Is The Political Cost of Climate Action.... Inflated?

Governments and regulatory bodies looking to address climate change absorb a political cost. They must balance the long-term benefits of preserving the environment with the short-term backlash from constituents who fail to recognize the urgency behind finding a solution. This cost is magnified when the mechanisms used to address climate change are regulations and taxes, the two most politically popular words in the dictionary. When pulled, these levers are believed to lead to inflation. The relationship between inflation and climate polices is much more complex and context-dependent than politicians make it seem. While it’s true that businesses relying on carbon-intensive inputs or transportation may incur additional expenses due to the carbon tax, the direct causal effect on inflation has not been definitively proven. Regardless, the current political narrative states that these added costs are passed on to the customer, thus driving up prices. In North America, a continent driven by consumerism, that just won’t do.?

I got to thinking – is it realistic for governments/regulatory bodies to implement climate friendly policies without “sparking inflation” or “sacrificing economic competitiveness”??Is this a trade-off that we and politicians just have to accept? I decided to do some research of my own that extended beyond the Canadian economy to see if anyone, anywhere, has successfully cracked the code.

Here’s a summary of my findings/thoughts:

Cross Country Inflation Comparison (say that 5X fast)

According to the International Monetary Fund, Canada and the United States’ current inflation rates are 2.4% and 2.8% respectively. Interestingly, Denmark’s inflation rate is currently sitting at 2.8%. I’m no economist, but I recognize how differences in economic structures, policy, and external factors can make cross-country comparisons of inflation difficult. However, the United States, Canada, and Denmark are all advanced economies with relatively high standards of living and similar levels of economic development. If climate policies are the big bad driver of inflation, how is it that Denmark, a country with one of the most aggressive climate action plans in the world, has an inflation rate that’s on par with the United States and only 40 basis points higher than Canada? Compared to North America, Denmark has also been the most successful in reducing GHG emissions.

So what’s the secret?

Market Failure VS Market Opportunity

In North America, we are treating climate change like a market failure that can be corrected with taxes and regulations. In comparison, countries like Denmark are viewing climate change as an opportunity to drive innovation and economic growth. For example, both Canada and Denmark have implemented a carbon tax. In Canada, how the tax revenue is allocated varies by province, as some provinces reinvest revenue into climate-related initiatives, while others provide rebates or tax cuts to individuals and businesses, or allocate revenue to general government spending. In comparison, Denmark consistently uses revenue from carbon taxes to invest in renewable energy, energy efficiency, and other climate-related initiatives. For example, Denmark has created thousands of jobs through their development, construction, and maintenance of offshore wind farms. These jobs range from engineers, technicians, and project managers to manufacturing workers, port personnel, and service providers. Additionally, Denmark has created multiple revenue streams via electricity generation, sale of wind turbine components and technology, service and maintenance contracts, as well as taxes and royalties collected by the government. By capitalizing on this market opportunity, Denmark has attracted significant foreign investments and renewable energy technology has become one of their key export sectors.

Through strategically investing the tax revenue, the government is supporting economic activity, creating new jobs, and mitigating inflationary pressures. Not to mention, avoiding the long-term costs associated with environmental degradation and climate-related disasters (damages to infrastructure, health impacts, and disruptions to economic activities).

(Fossil) Fuelling the Fire

The Denmark and Canadian government have historically provided financial support to the fossil fuel giants, such as subsidies, tax breaks, and other incentives. To nobody’s surprise, Denmark has been the leader in phasing out financial support for this industry. Let’s not give them too much credit, though. In the fight against climate change, some countries are handed a head start while others must sprint from behind. The transition from fossil fuels to renewables is easier for Denmark than it is for North America. While Denmark has some oil and gas reserves located in the North Sea, Canada possesses significant fossil fuel reserves. Access to these natural resources allows Canada to be a major player in the global fossil fuel market, making it a huge piece of their economy. While swift action against climate change is necessary, completely defunding this sector immediately could have negative short-term economic and social implications for Canadians.

According to a recent report, the Environmental Defence advocacy group estimated that Ottawa provided at least $18.6 billion in support of the fossil fuel and petrochemical industries in 2023. Only $1.3 billion of that was for carbon capture and storage projects. It seems paradoxical to be putting a price on carbon, and simultaneously financially supporting the fossil fuel industry.

Understandably, the Canadian government will have to support industries that have historically driven economic growth. However, we should question the extent of this support and bake in stronger parameters. The government’s continued support only gives the fossil fuel industry an advantage over other renewable energy alternatives.?

Learnings from Denmark

Let’s reflect on the initial question posed: “Is it realistic for governments/regulatory bodies to implement climate friendly policies without sparking inflation or sacrificing economic competitiveness?”. In my opinion, the short answer is yes. The data from Denmark indicates that there’s a world where climate policy and economic growth can co-exist. What we can learn from Denmark is that the carbon tax can effectively reduce emissions, however its economic impacts are largely dependent on how the tax revenue is spent. Allocating tax revenue towards investing in renewable energy sources, while phasing out the financial support for fossil fuel giants, is necessary for curbing emissions and mitigating inflationary pressures. Canada’s economic reliance on the fossil fuel industry makes this issue more complex.

The government is currently funnelling billions of dollars into the fossil fuel industry, all the while implementing a carbon pricing strategy. These contradicting actions represent two forces working against each other. The government should reduce or phase out subsidies and tax breaks for the fossil fuel industry, reallocating funds towards renewable energy initiatives to support job creation in the renewable energy sector. This can help offset the economic impact on fossil fuel-dependent regions within Canada. While the fossil-fuel industry can’t be completely defunded, we could implement stricter parameters that align with climate goals and promote a transition towards cleaner energy sources. For example, tax incentives provided by government for fossil fuel giants could be strictly linked to investments in R&D, prioritizing initiatives like carbon capture and storage (CCS) or methane emissions reduction.

My 2°C Take

Human beings take action to avoid pain or obtain some form of gain. Historically, we’ve believed that humans may be more willing to take action if they perceive the risk of inaction to be high, particularly if it involves potential losses. However, I think the tides are turning. A new wave of psychology suggests that people are more inclined to take action to pursue gains rather than to avoid pain, challenging traditional notions of loss aversion and emphasizing the motivational power of positive outcomes. This is evident from the fact that “doom & gloom” marketing narrative surrounding climate change is failing to provoke action. North America’s emphasis on using punishment/disincentives to address climate change has created resistance from industries and individuals who perceive these measures as burdensome or unfair. This has resulted in political opposition (ex: “Axe the Tax”) which has hindered the popularity of climate policies. Instead, we should be offering positive incentives for businesses and individuals to innovate and invest in renewable energy and other environmentally friendly solutions. In Denmark’s case, offering financial, regulatory, and market-based incentives to motivate and reward environmentally sustainable behaviour has proved crucial for advancing carbon neutrality and promoting a green economy.

I hope to see the day where elected officials/politicians implement climate-friendly policies without fear of paying a political cost. After all, Denmark shows us that economic prosperity and environmental consciousness don't have to be mutually exclusive, but are actually mutually reinforcing. Perhaps confronting the climate crisis in a continent driven by capitalism and consumerism means reframing the challenge that lies ahead. Are we addressing a market failure or taking advantage of a market opportunity?

In my opinion, the true inflation is the perceived political cost associated with taking climate action.

Food for thought!