the start of this paper, “green” development in the long run is difficult to achieve without micro units (households and businesses) facing appropriate price signals. This implies the need for including, as part of effective long-term “green growth” policies, the removal of subsidies and other distortions (in particular for energy consumption) that lead to inefficiently low levels of market-motivated “green” investment. While many of the relevant distortions are politically motivated and thus difficult to remove, there are nonetheless several reasons why such changes in pricing policies need to be advanced.

While direct stimulus through increased spending may have higher near-term economic benefits in times of crisis (through additional employment and activity thereby generated), it is, under such circumstances, also likely to face higher financing costs than in more normal times. While wage rates and prices of some commodities may be lower in crisis times, fiscal budgets will be far tighter, and credit more expensive and more difficult to obtain.<sup>34</sup> Moreover, the drop in energy prices during a crisis may ease the political constraints on governments’ ability to implement a desired phase-out of energy subsidies.

In addition, long-run economic and environmental effects of removal of pricing distortions are likely to be far stronger than the effects of increases in direct government expenditures. The main reason is that the former provide increased incentives for long-term investment, thereby also increasing the efficiency of the long-term resource allocation. Pricing reforms can complement targeted direct investments to remove bottlenecks in the economy. Investments without pricing reforms face greater inertia by not embedding similar types of incentives.

Perhaps most importantly, an economy in crisis faces difficult tradeoffs. Decisions to set priorities must be made to allocate spending, in types and amounts, in a time of diminished resources and constraints on the ability to increase debt. As a result, the need to create additional “fiscal space” by raising additional public revenue without unduly distorting the economy also attains a higher priority – especially if there are also plans for significant direct stimulus.<sup>35</sup> Since the fiscal balance is typically worsened by such spending, the long-term growth prospects are more uncertain as the government’s future fiscal space is diminished.<sup>36</sup> In contrast, to the extent that fiscal measures that serve to correct energy-related price distortions also serve to increase government net revenue, such revenue can be used to help finance short-term stimulus and longer-term investment in green public-sector infrastructure with less of a long-term public debt burden. When indirect stimulus targets in particular the removal of environmentally harmful subsidies or under-taxation, the policies can also have substantial environmental- and climate-related “co-benefits”. For these reasons, as well as those cited above, the current crisis provides an especially important occasion for addressing persistent distortions in market prices or under-taxation of energy and other natural resources.

Some recent studies have attempted to quantify the magnitudes of direct and indirect subsidies in the environmental and natural resources sectors.<sup>37</sup> It will be important to improve such quantification, including also the revenue losses from under-capture of resource rents for

> 34 Indeed, at least in part as a consequence of the countercyclical cost and availability of funds and credit to governments, fiscal policy in many LICs tends to be not countercyclical but rather procyclical, as discussed by Kraay and Servén (2008).

> 35 See also IMF discussions of similar issues e g in Heller (2005).

> 36 See Servén and Kraay (2008) for a discussion of general principles of fiscal policy to meet the current crisis; their strong advice is that fiscal expansions be sustainably financed.

> 37 See for example IEA (2008).  UNEP (2008b) also addresses energy subsidies.

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