The Net Zero Review and implications for policy

The UK government recently published its Net Zero Strategy setting out how to meet its 2050 target; whilst HM Treasury published the Net Zero Review evaluating the key issues of the decarbonisation: the distribution of costs and benefits, impact on government finances, and the competitiveness of the economy.

Uncertainty of the overall impact of the 30-year transition remains high, but potential issues can be identified, monitored, and planned for – particularly when designing policies. So, what are the key topics discussed and what could it mean for policy?

Costs of action versus inaction

The costs of not acting on climate change are significantly larger than transitioning to net zero. Analysis by the Climate Change Committee (CCC) suggests a moderate net impact of the transition on the UK’s GDP by 2050, ranging from -0.8% to +3.4% depending on the model choice.

Furthermore, the costs of transitioning to net zero are likely to be overestimated. In the past, renewable energy costs have fallen faster than predicted.
Renewable energy, unlike fossil fuels, follow learning curves: as installed capacity increases the price decreases, as firms learn-by-doing. Data shows that electricity from solar photovoltaics cost US$359 per MWh in 2009 and declined by 89% to US$40 in just 10 years. Learning curves also operate in the battery industry – a key component of driving the reliability of renewable energy.

Compared to no action, an assessment by the Swiss Re Institute of direct and indirect climate impacts projects a far worse -3.1% to -8.7% impact to UK GDP by 2050 in their 2.6C to 3.2C warming scenario. These costs are likely underestimated as ‘tipping points’ and interactions in the natural ecosystem are difficult to model.

Greening the economy

The future of UK economic policy to green the economy is based on competitive markets delivering the most efficient transition, as the majority of investment will be through the private sector.

For the UK economy to remain at the forefront, competitive advantages such as in providing services for a low carbon economy including financing, legal and consulting expertise, and software services must be strengthened. In 2020 the UK had a trade in services surplus of £107.4 bn; in 2019 the UK was the world’s second-largest exporter of services. To build on this, the government will set out plans for the UK to be the world’s first net zero financial centre.

This strategy is intertwined with the government’s Levelling Up agenda as the UK’s most competitive green industries are geographically diverse, and this will require a flow of finances to those areas.

Though the net economic impact of the transition to net zero is likely small by 2050, significant distributional changes at sectoral and household level will occur. Power, housing, and electric vehicles are key areas where consumers may face costs and gain benefits during the transition. As a result, policies will be targeted towards households most acutely affected by technology transitions.

There is, however, significant uncertainty surrounding which technologies will be deployed and their associated costs during the 30-year transition. The scale of R&D and innovation required places the private sector in a position to seize the opportunities of the transition; yet the uncertainty means that policy is highly influential in supporting the innovation process. By increasing support for R&D and innovation in this decade and providing policy direction, the government can ease some of the uncertainty for businesses to invest in the infrastructure of the future.

Greening the tax system

The future of green tax policy is guided by the polluter pays principle, with two main pricing mechanisms: a direct tax and the emissions trading system (ETS).

Currently, the carbon price only applies to power, industry, and aviation sectors (33% of GDP), with policy implications that the UK ETS will likely expand to the two-thirds of uncovered emissions.

In line with the markets-based approach, carbon pricing is well suited to incentivise the private sector to deliver a significant proportion of the emission reductions required. For example, expanding carbon pricing to gas and reducing costs in electricity bills would improve price incentives.
The UK also has a carbon tax, the Carbon Price Support. It is currently levied at £18 per tonne on emissions from power generation and has played a role in reducing coal consumption by 84% in 10 years. Where demand is not responsive to changes in price, targeted and designed regulation will continue to have a central role in reducing emissions.

The Net Zero Strategy highlights the decarbonisation process as “a journey of unprecedented opportunity and change”, yet careful consideration of the scale of the challenge is required. CBI Economics, the CBI’s consultancy division, is well placed to support research and economic analysis on the net zero transition and policy evaluation for your sector.