Bernat Camps Adrogué and Ranil Dissanayake dissect the incoherence of UK carbon reduction strategies, highlighting how policies like the Energy Price Guarantee have greatly increased domestic emissions and undermined the achievements of UK climate mitigation aid.

Foreign aid can be a powerful tool to support developing countries, but for many donor countries, domestic policy can be much more powerful—especially when it comes to global goods like fighting climate change. The UK, for example, has far more scope to affect global carbon emissions through its domestic policy than through its foreign aid; and bad domestic policies sometimes completely undo any good that its climate mitigation aid achieves. In this blog we give a concrete example of the incoherence of UK action to mitigate climate change, demonstrating that when it is expedient for domestic politics, the UK is happy to spend money to increase emissions and that one single policy action—the UK’s Energy Price Guarantee (EPG)— increased emissions much more than the UK’s climate mitigation aid reduced it over the same period. We estimate that the EPG increased CO2 emissions by 3.2 million tonnes over the period October 2022-April 2023—double the achievements of UK climate mitigation aid over the same period, which we estimate at a reduction of just 1.6 million tonnes of CO2.

Between 2019 and 2021, the UK spent some £1 billion of foreign aid on reducing the pace of damaging climate change globally. Much of this “climate mitigation” aid aims to either reduce the rate at which developing countries emit greenhouse gases by shifting the energy sources the countries use, or to reduce the rate at which they deplete resources that store greenhouse gases (both fossil fuels and forest cover currently store carbon; removing and using releases it into the atmosphere). Climate mitigation aid accounted for around 3 percent of all the foreign aid the UK gave over this period, a substantial share of the resources available. At the same time, the UK has taken an increasingly hard line on the use of fossil fuel subsidies abroad, and the use of concessional finance for fossil fuel projects in poor countries. This kind of aid, and policy, is not without controversy:  our colleague Charles Kenny has forcefully made the case that climate mitigation should not be funded from aid. Indeed, some argue that a focus on reducing emissions in the poorest countries is at best an irrelevance and at worst actively bad for development and poverty reduction. We make two additional arguments here: that the incoherence between domestic and development policy on climate leaves countries like the UK achieving much less than they could and open to charges of hypocrisy, and that both domestic and development policy on climate change are ripe for reform. We illustrate these points using the UK’s Energy Price Guarantee—a policy with many analogues in other European countries.

A badly designed fossil fuel subsidy

The Energy Price Guarantee is the UK’s response to the surge in energy prices brought on by Russia’s invasion of Ukraine. Coinciding with winter, the UK government decided that in order to protect consumers already struggling with a broader cost-of-living crisis, it would take action to reduce energy bills. The policy it settled on was a per-unit price cap—effectively a subsidy—on gas and electricity costs for households. The logic for the price cap is simple. UK consumers need to consume energy to achieve what the government deems to be a minimally acceptable standard of living: to heat their homes, power their computers, dry their clothes, light their houses. Price increases, on top of an already difficult economic climate, would force some consumers to reduce their energy use, perhaps to the extent that they would be unable to meet these basic requirements, and might also force them to reduce spending on other necessities.

The EPG was designed to forestall this unacceptable outcome. Despite the logic laid out above, it has number of suboptimal characteristics. Firstly, it is a per unit subsidy applied at a flat rate; that is, the reduced price applies to the energy used regardless of how much is consumed in the household. That is defensible if some poor households need to consume a lot of energy, while others only a little, but it does mean that the energy used to heat Rishi Sunak’s swimming pool is subsidized at the same rate as the energy used to heat the bedroom of the impoverished pensioner the scheme is designed in mind of. Secondly, it is notably universal rather than targeted to poor households. The policy makes energy use cheaper for everyone in the UK regardless of income and wealth (and indeed, companion policies do similarly for businesses, for which we do not calculate the impact here). These are not new criticisms: the IFS articulated essentially the same concerns when the scheme was announced.

What’s more, price subsidization of energy has a carbon cost; it is not the case that energy demand is completely fixed, and all the government is doing is making energy bills more affordable. Consumers (and, indeed, producers) respond to energy prices in two ways. First, they reduce the amount of energy they use—not by as much as, say, they reduce their visits to the cinema as prices rise, but by some amount nonetheless. The price elasticity of electricity and gas have been estimated as 0.26 and 0.183 among UK household respectively, which means that for every 10 percent change in price, the amount consumed changes by 2.6 percent and 1.83 percent. At the same time, since energy price shifts have primarily been driven by supply restrictions in gas, consumers might also respond to changing prices by switching to greener alternatives where they are available. For example, that might mean installing solar panels. By subsidizing the price of energy (rather than using alternatives we suggest below), the government has reduced the incentive for consumers to take these actions. We estimate that, based on the size of the subsidy, the responsiveness of energy demand to prices, and the energy mix used over the months the subsidy was in place, the EPG resulted in an increase in carbon-equivalent emissions of 3.2 million tonnes. The full details of our method and estimates can be found in this technical document.

