1. CARBON PRICING AND DEVELOPING COUNTRIES KEY ISSUES Michael Keen Fiscal Affairs Department, IMF New York, June 17 2008

2. CONTEXT

3. Developing countries are: Responsible for relatively small part of GHG stock Likely to generate bulk of future emissions Most vulnerable to CC Curbing emissions raises issues of both: Efficiencyto avoid wasting resources Equityacross generations, countries, individuals

4. CARBON PRICINGPRINCIPLES

5. Can be implemented in many wayscarbon tax, cap-and–trade, hybridscommon objective being to face emitters with a price reflecting global damage they cause Price path needs to be: Credible, with price rising over a long period In first-best, uniform across sources and countries (will return to this…)

6. A quick reality check… Initial levels of carbon price commonly proposed $15-$60 per tC (= $2-$8 per barrel of oil)are dwarfed by recent oil price increases BUT that does NOT mean carbon pricing now unnecessary: The external damage is still there… …and whether it is higher or lower than we thought depends on whether current prices reflect demand or supply shock Credibility of increasing future prices critical

7. THE UNIFORMITY ISSUE

8. Intuition: Since damage is the same wherever and however emissions arise, so should be their price But first-best presumes that any equity concerns (across and within countries) are dealt with by other means (including, in principle, cross-country transfers)… …which is likely to be the case in developed countriesbut, otherwise, there is a case for a lower charge on poorer individuals

9. Caveats to case for lower carbon pricing in some countries: In terms of equity, low fuel prices: Are expensive in foregone revenue, and may Not be the best-targeted way to help the poor Exacerbate local pollution Leakage is a concern Likely extent remains unclear, though a few sectors seem key Possible policy responses: Border tax adjustment; Sectoral agreements

10. REVENUE ISSUES

11. Both carbon taxation and international cap-and-trade are possible sources of revenue (in latter case, so long as emissions rights not grandfathered)a potential benefit:

13. Proper use of this will be country-specific Earmarkingto roads, environmental spending…may help politically, but in economic terms is not necessary and can be damaging

14. International cap-and-trade (which in itself will imply uniformity across countries) leads in addition to cross-country flows, extent/direction of which depend on how emission rights are allocated Most schemes analyzed have OECD as net buyers of permits, and Africa and India as sellersbut differ e.g. on whether China a buyer or a seller

15. MACROECONOMIC EFFECTS

16. These are examined in IMFs Spring 2008 World Economic Outlook, using G-cubed, a calibrated intertemporal general equilibrium model Common tax imposed to achieve a 60 percent reduction relative to the 2002 level in world (energy-based) carbon dioxide emissions by 2100

17. NOTE: Output refers to gross national product, interest rate refers to 10-year real interest rate. For real effective exchange rate, a positive value is an appreciate relative to the baseline. Macroeconomic impacts generally modest: United States Eastern Europe and Russia JapanOPECWestern EuropeChina Other developing and emerging economies ConsumptionInvestment Current Account (percent of GDP; percentage points) Real Effect. Exchange Rate Interest Rate (percentage points) Output

18. Implied financial flows under cap-and-trade: United States Japan Western Europe Eastern Europe and Russia China Other emerging and developing economies OPEC By Initial Emissions Shares (percent of GDP) By Population Shares (percent of GDP) 2020 2030 2040 NOTE: A positive value denotes a receipt of transfersthe region is selling its emission rights.