Chapter 3. Unleash innovation to accelerate the transition

Why is innovation transformative?

Innovation – the creation and diffusion of new products, processes and methods – is fundamental to the economic transformation required to address climate change. The rate and direction of innovation will, to a large extent, determine the economic cost and therefore the likelihood of achieving the Paris Agreement’s mitigation and adaptation goals.

The world requires a radical change in the mix of technologies that underpin the production and consumption of goods and services. The IPCC Special Report on the impacts of global warming of 1.5°C finds that:

Opportunities for low-emission innovations are economy-wide, and include: technologies for renewable energy, energy storage and smart grids; energy-efficient lighting, heating and cooling in buildings; electric, hybrid and fuel-efficient vehicles; more efficient crop varieties, vaccines to inhibit methane production by ruminants and laboratory-grown meat; and carbon capture, storage and use technologies. New technologies such as permeable materials for pavements and roads, drought-resilient crops and improved irrigation schemes could also help populations adapt to climate impacts.

Innovation is not only about the development and diffusion of new and disruptive technologies. It is just as much about institutional and organisational changes, and new services and business models (e.g. energy-as-a-service platforms, electric car sharing, circular supply models), all of which can help drive the systemic changes needed in production and consumption for the transition towards a low-emission, resilient future. Technological and non-technological innovations can work in tandem to significantly reduce the demand for infrastructure services and open up new and more cost-effective pathways to achieve the goals of the Paris Agreement.

What is the state of play?

The development of technologies for climate change mitigation and adaptation has increased rapidly since the beginning of the century. Globally, the number of patented inventions related to climate change mitigation in buildings, transport and energy generation tripled between 2000 and 2010. However, inventive activity has been slowing across all major environment-related domains since 2011, both in absolute terms and as a share of total inventions (OECD, 2017_[2]). This might partly be a result of the recent fall in energy prices, which makes the value of future energy savings smaller, as well as the continued uncertainty over national and global climate policies.

However, there has been some progress in the diffusion of low-emission technologies. Renewable energy sources such as solar and wind are now cost-competitive with conventional sources of electricity in some markets and are being quickly brought to scale (IEA, 2017_[3]). Progress has also been made across other sectors such as transport, where there have been improvements in vehicle efficiency and a doubling of electric car sales between 2014 and 2017 (IEA, 2018_[4]). In forestry and agriculture, satellite imagery has revolutionised data collection and monitoring of deforestation, helping to inform policy making and enhance enforcement efforts.

Many of the emerging innovations have their roots in the digital revolution. Digital technologies are facilitating investment and citizen engagement in renewable energy and other sustainable development projects enabling more decentralised and flexible energy systems, and increasing energy efficiency (see Box 3.1). For example, smart charging technologies for electric vehicles are helping address intermittency in renewable energy supply, while smart meters are changing energy consumption patterns in homes and businesses.

Despite pockets of progress, the current level of innovation falls short of what is needed to reach the 2°C goal, let alone move towards 1.5°C, with severe implications for human health and well-being, biodiversity and economic growth. Of 38 clean-energy technologies included in the IEA’s Sustainable Development Scenario in their World Energy Outlook (which is consistent with the 2°C goal), only four are on track to penetrate markets sufficiently: solar photovoltaic, lighting, data centres and networks, and electric vehicles. The majority of technologies need more progress, and a quarter are classified as “not on track”, including carbon capture and storage, concentrating solar power and geothermal and ocean technologies (IEA, 2018_[4]).

What are the barriers and opportunities for change?

To increase the likelihood and reduce the cost of achieving and adapting to the 1.5°C or 2°C goals, the world must accelerate the deployment of existing innovations in technology, business models and services, and swiftly move the next generation of climate solutions from the lab to the market. These innovations need to be adopted as widely as possible to ensure shared prosperity and an inclusive transition to a low-emission and resilient future. As no single government has all the technological, scientific, financial and other resources needed to address climate change, it is important that strong national policies for innovation are accompanied by effective international co-operation in the development and diffusion of innovations.

Advanced, emerging and developing economies face different challenges and opportunities in delivering climate solutions. However, there are four principal barriers to innovation that they all must overcome. First, markets undersupply innovation because of the positive externalities associated with the generation and diffusion of knowledge (i.e. firms do not capture all the benefits of their innovations). Second, when firms and households do not have to pay for environmental services or the costs of pollution, the demand for green innovation is limited and the incentives for companies to invest are lower. Third, financing of the more radical types of innovation that could potentially be introduced by new market participants is constrained by information asymmetries, which can be exacerbated if there is uncertainty concerning future policy settings. Fourth, the international dissemination of climate technologies can be undermined by trade barriers and a lack of country capacity to adopt, adapt and deploy new technologies.

Innovation is not only critical for addressing climate change; it lays the foundation for new businesses, new jobs and productivity growth and it can help drive progress towards other Sustainable Development Goals (SDGs). To reap the full benefits of innovation, governments need to have the foresight and flexibility to take advantage of new technologies and opportunities, such as the digital revolution, and be prepared to break dependencies on institutions and technologies with which they are familiar.

