D4.2 Case Study Innovation

Rienks, Harm and Brendan Moore (2023): EU Innovation Funding for Climate Neutrality. D4.2: 4i-TRACTION case study report. Wageningen University, Wageningen and Vrije Universiteit Brussel, Brussels.

Report: EU innovation funding for climate neutrality

In this report, we examine four interconnected research questions related to innovation policy for climate change in the EU.

Achieving the goals of the Paris Agreement will require a deep, rapid, and system-wide transformation of how society operates. For this transformation to be successful, carbon-intensive technologies will need to be substituted by low-carbon alternatives. Some of these technologies can be replaced by existing ones, such as traditional solar photovoltaics and wind energy. But given the urgent need to reduce emissions, new technologies are also necessary and existing technologies need to be further developed. Governments can accelerate innovation by eliminating or reducing the obstacles that impede it. One key obstacle, especially for technologies that are in the early stages of development, is a lack of funding. Private investors are often hesitant to provide funding for such technologies, leaving the public sector as a vital source for financing. Therefore, public funding for technological innovation is a core instrument for climate mitigation policy.

Which level of government should be tasked with innovation policy?

Our theoretical framework regarding the appropriate level of government to design innovation policy is mainly based on the fiscal federalism literature. The key finding here is that, for technologies in the early stages of development, it is surprisingly difficult to find arguments relating to efficiency or effectiveness that support decentralization for climate-related R&D funding. This is in contrast to the arguments that support centralization. Here, the incentives of a higher level of government – the EU – seem to be more aligned with stimulating climate change mitigation innovation, especially because it better internalizes the positive cross-border externalities associated with innovation. Additional arguments for centralization include reduced administrative costs for distributing and monitoring funds (economies of scale), reducing transaction costs related to cross-border cooperation, the avoidance of overlapping (duplicate) policies, increased potential for competition between innovative firms, and a reduction of political risk in case of failed innovation projects. For technologies that are more mature the arguments that support decentralization become stronger. In these later stages of development, problems become less technical and more uncertain, making the context in which an innovation is used increasingly important. The relevance of policy learning/experimentation and jurisdictional competition increases, making the member state and regional levels of government increasingly efficient in designing and implementing innovation policy.

How much public funding is required for climate change mitigation R&D?

Our theoretical reflection with regard to the required amount of public funding for climate change mitigation R&D is based on Integrated Assessment Models (IAMs). We begin this analysis by using the estimates from McCollum et al.’ IAM multi-model analysis of the required future low-carbon energy investments in the EU. Based on these estimates, we calculate a lower bound (based on average historical financing mixes) of required public R&D funding and a higher bound (based on pre-existing results of expert surveys). This explorative exercise suggests that in 2025 EU R&D funding aimed at climate change mitigation should be between 0.01% and 0.15% of GDP to be compatible with a 1.5 °C scenario.

Drawing on estimates from the IEA we find that public R&D funding devoted to clean energy in Europe was around 0.06% of GDP in 2021. This suggests that actual public R&D funding within Europe falls within the estimated range of required funding but lies close to the lower bound. Because it lies close to the lower bound, we expect that there is still space for additional public R&D funding. Funding from Horizon Europe, LIFE, and the Innovation Fund (which we estimate between €3–8.7 billion) amounts to between .02% and .06% of GDP.  This suggests that there is also space to increase government R&D funding at the EU level.

What does the current EU innovation funding landscape for climate mitigation look like?

The existing EU funding landscape is both extensive and complex. Our analysis identified three overarching programmes (Horizon Europe, the Innovation Fund, and the LIFE Programme) including nine sub-programmes that provide significant grants to early-stage, low-carbon innovation at EU level. We identified 400 projects related to climate mitigation and technological innovation that mobilised at least €4.9 billion from the EU funding landscape. We also identified 23 distinct technologies (e.g., solar, hydrogen) and topic areas (e.g., transport, maritime) that the 400 projects support. Despite this broad coverage, a few technologies stand out as attracting most of the support, with CCU/CCS/CDR, energy storage, and hydrogen alone attracting nearly 60% of available funding. The 23 large-scale projects in the Innovation Fund likewise account for around 60% of the €4.9 billion we have analysed.

How might the EU innovation funding landscape evolve under the four policy avenues? What are the impacts?

Our impact assessment of the potential direction of EU innovation policy under each of the four policy avenues, and the impacts this might have, yielded several cross-cutting findings. First, some avenues – especially Sufficiency & Degrowth – might be expected to push for greater decentralisation to better deal with regional/local issues, while the Green Economic Liberalism might be expected to take a flexible approach based on criteria similar to those we derived from fiscal federalism above. In contrast, the Green Industrial Policy and Directed Transition avenues would be expected to lead to greater centralisation of innovation policy at EU level. Second, the Green Economic Liberalism avenue would prefer a strong degree of technological neutrality, whereas the other three avenues would likely see various levels of ‘picking winners’ when it came to innovation funding. Third, within the three avenues that would be more amenable to picking winners, priority areas would likely differ. For example, Green Industrial Policy and Directed Transition would be expected to prioritise technological solutions (such as CCS and hydrogen) while the Sufficiency & Degrowth avenue might see much greater focus on energy efficiency and social innovations related to lifestyle change.

Policy recommendations

Despite the large rise in public funds by the European Union in recent years, we find that there is still ample scope to increase public R&D funding for climate change mitigation technologies within the EU. But even when funding is not increased, our theoretical framework suggests that innovation policy within the EU could be made more effective when member states consider shifting their public R&D funds from technologies in the early stage of development, to technologies that are more mature. Simultaneously the EU could shift some of its funding from funds aimed at more mature technologies towards the Innovation Fund, and especially, Horizon Europe, to compensate for the funding changes by member states.