Greenflation: The Achilles heel of the green economy?

Greenflation: The Achilles heel of the green economy? Paul Pernot, MiM student and ESSEC Business School Winner of the 2022 CoBS student CSR competition, analyses the increasing phenomenon of greenflation and offers several ways forward to stabilize the green transition.

Paul Pernot, MiM student and ESSEC Business School Winner of the 2022 CoBS student CSR competition, analyses the increasing phenomenon of greenflation and offers several ways forward to stabilize the green transition.

Greenflation: The Achilles heel of the green economy? by Paul Pernot.

Greenflation: The Achilles heel of the green economy?

In Avignon, a city in the south of France, George R. was planning to renovate his bathroom in early 2022. When he asked his plumber for a quote, the plumber handed him a piece of paper and said: “It’s valid for fifteen days”. Fifteen days is a very short time! The plumber, faced with George R.’s apparent hesitation, justified himself: “I know, but I have to do this so that I don’t put my business at risk by buying materials that are becoming ever more expensive every day. That’s the way everyone does it now”.

The plumber is right. The price of some commodities has soared in recent months. The price of PVC (composed of 43% oil), which is widely used for plumbing, rose by 90% between May 2020 and August 2021. The reason to this is a multiple one: after Covid-19, the price of oil has risen considerably, then remained high due to the geopolitical situation, but may continue to rise in order to meet the goals of the 2015 Paris climate agreements (Schnabel, 2022). Other commodity prices are rising: copper, aluminum, lithium, cobalt, to name but a few, and again, the increase is linked to the green transition.

In short, if commodity prices rise because of the transition to a green economy, so do the costs of all goods and services: that’s inflation. Well, actually, it’s greenflation.

Greenflation: a very recent concept

The concept of greenflation can be summarised as the increase in prices of goods and services (inflation) as a consequence of the transition of the current economy to a greener one (i.e. net-zero economy). As the concept is not yet set in stone and is the subject of much debate among economists, I will voluntarily use a broad definition.

Nevertheless, it is essential to point out that not all price increases are the result of greenflation. For instance, it would be absurd to think that greenflation is sufficient to explain the annual inflation rate of 5.3% in the European Union in December 2021 (Eurostat 2021), as there are many other reasons for the rise in prices. Yet greenflation remains necessary to explain the inflation we are experiencing.

Nor is greenflation a sign of a failure of the economic system because it is characterised by continuing inflation: the green transition is a mammoth task which requires massive investments (Blas, 2022). Indeed, the American economist Pr. Harold T. Shapiro (1981) thought that continuing inflation could not be understood in a purely economic way. According to him, “inflation relates more directly to our political system’s response to a changing social agenda than to any unresolved deficiency in our economic system”. In fact, the Covid-19 crisis was the landmark for a global awareness of the social and environmental issues within our society. It has shaken up political agendas and accelerated the green transition.

Causes and manifestations of greenflation to bear in mind for effective responses

First of all, greenflation is reflected in an increase in the price of some commodities. The latter should be understood as the meeting of a strong demand for metals necessary for the green transition and a supply that is unable to meet such demand. Supply is low due to massive under-investment in the mining sector, which had been already heavily impacted by Covid-19. China, for example, supplies nearly 60% of the world’s aluminum, but has decided to cap new smelting in order to be in step with its carbon neutrality campaign (Sharma, 2021). Lastly, the decrease in productivity induced by environmentally friendly and ethical agriculture results in higher prices for agricultural materials.

The greenflation cycle.
The greenflation cycle

Moreover, greenflation is closely linked to rising energy prices. Contrary to what one might think, the cost of green energy has become cheaper than the cost of fossil energy. An IRENA report (2019) shows that onshore wind and solar photovoltaic power are now frequently less expensive than any fossil-fuel option and thus without any subsidies. However, renewable energies are not sufficiently scalable and require high investment (Schnabel, 2022).

In the United States alone, it would take nearly $4.5 trillion in investment to move to 100% renewable electricity generation (Shreve, 2019). Another problem is that many economies still rely on burning fossil fuels to generate electricity. Yet the price of oil is rising. Undoubtedly, the war in Ukraine has contributed to the rise in energy prices, but this is not the only reason. OPEC has significantly reduced its upstream investments since 2015 and pressure from investors is forcing oil majors to reduce their investments in exploration-production and to gradually turn to renewable energy. These trends lead to higher fossil fuel prices.

At the end of the day, greenflation is the increase in prices due to environmental taxes.  The latter are essential for the green transition to achieve its goal (Remeur, 2020). This is because they integrate negative externalities into the price of goods and services, and in this way can influence consumer behaviour. For example, imagine yourself in a supermarket, in front of the fruit and vegetable section.  Apples from your country cost $2.9 per kg and those from the other side of the world cost $3.5 (because of a possible environmental tax). Of course, if you are on a budget, you would buy the locally grown ones. Environmental taxes can therefore encourage consumers to consume in a more sustainable way and are a real game changer for the ecological transition.

