A FRAMEWORK TO DECARBONISE THE ECONOMY
CO2
INTRODUCTION
DESIGNING AND MONITORING STRATEGIES TO ACHIEVE CLIMATE CHANGE TARGETS WHILE BOOSTING GROWTH AND SOCIAL COHESION
To help countries tackle climate change, the OECD Economics Department offers the following roadmap for designing comprehensive decarbonisation strategies while promoting growth and social inclusion (Figure 1). First, policymakers should establish national climate targets and take stock of the current policies in place. Then, they need to monitor current and future progress.
When weighing pros and cons of policy instruments across various aspects it becomes clear that there is no single instrument superior to others. Thus, decarbonisation strategies have to rely on a wide mix of policies and instruments. There are three basic building blocks that any effective decarbonisation strategy should include:
1 Emission pricing
2 Standards and regulations
3 Complementary policies to facilitate the reallocation of capital, labour and innovation towards low-carbon activities and to offset the adverse distributional effects of reducing emissions.
However, there is no one-size-fits-all policy mix as countries have different economic structures, social preferences and political constraints. To manage these differences and increase public acceptability of climate mitigation policies, countries need a robust and independent institutional framework, stakeholders engagement schemes, and credible communication campaigns.
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FIGURE 1. A ROADMAP TO DESIGNING A COUNTRY-TAILORED DECARBONISATION STRATEGY
MEETING CLIMATE TARGETS REQUIRES A SUBSTANTIAL UPGRADE OF POLICIES
Our well-being and that of future generations is at risk because of climate change. Despite new commitments made in 2021 (e.g. at COP26 in Glasgow and in the months leading to it), countries’ climate mitigation pledges as well as policies are still not enough to limit the rise in world temperature “well below 2 degrees compared to pre-industrial levels” (Figure 2). Often, policymakers hesitate to take more decisive action, fearing economic and distributional costs. Until now, economic growth has been accompanied with increasing emissions. In 2020, the COVID pandemic lockdown measures reduced global emissions by 5.2%, a yearly reduction consistent with 2030 climate mitigation pledges. Nevertheless, as world GDP dropped by 3.4% it came at huge economic and social costs. This experience highlights the need for new approaches and policies to reconcile decarbonisation efforts with growth and social inclusion.
Scenarios of CO2 emissions over time (2000-2050) and respective expected temperature rise by 2100
Note: Expected temperature rises by 2100 are relative to pre-industrial levels, and are subject to an upward risk due to uncertainties in the estimate and possible future changes in policy. Further explanation and information on the data appear with the paper’s Figure 5.
Source: IEA 2021.
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FIGURE 2. THE WORLD’S GHG EMISSIONS ARE NOT IN LINE WITH NET-ZERO BY 2050
MULTIPLE MARKET FAILURES
CALL FOR A COMPREHENSIVE POLICY MIX :
THE CHALLENGE OF DESIGNING
COST-EFFECTIVE DECARBONISATION STRATEGIES
Countries’ diverse economic structures (Figure 3), varying social preferences and political constraints necessitate tailored policy strategies. In addition, multiple market failures and contrasting policy objectives make the design of cost-effective decarbonisation strategies challenging.
One major market failure is the negative externality of greenhouse gases (GHGs), creating a wedge between the marginal social costs and the private costs (i.e., private polluting firms do not pay for the environmental damage they cause), which leads to prices that do not reflect actual climate damages.
A second major market failure concerns the under-provision of “green” innovation and technological developments, as knowledge is, to a large extent, a public good (i.e., once knowledge is created thanks to the investment of some, it is easily accessible to others for minimal or no costs. Investors may hence be reluctant to pay the initial price to begin with, as they may not see worthwhile returns). Other market failures worsen these two problems. For example, co-benefits of reducing emissions – such as improved health and biodiversity – remain unpriced, thus weakening incentives to fight climate change; and network effects may hamper wider use of “green” technologies.
3. SECTORAL SHARES OF EMISSIONS VARY ACROSS COUNTRIES
GHG emissions share (excluding land use, land-use change and forestry) for selected OECD countries
Source: OECD, Green Growth Database.
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FIGURE
Agriculture 9% Industrial processes 7% Waste 3% Energy Industries 29% Manufacturing 12% Transport 24% Residential 11% Other 5% Energy 81% OECD 2019 or latest available year 32% 6% 2% 19% 7% 20% 14% 0% 60% Ireland, 2019 6% 22% 4% 18% 16% 18% 12% 4% 68% Slovak Republic, 2019 16% 9% 4% 11% 12% 29% 18% 1% 71% France, 2019 3% 7% 2% 35% 24% 13% 8% 8% 88% Korea, 2018
Governments use a variety of policy instruments to reduce emissions. The OECD’s A Framework to Decarbonise the Economy examines a variety of climate policy instruments, falling into two broad categories:
1. Emission pricing instruments
2. Standards and regulations
The paper compares the policyies and instruments’ performance across several key criteria:
• Lowering abatement costs in the short and medium-long term
• Administrative costs
• Ability to deal with uncertainty
• Reallocation and distributional concerns
• Political economy and public acceptability
• Impact on the public budget
Such a comparison shows that no single policy instrument is superior to the others along all these key criteria (Table 1). This is why countries need to adopt a comprehensive climate policy mix that includes complementary measures to enhance the cost-effectiveness and social acceptability of decarbonisation strategies.
TABLE 1: KEY CLIMATE POLICIES EXAMINED VIA THE ASSESSMENT CRITERIA
Note: the cell colouring indicates how favourable the assessment criteria are for a given policy instrument (green: highly favourable; orange: medium favourable or mixed outcome; red: unfavourable; white: not applicable).
