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«© 2013 The International Institute for Sustainable Development © 2013 The International Institute for Sustainable Development ...»

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Green Industrial Policies We have described how the term “green industries” is both cross-cutting and sectoral at the same time. A central obstacle to the earlier emergence of green industries is the lack of a market, as conventional markets have failed to correctly price externalities. Most prominently, the failure of markets to align the social cost of carbon with its private costs has led to an unsustainable mode of industry that is fuelling global warming. Because of this market failure, green industries are essentially infant industries, driven by policies that support the market through both the stimulation of demand and supply.

From an economic point of view, an optimal policy would consist of correctly pricing the externalities. For example, the first-best policy to control greenhouse gas emissions would be a tax or a cap-and-trade system that ensures that the social cost of carbon would equal the costs of reducing emissions (marginal abatement cost) (Morris, Nivola & Schultze, 2012). Rectifying the market failure would level the playing field for green industries, which then would not need additional government policies to sustain them. However, such market-based policies are currently completely lacking in developing countries and at best insufficient in high-income countries. While the desirability of such policies over the longer term is undoubted, and they are certainly a central element of a green economy, their precipitate introduction could in practice choke existing industries over the short term (especially in developing countries) and hence be incompatible with green growth (United Nations Department of Economic and Social Affairs, 2011).

Thus, in the absence of comprehensive policies that tackle environmental externalities at the source, countries are widely resorting to green industrial policies to spur green growth.

Moreover, green industries are not exempt from those (non-environmental) externalities that many conventional industries are facing either (see chapter 2). There is indeed much reason to believe that non-environmental externalities are even amplified in the case of green industries.

High uncertainty over technological developments and policy-induced market trends expose investors to unmanageable risk, exacerbating credit market imperfections and hampering the provision of much needed green financing (World Economic Forum, 2013). Investment subsidies can help to efficiently spread the risk by transferring it from private investors to taxpayers (Karp & Stevenson, 2012). Technological leadership of high-income countries has favoured the emergence of green industries in those countries, and policies that facilitate and accelerate technology transfer are indeed central to ensuring global technology diffusion. But innovation in green industries is much more specific to local conditions, providing significant opportunities for indigenous innovations: while a state-of-the-art computer chip will be the same whether used in Mexico or Thailand, green technologies require adaptation to local soil, water, air, wind and sun conditions, among others (Dutz & Sharma, 2012). For example, only 1 per cent of Chinese solar IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy photovoltaic patents are also filed abroad, suggesting they primarily target the specific features of the Chinese market (Popp, 2012). Hence, “self-discovery” in green industries appears to be of greater significance than has been the case in conventional sectors, and this calls for governments to more actively engage in technological research, development, and demonstration, deployment, and diffusion.

Moreover, even if technological capabilities exist, new technology adoption is subject to path-dependency, as industries only sluggishly refrain from applying old production methods (United Nations Department of Economic and Social Affairs, 2011). Addressing knowledge and information gaps through targeted policies can help firms realize costefficient technological improvements (GEA, 2012). Promoting green industries can also create first-mover advantages, and learning by doing might yield strategic advantages in the rapidly evolving global market for green industries (Altenburg, 2009). Finally, coordination failures are pervasive, given that current infrastructure has gradually emerged in tandem with conventional industries and is often inadequate for green industries. For example, the development of a market for electric vehicles hinges critically on the availability of recharging stations, with common standards for charging plugs and other technicalities. Likewise, a move toward closed-loop production systems in manufacturing will only be viable if ancillary businesses develop simultaneously, implying the coordinated clustering of industries to optimize resource flows among them (UNEP, 2012b).

Nevertheless, the second-best character of many green industrial policies that is due to the absence of more comprehensive environmental policies illustrates two key differences relative to traditional industrial policies. First, the scale of required government intervention is much larger in green industries, which fundamentally rely on government policy to build their markets. In contrast to the bulk of traditional industrial policies, the focus of green industrial policies is not merely on pushing the supply side. An equally important component of green industrial policy is to create demand: the development of green industries is endogenous to government policies that support them (Karp & Stevenson, 2012). Second, depending on the nature of the market failure at hand, industrial policies might be required for a much longer period. If the market failure is permanent and cannot, for whatever reason, be addressed by marketbased policies, industrial policies would be required to equally persist to ensure a level playing field (Dutz & Sharma, 2012). These characteristics substantially complicate analytical first-best industrial policy evaluations based on the Mills-Bastable test (as discussed in the last chapter), part of which requires that industries remain competitive once support is withdrawn.





Green industrial policies are not new but have gained much attention in recent years, as governments throughout the world have attempted to capitalize on the opportunity presented by the 2008/2009 economic crisis to promote a transition to a green recovery (De Serres, Murtin & Nicoletti, 2010). Major governments promised some US$195 billion of “green stimulus” programs, US$141.8 billion of which had been spent by the end of 2011 (McCrone, 2012).

