In Depth: Sustainability, Growth and Competitiveness—The Way Forward

Are there environmental limits to growth?

Since the beginning of recorded history, humans have improved their conditions by—among other factors—modifying their surrounding environment and making the most of scarce resources. Technical progress occurred first with the agricultural revolution, and with the industrial revolution later, eased food and energy constraints and allowed humans to prosper. However, continuous industrial expansion and population growth have put tremendous pressure on the environment and an excessive environmental footprint. If not addressed, environmental degradation may hinder further economic progress, compromise the prosperity built over centuries, and threaten life across the planet.

According to a seminal 2009 Nature article ten ecological factors can potentially destabilize the planet’s ecosystem—and three of these have already exceeded their “limit” (Figure 3): climate change, nitrogen cycle (pollution from agriculture) and biodiversity loss (extinction of species).¹

Figure 3: Environmental priorities

Note: The inner blue shading represents the proposed safe operating space for ten planetary systems. The red wedges represent an estimate of the current position for each variable. The boundaries in three systems (rate of biodiversity loss, climate change and human interference with the nitrogen cycle) have already been exceeded.

Exceeding these environmental boundaries will have dire and far-reaching consequences, including rising sea levels, more frequent floods, hurricanes, heatwaves and droughts, accelerating biodiversity loss, and acidification of seawater, which in turn will reduce prosperity in vast swathes of the world.²

Although the linkages between biological ecosystems and human actions are complex, it is possible to distil the causes of these three environmental emergencies into two predominant human activities: energy use and food production.

The first environmental emergency—climate change—is caused primarily by emissions of greenhouse gases (GHG), which are largely attributed to energy use. The United States’ Environmental Protection Agency estimates that more than three-fifths of both US and global GHG emissions are a by-product of one of the following types of energy use: electricity generation, heating, fuel transformation and transportation.³ The other two sources of emissions are industrial processes (including chemical, metallurgical, waste management and mineral transformation processes, as well as a small portion of fossil fuels burned for energy), which account for one-fifth of the country’s emissions, and agriculture and deforestation, which together account for the remaining one-fifth share of total emissions (Figure 4).

Figure 4: Share of GHG emissions by source, United States, 2017

Notes: Energy includes emissions from transportation, electricity production and heating. Industry includes emissions from burning fossil fuels for energy and certain chemical reactions in production processes. Agriculture emissions are those from livestock, agricultural soils and rice production.

The second environmental emergency—the nitrogen cycle—is caused, for the most part, by industrial agriculture, which overloads the soil with nitrogen and phosphorus from animal manure and chemical fertilizers.

The causes of the third emergency—biodiversity loss—are more difficult to identify because they intertwine with many of the ecological factors referenced in Figure 3. Among them are practices related to food production (i.e. over-fishing and deforestation for agriculture land use), by-products of energy production (i.e. chemical pollution, indirect effects of climate change), rapid urbanization and pollution from industrial production or waste management.

In addition, population growth—the world’s population is expected to reach 9 billion by 2050—may counterbalance efforts to reduce per-capita resource consumption and can lead to even more pressure on those factors that are currently still within the planet’s limits (i.e. land use, fresh water use).⁴ Based on Global Footprint Network estimates,⁵ a population of 9 billion people with the standard of living of today’s average European would have an ecological footprint that would require about 3.4 planets, thus clearly exceeding environmental boundaries.⁶

How and when the combination of these factors will impact human life or even just economic activity is uncertain.⁷ However, difficulties in forecasting accurately the effects and severity of environmental tipping points must not be an excuse for inaction. As the potential effects of environmental risks extend well beyond economic stability and prosperity, their mitigation should be regarded as an unconditional policy objective. As such, the success of environmental policy crucially depends on both forward-looking leadership vision and private sector awareness and choices.

