SustainaWeekly - The decoupling of emissions and economic growth

Economist: Many developed economies in particular have now achieved a strong decoupling between GDP growth and growth in CO2 emissions. Many emerging and developing economies have not yet achieved decoupling demonstrating that the stage of economic development plays a key role. This reflects the amount of resources available for green investment, available technologies and the share of industry in the economy.

Strategist: The ASCOR project provides various metrics that assess climate change risks and opportunities at a sovereign level. The tool aims to provide a comprehensive and freely available framework that investors and issuers can use as a common standard. This framework can be a compliment to other frameworks, such as ESG country scoring and the use of proceeds tool of the Climate Bond initiative.

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Economic growth and sustainability can go hand-in-hand

• Reducing carbon emissions can go hand-in-hand with economic growth

• Many developed economies in particular have now achieved a strong decoupling between GDP growth and growth in CO2 emissions

• Many emerging and developing economies have not yet achieved decoupling demonstrating that the stage of economic development plays a key role

• This reflects the amount of resources available for green investment, available technologies and the share of industry in the economy

While many people believe that ‘de-growing’ the economy is necessary to meet CO2 reduction targets, others believe that improving living standards in an economic sense can be consistent with decarbonisation. It remains an interesting discussion, with plausible reasoning being offered from the two different sides. In this analysis, we further examine the relationship between the trend in CO2 emissions and the economic developments of countries and regions. It shows that a decoupling of economic growth and CO2 emissions is more common in developed economies.

Decoupling

The arguments from the two aforementioned camps is in most instances clear and follows a credible line. For example, the ‘de-growers’ want to prioritize climate change by consuming much less. On balance, by reducing consumption strongly, we use less energy and resources. This gives sustainable development a stronger boost, which is good for our well-being in general. The ‘growers’, on the other hand, see an increase in prosperity as a prerequisite for sustainability and tackling climate change. They argue that only stronger economic development and an increase in prosperity will enable countries to invest in low-carbon innovation and technologies to become more sustainable at a faster pace. In addition, continued expansion is possible by changing the way we produce and by increasing our energy efficiency. It is often added that ‘de-growth’ for the sake of climate is undesirable because it increases the likelihood of social unrest in a society. To gain a better understanding about the relationship between GDP growth and the trend in CO2 emissions, we use historical data for the period 1995-2021 and a model that provides more insight into the matter.

Decoupling occurs once there is a clear trend, for example, where continued growth in the economy is accompanied by a further contraction in CO2 emissions. Then decoupling can be called ‘strong’. It can all be mapped with the so-called 'Tapio decoupling model' (from Energy Report, November 2022). The model is shown in the figure below, using GDP and CO2 data on a global basis.

Breaking the negative link between CO2 emissions and GDP growth altogether will be crucial to achieving climate goals. From a global perspective, a weak decoupling of GDP growth and growth in CO2 emissions is apparent. Global GDP growth is accompanied by an increase in CO2 emissions, but GDP growth exceeds CO2 emissions growth. From this global perspective, this makes the ‘de-growth’ argument partly credible. After all, the decoupling between the two magnitudes is weak and this calls for an increase in energy efficiency to more strongly reduce CO2 emissions. However, the global picture hides a lot of detail. In fact, the developments by region and in countries give a better insights. The variation between regions and countries is large. Further analysis shows that there are cases where economic growth does not go hand-in-hand with an increase in carbon emissions. Not only the efforts of companies and individuals play a key role here, but also government climate policies. If these policies aim to increase energy efficiency, promote low-carbon energy and/or techniques, and encourage behavioral changes, the result will be lower energy intensity and thus lower CO2 emissions. However, this requires large investments, both public and private.

Decoupling by region

Many countries have committed to take measures to limit global warming, regardless of economic development level. However, some governments hesitate to take more ambitious measures to reduce CO2 emissions faster if they have to bear the price of its economic loss, whether real or perceived. It stands in the way of a decoupling between the trends in CO2 emissions and GDP growth. Countries with ambitious climate policies that focus much more on renewable energy deployment and sharp reductions in greenhouse gas emissions, for example, tend to show greater decoupling. But the degree of decoupling also depends heavily, for example, on the stage of economic development of countries. According to the United Nations Intergovernmental Panel on Climate Change (IPCC), countries are more likely to achieve decoupling of GDP growth and growth in CO2 emissions at higher levels of economic development. This is because these countries have more resources to invest sufficiently in the transition to a low-carbon economyand shifted heavy industries abroad (see our note on electricity). Moreover, businesses in these countries have more and often earlier advanced options available for further improvements in production efficiency and other decarbonization measures. And finally, these advanced countries transformed their economies over time towards the more services oriented sectors, with a much lower energy intensive and emissions intensive economic activities. This has contributed to a faster reductions in CO2 emissions.

