Growing clean

The 2020s will see the UK’s journey to net zero enter a new phase. In the decade ahead, large scale reductions in emissions will be required from buildings and surface transport, as well as continued rapid decarbonisation both in electricity supply and elsewhere. This will require major economy-wide changes that will have significant impacts on households and firms across the UK.

Investment and innovation will be key to achieving this: the Climate Change Committee estimated that an additional £13.5bn of investment will be needed in 2022, rising to over £50bn by 2030, to meet the UK’s net zero goals, and around 85 per cent of decarbonisation between 2020 and 2035 will involve low carbon technologies or fuels alone or in combination with behaviour change. Both the invention of new technologies and the deployment of existing ones will be important. Globally, over the next three decades, the International Energy Agency estimates that “almost half the [emissions] reductions come from technologies that are currently at the demonstration or prototype stage”. These conclusions spark a variety of responses. The required scale and pace of the investment lead some to question its viability. Others suggest that, given the UK’s current low levels of investment , investing and innovating our way to net zero will address the UK’s chronic underinvestment in innovation, capital and skills.

The reality is that change is coming over the next decade, and, although there will be upfront costs, these changes and the associated investments will provide opportunities for cost savings via improved resource efficiency, growth via the development of new products and services to serve growing domestic and international markets, and broader co-benefits such as cleaner air and improved health. But it is not realistic to assume that we can rely on the private sector to naturally choose the smoothest and cheapest path to net zero. The required innovation – which is radical, and involves the transformation of entire systems in many cases – will not happen at the necessary scale and pace without incentives, regulation, government spending and participation from civil society.

From the perspective of UK policymakers designing these interventions as part of a new economic strategy then, a key question is how to best target investments and design policies to promote the development of current and potential future competitive strengths, and to avoid the pitfalls of attempting to ‘pick winners’.

To inform this, this report provides a hard-headed assessment of the opportunities presented to UK plc by the move to net zero, and considers how best these can be unlocked. It does this by considering carefully the UK’s pre-existing relative strengths in technologies, goods and services that are relevant for net zero. It also undertakes a series of ‘deep dives’ into key areas in the UK’s decarbonisation journey to investigate the extent of UK strengths that can be built upon to accelerate domestic deployment of related technologies as well as unlock export opportunities. Finally, we assess how the UK’s financial sector can be oriented towards delivering the investment needed for net zero, and for realising related opportunities in the UK. The focus is on innovators or firms creating technologies, products and services that are relevant for delivering net zero and that can generate value in the UK; the implications of the net zero transition for workers will be considered in a future Economy 2030 report.

The UK is specialised in clean technologies overall, as assessed by data on patenting, ranking fifteenth globally on this measure. In volume terms, the UK lags behind some countries that are also more specialised in clean technologies: for example, South Korea and Japan produce around four times as many clean patents per 100,000 workers compared to the UK. Nevertheless, within the overall category of clean technologies, there are a few subcategories that stand out for the UK, in particular tidal, offshore wind and nuclear energy and carbon capture usage and storage technologies.

Importantly, we also find that the expected ‘national’ returns from government support for innovation – including private returns for the innovator as well as direct and indirect knowledge spillovers for other UK innovators – are particularly high for both tidal and offshore wind energy technologies; these both have estimated returns of nearly three times the average across all technology fields. This means that government support for these technologies is particularly likely to generate value that is retained in the UK.

Overall, the UK is heavily specialised in services, and areas such as green finance and related services present key opportunities in the UK. But as we have highlighted in previous Economy 2030 reports, the UK also has revealed comparative advantage in certain goods categories such as pharmaceuticals, which rely heavily on the UK’s strong science base and universities. These are also a source of strength when it comes to net zero. In fact, the UK is already a major exporter of ‘green’ goods. The UK ranks 9th globally on ‘green’ exports, accounting for 2.5 per cent of global export volume of such products. This share is similar to France, but significantly lower than China, Germany and the US (at 19, 13 and 10 per cent respectively). Digging deeper at the product level, the UK is specialised in a number of ‘green’ areas. This includes some more complex green products which tend to be more technologically sophisticated, and there is evidence that specialisation in complex products is associated with higher incomes. Finally, among green products where the UK does not currently have comparative advantage, there are a number of complex products which are relatively close to the UK’s existing capabilities – including in renewable energy and environmental monitoring equipment – that represent areas of opportunity.

