Restoring growth and confidence through green innovation

Dimitri Zenghelis / Jun 2012

EU Environment Commissioner, Janos Potočnik at a precious metals recycling plant in Antwerp. Photo: European Union 2012

The current period of low confidence and sluggish private investment presents a golden opportunity for UK to boost employment and stimulate economic growth, while encouraging competition and innovation. At the same time, we can cost-effectively meet tough emissions targets and leave a long-lasting legacy in the transition to a resource-efficient green economy. Growth requires investment, yet investment has slumped to record lows in most rich countries mainly because households, businesses and banks are nervous about future demand, and have responded by forgoing more risky investment in physical capital.


Figure 1: Fixed investment

United States      

United Kingdom    


Source: Bureau of Economic Analysis/Office of National Statistics, quarterly data to fourth quarter of 2011.

Instead, companies and households are stashing private saving into ‘risk-free’ assets such as solvent sovereign bonds. As a result, annual private sector surpluses over the past few years have been at record levels, and amounted to £99 billion last year, equivalent to 6 per cent of UK GDP.


Figure 2: Sector financial balances (net lending)

United States            


United Kingdom

Source: Bureau of Economic Analysis/Office of National Statistics, data to fourth quarter of 2011.

After the financial crash, households, businesses and banks undertook necessary and unavoidable long-run stock readjustment in balance sheets. But many rich economies are now trapped in a classic ‘paradox of thrift’, in which greater saving and cost-cutting is the rational response to economic gloom at the level of an individual business (which also sheds labour), bank (which restricts credit) and household. But when everyone retrenches simultaneously, fear of extended recession becomes a self-fulfilling prophecy yielding a vicious circle of low demand and low investment.

Desired saving has exceeded desired investment in many advanced economies to such a degree that global real ‘risk-free’ interest rates for the next 20 years have been pushed below zero. Solvent governments are being paid to borrow; a truly perverse state of affairs given the need for productive investment. These low rates do not reflect a collapse in the underlying returns to capital, but instead reflect desperately depleted confidence.


Table 1.  Daily United States Treasury yield curve rates


1 Month 

 3 Month  

 6 Month 

 1 Year 

 2 Year 

 3 Year 

 5 Year 

 7 Year 

10 Year 

 20 Year 

23 May 2012











Source: United States Treasury

What is needed to restore confidence is a clear strategic vision with supporting policies to guide investors. In the past, we have seen rearmament or Roosevelt’s New Deal. In this case, recognising the inevitable transition to a low-carbon economy, and helping drive forward investment in resource-efficient, innovative sectors, could restore growth and leave a lasting legacy. As well as bringing energy security, tackling climate change, and saving consumers and businesses costs in the long run, these sectors offer long-term returns for investors.

Standard macroeconomics and the economics of market failure tell us that the best time to support investment is during a protracted economic slowdown. Resource costs are low and the potential to crowd out alternative investment and employment is small. In addition, although public budgets are stretched, there is no shortage either of private capital available for investment, or of investment opportunities with potential for profitable returns.

Policies to encourage low-carbon investment would provide new business opportunities, generate income for investors and would have credibility in the long term because they address growing global resource challenges, while tapping into a fast-growing global market for resource-efficient activities.

The most recent figures published by the Department for Business, Innovation and Skills show that the UK low-carbon and environmental goods and services sector had sales of £116.8 billion in 2009-10, growing 4.3 per cent from the previous year and placing the UK sixth in the global league table. But the private sector is not investing as heavily as it could in green innovation and infrastructure because of a lack of confidence in future returns in this policy-driven sector. The lack of confidence is due to uncertainties surrounding current energy and environment policy.

The reliance on policy to drive this market has advantages in the current fragile economic environment. Cautious investors can be driven to act now by correctly priced public resources, sweeping standards, regulations and technology support without relying on private sector sentiment to drive demand. South Korea and China have understood the logic of this approach. China has moved decisively to embrace high technology low-carbon growth, notably in its stimulus package of 2008-2009 but also, and more importantly, in its outline for the 12th five-year plan which sets strong targets. China and other countries recognise that investment flows to the pioneers of the revolutions. Moreover, the commercial opportunities are magnified by the fact that the necessary change will be transformative. It will require major investment in all regions of world across all economic sectors including buildings, transportation, agriculture, manufacturing and communications.

The expenditure involved in making the transition to a resource-efficient economy must be assessed as an investment, rather than a cost. It is also important to understand the full dynamic economic costs, benefits and risks including the cost-savings from induced innovation.

Only the Government can limit policy risk. Thus, by backing its own green policies, the Government can stimulate additional net private sector investment, and make a significant contribution to economic growth and employment. It can do this, for instance, by allowing a well-capitalised Green Investment Bank to operate as a lending institution, sharing some of the risk of private investments in green infrastructure. The UK should also work with European Union to increase the target for emissions reductions for 2020 to 30 per cent from 20 per cent, supporting the carbon price within the Emissions Trading System. Promoting future growth also requires policies to shift tax base towards materials and resources, and away from intellectual activity. Finally, loose talk conveying the false impression that there is a choice between environmental responsibility and economic growth undermines private sector confidence and needlessly raises the risk premium on such investment. There is no lack of private money, just a perceived lack of opportunity. This opportunity should not be wasted.

Dimitri Zenghelis

Dimitri Zenghelis

June 2012

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