Climate Policy from a Keynesian Point of View


People may arrive in one or the other of these camps for many reasons. Advocates of the investment-centred approach tend to link climate policy to broader concerns over economic justice. Developments like the Gilets Jaunes protests in France, and more recent responses to rising energy prices in the wake of the war in Ukraine, have raised doubts about the viability of aggressive carbon pricing, making an investment-centred approach more attractive. More subtle, but equally important, are the different underlying economic visions behind the two approaches to climate policy. This paper brings these submerged differences to the surface.


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Climate change is perhaps the greatest challenge of our times. Few today disagree on the need for immediate action to reduce carbon emissions. But there are deep divides over what kind of action is called for.

To an economist, one division stands out, between what we might call a price-centred versus an investment-centred approach to climate policy. The first sees the fundamental problem as a market externality. Because the cost of carbon emissions is not incorporated into prices, we spend too much on carbon-intensive goods and services and too little on alternatives. The goal of regulation should be to correct this mispricing; once this is done, private businesses and consumers can find the lowest cost path to decarbonising the economy in a decentralised way. From this point of view, the fundamental choice is how high the carbon price should be. This in turn reflects the trade-off between reducing carbon emissions and maintaining current living standards. The faster we want to move towards our long-term climate goals, the more consumption we will have to give up in the present.

Until recently, the dominant perspective on the economics of climate policy was a tradeoff between current consumption and climate spending, where the key question is how to set the right price for climate externalities.[1]

More recently, though, a different approach to climate policy has been gaining ground and emphasises more direct measures to boost climate investment rather than taxes or other forms of carbon pricing. This vision of climate policy, sometimes referred to as the Green New Deal in the United States or the Green Deal in Europe, sees decarbonisation as a project of actively building up a low-carbon economy, with the state playing a leading role, both through public investment and measures to direct private spending. This second vision rejects the trade-off between climate goals and current living standards.

People may arrive in one or the other of these camps for many reasons. Advocates of the investment-centred approach tend to link climate policy to broader concerns over economic justice. Developments like the Gilets Jaunes protests in France, and more recent responses to rising energy prices in the wake of the war in Ukraine, have raised doubts about the viability of aggressive carbon pricing, making an investment-centred approach more attractive. More subtle, but equally important, are the different underlying economic visions behind the two approaches to climate policy. In this paper, I bring these submerged differences to the surface. In particular, I sketch out the radical Keynesian vision of the economy that underlies strong forms of the investment-centred response to climate. I hope this elucidate how disagreements over climate policy arise, not just from different political judgements or preferences, but from alternative models of how the economy works.

Alternative visions of the economy

The fundamental macroeconomic model in modern macroeconomics is of a single, infinitely lived, infinitely foresighted “representative household” choosing how to best divide their time between labour and leisure. This single household performs all the labour in the economy and also owns all the capital goods; they have a given technology for turning labour into products and services, and for investing today to produce more in the future. They know the true probabilities of all possible future events that might change these trade-offs. Based on this, they can pick the future path that gives them the best trade-off between labour and consumption.

Of course, there are many variations on this basic model, but they share the essential features that resources and technology are given, known, and fully utilised; the only question is what way of using them will deliver the most well-being or utility.

It is this conception of economics that the Keynesian revolution challenged, though it did not ultimately overturn it. The heart of the Keynesian vision is the idea that the central economic problem is not scarcity, but coordination. Production does not just require the use of labour and other resources, it also poses immense organisational problems. Industrial production requires the cooperation of enormous numbers of people. Modern corporations, financial institutions, and governments have allowed us to cooperate on a larger scale than in earlier times, but there is an almost endless scope for further improvement. So while limits to physical resources certainly exist – this is why we are talking about climate policy in the first place – it is wrong to imagine them as adding up to an overall limit on potential output. A country may possess a certain number of acres of arable land or a certain annual flow of potable water, but to turn these into an economic constraint, we must assume they are already being put to their most valuable use. This would be plausible in a world where a single agent made all decisions about production, using a fully-specified technology. In the real world, it is less so.

As development economist Ha-Joon Chang likes to point out, real processes of economic development look nothing like the smooth trade-offs between present and future goods described by economic theory. His native South Korea is a case in point. In 1960, it was one of the poorest countries in the world – one of its main exports was human hair for wigs. Its ascent to one of the world’s leading exporters did not come from new endowments of resources falling from the sky, nor did it involve any sacrifice of current consumption in return for faster growth – Korean living standards rose rapidly during industrialisation. Rather, it came from new coordination mechanisms that greatly expanded society’s productive capabilities. Through a variety of mechanisms, the state actively channelled investment to new higher-productivity industries.[2] The orthodox economics that says we cannot have rapid decarbonisation without giving up current consumption would have ruled out this sort of industrialisation, too.

