1. Ragnar Arnason Comments on Environmentally harmful subsidies: - Developing a checklist - OECD Workshop on Environmentally harmful subsidies 7-8 November 2002

2. Basic considerations 1.There is a good (but not an unqualified) economic case for removing (or reducing) subsidies 2.There is an even better economic case for removing economically harmful subsidies (…if by “harmful” we mean deviation from the “optimal harm”)

3. …..but 1.Not all subsidies are equally harmful 2.There are lot of counterexamples (i.e. where subsidy is economically beneficial and its removal a mistake)

4. p1p1 MC 1 q1q1 q0q0 quantity $ p0p0 MC 0 q*

5. Therefore we need more information Basically, an empirical economic/environmental general equilibrium model But, this is not available (…and not in sight) And environmental concerns are pressing Therefore we need some guidelines – a checklist perhaps. But with almost no theory and little data this is very difficult!

6. An illustration Following Jan Pieters, assume: Government wants to reduce environmentally harmful subsidies by a given amount Which subsidies should it reduce and by how much?

7. y x Two environmental goods: y and x Budget constraint Social indifference curves x*x* y*y*

8. But this is too simplistic Environmental goods cannot really be generated (or bought) at a constant rate. Subsidy reduction (may) produce environmental goods That production is the output of the economic and environmental GE-system If that production is well behaved (..not particularly likely), it will look like:

9. Production of environmental goods y x Production possibility frontier

10. y x x*x* y*y* A possible case

11. y x x*x* y*y* Another possible case

12. y x x*x* y*y* Yet another possible case

13. Back to the checklist A checklist is supposed to reflect this –Not the optimal solution –But the ranking of of alternatives for allocating subsidy reductions. –So, we can Do things in the right order Avoid drastic mistakes Note: The ranking depends on the situation! It cannot be invariant (over space, time, extent of subsidies, output, cultures etc)!

14. Therefore, to compile the checklist, we need to know 1.The transformation frontier 2.The social preference (utility) map 3.In a dynamic context

15. The transformation frontier (How do subsidy reductions translate into environmental benefits) For all environmental variables! Requires intricate economic knowledge (dynamic GE model) Requires intricate environmental knowledge (how does economic activity really affect the environment) We don’t have this knowledge!

16. The social utility map Basically environmental valuation This is a function of environmental quality This is a function of the state of the economy (all economic variables) We don’t have this knowledge!

17. We are like a man sent to the supermarket to buy groceries He has a certain amount to spend But doesn´t know the price of the goods (I.e. how much he gets for a given expenditure) He doesn’t know the utility generated by the goods. What can he do?

18. The problem is one of choice under uncertainty Only if all outcomes are equally likely will it be optimal to do nothing. Assuming constant risk over choices, the best choice is to pick the most likely options. This is precisely what a good checklist is supposed to do It increases the likelihood of a good choice

19. Jan Pieters checklist Not solidly founded in theory But impressively intuitive (and practical) Misses two important aspects: –Corresponding to every subsidy is a tax –The environmental gains must be valued Apart from this I found myself in general agreement

20. Flow chart behind the checklist Subsidy removal likely to be environmentally beneficial Description of the subsidy Policy filter effective Benign alternatives available Conditionality leads to higher volumes Concentration of market power Subsidy removal not likely to be environmentally beneficial Effects are indeterminate no yes no yes Environmental variables valuable Subsidy financing “problematic” no