A look inwards: carbon tariffs versus internal ... look inwards: carbon tari s versus internal...

A look inwards: carbon tariffs versus internalimprovements in emissions-trading systems

Marco Springmann

(formerly at DIW Berlin)

RFF, Washington DCSeptember 5, 2012

Marco Springmann A look inwards: Carbon tariffs vs. ETS improvements

Context

Many recent climate-policy proposals contain provisions forcarbon tariffs (BCAs):

In the US: Waxman-Markey (HoR), Kerry-Boxer,Cantwell-Collins (Senat)In the EU: Revised directive of the EU ETS

The objectives for implementing carbon tariffs are to:

reduce carbon leakage;avoid negative competitiveness impacts of domestic industries;increase the cost-efficiency of domestic abatement efforts.


Context

However, economic analyses paint a mixed picture:

Some find that BCAs could be partially successful in reducingcarbon leakage and in restoring the competitiveness ofdomestic industries (Bohringer et al., 2011; Burniaux et al.,2010; Winchester et al., 2011; Fisher and Fox, 2009).Others find only small overall effects and little potential forreducing leakage (McKibbin and Wilcoxen, 2008; Dong andWhalley, 2009; Peterson and Schleich, 2007).However, many studies agree that BCAs place considerableburden on those developing countries against whose productsBCAs are imposed (Babiker and Rutherford, 2005; Droge andKemfert, 2005; Mattoo et al., 2009).


Context

⇒ BCAs are politically contentious:

China sees BCAs as trade protectionism, illegal under WTOlaw, and threatened with trade war.BCAs are at odds with industrialized countries’ commitmentswithin the UNFCCC and could impede negotiations on a globalclimate agreement.

BCAs perpetuate Kyoto dichotomy:

Divide countries into potentially tariff-imposing Annex Icountries and targeted non-Annex I countries.


Kyoto dichotomy: not so clear-cut


Kyoto dichotomy: not so clear-cut

Several non-Annex I countries, such as China and SouthKorea, are planning to implement ETS within this decade.

Many Annex I countries, such as the USA and Canada, havenot yet adopted comprehensive carbon-pricing policies.

Existing ETS, such as the EU ETS and RGGI, are plagued byproblems of overallocation.

⇒ Before extending domestic emissions regulation throughimplementing carbon tariffs, it might be more appropriate forAnnex I countries to further the improvement of domesticclimate policies and to link existing and planned ETS.


External vs. internal efficiency improvements

From an economic perspective, both policies can increasecost-efficiency of A1 domestic abatement efforts:

Carbon tariffs induce external efficiency improvements throughindirect regulation.Expansion and linking of A1 ETS induce internal efficiencyimprovements through better distribution of abatement burden.

Although in principle both policies could be pursued together,they are likely to preclude each other politically due to theincompatibility of incentive structures:

BCAs are politically confrontational and inconsistent withcooperative initiatives aimed at linking ETS.Linking ETS across A1 can be interpreted as first step forlinking to NA1 ETS, which would remove the basis for BCAs.


Study outline

This study:

Assesses the potential economic gains from extending thesectoral and regional coverage of A1 ETS vis-a-vis theimplementation of carbon tariffs on imports from NA1.

⇒ Seeks to answer the question whether besides the politicalappeal, there exists also an economic rationale for pursuinginternal efficiency improvements from ETS enhancement overexternal ones from implementing carbon tariffs.

Method:

Cost-effectiveness analysis with an environmental CGE modelof the global world economy.

Implementation of ETS and carbon-tariff policy trajectories.


ETS scenarios

ETS scenarios are informed by current climate-policyfragmentation:

ETS exist in several A1 regions: EU (EU ETS), New Zealand(NZ ETS), several US regions (AB32 in California, RGGI innortheastern and mid-Atlantic states), and in Tokyo (Japan).ETS are foreseen to be implemented in the next few years inwestern US states (WCI) and Australia.Most ETS are hybrid ones with partial sectoral coverage.

⇒ Reference scenario: regional-hybrid ETS

non-linked ETS in each A1 region;sectoral ETS coverage: ELE, OIL, EIT;20% total A1 reduction target (5% reduction target fornon-ETS sectors; ETS targets scale endogenously by region).


Policy trajectories

Policy trajectories represent choice between implementingcarbon tariffs or pursuing A1 ETS extension:


Carbon-tariff scenario

Carbon-tariff scenario:

Informed by current US and EU proposals, but still idealizedin political terms.

A1 levies carbon tariffs on EIT imports from NA1.

Tariff level is proportional to carbon content of imports fromNA1 and price of carbon in A1.

Carbon content computed from all direct andelectricity-related CO2 emissions.


Model results – Welfare

A1’s welfare increases in all policy scenarios.

Greatest welfare gains result from full ETS expansion.



NA1 welfare decreases in all policy scenarios.

Greatest welfare losses result from carbon tariffs.



Global welfare increases in all policy scenarios.

Greatest global welfare gains for full A1 ETS extension.



