Carbon pricing isn’t enough to drive a green recovery. Here’s why

June 2, 2020

This post is part of Smart Prosperity Institute’s Smart Stimulus Project and supports the work of the Task Force for a Resilient Recovery. Want to receive our latest analysis and insights? Sign up for our monthly updates here.

Canada’s economy has ground to a virtual halt. Job losses have totalled over three million in the last two months. Discussions around how to kickstart the long climb to economic recovery, once the health crisis is behind us, are well underway.

Meanwhile, how Canada recovers from COVID will impact another national priority: climate change. In choosing recovery measures, governments will have the choice to build back a carbon-intensive economy or to continue its gradual decarbonization. Some are advocating that decarbonization can be achieved simply by raising the carbon tax dramatically and allowing the market to drive change. And the economic recovery? These proponents see it as a separate issue.

That argument is wrong. It misunderstands the current crisis and ignores the realities on the ground. We are not fighting climate change in normal times, we are trying to advance a net-zero transition during an economic meltdown.

Canada will need stimulus spending, and it should drive investment and jobs in green opportunities. Policymakers should also recognize that carbon taxes are no replacement for green stimulus when it comes to supporting a net-zero transition in exceptionally unpredictable times.

It’s the economy

To believe that stimulus will not be required, one would need to believe the economy will rebound on its own without any support as soon as lockdowns end. There are currently a number of unknowns, but we know the impacts on this crisis on households and businesses make that unlikely.

In a world of open borders, international supply chains and social distancing, a full and sudden rebound of demand and spending to pre-COVID levels in Canada is doubtful. Viral outbreaks elsewhere, and reduced spending on services like tourism and entertainment, make any immediate rebound profoundly unlikely. The more likely outcome is a gradual decay of balance sheets and waves of private defaults. Without intervention, this could descend into a depression.

It is therefore likely that some measure of stimulus will be required to drive supply and induce demand in the climb towards a recovery. Spending will be needed to fuel growth by driving investment and creating jobs. Importantly, we need to remember that this is the explicit aim of stimulus: to drive investment and create jobs. If that stimulus is green, then the whole point of green stimulus is to create jobs and drive market investment into low-carbon or environmentally-friendly solutions. It may have a secondary benefit of reducing emissions, but that is not its primary aim.

This is different than a carbon price. The aim of a carbon price is to support market investment in a low-carbon direction over the long-run. Stimulus is all about short-term public sector spending to drive growth. We can, and should, have both. But they each occupy a different space in a policymaker’s toolkit, and support distinct objectives.

Thinking long-term

It is incorrect to say that carbon prices alone are enough to reduce emissions. This is especially true in a crisis, partially due to the rebound effect that accompanies an economic recovery. Emerging from the 2008-2009 financial crisis, global emissions grew by 6.1% in 2010. Green stimulus-style investments made up only a small percentage of global investments, thereby increasing the fossil fuel intensity of the global economy. While we cannot credibly argue that this would not have happened had there been more green investments, we can absolutely connect investments in fossil fuel infrastructure to increases in carbon emissions.

We are getting ever closer to 2050, when the government has set a target for net-zero carbon emissions, and now face a reality where the infrastructure we build today has to be compatible with that world. If Canada fails to make the investments necessary to enable decarbonization to the pace and scale needed to meet targets today, it will likely have lost its last chance to do so.

That means any individual advocating against green stimulus must acknowledge two realities. One, stimulus will occur whether they support it or not. Two, spending on brown or carbon-intensive measures will either result in Canada not meeting its climate targets, or knowingly funding future stranded assets. Either way, it is a distinctly sub-optimal outcome.

A final note in this discussion is that prematurely and abruptly raising a carbon price reduces the effectiveness of the instrument. Carbon prices are designed to send market signals that inform investment over the long-term. To allow for firms and households to plan, they need to slowly increase over time. Canada has already increased its federal carbon price in 2020. Rapid and abrupt increases will add uncertainty around spending. Far from helping, this will actively slow a transition, harm economic competitiveness and impose high costs on households.

Advocating that Canada should rely solely on market-based policies during an era of prolonged economic uncertainty is nonsense. Canada will need stimulus to support a climb towards normal and its recovery. Green stimulus can ensure we advance a recovery and foster clean competitiveness moving forward. Canada should not waste time second-guessing itself about what will be needed to rescue our country’s future.