The UK and Australia are set to sign a free-trade deal at the G7 summit in Cornwall on 11–13 June. This will eventually give tariff-free access to each other’s markets, with existing tariffs being phased out over a 15-year period. It is the first trade deal not based on an existing EU template. The government hopes that it will be followed by trade deals with other countries, including New Zealand, Canada and, crucially, the USA.
But what are the benefits and costs of such a deal?
Trade and comparative advantage
The classic economic argument is that free trade allows countries to benefit from the law of comparative advantage. According to the law, provided opportunity costs of various goods differ in two countries, both of them can gain from mutual trade if they specialise in producing (and exporting) those goods that have relatively low opportunity costs compared with the other country. In the case of the UK and Australia, the UK has a comparative advantage in products such as financial services and high-tech and specialist manufactured products. Australia has a comparative advantage in agricultural products, such as lamb, beef and wheat and in various ores and minerals. By increasing trade in these products, there can be a net efficiency gain to both sides and hence a higher GDP than before.
There is clearly a benefit to consumers in both countries from cheaper products, but the gains are likely to be very small. The most optimistic estimate is that the gain in UK GDP will be around 0.01% to 0.02%. Part of the reason is the physical distance between the two countries. For products such as meat, grain and raw materials, shipping costs could be relatively high. This might result in no cost advantage over imports from much nearer countries, such as EU member states.
But modern trade deals are less about tariffs, which, with various WTO trade rounds, are much lower than in the past. Many imports from Australia are already tariff free, with meat currently having a tariff of 12%. Modern trade deals are more about reducing or eliminating non-tariff barriers, such as differing standards and regulations. This is the area where there is a high degree of concern in the UK. Import-competing sectors, such as farming, fear that their products will be undercut by Australian imports produced to lower standards.
Costs of a trade deal
In a perfectly competitive world, with no externalities, labour mobile between sectors and no concerns about income distribution, eliminating tariffs would indeed provide an efficiency gain. But these conditions do not hold. Small farmers are often unable to compete with food producers with considerable market power. The danger is that by driving out such small farmers, food production and supply might not result in lower long-run prices. Much would depend on the countervailing power of supermarkets to continue bearing down on food costs.
But the question of price is probably the least worrying issue. Meat and grain is generally produced at lower standards in Australia than in the UK, with various pesticides, fertilisers and antibiotics being used that are not permitted in the UK (and the EU). Unless the trade deal can involve UK standards being enforced on products produced in Australia for export to the UK, UK farmers could be undercut by such imports. The question then would be whether labelling of imported food products could alert consumers to the different standards. And even if they did, would consumers simply prefer to buy the cheaper products? If so, this could be seen as a market failure with consumers not taking into account all the relevant health and welfare costs. Better quality food could be seen as a merit good.
Then there are the broader social issues of the protection of rural industries and societies. Labour is relatively immobile from farming and there could be a rise in rural unemployment, which could have local multiplier effects, leading to the decline of rural economies. Rural ways of life could be seriously affected, which imposes costs on local inhabitants and visitors.
Trade itself imposes environmental costs. Even if it were privately efficient to transport products half way around the world, the costs of carbon emissions and other pollution may outweigh any private gains. At a time when the world is becoming increasingly concerned about climate change, and with the upcoming COP26 conference in Glasgow in November, it is difficult to align such a trade deal with a greater commitment to cutting carbon emissions.
- UK makes free-trade offer to Australia despite farmers’ fears
BBC News (22/5/21)
- UK-Australia trade deal: What are the arguments for and against?
