Climate Change: An Economic Perspective PDF

Session 1 CLIMATE CHANGE: AN ECONOMIC PERSPECTIVE putting a price on carbon Emmanuel COMBE Full Professor at Skema Business School September 2024 Some readings Ph. Aghion & alii (2020) The power of creative destruction, Harvard University Press (chapter 9) C. Gollier (...

Session 1 CLIMATE CHANGE: AN ECONOMIC PERSPECTIVE putting a price on carbon Emmanuel COMBE Full Professor at Skema Business School September 2024 Some readings Ph. Aghion & alii (2020) The power of creative destruction, Harvard University Press (chapter 9) C. Gollier (2019) Le climat après la fin du mois, PUF W. Nordhaus (2019) The Climate Casino, De Boeck J. Tirole (2016) Economics for the common good, Princeton University Press (chapter 8) Introduction - Global warming and its potential effects Part 1 - What should we do? Usual approaches and their limits Part 2- What should we do? Putting a price on carbon  Increase in CO2 concentration in the atmosphere (280 ppm to 410 ppm) (greenhouse effect) Increase in average temperature over the last century (+ 1 0C) A causal link but a debate on the "climate sensitivity » Source: IPCC, 2021 Probable cause of global warming ✓ Strong economic growth since the 19th due to the use of cheap fossil fuels (oil, gas, coal) → The Kaya equation: CO2 = GDP x E/GDP x CO 2/E A correlation between growth and emissions Source: IPCC, 2021 Likely economic consequences of global warming ✓ Indirect effect: sea level rising + ice melting, extreme events occuring (hurricanes, drought, fires, floods) → increasing costs ✓ Direct effect: negative impact on labor productivity, when temperature is not at its optimal level → inequalities between Northern and Southern countries The challenge: key figures ✓ The Paris Agreement stated objective: to limit the rise in temperature to +2 0C by 2100 ✓ To reach this goal, our remaining carbon budget is 800 Gt of CO 2 ✓ Global emissions are 42 Gt per year → 20 years before we hit the limit → Emerging countries are speeding up their growth and... therefore polluting more The European ambition: "Fit for 55" (July 2021) ✓ 12 measures within the framework of the Green Deal, including: increased carbon tax with the end of free quotas, increase the share of renewables, the end of combustion engines in 2035 ✓ Objective: -55% by 2030 and carbon neutrality by 2050 ✓ Strong redistributive impacts on consumers → Social fund of 72 billion euros  Video Putting the topic in economic terms https://www.youtube.com/ watch?v=k468cQbmYdQ  Part I What should we do? Usual approaches and their limits The usual approaches ✓ Degrowth ✓ Green innovation ✓ Consumer’s preferences ✓ Prohibition/obligation ✓ Environnemental Activism Degrowth... Degrowth ✓ A simulation (Bazot 2021): what per capita income would be compatible with climate neutrality in 2050? ✓ Assumptions: world population growth of 30% + a decrease of 60% in the use of fossil energies + world income is distributed equally = 572 euros per month and per person Green innovation (1) ✓ Promoting the development of a mix of renewable energies (wind, solar) ✓ A successful example: Nordic countries A large share of green energies Differences in the energy mix between countries A policy applied to all sectors (no exemptions) A policy of high subsidies and taxes... but with a strong redistribution Betting on green finance Green innovation (2) ✓ Main obstacles to the energy change: « clean » technologies are still costly to produce, compared to fossil energy + "path dependency" problem (Aghion & alii 2016) ✓ To get out of path dependency, States will play an important role: subsidize green innovations + carbon taxes Green innovation (3) ✓ Another solution is to promote the development of intermediate ("less dirty") energies such as shale gas ✓ But be careful of the two opposing effects: substitution effect but also... scale effect! ✓ Risk of an intermediate energy trap (Aghion & alii 2020) Green innovation (4) ✓ Green innovation also requires an industrial policy to support innovation and production ✓ European Union: role of IPCEI ; see the case of Hydrogen with 2 levers (R&D and production/storage) ✓ United States: role of the Inflation Reduction Act ; subsidies to produce « green » in the United States Source : Commission Européenne 2022 Role of consumer’s preferences (1) ✓ Consumer information (see the « carbon scoring » approach): necessary but sufficient? ✓ (Voluntary) carbon offsetting: guilt-free but sufficient? ✓ Environmental awareness of consumers for green products influences the technological choices of firms, if there is strong competition cf. Aghion & alii 2020 Source: Aghion & alii 2016 Role of consumer’s preferences (2) ✓ But consumers still need to be properly informed. ✓ However, proliferation of labels with little credibility, and even misleading risk of misuse by companies: "greenwashing", to the detriment of consumers and... competitors ✓ Need for stricter regulations: project of Green Claim Directive in Europe (March 2024) Source : Commission Européenne 2022 Role of consumer’s preferences (3) ✓ A risk of anti-competitive practices: colluding to avoid competing on the environmental merits of products ✓ Competition policy has a role to play in combating cartels that delay/block the environmental transition. Source : Commission Européenne 2021 Prohibition/Obligation ✓ With a prohibition/obligation, the target will be achieved with certainty (subject to having a checking