When it comes to choosing approaches to climate policy, policymakers often choose the carrot—incentives and subsidy programs that speed the adoption of specific “green” technologies to lower emissions—rather than the stick that puts a price on emissions. Do these programs deliver the greatest bang for the buck in terms of emissions reductions? A new study shows that not only can these programs lead to spending that doesn’t maximize emissions reductions, but that policymakers may intentionally be choosing to fund programs they know won’t deliver the greatest carbon reductions for their money in order to achieve other political objectives.
“Policymakers like the carrot approach to climate policy because it provides the freedom to choose their spending, but it’s this freedom that allows other motives to creep in,” says co-author Magne Mogstad, the Gary S. Becker Distinguished Service Professor in Economics and the College at the University of Chicago. “Instead of purely looking at the greatest carbon reductions for the least cost—which they often understand in advance—other more political motives sway decisions and lead to what we call ‘green waste’.”
Mogstad and his co-authors Ingvil Gaarder, Morten Grindaker and Tom Meling, study a specific public program for green investment subsidies in Norway called Enova. Through this program, the government subsidizes low-emission technologies such as electric heavy machinery, solar panels, and central heating systems. To determine whether policymakers direct funding toward the most effective programs, the researchers examine how much funding each program receives and both the expected and actual emissions reductions from each.
They find that policymakers are spending their money on less effective programs, causing “green waste.” If they had better targeted their spending, the same carbon reductions could have been achieved at about half the cost. Put another way, each euro spent could have reduced about 84 percent more carbon emissions.
Did policymakers just not know ahead of time which programs would deliver the greatest reductions? The researchers discovered this was largely not the case. Only 10 percent of funds directed at programs that were less efficient at reducing emissions resulted from failing to identify the programs with the greatest returns. Instead, policymakers intentionally chose programs that were less efficient at reducing emissions because they were driven by other motives. For instance, they selected programs that were more politically popular or that helped certain regions or interest groups. Ninety percent of funding directed at programs that were less efficient at reducing emissions was driven by these other motivations.
Simply reallocating money from weaker to stronger programs within Enova would increase the effectiveness of climate spending for emissions reductions by about 12 percent, the researchers found. They propose that each investment should need to meet a minimum level of emissions reduction for the cost. If it can’t meet this benchmark, it should not receive funding.
To reduce the most carbon at the least cost, the research found that policymakers should turn to the stick approach—such as by strengthening cap-and-trade regulatory schemes. Reallocating the money invested in subsidies toward the EU Emissions Trading System could increase the effectiveness of climate spending by about 75 percent. Policymakers could do so by buying and deleting permits within the market, making fewer permits available to purchase and causing overall emissions in the system to fall.
“This study provides more evidence that the market approach to climate policy is highly effective—reducing emissions at the least cost,” says Tom Meling, Assistant Professor of Finance at Ohio State University’s Fisher College of Business. “We suggest that if markets aren’t an option, then policymakers should build some benchmark into subsidy programs to keep the focus on carbon emissions.”