Tag: environmental externalities

The Paris Climate Change Conference (COP21) is under way. At the opening on November 30, 150 Heads of State gathered in Paris, most of whom addressed the conference. With representatives from 195 countries and observers from a range of organisations, the conference is set to last until 11 December. Optimism is relatively high that a legally binding and universal agreement will be reached, with the aim of keeping global warming below 2°C – what is generally regarded as a ‘safe’ limit.

But although it is hoped that a successor to the Kyoto Protocol of 1997 will be put in place, there are many problems in getting so many countries to agree. They may all wish to reduce global warming, but there is disagreement on how it should be achieved and how the burden should be shared between countries.

There are several difficult economic issues in the negotiations. The first is the size and impact of the external costs of emissions. When a country burns fossil fuels, the benefits are almost entirely confined to residents of that county. However, the environmental costs are largely external to that country and only a relatively small fraction is borne by that country and hardly at all by the polluters themselves, unless there is a carbon tax or other form or penalty in place. The problem is that the atmosphere is a common resource and without collective action – national or international – it will be overused.

The second problem is one of distribution. Politicians may agree in principle that a solution is necessary which is equitable between nations, but there is considerable disagreement on what is meant by ‘equitable’ in this context. As the third Guardian article below puts it:

The most important hurdle could be over whether industrialised countries like the US, UK and Japan, which have contributed the most to the historical build-up of emissions, should be obliged to cut more than developing countries. India, on behalf of many poor countries, will argue that there must be “differentiation” between rich and poor; but the US wants targets that are applicable to all. A collision is inevitable.

A third problem is that of uncertainty. Although there is general agreement among scientists that human action is contributing to global warming, there is less agreement on the precise magnitude of the causal relationships. There is also uncertainty over the likely effects of specific emissions reductions. This uncertainty can then be used by governments which are unwilling to commit too much to emissions reductions.

A fourth difficulty arises from the intertemporal distribution of costs and benefits of emissions reductions. The costs are born immediately action is taken. Carbon taxes or charges, or subsidies to renewables, or caps on emissions, all involve higher energy prices and/or higher taxes. The flows of benefits (or lower costs), however, of reduced emissions are not likely to be fully experienced for a very long time. But governments, whether democratic or dictatorships, tend to have a relatively short time horizon, governed by the electoral cycle or the likelihood of staying in power. True, governments may not be solely concerned with power and many politicians may have genuine desires to tackle climate change, but their political survival is still likely to be a major determinant of their actions.

Of course, if there is strong public opinion in favour of action to reduce emissions, governments are likely to respond to this. Indeed, all the expressions of public support for action ahead of the conference from all around the world, do give some hope for a strong agreement at the Paris conference. Nevertheless, there is still widespread scepticism in many countries over the relationship between human action and climate change, and many argue that the costs of policies to tackle climate change exceed the benefits.

Game theory can shed some insights into the difficulties ahead for the negotiators. The global optimum may be for a strong agreement, binding on all countries. The Nash equilibrium, however, may be a situation where countries push for their own interests at the expense of others, with the final agreement being much more minimalistic.

There do, however, seem to be more reasons to be cheerful at this summit that at previous ones. But negotiations are likely to be hard and protracted over the coming days.

Videos and webcasts
Paris Climate Conference: The Big Picture Wall Street Journal on YouTube, Jason Bellini (30/11/15)
Why is the Paris UN climate summit important? PwC, Leo Johnson (14/10/15)
Paris climate change summit 2015: ‘the near impossible task’ Channel 4 News on YouTube, Tom Clarke (30/11/15)
COP21: Rallies mark start of Paris climate summit BBC News, David Shukman (29/11/15)
With climate at ‘breaking point’, leaders urge breakthrough in Paris Reuters, Bruce Wallace and Alister Doyle (1/12/15)
COP21: Paris conference could be climate turning point, says Obama BBC News (30/11/15)
Leaders meet to reach new agreement on climate change BBC News, David Shukman (30/11/15)
Poll: Growing Doubts Over Climate Change Causes Sky News, Thomas Moore (30/11/15)
Paris climate protesters banned but 10,000 shoes remain The Guardian (29/11/15)

