91av

Since the Industrial Revolution, the concentration of carbon dioxide
in our atmosphEre has steadily increased. Global warming is attributed to
the burning of fossil fuels to meet the ever increasing demands of industry
for energy and transport. The extra carbon dioxide in the atmosphere comes
mainly froM the fossil fuels burnt by cars, trucks and in power stations.
Scientists, notably those on the Intergovernmental Panel on Climate Change,
agree that global warming is likely. The problem now is what practical measures
to take to prevent it.

The British government has adopted a target of reversing the upward
trend in carbon dioxide emissions and stablising them at their 1990 level
by the year 2005, provided other countries also reduce their emissions.
Yet this target raises many questions. Why 2005 and not 2000 as adopted
by other European countries? How will stability be achieved? What will the
costs be? The government has provided no convincing answers, and has no
coherent policy for reaching this target. The battle against inflation,
the freedom of the motorist and privatisation of the electricity supply
have been given clear priority. Any limits on the emission of carbon dioxide
and other potent greehouse gases such as methane will have to change the
way both industry and individuals use coal, oil, gas and electricity. Increase
the cost of releasing carbon dioxide, argue economists, and industry should
respond by cutting back.

In choosing a target for the level of carbon dioxide in the atmosphere
in the future, the relevant question is not whether to reduce emissions
of carbon dioxide, but rather by how much, and when. Economists approach
these issues by calculating the cost of reductions in carbon dioxide, and
subtracting this cost from the value of the benefits that would also come.
The best target is that which gives the greatest surplus of benefits over
costs.

But the cost depends upon what policies are to be adopted. Should carbon
dioxide be reduced by cutting down on the use of cars, or by building nuclear
power stations? Should the price of energy be raised, or should the government
subsidise home insulation? And different routes to the same target will
involve a variety of costs. Do stringent restrictions, suddenly imposed,
have a better effect than a steady decrease in permitted levels?

These questions do not have simple answers. Predicting how people will
behave in response to, say, an increase in the price of petrol involves
many tangible factors. Calculating the benefits of environmental improvements
is even more complex. What is the benefit of avoiding global warming? A
warming of the British climate may not be very detrimental, and could conceivably
be beneficial. It could even improve argriculture, reduce heating bills
and improve the quality of life, but this may happen at the cost of higher
insurance payments to those at risk from storms and floods.

On the international scale, the impact is more straightforwardly negative.
The benefits of a reduction in our emissions accrue to others, not necessarily
to ourselves. Any country concerned about limiting emission of greehouse
gases needs to find some way to measure the benefits that this would bring
to other parts of the world.

Global warming is a global promblem; the best way forward seems to be
international agreement. The cost to Britain of reductions are relatively
high and the benefits are relatively low, so it makes sense to reduce our
emissions only if others do so as well. The problem is how to achieve international
cooperation. Success depends on three factors: first, we must be able to
measure the emissions of carbon dioxide; secondly, monitoring must be impartial,
so that detection of cheating is automatic; thirdly, any country that cheats
must be punished, and the cost of the punishment must be greater than the
benefits of cheating.

If any of these factors are missing, then each country would be better
off if it cheated while everyone else cut their emissions. The benefits
come to all of us. Britain could gain from the actions of others without
incurring any costs to its economic competitiveness. Indeed, almost all
countries have strong incentives to free-load in this way. But if many do,
then the cooperation collapses, and all countries lose the benefits. Devising
some sort of world convention with binding targets for carbon dioxide emissions
will be virtually impossible if, for example, China does not permit an outside
world body to check its performance, and if the world is unwilling to punish
failure to comply. Some world body – probably the UN – would have to police
a convention; the prospects for success are far from encouraging.

No one has yet conducted a proper analysis of the economic costs and
the benefits of global warming, and so far there is no binding world agreement,
but the British government has nevertheless adopted a unilateral target.
Other countries have set their own targets. But so far there is very little
idea of how they will be achieved. Existing policies, such as the encouragement
of fuels other than coal and oil for electricity generation, and tougher
enforcement of speeding limits, are inadequate. We are still very much at
the drawing board of environmental policy.

But the pressure to detail the practical measures necessary to meet
policy targets will increase. Here, ecnomics offers two broad approaches,
one based on government regualtion and enforcement (known as ‘command and
control’), and one based on prices (‘market based’). Command and control
has been the traditional approach to limiting pollution. The government
decides what constitutes the best technological solution to a problem and
then imposes that solution on businesses and households. For example, the
government specifies what standards of insulation a house should reach through
building regulations; it decides what sort of nuclear power stations should
be built; and it requires that at least some coal-fired power stations should
have flue gas desulphurisation units.

More generally, pollution control in Britain has been based on negotiation
between government and businesses, setting the maximum level of pollution
acceptable from large industrial plants and sewage treatment works. Officials
decide what can be achieved on the basis of best practice, after taking
costs into account. They then issue a ‘consent’, effectively giving the
businesses permission to pollute.

The problem with this approach is that it assumes that the government
knows best – that planners in government offices are able to work out which
method is the best practical route. Many people feel that the marketplace
is a better bet. After all, the worst environmental problems in Europe are
to be found not in the market economies of the West, but in the East. And
there are few who would hold up Britain’s record on limiting pollution as
a shining success.