Multiple signals indicate that environmental damage and losses are already occurring, becoming larger and reinforcing one another.⁸ These trends should prompt a swift global response towards a lower footprint, while bearing in mind the fundamental and complex trade-offs involved across the ten environmental boundaries. For instance, reducing nitrogen to within environmental limits may reduce crops by more than 30% globally, which would have an unacceptable impact on food security.⁹

How to address these potential trade-offs and distribute these costs across geographies, social strata and generations is is among the key challenges for policy-makers and global governance over the next decade. Since environmental constraints are global, effectively reducing environmental threats requires very close cooperation among countries in addition to national efforts.

It is possible to decompose economic growth into three elements: (1) growth in labour force, (2) growth in physical and natural capital inputs, and (3) total factor productivity growth (TFP) growth, the “unexplained part” of GDP growth, which encompasses all non-physical inputs, such as technological progress, human capital, and institutional and cultural factors (Figure 5).

Figure 5: Economic growth and the environment framework

TFP growth is considered to be the best predictor of cross-country variations in living standards. That is why TFP growth is at the core of the Global Competitiveness Index 4.0 (GCI), which benchmarks its drivers (see Box 1 in Chapter 1).

As discussed above, there are constraints to achieving growth through the accumulation of factors of production. In contrast, the environmental impact of TFP growth is significantly less taxing.

To some extent, sustainability and TFP growth go hand in hand: there is some evidence that failing to address the environmental tipping points will affect productivity. Environmental-driven TFP losses may even outweigh the costs associated with transitioning to a low-carbon economy through different channels.

- Climate change. Rising temperatures and modified rain patterns, caused by climate change, will reduce crop yields and intensify crop volatility, resulting in lower agriculture productivity. Other potential channels through which climate change could reduce productivity include capital depreciation due to infrastructure damage from extreme weather events and a fall in both labour supply and workers’ output due to higher temperatures.¹⁰ In addition, these effects will likely exacerbate poverty by the fact that the effects of climate change will disproportionally penalize farmers in developing countries that depend on producing staples for their livelihoods. A 2018 FAO report finds that “[i]n low-latitude regions, where most developing and least developed countries are located, agriculture is already being adversely affected by climate change, specifically, by a higher frequency of droughts and floods”. According to this study, in West Africa and India crop yields could fall 2.6–2.9% by 2050. Combined with significant population growth in these areas, this reduction is likely to reduce in massive food shortfalls.

- Pollution. The negative effects of pollution on productivity are mainly manifested through health. A large body of research shows that exposure to chemicals and air pollution increases the incidence of non-communicable diseases and mortality rates. Among them, a recent study attempts to quantify the link between air pollution and economic production and estimates that an increase in exposure to PM2.5 by 10 micrograms per cubic metre reduces daily output by 1%.¹¹

Further, constraints to specific renewable and non-renewable inputs such as energy and water may have important productivity spillover effects:

- Energy. Despite increasingly efficient electric vehicles, growing installed capacity of solar and wind farms and energy-saving appliances, non-renewable resources still account for over 80% of global energy consumption.¹² In the short run, the lack of alternatives to meet the global demand for energy, a push towards non-fuel energy may lead to an increase in production costs in most sectors and therefore hurt productivity. For example, modern agriculture requires significant fuel consumption for tillage and harvest operations.¹³ Similarly, an increase in transport costs due to a surge in fuel costs would make current manufacturing value chains less feasible.

- Water: Episodes of water shortage have proven to have an extremely negative effect on productivity in agriculture, as well as for smelting, chemical and mining activities.¹⁴

Highly competitive economies are better positioned to make the difficult transition to a low-footprint economy happen more smoothly. For instance, transitioning to a low- or zero-carbon energy mix will necessarily require faster technological progress. Highly competitive countries, by providing a more conducive innovation ecosystem, are better placed to foster the emergence of new technologies in all sectors, including potential breakthrough technologies in green inventions (Figure 6).