Articles

COP-21 climate deal in Paris spells end of the fossil era The Telegraph, Ambrose Evans-Pritchard (29/11/15)
Is there an economic case for tackling climate change? BBC News, Andrew Walker (28/11/15)
World Leaders in Paris Vow to Overcome Divisions on Climate Change Wall Street Journal, William Horobin and William Mauldin (30/11/15)
Experts discuss how to build a carbon-free energy industry The Guardian, Tim Smedley (25/11/15)
Africa could lead world on green energy, says IEA head The Guardian, Anna Leach (11/11/15)
Climate change talks: five reasons to be cheerful or fearful The Guardian, John Vidal (30/11/15)
The Paris climate change summit, explained in 4 charts The Washington Post, Philip Bump (30/11/15)
Why This Goal To Curb Climate Change ‘Is Not Ideal’ Huffington Post, Jacqueline Howard (30/11/15)
Paris climate change talks: What the different groups attending expect from these crucial meetings Independent, Tom Bawden (29/11/15)
UN Climate Change Conference: World Leaders Call For Price On CO2 Emissions Despite Uphill Battle At Paris Summit International Business Times, Maria Gallucci (30/11/15)
World Bank, six nations call for a price on carbon SBS (Australia) (1/12/15)
Uruguay makes dramatic shift to nearly 95% electricity from clean energy The Guardian, Jonathan Watts (3/12/15)

Questions

  1. Why is COP21 considered to be so significant?
  2. For what reasons is there hope for a binding agreement to limit global warming to 2°C?
  3. What would be the effect on global warming of the commitments made by more than 180 countries prior to the conference?
  4. What market failings contribute towards the problem of global warming?
  5. Why, if all countries want to achieve a binding agreement at the Paris conference, is it likely to be so difficult to achieve?
  6. Explain what is meant by a ‘Nash equilibrium’ and how the concept is relevant to international negotiations.
  7. Why is China investing heavily in solar power?
  8. Could Africa lead the world in green energy?
  9. Is a ‘cap and trade’ (tradable permits) system (a) an effective means of reducing emissions; (b) an efficient system?
  10. What is the best way of financing investment in renewable energy?
  11. How does the structure/order of the Paris conference differ from previous COPs? Is such a structure more likely to achieve substantial results?

Is slower economic growth a cost of cutting greenhouse gas emissions? Apparently not – at least according to two studies: one by DIW Econ, a German institute for economic research, and the other, earlier this year, by the International Energy Association (see reports below).

The IEA study found that, despite global GDP having grown by 6.4% in 2014, global emissions remained flat. The DIW Econ study found that from 2004 to 2014, OECD countries as a whole grew by 16% while cutting fossil fuel consumption by 6% and greenhouse gas emissions by 6.4%.

But what does this mean? If growth accelerated, what would happen to greenhouse gas emissions? Would they begin to rise again? Probably.

The point is that various developments, largely independent of economic growth have been reducing the greenhouse gas emissions/GDP ratio. These developments include: technological advances in energy generation; the switch to alternative fuels in many countries, thanks, in large part to lower renewable energy costs; increased energy efficiency by consumers; and a continuing move from energy-intensive manufacturing to less energy-intensive services.

So if governments forced more radical cuts in greenhouse gases, would this reduce the rate of economic growth or have no effect? For a given level of technological advancement, the initial effect would probably be a reduction in economic growth. But to the extent that this encouraged further investment in renewables and energy saving, it might even stimulate economic growth over the longer term, especially if it helped to bring lower energy prices.

A big problem in decoupling economic growth from fossil fuel usage is that developing countries, which are taking a growing share of world manufacturing, are more heavily dependent on coal than most developed countries. But even here there seems to be some hope. China, the biggest manufacturer in the developing world, is rapidly increasing its use of renewables. As the IEA press release states:

In China, 2014 saw greater generation of electricity from renewable sources, such as hydropower, solar and wind, and less burning of coal.

If the world is to tackle global warming by making significant cuts in greenhouse gases, there must be a way for developing countries to continue growing while making less use of fossil fuels.

