Green economy transition - examining the role of public finance and fiscal policy

08 November 2017

Discussions about the global green economy transition, the kind of which will take place at COP 23 this month, usually focus on its environmental or developmental impacts. But the global transition to a greener economy will also transform the public finances of many countries, particularly those dependent on natural resources.

Admittedly, the link between the transition to a greener economy and public finance may not be obvious. However, once the connection is understood, the implications for public finances and economic development are quite startling.

We have been working with the European Bank for Reconstruction and Development to do just that. In fact, we will be talking at COP 23 to argue for developing a better understanding of the linkages between public finance and the green economy transition.

How is public finance linked to the green economy transition?

So how are these two issues connected?

In essence, the link stems from an extension of the stranded assets debate which argues that natural resources, such as fossil fuels, may become unviable in the future from either a financial perspective due to changes in patterns of production and consumption or from a regulatory perspective due to global emissions reductions targets. This could result in significant financial risks for asset owners, such as through premature write-offs and devaluation of assets exposed to the financial and regulatory implications of the green economy transition.

And this is where public finance is implicated. This can be broken down into two areas, corresponding to the dual role of governments as both asset owners and fiscal policy makers.

1. Government as an asset owner

Governments are, collectively, one of the largest owners of assets that will be exposed to risks related to the green economy transition. For instance, in 2014, governments were estimated to own interests amounting to over 50% of global fossil fuel production, and as much as 70% of global oil and gas production.

This role of asset owners creates direct exposure for public finances from the financial risks of asset stranding.

2. Government as a fiscal policy maker

Public finance also faces indirect exposure to the financial risks of asset stranding through the framework of tax and spending policies developed and administered by governments. Changes to the economic value of assets due to the process of stranding will be transmitted to public finances through these policy linkages. For instance, asset stranding has the potential to influence the value of tax revenue generated by the oil sector, which could have consequences for transfers to sovereign wealth funds backed by hydrocarbon revenues.

While the focus is predominantly on the risks to public finances, there may well be some opportunities. For instance, as fossil fuel prices drop due to falling demand as a result of the green economy transition, the cost of providing fossil fuel subsidies will also fall. This could create expenditure savings and, more importantly, an opportunity to reduce the level of subsidy further (or even phase out completely).

In short, the process of asset stranding will change the composition of government revenues and expenditures through a combination of direct and indirect mechanisms. Without timely and appropriate fiscal policy responses to these impacts, the net effect could result in a deterioration of public finances.

Indeed, if left unchecked, these impacts could quickly result in unsustainable levels of government debt or depletion of sovereign wealth funds. And this would not be consistent with principles of intergenerational fairness and could pose significant obstacles to realising the long-term economic vision of many countries.

In our next blog, we’ll look at how fiscal policy can respond to the impacts of a green economy transition.

For more information please contact:

Amal Larhlid  - Leader, Global Fiscal Policy Advisory
T: +44 (0) 207 804 0339 | E: [email protected]

Andrew Wilson - Global Fiscal Policy Advisory
T: +44 (0) 207 213 4605 | E: [email protected]