ETS extensions yields greater or comparable welfareimprovements than implementing carbon tariffs.

However, each policy trajectory has different welfaredeterminants:

Extending ETS coverage generates welfare improvementsprimarily by equalizing marginal-abatement costs and theassociated gains from trade in emissions permits.Implementing carbon tariffs on EIT imports generates welfareimprovements through increases in domestic production andterms-of-trade effects.

⇒ Policy trajectories yield different sectoral impacts.


Model results – EIT Output

Greatest EIT output changes due to carbon tariffs.

A1’s EIT output is greater in full ETS than in hybrid ones; viceversa for NA1.


Model results – Carbon price

ETS expansion decreases carbon prices in most regions.

Carbon tariffs have only a marginal effects on carbon prices.


Model results – Carbon leakage

Policy scenarios have little effect on carbon leakage.

Carbon tariffs mostly affect competitiveness channel through shiftsin EIT production; most leakage due to changes in fossil-fuel prices.


Model results – Upshot

Full ETS extension increases A1’s, NA1’s, and global welfaremore than implementing carbon tariffs.

Major impacts of ETS extensions are mediated throughinfluence on carbon prices.

Major impacts of carbon tariffs are mediated through changesin EIT trade and output.

There is only a small effect of either policy on carbon leakage.

Q: How robust are the welfare results?


Sensitivity analysis

The results above hold for specific parameter values only.

The welfare effects of A1 ETS expansions are influenced by

Differences in marginal-abatement costs,Magnitude of emissions-reduction,Emissions-reduction split between ETS and non-ETS sectors.

The welfare effects of carbon tariffs are influenced by

Tariff level,Carbon price and the calculation of carbon content,Assumptions governing trade and fossil-fuel supply responses.

Important for either policy’s effects are:

Coalition size of emissions-abating countries,Temporal evolution of economic activity and emissions.


Sensitivity analysis

Relative A1 welfare benefits of full A1 ETS extension arerobust with respect to:

Laxer and more stringent sectoral ETS regulation;Smaller and greater A1 emissions-reduction targets;Domestic and full accounting of embodied emissions;Changes in trade substitution and fossil-fuel supply elasticities;Different reference ETS reference scenarios (reg-full,int-hybrid).

Changes in A1 preference ordering can occur for:

Change in coalition size;Change in year of implementation.


Sensitivity analysis – Coalition size

Withdrawal of Canada, Japan, and the USA does not change thecoalition’s preference for ETS extension.

Withdrawal of RUS, and joint withdrawal of USA, RUS, JPN, CAN(A1s) reverses preference ordering for all policy trajectories.

⇒ Small coalitions prefer carbon tariffs over ETS extensions.


Sensitivity analysis – Target year

A1 welfare preferences largely preserved in 2010, reversed in 2020.

Prime reason is increase in MACs over time → reduces potentialETS efficiency gains and increases carbon-tariff base.

⇒ ETS extension is preferred as early action.


Conclusions

Subglobal climate policies will be the norm for some years.

This study compared two policy trajectories for improving theefficiency of subglobal emissions regulation:

Confrontational trajectory: A1 imposes carbon tariffs on EITimports from NA1.Cooperative trajectory: A1 extends sectoral ETS coverage andpursues ETS linking across A1.


Conclusions

Core result: A1 ETS extensions yield comparable welfareimprovements for A1 as implementing carbon tariffs, and greaterimprovements for NA1 and globally.

A1 preferences in more detail:

Full ETS extensions are preferred over BCAs in most scenarios.Partial ETS extensions are often preferred less than BCAs.Early implementation and large coalitions favor ETSextensions, whereas late implementation and small coalitionsfavor BCAs.

Caveats:

The CGE model and model scenarios are highly idealized andabstract from economic, legal, political, and regulatory detail.For example, considerable efforts would be necessary toovercome current barriers to ETS linking and harmonizeETS-design issues, such as sectoral coverage and inclusion ofcost-containing measures.


Outlook

Current UNFCCC negotiations envision collaborative action:

The Durban Platform (COP-17, 2011) is tasked to develop aglobal universal legal climate agreement by 2015, to beimplemented by 2020.

This, together with emerging NA1 climate policies, wouldmake imposing carbon tariffs obsolete.

⇒ More sustainable option: support the UNFCCC process andfocus on internal efficiency improvements.

EU Commission’s policy vision of a linked OECD carbonmarket within this decade moves in that direction.

This study suggests that, in addition to the political appeal,there exist also an economic rationale for pursuing internalefficiency improvements over external ones.


Thank you

Comments and suggestions:

[email protected]


Back-up slides


Model framework

Energy-economic model:

CGE model based on GTAP7inGAMS (Rutherford, 2010);

Extended by explicit representation of energy sector and carbonmarket (Rutherford and Paltsev, 2000; Bohringer et al., 2011).

Assumes optimizing behaviour of economics agents

1 Consumers maximize welfare subject to budget constraints;2 Producers combine intermediate inputs and primary factors at

least cost to produce output.

