Technological and institutional change for a transition to a low carbon economy: a co-evolutionary framework

Transcription

1 Technological and institutional change for a transition to a low carbon economy: a co-evolutionary framework Timothy J Foxon Sustainability Research Institute, School of Earth and Environment, University of Leeds Leeds LS2 9JT, U.K. t.foxon@see.leeds.ac.uk Paper for EAEPE (European Association for Evolutionary Political Economy) 2007 Confererence: Economic growth, development, and institutions - lessons for policy and the need for an evolutionary framework of analysis, Porto, Portugal, November 1-3, 2007 Abstract This paper develops and applies a co-evolutionary approach to the analysis of technological and institutional change required for a transition to a low carbon economy. A co-evolutionary approach combines evolutionary understanding of how the dynamics of a system arises through processes of variation, selection and retention with a causal account of interactions between systems. Following recent literature, the paper argues that a co-evolutionary analysis of interactions between technological systems, institutional frameworks and firms strategies provides a fruitful approach to understanding long-term industrial change. Political commitments to mitigate climate change will require a radical transformation of current carbon-based energy systems, and hence technological and institutional innovation to overcome the current state of carbon lock-in. The paper argues that current policies have largely been driven by mainstream economic thinking and that this helps to explain the relative failure of policy measures introduced so far. This is illustrated by examples relating to the European carbon trading system, UK renewables policy and strategies of incumbent European electricity companies. The paper concludes by arguing that a coevolutionary approach would provide a richer basis for informing future policy interventions to overcome carbon lock-in and promote a transition to a low-carbon energy system. Keywords: Co-evolutionary approach; technological and institutional change; lock in. EAEPE research area: [C] Institutional Change. 1

2 1. Co-evolutionary approach to long-term industrial change Three main bodies of literature have contributed to understanding long-term industrial change: evolutionary economics, business and economic history, and strategic management. Recent work has sought to combine insights from these three literatures to develop a co-evolutionary approach. Building on his pioneering work developing an evolutionary theory of economic change (Nelson and Winter, 1982), Richard Nelson has argued that economic growth theory requires analysis of the co-evolution of technologies, industrial structures and institutions (Nelson, 1995; 2005). In particular, he has focussed on the role of institutions as a factor shaping economic performance (Nelson and Sampat, 2001). Institutions here are understood as social technologies, i.e. ways of organising and co-ordinating human activity, for example the management of firms, which facilitate particular courses of action, whilst creating barriers to other activities. Firms business activities thus become organised into routines or set patterns of behaviour. In his study of the historical dynamics of the synthetic dye industry in the late 19 th and early 20 th centuries, Murmann (2003) uses a co-evolutionary approach to analyse the interactions between technological development, institutional change and firms strategies. Drawing on wider work examining how evolutionary change arises through three causal processes of variation, selection and retention (Ziman, 2000; Hull, 2001), he provides a definition of coevolution: two evolving populations coevolve if and only if they both have a significant causal impact on each other s ability to persist (Murman, 2003, p.210). This causal influence can arise through two avenues: by altering selection criteria or by changing the replicative capacity of individuals. He uses this approach to examine the key factors that led the German chemical industry to become leaders in the synthetic dye industry at the expense of their British and U.S. counterparts. These included firms establishment of in-house R&D laboratories leading to the development of an increasing variety of new synthetic dyes, and the stronger cross-fertilization between the dye industry and chemical research and teaching at German universities, including exchange of personnel and formation of commercial ties. A key factor was that the early success of the German chemical industry enabled it to gain a strong position to lobby, with academic support, for increases in educational spending and a more favourable patent regime. In this way, 2