process) ✓ But this policy does not minimize costs when firms are differents ✓ Used in Europe to achieve carbon neutrality in the air transport: see ReFuel UE Environnemental activism ✓ "Naming and shaming" reputational penalty ✓ Legal action in the name of "climate justice » Injunction to implement climate policy (see Massachusetts v. EPA 2007) Netherlands/Urgenda (2018) "Case of the Century » in France (2021) Right for victimes to be compensated → Low effectiveness  Part II What shoud we do? Putting a price on carbon To begin with: the "tragedy of the commons" (Harding) A negative externality problem  Course The heart of the problem: an externality reminder ✓ Definition of an externality The consumption or production of an entity has an impact on another entity, without this interaction passing through the pricing system ✓ Two cases of externalities: - Positive (see innovation and copy) - Negative = pollution  Course pollution emission reminder Firm residents What compensation? imitation Inventor copycat what payment? firm  Course The heart of the problem: a negative externality reminder ✓ Private/social interest mismatch - Positive externality: social gain > private profit - Negative externality: social cost > private cost ✓ Consequence of an externality - Positive = under-investment, under-production - Negative = over-production, over-consumption Source: Federal Reserve Bank of San Francisco, 2002 The remedy: putting a price on the externality The "Pigou tax" must be equal to the difference between the social and the private cost The remedy: putting a price on the externality The Pigou tax will lead to an increase in the production costs and therefore... to a reduction in production and consumption The main issue ✓ How to put the "right" price on carbon? ✓ Several methods of calculating the current and future damage (it is therefore necessary to have a discount factor) →usual estimate : between 50 and 100 € per ton Policy implications ✓ The Pigou tax is at the origin of the "polluter must pay" principle and is materialized by the "carbon tax » ✓ The primary purpose of a “carbon tax” = to change behaviours (rather than generate tax revenue) Policy implications ✓ An extrem case: the carbon tax radically modifies behaviours → tax revenues tend towards zero ✓ Example of the Irish tax on plastic bags (2002): a full and rapid success! Policy implications ✓ Introducing a carbon tax requires a strong political consensus on environmental issues ✓ It assumes a total commitment of the civil society (Green Tax Commissions) The carbon tax: the French example ✓ France accounts for a small share of total carbon emissions, even taking into account the "carbon footprint" (role of nuclear power) ✓ France has committed to a process of reducing emissions with the SNBC strategy: 310 millions tons of CO2 by 2030 The carbon tax: the French example ✓ Some key measures: The TGAP (1999) covers the storage of household waste, detergents and related products, etc. The "Climate and energy contribution” (CEC) (2015) on fossil fuels (7€ to 44€/t in 2018) Yellow vests episode: blocking the CEC ✓ Still limited share of environmental taxes Source : CAE 2019 The carbon tax: an unpopular tool ✓ The one who pays the carbon tax is not necessarily the one who is taxed ✓ Perceived as a yield tax and not as an incentive tax ✓ Often implemented with some sectoral exemptions ("why should I pay?”) The carbon tax: an unpopular tool ✓ Lack of transparency on how revenues are used ("Give the money back" in one way or another) ✓Anti-redistributive aspect → role of compensations (energy cheques, etc.) ✓Tax = punishment = message that fighting climate change has a cost (which is true) → Low political acceptability → Find an alternative and credible way? From carbon tax... to carbon card? (1) ✓ The principle: each citizen has an annual right to emit a certain quantity of CO2; unused credits can be resold ✓ Redistributive impact: sellers tend to be low- income earners ✓ Possibility of modulating the credit, depending on variables such as household composition, location, etc. From carbon tax to carbon card (2) ✓ Usual criticism of the carbon card: low social acceptability (possibility for rich people to buy rights to pollute) ✓ Radical variant (inspired by wartime food rationing policies): assign each individual a quantity of emissions, with no possibility of exchange ✓ This variant satisfies an egalitarian sentiment.  Session 2 CLIMATE CHANGE: AN ECONOMIC PERSPECTIVE From emission allowance markets to cross border tax Emmanuel COMBE University Professor, Professor at Skema Business School October 2024 Part 1 – « Cap and trade » : The growing role of emission allowance markets Part 2 - What international coordination in the face of global warming? The principle ✓ Setting a maximum level of pollution ("cap") and giving each firm permits to pollute and the right to exchange them ("trade") → A market with a price of CO2 ✓ The permits market allows governments to meet their objectives, but gives some flexibility to firms A numerical example (1) ✓Two companies A and B. ✓ Each company emits 100,000 tonnes of CO2 per year, or 200,000 tonnes in total ✓The government decides to reduce total emissions to 190,000 t ✓ It grants 95,000 emission rights of 1 t to each company A numerical example (2) ✓Company A has a modern technology: cost of reducing 1 t = 5€. ✓ Company B has an old technology: cost of reducing 1 t for B = 15€. → trading opportunity