The pandemic, we often hear, forces us to rethink the economy. We leave one model behind: the small, austerity-obsessed state that outsources macroeconomic stability work to unelected central banks. Central banks, in turn, have worked to target inflation under a regime of benign neglect for unemployment; it was assumed, meanwhile, that the bond market should and would discipline governments in fiscal correctness.
Now, the Biden administration’s “once-in-a-generation” spending plans suggest a paradigm shift is underway. It puts governments, through fiscal policy (taxation and spending), in the driver’s seat. In this sense, macroeconomics has the potential to become more democratic. But are we celebrate too early? The great test of paradigm shift, perhaps the fundamental test, is how we proceed to decarbonize our economies.
There are two ways to organize the low carbon transition: by the State itself or by the financial sector. What you might call the “big green state” approach involves massive public investment in green infrastructure and industries. When private finance recently bemoaned Biden infrastructure plans, he was opposed to a path of decarbonization of large states that rejects the rhetoric of public-private partnerships.
Indeed, the “big finance” approach wants the state – through its fiscal and central bank arms – to simply guide the private sector by changing price signals. In this scenario, the state plays a less important role, making carbon expensive by forcing companies to pay to pollute. For example, Germany recently introduced a tax of € 25 (£ 21) per tonne of carbon emissions on petrol, diesel, fuel oil and gas. According to wisdom, higher carbon prices will encourage producers and consumers to switch to green energy. Private finance is there to lend the money that this transition requires.
The numbers behind private green investment seem to add up: there are now $ 30 billion (£ 21 billion) in ESG (environment, social and governance) assets. The green “rush” is expected to accelerate as central banks move to decarbonize their operations and reduce subsidies to carbon-intensive activities. Take the plans of the Bank of England: as part of its new environmental mandate, it argues that the transition to net zero must be financed largely by private (as opposed to state) funding, in an orderly fashion that requires central banks to subsidize green and ‘escalate’ only to penalize the financiers of the carbon if, over time, companies fail to meet decarbonization commitments.
The strategy of hugging carbon financiers is at the heart of the Cop26 conference taking place this year in Glasgow. The new hot private sector concert for senior officials, it is green finance. But the world of “green finance” is characterized by injustice and inequality. It reduces democratic government action to higher carbon taxes, which often place the charged decarbonisation on the poor. Government spending should be directed towards “derisk”Private infrastructure, to bridge the gap between the charges paid by users of essential public services and the commercial rates of return expected by private investors.
Yet, having privatized public services while increasing carbon taxes on ordinary citizens threatens a political backlash, which will reduce politicians’ appetite for meaningful decarbonization measures. It will also increase pressures to trust global asset managers to set the pace for green investing, even as the ‘environmental, social and governance’ (ESG) rush of financiers is plagued by greenwashing: PR drills that put green labels on high carbon activities. This greenwashing is a characteristic, not a bug, of the great decarbonization carried out by finance. It allows private finance to both take advantage of the green subsidies promised by central banks and protect the profits of democratic forces that could one day move from hugging to penalizing carbon financiers.
The big finance approach owes its political appeal to fiscal fundamentalists who point to increases in public debt linked to Covid-19 to argue that the state simply cannot afford to green the economy. Instead, financiers toss billions of ESG investments in front of politicians, tricking them into believing the market will deal with the climate crisis. This validates an unambitious carbon policy, as we see too clearly in EU sustainable finance initiative, which created a system of green public standards. Four years after its launch, this classification system for “sustainable” activity is now seriously threatened with greenwashing Member States wishing to include natural gas and other polluting activities in its scope. In turn, the European commitments in parallel develop a system that aims to penalize the dirty loans have evaporated.
It is easier to give in to vested carbon interests when politicians cannot rely on a plausible green macroeconomic paradigm; instead, they still face threats on a daily basis that central banks affected by inflation will withdraw their protective hand from government bond markets. Indeed, central banks, worried about the inflationary pressures triggered by the reopening of economies, are now fiercely debating the speed at which borrowing costs should be allowed to rise.
Climate activists must be prepared to lead the battle against fiscal fundamentalists with a simple message: government is not a household. It has central banks on its side, and if there’s one macroeconomic lesson the pandemic has taught us, it’s that central banks can do a lot. In high-income countries, central banks bought almost all of the debt issued by governments in 2020. They can and should continue to work closely with governments to accelerate decarbonization. We cannot rely on private finance to get us out of a climate crisis to which it has systematically contributed. We need to take carbon financiers away from accountability, and we do this by ensuring that the democratic state – not investors – leads the way.