The difference in the degree of decoupling and the stage of economic development also emerges from our analysis. For example, a clear difference can be seen between different regions, such as Asia, South America (emerging economies) on the one hand, and North America and the eurozone (developed economies) on the other. China has indicated that peak CO2 emissions will be reached in 2030. India's peak emissions are also around that year. Both countries are still developing and have high economic growth numbers, which is associated with high and increasing greenhouse gas emissions. However, the figures also show that Asia is often also in the phase of weak decoupling. In this case, both GDP and CO2 emissions are growing, but the GDP growth rate is at least 20% higher than the growth rate of CO2 emissions.

Most countries in South America are also emerging economically and, as a result, an expansion of negative decoupling is still frequent. However, according to a November 2022 OECD report, South America is in a ‘good position to begin an effective green transition and make faster progress toward its economic, social and environmental goals’. The region ranks relatively well on many sustainability indicators. For example, per capita emissions are lower than other regions with similar levels of development, and its energy mix is already greener today. Renewable energy sources represent 33% of its total energy supply, compared to 13% worldwide, according to the OECD.

Many countries in Europe have already decoupled CO2 emissions from GDP growth. The United Kingdom, France, Germany, the Netherlands, Sweden, Finland, Denmark, Italy, the Czech Republic and Romania are some examples where this process is observable. Outside Europe, the US is the largest country that has experienced several consecutive years in which economic growth has been largely decoupled from CO2 emissions growth.

The table above shows that ‘strong negative decoupling’ (the darkest red areas) is more something of the past and, for now, only occurs during major economic shocks. In any case, this extreme situation has not been observed at the regional level since 2016. Of course, this situation can occur at the country level.

In any case, it is clearly visible from the table that during economic shocks or other external dismay (like a pandemic), the trend in the linkage between CO2 emissions and GDP is disturbed considerably. Around economic shocks the negative decoupling often increases, varying between strong, weak and expanding. We see this occurring during the 1997 Asian Financial Crisis, the 2000 Dotcom Crisis, the 2008-2009 Financial Crisis, and the milder crises in 2012 and 2016. In the Covid year 2020, it was especially recessive decoupling across all regions. Then both GDP and CO2 emissions declined firmly, but CO2 emissions declined much more sharply. The world was in lockdown, and this resulted in a strong decline in the movement of people and goods, causing CO2 emissions to fall more quickly.

Decoupling in the Netherlands

The decoupling of GDP growth and CO2 emissions growth is partly seen in the Netherlands as well, although here the variation in outcomes are sometimes much larger. In the left graph below, the dots are scattered across almost all areas of the matrix, except in the 'strong negative decoupling' area. The outliers in the Netherlands in the relationship between growth in CO2 emissions and GDP growth are particularly noticeable in the 1970s, but partly also in the 1980s.

The general trend seen for the Netherlands run from weak decoupling to strong decoupling. However, in terms of emission reduction since 1990, the Netherlands compares worse than other EU countries. Compared to 1990, total greenhouse gas emissions in the Netherlands have fallen less than the EU average and almost all major economies in the eurozone. This underperformance has been linked to relatively slow progress towards renewables, and to some extent also because of large reliance on gas in the Netherlands. But over the past decade, the Netherlands has stepped up and performed better than the EU average.

In many sectors, CO2 emissions have declined since 1995, while their value added has grown. These are all dark green dots in the right-hand figure above. Almost two-thirds of the sectors are plotted there, with mostly industrial sectors, but also energy supply, retail and ICT-services sector. About eight sectors show a weak decoupling over time, with GDP growth exceeding growth in CO2 emissions. Finally, two sectors show both a decline in value added and emissions, where the decline in CO2 emissions has been sharper.

Maintaining economic growth is important for further sustainability

This analysis shows that reducing carbon emissions need not necessarily be accompanied by a decrease in economic growth. Decarbonization of an economy can be well achieved by improving energy efficiency and reducing carbon intensity. To this end, companies in sectors have various measures and techniques available to decarbonise, with many low-hanging fruit (see here). However, there is no one standard success formula, no common climate policy or other typical solution that leads to stronger decoupling. Some countries have an ambitious and strict climate policies, which accelerates decoupling, while other countries have managed to increase both private and public investment sharply in renewable energy.

In any case, our analysis shows that limiting CO2 emissions can go well hand-in-hand with maintaining economic growth. The data show that many countries have achieved a strong decoupling, with CO2 emissions decreasing and the economy growing. The results thus offer a strong argument that economic growth is an important and perhaps crucial condition for further sustainable development. However, it does not take away from the fact that a strong rationalization of our consumption behaviour for further sustainable development is eminently a good way to contribute to our goal of a stronger reduction of CO2 emissions towards 2030 and 2050.

Finally, it remains a complex story for developing and also emerging countries to achieve strong decoupling. As long as this does not happen, then it may eventually become a major threat to global warming mitigation. Many of these countries (especially developing countries) may not have the resources to invest in a low-carbon economy. The investment gap of these countries is much larger than for advanced economies. In the end, this relates strongly to the need for climate solidarity.