Carbon Markets and Beyond: G-24 Discussion Paper Series The Limited Role of Prices and Taxes in Climate and Development Policy - UNCTAD
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UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT
G-24 Discussion Paper Series
Carbon Markets and Beyond:
The Limited Role of Prices and Taxes
in Climate and Development Policy
Frank Ackerman
No. 53, December 2008
UNITED NATIONSG-24 Discussion Paper Series
Research papers for the Intergovernmental Group of Twenty-Four
on International Monetary Affairs and Development
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All rights reservedCarbon Markets and Beyond: The Limited Role of Prices and Taxes in Climate and Development Policy iii
Preface
The G-24 Discussion Paper Series is a collection of research papers prepared
under the UNCTAD Project of Technical Support to the Intergovernmental Group of
Twenty-Four on International Monetary Affairs and Development (G-24). The G-24 was
established in 1971 with a view to increasing the analytical capacity and the negotiating
strength of the developing countries in discussions and negotiations in the international
financial institutions. The G-24 is the only formal developing-country grouping within
the IMF and the World Bank. Its meetings are open to all developing countries.
The G-24 Project, which is administered by UNCTAD’s Division on Globalization
and Development Strategies, aims at enhancing the understanding of policy makers in
developing countries of the complex issues in the international monetary and financial
system, and at raising awareness outside developing countries of the need to introduce
a development dimension into the discussion of international financial and institutional
reform.
The research papers are discussed among experts and policy makers at the meetings
of the G-24 Technical Group, and provide inputs to the meetings of the G-24 Ministers
and Deputies in their preparations for negotiations and discussions in the framework of
the IMF’s International Monetary and Financial Committee (formerly Interim Committee)
and the Joint IMF/IBRD Development Committee, as well as in other forums.
The Project of Technical Support to the G-24 receives generous financial support
from the International Development Research Centre of Canada and contributions from
the countries participating in the meetings of the G-24.Carbon Markets and Beyond:
The Limited Role of Prices and Taxes
in Climate and Development Policy
Frank Ackerman
Stockholm Environment Institute
and Tufts University
G-24 Discussion Paper No. 53
December 2008Carbon Markets and Beyond: The Limited Role of Prices and Taxes in Climate and Development Policy vii
Abstract
The climate policy debate has advanced from science to economics, with a growing focus on creating
carbon markets and getting the prices right. This is necessary but far from sufficient for an effective
and equitable response to the climate challenge. While market-oriented forces such as the IMF and
the World Bank have focused almost exclusively on carbon markets, others, such as the Human
Development Report and the Stern Review, have emphasized the need for complementary, non-market
climate initiatives to promote energy conservation and above all, to create and adopt new low-carbon
technologies.
The equity implications of market-based policies depend on the price elasticity of demand. When
demand is elastic (i.e. the elasticity is large in absolute value), as in the case of industrial energy use,
price incentives are quite effective and distributional impacts are minimized. On the other hand, when
demand is inelastic (i.e. the price elasticity is close to zero), as in the case of transportation fuel use,
price incentives are less effective, worsening income inequality but doing little to change in energy
use and carbon emissions. Thus non-market policy instruments are particularly important in sectors
with inelastic demand for energy, such as transportation.
Price incentives alone cannot be relied on to spark the creation of new low-carbon technologies.
Many technologies display “learning curve” effects, starting out with high unit costs and becoming
cheaper as they are used more widely. Wind power, which is now commercially viable, only became
affordable as a result of decades of government subsidies and research support. The same will be
true of other low-carbon energy technologies, which will be needed for a sustainable solution to the
climate problem.
Policy debate has focused on the need for a globally harmonized price for carbon. This is not required
by economic theory; in an unequal world, the logic of market economics implies that richer countries
should, in effect, have a higher price for carbon. It appears likely, nonetheless, that a consistent global
price will eventually be adopted. This will make the benefit of reducing carbon emissions loom larger in
lower-income countries. As a result, a wider range of carbon-reducing technologies will be profitable
in developing countries, creating opportunities for “leapfrogging” beyond the technologies in use in
high-income countries – thereby helping to launch a new, green path to development.Carbon Markets and Beyond: The Limited Role of Prices and Taxes in Climate and Development Policy ix
Table of contents
Page
Preface . ............................................................................................................................................. iii
Abstract . .............................................................................................................................................vii
I. Introduction......................................................................................................................................1
II. The state of the debate......................................................................................................................2
III. What do carbon prices accomplish?.................................................................................................4
IV. Where do new technologies come from?.........................................................................................6
V. Carbon markets and developing countries.......................................................................................7
VI. Conclusion........................................................................................................................................8
Notes ....................................................................................................................................................9
References ....................................................................................................................................................9Carbon Markets and Beyond:
The Limited Role of Prices and Taxes
in Climate and Development Policy
Frank Ackerman*
I. Introduction technologies. A harmonized global price for carbon
emissions is not essential as a matter of economic
theory, but is nonetheless likely to be adopted. This
The good news is that all major voices in the
will make the opportunities and incentives for innova-
climate policy debate, including the Bretton Woods
tion even greater in developing countries, creating the
institutions (the International Monetary Fund and the
economic basis for leapfrogging beyond the technolo-
World Bank), are taking the problem seriously. Skep-
gies adopted in high-income countries.
