w arming The MacroEconomics of European Economies MSc in Economic Policy Studies John FitzGerald March 2015 Course Outline How does an economy work JF 1612015 The genesis of macroeconomics ID: 418018
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Slide1
Environmental economics and the economics of global warming
The Macro-Economics of European Economies
MSc in Economic Policy Studies
John FitzGerald, March 2015Slide2
Course Outline
How does an economy work? JF
16-1-2015
The genesis of macroeconomics
AM
23-1-2015
Modern macroeconomics
AM
30-1-2015
Banks and financial markets
AM
6-2-2015
The recent crisis AM
13-2-2015
The labour market
JF
20-2-2015
Fiscal Policy JF
6-3-2015
Trade JF
13-3-2015
Environmental economics & the economics of global warming JF
20-3-2015
The future of the Irish economy AM and JF
27-3-2015Slide3
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 PoliciesSlide4
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?Slide5
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 countriesSlide6
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)Slide7
Economic Tools for Analysis
Externalities - market failures
Valuing the environment
Cost-Benefit analysis
Trade and the environment
Instruments for policySlide8
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?Slide9
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
G
lobal warming - keeping temperature rise under 2 degreesSlide10
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 measurementSlide11
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?Slide12
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 answerSlide13
13
Low carbon in what sense?
Attribution of CO
2
emissions by demand, plus imports
Source: ESRI/EPA ISus model; Hertwich & Peters, 2009 (43) Env Sci Tech.Slide14
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.Slide15
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 costSlide16
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 itSlide17
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 costSlide18
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
!
ResearchSlide19
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
ItalySlide20
Climate change policy in practise
Policy Instruments
EU emissions trading scheme (ETS)
Carbon Tax
Tackling acid rain
EU policySlide21
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
!
ResearchSlide22
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 localSlide23
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?Slide24
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 producersSlide25
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 upSlide26
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. 2012Slide27
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 verifySlide28
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 losersSlide29
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 playersSlide30
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 Slide31
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
flexibilitySlide32
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 differSlide33
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 effectsSlide34
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, %
-0.9Slide35
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”Slide36
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-fuelsSlide37
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 competitionSlide38
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 countriesSlide39
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?Slide40
Other Renewables
Wave and tidal
Experimental, high risk
Share R&D costs
Tidal unlikely to be economic
Wave??
Biomass
Replace peat gradually
Peat should drop out because dirtySlide41
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?Slide42
Energy EfficiencyWhere 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 benefitsSlide43
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?Slide44
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
?Slide45
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&DSlide46
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 scienceSlide47
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!Slide48
Lecture 27th 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
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 2010Slide49
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/2014/07/2014-07-01-MTES-Structural-Reforms_Staff-Working-Paper_finalforpub2.pdf