Impressions from a Seminar on Institutions, Innovation and Climate Change in Mexico City

This week, I was in Mexico City at a seminar on “Institutions, Innovation and Climate Change” hosted by the Universidad Autónoma Metropolitana. The following are some of my totally subjective personal highlights.

Mexico City's Cathedral

Mexico City's Cathedral

Climate Change and the Economic Crisis

Alejandro Nadal from the Colegio de México posited that there is an elephant in the room in all discussions about climate change: macroeconomic policy, that is, fiscal policy, exchange rate policy, wage policy, financial liberalisation etc. Macroeconomic policies shape the entire economic framework and are therefore crucial in the fight against climate change.

Nadal briefly sketched the evolution of macroeconomic policies since World War II. Under the Bretton Woods system, the priorities of of macroeconomic policy were full employment and social welfare, in developing countries the priority was development. With the demise of the Bretton Woods system in the 1970s new opportunities arose for financial speculation and the 1980s saw the return of neoclassical macroeconomics. The priorities shifted to price stabilisation, fiscal discipline and balanced budgets, economic liberalisation, deregulation and privatisation.

The result for developing counries was lower levels of fixed capital formation and lower growth rates than during the Bretton Woods era. The massive expansion of the finanical sector that was facilitated by deregulation has had the result that nowadays macroeconmic priorities are organised around the needs of the financial sector.

Nadal highlighted that in contrast to stagflation in the 1970s the current financial crisis was not caused by external shocks, it was caused by the very economic model current policies are based on.

Central elements to achieve price stabilisation have been tight credit with high interest rates and restraining income policies, with the aim to reduce aggregate demand. Many countries have seen a reduction of real wages over the last decades.

Putting fiscal priority on balanced budgets means to put debt servicing as the top priority and to aim for a primary budget surplus (i.e. to have a surplus before interest payments). This could in theory be achieved with a progressive tax structure, but in practice tax structures have usually become more regressive. Another element for balancing budgets is to curtail public sector appropriations, growing maybe a little bit in health services, education, infrastructure etc., but not keeping pace with actual needs.

Nadal pointed out that this regime actually never balanced external accounts, instead many countries have had a chronic imbalance. Meanwhile, social inequality has increased and the Millenium Development Goals will almost certainly not be met.

Is there a new growth engine for the world economy? The USA is no longer able to act as consumer of last resort and China is sitting on a huge real estate bubble and significant overcapacity in important industries. The economies of Brazil and India are not large enough. So prospects are bleak. In addition, the policy response defies the dynamics of supply and demand – this is the worst time to talk about austerity while aggregate demand is going down. While the financial sector is worried about inflation, what is ahead may rather be deflation.

The impacts of the global crisis on climate policy are that mobilising financial resources (public and private) for climate protection is going to be very difficult.

In addition, most estimates of adaptation costs underestimate the real costs. They are usually based on a methodology of calculating the incremental investments needed for climate proofing baseline investments – but the current level of initial investments is too low due to macroeconomic priorities.

Vulnerability as such also strongly depends on macroeconomic policies. People’s economic capacity and hence their capacity to adapt to climate impacts is strongly impacted by policies with relation to real wages, the tax structure (progressive or regressive), social services, cost and access to credit, etc…  In addition, to adapt to climate change massive investments are needed in sectors which are under the aegis of the public sector, such as transport infrastructure, the health system etc. And due to the current macroeconomic priorities these sectors are already massively underinvested in developing countries.

In conclusion, Nadal maintained that “this is a capitalist crisis but we don’t have time for a revolution. But we do have time to re-organise macroeconomic policies.”

Wind Power Technology Assimilation in China, India and Brazil

Rainer Walz from the Fraunhofer Institute for Systems and Innovation Research in his presentation examined how China and India managed to catch up in wind energy technology. China has built strong domestic value chains with domestic actors in most parts of production. In India, first foreign companies became active but then a domestic champion (Suzlon) started up. By contrast, in Brazil turbine manufacturing is still dominated by foreign companies while Brazilian companies are active in component manufacturing.

China used a very sophisticated policy, based on electricity tariffs, local content requirements, and utilities being ordered to install wind power. In India the framework was mostly set at the level of the federal states, which pursued diverse policies.

