Great Green Transition and Finance

Climate Policy DOI: 10.1007/s10272-020-0896-y Claudia Kemfert, Dorothea Schäfer and Willi Semmler Great Green Transition and Finance European governments are struggling to regain economic strength in the coronavirus pandemic as in many countries the number of new infections seems to gradually subside. Growth rates deep in the red call for a reconstruction programme when the crisis is finally manageable and economic activity can resume. Amidst this, there are again influential groups that claim “this is not the time to insist on strict climate protection goals”. On the contrary, the ongoing COVID-19 crisis has clearly illustrated what climate disasters, often occurring locally, could do to the life of citizens. The reconstruction programme needs to initiate the great green transition. The transformation from a climate-distorting to a climate-protecting economy opens up investment opportunities and points to financing needs comparable with those necessary for the rebuilding of the European economy after World War II. The great green transition is a unique chance to pursue policies for a new and sustainable growth regime. European governments are striving to meet the ambitious goals of the Paris Climate Agreement of 2015. The German government wants to limit CO2 emissions so that the global temperature increase does not exceed 1.5 degrees Celsius. How German society can achieve this goal is still an open question. However, concrete steps must be decided upon urgently, and rapid implementation is key. Within this scenario, the financial sector faces a dilemma. The climate crisis is a source of financial market instability. Without strict greenhouse gas emission regulation, climate disruption risks increase that are potentially depreciating the assets of banks and other financial institutions. However, with stricter regulation and higher CO2 emission pricing, there is a risk that the legacy investments of financial institutions in the fossil fuel sectors will be devaluated, a risk that increases with stricter regulation and rising CO2 emission pricing. © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre for Economics. Claudia Kemfert, German Institute for Economic Research (DIW Berlin); and German Advisory Council on the Environment (SRU), Berlin, Germany. Dorothea Schäfer, German Institute for Economic Research (DIW Berlin), Germany; Jönköping International Business School, Sweden. Willi Semmler, New School for Social Research, New York, USA; University of Bielefeld, Germany. ZBW – Leibniz Information Centre for Economics On the other hand, the transformation from a climate-distorting into a climate-protecting economy opens up new investment opportunities. The resulting financing needs will be in a range that is likely to be comparable only with the volumes needed for rebuilding the German economy after the World War II, or for the reconstruction of the East German economy after the reunification. The transformation requires investments in all areas of the economy: low-carbon and climate resilient infrastructure, including energy, transport, drinking water, sanitation and telecommunication; human capital investments (for planning and implementation, advice, risk management, auditing and regulatory capacity); refurbishment and redesign of public and private buildings (transformation of the construction industry); agriculture; tourism and many other areas (Dullien, 2019a; Krebs, 2020). The investment requirements are so huge that it is justified to call the path to a carbon-free and sustainable economy the ‘great green transition’. Eventually, during the transition period, the German corporate sector, which joined the German state and private households in being a net-saving sector, may again become a net-investing sector (Flassbeck, 2019). Along with the huge opportunities embedded in the financing of the great green transition come huge uncertainties for financial institutions, however. To a large extent, the transition path is unknown. Success in transforming the economy will require, and be highly dependent on, innovative firms inventing, producing and selling climate-protecting technologies and products. Accordingly, financial institutions face huge innovation risks when funding the great green transition. Innovative companies are more financially constrained than those firms using and selling proven technologies and products (Jensen et al., 2019; Schäfer et al., 2017). The reason for severe funding gaps is the huge uncertainty revolving around the question 181 Climate Policy of long-term sustainability and market success of innovative products and technologies. Therefore, banks and institutional investors funding climate tech firms face two kinds of depreciation risks. At the one end, if the financial industry conducts a wait-and-see strategy and sticks to their traditional investment policy, stranded legacy assets may become a huge source of future losses should loans and other funding of traditional fossil fuel investments become non-performing. At the other end, if the financial industry immediately switches to funding only innovative, yet not financially self-sustainable, climate tech firms with new technologies, it faces the typical first-mover risk in completely new, innovative and unknown areas of business. Thus, the crucial question is: how can the necessary investments be initiated, carried out and funded without generating a situation in which devaluation and depreciation endangers the stability of the financial sector? In 2019, the German climate cabinet proposed a mix of policies – innovation support for green energy, fiscal policies (tax and subsidies), carbon pricing and issuance of green bonds. Often, German climate policy is considered ‘too little and too late’, yet it seems to be an important first step in the right direction as it focuses on a mix of instruments instead of just one. Indeed, a mix of policies is required to achieve the great green transition. Redirecting innovation policy and innovation finance, large scale issuance of green bonds, active fiscal policy, supportive monetary and credit policies, fair transitions of employees in old industries in the labour market and better insurance policies are necessary to allow a faster transition to a low-carbon economy. Macro instruments for the great green transition Carbon pricing and green bonds Sovereign institutions and their chosen policy instruments will play a decisive role in mitigating the multiple dilemmas arising around a timely and sufficient provision of funds for the great green transition. Why is it so important to use a mix of policy instruments at the same time, for example, CO2 pricing and green investments? The pricing of CO2 emissions is now largely undisputed. Disputed, however, is how the p (...truncated)