The Next Stage of Climate and Industrial Policy Demands Carbon Pricing

As major economies recalibrate both their climate and industrial strategies, the question of whether subsidies alone can drive a durable industrial growth and low-carbon transition has come to the forefront. In the United States, the passage of the One Big Beautiful Bill (OBBB) marked a decisive scaling back of clean energy subsidies originally unleashed by the Inflation Reduction Act. In China, the government has recently introduced the new political vocabulary of “anti-involution,” calling for the elimination of unproductive capacity that survives through external support, disorderly expansion, and homogenous competition. Despite their differences in policy orientation and objectives, both countries are grappling with the same dilemma of how to foster high-quality production while preventing fiscal exhaustion and industrial distortion.

These recent shifts call for a renewed look at carbon pricing, an instrument largely sidelined in recent years. Subsidies have undoubtedly accelerated the deployment and growth of many industries, but they are not a sustainable foundation for long-term decarbonization or economic upgrading. They also risk draining fiscal resources and entrenching inefficiency. A well-designed carbon price, by contrast, offers a more durable solution by simultaneously disciplining outdated capacity, creating fiscal space, and strengthening the competitiveness of industries with genuine growth potential. This is particularly relevant for China, where the imminent elimination of ‘zombie companies’ has become a pressing priority.

Subsidies have played a vital role in the early stages of industrial development by lowering entry barriers and de-risking initial investments. China’s achievements during the first phase of Opening and Reform, as well as the rise of renewable energy in parts of the United States—such as Iowa’s transformation into a wind power hub—are inseparable from government support that allowed new technologies and industries to scale at record speed. 

Yet as these programs expand, the limitations of subsidies have become increasingly apparent. First, subsidies reward outdated output rather than innovation. In China, sectors such as steel and aluminum have long benefited from preferential loans, tax breaks, and local government protection. These policies kept inefficient plants running but offered little incentive to adopt cleaner technologies or account for the true social costs of pollution. Instead of investing in greener and more efficient production, many firms simply expanded capacity to capture government support. The United States faces a different but related problem. While subsidies helped accelerate renewable energy deployment in states like Iowa, they did little to close the innovation gap. Production and equipment installation increased, but sustained investment in research and development lagged behind, leaving the U.S. less competitive in the long run.

Subsidies also impose heavy fiscal burdens. A 2023 report shows that the cost of clean energy tax credits under the IRA is projected at more than $1 trillion over the next decade, far above the original estimate of about $400 billion. OBBB’s retrenchment revealed how quickly political winds can shift when budgets tighten. 

Similarly, China’s “anti-involution” campaign begins by targeting precisely the conditions that have overburdened local government finances and distorted competition. Many “zombie companies” in heavy industry survive not by serving market demand, but by leaning on administrative protection or local subsidies. They cause pollution and crowd out resources that could support more innovative sectors. Local governments have often been reluctant to let these firms fail because they provide short-term tax revenues and employment. The Central Political Bureau highlighted this imbalance recently, and is committed to curb disorderly competition and “normalize corporate investment norms” at the local level. Even in sectors like electric vehicles and renewables, government supports have at times encouraged disorderly expansion and homogenous competition, raising questions about whether the inefficiencies and waste generated in the process may have offset part of the intended environmental gains.

In this case, carbon pricing could serve as an effective instrument to address the shortcomings of subsidies. By internalizing the cost of emissions, it creates a uniform signal across the economy: polluters pay more, innovators pay less. The market will select firms that can thrive under carbon regulation. Carbon pricing is fair because every ton of carbon faces the same cost, predictable by giving firms long-term clarity, and fiscally sustainable since it both rewards verified reductions and generates revenue for reinvestment into innovation, social equity, or debt reduction, rather than draining the public budget. It provides a balanced policy mix, disciplining incumbents while allowing targeted support for truly hard-to-abate sectors and early-stage technologies.

By placing a direct cost on emissions, carbon pricing gives the Chinese central government a powerful tool to discipline local protectionism. It makes support for zombie companies fiscally unattractive, encouraging local governments to withdraw protection. Unlike China’s past supply-side reforms that sought to eliminate excess capacity through administrative bans and left structural distortions unresolved, carbon pricing works by “unclogging” market incentives, allowing inefficient firms to exit naturally. 

Beyond cleaning up inefficient capacity, carbon pricing also unlocks opportunities for strategic reinvestment. Revenues generated from pricing schemes can be channeled into emerging sectors that represent the next frontier of decarbonization, including carbon capture and storage (CCUS), blue carbon ecosystems, and other decarbonization solutions that remain underfunded yet vital to China’s long-term climate strategy. These new avenues provide precisely the kind of “anti-involution” opportunities that policymakers seek: shifting resources from propping up outdated firms to supporting industries with genuine potential and global relevance.

The European Union has already demonstrated how carbon pricing can successfully evolve into an international instrument with the European Union’s Emissions Trading System (EU ETS). Emissions from covered sectors have fallen by 47 percent since 2005. Carbon pricing schemes also mobilized more than $100 billion for European public budgets. Currently, with the introduction of the Carbon Border Adjustment Mechanism (CBAM), the EU is also extending its carbon pricing logic beyond its borders, attempting to shape the rules of global trade. For the rest of the world, developing a more mature carbon pricing framework would not only strengthen domestic industrial upgrading but also secure a stronger voice in the emerging international regime where carbon pricing increasingly defines competitiveness.

For the United States, it is unfortunate that currently any topic related to climate change is politically toxic and untouchable at the federal level. The OBBB also once again presents the reality that any policy explicitly imposing a cost on carbon or extra burden to taxpayers is still dead in Washington. This resistance has already curtailed IRA subsidies, and it would likewise obstruct efforts to introduce carbon pricing. Nevertheless, the political impasse should not preclude preparation. Especially designing a carbon pricing framework is a technical exercise as much as a political one. More academic research and state-level experimentation into pricing mechanics could lay the groundwork for future adoption. If the U.S. continues to sit out, it risks ceding leadership to the EU and potentially China in setting the rules of the global low-carbon economy.

The age of subsidy-driven climate policy is reaching its limits. As fiscal burdens grow and inefficiencies deepen, carbon pricing offers a more durable foundation: it disciplines inefficiency, creates fiscal room for strategic investment, and provides long-term clarity for industry. Europe has proven its effectiveness; China faces structural pressures that make such a shift increasingly relevant; and the United States cannot afford to remain absent. The future of climate and industrial policy will be increasingly shaped by carbon prices.