Article

Cutting greenhouse gas emissions won’t slow global economic growth — report The Guardian, Bruce Watson (26/9/15)

Reports

Turning point: Decoupling Greenhouse Gas Emissions from Economic Growth DIW Econ, Lars Handrich, Claudia Kemfert, Anselm Mattes, Ferdinand Pavel, Thure Traber (September 2015)
World Energy Outlook Special Report 2015: Energy and Climate Change International Energy Agency (June 2015)

Questions

  1. What are the possible causal relationships between cutting greenhouse gas emissions and the rate of economic growth?
  2. What incentive mechanisms can governments or other agencies adopt to encourage reductions in greenhouse gas emissions without reducing economic growth?
  3. Can a cap and trade system, such as the European Emissions Trading Scheme help to achieve a given level of emissions reduction at minimum cost to economic growth? Explain.
  4. How might the developed world support developing countries in moving to a low carbon technology?
  5. What factors lie behind the falling costs of renewable energy? Are these the same factors that lie behind the falling cost of oil?
  6. What political problems might hinder the greater production of renewable energy?
  7. How might an economist set about determining a socially optimal amount of fossil fuel production? What conceptual and philosophical problems might there be in agreeing what is meant by a social optimum?

According to a recent IMF Survey Magazine article, Counting the Cost of Energy Subsidies, world-wide energy subsidies in 2015 account for $5.3 trillion or 6.5% of global GDP. The article summarises findings of an IMF working paper (see link below), which provides estimates by country, product (e.g. coal and oil) and component (e.g. global warming, local air pollution and congestion) in an Excel file

The working paper argues that energy subsidies are both larger and more pervasive than previously thought. According to the IMF Survey Magazine:

Eliminating global energy subsidies could reduce deaths related to fossil-fuel emissions by over 50 percent and fossil-fuel related carbon emissions by over 20 percent. The revenue gain from eliminating energy subsidies is projected to be $2.9 trillion (3.6 percent of global GDP) in 2015. This offers huge potential for reducing other taxes or strengthening revenue bases in countries where large informal sector constrains broader fiscal instruments.

In interpreting the findings it is important to understand how the term ‘subsidies’ is being used. According to the report, most of the $5.3 trillion “arises from countries setting energy taxes below levels that fully reflect the environmental damage associated with energy consumption.”

In other words, the term subsidy is being used whenever taxes do not fully account for the negative externalities associated with extracting and burning fossil fuels. Perhaps a better term would be ‘under-taxing’ rather than ‘subsidising’. Nevertheless the scale of not internalising externalities is huge. As Lord Nicholas Stern (author of the 2006 Stern Review on the Economics of Climate Change) says:

“The failure to reflect the real costs of fossil fuels in prices and policies means that the lives and livelihoods of billions of people around the world are being threatened by climate change and local air pollution.”

But, while not taxing external costs account for more than 80% of the underpricing of fossil fuel energy, some three-quarters of these external costs relate to local environmental damage, rather than international damage such as global warming. Thus charging for these external costs would benefit primarily the local population, as well as generating revenues, and thus provides a strong argument for governments raising energy prices through increased taxes or reduced subsidies.

So which countries are the major culprits in ‘subsidising’ fossil fuels? What specific measures does the IMF recommend to tackle the problem and what countries are addressing the problem and in what ways? The working paper and articles address these questions.

Articles

Counting the Cost of Energy Subsidies IMF Survey Magazine (17/7/15)
G20 countries pay over $1,000 per citizen in fossil fuel subsidies, says IMF The Guardian, Damian Carrington (4/8/15)
Fossil fuels subsidised by $10m a minute, says IMF The Guardian, Damian Carrington (18/5/15)

Working Paper

How Large Are Global Energy Subsidies? IMF Working Paper, David Coady, Ian Parry, Louis Sears, and Baoping Shang (May 2015)

Questions

  1. Explain how energy subsidies are defined in the IMF working paper.
  2. What measurement problems are there in calculating the size of the ‘subsidies’?
  3. Draw a diagram to show how the under taxing of fossil fuel usage leads to a greater than socially optimum level of consumption of fossil fuels.
  4. What specific policies are pursued by the four biggest fossil fuel subsidising countries?
  5. What political problems are there in persuading countries to reduce fossil fuel subsidies/increase fossil fuel taxes.
  6. Is there a relatively high or low income elasticity of demand for energy? What are the implications of this for different income groups of policies to hold down energy prices?

The Office for National Statistics (ONS) reported that the quantity of retail sales in the UK was 3.9% higher in August than it had been in July. However strong price competition meant that the value of these sales increased by only 0.4%. What were the key factors driving the big increase in the quantity of sales? Was it simply the response of consumers to falling prices?

