Scaling Up Low-Carbon Technologies with Dynamic Industrial Policy

This commentary is part of the annual Energy Futures Forum, a project from the CSIS Energy Security and Climate Change Program exploring changes to the energy and climate landscape over the next 10 years.

The Current Context for Low-Carbon Technologies

Addressing climate change requires a more comprehensive, inclusive, and dynamic approach to stimulating innovation and accelerating adoption of low-carbon technologies. Expectations, experimentation, and iteration will be key to successful implementation of the transition to a clean energy economy. The urgency of addressing climate change has made the speed of the transition a key policy goal and elevates the role of a virtuous cycle of low-carbon technology adoption, improving performance, reducing costs, and improving feasibility, all of which begets more adoption. For many low-carbon technologies, the United States is reaching the takeoff mode within the S-curve of technology adoption, which in turn is making net-zero emissions goals feasible. In the U.S. context, implementation at the state level, including permitting and local learning, are becoming the focal point as the ten-year program of tax credits and other incentives under the Inflation Reduction Act (IRA).

At present, major progress in a broad range of low-carbon technologies, enabled by digitalization, is making the transition to a low-carbon economy more feasible and affordable. Despite this progress, the rationales for policy intervention remain. Negative externalities associated with pollution, positive externalities associated with knowledge spillovers from investments in innovation, and other market failures create a strong need for policy support. The combination of the Infrastructure Investment and Jobs Act (IIJA) in 2021, the CHIPS and Science Act in 2022, and, crucially, the IRA in 2022 provide a substantial step in the right direction in addressing these market failures. A key attribute of this set of bills is that they represent a comprehensive policy mix, rather than relying on a single policy instrument, and thus suitable to a context of multiple market failures. The combination also makes the policy mix more robust, such that they create consistent expectations for investors over a long period of time and are less sensitive to short-term perturbations such as business and electoral cycles.

Technological Advances Make Net-Zero Emissions Targets Feasible

Empirical results show that improvements in low-carbon technology are helping make net-zero emissions targets feasible. Purposive policy support in the past has helped catalyze these improvements. A key mechanism behind these changes has been learning by doing, which is the notion that technology adoption creates opportunities for improving technology (for example by user-led innovation), gains from economies of production scale, and incremental improvements in manufacturing that increase as technology adoption increases. Once initiated, this process can become self-reinforcing as the resulting learning leads to lower prices and thus access to a broader set of users, whose adoption in turn begets more opportunities for learning by doing.

This mechanism has been in place for a variety of low-carbon technologies and the empirical evidence shows these changes have been dramatic. For example, the 2022 Intergovernmental Panel on Climate Change (IPCC) report shows that the cost of three key mitigation technologies—solar, wind, and batteries—have steadily declined in cost. Costs of wind power has fallen by more than 50 percent in the past 10 years, solar by almost 90 percent, and batteries relatively the same.

These cost declines have also been associated with exponential growth in technology adoption. While their overall shares of energy and transport remain in the single digit percentages, their continued exponential growth over the next several years would transform them to become the core of the electricity and transportation system. Indeed, the International Energy Agency has predicted this.

Policies have played a central role in enabling these trends, including public research and development (R&D) funding, technology demonstration programs, support for early niche markets, as well as subsidies and emissions trading, which create large and growing markets. These changes have gone well beyond the incremental and early stage. The 2022 IPCC report found that 18 countries have reduced their emissions over a period of at least 10 years, even when counting their emissions embodied in imported goods for emissions generated in other countries. The United States is one of these 18 countries. While global emissions continue to grow, that growth has slowed and continued technology improvement has the potential to reverse emissions in other countries. Rapid decarbonization in pursuit of net-zero emissions in the 2050–2070 period is now feasible. Continued improvement depends on continued policy support.

Policy Rationale and Policy Evolution

Despite these impressive advances in the costs and adoption of low-carbon technologies, governments still have a role to play for at least five reasons:

1. Pollution Externalities: Emissions of greenhouse gases create damages not incurred by those making decisions about emitting activities leading to over-production of those activities.
2. Knowledge Spillovers: Investments in innovation, such as research and design, can be reverse-engineered and imitated by competitors leading to underinvestment in innovation.
3. Innovation System Failures: Successful innovations depend on the health of seven key functions of innovation systems, such as resources, guidance of search, and entrepreneurialism.
4. Inclusive well-being: The distribution of the benefits of technology and policy matters, beyond their aggregate impact on social welfare.
5. Speed of Transition: The United States and 195 other countries were signatory to the 2015 Paris Agreement to keep global temperature change below 2 degrees and make efforts to keep it below 1.5; it is at 1.2 at present. Both targets require emissions to reach net zero—by 2050 for 1.5 and by 2070 for 2—and both require rapid transformation of the global economy.

Climate policy design can improve outcomes by taking these market failures into account.

