Optimizing Canada’s policy toolbox for clean growth

by Marisa Beck, Don Drummond, Stewart Elgie. Originally published on Policy Options
February 22, 2023

To achieve net-zero emissions by 2050 and to build a vibrant, inclusive and resilient economy, Canada needs to mobilize private investment – and fast – toward clean technologies, projects and businesses. Otherwise, the economy will falter, leaving Canada unable to significantly curb emissions and unable to remain competitive in the accelerating energy transition around the world.

But Canada’s track record with mobilizing private investment has been insufficient. How can Canadian governments attract investment to advance clean growth as quickly and as efficiently as possible?

While the task may be challenging, it is possible for Canada to keep up with its allies and trade partners in navigating this transition. Ottawa needs to further strengthen the most effective tool in its collection – carbon pricing – and add new tools to directly address the remaining barriers to mobilizing private investment. It also needs to develop clean growth strategies for key sectors and systems by working with experts, the provinces and private actors to enable the various tools to work together to build a solid foundation for Canada’s net-zero economy.

So far, Canada has rightly relied on carbon pricing as its main decarbonization investment driver. The policy’s influence on investment decisions is expected to become even more important as the price increases in the future. Carbon pricing is both an effective and efficient tool to address a key market failure that can disadvantage low-carbon technologies – that a product’s market price does not typically account for the damage from carbon emissions in its production and consumption. As a result, companies lack that incentive to invest in the adoption of cleaner technologies.

The national minimum price on carbon pollution will increase to $65 a tonne of greenhouse gas emissions (GHG) on April 1 and will go up to $170 a tonne by 2030. But Canada needs to strengthen and simplify its carbon pricing system to maximize its impact on private investment decisions. Carbon contracts for difference – a way to remove uncertainty over future carbon prices – can help reduce uncertainty for investors worried about whether a future government will stay the course on carbon pricing. Also, strengthening carbon pricing for industry across all provinces and territories can further reinforce decarbonization incentives for investors.

While carbon pricing is a necessary policy tool to mobilize private capital for clean growth, it’s not enough on its own to meet Canada’s net-zero targets. There remain several Canadian market failures that prevent companies and financial institutions from aligning their investments with Canada’s clean growth objectives:

• Decades of fossil fuel subsidies have created an uneven playing field. The federal government has historically implemented policies that supported growth in the fossil fuel sectors. Fossil fuel use is expected to decline worldwide in a net-zero future. But these subsidies, both past and present, have created a lasting competitive advantage for fossil fuel industries and an additional hurdle for competing clean-energy technologies that carbon pricing alone will not be able to overcome.
• Investors in low-carbon projects often face high capital costs, long return horizons and high risks. These projects can offer significant public benefits and future profits but may not generate short-term returns for investors. Even taking carbon cost savings into account, such first-of-their-kind projects are often unable to attract enough private capital to get off the ground. A key reason is that private investors can’t fully capitalize on the other social and economic co-benefits of these projects, such as job-creation, new trading relationships and opportunities for Indigenous economic leadership. Initial investors also may drive costs down the learning curve and contribute to building competitive industrial clusters, but they are unable to profit from these future benefits.
• Clean growth policies in other jurisdictions, most notably the United States, can also distort the private investment playing field. In August 2022, the U.S. Inflation Reduction Act introduced nearly US$370 billion in subsidies to producers and consumers of various low-carbon technologies. Almost overnight, the act has put Canada and governments around the world under pressure to respond in kind to stay competitive in the race for global energy transition capital.

To address these issues and to maximize environmental, economic and social returns from private investment in low-carbon technologies and projects, it’s crucial that governments keep the carbon pricing system in place and build additional targeted policies around it. For example, focused, time-limited incentives and public investments can help to better align private and social returns and thereby accelerate capital flows into decarbonization.

This process is now underway. The 2022 federal budget and fall economic statement introduced new mechanisms for supporting clean energy projects. The soon-to-be-launched Canada Growth Fund will invest in clean energy projects and businesses to attract private capital; an investment tax credit for a variety of clean technologies will provide financial incentives for investors; and the Innovation and Investment Agency will support businesses to commercialize clean and low-carbon innovations. The 2023 federal budget should include further action, such as a manufacturing investment tax credit for clean technologies.

But arguments in favour of additional support policies to help address market failures in Canada are not a licence for scattered and excessive public spending. Public funds are scarce and opportunity costs are high. Prudent selection of funding recipients is necessary to maximize social returns from public investment. Governments must be careful that public funding doesn’t turn into windfall profits for certain corporations – typically those that are good at lobbying. Governments should define their priorities clearly and transparently to increase accountability and limit susceptibility to industry lobbying.

The net-zero shell game

Budgeting for net-zero emissions in inflationary times

Nature-based solutions to help us reach net-zero

That is why although there are promising policies in the works, ad hoc responses to the U.S. Inflation Reduction Act cannot replace the co-ordinated development of clean growth strategies targeting key sectors and systems. Although growing the policy toolbox is important to channel private capital as intended, Canada’s response must integrate into a wider strategic effort that identifies and effectively capitalizes on the country’s most promising transition opportunities.

This strategic effort should also align provincial and federal clean growth policies, carbon pricing and other financial instruments, as well as non-financial levers, including agile permitting processes and regulations. Strategic reform of Canada’s financial system should also be part of this effort, through development of a clean investment taxonomy and the strengthening of climate disclosure rules to nudge investors toward choices aligned with Canada’s net-zero transition. This will reduce the need for government intervention in the future.

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The good news is that Canada has the policy tools – both those already in the toolbox and others on the way – to accelerate the flow of private investment into clean growth opportunities. It now needs a targeted, strategic process to set priorities and organize those tools so they can quickly and effectively do so, helping to ensure that Canada’s future economy is being built on a strong foundation.

This article first appeared on Policy Options and is republished here under a Creative Commons license.