Getting government green industrial policy right

By Bruno Arcand

Bruno Arcand is a PhD candidate at the School of Public Policy and Administration at Carleton University and is affiliated with the Centre for Net-Zero Industrial Policy.

In recent years, green industrial policy – that is, the intentional effort by states to restructure the economy towards low-emission, resource-efficient prosperity – has gained global momentum in political circles.

Canada is no exception. The federal government signaled the importance of a “robust” industrial policy to advance the net zero transition and grow the economy.

As some observers pointed out, there is work to be done to improve the institutional foundations of Canada’s green industrial policy. Still, the rise of green industrial policy represents a shift in government rhetoric: from a focus on carbon pricing as the “cornerstone” of its climate strategy to the need for massive public investments in building a green economy. 

Yet some critics question the value of this approach. A common objection to industrial policy is that it amounts to state efforts to “pick winners,” that is to say, favoring – usually through subsidies and preferential treatment – specific regions, sectors or technologies.

Economists are generally skeptical of this approach to boosting economic growth. This skepticism comes in two main forms.

The first is information-related: critics argue that governments lack the expertise to allocate capital efficiently. The second has to do with incentives, where government decisions are perceived as being driven more by political than economic considerations (think of all the issues politicians must worry about, beyond productivity, to win elections).

These two obstacles reinforce each other. Governments’ lack of technical expertise makes it dependent on private input, which encourages businesses to organize and influence policymaking and can lead to even more politicized public investment decisions.

In the past, many have used this line of argument to oppose public investment in specific technologies. This opposition persists in the case of green technologies.

Economists' conventional wisdom is that the most effective way to grow the economy while reducing emissions is to set an economy-wide price on carbon. A key reason is due to its technological neutrality; a carbon price lets the market choose the winning technologies through pricing mechanisms, rather than government intervention.

As a result, some view subsidies that target specific green technologies as inefficient and costly.

Certainly, some level of skepticism can be useful to avoid exaggerating the promises of green industrial policy. Past failures illustrate the importance of institutional safeguards (such as independent policy evaluation) to minimize policy costs.

How can government pick winners well?

Yet the argument that “government cannot pick winners” seems misleading to guide the role of the state in tackling climate change, for at least two reasons. 

The first concerns empirical evidence around climate policy. Over the past few decades, the deployment of carbon pricing mechanisms has been slow, and the results (in terms of emissions reductions) are rather limited to date.

Moreover, a global carbon pricing regime seems unlikely due to difficult international cooperation. In this context, the track record of carbon pricing pales in comparison with the high expectations that economists tend to have for it.

On the other hand, scholars have shown the key role of public investments in driving down the cost of green technologies (think of solar and wind) and building global momentum for decarbonization. Empirical evidence therefore suggests a more effective view of green industrial policy than that portrayed by its skeptics.

The second reason concerns the role of the state in the development of fossil fuel-based energy systems. Over the course of the 20th century, countries made massive investments to support the growth of hydrocarbons and their infrastructures.

Achieving net-zero emissions implies a societal transformation similar to past energy transitions, which, as history shows, greatly benefited from an active role by states in shaping the pace and direction of technological change. Policymakers should therefore strive to learn from these past transitions before pursuing a technology-neutral approach that is theoretically the most efficient but has little empirical basis. 

All this suggests that the key question is not whether governments can pick winners, but how to do it well. One way to help us think about this issue is to consider the specific goal of achieving net-zero emissions by 2050.

Reports from major international organizations (such as the International Energy Agency, and BloombergNEF) indicate that technological clarity around net-zero pathways varies from sector to sector. In practice, this means that state strategies for picking winners should be sector-specific.

In certain sectors, experts broadly agree on the main technology for delivering net-zero emissions: for example, electricity for passenger cars, heat pumps for space heating and renewable energies for power generation. In such cases, the main challenge for states seems to be less about picking the “right” technology and more about coordinating investments across the value chains to accelerate net-zero transitions while maximizing domestic economic benefits.

In other sectors, there is much greater technological uncertainty around net-zero pathways (e.g. cement, steel, petrochemicals, marine shipping, aviation).

A good way to think about picking winners in these cases is experimentation: funding technologies through a portfolio of projects with clear success metrics (targets) and institutional safeguards to “kill” unpromising technologies.

The U.S. Defense Advanced Research Projects Agency (DARPA), which has funded cutting-edge technologies (e.g. GPS, the Internet), offers a useful blueprint to learn from.

Additionally, the net-zero target reduces reliance on novel technologies to deliver deep decarbonization. As the International Energy Agency pointed out, most technologies needed to put the global economy on a net-zero path already exist – being either on the market or in prototype and demonstration phases.

For states, the priority should be speeding up the learning curve of existing but immature technologies, rather than inventing novel ones. This approach reduces the risk of picking the “wrong” technologies.

A key task for policymakers in this context is to roll out technologies in the right sectors and regions. This entails going beyond the goal of de-risking green technologies. States need to invest in infrastructure and adapt the regulatory framework to advance net-zero transitions, both of which are bound to be technology-specific. 

Shifting to productive dialogue on green industrial policy

The argument to oppose industrial policy because governments can't pick winners has always been somewhat misguided. This seems all the more true in the net-zero context.

There is little reason to believe that technology-neutral policies are best placed to transform the economy and achieve a specific environmental performance (net zero) by a specific timeline (2050).

The Inflation Reduction Act, which places public investment at the center of U.S. climate strategy, reinforces the need for Canada to move away from market fundamentalism to navigate this competitive landscape.

Clearly, stressing the importance of green industrial policy is one thing; putting it into practice is quite another. In Canada, governments must overcome the long tradition of hostility to industrial policy, which undermines their capability to drive economic development.

A key starting point for Canadian policymakers should therefore be to develop in-house expertise and public-private institutions to access high-quality data and set up rules-based institutions to guide their climate investments.

Getting these institutional reforms right will be crucial to overcoming the pitfalls of green industrial policy.

But to get there, we must first recognize that the “picking winners” dilemma is not the end, but the beginning of the conversation about what makes good green industrial policy.

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