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Green Industrial Policy and the World Trading System

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Green Industrial Policy and the World Trading System Issue Brief ENTWINED 2013/10/30 17 Green Industrial Policy and the World Trading System By Aaron Cosbey ABOUT THE AUTHOR Aaron Cosbey is a development economist specializing in the areas of trade, investment, sustainable development, and climate change. He is Associate and Senior Advisor with the Trade and Investment Program, and Associate with the Climate Change and Energy Program, at the International Institute for Sustainable Development, Canada, where he directs the Institute’s suite of work on trade and climate change. He has published widely for over 20 years in the area of trade and sustainable development, and for more than 12 years in the area of climate change and energy, and has consulted to governments, research institutes, academia, UN agencies, NGOs and IGOs. His work with ENTWINED includes research on green industrial policy and on border carbon adjustment. GREEN INDUSTRIAL POLICY AND THE WORLD TRADING SYSTEM Green Industrial Policy and the World Trading System By Aaron Cosbey PURPOSE OF THE ISSUE BRIEF: Drawing on country case studies THIS BRIEF TARGETS of renewable energy support conducted for ENTWINED, • Environmental policymakers considering support for domestic and on the extensive industrial policy literature, this brief ”green” infant industries, for example in the renewable aims to highlight some of the key lessons for policy makers energy or low-carbon auto sector. considering adopting green industrial policies. It also aims to contribute to the debates over whether WTO law needs to • Trade policymakers considering calls for revised trade rules to be reformed to accommodate industrial policy measures that allow for green industrial policy. address climate change and other global public goods. • Policy analysts hoping to better understand how to craft What is green industrial policy? effective green industrial policy. Industrial policy, broadly cast, can be defined as, “a set of policies that selectively favours the development of certain industries over others” (Schwarzer, 2013). The definition used in this brief is KEY MESSAGES broad, spanning from policies directly supporting certain sectors • There are a number of sound rationales for employing in- — such as tax breaks to certain firms — to policies that create a dustrial policies to support emerging green sectors, including more conducive investment climate for innovative ventures across a benefits that go beyond the national level to global goods range of sectors — such as science and innovation policies. Green such as mitigating climate change. industrial policy, more specifically, is any such policy that supports the development of industries that produce “green” goods, or goods • The details matter; we have many more negative examples that: of industrial policy than we do positive, and the tools must fit both the specific market failure being addressed, and the realities of the implementing economy. • Have better environmental performance in operation than their competitors (e.g., electric vehicles, renewable electricity- • Industrial policy is inherently difficult for governments be- generating equipment, biofuels) cause, among other things, it demands a great deal of techni- cal and sector-specific knowledge, and it is subject to intense • Directly address environmental problems (e.g., environmental rent-seeking by the supported firms. remediation technologies) • Subsidies may be an appropriate tool for green industrial • Are produced in a way that is environmentally preferable to policy in certain cases. But it is difficult to see how trade rules their competitors (e.g., organic agriculture). might accommodate their sensible use without also allowing their misuse. The majority of green industrial policy in the last five years targets • There may be a case for special trade rules that allow for the development of new low-carbon energy technologies, such as industrial policy that achieves generally agreed global goods solar PV and wind turbines. such as mitigating climate change and fostering development Green industrial policy is at the heart of many of the most in least-developed countries. vexing current trade and environment frictions. Starting from zero disputes five years ago, such policies are now the subject of ISSUE BRIEF 3 GREEN INDUSTRIAL POLICY AND THE WORLD TRADING SYSTEM scores of national trade remedies (including the largest domestic incentives to invest in innovation, to subsidize R&D activities, or trade-remedy case in history, brought by the EU against Chinese to subsidize worker training. solar PV imports), as well as three separate WTO disputes. This is understandable, on several scores. First, industrial policy is • The special case of environmental externalities: Environmental explicitly aimed at distorting the international flow of trade and externalities are a special case of lack of appropriability — special investment, looking to grow so-called infant industries that will because of the scale involved. There are massive environmental take market share from foreign competitors. Second, the value of benefits to investment in green technologies — climate change the coming green economy is huge and growing, with the potential mitigation and adaptation being the most significant category — value of investment estimated at between US$ 1 to US$ 2.5 trillion that are not captured by investors’ returns. Subsidies can internalize per year (UNEP, 2012:23). Governments understandably want to these external benefits. direct their national economic growth toward these important markets of the future. • Capital market imperfections: For various reasons, firms may find it difficult to finance their operations as they try to move along Rationales for green industrial policy the cycle of innovation from R&D to final deployment. Lenders The first major movement toward green industrial policy came in may be unfamiliar with new technologies, assigning them overly the wake of the 2008 financial crisis, as part of national efforts to high risk factors. Access to equity finance may be limited by the stimulate economic activity. Hundreds of billions of dollars were immaturity of the domestic market. Lenders may be hesitant to injected by governments into the economies of the EU, US, China lend to smaller firms with short track records, irrespective of their and Korea, to name the biggest spenders. fundamental creditworthiness. The role of government would be It is reasonable to ask why governments should spend such to facilitate finance by various means, including loan guarantees, money at all. Until recently, the accepted wisdom of most educating financiers on new technologies and direct financial economists was that governments were terrible at picking winners support. and losers, and were doomed to waste money if they tried. The counsel of this particular aspect of the Washington Consensus was • Learning by doing: It may be that firms in a particular country that government resources would be better directed at ensuring have a latent comparative advantage in a sector that can only be sound fiscal policies and macroeconomic stability, in order to captured if they learn by doing (Krugman 1987). Established firms attract investors that could function and thrive without need of may exist that are currently more competitive, but against which government support. domestic firms could compete if only they could achieve a certain This section will survey some of the rationales for using green level of production, learning as they go. Where such a dynamic industrial policy, almost all of which involve some sort of market exists (and it is, of course, difficult to say ex ante that it does), there failure. That is, without government intervention the free market would be an argument for government support to help kick-start solution turns out to be sub-optimal. Later in this brief we will and scale up the process of production or deployment through, look more critically at the use of such intervention. for example, government procurement, support for demonstration Most of the justifications for government intervention are projects, or demand-side incentives to deployment such as premised on the idea of latent comparative advantage: with a little discriminatory feed-in tariffs. help, a true comparative advantage could be fostered in some sectors. What varies from justification to justification is the reason • Increasing returns to scale: There are some sectors where the why help might be needed. larger a producer gets, the more competitive it becomes, because the incremental cost of production is continually falling (or at • Knowledge or information externalities/spillovers/lack of least falling over the whole range of possible production for which appropriability: There are a number of reasons why individual there is demand). Where such a dynamic exists (and where limited firms may not be fully compensated for the social benefits private-sector financing makes it impossible for the firm to use created by their investments in innovation, and therefore would private capital for expansion) there may be some justification underinvest. They may be concerned that at least some of the for government helping firms reach a size at which they can be fruits of their investment will be exploited by their competitors, competitive on the global market. Grossman (1990) warns that the for example through imitation of their ideas (Bardhan, 1971), benefits of such actions diminish if several countries engage in the or concerned that the costly process of discovering
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