According to Dani Rodrik from Harvard University, the investment of tens of billions of U.S. dollars by the United States alone may be the biggest industrial policy effort in history.8 In what follows, we will present a brief overview of green industrial policies, highlighting emerging findings on the potential and shortcomings of particular measures.

Regulatory and Control Mechanisms Regulatory and control policies are demand-side policies that impose decisions on business choices and operations, either through technology standards (requiring the use of certain technologies) or performance standards, such as

http://www.economist.com/node/16741043, accessed on January 23, 2013

IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy setting specific environmental targets (De Serres et al., 2010). While completely lacking before the 1960s, such policies have gained increased momentum throughout the world. The initial focus of such policies was purely environmental, regulating emissions and waste in manufacturing industries or reducing the use of toxic substances. More recently, they have become important elements of promoting greater resource efficiency and innovation more generally, for example through energy-efficiency codes for buildings, and air, water and fuel efficiency standards (United Nations Department of Economic and Social Affairs, 2011). For example, the European Commission has currently included more than 30 energy-using product categories in an eco-design regulation that sets minimum energy-efficiency requirements and environmental performance norms based on a life-cycle approach (GEA, 2012).

But industry regulation is also widespread in developing countries. In 2005 China had implemented regulation that provided for the gradual phasing out of inefficient production capacities in iron and steel, cement, power generation, coal mining and others (GEA, 2012). India has effectively regulated the conversion of Delhi’s three-wheeler taxis to natural gas, among other policies to reduce urban air pollution (Asian Development Bank, & Asian Development Bank Institute, 2012). Since complying with regulation is usually associated with costs to industries, this trend is counterintuitive. One reason for this widespread adoption of regulatory measures might be a decline in adoption costs for green technologies, stemming from international technology diffusion. Indeed, looking at adoption rates across countries for regulations concerning coal-fired plants, Lovely and Popp (2011) find that countries adopting such regulations at later stages do so at lower levels of per capita GDP than earlier adopters. Another reason might be that it appears that firms often operate at inefficient productivity levels within their efficiency frontiers, in which case environmental regulation might actually increase productivity (De Serres et al., 2010). A number of studies also find empirical backing for longer-term productivity gains, which materialize after initial setbacks (see e.g. Lanoie, LaurentLucchetti, Johnstone & Ambec, 2011).

Targeted regulations are usually a subset of and mostly motivated by overarching renewable energy targets. Reviewing the policy landscape for renewables around the world, REN21 (2012) identify 118 countries that had such renewable energy targets in place in 2011, more than half of which are developing countries. Fuel mandates and blending requirements are a major tool underlying policies to support biofuels in 46 countries, and obligations to use renewable energy heat are gaining attention for their potential to encourage growth independent of public financial support (Intergovernmental Panel on Climate Change, 2011).

However, regulatory policies are rarely purely regulatory. One reason is that regulatory or legislative policies usually back economic instruments (UNIDO, 2011). Another reason is that green industrial policies are usually policy mixes.

The case of feed-in tariffs (FITs) illustrates this (Table 1). FITs are the major policy tool for promoting renewable power generation and have been in use across 65 countries in early 2012. In general, FITs are considered to be very effective tools and are credited for having successfully driven 64 per cent of global wind and 87 per cent of global photovoltaic capacity (UNEP, 2012a). But regulations and requirements are only part of the design of FITs, as energy providers are usually guaranteed a higher-than-market selling price. As such, purely regulatory policies often have to be complemented with other policies, for example establishing cost-sharing mechanisms between ratepayers and taxpayers, which effectively amount to subsidies.

–  –  –

While regulation is a key instrument in establishing a market for green industries, governments appear to frequently have difficulties carefully designing such policies. For example, price-based regulation in the energy sector needs to take into account that demand is generally quite unresponsive to price changes, due to lack of alternatives (Hallegatte et al., 2012). Hence policies must simultaneously support the provision of substitutes. Another major complication appears to be that governments need to balance concerns for the confidence of investors, who face substantial regulatory and policy risks when making decisions, and policy flexibility, in order to avoid distortive and costly policy lock-ins.

Regulation needs to keep up with developments in technology, markets and other relevant factors in order to not stifle technological innovation (UNEP, 2012b).

Such problems in the solar photovoltaic market have become clear in recent years, as increased cost-efficiency in the manufacture of solar panels, notably in China, has led to a global glut in supply and increased installations worldwide.

Consequently, the costs of FIT programs that usually guarantee a certain fixed price for renewable energy supply over a long period of time have increased significantly, leading several countries to redesign their policies in order to suit them to the novel circumstances. In some cases, FIT schemes were suspended for some time until new legislation was enacted, leaving new investors uncertain for several months over future policy developments. Keeping legislation abreast of market developments is often difficult and requires efficient systems of government as well as highly competent bureaucrats. In general, the literature emphasizes that regulatory policies that have a positive net impact on profitability and productivity need to be focusing on end results rather than means, and be stable and predictable (Dutz & Sharma, 2012).



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