The Anatomy of the Net-Zero Transition

Originally published at Project-Syndicate | March 11, 2022

Reaching net-zero emissions by 2050 – and thus limiting the rise in global temperatures to 1.5°C above pre-industrial levels – implies profound economic and societal shifts. According to a new report, a successful transition would have six key characteristics.

BOSTON – Now that addressing climate change has become a top priority worldwide, economic policymakers and corporate strategists alike are embracing sustainability goals – most notably, “net-zero” greenhouse-gas (GHG) emissions. But what will it take to get there? In a new McKinsey Global Institute report, my co-authors and I aim to answer this question.

Using the Network for Greening the Financial System’s Net-Zero 2050 scenario, we simulated a relatively orderly transition that would limit the rise in global temperatures to 1.5° Celsius, relative to pre-industrial levels. While this is not a prediction or a projection, our scenario-based analysis provides an understanding of the nature and the magnitude of the changes the net-zero transition would entail, and the scale of the response needed to manage it. We find that achieving this target would involve profound economic and societal shifts – affecting countries, companies, and communities. Ultimately, we found that a successful transition would have six key characteristics.

First, the transition would be universal. Every country and economic sector contributes to GHG emissions, directly or indirectly. Getting to net zero thus means that transformation has to happen everywhere. And, given the interdependence of energy and land-use systems, coordination will be essential. The adoption of electric vehicles (EVs), for example, will lead to significant emissions reductions only if the electricity used to power them comes from low-emissions sources.

Second, a successful net-zero transition would entail significant economic shifts. We estimate that getting to net zero would require $275 trillion in capital spending on physical assets by 2050 – an average of $9.2 trillion per year. That is $3.5 trillion per year more than is currently being invested today. Expected increases in spending as incomes and populations grow, and transition policies that are already legislated, narrows the gap, but the required rise in annual spending would still be about $1 trillion.

Meanwhile, some existing spending would need to be reallocated from high- to low-emissions assets. The labor market, too, would undergo a major adjustment: under the NGFS scenario, about 200 million jobs would be created and 185 million lost by 2050 from a net-zero transition. Worker reskilling and redeployment would thus be crucial.

The third key characteristic of the net-zero transition is that policies – and the associated investments – must be front-loaded. Under the NGFS scenario, spending would increase from 6.8% of GDP today to about 9% of GDP between 2026 and 2030, and then decline. More broadly, action to arrest the buildup of GHGs in the atmosphere and mitigate physical climate risks would need to be taken this decade.

Fourth, the effects of the net-zero transition will be felt unevenly. The sectors with the highest degree of exposure – because they emit significant quantities of GHGs (for example, coal and gas power) or sell products that do (such as petroleum products) – account for about 20% of global GDP. Sectors with high-emissions supply chains, such as construction, account for a further 10% of GDP.

At the country level, developing economies would have to devote a larger share of GDP than rich countries – almost 11% in India, compared to 4-5% in the European Union and the United States – to support economic development and build low-emissions assets. Deploying this capital could prove challenging for many developing countries. Their economies also tend to be more concentrated in the most exposed sectors, subjecting them to greater economic shifts.

Similarly, within countries, the communities that rely heavily on the most exposed sectors would face the highest costs. In the US, for example, 44 counties rely on coal, oil, and gas, fossil-fuel-based power, and automotive manufacturing for more than 10% of employment. And, of course, lower-income households would struggle more than their wealthier counterparts to cope with any cost increases that are passed through to consumers – though in some cases, such as mobility, upfront capital spending by consumers could yield lower operating costs over time.

The net-zero transition’s fifth characteristic is that it is exposed to short-term risks, including worker dislocation and stranded assets. We estimate that, in the power sector, $2.1 trillion worth of assets could be retired or underutilized between now and 2050. And if the deployment of low-emissions technologies does not keep pace with the decommissioning of high-emission technologies, there could be shortages and price spikes, potentially eroding support for the transition.

At the same time, the net-zero transition holds major opportunities – the sixth key characteristic. For companies, decarbonization could make existing processes and products more cost-effective, and new markets for low-emissions goods will become increasingly lucrative.

Companies can also gain by supporting the production of these lower-emissions products – for example, by providing mineral inputs (such as lithium for batteries), physical capital (including solar panels), or infrastructure (like EV charging stations). Support and technical services, such as forest management, engineering and design, financing, risk management, and emissions measurement and tracking solutions, would also be needed.

Countries can benefit, too. To strengthen their positions in the net-zero economy, they can leverage their natural capital (like sunshine, wind, and land that can be reforested) and invest in technological, human, and physical capital. And we cannot forget the most important benefit of all: preventing the further buildup of physical risks that could trigger the most catastrophic effects of climate change.

Policymakers and business leaders should be integrating these insights into all their decisions as they seek to pursue an orderly, timely, and smooth net-zero transition. This includes a recognition that abrupt, poorly planned changes would increase risks as surely as delays would. Given the universal nature of the transition, it must be tackled in a newfound spirit of cooperation.

Many questions remain unanswered, including who pays, and how much, for what. But, with the proliferation of net-zero pledges, the search for solutions has more momentum than ever.

Mekala Krishnan: A partner at the McKinsey Global Institute.

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