The data indicated that there was strong demand for goods associated with the housing market such as carpets, fridges and cookers. Spending on furniture increased very rapidly with sales rising by 24% over a 12 month period. Flat packed furniture proved to be particularly popular with consumers.

There was also strong demand for electrical goods and more specifically vacuum cleaners. The ONS estimated that a boom in the sale of vacuum cleaners in August was responsible for 25% of the increase in retail sales.

Why did the sales of vacuum cleaners increase so rapidly in August? Did UK households suddenly decide to keep their houses cleaner? The sales data shows that certain types of vacuum cleaners sold in much larger numbers than others.

For example, Tesco reported a 44% increase in the sales of 2,000 watt vacuum cleaners in the last two weeks in August while the Co-op reported an increase of 38%. Referring to the last weekend in August, the head of small domestic appliances at the on-line retailer ao.com stated that

We saw a huge surge in sales of corded vacuums over 1,600 watts over the weekend, with sales quadrupling.

There were also reports that a significant number of customers were buying more than one vacuum cleaner with these larger motors.

The key reason for the sudden surge in demand was the implementation of new regulations by the European Union as part of its energy efficiency directive. The ultimate objective of this directive is to reduce climate change. The specific policy that appears to have had such a big impact on consumers in the UK was the ban imposed on firms in the EU from making or importing vacuum cleaners that have motors above 1600 watts. This ban came into effect on the 1st September 2014.

A spokesperson for the consumer group Which? stated in August that

If you’re in the market for a powerful vacuum, you should act quickly, before all the models currently sell out. A Best Buy 2,200-watt vacuum costs around £27 a year to run in electricity – only around £8 more than the best scoring 1,600-watt we’ve tested.

The EU plans to reduce the maximum permitted wattage in vacuum cleaners to 900 watts in 2017. Restrictions have already been imposed on bigger electrical appliances such as televisions, washing machines and refrigerators. The EUs Ecodesign directive may also be extended to a range of smaller electrical appliances such as toasters and hair dressers in the future. It’ll be interesting to see if consumers respond in the same way to regulations imposed by the EU in the future.

Ten days left to vacuum up a powerful cleaner BBC (21/08/14)
Housing boom, food discounting and vacuum ban boost UK spending The Guardian, Larry Elliott, Phillip Inman, Lisa Bachelor (18/9/14)
UK retail sales boosted by vacuum cleaner sales BBC (18/9/14)
Retailers sell out of vacuum cleaners ahead of EU ban The Telegraph, Elliot Pinkham (30/8/14)
Power surge! Fourfold rise in sales of super vacuums: Some customers buying two or more models to beat new EU regulations Daily Mail, Andrew Levy (1/9/14)
Energy Efficiency Directive European Commission (accessed on 24/9/14)
Vacuum cleaner splurge pushes up UK retail sales The Guardian, Phillip Inman (18/9/14)

Questions

  1. Using a demand and supply diagram, illustrate what has happened in the market for high wattage vacuum cleaners in August. Pay particular attention in your answer to the role of expectations.
  2. What did your previous diagram predict would happen to the price of high wattage vacuum cleaners in August? Did this in fact happen?
  3. A fully informed rational consumer may purchase a higher wattage vacuum cleaner if they consider that the improvement in cleaning performance is greater than the extra cost of purchasing and using the cleaner. Can you provide an economic rationale for banning the sale of these machines in these circumstances?
  4. Using a demand and supply diagram illustrate the impact of banning the sale of a product in a competitive market.

The UK hosted the third Clean Energy Ministerial conference on 25/26 April 2012. More than 20 energy ministers from around the world attended. In his address, David Cameron, gave his backing to more wind farms being built in the UK, both onshore and offshore.

Currently just under 10 per cent of the UK’s electricity is generated from renewable sources. But to meet agreed EU targets this must increse to at least one-third by 2020. Most of this will have to come from wind.

But whilst wind turbines create no CO2 emissions, electricity generated from wind is currently some 15% more expensive than from gas. To make wind power profitable, energy companies are required by law to generate a certain percentage of their electricity from renewables and the cost is passed on to the consumer. This adds some £20 per year to the average household energy bill.

