European climate-neutral industry: new requirements for the member states’ governance

In the recently announced targets for reaching carbon neutrality by the mid-century, most developed countries (representing about 80 percent of the global economy), revealed a comprehensive set of new political economy’s instruments, often called “green industrial strategy”, to trigger the necessary mechanisms within both the zero-carbon energy sources and production across all development sectors. Embarking on this priority, the EU states are to redesign their political-economy’s guidance while learning from the existing best examples, as well as exchanging knowledge and experience on the paths to industrial carbon neutrality.

Modern post-pandemic national socio-economic perspectives are fool of complicated challenges and solutions for contemporary governance system, including, e.g. inclusive growth, productivity and competitiveness, environmental sustainability, digital and climate change transitions, etc. 

Several European states have already visualized changes in national political economies; thus, the Netherlands’ government adopted a series of policy instruments to reach carbon neutrality in the country’s manufacturing sector by 2050, which included a combination of increasing carbon prices coped with innovation and technology support, leading to trade-offs between short-term emissions cuts and longer-term technology shifts.

The country’s carbon levy sets an ambitious price trajectory to 2030, but is tempered by extensive preferential treatment to energy-intensive users, yielding a highly unequal carbon price across firms and sectors. The country’s technology support focuses on the cost-effective deployment of low-carbon options, which ensures least-cost decarbonisation in the short run but favors relatively mature technologies.

The Netherlands experience shows policy adjustments to reach the country’s carbon neutrality objective, including the gradual removal of exemptions, enhanced support for emerging technologies and greater visibility over future infrastructure plans.

More in: https://www.oecd-ilibrary.org/science-and-technology/policies-for-a-climate-neutral-industry_a3a1f953-en

 

Science and innovation for a modern industrial policy   

The following science, research and innovation efforts shall be included in the new political-economy’s planning in the EU member states:   

 = The EU/global strategies towards carbon neutrality: an ambitious climate agenda for the Netherlands could serve as a positive example for other EU states and many OECD and non-OECD countries. It is appeared that reaching carbon neutrality requires ambitious policies and the need for a renewed “green industrial policy”: industry’s carbon neutrality will rely on a diverse portfolio of national science and technologies. Ultimately, current decarbonisation strategy will revolve around carbon pricing and technology/innovative support.  

= Specific approach to carbon and electricity pricing can be a plausible solution with a clear carbon price trajectory, tempered by overlapping competitiveness provisions and uneven rates across firms and sectors. The effective carbon rate can serve as a synthetic indicator of carbon pricing in the EU member states with a price signal on electricity use.  

= Innovation and effective transitional (digital and climate) policies shall include effective trade-offs between short-term cost efficiency and long-term decarbonisation aspects.  

= Some complementary policies and frameworks shall be considered too, including pollution standards and other regulatory instruments, infrastructure policies and “business dynamism” with a due attention to the necessary skills for the green economy. Venture capital shall assist the national path to green growth and resilience.   

More in: https://www.oecd-ilibrary.org/docserver/a3a1f953-en.pdf?expires=1619625057&id=id&accname=guest&checksum=742CE1837D676A01CFB036319E1442EB

 

The Netherland’s example

The Netherland’s parliament passed a new Climate Act in May 2019 aimed at reducing domestic greenhouse gas emissions by 49 percent by 2030 compared to 1990 levels, and by 95 percent by 2050. The National Climate Agreement, adopted in June 2019, translates the national 2030 target into sectoral objectives; e.g. the Dutch industrial sector has to reduce its emissions by 14.3 megaton’s of CO2 equivalent (Mteq CO2) by 2030 compared to a baseline scenario, a reduction of about 59 percent compared to 1990.

In addition, the EU institutions have been “pushing” the Netherlands towards raising its 2030 emission reduction target from 40 to 55 percent; the EU has collectively adopted a more ambitious target in December 2020 and the Netherlands is considering how best to adapt its reduction goals. At the 2050 horizon, the Climate Agreement calls for a carbon-neutral industry: “by 2050, the country is expected to have a thriving, circular and globally leading manufacturing industry with an almost zero greenhouse gas emissions”.