ticism about the science is no longer an option: the
world’s scientists have never been so unanimous, and
More specifically, this paper argues that appro-
so ominous, in their projections of future perils.
priate carbon prices and functioning carbon markets
are necessary but not sufficient. It begins with a
The bad news is that for too many participants in review of recent publications on climate policy from
the debate, including the Bretton Woods institutions, the IMF and the World Bank, contrasting them with
climate policy primarily consists of manipulating other recent recommendations. It then examines the
markets and prices. If the only tool you have is expected impacts of a higher price of carbon, which
market liberalization, then every problem looks like will be both inequitable and, in some respects, inef-
a question of getting the prices right. But setting a fective if adopted alone. Turning to more positive
price for carbon emissions is only the beginning of solutions, the nature of technology, particularly its
climate policy, not the end. path dependence and learning curve effects, requires
carefully designed public investments to launch a
The message of this paper for developing climate-friendly development path. And the impacts
countries is that it is important to look beyond the of carbon prices and markets on developing countries
technical debates over carbon markets. To address the create both unique problems, such as proportionally
threat of climate change, it is necessary to charge a greater economic burdens, and unique opportunities,
price for carbon emissions – and it is also necessary in the proportionally greater incentive to innovate and
for governments to do much more, taking action to establish a new leadership position in 21st century
support innovation and diffusion of new, low-carbon technologies.
* This work was carried out under the UNCTAD Project of Technical Assistance to the Intergovernmental Group of Twenty-Four
on International Monetary Affairs and Development with the aid of a grant from the International Development Research Centre of
Canada.2 G-24 Discussion Paper Series, No. 53
II. The state of the debate possible to achieve climate stabilization at moderate
total cost, considerable ingenuity and new policy
The IMF simply assumes that climate policy directions will be required; by themselves, price
consists of getting the (carbon) price right: changes of pennies per gallon of gas are not enough
to achieve anything of importance.
An effective mitigation policy must be based
on setting a price path for the greenhouse gas For the World Bank, the success of market based
(GHG) emissions that drive climate change policy is already obvious:
(IMF, 2008, chapter 4: 2).
The carbon market is the most visible result
Although making an occasional nod to the im- of early regulatory efforts to mitigate climate
portance of developments such as hybrid vehicles change … Its biggest success so far has been to
or energy efficiency,1 the IMF’s focus is almost en- send market signals for the price of mitigating
carbon emissions. This, in turn, has stimulated
tirely on market instruments. Adaptation to climate
innovation and carbon abatement worldwide,
impacts will, the Fund notes, require large increases
as motivated individuals, communities, com-
in infrastructure spending – but much more is said panies and governments have cooperated
about market opportunities for hedging against to reduce emissions (Capoor and Ambrosi,
predictable short-term climate fluctuations, through 2008: 1).
weather derivatives and “cat” (catastrophic risk)
bonds. Mitigation, i.e. emissions reduction, is ad- This success, according to the Bank, is based on
dressed primarily through detailed modelling of the two major markets for carbon emissions, the EU’s
expected effects of carbon taxes or trading schemes. Emissions Trading Scheme (ETS) and the Clean
This modelling effort shows that the Organization Development Mechanism (CDM) provisions of the
of the Petroleum Exporting Countries (OPEC) will Kyoto Protocol. They account for about US$ 50 bil-
be the biggest losers from a moderate carbon price, lion and $13 billion, respectively, of the $64 billion
while global trading of emissions allowances will in worldwide carbon market transactions in 2007
probably benefit China above all, due to that country’s (Capoor and Ambrosi, 2008: 1). Both markets, as it
massive opportunities for comparatively low-cost turns out, are works in progress: the ETS initially
emission reductions. gave away virtually all emission allowances to ex-
isting emitters, rather than auctioning them – and
The IMF analysis sets a target of a 60 per cent set such a high cap that the price of allowances fell
reduction in carbon emissions, relative to 2002 levels, embarrassingly close to zero. (Revisions to the ETS
by 2100, in order to stabilize CO2 concentrations framework are addressing these design flaws for
at 550 parts per million (ppm). This is a signifi- future years.) CDM has been beset by procedural
cant change from business-as-usual, although less delays and complexity, imposing unduly burdensome
ambitious than the targets advocated by many govern- start-up costs. A large majority of CDM funding to
ments and independent analysts; there is a growing date has flowed to China, suggesting that CDM does
concern among climate scientists that 450 ppm or not yet provide a truly global mechanism for financ-
even lower concentrations may be needed to avoid ing emission reduction.