Over the coming years, many new power plants will have to be built to replace the electricity generated from older plants that reach the end of their life. So what types of plant should be built? Unfortunately measuring the costs and benefits from power generation is not easy. For a start, energy needs are not easy to predict. But more importantly, electricity generation involves huge environmental and social externalities. And these are extremely difficult to measure.

What is more, the topic is highly charged politically. The social costs do not fall evenly on the population. People might favour wind turbines, but they do not want to see one outside their window – or from their golf course!

The following videos and articles will give you some insight into the difficulties that any decision makers face in making the ‘right’ decisions about electricity generation

Webcasts and podcasts
Can Cameron still claim the ‘greenest government ever’? Channel 4 News, Tom Clarke (26/4/12)
Energy Secretary: UK will meet green targets BBC News, Ed Davey (25/4/12)
Donald Trump attacks Scottish government’s green policy BBC News, James Cook (25/4/12)
Trump: Wind farms ‘bad for Scotland’ BBC News (24/4/12)
Tycoon Trump fights Scotland over wind farms near golf resortReuters, Deborah Gembara (25/4/12)
Wind power blows Siemens off course Euronews, Anne Glemarec (25/4/12)
Mexico inaugurates largest wind farm in Latin America BBC News, Carolina Robino (9/3/12)
BP’s Flat Ridge 2 Wind Farm in Kansas YouTube, BPplc (10/4/12)
Arnold Schwarzenegger: Green quest goes on BBC News (26/4/12)
Denmark Pioneers Clean Energy Green TV (18/4/12)
EU wind industry defies recession Green TV (16/4/12)
Wind Farm Issues – Compilation LiveLeak (15/4/12)

News articles
David Cameron commits to wind farms The Telegraph, Louise Gray (26/4/12)
David Cameron says wind energy must get cheaper The Telegraph, Louise Gray (27/4/12)
Could 2012 be year of the wind turbine? The Telegraph, Louise Gray (3/2/12)
Green energy vital, says David Cameron Independent, Emily Beament (26/4/12)
Cameron: renewables are ‘vital to our future’ businessGreen, Will Nichols and James Murray (26/4/12)
Green energy ‘must be affordable’ – Cameron BBC News (26/4/12)
Wind farms will kill tourism, says Donald Trump Independent (25/4/12)
Donald Trump accuses Salmond of ‘betrayal’ over wind farm plans The Telegraph, Simon Johnson (25/4/12)
Turbine scheme provokes wuthering gale of protest Independent, Mark Branagan (6/4/12)
Prince Charles endorses wind power in new film at Sundance Festival The Telegraph, Roya Nikkhah (29/4/12)
Study claims tourists ‘not put off’ by wind farms in Scotland BBC News (24/4/12)
Tide turns in favour of wave power instead of wind farms Scotsman, David Maddox (23/4/12)
Rush towards wind-generated electricity will not reduce fuel poverty Power Engineering (21/4/12)
Shell says no to North Sea wind power Guardian, Terry Macalister (26/4/12)
David Cameron, the Speech He Needs to Make Huffington Post, Juliet Davenport (25/4/12)
Campaigners want David Cameron to come clean over wind farm policy Western Daily Press (27/4/12)
Being Green Doesn’t Mean Higher Electricity Costs Says Green Energy UK DWPub (27/4/12)

Documents
Cost Benefit Methodology for Optimal Design of Offshore Transmission Systems Centre for Sustainable Electricity and Distributed Generation, Predrag Djapic and Goran Strbac (July 2008)
A Cost Benefit Analysis of Wind Power University College Dublin, Eleanor Denny (19/1/07)
Ecological and economic cost-benefit analysis of offshore wind energy Renewable Energy 34, Brian Snyder, Mark J. Kaiser (2009)

Questions

  1. Why is difficult to predict the future (financial) cost per kilowatt-hour of electricity generation by the various methods?
  2. Why is it difficult to estimate the demand for electricity in 10 years’ time?
  3. Identify the external benefits and costs of electricity generation from (a) onshore wind turbines; (b) offshore wind turbines.
  4. Is ‘willingness to pay’ a good method of establishing the value of external benefits and costs?
  5. What are the steps in a cost–benefit analysis?
  6. What types of problems are there in measuring external benefits and costs?