The transition to a green economy will require large investments by firms. This column uses new survey data to study the importance of climate-related investment for UK firms. Over half of firms expect climate change to have a positive impact on their investment in the medium term, and around two-thirds of these investments are expected to be in addition to normal capital expenditure. Climate investment will be driven by larger firms and those in more energy-intensive sectors. Nevertheless, under reasonable assumptions, these investment plans are still not sufficient to meet the estimated targets implied by the UK Net Zero Pathway.
Climate change can affect the macroeconomy through a number of channels (Angeli et al. 2022). Physical impacts can affect output (Bilal and Känzig 2024) and inflation (Parker et al. 2021). Likewise, the transition to a low-carbon economy can impact activity through policy changes (D’Arcangelo et al. 2023), preferences (Stantcheva et al. 2022), and technology (Cervantes et al. 2023). A key driver of the transition will be climate investment by firms. This column, based on our recent working paper (Srivastava et al. 2024), uses new data from the Decision Maker Panel (DMP) survey to analyse the scale of climate investment that UK firms are undertaking and study their implications for aggregate business investment.
The Decision Maker Panel
The Decision Maker Panel is a monthly online survey of UK firms. 1 It was established in 2016 and is run by the Bank of England, in collaboration with King’s College London and the University of Nottingham. On average, it collects almost 2,500 responses each month. Firms are asked about realisations and year-ahead expectations for their sales, prices, employment, and investment. In addition, special questions on topical issues are added to the survey over time. Recently it has been used to study the impact of higher interest rates (Shah et al. 2024), inflation expectations (Yotzov et al. 2024), and firm price-setting behaviour (Bunn et al. 2023).
New data on climate-related investment
Between August and October 2023, firms in the DMP were asked a series of questions regarding the impact of climate change (covering both physical risks and climate-related policies) on their investment behaviour. The main questions were:
- How has climate change affected your capital expenditure over the past three years? And how do you expect climate change to affect your capital expenditure over the next three years?
- How much of climate-related capital expenditure will be offset by lower capital spending elsewhere?
- What are the most important sources of climate-related capital expenditure (e.g. energy efficiency, switching to green energy, etc.)?
- How do you expect to finance climate-related capital expenditure over the next three years?
The survey received 2,108 responses. In addition, the questions on expected climate investment were asked in 2021, which allows us to compare how these responses have changed across DMP firms over the two periods. The analysis weights results by industry and employment shares. The main findings are similar when using investment weights instead.
Magnitude of climate-related investment and firm heterogeneity
Firms expected to make more climate-related investments over the next three years than they had done over the previous three years. Figure 1 shows that over the past three years, 32% of firms reported that climate change had a positive impact on their capital expenditure; 63% reported no material impact and around 5% reported a negative impact (Panel A, navy bars). However, over the next three years, 53% of firms expected a positive impact, whereas only 39% expected no impact, and 8% expected a negative impact (maroon bars).
By assigning quantitative values to these categories, we estimate that climate change had accounted for around 2.5% of aggregate capital expenditure over the past three years at the time of the survey and was expected to account for 5.5% over the next three years (Panel B). To get an approximate monetary value for these investments, we use the annual business investment data published by the UK Office for National Statistics (ONS). In 2023, business investment was £241 billion. Based on this figure, and our estimates from the DMP, climate-related investment accounted for around £6 billion per year over the past three years, and this was expected to increase to £13 billion per year over the next three. Thus, although climate investment is expected to increase, these expectations are below the estimates in the UK’s Climate Change Committee’s Balanced Net Zero Pathway, which requires green (business) investment closer to £20-22 billion per year (Climate Change Committee 2020).
Firms in the DMP were also asked to estimate how much climate investment will be additional to existing capital expenditure, versus offset by lower spending elsewhere. In aggregate, just over half of climate-related investment was expected to be additional. 90% of firms expected at least some of the climate-related investment to be additional to normal spending, with 20% of firms expecting it to be fully new capital expenditure. Based on these responses, we estimate that aggregate business investment will be around 3.1% (or £7.5 billion per year) higher, on average, than it otherwise would have been over the three years from 2023 (Figure 1, Panel B).
