Climate Change and the Competitiveness of Nations

European Straits #20

Dear all,

I happened to be in Las Vegas, with a direct view on the Trump Tower there, when we learned about Donald Trump’s decision that the US should leave the Paris agreement. This deplorable decision only reinforces the critical threat of climate change. But I’m also convinced it puts the US on the losing side of economic development and jobs creation in decades to come.

With his ‘Schumpeterian Growth paradigm’, Philippe Aghion, one of the leading French economists, helps us understand why. In his inaugural lesson at the Collège de France two years ago, titled “Les énigmes de la croissance” (“the enigma of economic growth”), Philippe reminded a captivated audience that most of his research has been dedicated to the complex relationship between competition and innovation.

A widespread view is that too much competition takes a toll on innovation: it forces businesses to cut their margin down, depriving them of the economic surplus necessary to invest in new products or processes. Philippe’s work with Peter Howitt, however, leads to a different conclusion: in the presence of an additional constraint (increased competitive pressure or a binding norm), businesses behave differently depending on their culture and their positioning. Those close to the "technological frontier", otherwise called “neck-and-neck firms”, redouble their efforts to innovate in the face of constraints in order to preserve their competitiveness. Those who are already behind in terms of innovation weaken even more and are eventually forced to exit the market.

This tells us a lot about Trump’s decision. Instead of supporting job creation, laxer regulations regarding climate change will remove an incentive for American firms to innovate, thus trapping them in a war of attrition where their only weapon is to lower prices. This is consistent with Michael Porter’s seminal research on strategic positioning. In his work on the competitiveness of nations, Porter describes the extent to which regulations designed to limit carbon emissions in countries such as Japan, Germany, Sweden, and Denmark have allowed domestic manufacturers to take the lead in energy efficiency and pollution reduction, particularly in relation to their US competitors.

In other words, it is not enough to have a vibrant business sector, as the US does, to innovate and sustain higher productivity gains. Norms and regulations imposed by the state are needed to stimulate and channel these innovation efforts and facilitate their widespread dissemination.

Obviously, Donald Trump couldn’t care less about long-term US economic growth. And from a political (and electoral) point of view, you can understand why. When a politician explains to endangered workers in traditional industries that they’ll soon find a new job in more forward-looking and innovative sectors, voters don’t believe it—and they’re right not to, as the probability of laid-off workers finding a job that matches their skill set in the same geographic area and with a comparable wage is indeed very low.

In truth, we’re in desperate need of a convincing discourse by liberal leaders that establishes a clear relationship between preserving the environment and creating jobs for workers of all ages and all levels of education. For too long, those leaders have been trapped in an ever-more ineffective discourse that involves regulatory and tax incentives for businesses as well as lifelong education for displaced workers. The reason it doesn’t work politically should be obvious: voters don’t care about tax incentives for businesses and they don’t believe the hype when it comes to being trained for another job.

The solution is not to demonstrate that the government will preserve existing jobs or recreate those that have long since disappeared: it can’t and it won’t. Rather, we should draw inspiration from Mad Men’s Don Draper: “If you don’t like what’s being said, change the conversation.” What liberal politicians should do is piggyback on the vision of entrepreneurs and harness their unmatched ability to move the needle on complex problems. Rather than explaining what government can do, they should understand what entrepreneurs can do to reduce carbon emissions and create jobs, then simply figure out what government can do to make it easier: it mainly takes what Carlota Perez calls a “new direction for innovation”, i.e. regulations and the resources to make that direction effective.

I myself am convinced that the likes of Elon Musk will contribute more to curbing carbon emissions than any tax credit or government subsidy: as entrepreneurs, they can harness the power of personal computing and networks to effectively fight climate change...provided favorable regulations are in place!

There’s one consolation in all this: as Trump brings the US backward, European policymakers could finally convert to the idea that entrepreneurship enhanced by forward-looking regulations may be the solution.

Warm regards,

Nicolas