serious risks of catastrophic change. Yet in the IMF’s
view, the world can move slowly and still reach the Meanwhile, research sponsored by the World
target comfortably: Bank has demonstrated that there is substantial
variation in carbon emissions at the same level of
Carbon-pricing policies … must establish a
development:
time horizon for steadily rising carbon prices
that people and businesses consider believable. The ranking of countries by emissions intensity
Increases in world carbon prices need not be [i.e., emissions/GDP ratio] … was not system-
large – say a $0.01 initial increase in the price atically related to GDP per capita … Emissions
of a gallon of gasoline that rises by $0.02 every per capita were positively but only moderately
three years (IMF, 2008, chapter 4: 42). correlated with GDP per capita and showed no
evidence of an eventual decline in emissions
Changes in carbon prices of this magnitude are per capita at higher per capita income (the
dwarfed by recent swings in the price of gasoline, a Environmental Kuznets Curve phenomenon;
topic discussed in the next section. While it may be Bacon and Bhattacharya, 2007: 2).Carbon Markets and Beyond: The Limited Role of Prices and Taxes in Climate and Development Policy 3
This finding should give rise to curiosity about economy. They are not a sufficient condition.
the subtler economic and non-economic determinants Governments have a critical role to play in
of emissions. It suggests that growth is not equally setting regulatory standards and in supporting
good, or bad, for carbon emissions in all contexts. low-carbon research, development and deploy-
ment (UNDP, 2007, Summary: 20, 21).
Therefore, merely speeding up or slowing down eco-
nomic growth may not be the most efficient policy;
HDR calls for carbon markets to be accompa-
it is also important to understand what differentiates
nied by government incentives for renewable energy
high versus low emission countries at the same level
production, tightened standards for vehicle fuel ef-
of economic development. (The same question can
ficiency, expanded research on carbon capture and
be asked about states within the United States, which
storage technology, and increased technology transfer
differ in carbon emissions per capita by a ratio of
to developing countries.
more than six to one.)
One of the most detailed recent proposals is
The World Bank’s overall approach to the issue
Nicholas Stern’s “global deal on climate change”
sounds multi-faceted, if somewhat abstract. A pro-
(Stern, 2008). Stern argues that climate stabilization
posed “strategic framework” (World Bank, 2008) for
requires cutting global emissions to half of the 1990
the Bank lists six “pillars,” of which three are focused
level by 2050, with continuing declines thereafter.
exclusively on market instruments,2 while three are
The 2050 target is so low – 2 tons per capita, not
more general or ambiguous.3 However, critics have
much above the level of emissions today in India,
claimed that reality falls short of the World Bank’s
and less than half of China’s current emissions – that
rhetoric. According to a report from the Institute for
there is virtually no room for any large country to be
Policy Studies (IPS), an NGO in Washington DC,
significantly above the average. Stern calls for bind-
the Bank’s $2 billion in carbon finance projects suf-
ing national reduction targets, to be adopted soon by
fer from an extreme lack of transparency, and have
developed countries and the fastest-growing middle-
resulted in very little confirmed reduction in carbon
income countries, and by all other countries by 2020.
emissions (Redman, 2008). Less than 10 per cent of
Stern envisions a carbon market, in the form of a
the funding has gone to renewable energy, while 75 per
global cap-and-trade system that allows developing
cent or more has gone to the coal, chemical, and iron
countries to sell emission rights, combined with ar-
and steel industries. In the sponge iron industry in
rangements for technology transfer, and large-scale
India, IPS reports that the incentives for carbon reduc-
government support for the development of new
tion have been generous enough to cause a perverse
technologies. In the words of his summary,
expansion of the relatively energy-inefficient industry,
in order to gain additional carbon reduction credits. The world should aim for a liquid international
carbon market in order to allow for the most
Other voices in the international debate have effective, efficient and equitable emissions
recognized the greater urgency of the problem, and reductions. In addition, non-price interventions
have set more detailed reduction targets, such as are required to expand the global market for
80 per cent reduction in developed countries and low-carbon technologies, support common
standards and promote cost-effective reduced
50 per cent worldwide by 2050, with even greater
deforestation (Stern, 2008: 3).
