Green finance, green banking, green investing — in a time of climate change, the capital markets obviously want to assist in the necessary transformation of our economies. Unfortunately, the state is increasingly interfering in these markets in a way that will prove counterproductive because it falls into the same mental trap that once ensnared the Soviet Union’s central planners.
The problem has to do with definitions, and who does the defining. What exactly counts as “green” (as opposed to brown, presumably)? If this assessment is left to decentralized markets, they’ll have a good chance of allocating capital efficiently. If it’s left to bureaucrats, capital will be wasted, hindering rather than helping our efforts against global warming.
The European Union, for example, just issued the largest ever green bond. This time, it borrowed the green label from categories and methodologies developed in the private sector. That seems sensible.
But in the future, the EU doesn’t want to leave the business of definitions to the private sector: It’s working flat out to finalize its own taxonomy. That’s a fancy word for classification, which most people last heard in school when learning about Carl Linnaeus’ system of ordering the biological world by kingdoms, species and so forth.
The EU’s taxonomy is intended to bestow the green badge on companies and activities — or to withhold it — to “help shift investments where they are most needed.” In future, for example, a lender to an EU-certified green business might be allowed to hold less capital against the loan, while the borrower pockets the coveted “greenium” in the form of a lower interest rate. Borrowers without the badge, it follows, will pay more for capital.
I’m sure the EU has done its best in convening various experts and geniuses to be the new era’s Linnauses (or should that be Linnaei?). But allow me to point out that all-knowing sages working for governments don’t have the best record in allocating capital.
Look, for example, at the current spat between the EU’s two most powerful countries, France and Germany. Usually, though not always convincingly, they claim to be a “tandem” pedaling the bloc forward. When it comes to the taxonomy, they’re pedaling in opposite directions.
France gets most of its electricity from nuclear energy, which has the huge advantages of being reliable and clean — that is, it emits no greenhouse gases. It also has the disadvantage of producing toxic waste and making some people feel unsafe. France is now betting big on a new generation of nuclear technologies that still have the pluses but less of the minuses. Naturally, Paris wants the EU’s green label for those investments.
Germany takes the exact opposite stance. Following the nuclear disaster in Fukushima, it rashly decided to exit nuclear energy completely and will turn off its last fission-powered plant next year. And the Greens, who will play a big role in the next German government, loathe nuclear technology with a zeal bordering on religion. So Germany is fighting against giving nuclear technology the green label in the EU taxonomy.
The result is a messy power struggle over categories, with the French lining up an alliance of nine EU countries and Germany enlisting the support of other member states. A similar confrontation is holding up the classification of natural gas. It’s a fossil fuel, and thus dirty, but it’s much less dirty than coal, which it could help to replace during the transition to an all-renewables future. So, what label should gas have? Future battles could be about hydrogen or any number of industrial processes.
These decisions, as ever when the state does the planning, will ultimately come down to political power more than economics and science. And that’s bad policy. Enlightened governments — like Finland’s — realize instead that we’ll need a pragmatic portfolio approach to reforming our energy systems. We can’t afford to rule out entire scenarios based on some bureaucrat’s label.
The EU taxonomy looks even more misguided when you realize that it interferes with a better European policy that could be both market-friendly and effective if given a proper chance. This is the carbon price that’s set in the EU’s Emissions Trading System. The EU caps the amount of greenhouse gases European industry may emit and then lowers that threshold over time — that’s what we need. The system then lets companies buy or sell allowances, ensuring emissions are reduced fastest where it is cheapest to do so.
This carbon price is the right tool to shift capital to where it is needed. Companies, products and processes that are based, even opaquely, on dirty technologies will become less attractive for investors. Their cleaner rivals will draw more capital instead. Adam Smith’s invisible hand would eventually decide the best mix of wind, solar, nuclear, gas and everything else.
The taxonomy distorts that steering mechanism. Suddenly, the cost of capital — and, thus, the discount rate used by investors — for technology A becomes artificially high, that of technology B unnaturally low.
At the risk of sounding like a broken record, I’d like to renew my plea to policymakers from Berlin, where they are deep in coalition negotiations, to Brussels and all other capitals of the world: Go ahead and hike the cost of carbon emissions, which are humanity’s common enemy. But then renew your trust in the market to do what it takes to reduce them.
Bloomberg
