10 THE MACROECONOMICS OF THE GREEN TRANSITION

Bob Hancké, PEACS

7 MARCH 2025

One of the main concerns about the green transition has been its massive cost. Even though the net costs are hard to evaluate ex ante, because we may miss some of them, there is little doubt, as I pointed out a few weeks ago, that we are talking many hundreds of billions of euros, dollars or pounds. While costs are hard to pin down precisely (more details on that in a few weeks), we can approach this question differently, using a balance sheet approach to estimate effects on GDP. Instead of bean counting, in other words, with the risk that some beans fall under the table, we can think of the problem more conceptually.

Let us start with a very important central point on the cost side that many green optimists ignore: we are going to have to spend a lot of money to do essentially the same things that we did before the green transition but without any significant, quantifiable net economic gains, as Jean Pisani-Ferry argued in the Financial Times several months ago (FT 04 Sept 24). We will build electric cars instead of thermal engine-based vehicles to get from A to B, with green energy instead of fossil fuels, and find low-carbon methods to make steel, but we will not increase output – in fact, we will engage in the (necessary) destruction of hitherto well-performing but brown assets.

A very important caveat to this point is that such a summary statement about the bottom line ignores the shadow gains that an important drop in CO2 would produce, and the undoubtedly real but hard-to-estimate benefits that follow from that, such as avoiding the destruction of towns and communities, controlling soaring insurance costs because of global heating, reducing health costs and adapting houses and life in general to a changed climate. What is not included in the costs before the green transition are unaccounted and therefore often treated as unrealised, invisible gains. While that may certainly change if the externalities of climate change are accounted for, for example if the public health benefits of the green transition become clearer, such a world is currently still far away. Until we get there, therefore, and with only a modicum of exaggeration, the green transition imposes a high cost just to stand still. (In the appendix to this week’s essay I discuss the key problems with the line of argument that suggests that an adequate response to climate change requires zero or negative growth.)

This excessive pessimism may be unnecessary, though, because the single most important likely economic bonus of the green transition is a significant public investment boom – cf. IRA, Green New Deal, European Green Deal, etc. – matched by private investment in the short and medium term. Paul Krugman suggested in the New York Times (in August 2023) that one IRA dollar generated two dollars of private investment. This is an important insight, since investment is one of the drivers of both short-term and long-term economic growth.

A simple but powerful way to get to that conclusion and figure out the likely macroeconomic effects that handles both sides of the ledger is to take the standard national accounting identity in which (growth in) national income Y is the sum of (developments in) consumption C, investment I, government spending minus taxes G, and net exports X-M (Y=C+I+G+X-M) and estimate what, ceteris paribus, the green transition will do to its components.

The effect on consumption is likely neutral or positive, but almost certainly not negative, unless governments increase taxes dramatically, or uncertainty forces households to save more (we denote this as ∆C=+0 in the national accounting identity). Investment effects will be significant and positive (∆I>0), since we are replacing as good as the entire productive apparatus of the economy. In the short run other terms in the national account usually move only slowly: households very rarely reduce short-term spending dramatically, ditto for taxes and government expenditure. And exports and imports do not often go through wild swings, unless the terms of trade shift because of a significant change in the real effective exchange rate.

While a reduction in government spending is, again all other things equal, not a likely prospect, and the rise in public investment will be positive, there is the possibility of slightly negative effects on public consumption. Most of that will not shift dramatically, however, because it is earmarked spending (in defence, welfare, and education, for example), which cannot change much without undermining the essential purpose of the state. It may rise, in fact: the deep industrial restructuring associated with the green transition will require significant accompanying social measures to handle dislocation, at least a part of which will be passive adjustment in the shape of subsidies, grants, and social plans alongside regional redevelopment programmes in the old brown regions. The actual effect of the green transition on net fiscal positions will therefore depend on the relative levels of interest rates and growth rates. If growth rates are higher than interest rates, the net growth effects of the green transition will fund part of the adjustment; in the alternative scenario, a combination of higher borrowing and lower spending will likely entail. But this does not necessarily imply a fiscal trauma, since governments could cover the net shortfall by issuing very long-term ‘green bonds’ (parallel to war bonds) over several decades or more, with a very low interest rate.. The overall outcome on government can, thus, be summarised in the notation ∆G>+0.