between A and B A numerical example (3) ✓ In the absence of a trading system, the cost of reducing pollution is : (5 000 x 5€) = 25 000€ for A (5 000 x 15€) = 75 000€ for B ✓ The total cost of reducing pollution is therefore €100,000 A numerical example (4) ✓ Let's assume that the permit price is 10 € ✓ Firm A will prefer to reduce its pollution by 10,000 t and sell all its permits to firm B ✓ Firm B will prefer to buy permits rather than to reduce pollution A numerical example (5) ✓ Net cost to Firm A: (10 000t x 5€) - (5 000 x 10€) = 0€. ✓ Net cost to Firm B: (5,000t x 10€) = 50,000€ < 75,000 → Total cost of pollution control: 75 000€ < 100 000€ The emission allowance markets ✓ Fight against acid rain in the USA in 1990 (Clean Air Act): a successful "Cap and trade" program; SO2 and Nox emissions have been drastically reduced ✓ The emission allowance markets made a come- back in Europe in 1997 after the Kyoto Protocol (Article 17) The emission allowance markets ✓ After the Kyoto Protocol, a strong European commitment: -8% of CO2 emissions (compared to 1990) over the period 2008/2012 ✓ Europe confirmed its commitment and extended it in 2021 with the Green Deal: 2020: - 20% 2030: - 55% 2050: 0 net emissions The emission allowance markets ✓ Each European country has been allocated quotas, that it dispatches between firms ✓ A carbon market was set up in 2003, covering 45% of emissions and involving 11,000 factories The emission allowance markets ✓ A share of permits were allocated free of charge (to avoid "carbon leakage"), especially in the raw materials industry and in the airline industry (long haul flights) ✓ Companies were allocated very high quotas → low price of carbon until...2018 → no “price signal” ✓ The situation has changed since 2018! The emission allowance markets Source : Commission Européenne 2022  Part 2 What international coordination in the face of global warming? Real obstacles to an international agreement ✓ Large number of countries → coordination costs ✓ Heterogeneity of countries in terms of CO2 in terms of carbon pricing in terms of the direct impact of global warming Source : i4CE (2022) A fundamental issue ✓ If other countries act, we have no incentive to fight against climate change (classical problem of a « public good ») ✓ At the end, no one will act → a "prisoner's dilemma  Course Country B reminder Limiting emissions Do nothing Limiting (10 ; 10) (0 ; 15) emissions Country A Do (15 ; 0) (5 ; 5) nothing Nash equilibrium The country that fight against global warming will suffer two drawbacks: ✓ Its production costs will increase and … the prices too ✓ A risk of «carbon leakage» → companies will relocate Carbon leakage is estimated to be between 5 and 30%. Recent history of international climate conferences confirm that economists' doubts are relevant... ✓ Kyoto (1997): not everyone ratified the agreement ✓ COP21 (2015): 189 countries sign... but each decides on its own effort + no verification/sanction mechanism First solution (1) ✓ A single and worldwide carbon price (Tirole, Weitzman) = a clear price signal ✓... with compensation for poor countries or countries that reduce their emissions significantly (transfer of clean technologies) First solution (2) ✓ Advantage: no «carbon leakage» ✓ Limits: government are reluctant to impose carbon taxes + long negotiations regarding compensations Second solution (1) ✓ Each person in the world will receive the same emission allowance + international market for trading allowances ✓ Total CO2 emissions are at 43 billion tons; if the target is 38 billion, each person should receive an allowance per year of 5 tons Second solution (2) ✓ Advantages: all countries participate in the fight against climate change + no "grandfather rule" + a worldwide market to trade allowances ✓ Limits: the same as the first solution Third solution (1) ✓ Set up a « Climate club" (Nordhaus 2015) ✓ Inside the club: a single carbon price / outside the club: a carbon border tax ✓ A punitive tax (4% on imports) ? Third solution (2) ✓ Set a tax equal to the carbon tax differential → it allows us to fight against "climate dumping" and would be compatible with the WTO rules ✓ Europe has decided to implement a border tax policy, as part of the Green Deal = Carbon Border Adjustment Mechanism (CBAM) Recent agreement in Europe; progressive implementation since 2023 The CBAM ✓ Gradual entry into force: reporting to begin in 2023; full implementation from 2026 onwards ✓ CBAM covers only direct emissions (scope 1) and 5 at-risk sectors (including cement, aluminum); gradual extension to maritime sector and intra- European flights Some CBAM challenges (1) ✓Right evaluation of the carbon intensity of imported products ✓ Compatibility with WTO rules? ✓Risk of retaliation from other countries (outside the Club) ✓ Redistibutive impact on consumers → Social climate fund Some CBAM challenges (2) ✓ Ending free allowances in Europe ✓ Higher product prices → It will reduce export competitiveness ✓ Only primary products are targeted by CBAM → Risk of carbon leakage downstream ? Source : Ministère de la transition écologique (2023) To conclude... ✓ A positive view of voluntary solutions (changing consumer behaviour, combating greenwashing, etc.) but some doubts about their effectiveness ✓ High hopes for policies to support green innovation ✓ A consensus among economists on the need for a carbon tax but … some doubts about the ability to implement it for political reasons