How moving away from fossil fuels will improve productivity
The UK economy is currently mired in crises: a climate crisis; an energy crisis; a cost of living crisis. The root cause of all of these crises is fossil fuels, which have underpinned our economy since the industrial revolution but are now burning our planet and a hole in our pockets. It’s more important than ever for us to switch away from fossil fuels. It’s also a good time to ask whether this move could be good for the economy as well as the climate.
It is common to hear about the jobs that the move to net zero will create, from servicing wind farms to retrofitting homes. But what our economy really needs is for productivity to increase.
Productivity is a measure of how much output we produce for every hour we work and it is the main way we get richer in the long run.
Most economists assume that the switch to net zero would be bad for productivity. They say it would impose new costs on businesses, force us to do things less efficiently and divert investment away from things people want and into green technology.
But looking more closely at the details suggests that these assumptions are not always accurate. While some steps on the path to net zero will no doubt reduce productivity, there are also plenty of ways the green transition could make us more productive. And as time goes on, the more optimistic things seem to get.
A new paper by Nesta and Green Alliance looks in detail at the different changes the UK needs to make to reach net-zero targets and assesses their likely impact on productivity. While it is a mixed report card, there is plenty of good news.
Some aspects of net zero will make us more productive. Renewable energy, which is now cheaper than fossil fuels and reduces our reliance on imports, will raise productivity, as will more efficient technologies such as those used in electric vehicles. Others will almost certainly be bad for productivity – such as decarbonising the steel industry and reducing agricultural emissions. Some changes – including the switch to heat pumps and other low-carbon heating sources – are more ambiguous. It is too early to tell what effect they might have on productivity.
What are the factors that help us understand what effect net-zero policies will have on productivity? Efficiency is a big factor that is (mostly) on the positive side. Many low-carbon technologies are far more energy or resource efficient than their fossil fuel equivalents and so cost less to run, lowering input costs. If they replace or reduce fossil fuel use, that also means reducing energy imports, which is generally good for productivity.
There are other positive side-effects too. Many net-zero measures, from reducing car use to better insulated homes, have health benefits which have a knock-on benefit to productivity. Some new industries will require higher skill levels – heat pump engineers are a case in point – that can pave the way for increasing the UK’s human capital. Harder to quantify is the development of unforeseen goods and services – what new innovations might be possible, for instance, in a world of abundant, clean energy?
"Many net-zero measures, from reducing car use to better insulated homes, have health benefits which have a knock-on benefit to productivity."
Of course there are also productivity losses associated with many net-zero policies. One of the most significant is the transition costs of switching to net zero, the investments we will have to make which could otherwise be invested in other, productivity-enhancing measures. These transition costs are likely to be significant – the Climate Change Committee estimated them at around £50 billion each year, more than 2% of GDP.
For some activities, running costs will also increase. For low-carbon industries or the circular economy, businesses are likely to have to adopt more expensive or labour-intensive processes to get rid of their carbon emissions. There may also be increased system costs to address, such as the additional pressure electric vehicles and heat pumps put on the electricity grid.
To give an example of how these costs and benefits to productivity weigh up, let’s look at heat pumps, one of the measures in the ambiguous category. Heat pumps are more expensive than the boilers they will replace, but they are also far more efficient, using three to four times less energy. They will also require more skills and innovation, which should help raise productivity. It is hard to tell which of these effects will be more important in the long term, but there are plenty of factors to weigh up.
One feature of net-zero technologies we must not ignore is their tendency to improve over time. Ten years ago, it would have seemed impossible that wind and solar power could compete with coal and gas; now it is cheaper and set to get cheaper still. Electric vehicles are developing in a similar way and other technologies may follow. It’s important not just to analyse net-zero technologies as they are today, but to consider their scope for improvement over time.
This leads us, finally, to the question of policy: what can governments do to enable a more productive switch to net zero? The simplest answer for the UK government is to repeat what it has done with renewables. It obliged energy suppliers to switch towards renewables, it invested in research and innovation and it gave confidence to businesses – via Contracts for Difference – that they would get support until they were able to compete on their own terms. A variant of this approach – a mix of innovation, gradually decreasing financial support and gradually increasing regulation – will be needed for most of the different challenges involved in reaching net zero. If governments get this right, they could find that the economy ends up both greener and more productive.