Lower carbon emissions won't mean slower economic growth

Rather than stifling economic growth, the transition to green electricity generation and electric vehicles over the next two decades could boost business investment and GDP growth, although the path will inevitably be bumpy. What’s more, there will be a much greater focus on a business’s carbon emissions by customers, financiers and regulators. This will impact competitiveness in a much greater way than before. The middle market should prepare itself for the transition to a less carbon intensive economy.

There is a common view that economic growth and carbon dioxide emissions (CO2) go hand-in-hand. After all, more economic activity means more factories, more vehicles, and more electricity plants spewing emissions into the atmosphere. It follows that, to reduce CO2 emissions, we will have to sacrifice at least some economic growth and the lifestyle improvements that go along with it. 
In reality, the picture is more nuanced. Admittedly, when an economy first begins to industrialise its CO2 emissions increase along with its economic growth – factories produce more emissions than subsistence farming does. But once an economy has developed past a certain level, CO2 emissions and economic growth tend to have an inverse relationship, that is as the level of GDP rises its CO2 emissions fall. Since 1965 the UK’s level of real GDP, which takes inflation into account, has risen threefold, and at the same time CO2 emissions have halved. 

There are four key reasons for this. 

First, in a market economy like the UK, energy is expensive, so firms and households have an incentive to minimise its use. Improvements in technology and processes boost efficiency and productivity, allowing the economy to produce more goods and services with less energy.

Second, the UK economy has become more services orientated over the last 50 years. In 1970, manufacturing made up 30% of the UK economy. By 2020, this had fallen to just 10%. As manufacturing tends to use more energy than services does, the shift away from manufacturing has made the UK economy less energy intensive.

Third, like many developed economies, much of the UK’s heavy industry and associated carbon emissions moved abroad where there was cheaper energy, land and labour. This allowed the UK to import the finished product without incurring any of the emissions.

These three factors combined mean that the UK’s energy intensity, which is how much energy it takes to produce a unit of GDP, has fallen by 75% since 1965.

Fourth, the UK has been a world leader in reducing the role of coal, the dirtiest fuel commonly used for electricity generation. In 1965 coal provided almost 60% of the energy used in the UK, but by 2020 it was just 2% and was zero for most of 2021. Coal has been replaced by natural gas (38% of total) and renewables (17% of total). 

Carbon neutral by 2050

So, what does this mean for the UK economy and carbon emissions in future? Carbon emissions should continue to fall as the economy becomes more productive and renewable electricity generation grows. Based on current trends, CO2 emissions will fall by a bit more than half by 2050. 

This is obviously good, but it won’t be enough to reach the government’s target of net zero carbon emissions by 2050. As a result, the government will focus on reducing the use of fossil fuels through two key policies: banning petrol and diesel engines by 2030, and for all the UK’s electricity to come from renewable sources by 2035.

Banning petrol engines

Switching the UK’s fleet of about 35m cars and vans to electric vehicles will require a huge amount of investment in electricity generation, in the grid itself, and in charging stations.  

National Grid, which manages the UK power grid, estimates that electrifying all of the UK’s vehicles will add about 10% to electricity demand if there is widespread use of so-called ‘smart’ charging, which will charge cars when demand for power is low. If smart charging doesn’t catch on, then electricity demand for vehicles could rise by as much as 30%. 

The electricity network will also require significant investment if it’s to handle the higher voltages needed to charge electric cars. Estimates vary, but the Climate Change Committee (CCC) suggests that the investment needed in electricity generation and the grid might cost an additional £50bn over the next ten years. In addition, the construction of a network of public charging points could cost another £20bn. 

Green electricity 

At the same time, renewable power generation will need to increase dramatically. The technical difficulties associated with renewable power, such as intermittent generation and storage capacity, mean it will be more difficult to phase out natural gas in favour of renewables than it was to replace coal with gas. Indeed, the recent surge in electricity prices to record levels was partly due to a lack of wind to power turbines. 

Natural gas produced about 114 Terawatt hours of electricity in 2020 (about a third of the UK’s total) and a similar amount to renewable power. Renewable electricity generation will therefore need to double over the next decade to hit the government’s goal of all-green electricity. Aurora Energy Research suggest this could require another £50bn of investment, mainly in wind power.

While a price tag of £130bn may sound expensive, spread over a decade it would represent an increase of about 5% a year in business investment. Given business investment makes up around 10% of GDP, this could theoretically boost economic growth by 0.5% a year. In reality, though, the boost will be smaller because many of the materials needed will be imported. 

The takeaway for the middle market 

While the government’s climate change aims are ambitious and the recent surge in electricity prices is just one example of the possible bumps in the road, they’re certainly not impossible. The direction of travel is clear even if the government misses its targets. Renewable electricity generation and electric vehicles will continue to take a larger market share over the next few decades. What’s more, the goal of net zero carbon emissions does not necessarily mean lower GDP growth over the next few decades. In fact, a surge of investment in green technology could boost investment and provide high productivity jobs, especially outside of London and the South East. 

Middle market business leaders in the UK should be aware of the structural changes that are coming in the UK transport and electricity markets, and aim to position themselves ahead of the curve. Consumers, financiers, and regulators are all increasingly concerned about carbon emissions. As such, investments that reduce carbon emissions can cut operating costs, boost productivity and increase competitiveness.