Europe’s Sustainable Taxonomy Is a Sideshow

Lambert here: Unsurprisingly. When I was touring the biosphere, whether for sand, or peat, or soil, I would always look for the relevant taxonomy. Invariably, there were several, and invariably they were invaluable heuristics for scientists or commercial enterprises, but heuristics is what and all they were. I think heuristics are important, but trying to make them drive investment decisions is a mistake, as the article shows.

By Georg Zachmann, a Senior Fellow at Bruegel, where he has worked since 2009 on energy and climate policy. His work focuses on regional and distributional impacts of decarbonisation, the analysis and design of carbon, gas and electricity markets, and EU energy and climate policies. Originally published at Bruegel.

In recent months, despite a dramatic energy crisis, much of the attention in European Union energy and climate discussions has focused on the so-called taxonomy for sustainable activities, a labelling system intended to guide investors. In the debate, the complex topic has been simplified to the question of whether gas-fired and nuclear power plants can be considered to be environmentally sustainable technologies. In early February, the European Commission issued a regulation setting out the conditions under which gas-fired and nuclear power plants can be considered ‘sustainable’ by investors. This regulation will become law if neither a majority in the European Parliament nor a reinforced qualified majority of more than 20 EU countries reject it.

It therefore remains unclear if the regulation will survive. But why the big buzz, and does it matter?

Companies that want, or are required to, report which of their investments are ‘sustainable’ must use the long and complex taxonomy list. The underlying idea is that financial investors might pay a premium for such assets on the basis either that they will be less exposed to climate-policy risks in the future and/or that they value ‘sustainable’ investments. The taxonomy is thus supposed to prevent the misuse of the label ‘sustainable’.

The energy put into the discussion shows that labelling in line with the taxonomy is expected to be a crucial signal for investors, and hence a major contribution to decarbonisation. But this is not plausible. Most economic activities will not be labelled sustainable and they will continue to be financed if they promise to generate sufficient profits. The ‘green premium’ – that is, the observed discount on capital cost for sustainable projects– is estimated to be some 1 to 20 basis points. For a combined cycle gas turbine that costs €1 billion, a 20 basis-points higher interest rate would mean €2 million per year in saved capital costs. To put this into perspective, a small €1 per tonne increase in the carbon price by would also mean €2 million higher annual costs. This implies that the vigorous political discussion on the taxonomy cannot only be about the direct implications of a publicly endorsed green label.

Two much more impactful indirect effects of the taxonomy might explain the vigour of the discussion. First, the public discussion about what is classified ‘sustainable’ in the taxonomy provides investors and policymakers with an indication of the public perception of different technologies. If the discussion on a rather mundane labelling list tells investors which technologies are unlikely to maintain/obtain public support (eg in the form of favourable regulation), they might refrain from putting too much money into them.

The second and more concrete impact is that a list endorsed by European lawmakers might start to be used well beyond what it was designed for initially. It is easily conceivable that European public banks will be asked to strongly prioritise the financing of projects labelled sustainable. The European Investment Bank has already indicated that for gas plants it will apply even stricter conditions than the European Commission. Possibly more importantly, the criteria might also be referred to in new legislation, such as in assessments of EU countries’ recovery spending plans, in decisions on state aid or climate finance projects, or by courts when interpreting the law. Consequently, a relatively mundane list might gain a life of its own that can shape what administrations that have no mandate/expertise to look into the details consider ‘sustainable’. This justifies the vigour of the debate. But it also implies that the process that determined the rules was not designed for such far-reaching implications.

But the main problem is that the very idea of using a binary list of economic activities to guide investors is imperfect for many reasons:

  1. Sustainability has many dimensions; for example, all scalable technologies for producing electricity bring with them sustainability concerns (including nuclear waste, the impact of wind and hydro on biodiversity, surface sealing from ground-mounted solar panels, seismic activity from geothermal energy) that need to be traded-off against each other. Moreover, if one takes into account other societal goals (see for example the UN Sustainable Development Goals) many activities that did not make it onto the sustainability list still represent the best compromise investment for human progress. Four cheaper, but not thermally isolated new school buildings in rural Bulgaria might be better than three more expensive well-isolated ones.
  2. Some not strictly sustainable activities might be more sustainable than some labelled activities; an aluminium plant that provides flexibility might be much more valuable to the electricity system than resource-intensive batteries, but only the latter can be considered ‘sustainable’.
  3. The environmental benefits of two same-sized projects might be extremely different, but both might obtain the same label. An offshore wind park that produces 5000 TWh might get the same label as a similarly expensive new skyscraper that meets the energy-efficiency standards and saves maybe 50 GWh. In a financial report €1 billion spent on the former and €1 billion on the latter can be added up to €2 billion of sustainable investment.
  4. The assessment of sustainability might change over time, as well illustrated by the changing perception of nuclear in some European countries. But will financial investors have to worry that their assets might lose their green labels, or will governments have to stick to the labels given more than a decade ago?
  5. Sustainability in one segment of the value chain does not imply that the complementary system is the most sustainable; for example, the electricity-intensive production of green steel in renewables-poor regions uses up ‘green’ electricity so that fossil plants stay in the system.
  6. The sustainability of an activity is often conditional on many other factors; a new sustainable steel-plant in a poorly-connected location might require the building of massive (potentially unsustainable) infrastructure and dwellings.

The development of the taxonomy should have made clear that sustainability is a multidimensional concept involving numerous complex trade-offs. Making investment projects fit into the relatively simple criteria will cost valuable flexibility and might imply inefficient choices. Even a more sophisticated list would not be able to reliably guide investments towards a sustainable economy. But how can the financial sector then be steered towards more sustainable investing?

Two parts of the answer are already in place: emissions reduction targets and a price-based compliance mechanism (the EU emissions trading system). Both can and should be further strengthened, but that is another debate. But financial market participants and other stakeholders also want more concrete guidance on which investments contribute to the transition to a sustainable economy. Given the complexities, a binary classification system does not provide this. What would really help would be analytically-sound and widely-consulted government strategies and plans that underpin future energy, climate, infrastructure, research, industry and other policies. Existing processes such as the development of National Energy and Climate Plans, European network planning and Commission impact assessments provide starting points for fact-based discussion to find consensus on feasible decarbonisation pathways. This discussion and the analytical work that underpins it will give investors and financial market participants a clearer sense of the many activities that might contribute to the transition.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. Synoia

    To have “sustainable” leads to less consumption, and less consumption leads to less people.

    I doubt there is any rational human mechanism which can reduce the number of people. Thus nature’s mechanism will prevail.

    Wars, famine, pestilence and death. aka the Four Horsemen of the Apocalypse.

    I wonder when the Rich will start the cull.

    1. Bellatrix

      We are still too useful, for now, but as AI, robotics and similar technologies develop, our usefulness will decline accordingly and we will just be a burden. That’s when the logic for a “cull” increases exponentially and it will be a handy thing to own a mega-yacht or a secure compound on an island somewhere. A decade ago I would have said this jokingly, but not now.

    2. drumlin woodchuckles

      We are already into the cull. Ubiquitous immune-system-degrading pollution, ubiquitous xeno-estrogens to achieve dropping sperm counts, ubiquitous roundup fallout, the careful fostering of multi-antibiotic-immune super-bacteria, the deliberate spreading of covid everywhere . . .

      The Rich want to make it look like a series of slow-rolling accidents and diseases. They don’t want to speed up the cull so much that it looks like a cull to several billion ordinary people all at once.

      1. ChRmander

        And yet at the same time, making safe abortion, sex education and contraceptives hard to attain, which would let the overpopulation problem take care of itself.

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