Figure 6: Competitiveness and green inventions

Notes: The number of environment-related inventions (“green patents”) is expressed per million residents (higher-value inventions/million persons). Indicators of technology development are constructed by measuring inventive activity using patent data across a wide range of environment-related technological domains (ENVTECH), including environmental management, water-related adaptation, and climate change mitigation technologies. The total count includes only higher-value inventions (with patent family size ≥ 2). Detailed information on the methodology used to compute the patent counts is in the OECD Environment Database metadata.

In addition, countries that possess better human capital, better infrastructure and greater innovation capability are, on average, more likely to adopt a greener energy mix.

Success will depend on policy choices, as demonstrated by the fact that economies with similar level of competitiveness attain different sustainability performances.¹⁵ For instance, Denmark and Finland—both ranking high on the GCI 4.0—are among the best-placed nations to transition towards a cleaner energy mix (Figure 7). Similarly, while some highly competitive countries and emerging economies are not yet re-structuring their energy sectors towards sustainability, others are reducing their consumption shares of energy from non-renewable sources (Figure 8).

Figure 7: Energy Transition Index and Global Competitiveness Index

Figure 8: Trend in non-renewable energy consumption per capita, selected economies

Note: Renewable energy consumption (TJ) includes the following sources: hydro, solid biofuels, wind, solar, liquid biofuels, biogas, geothermal, marine and waste.

There is also potential for least-developed countries to do more to realize the still largely untapped potential of green energy leapfrogging. African economies such as Kenya, South Africa and Nigeria have introduced some low-carbon energy technology applications, but these have not led to a substantial investment in renewable energy.¹⁶ The policy priority in these countries is to provide widespread energy access; consequently, they are investing mainly in energy generation from fossil fuels, which to date are still cheaper and more scalable than renewables. Of all public financing for energy in Africa between 2014 and 2016, 60% went to infrastructure development for energy from fossil fuels while renewable energy projects received just 18%.¹⁷

There are, however, some encouraging developments. For instance, although India and China have increased their use of fossil fuels significantly, they are now multiplying their efforts to invest in renewables to cope with increasing demand for energy in their dynamic economies. China plans to become a world leader in climate protection,¹⁸ and has invested $132 billion in clean energy technologies so far.¹⁹ While Chinese coal-based electricity production will continue to grow until 2027, it is estimated that the country’s solar and wind penetration in its energy mix will reach 40% by 2040.²⁰

If realized, it will be an important step forward; yet, to date, no country has emerged as a comprehensive sustainability champion. A combination of much bolder environmental policies, more research and greater international coordination are needed to fast-forward the achievement of sustainable prosperity.

Without the ambition of providing an exhaustive and definitive set of environmental policies, we highlight four non-mutually exclusive, widely discussed measures that could stimulate faster transition towards a more sustainable economic development.

Openness and international collaboration
While a country’s commitment to an environmental agenda is crucial, sustainability issues are—by definition—a global problem. No country can manage environmental challenges with national policies only. It is essential that, even in a context of trade tensions and diminished commitment to international governance systems, countries discuss shared solutions to climate change and the transition to a low-footprint global economy.

Greater international coordination could also lead to an evolution in the treatment of environmental goods in international trade agreements,²¹ as well as in jurisprudence related to the interpretation of exceptions to the General Agreement on Trade and Tariffs (GATT) rules towards environmental policies aimed at reducing risks to human health and to animal and plant life.²²

Carbon taxes and subsidies
Getting the right price is essential for market mechanisms to work. Yet, currently, the prices of carbon-intensive products do not fully reflect their true cost because of unaccounted externalities and distortions from energy subsidies. According to the International Energy Agency and the OECD,²³ subsidies to fossil fuels from members and partner countries amounted to $140 billion in 2017,²⁴ most of which were “pre-tax” contributions used to support consumers. Although these subsidies have been decreasing since 2013, they are still significant, and the decline is partially the result of the lower oil prices of recent years rather than a policy change. Similarly, several countries—to reduce externalities—have started to put a price on carbon either in the form of a tax (a fixed amount to be paid for each ton of CO2 emitted) or as a result of the Emissions Trading System (ETS), which fixes the amount of “pollution permits” and lets the market decide their price. In 2019, all carbon pricing policy combined raised a total of $95 billion—a step in the right direction but still insufficient to incorporate externalities in fossil fuels prices.²⁵ According to the OECD, in 2019, 76% of emissions are still not subject to carbon pricing.²⁶