Following the national climate agreement and in order to accelerate and support the decarbonisation of industry, the Dutch government has already introduced new policy instruments: e.g. a carbon levy and enhanced subsidy programs such as the Sustainable Energy Transition Incentive Scheme (SDE++) on top of a number of existing policy instruments.

Besides, an increasing number of the EU states have already announced or are currently in the process of adopting or discussing climate neutrality targets: almost all of them are aimed at the 2050-zero horizon. The European Parliament is notably examining how the European Climate Law would enact a legally binding target of carbon-neutrality in 2050 in the context of the European Green Deal.

 

Policy’s main objectives

The national project “Sustainable transition of the Dutch industry” has the main objective to evaluate the consistency and cost-effectiveness of the set of new policy instruments to reach its 2050 decarbonisation objectives in the manufacturing sector, and to offer recommendations on adjustments of existing policy instruments and further measures.

The Dutch climate policy package offers a number of lessons for other states seeking carbon neutrality and illustrates the advantages of approaches that combine a strong commitment to both raising carbon prices and following technology support: these two pillars are mutually reinforcing showing a positive trajectory of increasing carbon prices which helps businesses to invest in low-carbon technologies. At the same time, the Dutch experience demonstrates the pervasiveness of competitiveness provisions and the trade-off between short-term emissions cuts and longer-term technology shifts.

The first pillar of the Netherlands’ approach, the carbon pricing signal, includes a carbon levy on industrial emissions that sets an ambitious price trajectory to 2030 and provides a strong incentive to encourage low-carbon investment in industry. It is designed so that the additional carbon price kicks in gradually, thus avoiding immediately burdening businesses with new taxes. However, the overall carbon price signal is tempered by provisions that grant extensive preferential treatment to energy-intensive users, including in the form of energy tax exemptions, lower tax rates for large energy consumers, and freely allocated carbon emissions allowances. This yields a highly heterogeneous effective carbon price across industrial sectors in 2021 (min. € 3-7 per ton in basic metals and refineries respectively), and as high as € 76 per ton for the food processing sector, with small firms typically facing much higher energy and carbon prices.

The government analysis acknowledges that “economic inefficiency and horizontal equity concerns arising from this uneven price signal call for broadening tax bases and gradually removing exemptions and preferential rates”.

 

The second pillar of the Netherlands’ decarbonisation strategy aims at supporting the uptake of low carbon technologies, focusing on the cost-effective deployment of both mature (e.g. renewable electricity) and radically new technologies (e.g. hydrogen) through subsidy programs and corporate tax incentives.

The national main instrument is in the Sustainable Energy Transition Incentive Scheme (SDE++), which subsidises the additional costs associated with adopting a low-carbon technology. The instrument is allocated to applicants in increasing order of subsidy requirement per ton of CO2 reduction in a tender open to new technologies and is funded through a surcharge on electricity and gas use. However, the surcharge provides generous exemptions for key sectors and lower rates for energy-intensive users. These features imply that small firms may disproportionately contribute to funding the SDE++ scheme: while the allocation design is economically efficient and ensures least-cost decarbonisation in the short run, it favors technologies that are close to the market at the expense of more radical alternatives that are still at an earlier stage of development, e.g. “green” hydrogen.

The Netherlands supports research and innovation mostly through broad tax credits and the “innovation program”; both are technology neutral though benefit mostly market-oriented technologies. Thus, the Dutch technology support policy package reveals a balanced approach that supports both emerging and mature technologies: options include holding separate tenders across technology readiness level for deployment instruments, and combining horizontal targeted research support for emerging technologies.

 

Structural transformations

The global community has acknowledged that reaching carbon neutrality by 2050 would require major structural transformations towards the use of green emerging technologies in most countries. In particular, carbon neutrality in industry entails a complete change towards zero-carbon energy sources, and more generally a shift away from fossil feedstock.

However, large investments are needed to adopt existing or close-to-the-market low carbon technologies, as well as emerging technologies, such as Carbon Capture and Storage (CCS), electrification, green hydrogen and bio-based materials, have to be developed and demonstrated. This requires bringing down the costs and improving the productivity of existing clean technologies, and developing new breakthrough technologies.

