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Environmental economics and the economics of global warming
The Macro-Economics of European Economies MSc in Economic Policy Studies John FitzGerald, March 2015
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Course Outline How does an economy work? JF 16-1-2015
The genesis of macroeconomics AM Modern macroeconomics AM Banks and financial markets AM The recent crisis AM The labour market JF Fiscal Policy JF Trade JF Environmental economics & the economics of global warming JF The future of the Irish economy AM and JF
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Outline of Lecture Theory – Economic Tools for Analysis Presentation:
Science of climate change Economic tools for analysis in environmental economics Presentation: The origins and resolution of the current crisis in Estonia, Bulgaria, Greece and Spain Break The origins and resolution of the current crisis in Latvia, Portugal, Spain and Italy Applied – examples of environmental policy design EU emissions trading scheme Carbon taxes Other Policies
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The science of climate change - 1
What is the sustainable level of emissions? Scientific consensus Climate is warming Due to human behaviour – greenhouse gases IIEA Occasional paper 3 Greenhouse gases accumulate in atmosphere Safe stopping distance very long Concentrations of greenhouse gases to double by 2100 Likely increase in temperature of between 2° and 4° To keep it to 2° need to greatly reduce world emissions Considerable uncertainty Better safe than sorry?
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The science of climate change - 2
The higher the temperature rise the greater the damage Non-linear effects – the bigger the increase in temperature the bigger the damage Modelling of climate change impact by region important Damages not evenly distributed Provide monetary estimates of damage However, not everything is quantifiable e.g. biodiversity Adaptation costs – and ability to pay them Discounting future costs – damages v adaptation costs Problem – far in the future Equity weights – because damage may be greater in poor countries
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The science of climate change - 3
“Climate change is a moral problem. The main reason to reduce greenhouse gas emissions is a concern for far away lands, distant futures and remote probabilities.” The people who emit most are least affected. “If you do not care about risk, the future, or other people, then you have little reason to care about climate change” (Anthoff and Tol, 2010)
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Economic Tools for Analysis
Externalities - market failures Valuing the environment Cost-Benefit analysis Trade and the environment Instruments for policy
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Environmental externalities
Market failure – the environment is “free” Nobody owns it – “tragedy of the commons” Examples of market failures: Emission of greenhouse gases Emissions of gases causing acid rain Pollution of a river Solid waste and litter Solutions – create a market? Can it be solved by an appropriate price? Apply quotas Confer ownership? Regulation?
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Valuing the environment
Stated Preference Ask people what value they would put on….. Revealed preference Infer it from behaviour Value over time Discount rate? Examples Dump for nuclear waste Electricity transmission lines Investment in public transport Global warming - keeping temperature rise under 2 degrees
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Environmental costs and benefits
Can you measure marginal abatement cost? Depends on the industry Can you measure marginal benefit from reducing pollution? Marginal abatement cost Example: A Farm and a fishery Marginal private benefit of farm from pollution Marginal environmental cost from pollution A deal is possible – depends on ownership and measurement
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Cost-Benefit Analysis
Framework for analysis Honohan, 1998 Cost of public funds Honohan and Irvine, 1987 Shadow price of labour Green jobs? Shadow price of capital?
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Trade and the environment
Making environmental costs real (e.g. tax) affects competitiveness If done unilaterally (e.g. EU) some activity relocates e.g. steel production shifting from Germany to China e.g. milk production shifting from Ireland to Brazil What are the environmental effects? Depends on whether world consumption changes Depends on production efficiency (including emissions) in different countries Moving milk production to Brazil would increase emissions. Question for later – how to deal with this? The carbon content of Irish (and EU) imports is much higher than of exports China is doing the dirty work of Europe and the US Food miles? Look at actual carbon content of production and the cost of carbon e.g. Growing French beans in Ethiopia and flying them to Ireland may result in less emissions than growing them in heated greenhouses in Ireland If there was a universal carbon tax then buying the cheapest would be the correct environmental answer
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Low carbon in what sense?
Attribution of CO2 emissions by demand, plus imports Source: ESRI/EPA ISus model; Hertwich & Peters, 2009 (43) Env Sci Tech.
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Distributional effects of climate change policy
Between countries Allocation based on models to ensure “equal burden” National targets may involve very large transfers if models wrong Problem – don’t know winners or losers or size of transfers Between household and company sector E.g. Germany: households lose, companies win Between producers and consumers E.g. Possible effects of UK carbon floor Between rich and poor E.g. Large Public Service Obligations (PSO) to pay for renewables etc.
