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Analytical and policy approaches to the climate and economy

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Institution
University College London
Author(s)
Paul Ekins, Professor of Resources and Environmental Policy, UCL Institute for Sustainable Resources, University College London
Published
Topic Area
The economic and fiscal impacts the green transition
Question
What measures can drive the green transition and climate mitigation?
Citation

University College London (2025) Analytical and policy approaches to the climate and economy, Contribution to ‘Compendium of Practice from a Global Community of Ministries of Finance and Leading Organizations’, Coalition of Finance Ministers for Climate Action

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It is now generally accepted that there are no “single bullet” climate policies that exert the necessary influence on the full range of stakeholders, from industrial sectors and firms to households and individuals.

Different policy levers can be suitable for agents that respond to different incentives. For market-based decision-making seeking optimization, price-based policy may work well; for decisions determined more by behavioral traits, regulation may be more suitable; and innovation and technological change can be incentivized by carbon pricing, although this also requires strategic investment.

Key Messages

  • Carbon pricing can be implemented via either a carbon tax or an emissions trading system (ETS). The former always raises revenue, while the latter only does so if the emission allowances are auctioned. Revenue-raising potential may also be an important consideration because the political acceptability of carbon taxes can be increased by spending the revenue on climate projects or on mitigating adverse impacts for vulnerable groups.
  • The effect of carbon pricing depends on the elasticity of demand for fossil fuels. Elasticity is higher in the long run, as this allows for investments in alternatives. If complementary policies are put in place before carbon pricing to accelerate such investments and thereby increase the price elasticity of demand, the effectiveness of carbon pricing could be enhanced.
  • In the energy sector, most strategic investment will need to come from the private sector, which requires an acceptable risk-return ratio. Governments can decrease the relative risk by coinvesting or providing assurance of future markets and prices (e.g., via contracts for difference [CfDs]), and by clarifying the risks of high-carbon investments via a credible decarbonization roadmap. Green subsidies (as well as the removal of fossil fuel subsidies), carbon pricing, stable tax incentives for private innovation, product standards, the demand-generating effects of regulation, and quality requirements can be leveraged to increase returns. For renewable energy, feed-in tariffs, renewable obligation certificates, or quota models such as renewable portfolio standards should also be considered.
  • Explicit fossil fuel subsidies have stayed at around US$500 billion per year since 2018, except for a pronounced spike in 2022. They rose to US$7 trillion in 2023 (if implicit subsidies from unpriced externalities are considered).
  • In principle, there are five stages to fossil fuel subsidy reform: (1) assessment of subsidies and pricing mechanisms, (2) building public acceptance, (3) social protection and compensation, (4) revenue redistribution and reinvestment, (5) complementary measures, (6) timing and price smoothing.
  • Ministries of Finance are in a good position to make use of sustainable finance, provided they have clear criteria for the kinds of investments that will qualify as “green” and that they are able to assess investment risks.
Keywords
carbon pricingclimate financefossil fuel subsidy reformnon-pricing policypolicy mix