Download How Does an Economy Work?

Environmental economics and the
economics of global warming
The Macro-Economics of European Economies
MSc in Economic Policy Studies
John FitzGerald, March 2015
Course Outline
1. How does an economy work? JF 16-1-2015
2. The genesis of macroeconomics AM 23-1-2015
3. Modern macroeconomics AM 30-1-2015
4. Banks and financial markets AM 6-2-2015
5. The recent crisis AM 13-2-2015
6. The labour market JF 20-2-2015
7. Fiscal Policy JF 6-3-2015
8. Trade JF 13-3-2015
9. Environmental economics & the economics of global warming JF 20-3-2015
10. The future of the Irish economy AM and JF 27-3-2015
Outline of Lecture
• Theory – Economic Tools for Analysis
• 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
• Presentation:
• 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
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 http://www.iiea.com/news/climate-change-report
• 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?
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
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)
Economic Tools for Analysis
• Externalities - market failures
• Valuing the environment
• Cost-Benefit analysis
• Trade and the environment
• Instruments for policy
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?
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
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
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?
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
Low carbon in what sense?
Attribution of CO2 emissions by demand, plus imports
80
70
60
50
Imports
Inventories
Investment
Government
Charity
Households
Exports
mln tCO2
40
30
20
10
0
-10
1990
1995
2000
-20
Source: ESRI/EPA ISus model; Hertwich & Peters, 2009 (43) Env Sci Tech.
2005
13
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.
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
Implementing Policy
• Ideally:
• one objective – one policy instrument
• Complexity is costly
• Costly for regulators
• Costly for firms
• Cost of running a good scheme can kill it
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
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
Presentations
1. The origins and resolution of the current crisis in Estonia, Bulgaria,
Greece and Spain
2. The origins and resolution of the current crisis in Latvia, Portugal,
Spain and Italy
Climate change policy in practise
• Policy Instruments
• EU emissions trading scheme (ETS)
• Carbon Tax
• Tackling acid rain
• EU policy
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
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
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
• Renewables
• Energy efficiency
• Clean Development Mechanism? Pay other countries to do it
• R&D – correct incentives?
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
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
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
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
Lessons from Quotas: ETS
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•
•
•
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
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
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
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
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
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
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, %
0.5
Wage Rates, %
-0.9
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”
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
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
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
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?
Other Renewables
• Wave and tidal
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•
•
•
Experimental, high risk
Share R&D costs
Tidal unlikely to be economic
Wave??
• Biomass
• Replace peat gradually
• Peat should drop out because dirty
Role for Nuclear?
• Minimum size 1000 MW?
• 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?
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
Domestic Policy
• Not fully worked out
• 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?
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?
Policy on Transport
• Carbon Tax - small effect
• Congestion key environmental issue
• Urban public transport
• Congestion charging
• Emissions reduction a by-product
• EU level crucial
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•
•
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Standards for fuel efficiency
Learn from California
Huge market - producers can react
Long lead in time on R&D
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
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!
Lecture
th
27
March
• Two topics related to previous lectures
• 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
1. EMU
A. Was it a good idea?
B. How can EMU be improved?
2. How would you have advised the government on the financial crisis?
A. In September 2008
B. November 2010
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: 333.7 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.
http://www.esri.ie/UserFiles/publications/RS37.pdf
• Honohan, 1998, on cost-benefit analysis http://www.esri.ie/UserFiles/publications/GRS172.pdf
• Anthoff and Tol, 2010, http://dx.doi.org/10.1016/j.jeem.2010.04.002
• IIEA Occasional paper 3 http://www.iiea.com/news/climate-change-report on the science
• On emissions embodied in trade: http://dx.doi.org/10.1080/09640568.2014.973936
• Conefrey et al., 2012 on the double dividend http://dx.doi.org/10.1080/09640568.2012.709467
• IGES, 2014, on using carbon taxes to finance buying permits http://igees.gov.ie/wp-content/uploads/2014/07/2014-07-01MTES-Structural-Reforms_Staff-Working-Paper_finalforpub2.pdf