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THE THREE BUIDLING
OF CLIMATE CHANGE POLICY STRATEGY
STONES
EMISSION PRICING INSTRUMENTS 1 STANDARDS AND REGULATIONS COMPLEMENTARY POLICIES 2 3
1. EMISSION PRICING
Emission pricing instruments include Greenhouse Gas (GHG) taxes and Emission Trading Schemes (ETS), such as the EU ETS, as well as other incentive-based instruments, such as taxes on polluting goods. An economy-wide uniform emission price, which is highly cost-effective in reducing emissions, should be a cornerstone of any mitigation strategy. In practice, however, emission prices remain generally low in many countries (Figure 4), partly due to fear of their negative distributional impacts and strong opposition of citizens.
FIGURE 4. MOST COUNTRIES UNDER-PRICE THEIR CARBON EMISSIONS
Carbon pricing score, 2018
Note: For an extended version, see Figure 13 in the full paper. The carbon pricing score (CPS) shows how close countries are to pricing carbon in line with carbon costs (EUR 60 is a midpoint estimate for carbon costs in 2020, and a low-end estimate for 2030). For example, a CPS of 100% against a benchmark of EUR 60 per tonne of CO2 means that the country prices all energy related carbon emissions in its territory at EUR 60 or more. In practice. Pricing all emissions at least at EUR 60 in 2020 shows that a country is on a good track to reach the goals of the Paris Agreement to decarbonise by mid-century.
Source: OECD, Effective Carbon Rates 2021 Database.
Though important, emission pricing may not be enough. Sometimes, firms and households are not price sensitive (i.e., their emissions remain high despite sizable costs attached to emitting activities). In addition, emission pricing does little to address coordination failures in innovation and licensing, thereby limiting knowledge spillovers and technological developments of new green technologies. Another issue is that different carbon prices across countries risk shifting high emitting production to countries with lower carbon prices (a phenomenon called “carbon leakage”), for which international policy coordination is crucial.
2. STANDARD AND REGULATIONS
To accelerate the deployment of low-carbon technology, standards, regulations and subsidies may set a wide range of different requirements, such as emission quotas, green certifications, technology mandates and others. They can be especially effective in cases such as restricting and phasing out highemitting activities or technologies within a certain timeframe. Standards and regulations do not directly set emission prices, but the cost they entail can be seen as an implicit emission price (contrary to emission pricing schemes, which set explicit emission prices).
Standards and regulations can effectively complement emission pricing and other incentive-based policies, especially when they are technology-neutral (e.g., tradable performance standards).
They can help to overcome coordination failures and can substitute emission pricing where firms and households are unresponsive to price changes.
A FRAMEWORK TO DECARBONISE THE ECONOMY 9
0 10 20 30 40 50 60 70 80 90 100 BRA IDN CHN ZAF USA JPN SWE MEX HUN ISR OECD DEU ESP GBR KOR NLD FRA NOR CHE EUR 60/tCO2
Standards and regulations can also effectively deal with some market failures – caused, for instance, by short-sighted behaviour, financial constraints and risk aversion – that emission pricing fails to address. For instance, energy efficiency labelling can nudge households into making purchases of goods and services that cause lower emissions. Yet, ill-designed and uncoordinated regulations may greatly increase the cost of decarbonisation. This is because they can blur price signals, blunt economy-wide incentives, pick “winners” and complicate performance monitoring. As a result, they can entail high implicit carbon prices that detract from the overall cost-effectiveness of decarbonisation strategies.
3. COMPLEMENTARY POLICIES
Complementary and framework policies do not directly aim at reducing emissions, but instead, lower the economic and social costs of policies doing so. They can be split into two groups : The first group includes policies that aim at boosting innovation capacity and improving the green business environment and infrastructure. These are; accelerating the development and deployment of new abatement technologies, e.g. R&D and innovation incentives (Figure 5); supporting business dynamism (e.g. lifting barriers for firm-entry, reforming insolvency regimes and reducing barriers to trade); promoting data consistency and comparability of ESG (environmental, social and governance) rating methodologies to crowd-in private capital; and increasing investment in infrastructure to upgrade electricity and transport networks. For example, the large increase in the number of electric-vehicle charging stations (600% between 2015 and 2021) in Norway has helped to reduce consumers’ “range anxiety”
(i.e., drivers’ concern that their vehicle does not have enough energy storage to cover the desired road distance) and supported electric vehicle sales.
The second group includes policies that aim at cushioning the distributional effects of climate policies and helping people during the climate transition. These are important – as climate policies tend to be regressive. Careful use of revenues from emission pricing can make climate policies more progressive, thus redressing unequal distributional impacts. While revenue earmarking creates rigidities in spending priorities, it can be a useful tool of decarbonisation strategies by strengthening commitment and communicating clearly how such additional tax revenues will be used. This can help build trust and reduce public perceptions of unfair distributional impacts. In Switzerland, for example, the carbon tax bill passed in 2018 included allocating about twothirds of the tax revenue to households and firms.
Another policy tool in this group is effective active labour market policies (ALMPs), as these can facilitate the deep restructuring of the labour market likely caused by climate policies. An example is the Danish ‘flexicurity’ system, in which ALMPs play a crucial role and includes training for skills demanded in green jobs.
FIGURE 5. ONLY A SMALL SHARE OF GOVERNMENT R&D BUDGET FOCUSES ON ENVIRONMENTAL ISSUES
Environmentally related government R&D budget, % of total government R&D, 2019 or last year available
Note: For an extended version, see Figure 18 in the full paper. Data refer to 2018 for Estonia, France, Israel, Korea and Poland. Source: OECD, Green Growth Database.
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0 2 4 6 8 10 12 14 16 LTU USA BEL ISR FRA FIN SVK KOR OECD ESP AUS GRC SVN COL %
