As hopes rise that the pandemic is almost over in the developed world, visions of a second “Roaring Twenties” to match last century’s post-pandemic decade have proliferated. In the Jazz Age of the 1920s, consumerism and mass culture took shape. Innovations emerged: automobile, radio, motion pictures and labour-saving electric appliances, for instance. It’s tempting to ask whether history will repeat itself. The automobile and the radio have been replaced by the green transformation as the major driver of change. But today’s secular stagnation will be tough to overcome. In our view there’s no sign at this stage that the worldwide transition to a carbon-free society will translate into higher productivity growth and higher GDP growth over the long term.
A circular relationship: It is known from economists and non-economists that productivity is a long-term determinant of return on capital and thereby of interest rates. Antonin Bergeaud, Gilbert Cette and Rémy Lecat showed that “interest rates are also a determinant of the minimum expected return from investment projects, and therefore of the productivity level required for such investments” (see here). To put it another way, the decline in real interest rates allowed weakly productive companies (including zombie companies) and projects to be profitable; this caused a slowdown in productivity. Bergeaud, Cette and Lecat state that the relationship between productivity growth and real interest rates is not unidirectional, but circular.
The natural disasters hitting the world in 2020 served as a wake-up call to governments and the private sector on the urgent need to tackle climate change and accelerate the transition to a carbon-free world. Companies have invested massively to reduce their carbon footprint. Governments have unleashed billions to stimulate investments in green energy. But there’s little sign it will lead to much higher average growth and productivity than before the pandemic. The prevalence of negative real interest rates is an indication that decarbonisation and sustainable investing is unlikely to improve productivity and thereby economic growth, at least in the short and medium term.
No technological breakthrough yet: One escape would be a technological breakthrough, but there’s still no sign of it. The digital revolution, which started at the end of the 1990s, has not stopped the decline in productivity. The green transition is only accompanied by a few concrete innovations. The sad reality of the green transition is that a large amount of the invested money goes to projects with little ability to change the face of the world. Many European countries have decided to exit nuclear power, mostly for ideological reasons. This is a risky political choice for the planet. Each time, it has resulted in higher reliance on more harmful energy sources, such as natural gas or coal. In Germany, CO2 emissions increased by 35 million tons per year, for instance. In Belgium, the decision to close two thirds of its nuclear power stations between 2022 and 2025 and to build gas power stations as a replacement will multiply CO2 emissions per kwh by 74. At the current level of technological development, renewable energies are not able to replace conventional energy sources. A distinction must be made between variable renewable energy (wind power and solar power) and controllable renewable energy (hydroelectricity and biomass). The first one is not useful in the energy mix towards a carbon-free world since it is not able to supply a steady supply of electricity. The second one must be an integral part of the energy mix. In recent years, governments have wasted a huge amount of money in wind and solar investments. But for most countries, these energy sources make little sense. The allocation of resources in the green transition is often misguided.
There are a few promising technologies but they are at the prototype stage. It will take several years, perhaps five to ten years, to reach large-scale industrial applications.
- China has invested billions of dollars to build a thorium-fuelled nuclear reactor by 2030. Thorium is a weakly radioactive metallic chemical element discovered in 1829 in Norway. It has several advantages over uranium: 1) it is four times more abundant and can be found all over the planet; 2) it produces less volume of waste. 83% of this is neutralised in 10 years, and the other in 300 years; 3) it is safer. It solidifies quickly when it is exposed to open air, and it does not emit radioactive gas. Some European countries have also started research on thorium, but with smaller budgets.
- Many countries are working on green hydrogen as a replacement for fossil hydrocarbons. Green hydrogen is an energy storage solution based on renewable energy. There are two pitfalls: one is a poor efficiency rate of 25% to 30%. This means that more than two-thirds of the renewable electricity produced at the start vanishes in the process; the other is high cost. Green hydrogen is four times more expensive than blue hydrogen, which is produced from fossil energy. This explains why the global production of green hydrogen is marginal—less than 5% of the total. It will require years of research and investment to improve the technology, hopefully.
- We mentioned that variable renewable energy is of little use in the energy mix. But technological improvement could change the situation in the next five to ten years. Large industrial projects seek to address the problem of wind intermittence. Instead of increasing the number of offshore wind farms individually connected to national grids (which increases costs and reduces systemic efficiency), the Dutch electricity transmission operator TenneT promotes the idea of artificial islands in the North Sea serving as hubs to distribute electricity in an optimised way to neighbouring countries. This is a pilot project and will take years to be rolled out.
Big government: Industrials have fully understood the challenges of the energy transition. But the private sector will not be able to bear the cost alone. There is no historical example where such a change has been achieved other than through a form of large-scale political intervention, massive public investments, and central economic planning. The recovery plans adopted to exit the Covid-19 recession are a first step. More than a third of the French recovery plan is devoted to energy transition. In the United States, more than $8bn has been allocated to hydrogen production, mostly blue hydrogen, as part of the infrastructure plan—there is more to come. But if we want the green transition to be synonymous with higher productivity growth and higher GDP growth, we first need to make sure that resources are optimally allocated. This is not the case yet.
In our view, the negative real rates are an economic sign that the green transformation needs to find a different path from here. If anything, it does us the favour of pointing out that in order to solve the green deficit we need to find productivity and a model which allocates higher marginal productivity, and not a political narrative of a change which is nothing but real change.
Source: Macrobond, Saxo Group research and Strategy
Source: Macrobond, Saxo Group research and Strategy