The Berlin Summit 2025: Modern Climate Policy – Designing a policy mix beyond the fixation on carbon pricing

Building on last year’s session on ‘Modern Climate Policy’, where we discussed the benefits of positive instead of negative market incentives, this year’s session moved beyond the either/or framing of carbon pricing versus positive incentives and focused on the design of effective policy mixes.

The paper presented in this session lays out the economic rationale for such a policy mix. The authors argue that addressing the climate crisis differs fundamentally from a pollution problem – as which it has been framed by traditional climate economics. It requires a systemic transformation of the economy, especially towards sustainable energy production and the electrification of other sectors.

This changes the policy handbook: to accelerate investment spending in clean energy technologies, we need policies that lower both financial and revenue risks, and reduce the cost of capital. To induce changes in consumption, it is essential to deploy positive incentives that target the price elasticity of demand by creating near-perfect low-carbon alternatives – essentially making sustainable choices radically cheaper, easier, and more attractive. A policy sequence that uses de-risking measures to enable clean technology deployment, and positive incentives to scale affordable low-carbon alternatives, can enhance both the effectiveness and political feasibility of carbon pricing.

Another key factor to consider is the role of Political Economy. Decarbonization is still widely perceived as a burden for consumers and businesses. Two alternative, positive narratives – highlighting the contribution of clean energy to overall economic prosperity, and to safety and resilience – are closely linked to the role of renewables in driving down electricity prices. Public narratives have not caught up with these realities yet, partly because economic projections have consistently overestimated future clean energy costs; because gas still has a price-setting role in wholesale electricity markets which prevents the cost advantage of renewables being tangible for consumers; and because many institutions, especially Finance Ministries, still focus on short-term marginal abatement costs instead of total costs.

A clear majority of session participants agreed that the cost of capital and the availability of low-carbon alternatives are crucial for decarbonizing the economy. As one of the session speakers puts it: “The climate transition is currently not going well in many parts of the world. The cost of capital, availability of low-carbon alternatives, and policy sequencing are key aspects to understand this.” Developments since the Ukraine war highlight this: despite rising carbon prices, investment in low-carbon alternatives has collapsed. This shows how capital costs and investment risks trump carbon price signals. However, there was also concern about the profitability of clean energy investments being very vulnerable to political uncertainties, e.g., the possibility of central banks raising interest rates.

The paper presentation sparked a vivid discussion about the fiscal costs of positive incentive policies. As several of the discussants pointed out, many support policies require public spending and their fiscal implications limit public support for the transition. From a distributional point of view, it is also essential to be clear about who is going to pay for this public spending. In addition, the depreciation of capital that happens when businesses and consumers replace carbon-intensive assets with low-carbon alternatives must be considered.

However, the term ‘cost’ is often used to capture multiple meanings. It is key to distinguish between support policies that result in budgetary costs, capital expenditure that is wealth-creating in the mid-term, and measures that do not require public spending. For instance, government loans are often described as fiscal costs but actually strengthen the state budget in the mid-term if returns are higher than the cost of capital. Similarly, credit insurance is a virtually fiscally cost-free way of de-risking investments.

The question then becomes where subsidies, tax credits, and grants are necessary and where the above mentioned, new credit instruments can deliver the desired results. An approach to more targeted spending with less fiscal implications could be to identify bottlenecks in the low-carbon transition and focus subsidies where they are most cost- effective.

Discussants also pointed to various specific policies to further investigate as part of an effective climate policy mix, namely the role of supply side policies that move beyond R&D to support manufacturing, and the role of state-owned enterprises, e.g., as energy grid providers.

It was emphasized that the design of positive incentive policies should make sure to consider distributional aspects – like, for instance, France’s social EV leasing program which offered incentives particularly to lower-income households. The concern was raised, that many European countries are not ready to implement ETS2 (the expansion of European Emission Trading to consumer-facing sectors) in its current legislative form without needing to massively subsidize low-income households. This gap in national budgets risks political backlash and could undermine Europe’s climate policy foundations.

Regarding the role of carbon pricing within the policy mix, two primary functions were discussed. First, the generation of revenue through carbon prices, which can be used to pay for subsidising low-carbon alternatives. This advantage, however, can become a hurdle for public acceptance as citizens perceive carbon prices as a means to extract resources from them. This perception even persists when revenues are redistributed on a per capita basis through carbon dividends, as a French survey found.

Second, carbon pricing can be used to address the free-rider problem in international trade and incentivise foreign governments to accelerate the decarbonization of their own economies, e.g., via the EU’s carbon border adjustment mechanism (CBAM). There was some scepticism among participants if CBAM will be able to do this effectively, especially if any international agreements are negotiated between the EU and other countries/regions that would allow imports to circumvent the law. Export credit agencies might be better suited to help develop clean industries abroad by providing credit insurance and decreasing the cost of capital in other countries.

As for the role of Political Economy for the energy transition, discussants endorsed the significance of narratives. What they deemed even more important is the political salience of economic benefits that come with the low-carbon transition. They argued that understanding when these economic benefits shape voters’ minds – which is influenced by the magnitude of the benefits, but also by their visibility, and their attribution to energy transition – needs to move centre stage. Participants also confirmed the role of renewables reducing electricity prices as a new competitiveness factor. In order to reap the full benefits of these price reductions, changes in market regulation are necessary to decouple electricity prices from the cost of gas.

In conclusion, the policy sequencing approach presented received broad support from the discussants as a politically viable pathway that could reframe the low-carbon transition as an opportunity. A key take-away from the discussion is the need to specify the fiscal implications of suggested policies in different contexts.