The green transition will be neutral or positive on (net) exports. It will be positive if green investment produces a positive shift in the terms of trade; however, if all trading partners invest in the green transition, the aggregate effect will be positive in many ways, but the net effect on individual countries will be insignificant because the competitive effects of these investments cancel each other out. That implies, of course, that regions that lag in their green transition will become less competitive, and that opens the door to one particular trade-related variable that runs through this: tariffs. If governments impose tariffs, trade will, all else equal, fall. However, without wanting to dismiss this, such a development should not occupy us here; it matters only if the tariffs are ‘endogenous’, i.e. if they are imposed because of the gains in competitiveness that result directly from green investment. Other tariffs, however important they may be in the real world, are contingent noise, not structural components of the green transition that will affect trade.

One additional export- and import-related mechanism that requires some attention are levies like CBAM (in the EU), which affect the imports from poorer countries that disproportionately export carbon-intensive goods. Because of this globally regressive effect, these green import duties will probably require some funds flowing back to the poorer countries to mitigate the negative effect on their aggregate income (CER 2024). However, since this is only a part of the collected carbon levies, and the bulk will likely be borne by larger, richer economies like the US, the UK and China, the net financial effect of the green transition on exports is almost certainly slightly positive (∆X>0).

Plugging all these ordinal estimates in the national account yields the following outcome:

∆Y = ∆C(>+0) + ∆I(>0) + ∆G(>+0) + ∆X(>0)

Recall that these are conservative estimates of the likely effects, and that they may well be more positive in the actual green transition.

Growth will, therefore, almost certainly not be as badly affected by the green transition as the pessimists think, as suggested by the absence of a strong negative sign on any of these terms, and the presence of many positive signs.

This conceptual exercise yields a second important insight: the rise in investment will be the main driver of (green) growth. Estimates of investment to support the green transition are not very good, and green investment takes place over several years, but (UK) Labour’s initial plan to spend £28 bn per year on the green transition gives a sense of the scale of the operation. Assuming, realistically, that every public pound, dollar, yen or euro draws in another two (as it did in the US), the green transition alone will be good for about £90-100 bn annually in the UK, probably three to four times as much in the EU (assuming fiscal limits under the Stability and Growth Pact can be relaxed), and more than a trillion US dollars in north America. The green transition will therefore largely pay for itself over the long run: not only will many costs be lower, but the investment boom will also increase economic growth, which will feed government coffers, while profits ought to follow suit.

That does not mean that we live in the best of all possible worlds; if investment produces both a short-term and a long-term stimulus, why is the green transition so slow and uneven? Making sense of that puzzle takes us back to an idea I developed several weeks ago. The problem with socio-economic effects is not one of one-off net size but of timing and geography: the different processes associated with the transition will play out over different time horizons, with partly overlapping and partly sequential distributive issues, many of which are geographically anchored because of the regional concentration of many brown activities. This tension between high, concentrated costs today and large but diffuse benefits in a distant and unknown future is a red thread running through the green transition, and growth and its effects will be uneven as a result. Green policies could address these tensions by smoothing out costs and benefits over a to-be-determined longer cycle through borrowing today against tomorrow’s aggregate benefits. If we know that we will gain, say, €500 million a year by avoiding several different costs of climate change (in health, housing, insurance, reconstruction, etc.), we save, say, €10bn over 20 years. It is not difficult to imagine that we borrow a part of that from our future income stream to smoothen the transition for social groups, regions and even industries that are disproportionately affected by the transition. Moreover, since much of the initial investment will be publicly funded, it would simply require low-interest long-term government debt. While there may be some practical issues with such an intertemporal arrangement, the basic concept seems quite straightforward. Investment banks do considerably more complicated things on a daily basis.

In a few days, I will evaluate the economic effects as they are experienced by households and other economic actors through the lenses of effects on jobs and groceries (employment and inflation). At the end of that exercise, I will loop back to the macroeconomics by looking at those effects in light of what central banks can do. But first a quick look at an argument that was quite important in transition debates a few years ago: ‘de-growth’.

Appendix: The problem with zero or negative growth as the solution to the climate crisis

For some the point of low growth resulting from the green transition is a good thing: they take it to its logical conclusion and suggest that we simply need to learn to live with extremely low, zero- or even negative growth (expressed in the ugly neologism ‘de-growth’). If CO2 emissions soared when (capitalist) economic growth soared, the solution is obvious: stop growing.