BBC News, Chris Morris (21/5/21)
- Australia–UK trade deal can help spur post-pandemic recovery
The Conversation, David Collins (20/5/21)
- Australia will set the precedent for UK trade deals
Prospect, David Henig (21/5/21)
- Britain beefs with Australian farmers as Boris Johnson backs trade deal
Sydney Morning Herald, Mike Foley and Bevan Shields (20/5/21)
- Boris Johnson defends Australia trade deal that will allow cheap foreign meat imports …
Mail Online, David Wilcock (19/5/21)
- City executives raise concerns over hidden costs to trade deals
Financial Times, Daniel Thomas (22/5/21)
- Australia trade deal: Ministers discuss British farmers’ concerns
BBC News (21/5/21)
- Boris Johnson Faces His First Real Brexit Trade Test
Bloomberg, Therese Raphael (21/5/21)
- UK-Australia trade deal could mean children and patients eating meat reared in ways illegal in UK, warn experts
Independent, Jane Dalton (11/5/21)
- Australian farmers rush to reassure UK over looming free trade agreement
The Guardian, Amy Remeikis (19/5/21)
- Brexit: Boris Johnson warned trade deal with Australia could ‘decimate’ British farming
Independent, Adam Forrest (20/5/21)
- Truss’s naivety on trade with Australia could leave the UK exposed
The Observer, Phillip Inman (22/5/21)
- ‘Irresponsible’ Australia trade deal will bring ruin for UK farmers, critics warn
The Observer, James Tapper and Toby Helm (23/5/21)
- Brexit: Boris Johnson rejects claim UK-Australia trade deal would see farmers ‘lose their livelihoods’
Sky News, Tom Rayner (19/5/21)
- Small farms have a huge role to play in our sustainable future
The Guardian, Charles, Prince of Wales (23/5/21)
- Farmers’ opposition to UK-Australia trade deal grows
BBC News, Claire Marshall (2/6/21)
- UK livestock farmers fear Australia trade deal will threaten way of life
Financial Times, Judith Evans and Sebastian Payne (8/6/21)
- Why might the UK government be very keen to sign a trade deal with Australia?
- Does the law of comparative advantage prove that freer trade is more efficient than less free trade? Explain.
- What externalities are involved in the UK trading with Australia? Are they similar to those from trading with the USA?
- If a trade deal resulted in lower food prices but a decline in rural communities, how would you establish whether this would be a ‘price worth paying’?
- If some people gain from a trade deal and others lose and if it were established that the benefits to the gainers were larger than the costs to the losers, would this prove that the deal should go ahead?
Back in October, we looked at the growing pressure in the UK for a sugar tax. The issue of childhood obesity was considered by the Parliamentary Health Select Committee and a sugar tax, either on sugar generally, or specifically on soft drinks, was one of the proposals being considered to tackle the problem. The committee studied a report by Public Health England, which stated that:
Research studies and impact data from countries that have already taken action suggest that price increases, such as by taxation, can influence purchasing of sugar sweetened drinks and other high sugar products at least in the short-term with the effect being larger at higher levels of taxation.
In his Budget on 16 March, the Chancellor announced that a tax would be imposed on manufacturers of soft drinks from April 2018. This will be at a rate of 18p per litre on drinks containing between 5g and 8g of sugar per 100ml, such as Dr Pepper, Fanta and Sprite, and 24p per litre for drinks with more than 8g per 100ml, such as Coca-Cola, Pepsi and Red Bull.
Whilst the tax has been welcomed by health campaigners, there are various questions about (a) how effective it is likely to be in reducing childhood obesity; (b) whether it will be enough or whether other measures will be needed; and (c) whether it is likely to raise the £520m in 2018/19, falling to £455m by 2020/21, as predicted by the Treasury: money the government will use for promoting school sport and breakfast clubs.
These questions are all linked. If demand for such drinks is relatively inelastic, the drinks manufacturers will find it easier to pass the tax on to consumers and the government will raise more revenue. However, it will be less effective in cutting sugar consumption and hence in tackling obesity. In other words, there is a trade off between raising revenue and cutting consumption.
This incidence of tax is not easy to predict. Part of the reason is that much of the market is a bilateral oligopoly, with giant drinks manufacturers selling to giant supermarket chains. In such circumstances, the degree to which the tax can be passed on depends on the bargaining strength and skill of both sides. Will the supermarkets be able to put pressure on the manufacturers to absorb the tax themselves and not pass it on in the wholesale price? Or will the demand be such, especially for major brands such as Coca-Cola, that the supermarkets will be willing to accept a higher price from the manufacturers and then pass it on to the consumer?
Then there is the question of the response of the manufacturers. How easy will it be for them to reformulate their drinks to reduce sugar content and yet still retain sales? For example, can they produce a product which tastes like a high sugar drink, but really contains a mix between sugar and artificial sweeteners – effectively a hybrid between a ‘normal’ and a low-cal version? How likely are they to reduce the size of cans, say from 330ml to 300ml, to avoid raising prices?
