How to balance sustainability and competitiveness

July 1, 2024
BGD Insights
BGD Insights

How can industrial policy balance sustainability and competitiveness? Bernhard Lorentz, Managing Partner and Global Consulting Sustainability and Climate Leader at Deloitte, discusses the Inflation Reduction Act, the European Green Deal, and the role of technology in combating climate change.

Interviewed by Klara Marie Schroeder

Businesses and governments around the world have started taking action to tackle climate change, yet it often seems that there is a trade-off between sustainability and competitiveness. How can industrial policy balance both?

International competitiveness is only affected if climate policy makes the production of the same product more costly in one country than in another. To what degree this leads to carbon leakage is difficult to say: For example, for a company to relocate production out of Europe, due to climate policy, it needs to be confident that the new host country doesn’t introduce similar climate-focused regulation in the next few years. Against the backdrop, that today, some 145 countries have set themselves net-zero targets, this confidence should be rather weak. So, for a company to really relocate it would typically require some additional benefits like simplification of supply chains, lower labour cost or lower energy cost.

Of course, governments also have instruments in the tool kit to weaken the impact of climate policy on competitiveness. For instance, they can introduce counterbalancing subsidies. Companies would need to pay for CO2 emissions but would receive subsidies linked to other indicators, for example the number of high-quality jobs provided or the contribution to GDP. Another example are border adjustments. This is essentially a tariff applied to imported goods that compensates for the difference in carbon pricing between the exporting and the importing country. The EU has agreed on a Carbon Border Adjustment Mechanism (CBAM) – a part of the Green Deal – which will be effective from 2026 onwards.

Finally, the world’s top-ten economies are responsible for 75% of the industrial emissions. So, coordinated policy decisions in just ten countries can easily mitigate distortions to competitiveness while tackling the vast majority of global emissions from industry. We see this happening in the G7 for example.

The IRA and the European Green Deal are two notable policy examples in this context. Which approach do you consider more promising?

The European Green Deal and the Inflation Reduction Act (IRA) are ground-breaking legislative efforts aimed at addressing climate change, but they differ fundamentally: The EU Green Deal aims at creating a net-zero green economy by 2050. It relies on the EU budget and other funding mechanisms like the Just Transition Fund to support regions and industries in transition. The cost of carbon is internalised via carbon pricing in the EU Emissions Trading System and the CBAM. From a climate and environmental perspective, it is the most ambitious policy programme in the world.

The US Inflation Reduction Act, in contrast, aims at reducing GHG emissions by 40%, by 2030 compared to 2005 levels, emphasizing job creation, energy security and economic growth, and aims at putting the US in the global leader position on green energy technologies. Contrary to the European Green Deal which relies heavily on regulation and legislative action, the IRA focuses more on financial incentives and tax credits. The IRA includes significant provisions on healthcare and tax reform, highlighting a broader economic and social policy agenda beyond just climate change.

I think, we, as Europeans, can certainly learn two important lessons from the IRA.

First, to be bold. The IRA’s tax credits and direct incentives for renewable energy, electric vehicles, and energy efficiency improvements rapidly stimulate private sector investment and consumer adoption of clean technologies. As such, the IRA unlocks learning effects, making the US industry more competitive and turning the US into a global leader in the supply of green hydrogen and other low-carbon fuels.

The second lesson is to embed climate action in the wider economic policy context. Too often, the public sees economic policy and climate action as conflicting objectives. However, deliberately, the Americans didn’t call the IRA the “Emissions Reduction Act” but, instead, made it clear that decisive climate action and economic policy go hand in hand.

Are EU member states currently doing enough to accelerate the impact of the European Green Deal? What regional challenges do they face?

While the Green Deal has a robust long-term decarbonization framework, it is also highly ambitious, economically costly and financially challenging and it relies heavily on the implementation and financial support from individual member states. Such a radical transformation of the society and the economy comes also with significant technical challenges regarding the development and deployment of new technologies and their required supporting infrastructure (grid extension, storage, etc.). Moreover, as in all transformation, social and equity challenges remain more relevant then ever: equitable transition with reduced burden on the low-income proportion of the society, leaving no one behind. Finally, as mentioned previously, the adoption of the IRA as a law in 2022, is seen as a threat to European EV and clean energy manufacturing, both from economic perspective and the sourcing of the activities.

The 2023 reforms of the European Green Deal introduced several measures aimed at addressing these challenges and enhancing the overall framework, by increasing funding, new financing mechanisms (such as green bonds) to attract private investments, enhanced regulatory measures (expansion of ETS and implementation of CBAM) and further job training and social inclusion initiatives. Although these reforms enhanced the Green Deal's potential to achieve its ambitious goals of climate neutrality and sustainability by 2050, the industrial competitiveness issues with the USA and the political and legislative complexity of consensus among 27 members states, including its dependence on the implementation and financial contributions of member states persist as key challenges.

Looking beyond the Western ecosystem: Are there any examples of pushing the green transformation of the economy in other regions that we should pay more attention to?

China is the biggest green energy market globally, accounting for about one third of the worldwide capacity of renewable energy. Last year China added more solar power installations than the rest of the world. It is the global leader in green investments, and it dominates global solar panel and battery markets. This is due to conscious industrial policy-making, development of a functioning green finance environment and critical support mechanisms.