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Climate change policy Target level of emissions set by politicians based on scientific advice Economic question: how can you achieve the target at minimum cost? How can you ensure that the cost of abatement is equal for all? What are the implications of unequal costs? Not just equity but also efficiency: By swopping obligations the same target could be met at lower cost
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Implementing Policy Ideally: Complexity is costly
one objective – one policy instrument Complexity is costly Costly for regulators Costly for firms Cost of running a good scheme can kill it
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Rationale for market-based interventions
Damage from carbon emissions unpriced Huge difference in abatement costs from different technical solutions Market based instrument allows the economy to choose least cost Carbon tax set equal to marginal cost of carbon Economic actors choose technical solutions where marginal abatement cost < cost of carbon E.g. firms use lower (zero) carbon energy sources E.g. consumers save energy E.g. investment in R&D to produce technologies that reduce carbon at low cost
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Instruments for environmental policy
Targets? A target is not a policy instrument Ownership? Prices - taxes Market chooses least cost solution, uncertainty about hitting precise target Potential “double dividend” – revenue used to reduce other taxes Subsidies Cost of public funds Quantity controls Uncertainty about the true future cost, more certainty about environmental effects Regulation Information deficit Regulator plays God but is not as wise - the market is closer to Solomon! Research
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Presentations The origins and resolution of the current crisis in Estonia, Bulgaria, Greece and Spain The origins and resolution of the current crisis in Latvia, Portugal, Spain and Italy
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Climate change policy in practise
Policy Instruments EU emissions trading scheme (ETS) Carbon Tax Tackling acid rain EU policy
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Instruments for environmental policy
Targets? A target is not a policy instrument Ownership? Prices - taxes Market chooses least cost solution, uncertainty about hitting precise target Potential “double dividend” – revenue used to reduce other taxes Subsidies Cost of public funds Quantity controls Uncertainty about the true future cost but more certainty about environmental effects Regulation Information deficit Regulator plays God but is not as wise - the market is closer to Solomon! Research
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Example – Acid Rain Different from climate change
Imposing National Obligations Clear up your own mess How much pollution in Ireland? How much damage does it do? Biggest problem elsewhere Pay Czech republic to clean up? Where not appropriate Where pollution is local
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EU Policy Original EU proposal of a carbon/energy tax in 1992
Today, multiple policies for one objective For sectors covered by Emissions Trading Scheme (ETS) Emissions Trading Renewables Energy efficiency For rest of economy – national choice? Carbon tax Clean Development Mechanism? Pay other countries to do it R&D – correct incentives?
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EU Emissions Trading Scheme - 1
If allocate permits to firms without trading For some the target / permit will be easy, for some very difficult This will impose differential costs on firms in a pretty arbitrary manner If allocate permits to firms with trading Firms will buy and sell permits so the cost for each firms is equal to the price Because the firms can sell the permit – it is an input with a cost so firms will include it in their price. All other firms will be passing on the permit cost If permits are provided free firms will make a windfall gain Transfer of resources from consumers to producers
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EU Emissions Trading Scheme - 2
“Grandparenting” a big problem No revenue for government to offset economic costs Transfer from consumers to shareholders Distortions Value depends on power station location Multiple rounds of permits Dirty plant must stay in business to collect the jackpot every few years Price driven up & NO clean up
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Taxation - a “Double Dividend”?
The environment does not have a price so it is “over-used”/ “abused” Putting a price on polluting – a carbon tax. Produces a dividend – reduced pollution – a welfare gain The tax revenue allows governments to cut other taxes Taxes on carbon are less damaging than taxes on labour Switch from a tax on labour to a tax on carbon: a second dividend Higher employment and output Conefrey et al. 2012
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EU Climate Change Policy - current
Reliance on national targets: Distributional Effects Not transparent because of targets and the Emissions Trading System (ETS) Using models to forecast outcomes 15+ years hence?? Nonetheless – substantial distributional effects Renewables Policy Do we need one? Renewables only have special value if reduce carbon Advantages: drives research – an infant industry argument Disadvantages: very expensive – often more expensive than alternatives Energy efficiency targets Where is the market failure? Difficult to quantify and verify
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Lessons from Quotas: ETS
Volatile C price : discourages C-saving investment Arbitrary baseline: allocation of permits hi-jacked Administration, traders, verifiers add to the cost Auctioning resisted : transfer of assets to industry. Industry adds the asset value to the output price, but government gets no revenue to offset costs Revenue from auctioning in the future? Taxes impose same cost on consumers But government has revenue to compensate More certain price – better for investment Lower administrative cost Less political buy-in from losers
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EU Climate Change Policy - future
Price the best answer, ETS a second best With ETS it should: Cover all emissions Auction all permits Don’t transfer resources to companies from consumers National limits result in international transfers If national limits – need a mechanism to ensure equity Possibility of a price floor? Ireland should seek safeguards for all players
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Non-ETS Sector The EU ETS covers only part of carbon dioxide emissions
Non-ETS: Households, transport, services Regulation was left to Member States Post 2012:targets for non-ETS emissions By 2020 EU emissions to be 10% below 2005 levels Ireland –20% Very demanding for Ireland
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Irish policy for non-ETS
