Will (state) capitalism save the climate?

President Biden’s Inflation Reduction Act (IRA), a misnamed piece of legislation which is effectively a Climate Change Act, has not only transformed US policy but has also produced a fundamental shift in the climate debate.

For years that debate focused on convincing policy makers and the wider public that climate change was real and a serious threat to them and their children.  With that goal largely achieved outside the backwoods of the US Republican Party the focus shifted to securing long term commitments from Governments and business to net zero, effectively meaning the elimination of carbon emissions.  In the wake of COP26 in Glasgow in November 2021, 132 countries had indicated some measure of support for net zero according to the authoritative zerotrader.net website.  That included 17 who had written a firm commitment into law.

After COP26 the wind of change weakened.  The world was distracted by the economic impact of Covid and by the security concerns raised by Russia’s invasion of Ukraine.   COP27 in Sharm el Sheikh in 2022 was generally regarded as a failure. Emissions continued to rise.

The IRA, however, has transformed the landscape. The scale of the commitment ($369 bn) has made the low carbon agenda an issue of international competition between the world’s three economic power blocs – Europe, China and the United States.   Each of the three areas which between them account for some 55 per cent of global GDP are now using subsidies to the low carbon sector to stimulate much needed economic growth and new jobs.  The winners will hold the edge in the vast global market for all aspects of the transition – from new supplies of wind and solar power to the multiple products and services which will be required for consumers to make the switch from their current dependence on oil, natural gas and coal.   That means electric vehicles, batteries and the associated charging systems.  Plus, new home heating systems which provide an alternative to gas fired boilers.  Plus, most important of all, new infrastructure to take clean power to the end users.

As a result, climate change is in the process of being translated from an environmental cause into a matter of big business and, for some, big profits.

The fact that capitalism, with more than a little help from the state, has taken over the cause might discomfort those who want to transform the existing economic system by sweeping aside private market economics and the hated multinationals. From the perspective of the climate, however, competition and market forces are much more likely to create the momentum which could take us towards net zero than idealists gluing themselves to motorways.

But who will win the competition?  For years China has led the process of low-carbon industrialisation as a result of sustained clarity of policy, strong central control and lavish public support for nominally private companies.  China holds a powerful position in key markets. The People’s Republic produces over half of all the world’s electric vehicles and is home to more than 70 per cent of all the world’s battery production capacity. China dominates the supply of wind turbines and solar panels and has used aggressive pricing to secure the leading share of western markets.  China is also one of the world’s leaders in advanced grid technology and has been quietly developing a new generation of nuclear reactors.

That lead however is now threatened.  Western resistance to Chinese control of critical infrastructure is strong and China has made no friends by its predatory attitude to intellectual property and its rigid resistance to reciprocity. President Xi, in some ways a moderniser, seems to continue to believe that China can dominate the global market without recognising that open trade in the end only thrives in an environment of mutual advantage. Political hostility is closing off markets to Chinese suppliers.  At the same time many emerging economies from Eastern Europe to India and Indonesia are realising that there are market opportunities for them in basic manufacturing producing panels and basic electric cars and as skill levels rise in much more advanced elements of the transition.

The European Union is most advanced in terms of climate change policy – with a target of net zero by 2050 and an objective of reducing emissions by 55 per cent from a 1990 baseline by 2030.   Outside Germany, however, Europe lacks an industrial base or the entrepreneurial spirit to seize the opportunities which are becoming available.  France, once a world leader in civil nuclear power, has suffered an embarrassing series of delays and cost overruns in key projects.  Just as Europe has failed to produce a major high technology business comparable to INTEL, Apple, Google or Amazon, so it has yet to produce a company capable of building a global low carbon business.  The good companies which do exist are relatively small and focused on specific local markets.

The European Commission has responded with irritation to the protectionist elements of the IRA legislation – in particular the local content clauses which require companies producing products such as green hydrogen, wind or solar power to source 20 to 40 per cent of the manufacturing components involved – including steel from US sources.  The US measures are already drawing business away from Europe with Ford announcing that they will build their latest electric vehicle plant in Michigan and European companies such as Audi and Air Liquide considering developing facilities in America.

The irritation has morphed into retaliation. In Davos European Commission President Ursula van der Leyen announced that Europe would produce its own industrial plan in response to the IRA, including a relaxation of rules on national support for key industries and subsidies to set up production facilities for renewable technologies in strategic value chains.   Germany and France would like to establish industrial champions and to secure for them a protected European market from which to build.

For the EU to put together a package of support matching the IRA’s  $369bn will be tough to achieve given the weakness of public finances in many European states after Covid and the associated constraints on borrowing.  The idea of a European Sovereignty Fund has been floated but the details of how such a Fund will be financed remain unclear.   For the moment progress seems to depend largely  on reshuffling existing budgets. The relaxation of rules on support for industrial investment is also a matter of unresolved complexity.  The proposal has opened up a conflict between France and Germany  who want to relax current rules and smaller European countries which fear being squeezed out of the game.

On current form, therefore, the US is the likely winner of the competition to create a low carbon industrial base.   The combination of large-scale entrepreneurial companies, world class research centred in the national laboratories and extensive public subsidies provides a powerful foundation.   The home market is strong and investment should bring costs down and open the way for significant export potential.   The fact that billions of people across the world cannot afford high-cost low-carbon alternatives can be seen as a barrier to change, but in a competitive environment the desire to break that could stimulate the research and development needed to produce affordable low carbon solutions.  Think of the mobile phone sector which has so successfully found ways to penetrate even the poorest parts of sub-Saharan Africa and South Asia.

The IRA is a powerful measure in the spirit of Keynesian economics and could have as big an impact as Roosevelt’s New Deal legislation.  Beyond the investment involved and economic consequences there is also an important political effect to be considered. Corporate shareholders, executives and employees enjoying growth driven by climate subsidies are not likely to vote for those subsidies to be ended.  The IRA gives the business world every incentive to support action on climate change.

Competition of course is dynamic.  The process of transition has hardly begun.   Taking the authoritative data produced by the International Energy Agency the key renewable sources – wind, solar and hydro power still account for less than 6 per cent of global energy supply.  Hydrocarbons still dominate consumption. Oil has a 29% share, coal 26% and natural gas 23%.  The decarbonisation of electricity supply has begun in earnest but electricity still accounts for only a fifth of total demand.  Electrification alone is set to be one of the great business opportunities of the 21st century.

The path to net zero is not fixed but that means there is great scope for further innovation beyond anything yet envisaged. New players could come from anywhere and many smaller countries will want to find niches they can fill.  Japan and the UK- both off the pace at the moment – still have the potential to catch up.

The UK’s technical and scientific strength could transcend the current problems of weak and ineffective public policy.   Japan holds great industrial potential through powerful multinationals such as Hitachi and Mitsubishi and has the experience to combine state and private power behind key projects.   Norway has already developed the model of commercially effective state energy owned businesses in the shape of Equinor and Statkraft and has the resources to develop its own sources of competitive advantage within the transition process.   And then do not underrate the existing energy businesses – from BP and Shell to Exxon and Chevron. All four have thrived over more than a century by adapting to a changing world.   All four are perfectly capable of buying into the process of change as the winners emerge.  Second mover advantage is an underrated strategic approach.

Across the world there are companies capable of becoming the world’s first low carbon multinational.  The competition will be intense, but the prize is enormous.   According to a detailed analysis from Bloomberg New Energy Finance (link) annual investment of some $ 4 trillion is needed to meet the commitments which have been made by national Governments.

The path forward is unmarked, and it is too early to pick the winners.  But the direction of change is clear.  Low carbon is becoming big business.