By: Ingvil Gaarder, Morten Grindaker, Tom G. Meling, Magne Mogstad
Context
There are two basic approaches to climate policy. The carrot approach, where governments invest in programs that speed the adoption of green technologies that lower emissions, and the stick approach, where regulatory approaches like carbon pricing or cap-and-trade markets increase the cost of pollution. While carbon pricing, like through a market, is largely viewed by economists as the most efficient approach, governments worldwide often choose the carrot approach.
The authors explore whether the carrot approach leads to what they call “green waste”—meaning programs do not achieve the maximum expected emissions reductions per dollar spent. If this is the case, the authors further ask about the extent of this wasteful spending and whether it is an intentional choice by policymakers.
Research Design
The authors study the main public program for green investment subsidies in Norway from 2012-2023. The program, Enova, has a mandate to reduce carbon emissions in private firms. Through this program, the government subsidizes the purchase and installation of 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 authors examine how much funding each program receives and both the expected and actual emissions reductions from each program. They compare the carbon emission reductions achieved per euro spent to other programs within Enova. They also compare the carbon emission returns of Enova programs to the emission reductions that could have been achieved by buying and deleting emission permits in the EU Emissions Trading System (EU ETS). By buying and deleting permits, fewer permits would be available to purchase, making the emissions cap tighter, and forcing overall emissions in the system to fall.
Findings
Policymakers are spending money on less effective carbon emissions-reducing programs, causing what the authors call “green waste.” The authors find that if policymakers had systematically better targeted their spending toward the most effective programs in terms of carbon emissions reductions, the same carbon emission reductions could have been achieved at about half (54 person) the cost. Put another way, the policymakers could have spent the same amount of money to reduce more carbon emissions if funding was allocated more effectively. Their conservative estimate shows each euro spent could have reduced about 84 percent more carbon emissions than under the program as it operated between 2021-2023.
Policymakers are intentionally choosing programs that reduce less carbon emissions, but that satisfy other motives. The authors find that policymakers do largely understand which programs would deliver the greatest carbon emissions reductions. But they are choosing not to invest in those programs. Instead, 90 percent of funding that went to programs that were less efficient at reducing emissions was motivated by other political or strategic factors. For example, they could have favored programs that were more politically popular or that helped certain regions or interest groups. 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.
Investing more into the EU ETS would lead to greater emissions reductions and cost less. The authors find that 60 percent of the funded projects produced smaller emission reductions per euro spent than could have been achieved by using the same funds to purchase and cancel permits under the EU ETS. In other words, reallocating the money toward the EU ETS could increase the effectiveness of climate spending by about 75 percent. If policymakers prefer to continue using the carrot approach and invest in “green” programs, they could better select programs based on their ability to reduce emissions. Reallocating money from weaker to stronger programs within Enova would increase the effectiveness of climate spending by about 12 percent.
Closing Take-Away
While market-based programs reduce emissions more efficiently, policymakers choosing to instead invest in “green” programs can better target their funding. Yet, even when policymakers understand the most effective way to target this funding, funding can still end up being allocated inefficiently because policymakers may have motives beyond maximizing carbon emission reductions. The authors propose that each investment should be expected to achieve at least a minimum level of emissions reduction per unit of subsidy cost. If a program cannot meet this benchmark, it should not receive funding.