Form the Dept. of Treasury November 13, 2023 By Eric Van Nostrand, Assistant Secretary for Economic Policy (P.D.O.) & Arik Levinson, Deputy Assistant Secretary for Climate & Energy Economics The Inflation Reduction Act (IRA) is the largest investment in reducing carbon pollution in U.S. history. But along with the Bipartisan Infrastructure Law (BIL) and the CHIPS and Science Act, the IRA also […]
November 13, 2023
By Eric Van Nostrand, Assistant Secretary for Economic Policy (P.D.O.) & Arik Levinson, Deputy Assistant Secretary for Climate & Energy Economics
The Inflation Reduction Act (IRA) is the largest investment in reducing carbon pollution in U.S. history. But along with the Bipartisan Infrastructure Law (BIL) and the CHIPS and Science Act, the IRA also serves as a key investment in our economic growth.
Some skeptics of government climate policy have claimed that initiatives like the IRA will slow U.S. economic growth. Such concerns have a long history. Since the beginning of serious environmental policy in the 1970s, critics have objected that pollution reductions would come at the expense of economic growth.
But that old objection does not reflect the economic reality that good climate policy can promote growth. That might sound like the metaphorical free lunch economists dismiss, but it’s not. We describe five ways that climate policies like the IRA can promote growth:
- lessening greenhouse gas emissions which result in costly climate damages;
- adapting to the effects of climate change;
- reducing economic damages from local pollutants often released alongside greenhouse gases;
- supporting innovations that have productivity benefits beyond their direct climate effects; and
- lowering economic reliance on fossil fuels with volatile global market prices.
(1) MITIGATING GREENHOUSE GASES
Reducing greenhouse gases mitigates the costly damages those emissions would have caused– the most direct way that climate policy benefits the economy. Some of those economic costs are obvious, like costs due to more frequent and more powerful hurricanes, floods, and fires. Others are more subtle but still pernicious. Temperature increases have been found to cause declines in students’ academic performance and future incomes, as well as diminish worker productivity, reducing economic potential across the economy.
The U.S. Council of Economic Advisers and Office of Management and Budget summarized twelve recent studies assessing the aggregate cost climate damages will impose on the U.S. economy. Collectively, they suggest climate damages are already reducing U.S. GDP, and that economic damages will accelerate as global average temperatures rise. Cutting back on greenhouse gases will therefore provide economic benefits, especially if the emissions reductions are part of a coordinated international effort like the Paris Climate Agreement.
The United States accounted for 13 percent of global carbon dioxide (CO2) emissions in 2022, and a quarter of the cumulative global CO2 emissions from fossil fuels burned since pre-industrial times. That means we cannot solve the climate problem ourselves. While we cannot ensure that all other countries contribute equally by reducing emissions, we can presume they will be less likely to pitch in if the United States, the country responsible for the largest share of cumulative emissions to date, fails to act.
That is one reason why President Biden signed the IRA, the largest-ever U.S. federal effort to reduce greenhouse gas pollution. Nine independent analyses reviewed in the journal Science project that the IRA will reduce U.S. emissions in 2035 to an average of 20 percent below what they would be without the IRA.
Even the most ambitious mitigation efforts, however, will be insufficient to avoid damages from the greenhouse gases already causing atmospheric changes. That leads us to a second set of climate policies that also benefit the economy: policies geared towards adaptation.
(2) ADAPTING TO CLIMATE CHANGE
Adaptation policies include building sea walls and reinforcing buildings, designing new forms of insurance and disaster response, and safeguarding critical infrastructure. Although those steps will be costly, not making adaptation investments would be even more costly. Adaptation investments help ensure that when climate-related weather disasters do happen, they cause less damage.
Economic research has corroborated the value of adaptation expenses. Globally, Hallegatte et al. (2013) calculate that spending $50 billion per year to build higher bridges and move transportation routes inland for 136 coastal cities around the world would reduce expected annual losses from climate change in 2050 by nearly $1 trillion. In the United States, Martinich and Crimmins (2019) estimate that proactive adaptation investments in just three areas—coastal properties, roads, and rail—could more than pay for themselves, reducing climate damages by $140 billion per year in 2090 (in 2015 dollars). The magnitudes of these worthwhile investments illustrate how costly it would be not to invest in adaptation.
Of course, government policies are not always necessary; many adaptations can be undertaken by individuals. People can reinforce and weatherize their homes and upgrade to new energy-efficient heating and cooling systems. But some families cannot afford those adaptations. That is why the IRA includes tax credits to help homeowners afford better doors and windows and energy-efficient temperature control. The credits reduce homeowners’ initial upgrade costs and enable future energy savings.
Moreover, some adaptations like seawalls and road reconstruction are public goods that cannot be left to markets. And that is a reason why President Biden signed the Bipartisan Infrastructure Law. Many parts of the $1.2 trillion law are designed to promote both growth and adaptation to climate change. For example, the law provides $16 billion for upgrading electric power grids. That helps reduce power outages—many of which are caused by extreme weather—that already cost the U.S. economy up to $70 billion each year.
(3) REDUCING LOCAL POLLUTION
In addition to improving the economy by mitigating and adapting to climate change, climate policy also benefits the economy by reducing local pollution.
When powerplants burn coal or people drive gasoline-powered cars, that causes greenhouse gas emissions that affect the global climate. Alongside those global pollutants, powerplants and cars also cause local air pollution like sulfur dioxide and particulates. Those local pollutants sicken nearby residents, raise their health care costs, and diminish their productivity, with negative consequences for the whole economy. Government climate policies intended to limit greenhouse gases can thus provide additional economic benefits from reducing local air pollution.
