Reframing climate policy: a reply to Simon Wren-Lewis

It is just over a year since we published Supercharge Me: Net Zero Faster, in the same week that Russia invaded the Ukraine. Six months later, the United States passed the Inflation Recovery Act. Both of these developments have profound relevance to climate policy – the main focus of our book.

Before we turn to these consequences, a brief recap of the central thesis. A number of factors motivated us to write Supercharge Me. The underlying economics dominating climate policy – carbon taxation – is bad economics, even worse politics, and flies in the face of the evidence of almost every policy that has actually worked. The dominant narrative in public discourse – that collapsing emissions required either complete lifestyle change or the end of rising living standards – is also almost entirely at odds with the growing consensus of energy policy experts.

These errors of perception and reality are linked. The consensus among energy policy experts – from Adair Turner, chair of the UK’s Energy Transitions Commission, to Jesse Jenkins and Mark Jacobson at Princeton and Stanford – is that the key to collapsing carbon emissions is: a) make electricity sustainable, and b) electrify transport, manufacturing and buildings. Accepting this premise, it is immediately clear that the popular narrative is false. Sustainable electricity and electrification require no lifestyle change, but vast capital expenditure which economic history suggests usually brings significant increases in living standards. There is no reason why the green industrial revolution should be any different.

It also follows logically that the economic consensus on carbon taxes is misguided. Accelerating investment by regulated utilities has never been achieved by taxing an externality. Economists have been stuck at the wrong chapter of the textbook – a position even The Economist seems to have acknowledged. The correct chapters of the economics textbook pertain to regulated utilities and the price elasticity of demand.

Making electricity sustainable requires accelerated investment by our regulated utilities. Policy intervention needs to engineer an acceleration in investment spending, and the levers are crystal clear: the cost of capital, the return on capital, mandated investment targets. We only need to look at what has worked. The sectoral story of UK carbon emission reductions is very clear. It is almost entirely accounted for by a growing share of renewables in electricity generation, and the regulated decline of coal (carbon taxes did play a role here, but a relatively trivial one, coal has largely been mandated into decline.) The most successful carbon-reducing policy of the UK government has probably been the use of Contracts for Difference (CFDs) to encourage investment in renewables. This is better described as the provision of insurance, rather than subsidy. By providing a floor on electricity prices paid to producers, the cost of capital collapses and investment spending accelerates. Ironically, prices have ended up been far higher than expected and the CFDs significantly profitable.

Why do these facts not dominate the political debate and prevailing discourse? If we consider the conclusions of the superb work by Doyne Farmer and his colleagues at Oxford, wealth creating renewable investment spending will also result in a secular decline in electricity prices. With a fully electrified transport, manufacturing and building infrastructure, we would collectively have far higher living standards. The green industrial revolution decidedly resembles that of information technology and telecommunications.

Although these arguments have failed to breach the prevailing discourse, they have been embraced wholeheartedly by the most significant policy-makers outside of Beijing – the Biden adminstration.

The inflation reduction act
Simon Wren-Lewis, Oxford University’s persistent and repeatedly insightful participant in macroeconomic policy debate, has written twice on the ideas in Supercharge Me. With great relief to us, he broadly agrees with the thesis. We had planned to write about the significance of the Inflation Recovery Act in the context of our policy thesis, but he has done a far better job. The punchline: the right policies (our emphasis) are also far more effective political economy (his emphasis).

We also want to take up his discussion of the costs of climate related investments, this was significantly the focus of his original discussion of the book. We argue in Supercharge Me, that the meaning which economists attach to the term ‘cost’ – and specifically ‘opportunity cost’ is very different to the meaning as understood in everyday language. If the state borrows at a fixed rate of interest of 1% real (adjusted for inflation) and invests at a return of 4%, this creates wealth. No one would really describe this as a ‘cost’ to society – rather it would be hugely remiss not to make such investments, which create wealth for present and future generations, independently of the objective of emission-reduction. An ‘opportunity cost’, as Simon points out, is economic terminology for the fact that by deploying resources for one purpose precludes the use of these resources for another. But this is not how the ‘cost’ of climate policy is explained in public discourse. Firstly, real interest rates are far below the financial returns to sustainable electricity investments – so as a matter of mathematical fact we are squandering an oportunity to create wealth. This was even truer when bond yields were at zero during the pandemic. Secondly, although it is a logical truth that by investing in green energy at the expense of investing in something else with a higher return there is an opportunity cost, it is far from obvious what these alternatives are, even before considering the environmental externalities.


It would remiss to end without mentioning Extreme Positive Incentives for Change (EPICs). This relates to two considerations. The objective of carbon reducing policies is to collapse emissions. This seems a truism, but seems lost on many advocates of carbon taxes, who talk about redistributing the revenues. Is it not self-evident that a successful carbon tax raises no significant revenue? Emissions would collapse and no one would have to pay. Again, the economics of externalities – where costs can be taxed and redistributed – misses the point. We are trying to rapidly change behaviour, which is where incentives and price elasticities become dominant. The chapter on the price elasticity of demand suggests that if you want to collapse demand, you should target the price of substitutes (after you have first created a substitute). This is not distracting theory, it is effective practice. High taxes on fuel have had minimal effects on emissions, pricing electric vehicles at a material discount have a dramatic effect on take up. Fuel is price inelastic, electrical vehicles are substitutes; with a good charging infrastructure, consumers if anything prefer electric vehicles to fossil fuel powered cars.

The ‘extreme’ dimension of EPICs applies less to perfect substitutes than to behavioural change which is challenging, such as installing heat pumps, electric radiators, insulation, solar panels or plant-based burgers. If behavioural change entails upfront costs, inconvenience or imperfect substitutes, the incentive must be extreme. The good news is that EPICs almost always surprise with take-up.

In this regard, it is a good thing that Senator Joe Manchin hasn’t read our book. The Inflation Reduction Act is designed to be deficit neutral. But there is a catch (discussed at length by Tim Sahay in Mark Blyth’s excellent Watson Institute debates at Brown University). There are large incentives for many investments, including for example the purchase of electric vehicles. In order to assess the fiscal implication, an estimate will have been made for expected take-up. But as we point out in Supercharge Me, the effects of EPIC policies are non-linear. Marginal incentives around inconvenient behavioural change usually have trivial effects, extreme incentives tend to dominate and take-up accelerates beyond policy-makers’ wildest estimates. There is already evidence is this regard. But, as Simon Wren-Lewis argues, articulately and rigorously, deficit spending is a price worth paying to clear our air, accelerate innovation, reduce the price of electricty. Oh, and save the planet.

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