Consumption and production of goods is represented by nested CESdemand and production functions;

Goods are differentiated by country of origin (Armington approach)

Elasticites and data on sectoral production, trade flows, tax levels,and CO2 emissions are adopted from the GTAP 7.1 database(Narayanan and Walmsley, 2008) and from Bohringer et al. (2011).


Model framework

Base year: 2004


Model framework

Production of goods is represented by nested constantelasticity of substitution (CES) production functions;

Elasticities of substitution are adopted from GTAP 7.1 andBohringer et al. (2011).


Model scenarios

ETS scenarios:

all scenarios: cost-effectiveness analysis with global emissionstarget: BAU NA1 emissions, 20% emissions reduction in A1.

reg-hybrid-ets: hybrid, non-linked ETS in each A1 region;sectoral ETS coverage: ELE, OIL, EIT; 5% reduction targetfor non-ETS sectors; ETS scales endogenously by region.

reg-full-ets: economy-wide, non-linked ETS in each A1 region.

int-hybrid-ets: A1 ETS are linked with each other, but havepartial sectoral coverage.

int-full-ets: A1 ETS are linked with each other, economy-widecoverage.


Model scenarios

Policy trajectories:


Model results – EIT

Energy-intensive (EIT) sectors:

EIT sectors are affected differently in Annex I countries thanin non-Annex I countries.

In A1, EIT sectors are regulated within Annex I countries’emissions-trading systems;In NA1, EIT sectors are subjected to carbon tariffs imposed byAnnex I countries.

However, each policy will, in general, affect both regionsthrough spillover effects.

As domestic EIT production decreases in Annex I countries,more EIT products are imported from non-Annex I countries.


Model results – EIT Exports

Carbon tariffs are trade-depressing globally and for NA1.

A1’s EIT exports increase in all scenarios, but most in thecarbon-tariff one; more in sectoral than in regional expansion.


Model results – Carbon price

Carbon prices:

Carbon prices correspond to the marginal-abatement costs ofthe sectors included in the ETS (EIT, ELE, OIL in the hybridETS, all sectors in the full ETS)

⇒ Carbon prices affect output of ETS sectors (see before).

Carbon prices indicate allocative efficiency: extending ETScoverage across sectors and regions equalizes MACs.


Model results – Carbon leakage

Carbon leakage:

Denotes an increase in NA1 emissions as a result of a decreasein A1 emissions.

Two major channels:

Competitiveness channel: A1’s EIT industries loose marketshare to NA1; emissions increase in NA1 due to increased EITproduction.Fossil-fuel channel: A1’s emissions abatement decreasesdemand for fossil fuels → decrease in world prices → increasefossil-fuel demand and emissions in NA1.

Carbon tariffs predominantly affect the competitivenesschannel through shifts in EIT production.


Sensitivity analysis – Hybridization and emissions reduction

Too stringent and too lax ETS regulation yield greater relativebenefits of ETS extension over implementing carbon tariffs.

Greater emissions-reduction targets enable greater efficiency gainsfrom ETS extension.

Sectoral ETS expansion becomes more beneficial than BCAs.


Sensitivity analysis – Tariff base and elasticities

Higher tariff levels increase relative benefits of BCAs; usingdomestic emissions intensities increases benefits of ETS extension.

Leakage-increasing changes in elasticities (e-Arm x 2, e-Oil /2)increase relative benefits of ETS extension.

Relative preference for ETS extension is largely preserved.



Some Annex I countries may not participate in ETS extensions:

USA has not ratified the Kyoto Protocol.

Canada, Russia, and Japan have announced in 2010 that theywould not take on further Kyoto targets.

Canada has formally withdrawn from the Kyoto Protocol in2011.



Withdrawal of Canada and Japan does not change the coalition’spreference for ETS extension.

Withdrawal of RUS, and joint withdrawal of USA, RUS, JPN, CAN(A1s) reverses preference ordering for all policy trajectories.

⇒ Small coalitions prefer carbon tariffs over ETS extensions.



Forward projections from 2004 to 2010 and 2020:

based on projections from the US DOE International EnergyOutlook (IEO) 2009 (GDP, CO2, PCRU)

follows three steps:

(1) labor and capital endowments are scaled by GDP growthrates; resource supplies are scaled by projected increases inenergy demand; and fossil-fuel prices are set at their projected2010 and 2020 levels(2) fossil-fuel inputs are scaled by AEEI (ratio of changes inenergy consumption to GDP); final AEEI values are adjustediteratively to match the projected CO2 emission levels bysector and region(3) fossil-fuel supply functions are recalibrated to assureconsistency of responses to changes in energy prices with theresource value shares and substitution elasticities adapted tothe projected baseline



A1 welfare preferences largely preserved in 2010, reversed in 2020.

Prime reason is increase in MACs over time → reduces potentialETS efficiency gains and increases carbon-tariff base.

⇒ ETS extension is preferred as early action.


Sensitivity analysis – Tariff base


Sensitivity analysis – Elasticities


Sensitivity analysis – Hybridization and emissions reduction






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