A Keynesian vision of climate economics

What does all this mean for climate policy? In the first place, it means that decarbonisation will be experienced as an economic boom. If we imagine the economy in terms of a fixed pot of resources to be allocated, then devoting more to climate goals must mean less for other purposes. If we think of the economy as an open-ended process of cooperation, then there is every reason to think that a big influx of new spending will mean more production of all kinds, especially if it is accompanied by new forms of coordination.

Renovating buildings, investing in new structures and equipment, building infrastructure and so on all add to demand. The decommissioning of the existing means of production does not, however, subtract from demand. Global investment in renewable energy and transmission, to take one important example, is already several times greater than investment in fossil fuel-generation capacity.[3] The former could easily rise to many multiples of its current level, while the latter cannot fall below zero. So a more rapid energy transition will certainly see higher investment in the aggregate. The same goes for other areas. A shift towards higher-density settlement patterns – an important part of a lower-carbon world – will involve a period of higher housing investment, even if the total amount of housing does not change.

It is important to distinguish here between the transition and hypothetical endpoint. The world of 50 or 100 years from now may well involve less market activity, less time spent in paid employment, and lower or even negative growth in wages and gross domestic product as we currently measure it. A world with more opportunities for creative expression, participation in public life, and time with family and friends could be experienced as one of material abundance, even with far less of the carbon-intensive activities we currently measure as “the economy”. But however we imagine life in the distant future, any path to a different world will require large outlays of money the faster we traverse it. In our world of chronic demand constraints, that implies faster-measured growth and higher incomes during the transition.

The second major implication of the Keynesian view of the economy is that there is no trade-off between decarbonisation and current living standards. The idea that there is a hard trade-off between current consumption and decarbonisation rests on the assumption that there is no meaningful slack in today’s economy, and that workers are already engaged in the highest level of productivity activity they are capable of. There is no reason to think this is true. The workers engaged in, say, expanding renewable energy capacity are not being taken away from equal-value activity in some other sector. They are, in the aggregate, un- or underemployed workers whose capacities would otherwise be wasted – and the incomes they receive in their new activity will generate more output in demand-constrained consumption goods sectors.

Another reason why decarbonisation need not come at the expense of current living standards is the prevalence of  increasing returns. Conventional economic models assume that production normally takes place under conditions of rising marginal costs – each unit of output costs more than the last one. But in real industries, per-unit costs fall as output rises because learning-by-doing seems to be almost universal in industry – the production process itself is the best source of knowledge about potential improvements.

Increasing returns fundamentally change the economics of decarbonisation. In a conventional model, substituting sustainable production for carbon energy production, for example, means replacing a lower-cost technology with a higher-cost one, and the cost disadvantage of the sustainable technology will only get worse as its share of production rises. This implies that decarbonising energy production will require devoting more resources to energy production than we otherwise would. In a world of increasing returns, by contrast, a new technology may initially face a cost disadvantage but that will narrow or disappear as it is more widely adopted. It is no secret that costs for many forms of renewable energy have fallen steeply as their scale has grown. In the United States, for example, the cost of solar power construction fell by half between 2013 and 2019, while the pace of capacity addition doubled.[4] In a conventional model, lower-carbon technologies must be more expensive than existing ones, since otherwise they would already have been adopted.

A third major implication follows from the first two: There is no international coordination problem in climate policy, because the countries that move fastest on climate will reap direct benefits.

The mainstream view is that international “free riding […] lies at the heart of the failure to deal with climate change”. Individual countries bear the full cost of decarbonisation measures, in this view, but only get a fraction of the global benefits, so countries that do not engage in decarbonisation can free-ride on the efforts of those that do.[5] It follows that binding international agreements are an essential precondition for effective climate action. This makes sense if you think that the benefits of climate change mitigation are global but require a costly diversion of real resources, and especially if you think of it mainly in terms of carbon taxes. From a Keynesian perspective, however, while coordination problems are ubiquitous, this particular one should not be a concern. It is true that countries that take an early lead in decarbonisation will contribute to a global public good. But investment-centred action on climate will not impose costs on their domestic economies. In the first place, aggressive decarbonisation will boost domestic demand, leading to faster growth. Second, many decarbonisation policies are likely to have co-benefits (to public health, for example) that outweigh their costs and will be realised at a national level. In these cases, rather than facing an international coordination problem, action on climate change can be seen as helping overcome political obstacles to policies that are already in the nation’s self interest. Third, early investment in decarbonisation will generate a persistent advantage in strategic industries.

