There are two ways to curb climate change: raise the price of “brown” energy or reduce the cost of “green” alternatives.
Raising the price of "brown" energy is appealing. In an idealized world, a price on carbon can reflect the damages that greenhouse gas emissions will cause over time and incentivize the search for more efficient ways to avoid emissions. But even in its idealized form, this is inherently inflationary — raising prices. Without subsidies to the poor, it also increases inequality, because lower- and middle-income households spend a larger share of their income on items like heating and transportation. Squeezing the supply of fossil fuels is even more painful; not only will prices rise, but if fossil fuels are removed without adding alternative supply, economic activity will decline without adequate energy to fuel it.
This is what is happening today, especially in Europe. Except instead of a radical carbon tax, it's caused by the war in Ukraine and Europe's desire to rid itself of reliance on Russian energy. As a result, energy prices are not rising according to how much damage greenhouse gases will cause; natural gas creates less greenhouse gas emissions than coal, but its price has risen further because Russia is a more significant supplier. We got a preview of this in 2021, when Russia cut back on natural gas supply to Europe. Governments stepped in to offset rising energy costs for the most vulnerable households and some businesses that are unprofitable at high energy prices were forced to stop production altogether. Now energy will likely need to be rationed again, and if Russian gas is replaced with coal, emissions will rise rather than decline.
With inflation already at the highest level in 40 years and the war in Ukraine creating new energy supply restrictions, political appetite for curbing climate change by further raising energy prices will continue to decline. To avoid our climate being a casualty of war and rising cyclical and secular inflationary forces, we need tools to curb climate change other than those that raise energy prices — tools that seek to reduce the cost of "green" energy. Instead of cap-and-trade schemes and cutting back on oil and coal production, we should be looking to mechanisms better suited to tackle climate change amidst rising inflation: green fiscal spending and R&D supporting tech advancements.
Green fiscal spending subsidizes the adoption of technologies like renewable electricity or electric vehicles (EVs) through tax credits or allocates government funds directly to build green infrastructure or buy EVs for government fleets. Unlike carbon pricing or supply constraints, each actor involved sees lower prices (through subsidies) or receives government cash, rather than experiencing higher prices and scarcity.
While an increase in government spending can contribute to higher prices, the effect wouldn’t be concentrated in energy (sparing that burden on lower- and middle-income households) and could be offset by reducing stimulative policies elsewhere. European governments are eyeing this route in response to the Ukraine war, exploring how they can use fiscal spending to accelerate the expansion of renewable energy capacity as climate-friendly replacements to Russian gas. The Biden administration hoped to pursue green fiscal subsidies; regardless of one’s views of the broader Build Back Better legislation, it's unfortunate that these specific policy ideas have stalled.
At a time of rising inflation, it’s important to note that technological transformation is a deflationary process. Tech breakthroughs lead to new technologies beating old technologies through better performance at lower prices. Previous energy transitions unfolded over long periods of time, as new capacity was built with new and cheaper technologies while old capacity gradually went offline. In contrast, to curb the worst impacts of climate change requires turning over the world's energy base over a few decades. The development of cheaper green technologies will contain the inflationary impacts of such a proactive transformation in the world's infrastructure.
Ample private sector capital is funding green tech developments, but the history of tech advancements illustrates that government support at the early stage is often critical. This is happening in China: The Chinese government spent significant sums subsidizing electric vehicles and solar technologies, and China is now the global leader in both. China is now investing in early technologies including green hydrogen and carbon capture and storage. There is significant room for Western governments to finance the development of technology to curb emissions, and the sums required tend to be vastly smaller and therefore less likely to fuel inflation.
How governments around the world pursue curbing climate change and meeting their Paris commitments will have important implications for global growth, inflation and asset prices. For example, massive quantities of commodities like iron, copper, and nickel will be needed to build the renewable power grid and the batteries for electric vehicles — but adequate supply of these metals will take years to build. Without a shift in government approach to climate, you can expect high volatility from an uneven and uncoordinated transition, with its inflationary effects compounding today’s already mounting inflation.
See related Bloomberg coverage here: https://www.bloomberg.com/news/articles/2022-03-15/bridgewater-urges-spending-on-green-energy-to-fight-inflation