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SocialValueofMitigationAction,ananchorfornewformsofcarbonpricing? Etienne Espagne (CEPII), Jean-Charles Hourcade (Cired), Emilio La Rovere (UFRJ), Baptiste Perrissin-Fabert (FranceStratégie),,AntoninPottier(EcoledesMines),PriyadarshiShukla(IIMA) ____________________________________________________________________________________ AftertheParisAgreementafreshlookisneededabouttheroleofcarbonpricesinclimate policies.Paragraph136oftheDecisionwhichnotestheimportanceofcarbonpricing,only applies to “non-party entities” and is not binding upon Parties to the Convention. Carbon prices will thus stay country-specific. This is in contrast with the idea that, in a “first-best” world,carbonpricesshouldrepresentthesocialcostsofclimatechange(SCC)andbeequated throughoutcountriesandsectorsmodulocompensatingtransfersforthelosers. Defacto,theParisAgreementgivesapivotalroletoINDCsforaligningthe+2°Cobjectiveand thesustainabledevelopmentgoals(SDGs).Carbonpriceswillbeoneofthepossibletoolsof theirdeploymentbuttheirlevelwillbeconstrainedbythepaceatwhicheachcountrycan embedthemintoreformsofitsfiscalsystemanditspublicpolicies.Thispacewilllikelynotbe consistent with the urgency of the climate challenge and leave unsolved how to meet the Article2oftheAgreementi.e.“makingfinanceflowsconsistentwithapathwaytowardslow greenhousegasemissionsandclimate-resilientdevelopment». Theusualresponsetothiscarbonpricegapliesincomplementarynonpricesignals.But,these toolsentailtheriskofpoliticalarbitrarinessandeconomicinefficienciesleadingtopolitical distrustofclimatepolicies.Thewayoutistogroundcomplementstocarbonpricesonthe legitimacyoftheparagraph108oftheDecisionoftheParisAgreementwhich“recognizes thesocial,economic,andenvironmentalvalueofmitigationactivitiesandtheirco-benefitsto adaptation,health,andsustainabledevelopment”(hereafterSVMA). ThenotionofSVMAresultsfromapoliticalprocesstriggeredaftertheCancun’scall(2010)for “building a low carbon society … that ensures … equitable access to sustainable development”1. This paradigm shift from climate-centric analysis forces economists to pay moreattentiontosecond-bestsituationsandtotheco-benefits/costsofclimatemitigation (Hourcade and Shukla, 2015). It more specifically re-opens the discussion about pricing policies apt to align climate policies and SDGs: carbon taxes, prices from carbon markets, internalcarbonpricesofprivateentities,notionalpricesinsectorialpublicpoliciesandprices otherthancarbonprices(realestates,land,interestrates,currencyexchangerates). However,thereisnogeneraltheoryofsecond-bestsituations(LipseyandLandcaster,1956) andtheSVMAisnotawell-establishedconceptineconomicanalysis.Thisiswhythispaper triesanddefinesitwhileclarifyingitslinkswithwell-establishedconceptslikethesocialcost ofcarbon,theshadowpricesofcarbon,notionalandmarketcarbonprices. 1. Socialcostsofcarbonversusshadowpricesofcarbon In economic policy debates confusion is sometimes created by the fact that some wellestablishedconceptsineconomicshaveotherconnotationsinthepolicyarena.Thismightbe thecasefortheconceptofsocialcostofcarbon(SCC).Inthecommonparlance,itevokesthe 1 th SeetheObama-RoussefdeclarationonJune30 2015andtheLCS-RnetDeclarationJune2015http://lcsrnet.org/lcsrnet_meetings/2015/10/1489 1 social and economic damages of emitting one ton of carbon. But this gives no ground for mitigationpolicies(forexampleforsettingacarbonprice)becausethereareasmanydamages as climate warming scenarios, hypotheses on the feedbacks on the ecosystems and views abouttheadaptivecapacitiesofimpactedsocieties.Toavoidconfusion,itwouldbebetterto makeadistinctionbetweentheSocialCostofClimateChange(SCCC)whichisthediscounting valueofclimatechangedamagesalongagivenemissionsscenarioandtheSCC. TheSCC,intheIAMsinceNordhaus(1994),isthetimeseriesofthecost,ateachpointintime, ofavoidingtheemissionofonemoretonalonganoptimalresponsepathwaywhichultimately equatestheSCCCandthediscountedvalueoftheSCCs.Thereferencepathwayisoptimalin ‘Ramsey’-likemodels(maximizationofasocialutilityfunctionoveragiventimeperiod)but notnecessarilyinrecursivemodels(‘Solow’-likeornot).Thisdoesnotmakeadifferencefor discussingtheSCCsifthereferencepathinrecursivemodelsisassumedtobe‘notmodifiable’ orthe‘bestreachableone’becauseofthetransactioncostsofreformpackages. InthiscasethelinkbetweentheSCCandcarbonpricesisstraightforward:letusthuspicture, ingraph1,aneconomyonaproductionfrontier𝐹# (Q,R)(i.e.thesetofmaximumproduction