Figure 1 Overall realised and expected climate investment
Notes: The estimates for total climate investment in Panel B are based on assigning values of -20%, -5%, 0%, +5%, and +20% to the respective categories from Panel A. The estimates on additional climate-related investment are based on assigning qualitative values to the categorical responses to this question. See Srivastava et al. (2024) for further details.
Beneath the aggregate numbers, there is considerable heterogeneity in climate investment expectations. Larger firms have made more climate investment in the past and expect to invest more in the future (Figure 2, Panel A). Furthermore, firms in industries with higher energy costs expect to invest more due to climate change. The relationship between energy costs and climate investment expectations was stronger in 2023 compared with 2021 (the previous time the questions were asked), suggesting that the energy price shock may have accelerated the green transition, which is consistent with other survey evidence from UK firms (Oliveira-Cunha et al. 2024). This is seen in Panel B of Figure 2, where the relationship between energy costs and expected climate investment is much steeper in 2023 compared with 2021.
Figure 2 Heterogeneity in firm climate investment
Notes: In Panel B, ‘Industry energy costs’ are measured as the intermediate consumption of energy (i.e. electricity; gas; petroleum) as a share of total intermediate consumption including labour compensation, at the SIC2 level, based on Supply and Use Tables from 219 published by the ONS.
Sources of climate investment and financing
In addition to the questions on expected climate investment, firms were also asked about the expected sources of climate-related investment. The majority of firms selected more than one category; the most popular choice was switching to green sources of energy (e.g. installing solar panels, electric vehicles, etc.), which was highlighted by 81% of businesses planning to make green investments (Figure 3). The second most common source, selected by 74% of firms, was energy efficiency improvements (e.g. insulation improvements, changing to LED light bulbs, etc.). There is also interesting sectoral heterogeneity in these sources of climate investment, which we discuss in detail in the paper. Higher industry energy costs are associated with a higher probability of investing in green energy sources. More productive firms are more likely to make investments in carbon capture technologies.
Figure 3 Sources of climate-related capital expenditure
Notes: This question was only asked to firms which expect climate change to have a positive impact on their capital expenditure over the next three years. Firms are allowed to select more than one option.
Finally, firms were asked about the main ways they expect to finance climate-related investments. The overwhelming majority (87% of firms) plan to use internal cash reserves, with only 27% expecting to use bank borrowing (Figure 4, maroon bars, firms were allowed to select more than one option). Cash reserves were most likely to be used by larger, more productive, and cash-rich firms. Figure 4 also compares these results with how firms typically finance overall capital expenditure (based on similar questions asked in the DMP). Internal cash reserves are again the most common source of financing, indicated by 84% of firms. However, bank borrowing is a more common source of financing for investment in general (around 42% of businesses), compared with climate-related investment. There are several reasons why bank borrowing may be a less frequent source of finance for climate investments. First, firms which intend to make climate investment may find it more difficult to obtain financing for this type of expenditure relative to other investments. Furthermore, if firms are expecting to make relatively small climate-related investments, they may be able to finance those with internal cash, rather than needing to apply for external financing.
Figure 4 Sources of finance for climate and total investment
Notes: The question on sources of climate-related finance was only asked to firms which expect climate change to have a positive impact on their capital expenditure over the next three years. Firms are allowed to select more than one option. See Srivastava et al. (2024) for further details.
Conclusions
The transition to a green economy will require large investments by firms. These will be needed in numerous areas, including transitioning to green energy sources, adapting to the physical impacts of climate change, and R&D in new technologies. However, data on the magnitudes of these investments expected by firms are still scarce. It is also not well-known how businesses expect to finance these investments, and whether there are specific constraints which may affect how much they can invest. This paper presents new findings from a large survey of UK businesses on climate investment, the types of investment, and expected sources of financing. Firms expect their climate-related capital expenditure to increase over the next three years from 2023, relative to investments over the previous three years. This investment will be driven primarily by larger firms and those with high energy input costs. Still, despite higher expectations over the medium term, climate-related investments remain lower than the targets estimated by the UK’s Climate Change Committee’s Balanced Net Zero Pathway.
Source : VOXeu
