Lecture 9: ECONOMIC INSTRUMENTS

EUROPEAN EMISSION TRADING SCHEME (EU ETS)

- emission trading scheme driving emission reduction in europe - checking emissions and permits • Covers 50% of European CO2 emissions. • Industry, electricity production and aviation. • Market of 150 billion Euro!

RESTORING LEVEL PLAYING FIELD BY CARBON BORDER ADJUSTMENT MECHANISM

- if steel comes from a place without climate policy, the producer has to pay a tax at the border and the other way around if they want to export

DIFFERENCE BETWEEN TAXES AND TRADABLE RIGHTS

- mainly certainty and which one we consider more important Taxation: • economic effects certain • emission reduction uncertain Tradable rights: • emission reduction certain • economic effects uncertain PRICES WORK! Gasoline price • US (€1,20) • Europe (€2,20) - cars are almost twice as efficient in europe to save money on gas

EU ETS AS WATERBED

- pushing on one side means the water will go up somewhere else - once you fix the emissions by trading schemes the emissions will be compensated somewhere else • Overarching ceiling makes other CO2 policy for sectors within EU ETS meaningless, such as windmills. • Limited long-term effect. • Electric cars are zero-emission - because they are covered by the trading scheme - because it has a fixed celing

PHASES OF EU ETS

- started in 2005 only covering co2 and large industries - there was one big celing slowly going down - the permits were given for free for participation - in each phase the cap was tightened and less emissions permitted - now green deal makes things a bit different - eu has a very solid valve to manage climate policy

WHY NOT SUBSIDIES?

Same problems as command and control plus • Pay the polluter instead of the polluter pays. • Distort labor markets (subsidies are financed by income tax). • Create rebound effects (lowering prices increase consumption). Good option if industry faces international competition from countries with less stringent climate policy (see next slides)

ECONOMICS

Social science that studies how people use scarce resources to satisfy their needs and wants. • Descriptive (how do people behave?) • Prescriptive (efficiency, optimal welfare)

THE PERFECT MARKET

THESE ARE 'MARGINAL' CURVES! - explain what happens with an additional unit demand curve: - with the first unit people are willing to pay a lot - with an additional unit, people are willing to pay less for another one supply curve - the more they produce the mroe expensive it becomes to make more perfect market is when there is equilibrium between supply and demand

(LECTURE 7) SOCIAL DILEMMA

We are primarily self-centered and inclined to shift costs to others. Solution: • 'Mutual coercion, mutually agreed upon' • Without governmental regulation, we will continue business as usual

CLIMATE MARKET

Without market where demand for stable climate and supply of emission reduction meet no emission reduction! supply and demand exist but they don't meet in the market - there is no supply because we re not taking it into consideration

invisible elbow

externalities - consequences that were not taken into consideration

'SITTING DUCKS' PAY MORE

personal consumers pay much more than companies who use much more - companies can leave countries because of the taxes

SOLUTION: MARKET FOR CO2-EMISSIONS

repairing the market 1. taxation - calculating the hypothetical price and imposing taxation on emiters - it will reduce emisions and everyone above the point will emit and pay 2. tradable emision rights - having few permits to emit - they get a price - kind of the same as the taxation

AUTONOMOUS EFFICIENCY GAINS DUE TO ENERGY PRICE

there has always been a growth in efficiency even without environmental laws - we are always looking for ways to save money

'INVISIBLE HAND'

• Adam Smith (1723-1790) • An Inquiry into the Nature and Causes of the Wealth of Nations (1776) • Mandeville (1724): "Private Vices ... may be turned into Public Benefits"

WHY 'MARKET' INSTRUMENTS INSTEAD OF COMMAND AND CONTROL?

• Billions of emissions sources of reducing emissions and billions of decision-makers. • Each measure has different potential and different marginal costs to reduce emissions

so why market insead of control?

• Central planners lack the information! • Market instruments restore the market and give incentives to emitters to use their own information.

CARBON PRICE INITIALLY LOWER THAN ANTICIPATED

• Clever negotiations by industry before phase I: overallocation. • Financial crisis. • High imports of international credits. • Positive price due to banking. • 2 billion ton surplus rights!

