You know it is coming every time a financial policymaker or central banker steps on stage. The ritualistic incantation, the insipid regurgitation before making a public statement:
“WE ARE NOT CLIMATE POLICYMAKERS! INDUSTRIAL POLICY IS THE POLICY OF FIRST RESORT! FINANCIAL POLICY IS SECOND BEST!”
(They obviously do not shout this. Financial policymakers are nothing if not measured.)
And while the statement may seem repetitive, there is nothing particularly offensive about seeking to centre what most would accept is the core policy lever that will determine the speed and scale of the transition. In some sense, it is good and right that financial policymakers increase the pressure to act.
The problem is that there is a good case to be made that the statement is in fact not true.
For one, financial policymakers are climate policymakers, whether they like it or not. A recent study by Matteo Gasparini and colleagues in Nature highlighted a range of inherent biases in financial accounting frameworks, tipping the scales against green assets.
Now, just because financial policy has an unintentional impact on other policy briefs doesn’t mean it immediately becomes “climate” policymaking. But it also doesn’t mean that unintentional consequences are somebody else’s problem.
Intentional impacts
And in practice, financial policies have intentional impacts on other policy briefs all the time.
Basel III has carve-outs for export finance following government lobbying. EU capital requirements provided preferential treatment for SMEs. UK and Dutch tax incentives are calibrated to bias against short-term assets. Collateral regimes are a minefield. France has special financial tax incentives for investing in the French film industry, for crying out loud – or should I say, sacré bleu!
I always tell my wife that the fact I once said pigeons get a bad rep as “flying rats” doesn’t mean I now “love all pigeons”. A swallow (or pigeon in this case) doesn’t make a summer! But in this case, financial policymakers have basically set up an entire pigeon birdhouse in the garden.
Ok, ok, maybe a tiny little, tiny tiny little climate policymaking. Don’t sweat it, financial policymakers! What’s in a name? “That which we call a rose / By any other name would smell as sweet!”
But all this doesn’t change the fact that industrial policy designed by industrial policymakers still comes first, does it?
Well… here is the case: We now live in a world where a) emerging markets have a larger emissions footprint than developed markets and so the path to net zero goes through them and b) a growing share of low-carbon alternatives are now either cost-competitive or actually cheaper.
Industrial policy obviously can incentivise capital. It is most effective, however, where it seeks to steer that capital to a more expensive solution through a subsidy or a tax or some other policy constraint.
When renewables are already cheap, it isn’t lack of a carbon tax holding us back. It’s Spades. In. The. Ground!
The interest rate spike was evidence to that effect. It cut many capital-intensive projects off at the knees.
The problem wasn’t that wind all of a sudden was more expensive than gas or coal (spoiler: it wasn’t). The problem was that wind had to be built and fossil power was already on the grid.
Industrial policy can juggle torches while swallowing a sword, but when interest rates spike it needs financial policy’s help to get Spades. In. The. Ground.
Rates, rates, rates
Few people have beaten this drum louder than Ulrik Fugmann over at BNP Paribas, who at a recent workshop simply said “Rates, rates, rates” when asked what the key climate policy lever was.
That isn’t to suggest industrial policy doesn’t matter (the Inflation Reduction Act wants a word!). And nor is financial policy the reason why we don’t have competitive zero-carbon alternatives in many parts of industry, or shipping, or aviation. Here, of course, industrial policy remains Queen.
On the other hand, simply relegating financial policy to “second best” as a principle misses a big part of the story.
There is a good case to be made that the primary determinant of whether we will decarbonise the power sector in emerging markets will not be the cost of renewables, but the cost of capital for renewables. Success in decarbonising is the East, and financial policy is the sun!
This will become even more true as climate impacts widen risk spreads, something already happening, according to research by SOAS. As risk premia widen, industrial policy simply won’t have the firepower to respond.
Of course, the type of financial policies we currently spend most of our time on aren’t really up to the challenge, because they are not looking at rates. Mandatory climate disclosure isn’t going to get Spades. In. The. Ground.
We need the big stuff. A cursive review of current initiatives shows that we are lacking. O capital requirements, O monetary policy, O tax incentives, O Romeo, wherefore art thou???
(Technically, wherefore means “why” and so the reference to Shakespeare’s play makes no sense. But I’m not a literati, so unintended impacts on the English language are apparently out of scope of my responsibility.)
Changing perception
In fairness, perception is changing. While many GFANZ investors have focused their political engagement on industrial policy to date, leading investors increasingly recognise the need to centre financial policies too.
And while my reference to insipid regurgitation at the beginning of this text was a rude one, it probably also wasn’t fair. Financial policymakers understand that to effect the change they want to see in the world, they have to speak softly.
In practice, more ambitious action is emerging. Collateral regimes are being adjusted by central bankers, tax incentives are finally considered for green assets, and it seems inevitable that insurance regulation will progress. All necessary!
But as long as we act like financial policy is a “nice to have”, a “second best”, many of these policies will eventually resemble another popular catchphrase of financial policymakers: “Too little, too late.”
Jakob Thomä is co-founder of Theia Finance Labs (formerly Two Degrees Investing Initiative), research director at Inevitable Policy Response and professor in practice at University of London SOAS.