In its Green Development Plan (as part of the 14th five-year Development Plan), China prioritizes renewable energy investments and emphasizes carbon neutrality by 2060. It’s comprehensive green financial system includes green bonds, green credit and environmental information disclosure mechanisms. To ensure cost competitiveness, the Chinese government provides substantial subsidies and incentives for renewable energy projects, including feed-in tariffs, tax benefits, and grants. Finally, significant investments in R&D have enabled China to make advances in renewable technologies, including next-generation solar cells, energy storage, and smart grid solutions, which is also one of the key reasons for China’s dominance in renewables and battery manufacturing.

Another impressive example with ambitious targets is India. The National Solar Mission established India as a major player in solar power development, with more than 70 GW of installed capacity as of 2023. India aims to reach 450 GW of installed renewable energy capacity by 2030 and achieve an electric vehicle share of 30%. The government of India also plans to position the country as a global leader in green hydrogen production.

There are two other countries that I think we should play close attention to: First, Azerbaijan, which hosts this year’s COP and has great potential to showcase an orderly transition away from fossil fuels, thanks to excellent renewable energy potential and an existing pipeline infrastructure that could make it an important supplier of clean hydrogen to Europe. The second is Brazil. Brazil boasts one of the world’s cleanest power systems and is a global leader of biofuel production. As the host of next year’s COP, Brazil’s progress in clean energy production will be an important case study for the challenges and opportunities of a just energy transition in the Global South.

Up to 50% of the emissions reductions needed by 2050 are expected to come from technologies currently in the early market stage. How should businesses and governments cooperate to help them scale more efficiently?

Achieving climate neutrality by 2050 requires massive investments in wind and solar power technologies, batteries, electrolyzers for renewable hydrogen production, electrification of end uses, efficiency improvements, synthetic fuel production, other renewable energy development and carbon capture and storage. Speed & scale matters. While some of these solutions, notably wind turbines and solar panels, are mature and economically competitive, many others remain in an early market stage. This low maturity is reflected in higher costs and greater risks associated with the development of their value chains. Low levels of maturity often also imply high technical risks (construction delays, underperformance, etc.) and economic risks (missing markets, limited cost competitiveness, etc.). These risks all translate into a higher cost of capital and subdued investment appetite.

There are two axes of action here: developing a low-risk project finance environment and investing early to quickly benefit from learning dynamics. Governments, development finance institutions and companies should work hand-in-hand together to create the low-risk project environment for immature technologies. This means developing guarantee & insurance frameworks to mitigate technical risks, establishing regulatory frameworks to enhance market conditions and providing various support mechanisms such as grants and concessional loans to improve financial viability of the projects.

Investments should start now, unlocking both economies of scale and learning-by-doing and financial learning, providing better economic and financial conditions for future projects. It is vital that our businesses and governments collaborate effectively to foster (green) innovation and to scale these technologies efficiently. Public-Private Partnerships represent a strategic avenue for our governments and businesses to work on projects jointly, sharing both the risks and benefits associated with the development and deployment of new technologies. Public-private partnerships can create the required visibility and confidence in private investors/lenders and enable efficient use of concessional and low-cost public capital.

Finally, such a partnership can be reinforced by inclusion of philanthropic investors, that would seek long-term profits if the projects were in line with their values (e.g., SDGs).

Speaking of technology: What is the most relevant technology in our fight against climate change? And what role should Carbon Dioxide Removal play?

Massive electrification will lead to more than half of the global final energy consumption relying on electricity. But electricity will also be essential to produce molecules – green hydrogen and low-carbon fuels – for hard-to-abate sectors where electrification reaches its limits. By 2050, renewables will cover 90% of electricity supply with wind and solar power in lead roles.

As electricity will be the primary form of energy in the future, electric vehicles, heat pumps and other electric appliances are also among the most relevant technologies in the fight against climate change. In a highly renewable future with significant volatility of final electricity demand and production, digital solutions (such as Internet of Things and smart appliances), as well as Artificial Intelligence (including Machine Learning) also have the potential to contribute significantly to the integration of renewables into power systems, enhanced management and prevision of electricity consumption levels in buildings and industries and more efficient organization of transport.

The majority of global climate experts and of the scientific community see carbon dioxide removal technology quite controversially and for good reasons: proclaiming direct air capture of CO2 in combination with geologic sequestration – especially when unrealistically low cost estimates are emphasized – is often used as an argument by those who try to delay the fossil fuel phase out.

Nevertheless, direct air capture technology will be indispensable to produce synthetic fuels, which are essential for the decarbonization of aviation and maritime shipping. Carbon capture and storage plays a small but important role in avoiding industrial emissions that cannot, otherwise, be tackled in a cost-effective way. Both technologies therefore deserve support. However, the combination of direct air capture and geologic sequestration will remain extremely costly and will not make any meaningful contribution to permanent removal of CO2 from the atmosphere. We have to solve the problem in a more conventional way and we know how, I stated this before.

Bernhard Lorentz is a Managing Partner and the Global Consulting Sustainability& Climate Leader at Deloitte.

He supports global companies in their “Great Transformation” towards a decarbonized future and defines new pathways to accelerate this transformation for entire industries.

Bernhard is the founding chair of the Deloitte Center for Sustainable Progress, and a founding member of the Hertie School, the Mercator Institute for China Studies, Agora Energiewende, the Mercator Institute for Global Commons and Climate Change, and the Climate Neutrality Foundation. He is also an Honorary Professor at the Free University of Berlin.

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