Alan Finkel explains the carrot and stick approach for a zero-emissions energy system

The world is undertaking the most difficult energy and economic transition since the start of agriculture – the enormous technological challenge to build the reliable, affordable, zero-emissions energy system of the future. 

Government interventions are essential to realising this transition. In Australia, the United States and many other countries, governments have provided incentives and implemented mandates for solar, wind and other zero-emissions technologies. Despite the enormous success these public investments have stimulated, much more needs to be done to drive the rapid electrification required to reach net-zero emissions.

Ultimately, the scale of required investment is much greater than what can be achieved by government alone. Fossil-fuel markets worked because they brought tremendous convenience to consumers. We need clean energy markets to work similarly well. Governments can nurture the growth of well-functioning markets by putting the right regulatory settings in place. They can stimulate demand for clean energy through subsidies, mandates, direct investment and carbon prices. Systematically building demand will attract investors and minimise supply-chain disruptions. 

Government interventions can generally be divided into ‘carrots’ – incentives such as subsidies – and ‘sticks’ – constraints such as carbon taxes and emissions trading schemes. 

Sticks

Most economists argue that an economy-wide price on carbon dioxide emissions – a carbon tax or an emissions trading scheme – is the most efficient and cost-effective way to stimulate the shift to net-zero emissions. The principle is that with an explicit price on emissions, the market will find the most economical paths forward. 

In emissions trading schemes, the desirable outcome, in which companies take steps to reduce their emissions, is not guaranteed because some companies will choose to pass on their costs to consumers, or purchase credits rather than invest in low-emissions technologies. Although purchasing credits is consistent with the economy-wide goal of reducing emissions for that year, it postpones the kind of investment that would provide long-term emissions reductions. 

The former chief scientist of Australia, Alan Finkel. Source: Supplied

Carbon taxes, by contrast, are predictable and cannot be avoided by purchasing credits, but they require governments to have a high degree of insight into the appropriate dollar value to be levied.

Ideally, carbon-pricing schemes would be implemented across the economy and in all countries. When they are limited to certain territories or sectors, they put domestic manufacturers at a disadvantage and can result in emissions being offshored to other countries. The planet is no better off. A better alternative would be a carbon consumption tax, as proposed in 2012 by Oxford University economist Dieter Helm. Such a tax would be applied to all goods, whether produced domestically or imported. It would avoid the need to protect trade-exposed industries, avoid driving manufacturing offshore, and allow countries to do what is right without fear of being disadvantaged. The European Union commitment to a carbon border adjustment mechanism (CBAM) to commence in January 2026 is a step towards Helm’s vision. 

Carrots

Increasingly, governments are turning to subsidies to drive the transition to low-emissions solutions. The advantage of subsidies is that they can be specifically directed to drive the adoption of initiatives that would otherwise be unaffordable before reaching scale. These initiatives include scaling up zero-emissions technologies, permanently reducing demand through efficiency measures, and diversifying the supply chain.

Such measures provide lasting benefits by driving down costs for future adoption. They can also be used to thwart unacceptable practices, such as forced labour and child labour. In some cases, they are used to achieve economic benefits such as the creation of regional jobs, or foreign policy benefits such as avoiding supply-chain dependencies on Russia and other countries of concern.

On 16 August 2022, US President Biden signed into law the Inflation Reduction Act, the most significant climate legislation in the country’s history. The centrepiece of the Act is a series of investment and production tax credits estimated by global investment bank Credit Suisse to be in the vicinity of US$800 billion. Given that every dollar in tax credits will attract several investor dollars, the total investment driven by the Act will be in the trillions. The hope is that this big step in spending will enable the United States to cut its emissions by 42% below 2005 levels by 2030. 

The cover of Alan Finkel’s new book, Powering Up: Unleashing the Clean Energy Supply Chain. Source: Supplied

The Act is all carrot. It is silent on carbon taxes and emissions trading schemes, but offers tax credits, loans and grants for investments in specific technologies, including solar farms, wind farms, electric vehicles, batteries, hydrogen, carbon capture and storage and sustainable aviation fuels. 

It is also a made-in-America Act. Businesses will be incentivised to manufacture in America. Tax credits will be higher if American steel is used in wind turbines. Electric vehicles will only qualify for subsidies if the minerals used in their batteries were mined and processed in America, Canada, Mexico or countries, such as Australia and Chile, with which the United States has a free trade agreement. 

The risk for other countries is that the Act will act like a magnet, attracting global investment and skilled workers. Just six months after the Inflation Reduction Act was legislated, US$90 billion of investment had been committed to clean energy projects.

The Act has a strong focus on jobs creation. But not just any jobs. It favours jobs that are well paid, skilled, and located in areas at risk of losing traditional jobs. For example, there will be dedicated grants and tax credits to support investment in the traditional car-building regions. 

Importantly, Republican-governed states benefit as much from the Act as Democratic-governed states. Even if the US election in November 2024 returns the presidency to the Republican Party, it is unlikely that Republicans in a future Congress would want to reverse legislation that is driving investment in their states. 

At home

The US federal government’s support for the clean energy transition is not unique. Let’s look at what is happening in Australia. 

Australia has been moderately successful in its solar and wind uptake. Following record investment, solar and wind’s share of electricity generation jumped from 9% in 2017 to 27% in 2022. Consequently, coal-fired electricity’s share fell from 71% to 56%, and natural-gas-fired electricity fell from 13% to 9%. By the end of 2021, the installed solar generation capacity was 990 watts per person in Australia, the highest in the world. The more ambitious policies brought in by the change of federal government in May 2022 will build on this base, with a target of 82% renewables by 2030. 

There are no carbon taxes or emissions trading schemes in Australia. However, the government is in the process of activating an existing scheme called the Safeguard Mechanism that will require Australia’s largest greenhouse gas emitters to keep their net emissions below a baseline allowance. The baseline will be progressively reduced each year through to 2050. 

The stronger policy efforts of the Albanese government, such as the $20 billion loan program for transmission lines, are well supported by increasingly ambitious state governments, which for some years now have provided support to stimulate investment in renewables. The focus on the clean energy transformation is strong, across the nation.

When it comes to responding to climate change, we must listen to the scientists. But we also need to listen to the engineers and economists. We need to reduce emissions as rapidly as possible while ensuring ongoing economic prosperity. 

Difficult as the transition is, for forward-looking countries, companies and individuals, it is full of opportunity to usher in the Electric Age and bring climate change to a halt.

Alan Finkel was Australia’s chief scientist from 2016 to 2020. He is a neuroscientist, engineer and entrepreneur. 

This is an edited extract from his new book, Powering Up: Unleashing the Clean Energy Supply Chain, which is available now.