Autumn Budget 2021 and Net Zero

Tackling cost of living challenges through productivity

With the Net Zero Strategy published and the Autumn Budget now delivered, a clearer picture is beginning to emerge around how the UK will transition to a net zero economy by 2050. While in his speech the Chancellor declared ‘jobs up, growth up and debt down’, this is set alongside the broader context of the cost and ‘who pays’ challenges associated with the net zero transition, and the central importance of growing our efficiency and productivity in tackling these and driving the transition.

With increases to the minimum wage, the public sector pay freeze scrapped and a cut to the Universal Credit taper rate by 8%, the Chancellor’s Budget statement clearly recognised the current ‘cost of living challenge'.

It also identified growing productivity and real wages as key in overcoming current inflationary pressures (where inflation is expected to average 4% over the next year) and enabling recovery in a manner that is fiscally and economically sustainable.

Our research demonstrates that such a focus on productivity and real wage growth, combined with borrowing focused on enabling future greener growth, must be maintained if the net zero transition is to be associated with outcomes characterised by growing and more equitable prosperity in all timeframes.

However, it also demonstrates that future inflationary pressures will not be limited to the external supply chain and energy price drivers we are experiencing now, but to just how we go about realising the net zero transition.

The cost of living challenge and the productivity gains solution

Our research, built around the need to address five ‘Net Zero Principles’, involves conducting scenario simulations to investigate and understand how the wider economy - including progress the Chancellor’s key indicators of productivity (GDP per worker), real wages and inflationary pressure (via the consumer price index, CPI) - and different regions, sectors and groups therein, will be impacted by a range of net zero pathways and actions. Three recurring finding emerge, higlighted in our Green Growth Discussion Paper, which reflect the need to focus on cost of living impacts as a key challenge and sources of efficiency and productivity gains, and real wage growth, as a central solution.

1. Reducing carbon emissions to meet net zero targets will inevitably involve new costs that must be recovered, which will in turn somehow feed through to higher prices of goods and services faced by consumers. For example, in our research on the impacts of enabling the required electric vehicle (EV) rollout, we consider how the cost of upgrading the electricity network infrastructure to meet increased and changing electricity demand will directly impact consumer energy bills.

However, even where direct cost burden is not put on households, they will ultimately bear the costs. For example, our current research (pdf) delivers particular insight on cases where a ‘polluter pays’ approach is applied for things like carbon capture and storage (CCS) in emissions-intensive process industries like chemicals – costs will ultimately be largely borne by households. This is because costs to firms will be transmitted through the prices of the things that we consume every day and/or through the tax we pay and the public services we rely on.

Moreover, there is the risk that where firms in the UK cannot maintain competitiveness through the required ‘greening’ of international markets, there is a risk that we may end up importing more of what we need, increasing risks of potential ‘offshoring’ of jobs and wage income, with obvious implications for the real earning power required to cover increases in the cost of living.

For this reason, the Chancellor’s focus on innovation and increased productivity in this year’s autumn budget becomes even more crucial: if households and businesses can become efficient both in using energy and in adopting and using low carbon technologies the real cost of delivering services, such as heat and transport, can fall even where market prices rise. Similarly, enabling access to alternatives to options that may become overly costly for some – such as switching to EVs, particularly where the nature and emergence of the second-hand market that so many rely on to buy cars is not yet clear – will become increasingly important.

Therefore, in addition to directly contributing to the nation’s productivity and Government’s ‘levelling up’ agenda, the Budget announcement regarding increased investment in regional public transport provision has been welcomed (with some caveats and calls for further funding) by those in Midlands and North of England. Those of us living and travelling in Scotland will hope for similar developments north of the border if delivering our mobility needs is to become not only greener but more affordable and accessible for all.

More generally, while direct interventions by Government to limit price increases, such as the energy price cap, do play an important role, the central and most sustainable route to limiting price increases and their impacts does lie in enabling and realising productivity and efficiency gains.

The opportunities and challenges associated with green growth

2. Exploiting wider ‘green growth’ opportunities will also play a key role in offsetting and redistributing the impacts of decarbonisation costs and growing real incomes, but with a risk of further cost of living pressures. The key challenge is how the issue of the UK’s labour supply constraint can be managed.

While a key aim of Government is to increase real wage rates for UK workers, where firms face rising (nominal) labour costs this is another source of more general pressure on the Consumer Price Index (CPI). For example, in our EV research, we find that while factors such as more reliance on domestic supply chains in fuelling our cars using electricity rather than gas are likely to deliver a sustained boost to UK GDP, employment, and real wage rates across most sectors of the economy, this is accompanied by lasting increases in the CPI and the price of energy therein.

Again, especially when not all households will share equally in the returns of a growing economy, but will be impacted by CPI rises, we find that to mitigate such impacts the ‘green growth’ process needs to involve increased efficiency, for example in how UK households use energy which is best enabled through commitment to substantial energy efficiency programmes of sufficient length to upgrade residences to required EPC C standards.

More generally, focus and commitment in supporting efficiency gains in how households and businesses use low carbon technology will help mitigate the impacts of increasing prices through efficiency gains in the use of technology in both the household and business sectors, alongside productivity gains in production activity that act to limit price pressures in the first instance.

Realising productivity gains through using technologies more efficiently

3. Net gains from exploiting green growth will be maximised where productivity gains can be realised in production and/or where people and businesses can learn to use new technologies more efficiently. Here the challenge for public policy and spending is how and when to best to deploy financial support to enable the required innovation and skills development, alongside alleviating budget constraints and avoiding the negative implications of sacrificing current consumption to pay for net zero investment, especially at a time when the economy is still recovering from the COVID slump.

This does introduce a range of tensions and trade-offs. For example, our research on the impacts of supporting residential energy efficiency gains shows that while substantial early action can deliver near term gains both in that efficiency and GDP/employment growth, where shortages of workers and skills to deliver retrofitting projects exacerbate wider labour supply challenges, this will ultimately bring additional cost of living pressures that need to borne by all households, not just more efficient ones.

In an industrial decarbonisation context, a different set of challenges and potential tensions exist. Here our research shows that, despite what some may argue is a moral imperative to have ‘polluters pay’, providing upfront/early public support – for example through the early stages of the CCS sequencing programme announced this month – on the clear basis of giving firms the space to build efficiency and potential competitive advantage in ‘early mover’ projects, can pay dividends across the wider economy over time. Crucially, such an approach helps avoid outcomes where costs may unevenly fall on the communities and regions (many of those the target of levelling up efforts) that host and depend on employment in and related to the clustered UK industry that must decarbonise if we are to achieve net zero.

Generally, our research demonstrates the risk of further cost of living and competitiveness/ potential ‘offshoring’ challenges in just how we go about delivering the transition, and the crucial role of delivering efficiency and productivity gains. This is why more controversial aspects of today’s budget, such as freezing fuel duty and the rebalancing of Air Passenger Duty. The latter favours regional businesses and connectivity within the UK, but against the longer haul flights (where the full emissions between take-off and landing have traditionally not been accounted for effectively if at all), requires careful ‘wider picture’ thinking.

Generally, whenever the economy has to adjust and transition, particularly in the context of the systematic shift required in how we live and do business, there is a wider risk of a range of unanticipated consequences. Understanding and anticipating these will be key for HM Treasury in delivering future Spending Reviews and Budgets that serve the needs of the nation in a sustainable way.

Image credit: Simon Dawson / No 10 Downing Street, CC-BY-NC-ND 2.0,