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The Financial Express

How can carbon pricing contribute to post-covid-19 recovery?


How can carbon pricing contribute to post-covid-19 recovery?

Looking beyond the pandemic, climate change poses the single most important threat to the regional economy, livelihoods and the natural environment in Asia and the Pacific. According to the most recent report from the Intergovernmental Panel on Climate Change, global temperatures are expected to continue rising until at least mid-century under all emissions scenarios considered. Strengthening climate ambition is a fundamental cornerstone to meet the commitments of the Paris Agreement and "build forward better", making economies more resilient, inclusive and green.

Many countries across the Asia-Pacific region are exploring how carbon pricing instruments (CPIs) can play a role in post-Covid-19 recovery efforts, aligned with low carbon development pathways. For example, China's emissions trading scheme (ETS) - the largest carbon market in the world - started trading in July 2021; Singapore is reviewing the rate of its carbon tax, the first one in the region; and Indonesia launched a trial ETS in March 2021 for 80 coal power plants, covering three-quarters of the power generation sector. Meanwhile, the ASEAN Working Group on Climate Change is leading a range of projects and capacity-building initiatives to support development of CPIs and introduction of carbon markets.

Overall, a total of 16 countries in Asia and the Pacific, including Brunei, Indonesia, Marshall Islands, Pakistan, Solomon Islands, Thailand, Turkey, Uzbekistan and Viet Nam, are at different stages of developing and implementing carbon tax as well as national and sub-national emissions trading schemes. However, implementation is challenging.

For instance, at US$3 per ton of CO2, Japan's cost of carbon is significantly lower than the international average for an economy of Japan's size. Similarly, the carbon tax introduced in Singapore in 2019 is 5 Singapore dollars (US$3.69) per ton of greenhouse gas emissions, while Kazakhstan set carbon price at 456 Kazakh tenge (US$1.10) per ton of CO2. Though China's ETS was announced in 2014, it became fully functional only in 2021. When the ETS was first introduced in Europe, the price of carbon was set to less than €5 per ton. By June 2021, it had risen to €50 per ton.

The macroeconomic impacts of a carbon price are multifaceted. Assuming it is applied upstream, such a price directly increases the costs of production. Part of this rise will be passed on to consumers through higher prices, pushing up inflation and constraining consumer spending. Some of the cost is also absorbed by firms' profit margins, raising the user cost of capital and constraining investment.

However, carbon prices encourage a shift to low-carbon and no-carbon energy sources by increasing the costs of carbon-intensive activities and burning fossil fuels. That, in turn, will cause a decline in the demand for fossil fuels, and a reduction of the global price of fossil fuels even before the carbon tax is applied.

A carbon price will also generate fiscal revenue, creating fiscal space that can be channelled back into the economy via tax cuts and incentives for low-carbon innovation. This may stimulate an increase in the share of renewables in the national energy mix as well as job creation.

Expanding on the earlier developed Macroeconomic Model, ESCAP is researching the design of carbon pricing instruments in the region and modelling the macroeconomic and social impacts of climate scenarios. The analyses include ESCAP 2020 research on enabling factors for more ambitious and more effective climate policies as well as the role of cross-border carbon pricing adjustments.

Preliminary results of carbon price modelling in the region illustrate that carbon pricing instruments can form a powerful component of post-Covid-19 recovery packages. Here are brief summaries of five of the key take-aways.

First, as might be expected, the higher the carbon price, the bigger the short-term impact on inflation (Figure-1) and the greater the progress towards emission reduction targets. The inflationary impacts tend to dissipate within about five years, followed by a period of disinflation after the price shock.

Second, coordinated regional action will increase the economic returns compared to carbon pricing initiatives introduced in a single country. Such a strategy will also reduce the risks of "carbon leakage" (Figure-2), which is the result of asymmetrical carbon policies, especially carbon pricing, and the resulting carbon cost that could displace production and/or investment, and the associated emissions

Third, if all the potential revenue from a carbon pricing scheme is collected effectively and then channelled back into the economy and into specific activities, it can simultaneously increase the level of economic activity, reduce inequality and poverty, encourage greenhouse gas (GHG) emissions reductions and stimulate innovation and new jobs in the renewable energy sector. If, on the other hand, no revenue is generated or recycled from the carbon policy, progress towards cutting GHG emissions will cause both economic and social costs.

Fourth, carbon revenue policy can be fine-tuned to support efforts to reduce poverty and inequality when required and be channelled into low-carbon social protection. To tackle air pollution, revenue can be used directly for provision of clean cooking facilities and subsidizing agricultural harvest machinery to reduce crop burning. Targeted spending can improve health outcomes and raise productivity while investments in energy efficiency and renewable energy will accelerate decline in emissions. Carbon revenue can support greener debt repayments reducing interest and repayments directed to nature-based solution investments and debt swaps to reduce the risks of unsustainable debt.

Finally, enabling factors - including the mainstreaming of climate issues into national policies, improving coordination among national and sub-national stakeholders and channelling climate funds downwards to local levels - will support the effectiveness of CPIs, laying the groundwork for more ambitious climate policy in the coming years.

Carbon pricing instruments hold the key to an ambitious climate policy architecture in the Asia-Pacific region. What is holding back robust implementation is the lack of accessible tools to holistically review the economic, social and environmental impacts of policy options. Simple, user-friendly tools for policymakers to experiment with different national and regional policy designs and explore macroeconomic, social and environmental indicators will close this gap.

 

[The piece is excerpted from www.unescap.org/blog]

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