This national-level analysis suggests that the UK is not the world leader overall in clean technologies or traded goods. It certainly does worse than Germany, which has stronger advantages in many areas of manufacturing, has more existing green strengths, and more proximate future opportunities, particularly in more complex goods. But the UK is among the top countries in terms of its specialisation in clean technologies and products, and there are specific areas of strength that can be built upon as part of a new economic strategy for the UK.

As well as being able to contribute to the UK’s future prosperity, there are also opportunities for the transition to a cleaner economy to help reduce regional inequalities within the UK. Analysis of patent data shows that, although patents overall (as with R&D activity more generally) tend to be concentrated in the ‘golden triangle’ regions, including Oxford, Cambridge and London, areas outside these innovation-intense regions (such as Derbyshire and Nottinghamshire, Cornwall and the Isles of Scilly and Lincolnshire) tend to be more specialised in clean technologies.

There are also interesting – and, for a government wishing to redistribute R&D spending and ‘level up’ the country, helpful – geographic patterns in the returns to investments in clean innovation. Investments in certain clean technologies, such as tidal and offshore wind, are not only likely to generate relatively high national economic returns, but also have the potential to contribute to regionally balanced growth. Investments in these technologies in less innovation-intense regions generate strong returns for those regions (and little leakage). Moreover, government support for these technologies in more innovation-intense regions generates spillovers for the rest of the country, as well as returns in these regions themselves. This highlights the economic contribution that strong innovation clusters can have in other parts of the country.

We also find that less productive regions tend to be more specialised in firms producing clean goods and services. There are over 20,000 such firms spread across the country, with around half being in services. The largest single subcategory, representing nearly 40 per cent of these firms, relates to demand-side management and digital technologies, which includes AI and Internet of Things for energy management and smart systems, highlighting the interplay between clean technologies and digital. Although these firms are generally located in more productive areas (which also tend to have more businesses in general), the fraction of such firms that are ‘clean’ firms is higher, on average, in areas with lower regional productivity. This result does vary by subcategory, though, with firms producing products and services related to low-carbon heat and buildings being particularly likely to be found in areas with lower regional productivity (such as East Wales, South Western Scotland and South Yorkshire), while areas around London are more likely to specialise in other areas including consultancy and services.

A related analysis of firms in the UK’s ‘high-growth economy’ (i.e. firms that have received growth finance or achieved rapid growth), finds consistent patterns. We find that a high share of these (38 per cent) tend to be located in London and the South East, but this is lower than the share of high-growth firms across all technologies (47 per cent). Within the high-growth economy, therefore, areas outside London and the South East appear to be more specialised in goods or services relevant for net zero.
This analysis suggests that doubling down on net zero capabilities in the UK as part of a coordinated growth policy could be consistent with both driving growth and addressing regional disparities in economic activity; future Economy 2030 Inquiry reports will analyse the jobs angle of the net zero transition explicitly.

The next phase of decarbonisation requires change across the UK economy. Urgent action is needed especially in surface transport, electricity supply, buildings, manufacturing and construction, and removals – the top five sources of CO2 abatement by 2050 under the Climate Change Committee’s balanced pathway to net zero. The first four of these sectors will need to deliver the majority of economy-wide abatement required by 2030 to keep the UK on track to meet net zero by 2050, with removals rapidly scaled up from 2030s. Within these sectors, we use various data sources to consider where opportunities might lie for the UK, looking at zero emission passenger vehicles (ZEVs) in surface transport; wind, nuclear and grid flexibility in electricity supply; low carbon heat and buildings; and carbon capture, usage and storage (CCUS), a set of technologies relevant for decarbonising heavy industry and enabling greenhouse gas removals.

Across these areas, we find varying evidence of pre-existing UK comparative strengths. For example, wind is an area where the UK has technological specialisation, and where we have seen that investments in innovation generate relatively high returns in the UK. However, the UK is not yet specialised in the exports of wind-related products. Denmark leads on this measure, despite having smaller installed capacity of wind power compared to the UK. Given its innovative strengths however, commitments to ramp up domestic deployment in the UK might generate new opportunities, including the potential to pioneer floating offshore wind.