The success of the tax on soft drinks in cutting sugar consumption depends on whether it is backed up by other policies. The most obvious of these would be to impose a tax on sugar in other products, including cakes, biscuits, low-fat yoghurts, breakfast cereals and desserts, and also many savoury products, such as tinned soups, ready meals and sauces. But there are other policies too. The Public Health England report recommended a national programme to educate people on sugar in foods; reducing price promotions of sugary food and drink; removing confectionery or other sugary foods from end of aisles and till points in supermarkets; setting broader and deeper controls on advertising of high-sugar foods and drinks to children; and reducing the sugar content of the foods we buy through reformulation and portion size reduction.
- Sugar tax: How it will work?
BBC News, Nick Triggle (16/3/16)
- Will a sugar tax actually work?
The Guardian, Alberto Nardelli and George Arnett (16/3/16)
- Coca-Cola and other soft drinks firms hit back at sugar tax plan
The Guardian, Sarah Butler (17/3/16)
- Sugar tax could increase calories people consume, economic experts warn
The Telegraph, Kate McCann, and Steven Swinford (17/3/16)
- Nudge, nudge! How the sugar tax will help British diets
Financial Times, Anita Charlesworth (18/3/16)
- Is the sugar tax an example of the nanny state going too far?
Financial Times (19/3/16)
- Government’s £520m sugar tax target ‘highly dubious’, analysts warn
The Telegraph, Ben Martin (17/3/16)
- Sorry Jamie Oliver, I’d be surprised if sugar tax helped cut obesity
The Conversation, Isabelle Szmigin (17/3/16)
- Sugar sweetened beverage taxes
What Works for Health (17/12/15)
- What determines the price elasticity of demand for sugary drinks in general (as opposed to one particular brand)?
- How are drinks manufacturers likely to respond to the sugar tax?
- How are price elasticity of demand and supply relevant in determining the incidence of the sugar tax between manufacturers and consumers? How is the degree of competition in the market relevant here?
- What is meant by a socially optimal allocation of resources?
- If the current consumption of sugary drinks is not socially optimal, what categories of market failure are responsible for this?
- Will a sugar tax fully tackle these market failures? Explain.
- Is a sugar tax progressive, regressive or proportional? Explain.
- Assess the argument that the tax on sugar in soft drinks may actually increase the amount that people consume.
- The sugar tax can be described as a ‘hypothecated tax’. What does this mean and is it a good idea?
- Compare the advantages and disadvantages of a tax on sugar in soft drinks with (a) banning soft drinks with more than a certain amount of sugar per 100ml; (b) a tax on sugar; (c) a tax on sugar in all foods and drinks.
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.
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)
How Large Are Global Energy Subsidies? IMF Working Paper, David Coady, Ian Parry, Louis Sears, and Baoping Shang (May 2015)
- Explain how energy subsidies are defined in the IMF working paper.
- What measurement problems are there in calculating the size of the ‘subsidies’?
- 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.
- What specific policies are pursued by the four biggest fossil fuel subsidising countries?
- What political problems are there in persuading countries to reduce fossil fuel subsidies/increase fossil fuel taxes.
- 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?
When an industry produces positive externalities, there is an argument for granting subsidies. To achieve the socially efficient output in an otherwise competitive market, the marginal subsidy should be equal to the marginal externality. This is the main argument for subsidising wind power. It helps in the switch to renewable energy away from fossil fuels. There is also the secondary argument that subsidies help encourage the development of technologies that would be too uncertain to fund at market rates.
If subsidies are to be granted, it is important that they are carefully designed. Not only does their rate need to reflect the size of the positive externalities, but also they should not entail any perverse incentive effects. But this is the claim about subsidies given to wind turbines: that they create an undesirable side effect.
