An IMF blog published on 11 May 2023 noted that a coordinated approach should be applied to subsidies, if climate change is to be managed successfully.
Subsidies are being used worldwide to support the green transition and they can be helpful where there are market failures. They can be used in a situation where carbon emissions are underpriced in comparison to their true cost to society or in situations where preferable policy solutions (such as carbon pricing) have not been introduced. Subsidies provide an incentive for businesses and consumers to move towards adopting clean technologies while also lowering the costs of the less polluting technologies.
Subsidies need to be consistent with WTO rules and need to be targeted towards situations where they can correct market failures, without discrimination between businesses. There is currently a danger of a race between economies to attract green investment by using subsidies, and this could distort global trade and result in significant fiscal costs. The outcome could be to undermine the rules-based international trading system and reduce efficiency.
In a more protectionist world, the emerging market and developing economies would have difficulty competing for investments with advanced economies and this could also hinder the transfer of technology to the developing world. The cost of the green transition could increase.
Europe’s Green Deal
The Green Deal industrial plan, proposed by the European Commission in January 2023, is currently under discussion and some parts of the plan have already been adopted. Under the Green Deal the European competition rules would be temporarily relaxed to allow for expanded subsidies for businesses producing green technology.
The EU policy makers could take some steps to increase the benefits from the Green Deal and avoid negative outcomes. The EU should continue to cooperate with the rest of the world to develop a multilateral approach to climate change mitigation and prevention. This could be through a climate club or an international carbon price floor , or could be an agreement on the appropriate use and design of subsidies. Such an agreement would need to be supported by a comprehensive analysis of the effects of various types of subsidies on climate and on economic outcomes, looking at competitiveness, resource allocation, and international trade.
The IMF blog notes that the relaxation of the EU state aid rules should be limited in size and duration. EU funding could be used to support member states that are not in a position to deploy subsidies to the same extent as other EU countries. The EU might also consider coordinated support for green industries throughout the EU, for example through a central fund. Also, a climate investment fund would help to finance the additional public investment required to achieve the climate goals. Subsidies can be focused on the activities that would give the greatest climate benefits such as developing new green technologies or facilitating existing technologies.