CARBON PRICING

• Covering 22% of global GHG emissions: 12 Gt CO2 eq. • Prices in implemented initiatives US $1-119 / t CO2 eq. (75% of the emissions covered are prices < US $20 / t CO2 eq.) • Annual value of carbon pricing initiatives in 2019 is just under US $45 billion. • Compare: annual emissions 50x109 ton CO2 eq. With carbon price US $100 / t CO2 this means US $ 5,000 billion

EXTERNAL EFFECT

• Effect of A's act on B's wellbeing, which A does not take into consideration when deciding to perform the act or not. • Can be negative, but also positive • Why doesn't A take the effect on B's wellbeing into account? • Because there is no transaction: A does not have to pay B; A is not paid by B. • Externalities have no price ex. being annoyed by the noise of the plane - the passanges never considered that

CONCLUSION ECONOMIC INSTRUMENTS

• Environmental economists prefer market instruments as most efficient. • The urgency of the climate crisis may require a climate Marshall plan, however

(LECTURE 4) MITIGATION OPTIONS

• From energy-intensive consumption to energy-extensive kinds of consumption (from labor-extensive to labor-intensive) • Same consumption with less energy (efficiency) • Use energy with less carbon emissions etc.

WHY NOT COMMAND AND CONTROL?

• Government lacks information. • Cannot offer incentives for all reduction measures. Only for specific technologies, but not for reducing consumption, for example. • Does not offer incentives for technological development. • Good option if consumers are too short sighted (i.e., unable to consider energy use over product lifetime)

ECONOMICS ABOUT EFFICIENCY AND UNCONCERNED ABOUT ETHICS!

• How to make the cake as large as possible? • How it is to be divided is not an issue. • Introduction of economic instruments introduces questions of distributional justice, however. who is to bear the burden of climate policy?

CLIMATE ECONOMICS

• How to reach optimal welfare given scarcity in environmental goods (absorption capacity of atmosphere for greenhouse gases) and scarcity in means to protect the environment (time, money, other resources ...) • What is the optimal target? Lecture 8 • What are efficient policy instruments to get there? Lecture 9

OPPORTUNITY COSTS AND WINDFALL PROFITS

• In the 1st and 2nd phase of ETS, electricity companies received rights free of charge. • Electricity companies raised prices although they received permits for free. • Economic rationality: permits have opportunity costs. • In the 3rd phase (from 2013) E-companies have to pay.

'CARBON LEAKAGE' (LIMITS TO REGIONAL CLIMATE POLICY)

• Internationally competing industry moves production to countries with less stringent environmental policy. • Foreign industry increases market share. • Consumers refuel across the border and fly via Dusseldorf

CARBON LEAKAGE

• Only relevant for industry that at the same time faces high international competition and high energy intensity. • Steel, cement, synthetic fertilizer. Share of energy costs in production costs of different energy-intensive industrial sectors in Germany, the USA and Japan in 2011

ENVIRONMENTAL ECONOMICS (classical view)

• Problem analysis: climate change is a form of market failure • Solution: repairing the market by 'market instruments' - putting a price tag on climate solutions ! Ecological economists propose more radical solutions

PERFECT MARKET CONDITIONS

• Property rights protected (against zero costs) • Full information (against zero costs) - consumers have to know about producers and producers about the wants of consumers • Rational consumers (transitive preferences = illogical consumers) • No monopolies • No external effects • No public goods - you cannot exclude people from consuming it

CARBON MARKET

• Reliable and accurate monitoring, reporting and verification of GHG emissions. • ETS is a financial market with all the risks it involves, including speculation. • Registry recording ownership of allowances must be secured, like any banking systems. - Stolen permits from a Czech firm in January 2011 prompted spot trading to close for nearly two weeks. • The hackers sold over EUR 7 million in emission permits from Blackstone Global Ventures. • In Greece hackers got onto the server system of the university of Patras and then stole EUR 4 millions in credits from the cement company Halyas

ARE PRICE SIGNALS ENOUGH?

• Some would argue it is too late for mere price signals. • What we need is a climate Marshall Plan: • Large scale government investments in renewable energy, retrofitting homes • Human inventiveness unlimited when profit can be made. • But no Delta works or man on Moon with price signals

DIFFERENT CLIMATE POLICY INSTRUMENTS (from soft - persuasion with gifts- to hard)

• Subsidies • Information (national campaigns, product labels, ...) • Market instruments (taxation and tradable rights) • Command & control regulation (standards)

NOT ALL POSSIBLE MEASURES ARE TECHNICAL

• Technical measures (efficiency): unchanged consumption (more efficient car) • Operational measures: different consumption (smaller car, public transport instead of car, move to a new house) • Volume measures: less consumption (refrain from a trip)

ARTHUR PIGOU (1877-1959)

• The Economics of Welfare (1920) • 'Pigouvean' tax to internalise negative external effects

WHY NOT INFORMATION?

• Will have some effect but ignores social dilemma (see Lecture 7) - explaining has no effect as it s still rational from an individual perspective to continue with business as usual