Higher carbon prices can spur investments in cleaner technologies
Making carbon emissions more expensive can encourage heavily polluting companies to invest in cleaner technologies, new research shows. The findings, recently presented to international policymakers, also highlight a challenge: companies need access to financing to make the transition.
Christian Thomann, affiliated researcher with both the House of Sustainable Society and Swedish House of Finance at the Stockholm School of Economics, presented the research at a webinar last week hosted by the Coalition of Finance Ministers for Climate Action. The Coalition brings together fiscal and economic policymakers from more than 100 countries to support climate action and the transition to low-carbon economies.
The study asks a question with direct relevance for climate policy: What happens to companies’ investments when emitting carbon becomes much more expensive?
The researchers studied Swedish manufactu
ring firms between 2000 and 2019, a period when the effective cost of emitting carbon rose by around 400 percent. They found that the biggest polluters responded by investing more, including in equipment and technology designed to reduce emissions.
“Carbon pricing is meant to give companies a reason to reduce their emissions. What we see is that when the price becomes high enough, the most carbon-intensive firms respond by investing in new and cleaner capital,” says Christian Thomann.
High-emitting firms increased investments
After a sharp rise in carbon prices from 2014, capital investment in the most carbon-intensive manufacturing industries, such as cement and steel, increased by more than 83 percent. The increase was 16 percent in the rest of manufacturing.
The researchers also found a particularly strong effect on investments aimed at cutting pollution. Among the highest-emitting firms, a 10 percent increase in the cost of emitting carbon was associated with a 7 percent increase in investments to reduce emissions.
This is important because reducing industrial emissions often requires more than changing day-to-day operations. Companies may need to replace existing machinery and production systems with cleaner alternatives. The findings suggest that sufficiently high carbon prices can help make those investments more attractive.
Access to finance makes a big difference
But not all high-emitting firms responded in the same way. The increase in investments mainly came from companies that had enough resources available internally. These firms reduced the amount paid to shareholders as dividends by roughly as much as they increased investments.
“Putting a price on carbon creates an incentive to change, but firms also need the financial capacity to act on that incentive,” says Thomann. “For policymakers, our results show why carbon pricing and access to finance need to be considered together.”
A higher carbon price can give companies a stronger reason to replace polluting equipment, but companies with fewer financial resources may struggle to make those investments – even when the incentive to do so is strong.
Lower emissions may take time to follow
The research also helps explain why climate policies may take time to produce visible reductions in emissions. Replacing large industrial equipment and production systems can take years. Reduced emissions resulting from investments in cleaner technologies today may therefore only become evident further down the road.
For finance ministers, the findings point to two connected issues: Carbon pricing can create a strong incentive for high-emitting firms to invest in cleaner technology, but the response might be concentrated among firms with enough internal funds to finance those investments.
Research details
“Carbon Pricing and Investment”
Authors:
- James R. Brown, Professor and Department Head, Texas A&M University
- Gustav Martinsson, Professor of Finance at Stockholm University and affiliated researcher with the House of Sustainable Society and Swedish House of Finance at Stockholm School of Economics
- Per Strömberg, Professor of Finance at Stockholm School of Economics and affiliated researcher with the House of Sustainable Society and Swedish House of Finance
- Christian J. Thomann, Associate Professor of Corporate Finance at KTH Royal Institute of Technology and affiliated researcher with the House of Sustainable Society and Swedish House of Finance at the Stockholm School of Economics