Recent economic research provides abundant examples. Air pollution reduces the productivity of factory workers, results in employees working fewer hours and taking more sick days, impairs adults’ cognitive performance on tests, and causes investors to make worse decisions and drivers to have more car accidents. Exposure to pollution during childhood, or even in utero, lowers future college attendance and earnings.
The domestic benefits from reduced local air pollution can be significant. The EPA estimates that its proposed new regulation limiting greenhouse gases from electric power plants will provide global benefits of $5.4 billion in 2030 from mitigated future climate damages. But the agency projects the rule to have even larger domestic air pollution benefits inside the United States, ranging from $6.5 to $14 billion in 2030 alone. Similarly, many of the IRA’s climate provisions also have local pollution benefits. One nonpartisan think tank estimated that the IRA will improve local air quality by enough that in 2030 Americans will collectively be losing 350,700 fewer workdays each year to illnesses.
(4) SPURRING INNOVATION AND SPILLOVERS
A fourth way that climate policy can promote growth is by backing innovative research and development (R&D). Without government support, private businesses underinvest in climate-related R&D for two main reasons.
The first is the classic market failure that applies generally to all R&D. Businesses that do invest in new products or production techniques have trouble preventing competitors that do not invest from exploiting their discoveries. As a consequence, many businesses underinvest. But the economy-wide benefits from R&D, including spillovers from researchers to competitors, exceed the returns to individual researchers. The gap between public and private returns is symptomatic of market failures, and a principal justification of government support for R&D of all types, not just climate-related R&D.
The second reason private businesses underinvest in climate-related R&D arises from the fact that the climate benefits of mitigating climate change accrue globally, not just to the people or businesses doing the mitigation. In economics jargon, mitigation benefits are a public good. As with any public good, leaving climate R&D to market forces has led to underinvestment.
Because the private sector underinvests, for these two reasons, the economic returns to government funding for climate and energy R&D can be especially large. That return on government investment in R&D motivates President Biden’s argument for many aspects of the IRA, as well as the IIJA and especially the CHIPS Act. The policies establish new R&D programs, strengthen existing ones, and advance public-private R&D partnerships, particularly in parts of the country and in academic institutions that have seen underinvestment.
Abundant anecdotes demonstrate the enormous returns on government funding for energy R&D. Decades of funding from the U.S. Department of Energy (DOE) preceded the development of hydraulic fracturing that led to the shale gas revolution and the United States becoming a net energy exporter. And DOE’s Next Generation Lighting program has similarly played a role in the development and spread of LED lights that use less power and last longer than the incandescent bulbs they are replacing, saving energy and reducing greenhouse gases.
More systematic evidence comes from the U.S. National Academies, which found that each patent filed by a DOE grant recipient leads to multiple patent filings by non-recipients. And for clean-energy research in particular, Howell (2017) shows that projects funded by the U.S. Department of Energy over the past 30 years have led to more private financing, more patented innovations, and significantly higher revenue than otherwise similar projects without government backing.
In recent years, the U.S. share of GDP devoted to energy-related R&D has lagged that of many OECD countries. In 2021, U.S. federal funds for energy-related R&D amounted to just 39¢ for every $1,000 of GDP. South Korea spent 42¢, Canada 52¢, Japan 57¢, and Norway $1.15. Policies like the Bipartisan Infrastructure Law will help us catch up, by expanding funds for 12 existing R&D programs at the Department of Energy and standing up 60 new programs.
(5) REDUCING ECONOMIC VULNERABILITY TO INTERNATIONAL PRICE VOLATILITY
Finally, climate policies that promote clean energy may buffer the economy from fluctuations in fossil fuel prices. Just in the past three years, natural gas prices have quadrupled and then fallen by 50 percent, causing significant swings in electricity prices. And oil prices, which account for more than half of the retail price of gasoline, swung from below $40 per barrel to over $130.
At the individual level, those price swings are tough on American businesses and households. Retail natural gas prices rise and fall with spot market prices. Oil accounts for more than half the cost of gasoline at the pump, so when oil prices triple gas prices can easily double. People who use natural gas for heating or cooking saw the prices they pay dip to record lows in 2008 before rising to ten-hear highs in 2022 following Russia’s invasion of Ukraine. And drivers of gasoline-powered cars have, in fact, seen gas-station prices double since a low point in 2020 when the pandemic reduced global demand. Businesses must build that price uncertainty into their plans, and households’ budgets can be upended by unexpectedly high utility bills or gas prices.
Renewable energy sources like wind and solar are not subject to that type of price uncertainty. Once the solar panels and wind turbines have been installed, the fuel to power them is effectively costless. Businesses and households that heat or cook with electricity powered by renewable energy will not be vulnerable to large price swings. And drivers of electric cars can rest assured that their transportation costs won’t suddenly double.
Economy-wide, international energy price fluctuations have long been blamed for causing or exacerbating recessions. Even temporary recessions cause persistent losses in employment and earnings, especially for young workers just starting out, and those losses are largest for the least advantaged workers, especially nonwhite workers and high school dropouts. Whether recessions in turn reduce aggregate economic growth has been debated, but at least one recent paper estimates that past deep recessions in the United States have resulted in permanent losses in productivity, persistent declines in inputs to production, and lower long-run output. Creating a more stable and resilient energy system may therefore benefit all Americans by making the economy less susceptible to price shocks that can trigger recessions.
This post summarizes five mechanisms through which the Inflation Reduction Act and other climate policies can both increase economic output and reduce climate damage. Policies that mitigate greenhouse gases and local pollution, adapt to climate change, spur innovations in energy technologies, and reduce our economic reliance on fuels with internationally set energy prices don’t just make sense for the environment and for the future of the planet. They make good economic sense for Americans today and in the future.