reductions required by 2100. Along with the urgency
of the issue, there has been a willingness to consider In short, all major proposals for climate policy
a broader range of policy instruments. For the Human include a substantial role for carbon markets and
Development Report (HDR): prices, either in the form of taxes or cap-and-trade
systems. Yet while the Bretton Woods institutions,
Setting ambitious targets for mitigation is
an important first step. Translating targets by their nature and by inclination, give primary
into policies is politically more challenging. emphasis to manipulation of prices and financing in
The starting point: putting a price on carbon carbon markets, others, such as Stern and the Human
emissions … Carbon markets are a necessary Development Report, see carbon markets as one part
condition for the transition to a low-carbon of a complex ensemble of policies.4 G-24 Discussion Paper Series, No. 53
III. What do carbon prices accomplish? Table 1
Impacts of a 20 per cent increase in
Discussion of carbon markets often highlights energy prices
the distinction between effects on prices and effects
on emissions. A cap-and-trade system causes a pre- Price elasticity of demand
dictable, explicitly stated reduction in emissions, but -1 -0.5 -0.2 -0.05
could lead to unpredictable or fluctuating prices. A
carbon tax does the opposite, causing a predictable, Change in quantity
stable effect on prices, at the expense of an uncertain (per cent) -20 -10 -4 -1
reduction in emissions. Those who, like Stern, focus
on the need to achieve a specific level of emissions Change in cost to
consumers (per cent) -4 +8 +15 +19
reduction tend to prefer cap-and-trade markets; those
who worry more about economic disruption tend
to prefer the predictable prices achieved by carbon
taxes.
This is, however, only one question about the 20 per cent increase in the price of energy at different
effects of carbon markets. A related question has elasticities, as shown in table 1.
received too little attention: when carbon prices are
increased, by a tax or a trading system, how large is At an elasticity of -1, the 20 per cent increase in
the (intended) effect on emissions, and how large is price causes a 20 per cent drop in demand. Consum-
the (unintended) effect on income distribution? ers purchase 80 per cent as much energy as before,
at 120 per cent of the former price per unit, so the
Increased energy costs to consumers fall dispro- total cost to consumers amounts to 96 per cent of
portionately on low-income groups; energy costs are the former total. At this elasticity, most of the effect
a larger fraction of income for the poor. As incomes is felt in the change in the quantity of energy (and
rise, total spending on energy also rises, but more therefore emissions), while total consumer spending
slowly; thus the fraction of income spent on energy is little affected.
decreases. The one major exception to this pattern
occurs in countries where some people cannot afford In contrast, at an elasticity of -0.05, a 20 per cent
fossil fuels, and instead rely on traditional biomass increase in price causes only a 1 per cent change in
fuels. Among the population that buys and depends quantity. Consumers buy 99 per cent as much energy
on commercial fuels, energy price increases are as before, at 120 per cent of the former price per unit,
regressive, taking proportionately more from lower- for a total expenditure of 119 per cent of the earlier
income households. cost. At this elasticity, there is almost no effect on
the quantity of energy and emissions, but a large ef-
To summarize in advance the point of this sec- fect on the total cost to consumers. The other values
tion, the effect of a carbon price increase depends shown in the table have intermediate results between
on the price elasticity of demand for energy. A larger these two extremes. Judged as a strategy to reduce
elasticity means that a price increase has more effect energy consumption and the resulting emissions
on emissions and less effect on income distribution; a with minimal burdens on consumers, energy price
smaller elasticity means that the same price increase increases seem quite effective at an elasticity of -1,
has less effect on emissions, but does more to increase but decidedly inferior at an elasticity of -0.05.
inequality.4 Since price elasticities are fairly small
for energy in general, and extraordinarily small for What elasticity values are applicable in reality?
petroleum products in the short run, price incentives Separate estimates have been developed for major
are a blunt and painful instrument for achieving lower energy markets including industrial energy use,
emissions. electricity, and transportation. The largest elasticities
are found in industry. Estimates from three research
The price elasticity of demand is, by definition, groups for 15 countries found the price elasticity for
the percentage change in demand that is caused by a industrial energy demand to be between -0.77 and
one per cent change in price. Consider the effects of a -0.88. The estimates for India and Brazil were notCarbon Markets and Beyond: The Limited Role of Prices and Taxes in Climate and Development Policy 5
significantly different from those for the developed automobile-dependent environment – including the
countries included in the studies (Roy et al., 2006). great majority in the United States, large fractions
Industrial energy use, in other words, provides fertile of many OECD countries, and increasing numbers
ground for the application of price incentives for in fast-growing, middle-income countries – has little
emission reduction. Indeed, industry lowered its en- control over the amount of driving required to go to
ergy use much farther and faster than any other sector work, school, stores, and other essential services. So
in response to the oil price shocks of the 1970s. in the short run, purchases of gasoline will be quite
insensitive to price.