While these claims run against the textbook economics of climate change, they are consistent with the way these questions are discussed in policy settings. The central macroeconomic problem facing China, in the eyes of many observers, is how to sustain rapid growth while shifting away from exports towards domestic demand. Although this is often framed in terms of raising consumption by Chinese households, decarbonisation spending would serve the same goal. Meanwhile, few – if any – observers in the rest of the world see state support for China’s wind, solar, and battery industries as public-spirited shouldering of the costs of the climate crisis. Rather, it is seen as a strategic challenge that other countries, in their own national interests, must seek to match.

None of this is to suggest that international agreements on climate policy are not desirable. The point is that it is wrong and counterproductive to suggest that the case for decarbonisation efforts at a national level is contingent on first reaching such agreements. The failure of the Paris Agreements has not stopped countries such as Germany from aggressively moving forward with decarbonisation efforts, nor should it be an excuse elsewhere.

Turning from the what and why to the how, a major implication of a Keynesian perspective for climate policy is that price-based measures cannot be the primary tool for decarbonisation. One major reason for this is the increasing-returns problem discussed above. Private decisions are made at the margin, but in a world of increasing returns, the trade-offs at the margin may not be a good guide to the full range of possibilities. Think again of fossil fuels and wind power. Not so many years ago, wind power costs were much higher than the costs of new fossil fuel power capacity. Even a very high carbon tax might not have been enough to close this gap, while imposing unacceptable hardship on consumers. Targeted subsidies for wind generation, on the other hand, were able to raise the scale of wind investment until eventually its costs fell below those of fossil fuel generation.

The same logic applies to consumption. When a society’s transport system is organised around private car ownership, for example, opting for more sustainable modes may entail considerable sacrifice and, hence, would require a very large price difference. This does not mean that a society-wide shift towards mass transit and more walkable settlement patterns would leave people worse off – but it does mean that a carbon price is unlikely to bring it about. What is needed is not incentives for people to make what is currently a very costly private choice, but rather public investment that over time will make that choice less costly.

Another fundamental obstacle to a price-based approach is coordination. Market signals work on the premise that each actor can take everyone else’s choices as given. But decarbonisation, like other major economic transitions, requires coordinated changes by many different actors. To take a familiar chicken-and-egg problem, one of the major obstacles to the widespread adoption of electric cars is the lack of charging stations. But it makes no sense for private businesses to invest in charging stations when the share of electric cars is still very low. What is needed in cases like this is a single decision-maker to ensure that all sides move forward together.  The fundamental constraint on decarbonisation, then, should not be seen as the productive capacity of the economy, but rather the planning capacity for large-scale non-market coordination.

A corollary of this is that central banks’ contribution must take the form of active credit policy. Today, most proposals for climate action by central banks involve treating “green” assets more favourably than “dirty” ones.[6] This might take the form of differential rate-lending facilities, purchasing assets, or accepting them as collateral at prices adjusted for carbon-intensity, or requiring climate-risk disclosure from banks and other financial institutions. Such measures are often framed as a natural extension of normal central bank policies towards financial risk, since the “dirty” assets impose greater risks – to their holders and to the financial system. Treating assets differently based on climate criteria would then contribute to the central bank’s financial stability mandate as well as the protection of its own balance sheet.

A fundamental problem with this approach is that there is no reason, in general, to think that the businesses that are at greatest risk from climate change are the same as the ones that are contributing to it. Borrowers whose repayment capacity is at risk from climate change need not be major carbon emitters. Buildings on the coast, for example, are at greater risk from sea-level rise but emit no more carbon than structures anywhere else. Conversely, there is no reason to expect the profitability of emitters to be reduced, except insofar as some other policy brings this about. The conflation of carbon intensity with financial risk from climate change in effect assumes that the policies to bring about decarbonisation are already in place – that the only risks the central bank needs to worry about are “transition risks” to firms negatively impacted by climate policy.

From a Keynesian standpoint, central banks should worry less about these transition risks and more about channelling credit directly to activities that contribute to the climate transition but are likely to face credit constraints. Most business investment is not especially responsive to interest rates. For larger firms, the hurdle rate for new investment appears to be high and basically invariant to market interest rates.[7] For smaller borrowers, constraints on how much (or whether) they can borrow are often more important than the interest rate. For example, there are many improvements to buildings that can reduce energy use and pay for themselves in a short period, but homeowners and small property owners will be unable to carry out these improvements because of the upfront costs. Credit facilities that specifically encourage this type of investment will have a much bigger impact than across-the-board measures that, at best, will have some small effect on bond prices.

