Choice of Policy Measures in Annex B Countries and Impacts on Non-Annex B Countries Workshop on Mitigation of Climate Change Socio-Economic Impacts of Mitigation Hotel Maritim, Bonn W. David Montgomery, Ph.D.

Policy Approaches Under Consideration Broad market based approaches have received most attention in studies of global economic impacts of climate change policy –Cap and Trade systems –Fuel or carbon taxes Increasing focus on “sectoral” measures in all Annex B countries as policies are implemented –Applied to specific economic sectors or industries –Based on technical standards, sector-specific limits, or fiscal measures Questions this raises –What are the impacts of “sectoral” or “bottom-up” measures on non-Annex B countries? –How do the impacts differ, depending on the sector regulated or instruments chosen? –What can be done to minimize adverse impacts?

Economy-Wide “Top-Down” Policies Include Emission Trading and Uniform Taxes on Carbon Content

Fiscal and Incentive Based Sectoral Policies Target Specific Fuels or Sectors

Bottom Up Measures Are Typically Sector and Technology Specific

Spillover Effects Of Broad Market Based Approaches Are Well-established Adverse impacts on most non-Annex B countries –Reduction in Annex B income reduces demand for imports –Increase in Annex B production costs increases real price of exports –Result is adverse shift in terms of trade for developing countries Potentially beneficial impacts on exporters of energy-intensive products –Increase in cost of EIS production in Annex B increases demand and price received for EIS exports –Reduction in cost of energy imports due to lower world oil prices reduces non-Annex B costs –Result is potential terms of trade improvement for large EIS exporters Large adverse impacts on energy exporters –Reduction in energy use reduces energy imports and world energy prices –All energy exporting countries suffer adverse effects Patterns of spillover effects are governed by trade and macroeconomic relationships

Paths for Spillover Effects Matter When Sectoral Policies Are Considered Spillover effects arise from changes in Annex B –Quantities of energy produced and consumed –Costs of production of manufactured goods and some services –Overall levels of economic activity These translate into terms of trade effects through –Direct effects in energy markets ­Changes in demand for imported energy –Substitution effects, mostly in markets for energy intensive goods ­Willingness to pay for imports ­Competitiveness of exports –Income effects in all markets ­Overall level of demand for imports

Impacts of Sectoral Measures Depend on the Sectors and Measures Involved Patterns of spillover effects are determined by which fuels and sectors are targeted by a policy

How Different Regions Are Impacted Depends on the Path of Spillovers Changes in different pathways create different types of adverse effects

The Choice of Sector Specific Policies Will Influence Where Adverse Impacts Appear Adverse impacts depend on –the sector that is regulated and –how it is regulated Regulations that increase the cost of industrial sectors –May benefit countries that export energy intensive goods to Annex B countries –Are likely to move terms of trade adversely to poorer countries that export resources and agricultural products and import manufactured goods Policies that reduce use of transportation fuels have large adverse effects on oil exporters –Direct reduction in consumption, oil imports and world oil price –No possible favorable movements in the terms of trade

Using MS-MRT to Quantify Relative Effects of Sectoral Policies Regions in MS-MRT usaUnited States, eurEurope (EU 15) jpnJapan eeuEastern Europe rusRussia chnChina indIndia oecOil exporting countries rowRest of world Sectors and goods GASNatural gas ELEElectricity OILRefined oil products COLCoal CRUCrude oil EISEnergy-intensive industries TRNTransportation OTHOther goods and services MS-MRT is a computable general equilibrium trade model based on the GTAP dataset –Fully dynamic, forward-looking model with Armington trade structure –Discussed in TAR and documented in Energy Journal and Journal of Energy and Natural Resource Economics –Being updated to GTAP6 data and current IEA World Energy Outlook –Generic sectoral policy scenarios were explored to quantify the connections between choice of policies and nature of adverse impacts

Policy Scenarios for Meeting Kyoto Targets UET"Universal emissions trade." This is the benchmark "low-cost" reference case in which the Annex-B countries trade emissions within and across boundaries. Russia is capped at BaU (no "hot-air") but participates in trading. US is assumed to remain outside the Kyoto Protocol in NTR"No international emissions trade." The Annex-B countries/regions each adopt efficient carbon abatement programs with equalized abatement costs across all sources, yet there is no trading between Annex-B countries. Sectoral shares of emission reduction in this case provide the basis for scenarios that shift burden to specific sectors. TRN"Regulated Transportation." No emissions trading and sectoral Annex-B instruments. Regulatory measures require 10% greater emission reduction in transportation than NTR and corresponding less in utilities and industry. UTL"Regulated Utilities." Analogous to TRN, but with 10% greater share of emission reduction for electric utilities. IND"Regulated Industry." Analogous to UTL with 10% greater share of emission reduction undertaken by both electric utilities and EIS. TRNX“Transportation exempted." No emission limit on transportation, with compliance achieved through greater reductions in other sectors.

Regional Economic Welfare Under Alternative Policies Percent Change in Consumption in 2015 from Baseline

Implications of the Scenarios Across all scenarios, oil exporters suffer the largest adverse effects –Loss to oil exporters is consistently larger than impact on any Annex B region The degree of harm to oil exporters is directly tied to stringency of transportation sector policies –Exempting transportation reduces harm close to zero –Greater reliance on transportation measures increases harm Other Annex B countries are affected as expected –Large exporters of energy-intensive goods may gain through improved competitiveness, but these gains would be erased if Annex B countries protect industries –The rest of non-Annex B countries suffer adverse affects

Why Do Adverse Impacts Differ? Impacts depend on which sectors and fuels are targeted –Policies with similar effects on energy use and demand for imports have similar spillover effects –Even if bottom-up policies are assumed to have no cost to the Annex B economy, they have adverse spillover effects –Reduction in oil imports lowers world oil price and causes harm to all countries with significant oil exports Policies that target transportation increase harm to oil exporters Impacts of sectoral policies that give preferential treatment to Annex B industry need to be examined more carefully to determine how non-Annex B competitors are affected

Remedies for Spillover Effects -- For Further Research Direct financial compensation –Estimating compensation requires modeling terms of trade and oil prices that would prevail “but-for” climate policies –Oil exporters suffer the largest adverse effects Special tariff concessions –Difficult to target to those with most harm Revision of fuel taxation –Exempting transportation sector or replacing gasoline revenues with carbon tax revenues reduces cost to EU countries, and –Reduce adverse impacts on oil exporters Removal of coal subsidies –Should improve economic efficiency in Annex B and lowers emissions –Would shift more of the emission reduction away from oil consumption