3 changes in industrial structure enabled firms behaviours which influenced the evolution of national institutions, so as to improve the selection environment for those firms. Applying ideas from complexity theory and evolutionary economics to business strategy, Beinhocker (2005) has also advocated a co-evolutionary approach. He argues that economic evolution arises as the joint product of evolution of design spaces relating to Physical Technologies, Social Technologies and Business Plans. Following Nelson, he defines Social Technologies as methods and designs for organising people in pursuit of a goal or goals (Beinhocker, 2005, p.262), including institutions, structures, roles, processes, and cultural norms. These three design spaces have their own processes of variation, retention and selection, but they co-evolve through interactions between these processes in the different spaces. Beinhocker argues that these co-evolutionary interactions have driven the creation of wealth in Western industrialised countries, crucially through the development of property-right based market economies which encourage the innovation of physical and social technologies for more efficiently and effectively meeting (and creating) consumer demands. 2. Path dependency and lock-in A key idea from economic history and complex systems thinking, which is carried over into a co-evolutionary approach, is the role of path dependency and lock-in (see Foxon, 2007). Path dependency is the idea that the successful innovation and take up of a new technology depends on the path of its development, including the particular characteristics of initial markets, the institutional and regulatory factors governing its introduction and the expectations of consumers (David, 1985, 1997). Of particular interest is the extent to which such factors favour incumbent technologies against newcomers. Arthur (1989, 1994) examined increasing returns to adoption, i.e. positive feedbacks which mean that the more a technology is adopted, the more likely it is to be further adopted. He argued that these can lead to lock-in of incumbent technologies, preventing the take up of potentially superior alternatives. Examples cited include the QWERTY keyboard layout (David, 1985) and the light-water nuclear reactor design (Cowan, 1990). 3

4 Arthur (1994) identified four major classes of increasing returns: scale economies, learning effects, adaptive expectations and network economies, which contribute to this feedback in favour of existing technologies. Scale economies, occurs when unit costs decline with increasing output. Learning effects act to improve products or reduce their cost as specialised skills and knowledge accumulate through production and market experience. Adaptive expectations arise as increasing adoption reduces uncertainty and both users and producers become increasingly confident about quality, performance and longevity of the current technology. Network or coordination effects occur when advantages accrue to agents adopting the same technologies as others, example, in telecommunications technologies, where the more others that have a mobile phone or fax machine, the more it is in your advantage to have one (which is compatible). Similarly, infrastructures develop based on the attributes of existing technologies, creating a barrier to the adoption of alternative technologies with different attributes. In his pioneering work on institutional change, North (1990) argued that all the features identified by Arthur as creating increasing returns to the adoption of technologies can also be applied to institutions. New institutions often entail high setup or fixed costs. There are significant learning effects for organisations that arise because of the opportunities provided by the institutional framework. There are coordination effects, directly via contracts with other organisations and indirectly by induced investment, and through the informal constraints generated. Adaptive expectations occur because increased prevalence of contracting based on a specific institutional framework reduces uncertainty about the continuation of that framework. In summary, North argues, the interdependent web of an institutional matrix produces massive increasing returns (North, 1990, p. 95). These ideas are closely related to that of cumulative circular causation in European institutional economic thinking, i.e. mutually reinforcing causation between variables of distinct open systems. This idea anticipates many of the conclusions of pathdependence theory because it incorporates the notions of strong positive feedbacks, inertia, initial conditions and bifurcation points (Berger and Elsner, 2005). 4

5 Pierson (2000) argues that political institutions are particularly prone to increasing returns, because of four factors: the central role of collective action; the high density of institutions; the possibilities for using political authority to enhance asymmetries of power; and the complexity and opacity of politics. In particular, he notes that the allocation of political power to particular actors is a source of positive feedback, as when actors are in a position to impose rules on others, they may use this authority to generate changes in the rules (both formal institutions and public policies) so as to enhance their own power. 3. Carbon lock-in A co-evolutionary approach provides more insight into the causal processes relating technological and institutional change, which can give rise to lock-in at a systems level. Unruh (2000, 2002) suggests that modern carbon-based energy systems have undergone a process of technological and institutional co-evolution, driven by pathdependent increasing returns to scale. He argues that this gives rise to technoinstitutional complexes (TIC), composed of technological systems and the public and private institutions that govern their diffusion and use, and which become interlinked, feeding off one another in a self-referential system (Unruh, 2000, p. 825). In particular, he describes how these techno-institutional complexes create persistent incentive structures that strongly influence system evolution and stability. Building on the work of Arthur (1989, 1994), he shows how the positive feedbacks of increasing returns both to technologies and to their supporting institutions can create rapid expansion in the early stages of development of technology systems. However, once a stable techno-institutional system is in place, it acquires a stability and resistance to change. In evolutionary language, the selection environment highly favours changes which represent only incremental changes to the current system, but strongly discourages radical changes which would fundamentally alter the system. Thus, a system which has benefited from a long period of increasing returns, such as the carbon-based energy system, may become locked-in, preventing the development and take-up of alternative technologies, such as low carbon, renewable energy sources. Furthermore, actors, such as those with large investments in current marketleading technologies, who benefit from the current institutional framework (including 5