Household demand for electricity is much less
elastic than industrial energy use. Recent estimates In the long run, as cars are replaced, high oil
for the United States have found a short-run price prices stimulate the sale of smaller and more fuel-
elasticity of -0.20, and a long-run price elasticity efficient vehicles, as began to happen in the United
of -0.32, broadly consistent with earlier research States during the price spike of 2007–2008. This
(Bernstein and Griffin, 2006).5 will eventually affect oil consumption, as the fleet of
cars on the road slowly becomes more fuel-efficient,
This finding of a relatively small elasticity for implying that the price elasticity will be greater in
electricity does not appear to be unique to the United the long run than in the short run.
States; the estimated long-run elasticity for Taiwan
is -0.16, described as “reasonably close” to the es- A comparative international analysis estimated oil
timates in “numerous other studies” (Holtedahl and price elasticities for many countries for 1979–2000
Joutz, 2004: 216). (Cooper, 2003). For the United States, it found a
short-run elasticity of -0.06 and a long-run elastic-
In both industrial energy use and electricity gen- ity of -0.46, broadly consistent with other published
eration, there are alternative fuels that yield the same estimates. For the G7 group of industrial countries,
result with differing carbon emissions. An increased short-run elasticities ranged from -0.024 to -0.071,
carbon price would cause a noticeable reduction in and long-run elasticities from -0.18 to -0.57. Using
industrial energy demand (less so in household elec- these estimates for the United States, a doubling of
tricity), and also a shift toward lower-carbon fuels oil prices causes a 4 per cent reduction in demand
– such as replacing coal with natural gas. in the short run, and a 27 per cent reduction in the
long run.
The picture is different in the transportation sec-
tor, where there is essentially only one fuel choice: A study focused specifically on the United
almost all transportation uses petroleum fuels. (On States gasoline consumption found that the short-run
a global basis, the available supply of biofuels is too price elasticity in 2001–2006 was -0.034 to -0.077,
small to make a noticeable dent in the demand for lower than estimates for earlier periods (Hughes
oil.) In the wake of the oil crises of the 1970s, most et al., 2006). The data did not permit estimation of
countries and industries have cut back on oil use a long-run elasticity. The authors speculated that
wherever possible; oil-fired electricity generation, increasing suburbanization and decreased avail-
once relatively widespread, is now common only in ability of mass transit have made it more difficult
OPEC countries. Today a majority of crude oil is used for most households to reduce their automobile use
for transportation, and a portion of the remainder is today. They concluded that changes in vehicle fuel
dedicated to non-fuel uses such as petrochemicals, efficiency would be the key to future changes in the
where there are no close substitutes. The connection United States gasoline consumption.
between petroleum and transportation is projected
to grow even tighter; an estimated two-thirds of Short-run price elasticities for gasoline and
the growth in oil demand through 2030 will be for other transport fuels are close to zero; this is why the
transportation.6 Thus the oil/transport market is 2007–2008 surge in the price of oil did not cause an
almost disjoint from the market for other fuels and immediate collapse in demand. (Many months later, a
end uses. global economic downturn led to lower incomes, oil
purchases and prices; that downturn was not solely,
The lack of alternatives to oil means that in the or even primarily, caused by the high price of oil.)
short run, price elasticity is close to zero for many An increase in oil prices is primarily a burden on
consumers. A household that lives in a completely consumers, and causes only a modest change in short-6 G-24 Discussion Paper Series, No. 53
run oil demand; its longer-term, beneficial effect is of “learning curves” or “experience curves.” As a
to accelerate the transition to a more fuel-efficient result, investment in start-up costs can determine
vehicle fleet. which technologies are cost-effective in the future.