ofacompositegoodQforagivenamountofemissionsreductionR.PointA,withnoemission reductions,representsthecaseof‘climateskeptics’forwhichtheSCCiszero.Ifthesocial welfare function is 𝑈# (Q,R) then point B maximizes social welfare. At this point, marginal abatementcosts(theslopeof𝐹# (Q,R)isequaltomarginaldamages(theslopeof𝑈# (Q,R). Both slopes are equal to α which represents the SCC, i.e. the loss of production and consumptionofQcausedbyoneadditionalemissionreduction. Difficulties around the value of the SCC have been extensively discussed around the Stern report(2007).Thisvalueisfunctionofparametersliketheexpectedeconomicgrowthrate, thepuretimepreference,therateoftechnicalprogressinlowcarbontechniques,theshape of the damage function in function of the temperature levels and of the vulnerability of impactedsocieties.Otherparameters,lesspresentinthedebate,alsomatter:theasymmetry between the utility of a gain and of a loss of income (Ambrosi et al. 2009), the 2 intragenerationalponderationofindividualsinthesocialwelfarefunctionandtheformsof inter-generationalsolidarity(LecocqandHourcade,2012). Because all these parameters can lead to infinite regresses of scientific and ethical controversies (Espagne et al., 2015), one alternative option is to adopt a cost efficiency analysis.Thiscomestocalculatetheshadowpriceofcarbon(ShPC)associatedwithaclimate objective treated as a political constraint. In graph 1, this is the slope β of 𝐹# (Q,R) at its crossingpointBwiththeline𝐸&°( (the2°Cobjective).Thisslopecanalsointerpretedasthe SCCforacountrywithasocialwelfarefunction𝑈& (Q,R).Contrarytoacost-efficiencyanalysis wheretheimplicitdamagecausedbytheemissionofoneadditionaltoofcarbonapproaches infinity,βcanbeinterpretedofasthewillingnesstopayfor𝐸&°( andallowsfor“overshoot scenarios” (Ambrosi et al 2003). Whatever the interpretation of β as a SCC or a SPC, however,policymakersshouldimplementacarbonpriceequaltothisvalue. 2.SCCina‘2ndbestworld’:ausefulindicator,anincompleteguideforaction Letusnowassume,ingraph2,thata)theeconomystandsatpointOon𝐹& (Q,R)strictlybelow thepotentialtechnicalpossiblityfrontier𝐹# (Q,R),b)thisrealproductionfronteeris‘movable’ throughreformpolicieswhichcanleadtheeconomytoA,BorI,andthatCisthepointtobe reachedtocomplywithitscontributiontotheParisAgreement’sobjectives. ItispossibletocalculatetheSCCsforA,BorI.ButtheseSCCsareex-postmeasurementof the welfare losses of decreasing emissions from a baseline resulting from policy packages adoptedforamixofclimateandnon-climateobjectives(Koketal.,2008).Theydonotprovide ex-ante guidance about the set of policy signals inciting the economy to locate itself on I (closertoO)forexample.Moreprecisely,thinkingthatthepolicysignaltobringtheeconomy fromBtoIisacarbonpriceequaltothedifferenceα − γoftheSCCsassociatedwiththese twopoints,comestoignoretheexistenceofinterplaysbetweenmitigationanddevelopment policiesandthatbifurcationstowardscarbonintensivedevelopmentpatternscanmakemore costlythereturntolowcarbonpathways. In this framework it is difficult to organize a negotiation process around the gains of cooperationhelpingtheeconomytoreachthepointC.Thebestinterestofeachcountryis indeed not to reveal the INDCs leading it from O to I because it would then negotiate compensationsforthelossofcompositegoodI–Cwheras,startingfromlessambitiousINDCs leadingittoBitcouldnegotiateforalossB–C.ThehighertheannouncedINDCs,thelesser compensationsthecountrywillbelegitimatetoask. 3 3.TheSVMAasuitableconceptfor2ndbesteconomies Beyond legitimate caveats against the idea of policies yielding both a climate and a developmentdividend,itmatterstounderlinethat,withoutthishypothesis,thereisnoroom fordiscussing‘equitableaccesstolowcarbondevelopment’.Theverynotionofdevelopment impliesachangeinthepaceanddirectionofthegrowthengine(theupwardmoveofthe productionfrontierandtheshapeofthismove).Inthiscontext,thenotionof‘co-benefits’ commonly denotes the non-climate related dividends of GHGs mitigation. It encompasses threedistinctcategories: - thedirectjointproductsofavoidedGHGsemissions:a)loweradverseconsequences oflocalairpollutiononhealthandonagriculturalproductivity,b)countries’energysecurity andlowervulnerabilityoftheirtrade-balancetothevolatilityofoilpricesandc)worldsecurity throughthedecreaseofenergytensions(IPCCWGIII,2014)andofclimateinducedmigration. Graph3usesthesocialwelfarefunction𝑈) (Q,R)insteadof𝑈# (Q,R)whichattachesagreater valuetomitigationactionsbyincorporatingtheirjointproducts. - the acceleration