Small-scale operators are encouraged to build small turbines by offering them a higher subsidy per kilowatt generated (through higher ‘feed-in’ tariffs). But according to a report by the Institute for Public Policy Research (IPPR), this is encouraging builders and operators of large turbines to ‘derate’ them. This involves operating them below capacity in order to get the higher tariff. As the IPPR overview states:
The scheme is designed to support small-scale providers, but the practice of under-reporting or ‘derating’ turbines’ generating capacity to earn a higher subsidy is costing the taxpayer dearly and undermining the competitiveness of Britain’s clean energy sector.
The loophole sees developers installing ‘derated’ turbines – that is, turbines which are ‘capped’ so that they generate less energy. Turbines are derated in this way so that developers and investors are able to qualify for the more generous subsidy offered to lower-capacity turbines, generating 100–500kW. By installing derated turbines, developers are making larger profits off a feature of the scheme that was designed to support small-scale projects. Currently, the rating of a turbine is declared by the manufacturer and installer, resulting in a lack of external scrutiny of the system.
The subsidies are funded by consumers through higher electricity prices. As much as £400 million could be paid in excess subsidies. The lack of scrutiny means that operators could be receiving as much as £100 000 per year per turbine in excess subsidies.
However, as the articles below make clear, the facts are disputed by the wind industry body, RenewableUK. Nevertheless, the report is likely to stimulate debate and hopefully a closing of the loophole.
Turbine power: the cost of wind power to taxpayers Channel 4 News, Tom Clarke (10/2/15)
Wind subsidy loophole boosts spread of bigger turbines Financial Times, Pilita Clark (10/2/15)
Call to Close Wind Power ‘Loophole’ Herald Scotland, Emily Beament (10/2/15)
Wind farm developers hit back at ‘excessive subsidy’ claims Business Green, Will Nichols (10/2/15)
The £400million feed-in frenzy: Green energy firms accused of making wind turbines LESS efficient so they appear weak enough to win small business fund Mail Online, Ben Spencer (10/2/15)
Wind power subsidy ‘loophole’ identified by new report Engineering Technology Magazine, Jonathan Wilson (11/2/15)
Feed-in Frenzy Institute for Public Policy Research, Joss Garman and Charles Ogilvie (February 2015)
- Draw a diagram to demonstrate the optimum marginal rate of a subsidy and the effect of the subsidy on output.
- Who should pay for subsidies: consumers, the government (i.e. taxpayers generally), electricity companies through taxes on profits made from electricity generation using fossil fuels, some other source? Explain your thinking.
- What is the argument for giving a higher subsidy to operators of small wind turbines?
- If wind power is to be subsidised, is it better to subsidise each unit of output of electricity, or the construction of wind turbines or both? Explain.
- What could Ofgem do (or the government require Ofgem to do) to improve the regulation of the wind turbine industry?
In market capitalism, the stock of manufactured capital provides a flow of output. The profitability of the use of that capital depends on the cost of investing in that capital and the cost of using it, and on the flow of revenues from that capital. Discounted cash flow techniques can be used to assess the profitability of a given investment in capital; the flows of costs and revenues are discounted at a market discount rate to give a net present value (NPV). If the NPV is positive (discounted revenues exceed discounted costs), the investment is profitable; if it is negative, the investment is unprofitable. (See Economics, 8th edition, section 9.3.)
There may be market imperfections in the allocation of investment, in terms of distorted prices and interest rates. These may be the result of market power, asymmetry of information, etc., but in many cases the market allows capital investment to be allocated relatively efficiently.
This is not the case with ‘natural capital’. Natural capital (see also) is the stock of natural resources and ecosystems that, like manufactured capital, yields a flow of goods and services into the future. Natural capital, whilst it can be improved or degraded by human action, is available without investment. Thus the natural capital of the oceans yields fish, the natural capital of the skies yields rain and the natural capital of forests reduces atmospheric CO2.
Even though some natural capital is owned (e.g. private land), much is a common resource. As such, it is free to use and tends to get overused. This is the Tragedy of the Commons – see, for example, the following news items: A modern tragedy of the commons and Is there something fishy going on?.
Natural capital accounting
But would it be possible to give a value to both the stock of natural capital and the goods and services provided by it? Would this environmental accounting enable governments to tax or subsidise firms and individuals for their use or enhancement of natural capital?