CCUS and nuclear are areas where the UK is specialised in both the exports of products, and innovation. CCUS, as yet limited in commercial application globally, can benefit from the UK’s transferrable expertise and capabilities in oil and gas. By contrast, on aggregate, the UK does not have comparative strengths in goods or technologies relating to ZEVs or grid flexibility. But the UK does have digital strengths which are not fully captured in such data, and which apply across both of these areas, for example in the development of connected and autonomous vehicles or smart grids. Finally, heat and buildings constitute an area where the evidence suggests that the UK does not yet have comparative advantage overall, but is specialised in specific products including heat pumps and insulation that are highly relevant for decarbonising its building stock and where largescale domestic deployment could generate new opportunities.

The scale and nature of the investment required to meet net zero requires the public and private sectors to work together. Some low carbon sectors, such as offshore wind, have reached a high degree of financial independence from public sources. Others, such as low carbon hydrogen, still require a large degree of support to become financially viable.
Different financial instruments are required at different levels of technological and commercial maturity. At the early stages of research and development, public finance has a role to play in technologically maturing low carbon sectors: for example, through providing grants to harness the UK’s strong university research base. But there is also an important role for venture capitalists and private equity to invest in emerging technologies, taking risky, high-growth potential positions following these innovation grants. The volume of venture capital investment in the UK is the highest in Europe, and has been growing rapidly. But clean technology firms have attracted a relatively low share of this to date, and this share has fallen from over 10 per cent in the early 2010s to under 1 per cent in 2020. There is evidence that, in the past, investments in these technologies have been considered riskier than, for example, software start-ups. This is beginning to change given the tougher policy commitments to net zero, but there is a clear role for Government to develop investable business models and to de-risk emerging sectors such as hydrogen and greenhouse gas removals, particularly in commercially maturing sectors.
Moreover, a place-based lens is required in decision-making around net zero investments, given that that there are different net zero growth opportunities across the country, and moving out of high carbon activities will have varying impacts on people and firms. By integrating considerations of place into capital allocation decisions and building capacity, the finance sector and related institutions can ensure that finance is channelled to the places that, socially and economically, stand the most to gain in the transition. The newly-formed UK Infrastructure Bank has a particularly central role to play in this area, given its dual objectives of supporting net zero and regional economic growth.

Building on its strengths in financial services, the UK has positioned itself as a leader in green finance, and is the first country to commit to creating a Net Zero Financial Centre by 2050. The UK has made a range of regulatory changes, including the introduction of mandatory climate reporting and transition plans for businesses, as well as the Bank of England’s Net Zero mandate. This has created the basis for the UK to continue leveraging its specialisation in financial and related services and potential for financial innovation in the transition to net zero. But a number of challenges remain. Environmental Social and Governance (ESG) ratings are often the basis of funds with a ‘sustainable’ label. But such ratings evaluate financial risks related to sustainability, rather than environmental impacts of the business in question. There is, therefore, a risk that ‘greenwashing’ prevents finance flowing to projects that can deliver net zero and generate related opportunities.

Net zero alone is not a silver bullet for reversing the UK’s economic stagnation and addressing inequalities: domestic implementation of climate policies and targets does not necessarily lead to domestic economic benefits or ensuring that these, and costs, are shared fairly. To maximise the chances that these objectives can be achieved, it will be necessary for the transition to be embedded into a coordinated and system-wide policy approach that stimulates increased and well-targeted investments across innovation, infrastructure and skills.

Done right, in 2030 the UK could have higher living standards, and better health and wellbeing, underpinned by UK businesses innovating and adopting cutting-edge clean technologies and practices fit for the mid-21st century. Future Economy 2030 reports will examine the jobs aspects of the transition, examining how the benefits of net zero investments can be spread across the country and how displacements can be actively managed against the background of over a decade of stagnant living standards, weak productivity and low investment, and in parallel with other drivers of change including Covid-19, Brexit and geopolitical instability in Europe.