The first post in this three-part series compared Australia's decarbonsation plans with the rest of the world. This second post considers the economics of Australia transitioning to a renewables-based energy system.

In a recent Grantham Research Institute Working Paper, I argue that the well-managed decarbonisation of a representative country's economy would be nationally net-beneficial even in narrow, neoclassical economic terms, for most sectors. The domestic energy sector is one of those where decarbonisation would be in the national economic self-interest, narrowly defined (ie. the appropriately discounted benefits of decarbonising the sector would outweigh the costs). And Australia has much better economic opportunities to decarbonise the energy sector than most countries.

As I make clear in my paper, this is far from an exact science: anyone who tells you they know the costs and benefits of a transition to a renewables-based power system in any country in 2030, let alone 2050, is having you on. Commonly used economic modelling approaches, for example, leave out many of the most important dynamics that will determine these costs and benefits. Hence the approach I take is to combine insights from economic theory with the partial empirical evidence we do have to mount a case that benefits are likely to outweigh costs.

These economic costs and benefits can, within a neoclassical framework, be considered narrowly (counting only the direct, private costs and benefits borne by the parties to a transaction, such as in the electricity market) or broadly (private costs and benefits plus social costs and benefits including, for instance, the costs or benefits to people who breathe the air fouled by coal-fired power generators).

Considered narrowly, the costs of a well-managed transition to a renewables-based energy system are, over the long term, likely to compare favourably with the continuation of a fossil fuel-based one. Yet key dynamics are hard to model, and are ignored or coarsely treated in standard modelling studies of the economic costs of decarbonisation.

Nevertheless, in Australia, as two leading analysts have already pointed out, the direct costs of achieving Labor's aspiration of 50% renewable energy by 2030 will be, for an undertaking of this size and importance, extremely modest.

In fact, various Australian studies have considered the economics of a zero or near-zero carbon electricity or energy system in Australia. These studies use different assumptions, and there are many uncertainties, but the broad conclusion is that the direct costs of a transition to a zero-carbon electricity/energy system would be eminently manageable in the context of a well-designed policy package, and could well bring significant cost savings relative to a fossil fuel-based 'business as usual' scenario.

Factor in the full social costs of the two different systems, and it seems clear that the renewables-based system will have much greater net economic benefits, even if you ignore the global social cost of carbon (ie. the impacts of climate change)  and count only the local/national social costs. The monetised social costs of burning fossil fuels, particularly coal, are very high, as the IMF has recently demonstrated. And the social benefits, in the form of greater 'knowledge spillovers' from innovation associated with a transition to a renewables-based system (assuming strong policy support for zero carbon innovation in the energy sector) would likely be very high, which would increase Australia's productivity and economic growth.

The likelihood that the benefits of decarbonising the energy system will outweigh the costs (and would manifestly be in our national interest when broader considerations are taken into account than cannot be squeezed into the neoclassical cost-benefit framework) means it makes sense for Australia to do this unilaterally. We do not need to wait for any international climate agreement, because the supposed logic of the global 'prisoner's dilemma' does not apply to the domestic energy sector.

Nevertheless, more focused forms of international cooperation would help improve the economics of Australia's energy decarbonisation even further. Agreements with other countries on technology support could usefully be explored (eg. coordinated or joint research, development and demonstration of emerging technologies relevant to Australia, such that as suggested by the proponents of the Global Apollo Programme for clean energy; and coordinated deployment of commercially available but less mature technologies).

As other countries continue to undertake similar energy transitions (see the previous post), the opportunities for exporting Australian goods and services, and for overseas investment, will only grow. For example, China's central bank estimates US$320 billion per year will need to be spent over the next five years to meet the targets in China's 13th Five Year Plan for decarbonising the energy system and cleaning up its environment.

Looked at holistically, with sensible assumptions and an understanding of the (hard/impossible-to-model) complex dynamics of energy decarbonisation, the economics of transitioning to a renewables-based energy system in Australia are extremely strong.

Photo by Flickr user David Clarke.