Tax best instrument Very little scope to change emissions by 2020 in non-ETS. More scope in ETS. However, Ireland cannot trade off ETS for non-ETS reduction. To reach the target Would require huge tax Other policies would be even more expensive Very inefficient if price on non-ETS market hugely greater than on ETS. Therefore, need flexibility
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Flexibility for non-ETS in EU
Three proposals Irish, Polish, Swedish Swedish adopted Allow countries to trade non-ETS quotas Equates non-ETS compliance cost across EU Competitiveness within EU ETS price the same Non-ETS price the same A level playing field in the EU However, potentially inefficient if prices differ
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Implementation in Ireland
Carbon Tax essential – in place Least cost implementation Should it be higher? The revenue allows Lower distortionary taxes elsewhere Has negative income distribution effect Supplementary measures Energy efficiency / insulation – social housing etc. Buy permits from other governments IGES, 2014 models effects
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Effects of a Carbon Tax – double dividend
Revenue recycled through lower income tax than before Net effect on economy is positive GNP, % 0.5 Employment, % Wage Rates, % -0.9
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Importance of Price Signal
Short-run emission reduction limited In long run emissions reduction will be achieved by new technologies A higher price promises a return on investment in R&D Sends signal – better than governments “picking winners” Best approach: “The polluter pays”
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Subsidies – Carrots?? Sourced from taxation, causes lost jobs and output elsewhere Rewards item subsidised, not reductions Need to be large to entice recipients Goes to many who would invest anyway (deadweight) Requires monitoring – rarely assessed Selection record is poor : inappropriate solar panels, bio-fuels. Dangerous support of liquid bio-fuels
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Capital Cost a Key Issue
Highly capital intensive industry Need new investment Rest of EU has not needed to worry They didn’t need new investment However, EU will need lots of investment for environmental reasons Reducing uncertainty for investors Crucial for competitiveness How to combine certainty with competition
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EU Renewables Obligation
Why have a renewables obligation? If there is a carbon price why is that not enough Are renewables “beautiful” Strong lobby Designed to drive research – infant industry argument Could the same result be produced by research rather than production? German approach – very expensive Allocation of obligations – distributional effects across countries
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Drive for renewables - Ireland
Delivering increase without a subsidy? Predominantly driven by the market Subsidy lower in Ireland than Northern Ireland Certainty minimises capital cost Simulating more renewables by 2020 If gas prices cheap then there is a significant cost If gas prices expensive then may be good value An insurance policy?
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Other Renewables Wave and tidal Biomass Experimental, high risk
Share R&D costs Tidal unlikely to be economic Wave?? Biomass Replace peat gradually Peat should drop out because dirty
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Role for Nuclear? Minimum size 1000 MW? Managing Risk Reserve needs
Reliable small units – not available Managing Risk Reserve needs Nuclear is “must run” as is wind Will not fit with the Irish system Too much wind? How much interconnection?
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Energy Efficiency Where is the market failure? What is wrong with the price? Possible lack of information, access to finance, economies of scale Important how you tell consumers Price on its own may not be enough Don’t impose energy efficiency obligations on suppliers Hides the cost. Likely to cost more than a national scheme BER scheme for dwellings delivering benefits
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Domestic Policy Not fully worked out Emissions Trading Renewables
Targets – imposed from outside Emissions Trading Made best of a bad hand Renewables A means to an end In long run ETS should be enough But ETS is distorted Absence of carbon tax No incentive to change Burden uneven – raises cost Carbon tax should be higher? Carbon leakage? Why subsidise peat?
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Transport - Aviation Very high income elasticity (responsiveness)
Low price elasticity The last use of fossil fuels Raise price Grandparented permits – billions for O’Leary Alternative mechanisms – Biggles?
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Policy on Transport Carbon Tax - small effect
Congestion key environmental issue Urban public transport Congestion charging Emissions reduction a by-product EU level crucial Standards for fuel efficiency Learn from California Huge market - producers can react Long lead in time on R&D
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Research Essential if the world is to reduce emissions Top-down:
The wise civil servant or Competitive model – basic research Market Driven: Profitable opportunities Builds on basic science
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International agreements?
No matter what the EU does it will not solve the problem Carbon leakage a real issue Getting agreement on a fair burden sharing across the world Almost impossible Difficult to verify and enforce CDMs not a solution In the end, when new carbon neutral technologies are the cheapest solution they will be adopted First get the technologies!
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Lecture 27th March Two topics related to previous lectures EMU
Prepare a few points on each topic. Lecture will be in the form of a debate Antóin Murphy and myself will participate, but not lead the debate EMU Was it a good idea? How can EMU be improved? How would you have advised the government on the financial crisis? In September 2008 November 2010
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Reading for this lecture
Basic text: “Introduction to Environmental Economics”, Hanley Shogren and White. Not very exciting, but provides the basics Chapters 2, 3, 4, 6 “Climate-Change Policy” Dieter Helm, OUP. Library: P59 A series of articles – much more comprehensive. Other reading. Examples: ESRI, Irish Energy Policy: An Analysis of Current Issues, Research Series No. 37, relevant parts of chapter 3. Honohan, 1998, on cost-benefit analysis Anthoff and Tol, 2010, IIEA Occasional paper 3 on the science On emissions embodied in trade: Conefrey et al., 2012 on the double dividend IGES, 2014, on using carbon taxes to finance buying permits MTES-Structural-Reforms_Staff-Working-Paper_finalforpub2.pdf
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