6 formal rules and public policies) will act to try to maintain that framework, thus contributing to the lock-in of the current technological system. Unruh illustrates this process through the example of the electricity generation techno-institutional complex, in which institutional factors, driven by the desire to satisfy increasing electricity demand and a regulatory framework based on increasing competition and reducing unit prices to the consumer, feed back into the expansion of the technological system based on large-scale centralised electricity generation. We develop this example in the course of our case studies below. 4. Responding to carbon lock-in In response to the risks posed by global climate change, many governments have committed themselves to achieving dramatic reductions in their emissions of carbon dioxide (CO 2 ) and other greenhouse gases. For example, the UK has committed to achieving a 60% reduction in its CO 2 emissions from 1990 levels by 2050, and has recently published a Climate Change Bill to make this commitment legally binding (Defra, 2007). This will require a radical transformation of current carbon-based energy systems, and hence technological and institutional innovation to overcome the current state of carbon lock-in. However, current policies have largely been driven by mainstream economic thinking and we argue that this helps to explain the relative failure of policy measures introduced so far, illustrated here by three examples. The main policy instrument deployed in Europe has been the introduction of a carbon emissions trading scheme (ETS) covering around 50% of industrial emissions. After failure to agree on a carbon tax in the 1990s and the need to reduce emissions to meet their Kyoto targets agreed, members of the European Union agreed to implement the ETS, initially for 2005 to However, the first phase of the European ETS from 2005 to 2007 was characterised by over-generous allocation of allowances by governments to firms. This led to a collapse in the trading price in March 2007, when it became clear that the majority of firms could meet their emission caps without buying any additional allowances (Carbon Trust, 2007). Though the European Commission has enforced more stringent caps for most countries for the second phase from 2008 to 2012, it seems that this is unlikely to achieve more than incremental 6

7 reductions in emissions. Furthermore, there is still considerable uncertainty over the plans for the third phase of the ETS from 2013, creating a barrier to long-term investment in more radical carbon mitigation measures. The framing of the ETS results directly from the application of neo-classical economic thinking to environmental problems. The ETS is seen as a mechanism to get the price of carbon right by pricing a previously unpriced externality. Though this will clearly provide an incentive for emissions reductions, it neglects complexities which are highlighted by a co-evolutionary approach. First and foremost is the fact that the allowance caps which are set by national governments are not determined by a rational process according to the size of emissions reductions needed, but are the result of a deeply political process, in which actors act according to their self-interest. As would be expected from historical analysis and institutional economic theory, firms which had power under current institutional arrangements lobbied to reduce the impact of the changes associated with the introduction of the ETS. In particular, these lobbying efforts led to the setting of less stringent caps by governments and also to the free allocation or grandfathering of allowances based on firms previous emissions. This has led to windfall profits for some firms, particularly electricity generators, as they have been able to pass permit costs on to consumers, despite getting these permits for free. The alternative scheme of auctioning allowances would force firms to pay for the number of permits that are likely to use, and would also create an additional revenue stream which governments could use to reduce labour taxes or invest in R&D and deployment of low-carbon technologies. 5. Renewables policy and the response of incumbents To address the challenge of climate change and concerns relating to energy security, European governments have also put in place specific policy measures designed to promote innovation in low-carbon technologies. Whilst other approaches tend either to look at the outcomes of such measures in providing incentives for low-carbon innovation, or to examine the processes involved in the design and implementation of these measures, a co-evolutionary approach seeks to examine the causal interactions in both directions. The rate of development and deployment of low-carbon technologies is strongly influenced by how incentives affect firms R&D and 7

