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Economic opportunities in a low-carbon world

by Eric Beinhocker and Jeremy Oppenheim
McKinsey's Climate Change Special Initiative

Policymakers often feel trapped between conflicting goals when addressing climate change. On the one hand they see the need for urgent action, but on the other they fear higher costs, slower economic growth, and a reduced standard of living for the citizens they serve. The media often reinforces these concerns with messages that tackling climate change is all about higher prices, economic sacrifice and reduced consumer lifestyles.

But taking strong steps to restrain climate change need not invite economic gloom. Our research shows that by adopting the right mix of policies, incentives and new technologies, policymakers in the world’s wealthier, developed nations would dramatically restrain the quantity of greenhouse gases emitted into the atmosphere, even as they promote job growth and wealth creation. Likewise, developing nations would find that strengthening energy efficiency can not only help them contribute to reducing global emissions, but also lead towards a more socially equitable as well as economically positive outcome.

The key to reconciling the twin goals of carbon abatement and economic growth is increasing “carbon productivity.” Just as one can measure the labour productivity of an economy – the amount of output created per hour worked – one can measure the carbon productivity of an economy by calculating the amount of output produced per metric tonne of carbon dioxide and equivalents (CO2e) emitted. The world today produces around 740 US dollars of gross domestic product (GDP) for every tonne of emissions. If we are to cut emissions in half by 2050 versus 1990 levels as recommended by the IPCC, and keep the world economy growing at more than 3 percent per year in real terms, then global “carbon productivity” must increase by a factor of at least 10; that means from 740 US dollars in GDP per tonne today to 7,300 US dollars by 2050.

This is a daunting challenge – but productivity increases of this magnitude have occurred before. During the industrial revolution from 1830 to 1955, U.S. labour productivity expanded by a factor of 10. A “low-carbon revolution” of the same order of magnitude can provide us with both the prosperity we desire, and the environmental security we need. An important difference between the carbon and industrial revolutions, however, is that the carbon revolution needs to happen three times as fast in order to prevent potentially irreversible climate damage.  

Financing a low-carbon revolution

McKinsey has conducted a bottom-up analysis of how much such a low-carbon revolution would cost, country by country and industry sector by industry sector. Overall, the shift to a low-carbon economy would require incremental capital expenditures averaging Euros 455 billion per annum between 2010 and 2030. This sounds like a lot, but it is only about 2-4 percent of expected capital expenditure during the period. Plus, as the money would largely go to investments in long-life assets, most of it would be financed through borrowing over time. We estimate that the total costs to finance such a transition between 2010 and 2030 would be an additional 0.7 to 2.3 percent of total financing for global capital expenditures. That is in the “noise” level of fluctuations in global capital flows and well within the world’s ability to finance. The recent fluctuations in oil prices have had a far greater economic impact – costing in the order of 5 percent of global GDP between 2004 and 2008 – let alone the funds the world will spend on recovering from the sub-prime crisis.

One of the reasons the costs of a carbon revolution are relatively modest is that almost a third of the abatement required would pay for itself over time through reduced energy expenditures. Work by the McKinsey Global Institute shows that through a variety of measures – ranging from enforcing better efficiency in buildings to installing low-energy lighting, and from developing more fuel-efficient vehicles to adopting best-practice industrial methods – we have the potential to cut world energy demand growth by more than half. That would be equivalent to 64 million barrels of oil per day, or almost one-and-a-half times the current annual U.S. energy consumption.

The energy efficiency improvements we identified would require additional annual investments of 170 billion US dollars over the next 13 years. But those investments would generate a return of more than 900 billion US dollars annually by 2020, thanks to reduced energy use. That’s an average annual rate of return of 17 percent based on a long-term oil price of 50 US dollars per barrel – the returns would be even greater with higher oil prices.

Improved energy efficiency is an easy sell because it makes sense from both an economic and energy security perspective, in addition to its positive impact on the climate. But harder choices will be required in the electricity-generating sector: renewables and other low-carbon options still cost more than most high-carbon sources. Incentives for renewables will be needed for some time as innovation continues and costs come down the learning curve. In addition, advanced technologies such as carbon capture and storage (CCS) will require significant investment. CCS seems unlikely to be commercially viable until 2030 at the earliest. In transportation, as well, it will require years of investment to develop and deploy a new generation of plug-in hybrids, electric vehicles and sustainable biofuels.

While these emerging technologies will require substantial investment flows, those investments will create jobs and economic growth. One has to remember that what economists view as “costs” in analyzing carbon abatement are for the most part investments in new capital stock. The building of that capital stock creates jobs, and if that capital investment is financed over time (as it would likely be), it can result in higher GDP growth. Finally, such a burst of investment can have knock-on effects, stimulating growth and innovation in other parts of the economy. Building the infrastructure of the Internet was an economic “cost,” but it has also created millions of jobs, and spurred growth and innovation. Even though the renewables industry is just at the beginning of its growth path, it already employs over 2.3 million people globally, and 170,000 jobs were created in 2006 alone.

Economic and social benefits of a low-carbon economy

Of course, just as with any major technology shift, the move to a low-carbon economy will cause job losses in some sectors, and there should be transition assistance for affected workers. But the evidence suggests that the low-carbon economy is likely to create more jobs than it will destroy. A research group at the University of California, Berkeley modelled a scenario where 20 percent of U.S. electricity demand was covered by renewables by 2020. They estimated that such a scenario would lead to the net creation of between 78,000 and 102,000 additional jobs – an increase of 91 to 119 percent compared to a situation where that same demand was covered by coal or natural gas.

Greater social equity could be an additional benefit of such a low-carbon revolution. Escalating energy costs, and the energy insecurity they impose, inflict a higher toll on lower-income consumers than they do on the middle class and the wealthy. This is not just an issue for the poor in impoverished nations, but the poor within wealthy countries as well. Improving energy productivity would thus disproportionately ease the burden on the poor, helping narrow the economic and social divide.
Developing nations have especially important reasons to advocate an energy-productivity revolution. Innovations in power generation technology – for example, through advances in solar power – could make electricity both more affordable and more accessible to areas such as the 100,000 villages in India that are still disconnected from that nation’s electricity grid. Increased electrification has a wide variety of development benefits ranging from improved healthcare and access to clean water, to greater economic growth. 

Other important strategies for carbon mitigation have co-benefits for development, such as improved soil tillage, which can boost agricultural productivity. While biofuels have been controversial, the development of a truly sustainable biofuels industry could offer vast economic opportunities for the world’s rural poor. Finally, it is clear that global climate goals will not be met unless we urgently stop and reverse deforestation. This will require developing ways to put an economic value on standing forests that will benefit the peoples of some of the world’s poorest countries and regions.

Economic growth, social equity and a healthy climate need not be opposing goals. By dramatically increasing “carbon productivity” – just as we have increased labour and capital productivity in the past – we can enjoy a growing economy and falling greenhouse gas emissions. Better still, the prospect of an improvement in social equity can avoid the risk of a “carbon divide” that might further separate the wealthy and the poor. Humanity has engineered many revolutions over its millennia of progress: The agricultural, industrial and information-age revolutions have expanded the economy and enriched society. A “carbon revolution” now holds out the hope of similar progress.

Eric Beinhocker is a senior fellow at the McKinsey Global Institute. Jeremy Oppenheim is the leader of McKinsey’s Climate Change Special Initiative.