregate terms, but very big in some sectors.” Governments will have to focus on supporting carbon-intensive industries and workforces to transition to a greener world, he commented.

Retargeting taxation

The transition will also place new burdens on public finances, said McCarthy, while whittling away at existing revenue streams: “Fossil fuels are quite tax-rich,” he pointed out: fuel duty revenues, for example are set to fall with the transition to electric vehicles (EVs).

Israel faces this challenge, commented Merav Kaplan, chief of staff at the Office of the Chief Economist in Israel’s Ministry of Finance. “We have a high tax on purchasing cars, and also on the use of fuel. We provided a tax discount of around 90% on the purchasing of electric cars,” she explained. “Now we are facing a trade-off between our desire to support climate goals on the one hand, and on the other hand the resilience of the tax system.”

The ministry has explored road user pricing, she said; but charging a flat fee per kilometre driven fails to target the problem of urban congestion, while systems that track location as well as distance have hit concerns over privacy. “We hope that we’ll find a technological solution – but it highlights the tension that exists between climate goals and the tax system,” she commented.

Funding the shift to net zero is particularly difficult for poorer nations, which face impossible choices between supressing carbon emissions and raising living standards. Morocco’s carbon reduction plan aims to cut emissions by 42% by 2030, said Bensouda, but it’s costed at US$50bn. “This massive funding cannot be met by public finance alone,” he said. The private sector must also contribute, and “it’s essential that the industrialised countries – the main polluters – provide sufficient support to assist developing nations to leapfrog the traditional development pathways”.

Must we accept accepted wisdom?

In middle income countries, public awareness of the problem is growing – but here too climate change struggles to compete with the pressing need for economic development. “Fiscal is a land of restrictions,” said Raúl Enrique Rigo, secretary of the National Treasury of Argentina. “Resources are limited, and we have to think about priorities all the time, because we cannot finance all the needs and demands of society.”

Where government does invest in action on climate change, said Rigo, it must both explain clearly how spending will address the problem, and demonstrate that its work is proving effective. “That connection has to be clear for everyone – for the politicians, the public, Congress,” he said. “If that connection happens to be blurred, uneasiness might flood in.”

Such concerns are widespread among finance department leaders, whose primary responsibilities are to avoid public finance deficits and ensure efficiency in the use of public money. But against the costs of investing in the shift to net zero should be set the costs of not doing so: runaway climate change would soon prove far more expensive than funding measures to avert it.

As Friis pointed out, “we accumulate wealth in the belief that wealth stays around – but a lot of wealth in western Europe is held in the pension funds, which own an awful lot of ‘brown’ capital”. These investments in ‘brown’ carbon-intensive industries may not hold their value as countries seek to decarbonise. “In the new world of permanently higher energy prices and all of those climate externalities, it may be that the rate of depreciation for that capital should be a lot higher than that set out in our current frameworks,” he commented.

These issues, however, are not fully recognised under economic models built around the conventional wisdom. “I’m not sure that our profession of economics and its founding ideas are really up to the job: factoring in the end of the physical world is not part of what we do,” concluded Friis. “We are talking about scarcity of resources, and how we exploit scarce resources to generate income, which accumulates in wealth. But what if the externalities are so overwhelming that it leads to a turning point in terms of climate change? You know, I don’t think the profession is necessarily up to the job.”

This is the second report on the Global Government Finance Summit held in Rabat, Morocco in June 2023, covering the session on how finance departments can support the drive for net zero. The first report covered Irish finance department chief economist John McCarthy’s analysis of his country’s economic strengths and weaknesses. Further reports will be published here soon.

To ensure that participants feel able to speak freely at the Summit, we give all those quoted the right to anonymise, edit or delete their comments before publication.