Technological change is path-dependent: the current
Any plausible carbon policy would, in the near suite of available choices depends on past policies
term, raise fossil fuel prices by less than the oil price and actions, just as the available technological op-
increases of 2007–2008. While such a policy might tions in the future will depend on our policies and
have an important effect on industrial energy use, it actions today.
would presumably have less effect on transportation
than the recent surge in oil prices. Something more The learning curve phenomenon is particularly
needs to be done, to reduce emissions on the scale important when there is a benefit to standardization;
and timetable projected by Stern and others. in such cases, an early market leader can become
“locked in,” whether or not it represents the ideal
technology (as occurred with the Windows operating
system and other Microsoft software for computers).8
IV. Where do new technologies come The current style of industrialization has been referred
from? to as “carbon lock-in,” meaning that carbon-intensive
technologies gained an early lead at a time when
Market-based incentives such as a carbon price fossil fuels were cheap and concern about global
are much better at some objectives than others. Price warming was not yet on the horizon (Unruh and
signals lead to efficient choices among existing Carrillo-Hermosilla, 2006). Today, the economic ben-
alternatives; this is the great success of the market efits of standardization and the low costs of imitating
economy. On the other hand, as noted in the previous and replicating existing technology keep the world
section, carbon prices will generally make the dis- locked into that same undesirable path.
tribution of income and resources more unequal. In
addition, carbon prices alone will not create the new Research on learning curves has often found that
technologies needed to solve the climate crisis. as the cumulative total production of a new product
increases, the unit cost declines at a predictable rate.
The pure theory of competitive markets has This is measured by the “progress ratio,” defined as
little to say about technical change. If, as in the text- the change in unit cost per doubling of cumulative
book model, all commodities are bought and sold by production. In a historic example from the early twen-
small, competitive firms, and all resources are used tieth century, Ford’s Model T had a progress ratio of
to produce the maximum possible satisfaction for 85 per cent throughout its long production run: every
consumers, who has the incentive and the ability to time the cumulative total production of Model Ts
invest in research? Yet new technologies do emerge, doubled, the price per car dropped by an average of
and productivity grows over time. Conventional 15 per cent (Abernathy and Wayne, 1974).
economic models have often addressed this question
with the ad hoc assumption of a predictable, constant New energy technologies often display strong
rate of technical change, unrelated to investment learning-curve effects. Research on wind power has
choices or policy decisions. In climate modelling, this found progress ratios as low as 80 per cent (i.e., cost
takes the form of an “autonomous energy efficiency reductions as great as 20 per cent from doubling of
improvement” (AEEI) parameter.7 That assumption production) (Junginger et al., 2005). While wind
has the unfortunate consequence of biasing results power is now competitive in the marketplace under
toward waiting for new technology to appear: abate- many conditions, this success was made possible by
ment will always be cheaper if it is done later, after decades of US and European government investment
better technologies have “autonomously” made their in research and development. Brazilian ethanol pro-
appearance. duction, another industry launched by government
policy, reportedly had a progress ratio of 71 per cent
In reality, new technologies do not drop from the from 1985 through 2002 (Goldemberg et al., 2004).
sky, independent of investments and public policies.
New technologies are created by conscious effort; With technological progress at these rates, it
they often start out expensive and become cheaper is often the case that private enterprises only find it
over time, a process that is often described in terms profitable to buy a new product after someone elseCarbon Markets and Beyond: The Limited Role of Prices and Taxes in Climate and Development Policy 7
has been buying it and bringing down the price for Instead, the United States Government moved rapidly
ten or twenty years. Hence the role for public sec- and succeeded in launching a suite of technologies
tor involvement: governments can and must choose that now dominate private markets and shape mod-
the new technologies to support, especially when ern life.
– as with climate policy – there is a clear need for
change. The market alone is not enough; without
public investment, no credible carbon price would
do an effective job of launching the crucial new re- V. Carbon markets and developing
newable and low-carbon technologies. On the other countries
hand, with adequate public support, vast changes are
possible. A plausible model of energy development, The discussion of learning curves, path depend-
incorporating learning curves, projects that solar ence, and technological lock-in applies equally to
photovoltaics, now one of the most expensive ways climate policy and technologies in developed and
to generate electricity, could be one of the cheapest developing countries. However, the current discourse
options by 2100 (Rao et al., 2006). on carbon markets and climate policies has unique
implications for developing countries, posing obsta-
This is not a unique characteristic of new energy cles and creating opportunities that are not present in
technologies; rather, it is the norm in technological higher-income countries.
