A Three-Dimensional Analytical Framework for Green Industrial Policy—Balancing Climate, Growth, and Security Goals

By Baihe Gu

The "Sustainable Development Report 2023" highlights that progress towards the Sustainable Development Goals (SDGs) is seriously off track.[1] Currently, hundreds of millions of people worldwide still live in extreme poverty, while affluent nations face the risk of economic downturn. The window of opportunity to limit global temperature rise to 1.5 degrees Celsius is rapidly closing. On the other hand, the global narrative is shifting in the 2020s. The pandemic and geopolitical tensions are leading more and more countries to prioritize security.

Decision-makers are currently facing simultaneous challenges of security risks, climate crises, and socio-economic challenges. As a result, many economies are intensifying their efforts in industrial policy. The United States' Inflation Reduction Act (IRA) and Infrastructure Investment and Jobs Act will provide over $400 billion in funding support for the green low-carbon sector. The European Union presented a Green Deal Industrial Plan to enhance the competitiveness of Europe's net-zero industry. Meanwhile, China is widely recognized as a successful representative of green industrial policy, having grown in recent years to become a leading force in the global green low-carbon industry.

Industrial policy essentially comprises a series of government intervention measures aimed at promoting the development of specific industries. Green industrial policy, on the other hand, consists of a series of policy tools aimed at promoting the development of specific green industries. Green industrial policies help address two types of market externalities simultaneously. One is positive externality of innovation. Green innovation by enterprises or individuals generates spillover effects, leading to broad social benefits. However, when enterprises or individuals cannot obtain returns commensurate with the risks they undertake in green innovation activities, their innovation incentives are undermined, dampening the motivation to innovate. The second is negative externality of the environment. We know that relying solely on the market itself cannot effectively solve environmental and climate problems, and may even lead to more severe environmental pollution and climate threats. Green industrial policies can stimulate enterprises to invest in green technologies through measures such as research and development subsidies and tax incentives, and guide the whole society to reduce environmental negative externality behaviors.

Since green industrial policy can be seen as part of a country’s growth strategy, rather than just addressing environmental protection issues, it is gaining favor from an increasing number of nations. Opponents question whether governments have sufficient capability to formulate effective industrial policies to intervene in the economy. However, a significant body of research supports the feasibility of green industrial policy, and there are indeed many successful cases in practice to draw upon.

With many governments now embracing green industrial policy, the key question is not whether it's needed, but how to effectively formulate and implement it.

Green industrial policy tools are diverse, including subsidies, tax incentives, local content requirements for manufacturing, R&D support, public procurement, tariffs, standards, and more. It's worth exploring how to tailor appropriate industrial policies or policy combinations based on each country's circumstances.

Here, we propose a three-dimensional analytical framework to assist decision-makers in better balancing the three goals of climate, economic growth, and national security when formulating green industrial policies.

Specifically, it's necessary to analyze the cost-effectiveness of each alternative policy in the three dimensions. This is a highly customized task, considering the potential impacts of policies across different time scales, spatial scales, and various technologies. It's important to note that this isn't a triple dilemma but rather a process of finding satisfactory solutions. Below, we provide an illustrative analysis using the example of how industrial policy can support one particular sector: renewable energy development (Table 1).

Table 1: Outlines the pros (green) and cons (red) of different policy tools for the three dimensions of economic growth, climate, and security.

The economic growth goal here mainly involves enhancing total factor productivity and fostering inclusive employment growth. The climate goal pertains to the deployment and dissemination of green technologies. National security objectives encompass supply chain security and energy security.

In the context of suboptimal green growth, measures supporting domestic green industry for competitive reasons can largely benefit the global community.[2] Effective support for early-stage technologies is more likely to create a first-mover advantage, nudging the technology development path towards national comparative advantages. Another category of competition measures, which prioritize beggar-thy-neighbor tactics such as trade restrictions, may not necessarily be effective for building domestic industries and can carry significant destructive consequences from a growth perspective.[3]

From a security perspective, the roles played by localized supply chains and diversified supply chains are similar. However, for countries without cost advantages, achieving the former typically incurs higher costs than the latter. Localized supply chains are often more closely associated with trade restriction measures. Measures such as high tariffs and mandatory local content requirements, which are aimed at mitigating risks through localization, can effectively reduce external dependencies. However, the effectiveness of these measures may diminish due to trade wars, uncertainties in domestic intermediate goods, and increased transition costs. For technologies deemed less critical, focusing security objectives on diversified supply chains may be a preferable option.

It's evident that global decarbonization requires an increase in the supply of green technologies rather than restrictions. Therefore, we propose that green industrial policies should be cautiously designed based on a nation's comparative advantages and the "criticality" of involved technologies. In most cases, offering more support rather than restrictions may be a better choice for balancing growth, climate, and security objectives.

Baihe Gu is a Chinese Visiting Scholar at the Climate Policy Lab at the Fletcher School, Tufts University.

References

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