The Bedrock of U.S. Climate Policy

The IRA on its own it is expected to reduce U.S. greenhouse gas emissions by 15 percent compared to the next 10 years without the IRA in place. A first important aspect of the IRA is that it on its own comprises a policy mix, including adjustments to the tax code creating incentives for a wide variety of climate mitigation measures, as well as non-climate components addressing deficit reduction (thereby addressing inflation) and access to prescription drugs. The IRA was passed on a party-line vote requiring only a simple majority because it was passed via the budget reconciliation process. Consequently, its measures need to have direct impacts on the federal budget and thus its measures primarily include changes to the federal tax code. The incentives address a wide variety of climate mitigation measures, including the core mitigation technologies like solar, wind power, and electric vehicles. It goes well beyond including demand-side measures (such as building energy efficiency retrofits), industrial decarbonization (such as carbon capture at industrial facilities), agriculture, and carbon removal technologies, among others. The diverse programs within the IRA also include a green bank, transit-oriented development, community engagement, and coastal adaptation.

A second crucial aspect of the IRA is its durability. Investors depend on a reasonable degree of policy certainty to make longer term investments, such as training employees and developing automation in production facilities. But the history of energy policy making in the United States has been characterized not by certainty but rather by policy volatility. Emission permit prices have risen and fallen, subsidies have come and gone, and commitments made under one administration have been reversed by the subsequent administration. Several aspects of the IRA make expectations much firmer. The IRA tax credits will be in place for about 10 years, 2022­–2031. Congress passed it so is not easily reversible like an executive order. It updates the federal tax code, which itself has been less susceptible to frequent change. It also has the potential to expand the coalition supporting it. To date one estimate finds that 80 percent of IRA credits in 2022 went to Republican congressional districts. These features mean that investors and firms can make long-term investments and know that the policy environment will be supportive.

Third, the IRA may turn out to have a larger impact than initially expected because of the virtuous cycle of technology learning. Because its climate provisions consist mainly of tax credits for low-carbon technology adoption, its aggregate value depends not on Congress but on technology adopters and others who file with these tax credits. Given what has been observed with the positive feedback mechanism of technology adoption in creating opportunities for cost reductions, resulting in lower prices and thus further adoption, there might be a larger impact than expected. As a result, estimates of the value of its climate package range from an initial assessment of $369 billion by the Congressional Budget Office with external estimates above that, for example $800 billion (Credit Suisse). Indeed, the justification of the higher estimate emerged from including technology learning. Further, the IRA should affect technology adoption outside the United States as well, even if the tax credits do not extend to those adopters, the lower prices of low-carbon technology will.

Implementation Challenges

Whereas technology dynamics and global effects give the IRA the potential to have a much bigger impact than expected, key implementation challenges exist:

• Rent-Seeking: Decisions about how to allocate funds and tax credits could be influenced by those positioned to benefit from them.
• Selection, Picking Winners: Government have assumed some responsibility for allocating across technology areas.
• Information Access: Agencies are making decisions that require detailed information and datasets.
• Risk Aversion: Bureaucrats may be focused on maximizing success of individual projects rather than a higher reward portfolio of higher-risk projects.
• Crowding Out: Government activities may substitute for private sector ones, especially if there is a tendency to minimize risk.
• International Linkages: Accessing the robustness and speed of a globalized innovation system while accommodating the recent imperative for national and local autarky.

Much of the IRA’s implementation will occur at the state level. Public utilities who regulate electricity and the increasing links to transportation will be central. The vast array of projects emerging from the new IRA incentives is most likely to be hindered by slow permitting. A robust result from modeling studies is that taking full advantage of emerging clean energy supply depends on expansion of the electricity transmission system. Permitting for it, as well as additional infrastructure, such as solar farms, wind farms, and carbon dioxide pipelines, depends on a light and fast permitting system. Federal permitting reform could play a central role, and states will be at the center whether there is federal action or not. Finally, local implementation, and resistance to it, will be central. We have seen in previous work that a process of local learning, for example where solar installers observe each other and share acquired know-how has had the best outcomes in enabling rapid adoption and has the important benefit of accumulating benefits within local communities. This further enhances durability and public support for the transition effort.

Dynamic Industrial Policy for Climate Change

The IRA, along with IIJA and CHIPS, is a major step forward on policy to develop and deploy the technology needed to address climate change, for the United States and for the world. This policy mix represents the logical progression from 50 years of policy directed toward energy and the environment. It also provides a test case of an emerging policy design architecture, dynamic industrial policy for climate change, which includes the following characteristics:

1. urgency and acceleration as policy goals;
2. access, inclusivity, and social acceptance as central goals from the start;
3. the adoption of multiple policies in a strategic sequence;
4. deep government engagement in the process of innovation;
5. support for local learning, implementation, and system integration;
6. boosted capacity in government for information and decisionmaking; and
7. innovative and adaptive policy to generate policy learning.

The triad of IRA, IIJA, and CHIPS, combined with continued cost reductions and rapid adoption of low carbon technology creates the opportunity for a transformative impact for climate change. The outcomes now depend increasingly on how well implementation is handled at the state and local government level, as well as U.S. interactions with other countries pursuing related initiatives with their own idiosyncratic approaches.

Gregory Nemet is a professor at the La Follette School of Public Affairs at the University of Wisconsin-Madison and a participant in the CSIS Energy Security and Climate Change Program’s 2023 Energy Futures Forum.   

The 2023 Energy Futures Forum was made possible by support from Chevron and general support to the CSIS Energy Security and Climate Change Program.