change. The United States Government has funded
the development of numerous innovative weapon sys- It has become commonplace to insist on the
tems, technologies that would not have automatically need for a globally harmonized price of carbon. Price
appeared without government support. Most of them, harmonization is thought to ensure efficiency in the
fortunately, have never been used. Along the way, worldwide distribution of abatement effort: with
many other technologies have been developed, with appropriate market institutions, investment in emis-
more peaceful applications to civilian life. In the words sions reduction will flow to the countries (presumably
of a history of microelectronics (Morton, 1999), developing countries) where the costs of reduction are
lowest. Fears about the effects of unharmonized car-
The U.S. military initially purchased nearly bon charges have slowed climate policy initiatives in
the total production of transistors in the early
some high-income countries, and have prompted an
1950’s, using them to make the new generation
of communications, radar and improved avion- unproductive and potentially protectionist discussion
ics systems, command and control systems, as of border tariff adjustments. This notion is mistaken
well as for missiles and jet fighters… both in fact and in theory. Empirically, only a handful
of industries are so carbon-intensive that a difference
The U.S. government acted as the major market
in carbon charges could lead them to move from one
for integrated circuits in the early years… In
1962 … the U.S. government, with extensive country to another – and many of them have already
research interests in space, defense, and other moved to middle- and low-income countries.
areas, purchased virtually 100 per cent of all
integrated circuits manufactured in the United In theory, remarkably enough, marginal abate-
States. ment costs do not have to be equal in every country in
order to achieve economic efficiency. Theorists who
As with wind power, a few decades of generous reach this conclusion generally rely on the unexam-
public support were sufficient to launch the micro- ined assumption that the world income distribution
electronics industry as a success in the marketplace. is equitable – or equivalently, that increases in per
And the list goes on and on: computers got their capita consumption are equally urgent everywhere
start with military purchases; the Internet grew out (Sheeran, 2006; Chichilnisky and Heal, 1994). In the
of ARPANET, a Defense Department-sponsored absence of that implausible assumption, it is more
network set up in the 1960s to connect military re- efficient to carry out higher-cost abatement efforts in
searchers around the country. richer countries. That is, in an inequitable world, ef-
ficiency can be improved by imposing higher carbon
None of these technologies appeared auto- prices in richer countries.
matically; if the world had waited for autonomous
technical change or relied on getting the prices It seems unlikely, however, that the enthusiasm
right, microelectronics might never have happened. for a consistent worldwide carbon price will be8 G-24 Discussion Paper Series, No. 53
dampened by these considerations. Climate analyses the Chinese auto industry has shown that there is little
from the Bretton Woods institutions (see section II), tendency toward leapfrogging beyond international
among many others, place a priority on establish- standards; in fact, the United States auto companies,
ing a single global carbon market. Thus developing left to themselves, have often allowed their Chinese
countries are likely to face a global carbon price, plants to lag behind their home-country technologies
while their local prices for labour, land and other (Gallagher, 2006). Stronger Chinese government
inputs remain far below the levels of higher-income policies and initiatives would be required to achieve
countries. Carbon emissions, or the credits for avoid- the potential for newer, cleaner vehicle technologies.
ing them, will account for a much larger fraction of Even for a developing country with the extensive
the value of production in lower-income countries. resources and potential of China, there is much that
The potential dissonance between expensive carbon needs to be done to reach this new technological
and cheaper local inputs creates both an obstacle and frontier.
an opportunity.
To realize the opportunity created by a global
The obstacle is that development may be carbon price in low-cost economies, there will be a
distorted in the direction of activities that yield need for research and development in appropriate,
marketable carbon reductions. Even undesirable cutting-edge technologies for carbon reduction. As
activities may be promoted, such as the expansion of with many of the new energy technologies that will
the sponge iron industry in India in order to generate be needed around the world, decades of public invest-
carbon credits (as cited in section II). Safeguards ment may be required before the developing-country
are needed to prevent “carbon-allowance-seeking” technologies are successful in the marketplace. This
investments along these lines; in any global carbon is one more reason why carbon prices are necessary,
market, it will be essential to verify that emissions but not sufficient, for an equitable solution to the
are not newly created in order to profit by reducing climate crisis.
them. The temptation to seek such bogus allowances,
unfortunately, is a natural consequence of a global
carbon price in a low-cost local economy.
VI. Conclusion
The positive side of the same pattern of prices
is that much deeper reductions in carbon emissions Setting a price for carbon emissions is a valuable
will be economical in developing countries. In the beginning, but not the end, of climate policy. Much
simplest terms, saving a ton of carbon is “worth” more needs to be done to complement the new mar-
more hours of labour at a lower wage rate. So there kets in carbon emissions, and to ensure an effective
may be a category of carbon-saving investments and policy response to the threat of climate change.
