Global uncertainty reduces innovation in renewable energy

The green transition faces significant challenges due to economic and policy uncertainty. Unpredictable returns on investments, especially in renewable energy, hinder innovation in this crucial sector. This column examines the impact of uncertainty on renewable energy patents. The findings show that a rise in uncertainty reduces green innovation by up to 1.5%, with stronger effects during recessions and periods of financial stress. Climate policy actions, such as carbon taxes and green R&D subsidies, mitigate the negative effects of uncertainty.

The recently released Draghi Report on the future of the EU (Draghi 2024) emphasises the need to reach climate neutrality targets for Europe (and worldwide). In addition to limiting global warming to 1.5°C to avoid climate disasters, the green transition may offer several opportunities to lower energy prices, ensure energy security, and relaunch economic and productivity growth. To achieve these objectives, new green technologies – able to facilitate the production and distribution of renewable energy, reduce its costs, and cut emissions – are crucial. As reported by the International Energy Agency (IEA), approximately one-third of emission reductions required by 2050 are based on technologies currently at the demonstration or prototype phase (IEA 2023).

However, innovation is costly in terms of both money and time. It requires investing in future projects, some with unpredictable returns – particularly in sectors where the benefits tend to materialise over time, such as the renewable energy sector (Slawinski et al. 2017). While the literature has long acknowledged that political and economic uncertainty reduces investment and innovation in general (Bloom 2009), little is known about the impact of uncertainty on green innovation, as well as the channels mediating this impact.

Uncertainty is harmful (especially) for green innovation…

In times of increasing global uncertainty and climate risks, estimating the effect of uncertainty on green innovation is crucial to quantify the extent to which uncertainty may jeopardise the efforts to produce and diffuse new green technologies. In a recent paper (Bettarelli et al. 2024), we empirically quantify the impact of economic and policy uncertainty (measured by the World Uncertainty Index proposed by Ahir et al. 2022) on renewable energy innovations, for a large group of advanced and developing economies since 1976.

Figure 1 shows that uncertainty shocks have substantial negative effects on the production of renewable energy patents. A one standard deviation increase in uncertainty – a value close to the effect of Brexit (i.e. 0.15 points) – reduces innovation by about -1.5% two years after the uncertainty shock, with the effect stabilising at about -1% in the remaining time horizons. Importantly, this effect is approximately one percentage point larger than the effect of uncertainty on non-green patents, suggesting that uncertainty is especially harmful for green innovation.

Figure 1 The impact of uncertainty on renewable energy patents

Notes: The graph shows the response of the number of new renewable energy patents (in %) to one-standard deviation increase in uncertainty, and 90% (68%) confidence bands as lighter (darker) shaded area. Impulse response functions are estimated using a sample of 81 countries over the period 1976-2020. The x-axis shows years (k) after the shock; t = 0 is the year of the shock.

…in new technological domains…

The fall in green innovation after uncertainty shocks is not the same across sectors and depends on differences in the cost structure and maturity of the different technology domains. We find that the short-term decline in green innovation after an uncertainty shock is larger for technologies related to sustainable ocean economy. In contrast, the negative impact of uncertainty shocks is more persistent for technologies related to energy generation, environmental management, and production or processing of goods, while it is negligible for technologies related to waste management, transport, and buildings (Figure 2).

Figure 2 The heterogeneous impact of uncertainty on renewable energy patents by sectors and technologies (peak effects)

Notes: The graph shows the peak (negative) response of the number of new renewable energy patents (in %) to one-standard deviation increase in uncertainty. ***, ** and * denote statistical significance of the effects at 90%, 95% and 99%, respectively.

…and during recessions and periods of financial stress

The effect of uncertainty on green innovation shown in Figure 1 masks significant heterogeneity across states of the economy. We find that during recessionary periods, the medium-term effect of uncertainty on innovation is about -3%, two times larger than in normal times (Figure 3). Similarly, when countries experience high levels of financial stress – measured as in the work of Ahir et al. (2024) – a one standard deviation increase in uncertainty leads to a short-term decrease of about 5% in the number of new green patents. The effect is also persistent, reaching a peak of about -7% four years after the shock (Figure 3). These results are consistent with previous studies showing that the effect of uncertainty on economic activity tends to be larger during recessions and periods of financial stress (Caggiano et al. 2014, 2017).

Figure 3 The impact of uncertainty on renewable energy patents across states of the economy and policy stance

Notes: The graph shows the medium-term response (i.e. four years after the shock) of the number of new renewable energy patents (in %) to one-standard deviation increase in uncertainty according to different scenarios (Baseline, Low GDP Growth and Environmental and Policy Stringency (EPS), and High Financial Stress). *** and * denote statistical significance of the effects at 90% and 99%, respectively.

Climate change policies are key to mitigates the effect of uncertainty

The implementation of climate change policies mitigates the negative impact of uncertainty on green patenting considerably, while weak regulations are associated with a larger negative effect. Climate policies positively affect innovation (i) directly, by targeting innovative activities related to green energy and production (e.g. credit and subsidies to R&D); and (ii) indirectly, by reducing the production of dirty energy (through taxes on pollutants, trading schemes such as carbon trading, energy saving and green energy certificates, and feed-in-tariffs for renewables) and increasing the demand for investment in green technologies (Popp 2010). Moreover, climate change polices contribute to boost the transition towards renewable energy in the aftermath of recessions (Deb et al. 2022).

Source: cepr.org