of technical change in such a way that a new production frontier 𝐹) (Q,R)isgeneratedbya“Schumpeterian”innovationwave(Stern,2015).Strictosensu,this isanetco-benefitifthelowcarbonbiaisintechnicalchangeyieldshigherdividendsthanthe business as usual one, in terms of long term economic growth and inclusive development (localresourcesefficiency,spatialdistributionofhumansettlements,accesstobasicenergy, transportandhousinginfrastructures,lessenergyandmaterialintensivedemandpatterns). - the indirect short and medium term macroeconomic and development benefits of well conducted low carbon transition: a) benefits of narrowing the gap between the propensitytosaveandthepropensitytoinvestthroughredirectingfinancialflowstowards productive investments b) strengthening the industrial fabric of each country through investinginlowcarbontechnologiesandlocalresourcesc)alleviatingpovertythroughhigher growth,higheremploymentandhigherfurnitureofbasicneed 4 With𝐹) (Q,R)and𝑈) (Q,R)theoptimumisnowsituatedonpointSwhichrepresentalevelof socialwelfarenotonlyhigherthanObuthigherthantheinitialobjectiveB.Theassociated SCCisδ.Butagainδrepresentstheoptimalcarbonpricetobeappliedifthetransitiontowards Ssucceeds.The‘if’remindsthattheParisAgreementisareasonableprophecyofthefuture andthattheissueishowtomakeitself-fulfilling.HerecomestheSVMA. TheglobalSVMAisthedistance,insocialwelfareunitsgiven𝑈) (Q,R),betweenSandO.This distanceisafunctionoftheslopeofOS(growthvariationassociatedwithonetonofavoided emission)andofthetransformationofthemarginalutilityofQandRbetweenOandS(in functionofthelevelofincomeandofthejointproductsofdecarbonization). IfwedividetheglobalSVMAbytheamountofavoidedemissions(𝐸&°( − 𝐸+ )weobtaina SVMAperton.Thislookslikeapriceofcarbon‘augmented’bytheincorporationofthecobenefitsofmitigation.Thisisimportantbutdoesnotchangethenatureofthecarbonpricing problem if it comes to say that carbon prices should be higher than when considering the climateexternalityonly.Thiswouldonlyresultinwideningthe‘carbonpricegap’. Toovercomethisproblem,itmatterstocomebacktothefactthattheendpointSisunknown ex ante because of a large set of uncertainties (technical change, growth impact of a new innovation wave, governmental judgments on development priorities and on the political acceptabilityofvariouspolicytools).Actually,totriggeracredibleself-fulfillingprophecy,the SVMApertonofavoidedemissionshouldprovideananchortofundingmechanismshelping tomaterialize,ex-ante,thesynergiesbetweendevelopmentandclimatepolicies,whilethe carbonprices(augmentedornot)cometoreward,ex-post,lowcarbondecisionseveryyear. Understood this way, the SVMA overcomes the baseline issue in the negotiation process. Indeed, countries will not argue that their baseline will be located in B in the absence of cooperationtomeet𝐸&°( .Wouldtheydoso,theywouldreceivelesssupportforatonof avoidedemissionsincetheadditionalvalueofmitigationaction(indicatedbytheslopeofBS) islowerthaniftheyaccepttotakeOasastartingpoint(slopeofOS>solpeofBS). 5 Concludingremarksaboutthe‘gooduse’oftheSVMA TheremainingquestioniswhetherthenotionofSVMAshouldremainarethoricalreference leadingtopinpointthecarbonpricegaporcanprovideananchortohelpclimatepoliciesand developmentpoliciesworkingsynergisticallyandtosetpull-backforcestohelpreorienting soon infrastructure investments and avoiding bifurcations towards a high carbon intensive developmentpathway.Complementarytocarbonpricesitsspecificcontributionshouldbe: - Tosupportinstitutionalcooperativearrangementsapttoreducetransitioncostsand transactioncostsofclimatepoliciesandmaximizetheircomplementaritywithotherSDGs, includingthroughpositiveeffectsofreducingincomeinequalitiesandpoverty - To hedge against the fragmentation of non pricing policies and climate finance initiativeslaunchedbysucharrangementsandtheirpotentialarbitrarinessandinefficiency - toreachhighlevelsovertheshorttermandtofacilitatethenarrowingofitsgapwith implementablecarbonprices. - to support the emergence and widespread use of financial devices to de-risk low carbon investments, specifically on infrastructure, and to build a new class of low-carbon assetstoattractmanycategoriesofsavers(bybackingfinancialproducts) - to be more easily negotiable that carbon prices because financial devices incorporating this value will bridge the funding gap which penalizes the deployment of infrastructuresindevelopingeconomiesandtheirretroffitingindeveloppedcountries. 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