That is a large impact, and likely an underestimate. For one thing, we count only the effect of the consumption subsidies offered by the UK government; a similar scheme supports businesses which we haven’t calculated a carbon impact for. And this is not the only support directly applied to energy bills by the government: an additional winter discount operated as a subsidy too. Beyond this, the chancellor confirmed in the recent budget that the fuel duty freeze will continue—a policy that had, by 2017, already caused as many emissions as nine African countries. Nevertheless, we compared our low estimate with the impact of the UK’s climate mitigation aid to give a sense of scale. With limited (and generous) assumptions about the impact of climate mitigation aid, we find that the carbon cost of the EPG is around double the benefit that is achieved by all of the climate mitigation aid given over the same period—likely around just 1.2 million tonnes. That is, for every tonnes of greenhouse gases our climate aid might have taken out of the atmosphere, the EPG put two back in.

The EPG is a symptom of broader ills in UK climate policy

This illustrates two points about the UK’s climate policy. First is its incoherence. This is not news: indeed, one of us wrote about the ubiquity of policy incoherence in 2021. But it is costly, and it leaves the UK open to a—largely justified—charge of hypocrisy. It is costly because considering the carbon impact of the policy would likely have pushed the government to take different policy actions. For example, the government could have made a regular or one-off cash transfer targeted to lower-income households of equivalent value to the subsidy. Doing so would have first removed the price distortion for higher-income families, restoring the incentive to economize on fuel use. It would also have allowed all recipients of the grant to use the resources to invest in energy-saving devices, or simply to reduce energy use and the put the additional money towards other expenses. An even milder alternative would have been targeted outreach and publicity to encourage energy-saving practices—an approach that the then-Prime Minister Liz Truss explicitly vetoed despite the fact that it was relatively cheap (budgeted at £15 million). Even maintaining the price subsidy approach but limiting eligibility would have reduced the carbon impact of the policy.

The incoherence of the policy also contributes to a keenly felt sense of hypocrisy. Using consumption subsidies that increase fossil fuel consumption at a time when the UK (and other donors, almost all of which have implemented similar energy policies recently) takes an increasingly strict line on the financing of fossil fuel projects in developing countries and regularly advocates for the removal of such subsidies in developing countries means that we are—in effect—asking the world’s poor to make sacrifices we are not willing to make ourselves. The point will not be lost upon them when climate negotiations continue.

The EPG’s climate impact also illustrates just how ineffectual working on climate mitigation through poor countries is relative to taking action at home. Simply by virtue of the fact that the UK’s energy consumption is far, far higher than that of most of the poor countries where most of UK aid usually goes, the scope to affect emissions is an order of magnitude higher at home than in those countries. And the key point really is about reducing emissions, not reducing energy use. We want to increase energy use globally, because it takes a lot of energy to maintain the standard of living we think people deserve—this is the very logic of the EPG. Yes, it’s true that there are countries where they are or will ramp up energy use rapidly (a good thing) and we should subsidise any  action they can take to reduce the emissions associated with this increase (though whether this should be aid or funded separately is another issue). But for the most part domestic energy consumption and emissions in the UK so dwarf what even fast growth in poor countries would suggest, we should be focusing on core development work and expanding energy access and reliability, and doing the heavy lifting on emissions at home.

The wrong response would be to double down on using foreign aid to fight climate change, reasoning that when emissions need to be temporarily higher domestically, that there is all the more reason to offset this with work in other countries. The reasoning is flawed for two reasons. First, there is no scenario in which shifting low-income countries towards cleaner fuels will make up for policy in developed countries, since the pace at which their energy consumption is growing is too slow to make a serious dent in global climate targets (supporting green energy in such places may make sense on its own terms, but that is an empirical question which depends on the local returns to such investments compared with alternative uses for foreign aid, such a fighting disease or supporting education). And secondly, the opportunity cost of using aid to mitigate climate change is enormous: it either achieves little in poor countries, where alternative uses for aid are very compelling, or vast amounts would need to be spent in relatively rich countries to shift their emissions, at the cost of those poor countries which need aid the most. Concentrating effort on domestic policies in places with much more scope to affect emissions is more direct and more efficient.

Options for reform

This suggests two ways to reform current practice. First, recognizing that domestic action has far more scope to affect emissions (both in terms of the scale of emissions we can reduce, and the directness with which UK policy action affects UK outcomes), the UK should assess and optimize its climate action across its full domestic portfolio. And rather than trying to contort climate action to fit the rules for counting aid, it should look at how it can achieve the most across its full locus of influence and then decide whether and if any of the most effective actions are focused on developing countries. Secondly, aid for climate mitigation should be reassessed. By virtue of its volume and the kind of countries it will be spent in, it is likely to be of second order importance to what can be achieved domestically. That means we should, in general, do less climate mitigation aid. It also means that when we do, we should be thinking much more ambitiously about how to get the most of it—whether that means operating through the MDBs or using pull financing to drive innovation and pay only for success.

In a paper about policy incoherence in 2021, Ranil wrote: “Facing multiple global, domestic, and development challenges, governments … should be thinking very carefully about how to get the most from limited resources. A start would be to stop undermining themselves willfully with suboptimal policy sets.” The way the UK has approached the EPG suggests that we are no closer to this end today.

This blog benefited from excellent comments by Sam Hughes, Charles Kenny, Masood Ahmed and Mark Plant.