National governance shall be oriented towards increasing these investments on the grounds of at least two well-known market failures that hinder decarbonisation. First, carbon emissions constitute an environmental externality, as the costs of the environmental damage from carbon-based production processes are borne by society as a whole rather than internalised by emitting firms. If not “internalizing” the full cost that emissions entail for society, it would lead business to under-invest in low-carbon products, in assets and in production processes.

Second, technological change, which allows reducing the cost of emission abatement over time, is subject to knowledge spillovers at both local and global levels, as firms investing in or implementing a new technology create benefits for others while incurring all costs.

These market failures imply that the market produces too many emissions and too little technology innovation related to decarbonisation.

Example: the Danish government proposal in energy efficiency suggested funding for the “green renovation” to social housing up to 2026 with about $5 bn; the project includes such measures as insulation, new energy-efficient doors and windows, as well as replacement of oil-fired heating, to name a few. Source:  

https://www.carbonbrief.org/coronavirus-tracking-how-the-worlds-green-recovery-plans-aim-to-cut-emissions?utm_campaign=Carbon%20Brief%20Weekly%20Briefing&utm_content=20210521&utm_medium=email&utm_source=Revue%20Weekly

 

Well-known imperfections in capital markets make the financing of “green research and development” difficult, particularly for radical or disruptive innovation, which may require public financing, for instance through direct or indirect government-sponsored venture capital. Large investments to decarbonise the industry sometimes also require coordination between private stakeholders, and with public stakeholders, because of the existence of network effects: e.g. some carbon-free sources of energy require large infrastructure deployment (like that of hydrogen) with further examples of market failures requiring public intervention, like high upfront costs, imperfect competition in energy markets, behavioral gaps and regulatory barriers, to name a few.

Public policies should encourage a cost-effective transition to carbon-neutral technologies and to preserve productivity: efficient policies would limit the number of losers and make the transition more acceptable. Besides, such policies should limit the impact of the transition in the short run on local firms’ competitiveness, while not compromising incentive for decarbonisation in the long run. A loss of competitiveness in the short run could not only affect economic prospects; the lack of mechanisms to penalize carbon-intensive imports would lessen the efficiency of the low-carbon transition by exporting emissions rather than reducing them (so-called “carbon leakage”). On the other hand, shielding carbon-intensive production from decarbonisation incentives would harm the long-run competitiveness of national economy by slowing down the carbon-neural transition in industry, thereby leading to stranded assets and jobs.

 

Complex set of policy’s objectives

Carefully designed national political-economy’s strategies are required relying on a consistent and articulated set of adequate instruments, corresponding to the climate-neutral transition.

The governance’s objective shall be oriented to foster the development of a de-carbonized growth and to re-direct innovation efforts from a traditional “dirty” to clean technologies (often called “green industrial policy”.

 

The latter generally consists of three main components:

  1. new and “transforming” industrial and manufacturing sectors which are only supporting deployment of new technologies and innovation (so-called green technologies); in this regard, using carbon pricing could be an important component of a green transition bringing down a relative initial cost of green technologies.
  2. A so-called “transforming society” to induce changes in producers’ and consumers’ behavior, in changing workforce-skills and enabling structural change. For this purpose, strong carbon pricing signals are required to drive behavioral changes, including investment in low-carbon technologies, as well as high-quality framework conditions to allow for an efficient and smooth reallocation of workers and capital.
  3. A policy-coordination at the European and global level as a key component in “green industrial policies” to develop technologies, infrastructures and standards needed for “green transition” Such coordination at the international level is important due to climate changes as a vital global challenge. Besides, transformation of global good-services’ markets and value chains would lead to closer interconnection of national economies, and would result in increased competitiveness.

 

Innovation policy and technology-support combined with strong carbon pricing signals and behavioral changes are thus main features in a modernized and future-oriented national “green industrial policy”. Therefore,  carbon pricing, innovation policy and technology support shall be mutually reinforcing: technology-specific support shall assist a stronger carbon pricing in the future (by lowering the cost of future green technologies), while strong future carbon prices ensure a demand for new low-carbon technologies developed due to technology-specific national governance’s support.

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