New theoretical modeling of green transitions

Reducing greenhouse gas emissions will require a green transition – a significant transformation of both consumption and production patterns. To study these types of transitions, Professors Torsten Persson at the Institute for International Economic Studies (IIES) and Timothy Besley at the London School of Economics and Political Science (LSE) present a model that differs from the usual approach in economics. One of their main results shows how market failures, as well as policy failures, can prevent welfare-enhancing green transitions, or make ongoing green transitions too slow. The paper “The Political Economics of Green Transitions” will be published by the Quarterly Journal of Economics in August 2023.

Illustration of the research

To reduce the risk of an environmental disaster, most observers believe that a radical structural transformation of production and consumption is required. In such a green transition, companies gradually switch to producing goods through green technology, while households switch to consuming these green alternatives. There are a variety of opinions on how best to achieve this change, but many economists think about the solution in terms of a social planner choosing a set of carbon taxes for the entire future, and commits future policies to this sequence.  

Besley and Persson’s modeling differs from this traditional approach in two ways. First, consumption patterns reflect not only changing prices and taxes, but also changing values. Some consumers care more about the environmental effects of their choices than others – they have green values. If there are more such green consumers around, the higher demand for green products raises the profitability for companies to use a green technology. This, in turn, makes it more attractive to hold green values, such that green consumption and green production feed back onto each other in a virtuous or a viscous spiral. This can result in a market-driven green transition. But it can also create a "trap" where welfare would be higher on an alternative path. To avoid such failures, economists have advocated corrective taxes and subsidies on brown (polluting) and green (non-polluting) goods.

IIES Professor Torsten Persson
IIES Professor Torsten Persson.

This is the second point where Besley and Persson depart from the beaten track. In their analysis politicians – rather than hypothetical social planners – make policy decisions. Since politicians are subject to regular elections where incumbents may lose power, they cannot make credible promises about future taxes or subsidies. When setting these policies, parties take into account the preferences of green and brown consumers/voters. As a result, a society may fail to undergo a green transition even when this is socially desirable. Moreover, in an economy that has already embarked on a green transition, the policies set by politicians may make the transition too slow. 

By examining these failures in both markets and policymaking, the authors offer a new perspective on how democratic politics can help (or subvert) solutions to dynamic social problems.  Specifically, they offer a new perspective on the role that policy can realistically play in a green transition: rather than being a main driving force, policy may at best facilitate an ongoing dynamic process of household and company decisions. 

Click here to read the paper on the Quarterly Journal of Economics' web