Suzlon and the Chinese companies Goldwind, Sinovel and Dongfang all started with licences from small second-tier companies in Europe that had no hope of entering Asian markets. The next step of technology acquisition was joint development of technologies and finally Indian and Chinese companies started to purchase producers from industrialised countries.

Technology transfer strongly depends on local capabilities. If they are in place, countries can usually get around barriers such as intellectual property rights.

Climate Policy in Terms of Industrial Policy

Martin Jänicke from the Free University Berlin examined eight cases of rapid technology diffusion. He highlighted that there have been numerous cases where diffusion turned out to be much faster than had been anticipated. For example, when Germany in 1998 set the target to derive 20% of electricity from renewables by 2020 it was strongly contested at the time. As it turns out the target has been achieved a decade early and the target is now 35% in 2020. The renewables industry even expects that the share will be well above 40%.

A similar development took place in Scotland, which this year set the target to source 100% of electricity from renewables by 2020, 9 years ago the target for 2020 was set at 50%. The UK as a whole has already reduced its greenhouse gas emissions by about 25% compared to 1990, which used to be the target for 2020. Now the government has set the target to reduce emissions by 50% by 2025. Interestingly, in the UK case the reductions came mainly from energy efficiency.

Jänicke highlighted that regions have a high relevance for industrial policy as they have to compete on global markets. Drivers for regional policy may be the desire to achieve first-mover advantages, opposition to the nation state like in Scotland, or relative regional poverty. For example, the German state of Mecklenburg-Vorpommern, which is the poorest German state, has a renewables share of more than 50% and established a special ministry for renewable energy.

Jänicke also pointed out that eco-innovation is policy-driven, with perceived policy stringency being the single most important factor. If governments set targets near the currently available domestic production capacity and establish a credible implementation programme, there is a high likelihood of market growth. The primacy of policy is also borne out by examples such as Denmark and Japan where the abolisment of ambitious policies almost immediately led to a sharp drop of renewables diffusion.

Focusing on governments rather than consumers also makes sense in terms of an efficient strategy. “It is easier to put pressure on the G-20 governments than to convince 7 billion people that green living is better. Government is the only actor that can achieve 100% solutions. To improve traffic safety, you wouldn’t hand out leaflets at the street corner.”

Strong government policy also induces social innovation. For example, Germany now has numerous “100% renewable energy regions”, which cover 1/4 of the German territory and 17 million people.

What is also important is that the diffusion of renewables contributes strongly to rural development. Rural employment in Germany is now going up for first time in 50 years.

Finally, Jänicke posited that the German success is not a unique story based on its previous industrial capacity. Many emerging economies like Vietnam or China are going in the green direction. But in addition to lead markets like Germany, which pay the price for the learning curve, a second step is needed, which is co-development of technology that is not only cheap but also does not need so much human capital and infrastructure, for example renewable energy for rural electrification. Such locally-adapted technologies should be pusued through joint ventures of  technology leaders and domestic partners.

Discussions

The open discussions during the seminar were also very interesting. It was highlighted that the crucial conflict in climate policy is not taking place internationally but domestically. The main conflict is the conflict between the innovators on the one hand and the incumbent industries whose business models rely on fossil fuels on the other hand. The international conflicts about who should go first are to a large extent just a smoke screen to cover up lack of domestic political will. To achieve any progress it will be necessary to overcome the blocking power of the incumbent industries. Political mobilisation of the population will be crucial for this, as will be coalitions with those companies that belong to the innovators.

Why do some cities, states and countries become front runners? It was pointed out that this usually has nothing to do with their economic capacity or the capacity of their political institutions. Instead, the impetus usually comes from dedicated political leadership. Such pioneers are another crucial element on the way forward. One of the main reasons why progress is so slow is that many people are not convinced that it is actually possible to sharply reduce emissions without wrecking the economy. Pioneers that show that it is possible are hence critical.

In terms of where to start the most urgent attention needs to be paid to long-term infrastructures – power production, transport and buildings. Once a coal power plant has been built, it will emit CO2 for at least 30-40 years. Once a road has been built, it will generate traffic for decades. Once a house has been built, it will not be renovated for at least 30 years. Preventing lock-in effects over the next decade is therefore crucial for being able to meet the long-term climate goals.

So overall quite interesting. But also quite exhausting with the jetlag and all.

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