On the princiuple that you should avoid arguments where no disagreements exist: there are certainly many ways in which we could produce less waste and significantly decrease carbon emissions, and some of that will entail lower harmful economic activity. Yet, overall, this simplistic argument is not very persuasive.

First, it mistakes an outcome (growth) for a policy lever. As a policymaker you could possibly influence productivity growth or innovation that might feed into higher or lower economic growth. You could try to influence credit conditions so money flows more easily, thus stimulating the economy. But it is hard to have a direct effect on long-term economic growth itself, which is the outcome of a complex vector of processes, policies and institutions, both in your economy and elsewhere. If turning growth on and off were that easy, many governments could conjure up higher growth at will instead of simply talk a lot about it. In fact, it is very difficult to implement policies that systematically reduce growth – or perhaps better: reduce economic growth without massive social and human cost. Recall how output fell in 2020, when we effectively strangled our economies. That was not what we think of as a pleasant time for most households. Or ask Ukrainians about the near-20% collapse in GDP after the war started in 2022. The reason reducing growth is very difficult is that many of the politics, policies, institutions and routines in our economies are extremely sticky. Changing them requires changing many deeper processes as well, beyond laws. Watch and see how US President Trump succeeds and blows up his mandate (even MAGA voters like a chicken in their pot and eggs in their shopping baskets), or fails and after hitting a bump in the road,  the US economy emerges in rude health.

Second, the de-growth argument seems to be barking up the wrong tree. Whatever the historical carbon debt, which is undoubtedly concentrated in the Global North, currently most carbon emissions – in total and per unit of growth – occur in the Global South, especially the relatively poor but fast-growing Asian economies. There is admittedly quite a bit of leakage because of the international division of labour and related transport costs, which makes the North more culpable than raw carbon emissions figures suggest. But the rich OECD countries have, by virtue of their deindustrialisation over the last 40 years, effectively moved towards a very low CO2 regime: 70 to 90% of employment and GDP in the advanced capitalist economies is in the services sectors, which account for about 20% of total carbon emissions – this is not only relatively low but also easy to decarbonise since it is primarily electricity. Even energy-hungry data centres could be accommodated if we go for 100% renewables and similar energy sources. In sum, zero or negative growth in the north will have negligible effects on global carbon emissions.

In addition, lower growth because of net-zero measures will also condemn poorer nations to poverty if they are effective. There may be ways to alleviate these negative repercussions, such as green technology and social compensation transfers, but they do not negate the asymmetric production of carbon and unjust distribution of effective carbon reductions. Carving out exemptions for the poorest countries will exacerbate and not alleviate the problem, since they are in relative terms among the largest polluters.

More importantly, we also have dramatically lowered the carbon intensity of every unit of growth over the past three decades, and our individual living standards no longer depend on destroying the planet as a result – assuming we can institute a wide array of low- or zero-carbon policies. While that may settle the argument for green growers (like me), advocates of de-growth see precisely that as the crux of the problem: we simply have too many units of growth. That explains the paradox of lower carbon intensity and rising CO2 levels in the atmosphere. While this sounds correct, it is ignorant of basic economic dynamics: long-term economic growth is mainly the result of two processes – population growth and productivity growth. The first means that growth feeds extra mouths (increased demand) while supplying the labour and, indirectly, the capital to do so. Productivity growth, in turn, raises living standards by increasing efficiency (doing relatively more with relatively less), while being neutral on higher carbon emissions: how we make things and what we make are two analytically, logically and empirically separate questions. Since global population growth is forecast to reach its peak around 2050 and productivity growth means doing more with fewer inputs (of which energy is one), low and zero-carbon green growth will, ceteris paribus, support and accelerate decarbonisation. No need for destitution, starvation and poverty, after all.

Finally, even though I certainly accept that you cannot always choose your friends in these debates, it is crucial to see that logically the argument of the de-growthers and the climate deniers shares an underlying architecture. Both rely on the same stark but incorrect choice: green or growth. Over the past few weeks, UK Labour Chancellor Rachel Reeves has supported new airport runways because they increase growth, German Chancellor-in-waiting Merz’s has raised alarms about the heavy economic drag of green policies (and the Greens before the election seem to have agreed), and this line of thinking has, of course, been at the basis of US President Trump’s enthusiasm for more oil. All of these, and many others alongside them, effectively say the same thing as the ‘de-growthers’ but simply draw the opposite conclusion.