Governments have a variety of economic policy instruments at their disposal to meet national development goals and manage the economy. These include fiscal, monetary, trade, welfare, labor and industrial policies. There is now a diversity of ideas for how to better incorporate climate, nature and equity into economic policy. This comes alongside a broader rethink of how governments can advance innovation and industrial policy, shift labor market policies to promote green jobs and promote new concepts of economic growth and prosperity in policymaking.
Governments have already begun to apply new economic thinking to fiscal policy. For example: 31 countries have implemented carbon tax policies; an estimated 78 countries have 1,340 environmentally-beneficial subsidies and payments in place; and policies like the European Union’s (EU) Cohesion Policy, which established funds to help less developed countries catch up in terms of decarbonization, environmental protection and development.
International institutions driving economic policy reform
Several international institutions that influence economic policy — like the International Monetary Fund (IMF), the EU Commission, the International Finance Corporation and the Organisation for Economic Co-operation and Development (OECD) — are also prompting policymakers to rethink fiscal policy in order to better address climate change, protect biodiversity and improve equity.
Governments are using fiscal policy tools, and gradually other economic policies, to steer markets toward strategic green industries and sectors in a “new era” of industrial policy.
Three key areas for fiscal policy reform
Fiscal policies can better support climate, nature and equity in three key areas: ending and repurposing harmful subsidies, pricing greenhouse gas (GHG) emissions and other environmental harms, and investing in innovation, growth and jobs. Systems Change Lab will revisit other policy areas in the future as global convergence on targeted economic policies is formed.
Ending harmful subsidies to support sustainability
Rather than taxing unsustainable activities, governments continue to subsidize the development of new fossil fuel reserves, overfishing, mining, land-degrading agricultural practices and harmful fisheries practices. Government subsidies provide non-market benefits through direct funding, preferential tax treatment, non-commercial loans or guarantees, or preferential pricing schemes. Each year, an estimated total $1.7 trillion in government subsidies is committed toward fossil fuels and harmful agricultural, fisheries and land use practices. These financial flows must be phased out and redirected to support a sustainable, decarbonized economy.
Implementing carbon pricing and market-based mechanisms
Setting prices on GHG emissions and harmful activities makes pollution-intensive activities more expensive, incentivizing pollution reduction or the development of lower-emission technologies. To internalize externalities, governments can “price” environmental impacts by imposing direct taxes on harmful activities or using market-based mechanisms such as emissions trading schemes to manage pollution.
Governments also use implicit prices that change the relative cost of sustainable and unsustainable activities through measures like fuel and energy taxes. Prices can reflect GHG emissions’ impacts on society (referred to as the social cost of carbon), or they can target an amount to incentivize the economy to meet specific GHG targets.
Scaling public finance for innovation, green jobs and climate action
Revenues generated by pricing and tax mechanisms, repurposed public subsidies or expansionary fiscal policy measures can significantly scale the amount of public finance that supports innovation, growth of decarbonization technologies, green jobs, marginalized communities and environmentally-beneficial activities. Governments are also typically the biggest consumer of goods and services in any economy, and can use this procurement power to rapidly scale decarbonization technologies.
Estimates suggest that global public investment in climate measures should increase to at least $3.8 trillion a year by 2030, drawing from both domestic and international sources. Finance to developing countries also needs to increase to meet the recent global commitment of $300 billion a year and work toward $1.3 trillion. Experts further suggest tripling public investments in nature-based solutions and increasing financial resources for biodiversity to at least $439 billion per year by 2030.
