Industrial strategy is big news. America’s Inflation Reduction Act (IRA), a gigantic subsidy and investment programme to turbocharge green industries in the world’s richest economy, dominates the business pages of newspapers. IRA is itself a reaction to China’s similarly ambitious Made in China 2025 programme, which includes a substantial green element. The EU has responded with its own Green Industry Plan. Pressure is mounting on the UK to follow suit. But why is industrial strategy being handed a pivotal role in tackling climate change?
There are two main reasons. First, because UK industry itself – particularly heavy manufacturing – is a major consumer of energy and, therefore, a big contributor to greenhouse gases. This has to change.
Second, industrial strategy has a role in shifting incentives towards more sustainable economic activities; for example, by encouraging people to buy electric cars and encouraging firms to develop greener technologies.
It will make us greener and richer
As I argue in my new book, published last week, this is not something that can be left to the market. Good policy can make a big difference. Since there is a particular problem of outcome uncertainty with green projects, the government can have an important strategic role in creating incentives and setting the lead for private sector investment. The practicality of carbon taxes, for example, depends on the future availability of alternative fuels to switch to. But developing these fuels depends on making the necessary investment now.
This is where a green industrial strategy comes in. Intervention allows current governments to influence the future actions of the private sector by building markets and supply chains in renewables with long lead times. Done well, it could make us greener and richer.
Let’s take the first task, greening industry itself. A major challenge for hitting net zero is the decarbonisation of factories and supply chains built around the consumption of fossil fuels. These industries account for around 16 per cent of the UK’s greenhouse gas emissions. The asset specificity of many of them makes reconfiguring along more sustainable lines expensive and difficult. Investors are wary of writing off sunk costs. And the workers need assurances they will be retrained for new opportunities.
Carbon pricing is the main incentive
Decarbonisation revolves around addressing practical barriers, mitigating ‘carbon leakage’ risks (where the emissions will simply be moved elsewhere) and using the state to kickstart large infrastructure projects. Subsidies and tax, and regulatory incentives, can be deployed to improve energy efficiency and support the retrofit of industries and supply chains. For new investments, carbon pricing is the main incentive for investors to back cleaner technologies.
Serious policy attention will also be needed to develop a regulatory and tax framework, and guidelines should be drawn up for state aid for strategic but polluting industries, like steel.
The second challenge is to create incentives for new, greener technologies. Conventional industrial strategies are often deployed to raise productivity by encouraging firms to invest in new technologies to shift into higher value markets. A green industrial strategy would use a similar rationale, albeit with the aim of getting firms to develop and bring new green products and technologies to market.
As these technologies would be valuable and exportable, a green industrial strategy could turn the UK into a science superpower. It could help us not only counter, but exploit, the important technology spillovers from IRA and the like.
Green innovation needs policy support
On the demand side, a stable and predictable price for green energy is a prerequisite for the market certainty energy companies need to invest in low emission technologies. It is already being done through long term contracts (feed-in tariffs) for utility companies, giving them confidence to invest.
This has proven effective in developing technology for wind power generation, which is now among the cheapest (and greenest) sources of energy. It could be deployed in other sectors as well, such as hydrogen.
Another potentially powerful measure on the demand side is government procurement, used to set the agenda and create new markets for green fuels and technologies. Public buildings and offices could be instructed to switch to clean energy suppliers, as could the private sector recipients of government contracts.
Industrial policies work on the supply side as well, operating directly on producer incentives by altering the cost structures they face in the market. Examples include imposing a carbon cap on manufacturers to limit their greenhouse gas emissions or banning the production of vehicles with engines powered by fossil fuels (as the government has done, from 2030, with some in the Labour Party calling for this to be earlier).
Positive inducements can work alongside, by directly subsidising R&D or the development of supply chains for renewables, for example. Stalled attempts to develop battery plants to support electric vehicle production in the UK show how complex, costly supply chains, dependent on an uncertain final market, are prone to co-ordination problems in the private sector, making state intervention a necessity. Unfortunately, the government has been slow to grasp the nettle on early intervention in organisationally complex sectors like electric vehicles. JLR’s decision to build its flagship battery factory in the UK is welcome, but it comes after a long period of uncertainty amid other cancelled projects like Britishvolt.
Investment should be targeted at economic and strategic priorities
To avoid similar disasters, the government should identify those parts of the clean energy supply chain of strategic or economic interest that should be domestic and target investment at them, or provide access to inexpensive private capital for firms that can help to build up the supply chain.
Advanced manufacturing tax credits, grants and other funding being issued by the US Department of Energy are an example of this. There could be more specific R&D tax credits for research into renewable technologies and support in the form of development contracts for private firms seeking to take them to market.
For all this to work, policy must be stable, predictable and committed. UK industrial strategies too often fail because decisions chop and change according to political whim, undermining business confidence. The climate emergency demands action now and is too important not to engender a robust and decisive response.