Concluding thoughts

The differences between the older climate economics – with its emphasis on trade-offs and price mechanisms – and the investment-centred approach not only reflect different views about what kinds of climate policies will be effective and achievable. They also reflect different, though not always articulated, visions of how the economy operates.

I have argued so far that some widely accepted economic constraints on climate policy are, in fact, not very important. I will conclude by suggesting two economic challenges for climate change that are, in my opinion, underemphasised.

First, if we face a political conflict involving climate and growth, it is not because decarbonisation requires accepting a lower level of growth, but because it entails faster economic growth than existing institutions can handle. Sustained strong demand and rapid growth may be limited not by any technical constraints on production, but by the distributional conflicts that arise, as low unemployment allows workers to demand a greater share of income and increased rights in the workplace.

The assumption that faster growth is possible only if workers remain docile is shared by many mainstream policy-makers. Former Federal Reserve chair Alan Greenspan observed in the 1990s that low unemployment was sustainable only because workers had been “traumatised” by the deep recession and attacks on trade unions in the previous decade.[8] More recently, the European Central Bank has demanded measures to weaken labour rights as a condition of accepting pro-growth fiscal measures in a number of European countries.[9] Today, business leaders on both sides of the Atlantic increasingly complain of “labour shortages”.

In principle, centralised bargaining could give workers a stronger voice in the workplace and a gradually rising share of national income without undermining the conditions for private investment. But under the neoliberal macroeconomic model, wage bargaining is decentralised, and limiting economic growth is the main tool for managing distributional conflicts. If decarbonisation leads to stronger demand and more rapid growth, this will empower workers to demand higher wages and more control over the workplace. In the absence of new institutions for collective bargaining, these demands will be a source of ongoing frictions and social conflict. The great political challenge of the climate transition may turn out to be not that ordinary people have to accept getting less, but that business owners have to accept ordinary people getting more.

Second, rapid decarbonisation will require considerably more centralised coordination than is usual in today’s advanced economies. If there is a fundamental conflict between capitalism and sustainability, I would suggest, it is not because the pursuit of profit implies or requires an endless increase in material throughputs. Rather, it is because capitalism treats the collective processes of social production as the private property of individuals. The rapid redirection of production – whether during industrialisation or in wartime – has always required a degree of central planning. Decarbonisation (and adaptation to the climate change already underway) will require collective decisions about many aspects of production and consumption that are today regarded as private choices. It will also turn many decisions that are already made collectively – but in ways that are regarded as natural or neutral – into visible political questions. To take one important example, a central bank setting an interest rate is already engaged in a form of planning, but this can be presented as a purely technical matter. If the climate transition requires central banks to channel credit towards specific sectors or businesses, the fiction of central bank “independence” will no longer be tenable, and their actions will be subject to the same kind of scrutiny and contestation as those of other branches of government. 

The planning required by the climate transition will run against decades of ideological opposition to central planning and to an expanded role for the public sector. But beyond these ideological obstacles, it will also face the more straightforward problem that many of the required institutions do not currently exist, at least not on the scale required. The tools of economic planning used so extensively (and, arguably, successfully) by notionally “capitalist” countries such as Japan and France in the post-war decades have long since been abandoned; rebuilding them is not an easy task. The investment-centred approach to decarbonisation calls for some institution that can identify a coherent set of priorities for climate investment and that has the authority – and political legitimacy –  to direct spending towards them. The lack of such an institution, and not any material scarcity, may be the most urgent and immediate challenge for the transition to a sustainable economy.

[1]  W. Nordhaus (2019), “Climate Change: The Ultimate Challenge For Economics”, American Economic Review 109(6): 1991-2014.

[2] H.-J. Chang (2010), Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, New York, NY: Bloomsbury Publishing.

[3] International Energy Agency (2021), World Energy Investment,

[4] US Energy Information Administration (2020), “Average U.S. Construction Costs for Solar and Wind Generation Continue to Fall,”

[5] W. Nordhaus (1993), “Reflections on the Economics of Climate Change”, Journal of Economic Perspectives 7(4): 11-25.

[6] For a typical example, see Network for Greening the Financial System (2021), “Adapting Central Bank Operations to a Hotter World: Reviewing Some Options”,

[7] S. A. Sharpe and G. A. Suarez (2021), ”Why Isn’t Business Investment More Sensitive to Interest Rates? Evidence from Surveys”, Management Science 67(2): 720-741.

[8] D. J. B. Mitchell and C. L. Erickson (2005), “Not Yet Dead at the Fed: Unions, Worker Bargaining, and Economy‐wide Wage Determination”, Industrial Relations: A Journal of Economy and Society 44(4): 565-606.