On 21 and 22 November 2013, the first World Forum on Natural Capital took place in Edinburgh. This brought together business leaders, politicians, economists, environmentalists and other scientists to discuss practical ways of taking natural capital into account in decision making. Central to the forum was a discussion of ways of valuing natural capital, or ‘natural capital accounting’. As the forum site states:
Natural capital accounting is a rapidly evolving new way of thinking about how we value the economic benefits we derive from our natural environment. The World Forum on Natural Capital will bring together world-class speakers, cutting edge case studies and senior decision makers from different sectors, in order to turn the debate into practical action.
But if natural capital is not owned, how is it to be priced? How will the costs and benefits of its use be valued? How will inter-generational effects be taken into account? Will firms price natural capital voluntarily if doing so reduces their profits? Will firms willingly extend corporate social responsibility to include corporate environmental responsibility? Will governments be prepared to introduce taxes and subsidies to internalise the costs of using natural capital, even if the effects extend beyond a country’s borders? Will natural capital accounting measure purely the effects on humans or will broader questions of maintaining and protecting environmental diversity for its own sake be taken into account? These are big questions and ones that various organisations are beginning to address.
Despite problems of measurement and incentives, sometimes there are clear economic benefits from careful evaluation and management of natural capital. Julia Marton-Lefèvre is Director General of the International Union for Conservation of Nature (IUCN). According to the first Guardian article below:
Her favourite example of natural capital working in practice comes from Vietnam, where “planting and protecting nearly 12,000 hectares of mangroves cost just more than $1m but saved annual expenditures on dyke maintenance of well over $7m. And that only accounts for coast maintenance: mangroves are also nurseries for fish, meaning livelihoods for fishing and source of nutrients … “
One organisation attempting to value natural capital is The Economics of Ecosystems and Biodiversity project (TEEB). It also looks at what organisational changes are likely to be necessary for the management of natural capital.
Based on data collected from 26 early adopter companies (60% of them with $10 Billion+ revenues each) across several industry sectors this provides real life evidence on the drivers and barriers for natural capital management.
Pricing the environment is a highly controversial issue. Critics claim that the process can easily be manipulated to serve the short-term interests of business and governments. What is more, where tradable permits markets have been set up, such as the EU’s Emissions Trading Scheme (ETS), prices have often been a poor reflection of social costs and have been open to manipulation. As Nick Dearden, director of the World Development Movement (WDM), says:
It is deeply ironic that the same financial markets that caused the economic crisis are now seen as the solution to our environmental crisis. It’s about time we learnt that financial markets need to be reined in, not expanded. Pricing these common resources on which people depend for their survival leaves all of us more exposed to the forces of the global economy, and decisions about whether or not to protect them become a matter of accounting.
The measurement of natural capital and setting up systems to internalise the costs and benefits of using natural capital is both complex and a political minefield – as the following articles show.
Putting a value on nature: Edinburgh conference says business is ‘part of the solution’ Blue & Green Tomorrow, Nicky Stubbs (20/11/13)
Edinburgh forum says putting value on nature could save it BBC News, Claire Marshall (20/11/13)
Natural capital must be the way forward, says IUCN director general The Guardian, Tim Smedley (11/11/13)
Is ‘natural capital’ the next generation of corporate social responsibility? The Guardian, Tim Smedley (7/11/13)
Natural capital accounting: what’s all the fuss about? The Guardian, Alan McGill (27/9/13)
Put nature at the heart of economic and social policymaking The Guardian, Aniol Esteban (1/3/13)
Campaigners warn of dangers of ‘privatised nature’ The Scotsman, Ilona Amos (21/11/13)
Edinburgh conference attempts to ‘privatise nature’ World Development Movement, Miriam Ross (18/11/13)
Valuing Nature BBC Shared Planet, Monty Don (8/7/13)
Sites concerned with natural capital
World Forum on Natural Capital
TEEB for Business Coalition
International Union for Conservation of Nature
- How would you define natural capital?
- What are ecosystem services?
- Is social efficiency the best criterion for evaluating the use of the environment? What other criteria could you use?
- How would you set about deciding what rate of discount to use when evaluating the depletion of or enhancement of natural capital?
- How can game theory provide insights into the strategies of both businesses and governments towards the environment?
- What are the arguments for and against attempting to value natural capital and to incorporate these values in decision making?