It’s bad for ya!

With apologies to George Carlin. A couple of weeks ago, I was closing my post on how to counter Chinese industrial policy with a bit of a rant about German carmakers. Today, I want to take up where I left and give another example of short-sighted investment decisions and their long-term consequences. This example has been provided by the government of David Cameron and Chancellor George Osborne in the form of austerity between 2010 and 2015.

After the financial crisis of 2008-2009, governments were suddenly confronted with much higher debt loads than they were used to in the past. They feared that this debt would reduce future growth, a belief largely driven by faulty and since debunked research. Hence, governments decided to reduce spending drastically to reduce the debt pile as fast as possible.

Nowhere has this austerity policy been more comprehensively enacted than in the UK. But today, we know that austerity was a terrible policy. First, economists are increasingly convinced that the pain of austerity was worse than the eventual gains in the form of lower debt/GDP-ratios. Second, austerity hit poorer households harder than wealthier ones, which in turn created resentment and helped drive the surge in populism.

But austerity also was bad for the climate and household finances as a case study by Immanuel Feld and Thiemo Fetzer indicates. In 2012, the UK government launched the Energy Company Obligation (ECO). Part of this scheme was an initiative to supply the most deprived households with retrofit energy efficiency measures such as double-glazed windows or wall and roof insulation to help them save energy. While the measure was nationally developed and funded, local councils were tasked with finding the households that would benefit the most from the scheme and coordinating the installation.

Unfortunately, though, local governments were defunded by austerity at the same time, depriving them from the much-needed personnel and knowledge to identify the right households and coordinate the retrofitting. As the charts below show, local authorities that suffered larger funding cuts made fewer retrofit installations.

Austerity and energy efficiency retrofit measures

Source: Feld and Fetzer (2024)

Fast forward to 2022 and we are in the middle of an energy crisis with natural gas prices going through the roof. And guess what, the government has to support households with subsidies to reduce their energy bills. In particular low-income households need those subsidies to survive. But these are the very same households that would have had more energy efficient homes and lower energy bills to begin with had the government not cut spending on local governments a decade earlier. In t he long term, then, the government spent more on providing energy subsidies to households than it cost to retrofit houses and reduce energy bills.

Today, we are again at a crossroad. Low economic growth and high inflation have created a backlash against investments needed for the energy transition. As a German news site recently put it: “People aren’t in the mood to save the climate”.

Are we once again going to give in to short-term thinking and the lack of money in government coffers and shrinking corporate profits? Or we can invest in our future, whether that is renewable energy, climate change adaptation, or innovative new technologies? The investments may reduce profits and increase deficits in the short run, but – if we are investing rather than consuming – it will increase long-term profits and reduce deficits while simultaneously save the planet.