Getting the basics right: the enabling environment for climate innovations

A sound enabling environment for innovation – e.g. well-aligned tax, competition, education, science, trade and investment policies – and a strong environmental policy framework must underpin efforts to scale up climate mitigation and adaptation innovation (OECD, 2015_[6]; Ang, Röttgers and Burli, 2017_[7]). Governments can help increase investor confidence and ensure that innovation activity supports rather than undermines the low-emission transition by setting a clear and stable policy signal through long-term low-emission development strategies (see Chapter 2) and carbon pricing. For example, the introduction of the European Union emissions trading system induced regulated companies to file 30% more patents in low-carbon technologies (Calel and Dechezleprêtre, 2016_[8]). However, the price of carbon emissions globally is still extremely low (OECD, 2018_[9])(see Chapter 4). Increasing the price on carbon would help catalyse private sector innovation in a cost-efficient manner, without burdening (and possibly even replenishing) public budgets. It would also incentivise behavioural responses by consumers, triggering additional energy savings.

A strong enabling environment for innovation is a necessary but not a sufficient condition for the transformation. To deliver transformative change, governments must also adopt a suite of demand- and supply-side innovation policies and finance measures that are tailored to the climate challenge.

Moving to the next frontier: mission-oriented programmes

One way governments can set the direction of innovation is by adopting mission-oriented programmes. Mission-oriented programmes align policies, public R&D programmes and public-private collaboration to overcome a concrete problem. This in turn helps to address a broader societal challenge or “wicked problem” – one that is complex, systemic, interconnected and urgent – such as climate change, environmental degradation and public health challenges (Box 3.2). At the core of the mission-oriented approach is the understanding that governments must not only correct market failures, but also actively drive and direct innovation by co-creating and co-shaping markets (Foray, Mowery and Nelson, 2012_[10]; Mazzucato, 2017_[11]).

Strengthening the market pull for climate innovations: demand-side policies

In the last decade, increasing attention has been paid to the role of demand-side policies for innovation to supplement the more traditional supply-side policies (e.g. R&D support). Demand-side policies can help direct resources and capabilities by creating or strengthening the market pull for climate innovations. In general, governments should emphasise competition and technology neutrality, rather than supporting specific technologies and solutions. However, judicious use of more technology-specific measures may be required to overcome the barriers facing low-emission technologies and drive transformative rather than incremental innovation. Feed-in-tariffs (FITs), for example, were instrumental in bringing wind power in Denmark and Germany to full commercialisation at a time when the technology was not yet competitive (OECD, 2011_[18]).

National and subnational regulations or performance standards have also demonstrated their effectiveness in encouraging more innovation. These include energy-efficient building codes or renewable portfolio standards that require electricity providers to include a minimum share of clean energy in their output mix (e.g. California Renewables Portfolio Standard) (Rozenberg, Vogt-Schilb and Hallegatte, 2014_[19]). However, these instruments tend to benefit technologies that are closer to market. This points to the need for a broad policy mix that includes both technology-specific and technology-neutral measures, regulatory and economic instruments, and direct R&D funding for technologies that are further from the market.

National and subnational public procurement can also be used to create market pull for climate innovations. By introducing climate-related criteria in procurement decisions, public procurement can bring low-emission solutions to market and trigger industrial and business model innovation through the creation of lead markets (Baron, 2017_[20]). A number of governments have adopted sustainable public procurement criteria and practices, such as tenders with lifecycle costing that incorporates the costs of emissions in value-for-money assessments, and market dialogues to help procurers and potential suppliers to formulate innovative tenders (OECD, 2017_[21]). Like regulations and standards, procurement can spur innovation without engaging new spending.

A less apparent demand-side policy that can promote innovation is standardisation. If standardisation occurs too early, it may shut out better technologies; if it occurs too late, the costs of transition may prevent diffusion of non-compliant innovations. However, if employed with care, standardisation can help create critical mass to benefit from economies of scale. An example of standardisation in practice is charging infrastructure for electric vehicles. Standards for physical plugs, as well as for payment and power supply could create a competitive market, while also ensuring consumer convenience. The EU standardised the electric plug used for normal alternating current (AC) charging in 2014, but competing systems exist for the more recent direct current (DC) fast charging and wireless charging technology. If standards are not designed with flexibility, they can be outpaced by technological developments.

Consumers can also catalyse and influence the direction of innovation. Governments can empower consumers by deploying policies that counter inertia and scepticism about new goods and services (OECD, 2011_[22]). Monetary or price-based incentives such as demand subsidies or tax allowances can encourage risk-averse consumers to buy innovative new products. For example, Belgium’s Walloon Social Credit Society (SWCS) offers advantageous loans to low-income households under its “Ecopack” scheme. These support the adoption of energy efficiency measures: installing heat pumps, photovoltaic panels, solar water-heaters and pellet stoves; or insulating roofs, walls and floors (Société Wallonne du Crédit Social_[23]). Information and awareness campaigns can also be used to influence consumer preferences and behaviour, where there may be information failures.