technologies that are profitable only in developing
countries, where the tradeoff between carbon and Reliance on carbon price increases alone would
other inputs is more favourable to emission reduc- be both ineffective and inequitable. For end uses with
tion. With appropriate public initiatives and financing small price elasticities, such as residential electricity
for these technologies, developing countries could and, above all, transportation, a higher fuel price leads
“leapfrog” beyond the patterns of energy use in primarily to a less equal distribution of resources, not
higher-income countries, establishing a new frontier to a reduction in carbon emissions. Other policies
for carbon reduction. are needed to offset the equity impacts of higher fuel
costs, and to launch the new, low-carbon energy tech-
The potential for leapfrogging beyond the cur- nologies of the future. Because technology choice is
rent technology frontier has been much discussed, path-dependent, with strong learning curve effects,
but is difficult to achieve. The classic example is in public sector initiatives are essential to ensure that the
telephones, where developing countries can now skip global economy follows a climate-friendly path.
the expensive development of universal land lines,
and go directly to cell phones. This is not, however, an The next international agreement on climate
example of jumping to an entirely new technology; it policy is likely to move toward a globally harmonized
became possible only after cell phones were invented carbon price. This creates a unique opportunity for
and commercialized in developed countries (Unruh developing countries, by making it cost-effective
and Carillo-Hermosilla, 2006). Likewise, research on to spend more local resources on carbon reductionCarbon Markets and Beyond: The Limited Role of Prices and Taxes in Climate and Development Policy 9
in lower-cost economies. A global carbon price Chichilnisky G and Heal G (1994). Who Should Abate Carbon
will make it profitable for developing countries Emissions? An International Perspective. Economic Let-
ters 44: 443–449.
to “leapfrog” beyond the technologies in place in Cooper JCB (2003). Price elasticity of demand for crude oil:
higher-income countries. estimates for 23 countries. OPEC Review 27(1): 1–8.
David P (1985). Clio and the Economics of QWERTY. American
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EIA (2007). International Energy Outlook. Energy Information
Notes Administration, United States Department of Energy
(DOE), Washington, DC.
Gallagher KS (2006). Limits to leapfrogging in energy tech-
1 E.g., “Energy-efficiency improvements are unlikely to nologies? Evidence from the Chinese automobile industry.
eliminate the need for carbon prices, but they would reduce Energy Policy 34: 383–394.
their level” (IMF, 2008, chapter 4: 40). Goldemberg J, Coelho ST, Nastari PM and Lucon O (2004).
2 “Consolidating Efforts to Mobilize and Deliver Finance”, Ethanol learning curve – the Brazilian experience. Biomass
“Expanding the Bank’s Role in Developing New Mar- and Bioenergy 26: 301–304.
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Friendly Development”. in Taiwan. Energy Economics 26: 201–224.
3 “Scaling Up Operational Approaches to Integrating Hughes JE, Knittel CR and Sperling D (2006). Evidence of a Shift
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“Clarifying the Bank’s Role in Accelerating Technology NBER Working Paper 12530.
Development and Deployment” and “Stepping Up Policy IMF (2008). World Economic Outlook: Housing and the Business
Research, Knowledge Management and Capacity Build- Cycle. International Monetary Fund, Washington, DC.
ing”. Junginger M, Faaij A and Turkenburg WC (2005). Global experi-
4 Price elasticities are, strictly speaking, negative numbers. ence curves for wind farms. Energy Policy 33: 133–150.
This discussion follows the common convention of refer- Morton D (1999). The Electrical Century: What Difference Did
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value) as “larger” elasticities; thus an elasticity of -1 is of the IEEE 87(6): 1049–1052.
“larger” than an elasticity of -0.5. OPEC (2007). World Oil Outlook 2007. Organization of the
5 See also Reiss and White (2005) estimating a long-run Petroleum Exporting Countries, Vienna, Austria.
price elasticity for California households of -0.39, and Rao S, Keppo I and Riahi K (2006). Importance of Technological
commenting that high-quality past studies have generally Change and Spillovers in Long-Term Climate Policy. En-
yielded estimates between -0.15 and -0.35. ergy Journal, Special Issue on Endogenous Technological
6 United States EIA (2007) says transportation will account Change and the Economics of Atmospheric Stabilisation:
for two-thirds of the growth in world oil use through 2030; 123–139.
OPEC (2007) data implies that transport will absorb 62 per Redman J (2008). World Bank: Climate Profiteer. Institute for
cent of the growth in oil use. Policy Studies, Washington, DC. 10 April.
7 The model used by the IMF, in the analysis discussed in Reiss PC and White MB (2005). Household Electricity Demand,
section II above, assumes an AEEI of 0.5 per cent per year Revisited, Review of Economic Studies 72: 853–883.
(IMF, 2008, chapter 4: 46). Roy J, Sanstad AH, Sathaye JA and Khaddaria R (2006). Sub-
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Sheeran KA (2006). Who Should Abate Carbon Emissions?
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