Green stimulus package together with a VAT rate cut could lead the UK out of recession in 2021

Analysis by global economics consultancy Cambridge Econometrics shows that if the UK government invested a relatively modest £11bn in a package of green measures, combined with a reduction in VAT from 20% to 15%, this could lift the economy out of a potential recession in 2021.

Modelling results show that the fortunes of the UK economy could be turned round with a targeted public investment programme to improve the energy efficiency of buildings and subsidies for new wind and solar power installations. Green measures were found to produce a larger stimulus than equivalent further reductions in VAT.

Combined with a cut in VAT the package could lead to GDP growth of 0.8% by as early as next year.

Hector Pollitt, Head of Modelling at Cambridge Econometrics, explains:

As government focus shifts away from crisis management there are increasing calls for policy makers to put a green recovery plan into action.

Our analysis finds that a green stimulus package, combined with a VAT rate cut, would be an effective way of stimulating the economy because it injects money into the economy quickly, without displacing spending elsewhere.

Our analysis shows that subsidies for companies to invest in renewable electricity generation is a particularly good option, it gives a welcome boost to the economy but also leads to a 12% drop in carbon emissions by 2030. This kind of government intervention is therefore beneficial to the economy and has a long-term positive environmental impact.

Cambridge Econometrics’ analysis of the government responses to the 2008/09 financial crisis found that environmental spending accounted for only a small share of the economic stimulus packages.

Twelve years on, the financial crisis caused by the COVID-19 pandemic and subsequent lockdown offers an opportunity for public policy intervention to be ‘reset’, providing a stimulus package which not only helps people get back to work but also sets the UK on a low-carbon trajectory more aligned with our ambitions to become a net-zero economy by 2050.

What would a green recovery package look like?

The call for ‘green’ recovery plans is gathering momentum around the world. Blueprints for a ‘Green New Deal’, and the European Commission’s ‘European Green Deal’, are already at a reasonably advanced stage.

Our analysis assessed two policies that would likely form core components of any green recovery package: improving the energy efficiency of buildings through a public investment programme and encouraging renewable electricity generation by providing subsidies for new wind and solar installations to power companies (60% of the capital cost).

The green package is modest – it would cost the government little more than £11bn per year over 2021-23. We combine it with a reduction in VAT of 5 percentage points to form a more comprehensive package – the reason for choosing VAT is that COVID-19 has hit household spending the hardest and restoring consumption will be key to any recovery. We compare the results against a scenario without the green measures but with a larger VAT reduction (i.e. the same overall cost to government).

gdp growth uk

The chart shows the impacts on UK GDP. The VAT reduction arrests continued falling demand in 2021, turning a 0.4% GDP loss into a 0.5% gain. If some of the money is instead spent on green measures though, GDP growth could be 0.8%.

GDP growth is also stronger in 2022. A 1.6% GDP increase becomes 2% with lower VAT. Again, diverting some of the funding to renewables and energy efficiency leads to a better outcome (2.2%).

Assessing the green measures separately

Overall, we find that the benefits of the energy efficiency programmes are limited. Paradoxically, the reason is that they are too cheap, so the stimulus effects are limited. Higher investment in energy efficiency is also partly offset by reduced investment by the energy sector, which now has a lower demand for its products.

However, if the investment is targeted towards low-income households (including those who lost jobs in the crisis), the social benefits could still be considerable (although issues in training suitable workers to install energy efficient equipment remain).

In contrast, the renewables subsidies show what happens when technology and policy align. Existing trends towards renewables are intensified and drive higher investment levels and GDP.

Good for the economy… and also for the environment

There is no doubt about the environmental benefits. Our current simulations suggest that the COVID-19 lockdown could result in UK CO2 emissions falling by 6% in 2020 but, without further action, the difference falls to less than 2% by 2030.

co2

The two green measures modelled here could reduce emissions by a further 12%. This figure is on top of other things that would happen anyway, such as coal power plants closing by 2025.