There is consensus in the scientific and policy community that market forces alone will not deliver an environmentally optimal outcome, hence the need for a combination of taxes and subsidies to correct energy prices to incorporate their externalities should be an important pillar in any viable energy transition strategy. ²⁷

Phasing out subsidies to fossil fuels and implementing bolder carbon pricing schemes, however, should be paired with measures that minimize the potential social costs of these reforms. For instance, as green regulations impose non-progressive costs of living on households,²⁸ they could be accompanied by progressive reductions in household taxes or other compensating mechanisms to avoid exacerbating inequality while transitioning to a more sustainable energy mix (see the following In Depth section on shared prosperity, growth and competitiveness).

Externality-adjusted prices could potentially further accelerate the re-allocation of investment towards green projects that are already taking place. Fund assets invested in sustainable investments have already increased by 34% in two years²⁹ to reach a total stock of assets of about $30 trillion in 2018.³⁰ At the same time, the Task Force on Climate-related Financial Disclosures (TCFD) is developing a voluntary, climate-related financial risk disclosures for companies which could lead to increase “sustainable investments”.³¹ Similarly, the share of stocks’ value of fossil fuels companies in the Standard & Poor’s 500 index has decreased from 29% to 5.5% over the past 40 years.³² These trends signal a higher sensitivity of fund managers to climate policy, as well as a change in the mindset and incentives of investors. However, they may not lead to sufficiently fast progress to achieve global environmental sustainability and need to be accompanied and incentivized further by policy interventions.

Incentives for green R&D
Renewable energy technologies still need to overcome technical limitations that prevent them from becoming the main and possibly the sole source of energy in the future. First, in terms of power generation, with current technology renewable electricity infrastructure requires significantly more land and materials than fossil fuel power plants to produce the same output. For instance, to produce 1 megawatt hour of power, fossil fuels plants require only 0.4 square metres of land; wind farms require one square metre (almost three times more land) and photovoltaic panels, 10 square metres (25 times more).³³

Second, the intermittent nature of output from renewable sources limits their use as the primary source of electricity. Large backup systems are required to guarantee supply at any given time. These backup facilities may still need to rely on fossil fuels to some extent, increasing the cost of power production and distribution.³⁴ Technical limitations and the continuous increase in demand explain why fossil fuels still account for about 80% of total energy consumption (as noted above), despite the significant decrease in the cost of electricity production from renewable resources.³⁵ More investments in research are needed to overcome these technical limitations and possibly develop other new technologies. According to the International Renewable Energy Agency, global investment in renewable energy in 2017 was about $280 billion;³⁶ up 77% up since 2007 and mostly provided by the private sector. Tax incentives and/or direct public investments could help to complement these efforts to accelerate the process towards more sustainable energy systems.

Green public procurement
The public sector represents an important economic actor. For instance, OECD countries spend about 15–20% of their GDP on public procurement, and industrial policy has leveraged government purchases in the past to generate knock-on effects on other buyers’ markets.³⁷ As such, public procurement can sustain markets for innovative products as well as for sustainable products or services.³⁸ Some countries have already started to introduce environmental standards in technical specifications, procurement selection and award criteria, and have inserted environmental performance clauses into contracts. Despite potential implementation challenges—such as difficulties in justifying higher prices, updating practices and ensuring staff expertise³⁹ —green public procurement can signal a major policy shift and break from the lock-in effects of status-quo technologies and production models.