Sound Climate Policy Correlates with Prosperity

The economy is facing major upheavals. In an interview with Badische Zeitung (BZ), the Mannheim economist Achim Wambach explains how climate protection and growth go together and why the challenges of structural change are particularly great in Baden-Württemberg.

BZ: In light of the COVID-19 crisis, energy crisis, and climate crisis, is it possible to maintain a positive outlook on the economy?

Wambach: We regularly seek insights from financial market experts, and their view on the current economic situation is bleak. Their prospects for the near future aren’t much brighter. We are still grappling with these crises, and the upcoming winter could prove challenging. Although our gas reserves are reasonably stocked, it may not be sufficient. However, where optimism finds its footing is in the demonstration of how adaptable and resilient businesses have proven to be throughout these crises. There were fears that the energy crisis would hit our economy much harder than it actually did, and this is promising for the transformation towards a more eco-friendly economy. Change is, indeed, possible.

BZ: Nevertheless, many entrepreneurs argue that Germany is losing its appeal as a business location.

Wambach: Indeed, we have experienced a noticeable decline in our appeal as a business location. This issue demands serious attention, and I’m uncertain whether the government is addressing it adequately.

BZ: What, in your opinion, should the government be doing?

Wambach: Currently, the government is extending support to companies pivotal for the green transition and contemplating an industrial electricity price cap for energy-intensive enterprises. However, these measures fall short. The challenge of structural change transcends the energy-intensive sectors; it affects everyone. We require an economic policy that benefits all stakeholders, e.g. through reduced corporate taxes. Also, streamlining approval processes is crucial, not limited to wind energy or network expansion alone. Barriers to digitalisation and the skilled labour shortage are equally critical matters that the government must address.

BZ: So, you are against an electricity price cap for the industry?

Wambach: The government has announced it as an electricity price cap lasting for six years. However, no one believes it will end after six years. Do we really want to permanently subsidise our industry? If a sector is not competitive, it shouldn’t be subsidised indefinitely. As energy becomes more expensive, companies with low added value may exit the market. But that is not necessarily a cause for concern in terms of the overall economy. We are not a low-cost energy country. Our strength lies in our human capital, excellent research institutions, and universities collaborating with businesses. Our strength is demonstrated through patents and knowledge, which also create high added value.

BZ: Can we leverage these strengths particularly well in Baden-Württemberg?

Wambach: The challenges of structural change are particularly great in Baden-Württemberg. The automotive industry faces a difficult task. Nevertheless, Baden-Württemberg is very well equipped. We see that our hidden champions, successful medium-sized companies, are able to adapt. However, the location argument also applies here. If they cannot keep up with the excessive documentation requirements or if the planning processes take too long, it will be difficult for these hidden champions to cope with structural change.

BZ: Are companies more likely to adapt or will older ones make way for newer entrants?

Wambach: Our business landscape comprises a diverse spectrum – from innovative enterprises, those choosing to relocate, to newcomers eager to settle in Germany, such as Tesla. Unlike the United States, we have demonstrated relative success in helping well-established companies reinvent themselves. Remarkably, among the DAX-listed companies, half are over 100 years old.

BZ: What about new innovation and start-ups? We have recently seen Tesla acquiring a start-up from Freiburg.

Wambach: There are vibrant ecosystems in places like Berlin, Munich, Karlsruhe, and Stuttgart, but on a broader scale, Germany lags behind. Securing funding remains a challenge, which places the onus on companies to foster innovation themselves.

BZ: Concerns have arisen regarding prosperity amid this transformation.

Wambach: Studies indicate that prosperity can be upheld. A sound climate policy correlates with growth and prosperity. The most efficient climate protection method is emissions trading, where companies must buy CO₂ emission allowances. These studies predict that emissions trading will cost us roughly three per cent of GDP by 2030. However, GDP is expected to grow by seven per cent during the same period. Thus, we anticipate a net growth of four per cent.

BZ: Is this growth happening despite or because of climate policy?

Wambach: Naturally, new jobs emerge as we increase wind turbine installations. Conversely, sectors tied to coal and gas may contract as we phase them out. Sustainability policies aren’t inherently growth programmes, but from a macroeconomic standpoint, there is no reason to doubt continued economic growth. We must remember our economy isn’t solely dependent on industry; the larger services sector plays a significant role. Nevertheless, we cannot downplay the fact that fossil energy will become costlier. Expenses like driving and heating will rise, hitting lower-income households harder, as they allocate a greater share of their income to these necessities. Therefore, climate policy must be interlinked with social policy.

BZ: One proposed model is the climate income, where revenue from the CO₂ price is returned to citizens per capita. What are your thoughts on this?

Wambach: In such a scheme, money is basically lost, as individuals receive funds the government previously collected through taxes. However, higher taxes deter people from working and investing. Hence, I would not endorse paying climate income to high-income earners. Even for lower-income individuals, it oversimplifies the situation. The energy transition does not affect all lower-income households equally; those in cities, living in well-insulated homes without cars, are less affected than those in rural areas. So, climate income would not be equitable.

BZ: The emissions trading system you advocate seems to put European companies at a disadvantage in the global market.

Wambach: Firstly, it is crucial to recognise that having an emissions trading system is an accomplishment for Europe – something the USA hasn’t achieved. What the Inflation Reduction Act accomplishes in the USA in CO₂ reduction would cost just a fifth under an emissions trading system. It is a significant European achievement, showcasing a strong belief in market mechanisms. However, it does indeed disadvantage European firms in global competition. Therefore, a mechanism for compensation is necessary: companies exporting steel to Europe should pay a tariff. Ideally, Europeans exporting steel abroad should receive reimbursement for the high climate-related costs, although this isn’t currently planned.

BZ: What is more effective: government subsidies or market interventions, like making heat pumps cheaper or gas heating more expensive?

Wambach: Often, providing incentives through the market is much more efficient. When carbon emissions become significantly costlier through emissions trading, people are more inclined to weigh the added costs of retaining their old gas heating systems versus installing heat pumps. However, we are witnessing a resurgence of industrial policy, particularly in the realm of climate policy due to urgency and geopolitical considerations. For instance, through the European Chips Act, chip companies receive billions to establish themselves in Europe, leading to a subsidy competition with the USA. But do we truly need complete independence from the USA? I understand the geopolitical argument concerning China and unstable global regions, but why against the USA?

BZ: Speaking of geopolitics, how do you view the long-term consequences of the Ukraine war, which has, for instance, boosted the arms industry?

Wambach: The war represents an unprecedented rupture. It is true that the arms industry benefits, but the significant loss of well-being we experienced last winter due to the costs of purchasing gas and rising food prices outweighs any potential economic gains. War is not a stimulus programme. Nonetheless, the arms industry in the USA has historically been a major catalyst for innovation. Technologies like drones, initially developed for military purposes, now have numerous civilian applications. Perhaps we can derive a positive impetus from this, acknowledging that nobody favours arms manufacturing, but it is a necessity, and we can also harness the economic opportunities it presents.