Towards new social tensions?

Social unrest and demonstrations caused by greenflation.

Greenflation will have the same negative effects as inflation and may lead to numerous social conflicts within states. Inflationary phenomena increase inequality (Albanesi, 2000). People on low and fixed incomes will be the most affected (Modigliani & Fisher, 1978).  Not only because their wages will not keep up with inflation, but also because the less well-off families hold their savings in cash, whereas the more well-off families hold real assets (ibid.). As a result, their purchasing power decreases. 

In France, the “yellow vests” protests that emerged in October 2018 exemplify the social tensions arising from greenflation. Indeed, the carbon tax increase wanted by the government was the straw that broke the camel’s back as this tax did not take into account the economic and geographical situation of the households. France is not an isolated case: the gradual end of consumer subsidies in Indonesia since 1998 has led to a 149% increase in the price of petrol, and to numerous riots throughout the country (Postic et al., 2019).

Moreover, rising energy prices are likely to amplify social inequalities. Energy poverty is a real issue throughout the world and can be defined as the inability to keep homes adequately warm (Atanasiu et al., 2014). Politicians should pay heed to Eurostat data on the issue: in 2020, 8% of the EU population (i.e. 36 million people) were affected by such poverty. However, not all countries are equally affected: Bulgaria and Lithuania are the most affected ones, followed by the southern European countries. More than intra-state social conflicts, the rise in energy prices is likely to worsen the phenomenon of a multi-speed Europe. 

Greenflation: Understanding the problem…

The situation is somewhat paradoxical: while the climate emergency is on everyone’s mind, how can one protest against measures in favour of the green transition? Is it not possible for humans to reduce their consumption to achieve the common good?

In order to better understand the “yellow vests” and their behaviour towards the carbon tax, I decided to conduct a survey within a Facebook group called “Gilets Jaunes [Yellow Vests]”. A small number of individuals answered (n=21). Provided that they took the survey seriously, 95.2% of them were against the carbon tax, while 38.1% attach great importance to the climate issue. In fact, the problem is rooted in the misinformation that abounds in such groups, with almost 23.8% of respondents believing that climate change is merely a political chimera. Lastly, the vast majority think that the carbon tax lacks transparency (95.2%) and want to see something concrete in return (85.7%). These results are in line with other articles that accused the tax of opacity in its functioning (Cessac, 2019).

…to provide efficient solutions

Understanding the problems linked to greenflation to provide efficient solutions.

Firstly, governments must be able to help the most vulnerable ones, who will be the most affected by greenflation. For example, they can distribute energy vouchers, as in France or in South Korea (Podesta et al., 2021), or offer a reduction in green energy tariffs. And since 2009, Spain has been offering a 25% reduction in the regulated price of electricity to low-income households.

Some states (or regions) have already implemented more advanced economic systems: revenues from the carbon market are allocated to a green fund separate from the general state budget (Postic et al., 2019). Quebec, for example, has a green fund that finances projects such as greener transport, help to farmers so they can meet the challenges of environmental protection, housing renovation, etc. (MDDELCC, 2017). In California, the fund set up has similar missions with the constraint that 35% of the funds must benefit disadvantaged or low-income households (Breslow, 2020).

Finally, more audacious but still feasible solutions to reconcile greenflation and social tensions are proposed by some NGOs. For example, the carbon tax imposed on individuals and companies could partly be used to distribute money to less well-off households in order to protect their purchasing power. This distribution to the least well-off households would take the form of a “climate income” calculated on the basis of income, location and household composition (Climate Action Network, 2019). Australia and Sweden have hitherto reduced the taxation of the lowest incomes thanks to the carbon tax (Postic et al., 2019), and thus limit the social impact of greenflation.

Communicate, communicate and communicate!

Following the “yellow vests” protests, it was regrettable for many activists that the French government gave up on increasing the carbon tax. Even worse were the prosaic explanations of the French government on the reasons for the withdrawal of the tax increase. Indeed, they dealt mainly with the tax pressure, whereas they should have highlighted the efficient, fair and transparent distributional policy that the possible upcoming modification of the tax could have enabled. The nub of the problem was the lack of transparency which led to the belief that the government had surreptitiously implemented a new tax.  It is indeed essential for governments to communicate clearly on how the tax works and to insist on its benefits. In this way, the population is more likely to accept environmental taxation (OECD, 2010).

In any case, it is of the utmost importance that governments do not give up on measures for the ecological transition. As there is no such thing as a free lunch, everyone must do their bit. But governments have a responsibility to help the most vulnerable so that the green transition is not only beneficial to the environment, but also to society as a whole.

See the full list of references used in this article. 

Greenflation: The Achilles heel of the green economy? By Paul Pernot. Link up with Paul Pernot on LinkedIn.
Paul Pernot

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