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Carbon budgets and the UK economy

A new report from Cambridge Econometrics today predicts that households will be better off financially as a result of carbon budgets. That contrasts somewhat with findings published previously by the CCC that there will be a small cost attached to carbon budgets (under 1% of GDP).

So what do we think about this? First, of course, the economy is a complex beast, and the precise impacts of carbon budgets are hard to predict.

We do know that some of the things involved in meeting carbon budgets – more efficient vehicles and appliances for example – will save money over their lifetimes, effectively making people richer. But others, like investment in renewable power generation, will increase energy costs (bad for GDP). Taken together we expect that overall these things will slightly increase costs; that’s the basis for the CCC finding of a small reduction in the rate of GDP growth.

However, carbon budgets will also redirect spending – generally away from energy use and towards more efficient products. Cambridge point to a shift from oil and gas towards appliances and vehicles for example.

How that plays through to UK GDP is tricky, and views differ between economic schools.

  • One view is that the economy generally does a pretty good job of sorting itself out and will be using its resources (such as its labour force) efficiently, so operating close to its optimum at any time. Any change in spending patterns therefore implies a move away from that optimum and a reduction in GDP (or at least it’s unlikely to imply an increase). Spending more in one place means spending less elsewhere, and the overall pie won’t be increased. In the economic modelling world, this view is reflected in ‘CGE’ (computable general equilibrium) models, such as the one run by the Treasury.
  • An alternative view, as embodied in the Cambridge ‘macroeconometric’ model, is that the economy is rarely in equilibrium and spending changes that boost demand will tend to lead to a GDP boost. So in the Cambridge analysis, it’s positive that carbon budgets increase spending on investments in the UK – wind turbines, efficient vehicles, appliances with lower energy requirements – whilst reducing spending on imported oil and gas. This stimulates the UK economy, leading to more jobs and higher wages as a result of the higher spending in the UK, and everyone ends up better off on average, even though energy is more expensive. Some will never accept that, but insofar as it could happen it will be most likely during an economic downturn, when spare resources are available and demand is low. That argument has been put forward by some economists in recent years as a case for a green fiscal stimulus.

Cambridge also highlighted some other benefits, which will be less contentious and echo findings in CCC’s 2013 review of the fourth carbon budget. They pick out increased energy sovereignty for the UK and improved air quality leading in turn to improved health.

Another point made by Cambridge that follows our own recommendations is that the distributional aspects within the bigger picture should be a key focus for policy. Some vulnerable groups, especially the fuel poor, will need support; potential impacts on competitiveness and energy-intensive industries will need to be managed.

It is also worth noting that there are some benefits of carbon budgets that were excluded from Cambridge’s analysis, which make the possibility of a positive economic impact more likely. One is the increased certainty that carbon budgets bring. That will reduce risks for businesses and we know that risks mean costs. There is also a possibility that UK firms engaging in the low-carbon economy in the UK are then able to export their services overseas into what is expected to be a rapidly growing global market for low-carbon goods and services.

Most importantly of course, carbon budgets are the UK’s contribution to tackling dangerous climate change. Whether they imply a small cost or a small benefit, carbon budgets are worth pursuing as insurance against the large costs expected from unmitigated climate change.

Carbon budgets attempt to plot the cheapest path to reducing the UK’s greenhouse gas emissions in the long term. We can cut carbon while still growing the economy, there will be a host of co-benefits for quality of life, and acting steadily and predictably will be cheaper than delay.