Tuesday, August 22, 2006

The economic case for reducing emissions

As I’ve discussed before, debates about reducing greenhouse gas emissions in Australia often pit ethical arguments in favour of reducing emissions against economic arguments that support doing nothing.

However, increasingly, there are good national economic reasons for taking strong efforts to start reducing our emissions.

In April, the Australian Business Roundtable on Climate Change put forward ‘The Business Case for Early Action’ on emissions. The Roundtable is a group of large Australian companies representing a cross-section of the Australian economy (including financial, energy and manufacturing companies). A group of businesses asking to be regulated by government? Asking for government to cap or tax their emissions? Why?

The same thing has been happening overseas. Also in April, CEOs of large energy and other companies such as General Electric, Wal-Mart, Shell and Duke Energy made submissions to a US Senate Committee saying they would welcome or accept mandatory caps on their emissions.

The Australian State and Territory governments last week released a very detailed discussion paper proposing a national emissions trading scheme. It also outlines some of the economic advantages of instituting a national scheme that provides some long-term guidance on what Australia’s climate change policy will be – whether by a national trading scheme, a carbon tax, or a long-term emissions reduction target.

So, here are some of the economic benefits of instituting a national scheme to reduce emissions:

Certainty is important for business

In the energy sector in particular, decisions often have long lead-times and long pay-off times. It can take a decade from the decision to build a large power station to the time it becomes operational and the station can operate for half a century.

Not knowing what rules will apply to greenhouse gas emissions in the future significantly increases the risks for investors, who are concerned about the risks of very expensive, long-lived assets. The current atmosphere of uncertainty can cause delays in investment until the policy position is clear. If this situation continues, it could mean higher electricity prices and less reliable supply than if the rules were clearly established in advance.

(NETS Discussion paper)

Delaying action could create economic shocks

The Roundtable’s ‘Business Case’ modelled the impacts of taking sustained action, starting in 2013, achieving 60% reductions by 2050 and also the impacts of the same reductions but starting in 2020. Under the ‘early action’ pathway, economic growth and employment growth would be higher, and the risk of recession and electricity prices lower than the ‘delayed action’ pathway. Of course, you can argue that the ‘no action’ pathway is best of all, but in a world where action is more and more likely to be demanded, adopting a ‘no action’ approach now increases the risk that the delayed action approach will be forced on us.

It’s likely that at some stage in the next few decades there will be a strong response (globally and/or domestically) and the ‘price’ of emissions may jump – perhaps strongly and suddenly. Taking action now reduces the risk of a shock in the future.

Encouraging action by other countries

Climate change will have substantial economic impacts on Australia. It’s in our interests that the world takes effective action to reduce its impacts. Taking active measures now gives us a more credible bargaining position later. Taking measures that help develop effective commercial technologies and institutions to reduce emissions will also make it easier for other countries (especially developing countries) to reduce their emissions. It also makes it more difficult for leaders of other countries to justify a lack of action on the basis that heavy emitters such as Australia are not taking action.

Encouraging commercialisation of technology

Australia is committing considerable funding to the politically uncontroversial route of supporting emissions reduction technologies. To get a return on these investments (in an environmental as well as economic sense), they need to be commercialised and adopted by industry. That is unlikely to happen (domestically at least) in the absence of measures that put a price on emissions and hence provide an incentive to adopt these technologies.

Until we have a strong international agreement to reduce global emissions, the economics for going it alone with a domestic scheme are unlikely to be compelling. But it is important to acknowledge that there are economic benefits of a strong domestic reductions scheme, the economic costs are more modest than is often assumed and there are strong ethical and political reasons for taking a national stand on this issue. Australia’s environment and economy are going to be heavily affected by climate change. In coming years, Australia may be pleading with other countries to take a stronger stand. We’ll be in a better position if we’ve taken a stand ourselves.



Anonymous said...

Emission quotas under cap and trade schemes are usually allocated based on existing patterns of emission. Initial allocations are therefore a gift to established companies and a barrier to entry for new competitors. No wonder companies are in favor. You would also expect companies to build or buy highly pollution plants before the introduction of the scheme. Or does the law in Australia deal with these problems?

David Jeffery said...

The discussion paper talks a lot about how to allocate permits and it's unavoidably a very political issue. The suggestion in the Australian scheme as I understand it is for the bulk of permits to be auctioned but for some to be allocated free to existing power generation companies that would be particularly negatively affected by the changes and others to be allocated free to existing companies OR new entrants in industries that would be particularly negatively affected.

I don't think it presents an incentive to build highly polluting plants now in order to get free credits to use later on.

Anonymous said...

If a company had to buy the permits, there would be no incentives to build highly polluting plants now. See also this post from Greg Mankiw,