8 investment decisions, for example, by affecting the expectations of future paybacks from these investments. The strength of the policy measures is governed by policymakers expectations of the magnitude of support needed to achieve technology learning and cost reductions, the potential improvements in technical and economic performance, the attitudes of firms, trade associations and pressure groups, and judgements relating to the political acceptability of all these aspects. These factors give rise to a process of co-evolutionary development of technologies and supporting institutional rule-systems. The cases that we have examined highlight particularly the influence of mainstream economic thinking in influencing policy development, and the role of incumbent firms in often following a dual-track strategy of investing in innovation of renewable technologies, whilst simultaneously lobbying to weaken implementation of policy measures designed to promote their development. The policy regime to promote the development of renewable electricity generation technologies in the UK has centred on a market-based instrument, the Renewables Obligation (Foxon and Pearson, 2007). The Renewables Obligation (RO) is a longterm policy instrument, providing an incentive for an annually increasing proportion of electricity to be supplied from renewable sources. The level of the obligation increases in annual steps from 3% in to 15.4% in , and to remain at (at least) that level until , with a guarantee that the level will not be reduced. The obligation is placed on electricity suppliers, (i.e. companies that sell electricity to private or business customers). At the end of each year, suppliers have to show that they have satisfied the obligation in one, or a combination, of three ways: (i) by direct sourcing of eligible renewable generation (qualifying for Renewable Obligation Certificates or ROCs); (ii) by buying an equivalent amount of ROCs in the trading market; or (iii) by instead choosing to pay a buy-out price, initially set at 3 p/kwh. The Obligation thus provides a strong incentive for electricity generating firms to invest in renewable generation technologies, by creating a market for suppliers to purchase the renewably generated electricity. However, in contrast to the support system provided in other countries such as Germany which provide guaranteed prices for a range of renewable technologies, the UK system is ostensibly technology-neutral, i.e. it does not distinguish between different renewable technologies. During its design, many firms and renewables trade 8

9 organisations lobbied for the Obligation to include bands for different technologies, reflecting the different stages that these technologies are at in the innovation process, rather than being technology-neutral. This was rejected on the grounds that [banding] ran counter to the market led approach which had been designed to ensure that suppliers would meet their Obligation by the most economic means and that the government did not want to distort the market place or send the message that some renewable technologies were more important than others in meeting UK targets (DTI, 2000). The renewables industry thus had insufficient power to overcome the dominant economic thinking that informed the design of the policy instrument. In practice, this has resulted in firms choosing to invest in the cheapest renewable technologies, particularly onshore wind, whilst giving rise to systems failures, i.e. providing little incentive for investment in early-stage renewables, such as biomass energy crops, wave and tidal power and solar photovoltaics (Foxon et al., 2005). Following lobbying by the now more influential renewables industry and recognition of the difficulties faced by early-stage renewables, the government reversed its position in its 2006 Energy Review to support banding within the RO, and detailed proposals are now the subject of consultation. A study by the author and colleagues of the German and Spanish electricity systems used a co-evolutionary approach (Stenzel et al., 2007) to examine how the evolution of firms strategies interacts with the evolution of technological and institutional systems. In particular, it examined the role of large incumbent electricity generation and supply firms. The co-evolutionary carbon lock-in argument (Unruh, 2000) suggests that firms that have achieved a dominant position under current institutional arrangements would always act to block changes to institutional rules that would tend to reduce that power. However, opening up the black box of firms strategies reveals a more complex picture. Firms with substantial sunk technological and intellectual capital in existing generation technologies are seen to lobby to weaken implementation of policy measures designed to promote the development and deployment of renewable technologies. However, the same firms often follow a dualtrack strategy of simultaneously investing in innovation of renewable technologies. This may be seen as a form of risk management, in seeking to maintain the status quo, whilst hedging against the possibility that changes in public attitudes and political 9

10 incentives will make renewable technologies increasingly profitable. This case is discussed in more detail in the paper by Stenzel and Frenkel (2007) at this conference. 6. Conclusions This paper has presented results from case studies of UK and European energy policy and argued that these cases illustrate the need for a framework to inform policy which incorporates insights from evolutionary and institutional economic thinking. It has argued that a co-evolutionary approach provides a useful framework for analysing the causal interactions between technology development, institutional change and firms strategic behaviour. Given the gap highlighted between the high-level political commitments made to mitigate climate change and the relative weakness of the existing policy instruments designed to provide incentives for low-carbon technologies, we argue that a co-evolutionary approach would provide a richer basis for informing future policy interventions to overcome carbon lock-in and promote a transition to a low-carbon energy system. 10

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