Fiscal policy Finance

What is the role of investment in delivering a just transition?

To decarbonise the economy, Scotland must overcome its historic problem of low investment.

What is the role of investment in delivering a just transition?

By Laurie Macfarlane

13 July 2023

Delivering a just transition to net zero by 2045 poses many practical challenges. Perhaps the most critical of these relates to mobilising investment. 

Decarbonising the economy will require large amounts of investment to transform carbon-intensive sectors and scale up green infrastructure. In Scotland however, the economy has long been held back by a chronic problem of underinvestment. 

The chart below shows an international comparison of investment in Scotland, the UK and OECD countries. For the past two decades, investment in Scotland and across the UK has consistently been among the lowest among advanced economies

To deliver a just transition, it is clear that Scotland must overcome its longstanding problem of low investment. But who should deliver this investment, and how much is needed? To answer these questions, it is important to clarify what we actually mean by ‘investment’.

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What is investment?

In economics, the term ‘investment’ refers to ‘gross fixed capital formation’. This relates to spending on the acquisition or repair of long-term fixed assets (such as buildings, wind farms or machinery) which help produce more output in future. This investment will likely create new jobs and help to increase output and productivity. This definition differs from how the term ‘investment’ is often used in other contexts.

For example, it may seem somewhat paradoxical that Scotland – with its large financial sector managing billions of pounds of assets – would suffer from low investment. But in finance, ‘investment’ has a much broader definition, relating to the acquisition of any asset. While there is some overlap, there are important differences between these definitions. In particular, investment in finance can often relate to the purchase of an existing financial or physical asset (e.g. shares in a company or a physical property), rather than the production or repair of a fixed asset.

In recent decades banks have shifted from mainly lending to businesses for productive investment, to primarily lending to purchase pre-existing assets – particularly real estate and financial assets. While these transactions may be profitable, they do not typically generate any new economic value, as the assets in question already existed. Instead, the transactions represent a change in ownership of an existing asset, rather than the production of a new asset. As a result, they do not increase investment in the economic sense.

Across the UK, it is estimated that less than 10% of bank lending flows to productive non-financial businesses, and only between 2% and 5% flows to small and medium enterprises (SMEs). As such, it is important to make a distinction between private finance and productive investment: Scotland has lots of the former, and too little of the latter. 

Of the bank lending that does finance productive investment, not all of it is socially or environmentally desirable. Since 2016 the five biggest UK lenders – Barclays, HSBC, Standard Chartered, Lloyds and Natwest – have channelled more than £300bn into fossil fuels. Rather than helping to tackle the climate crisis, this investment has actively fuelled it. 

In the context of delivering a just transition, it is not only the total quantity of investment that matters – but where that investment is directed.  

Who should deliver green investment?

Total investment includes that undertaken by the government (public investment), and that undertaken by the private sector (business investment). Both will play a vital role in accelerating a just transition to net zero. 

Businesses will need to invest to decarbonise their operations and invest in new production processes, products, and supply chains. Industry is Scotland’s second-highest emitting sector, and will need to rapidly decrease in the next decade.

But at less than 10% of GDP, the level of business investment in Scotland is among the lowest in the OECD. The causes of Scotland’s low business investment are longstanding and multifaceted. One reason relates to the UK banking sector’s reluctance to finance productive investment, as outlined above. Another relates to corporate short-termism: British companies often prioritise dividend payouts and share buy-backs over long-term investment. Uncertainties and trade frictions resulting from Brexit have also exacerbated the issue in recent years.

While increasing green business investment is crucial, alone it will not be sufficient to deliver a just transition. The reasons for this are twofold. The first relates to the urgency and scale of the challenge. Only governments have the resources and capacity to deliver a large and coordinated programme of investment in the timeframe required. As was shown during the Global the Covid-19 pandemics, governments – unlike individual businesses – have the fiscal resources to transform the economy at scale and pace, where there is the will to do so. 

The second reason relates to fairness. Alongside urgency, social and economic fairness must be a guiding principle of a just transition. Investment will be needed not just in the places where private markets can make financial returns, but also in areas that yield the highest social and environmental returns. Many investments required to deliver a just transition have essential public good characteristics that can be more effectively and fairly achieved through direct fiscal spending. Scaling up public investment is not only critical to ensure that the transition happens on the timeframe required – but also to ensure that costs and risks are shared in a just manner. 

In recent decades however, public investment in Scotland and the UK has been comparatively low. According to the Office for Budget Responsibility (OBR), public investment as a share of GDP across the UK has consistently been in the bottom quartile among OECD countries. 

How much investment is needed to deliver a just transition? 

The exact amount of investment required to deliver Scotland’s net zero commitments remains uncertain. However, it is clear that a major step change is required. 

The Climate Change Committee estimates that annual low-carbon capital investment will need to increase fivefold – rising from less than £1bn per year today to £5-6bn per year by 2030. As the chart below shows, key priorities include investing to decarbonise electricity supply, housing and commercial buildings, surface transport, fuel supply and land use change. 

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Delivering this will require coordinated efforts to raise both public and private investment, and re-align financial flows towards just transition goals. While this poses significant challenges, it also presents enormous opportunities for Scotland’s economy. 

Delivered effectively, it has the potential to create a new generation of well paid green jobs, raise living standards, reduce poverty, tackle deep-rooted inequalities. In contrast however, the consequences of failing to invest on the scale required are clear: Scotland will fail to meet its climate commitments, and a just transition will become a distant pipe dream. 

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