Shifting to a green economy: Lock-in, path dependence, and policy options

In the face of increasingly likely dangerous climate change, many developing countries are designing green economy or low-emissions development strategies, but are simultaneously on a course of investment that locks them into high-emissions infrastructure. Meanwhile, many high-income countries are working to reduce their emissions but are hampered by the cost of switching from an existing capital stock designed for a fossil fuel-based economy.

The paper is based on a model in which brown capital is more productive than green capital in a brown capital-dominated economy, while green capital is more productive in a green capital-dominated economy; that is, the model allows for “carbon lock-out”. Possible macroeconomic consequences of policies are explored to drive a transition to a low-carbon economy and policy responses in the case that macroeconomic imbalances result.

Key findings include that the effect of policy instruments depends on whether the economy is wage-led or profit-led, a distinction that emerges from post-Keynesian theory; that if investors hedge against uncertainty over expected levels of green and brown investment, then there is likely to be underinvestment in green capital even at quite high levels of green capital penetration, creating a substantial challenge for policymakers; and that a carbon price could help in controlling inflationary pressure arising from public green capital investment, in addition to its usual role of encouraging emissions reductions at the margin.

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