Dissatisfaction with command and control has led some to advocate that
price be used more directly in pollution control. Make damaging the environment
cost more, goes the argument, and there will be less damage. Market-based
approaches, generally in favour with the government, were given a boost
with the publication of the Pearce Report, Blueprint for a Green Economy,
in 1989, and the appointment of its author, David Pearce, as special advisor
to the Secretary of State for the Environment.

Pollution happens when polluters can escape paying for it. For example,
it is worth generators of electricity continuing to use dirty power stations
that emit sulphur because they do not have to pay damages to the Scandinavian
countries for the harm acid rain does to their forests and lakes. These
costs are seen as ‘external’ because they fall outside the exchanges considered
directly by the industry. The problem is to devise a way to include them
and make the polluter pay.

Taxes are one method. In the case of carbon dioxide, a tax could be
levied equal to the value of the damage done by the emissions. The tax would
put up the price of electricity and petrol, encouraging people to save energy.
It would also reward generators and car producers who invested in environmentally
benign technologies. There would be a reduction in demand and cleaner sources
of energy would be substituted. Given the target, this tax would have to
be set at whatever level was necessary to produce the supply and demand
side effects.

Carbon taxes could be levied in a number of ways. The obvious method
is to tax the emissions from each power station, factory and vehicle, but
this is hardly practical. An approximation would be to levy the tax on carbon
fuels, especially coal and oil. The carbon dioxide that comes out of power
stations is roughly proportional in the fuel that goes in and, by and large,
the more petrol a car uses, the greater the pollution. Taxes already exist
on petrol, and the principle could be generalised to other fossil fuels.
More crudely still, increase the price of electricity. The advantage of
this approach is its simplicity; the disadvantage is that nuclear and hydroelectric
power, for example, would be penalised alongside coal burning power stations.

Another method of using the market is through the fashionable concept
of marketable permits. The idea here is that the government decides how
much pollution will be permitted overall. Anyone who wants to release carbon
dioxide would need a permit, purchased from the government, which would
sell to the highest bidders. A private market in the permits would then
develop.

The beauty of this approach is that the market, rather than the government,
sorts out the cheapest way of achieving the chosen target. The permits would
be most valuable to businesses that incur the highest costs in reducing
their pollution. Operators of a dirty power station would be prepared to
pay a higher price for a permit, because they would otherwise have to pay
even more to cut their emissions. They would buy permits at a high price,
and pass the cost on to consumers. The polluter pays, producers who do not
use fossil fuels benefit, and the government achieves its target. In effect,
the market works out what the tax needs to be, rather than the government
setting the level in advance, and continually adjusting it to achieve the
required target. This system is the closest equivalent to an optimal tax
on carbon.

Carbon taxes and marketable permits do, however, have drawbacks, which
many think rule them out, at least in the short term. As with any regulatory
system, there are the practical difficulties of monitoring who is producing
which greenhouse gas. And the problems of tracking down illegal emitters
of carbon dioxide are far worse than tracing those who dump industrial waste
without the proper authority. But the most important hitch relates to the
effect of higher energy prices on the poor, who spend a greater proportion
of their income on heat and power than the rich. Electric heating is primarily
the heating of the poor and elderly, and is much more polluting than gas.
Carbon taxes would hit the poor very hard indeed: those struggling to keep
warm have little choice about the source of their power.

An obvious solution would be to offset the impact on the poor through
higher social security payments. The poor would be given back the additional
costs of purchasing electricity and other fuels. But some of these payments
would inevitably be spent on energy, partially defeating the purpose of
the tax. It is hard to reduce energy spending through a blanket system of
taxes without reducing the standard of living of the most vulnerable groups
in our society.

The second problem is assessing the impact of fluctuations in the price
of power. No one can be sure of the effect of a price rise on the use of
energy, so the taxes, or permit charges, would have to vary considerbly.
In much the same way that interest rates jump around to meet a monetary
target, taxes would have to vary whenever the achievement of the target
was in jeopardy. The fact that fuel prices are volatile makes matters worse,
as demonstrated by the high prices of oil attributed to the current tension
in the Gulf. Climate change is a long-term problem, and the impact of any
price mechanism must last at least as long. Producers and consumers must
realise that the impact is permanent and they have no alternative but to
change their habits.

In practice, no one policy option will achieve a government’s targets.
The way forward will require a mixed approach, combining command-and-control
with market mechanisms. The task is to decide which is best in particular
circumstances. Each route to achieving the target has different costs, and
we need to identify the cheapest. There is no environmental benefit from
economic inefficiency in cutting pollution. The cheaper the method, the
better.

Efficient decisions are made when the people making them are well informed
of the costs and benefits, and can exercise choices. Policies which rely
on market forces work best if consumers, have the relevant information,
and have a chance to alter their behaviour. As an example, if the price
of energy went up, people would be able to save money provided they know
what measures are sensible. But most people have little idea whether their
houses are well insulatd, or what savings cavity-wall insulation, boiler
replacement and double glazing will bring them. A sudden rise in the price
of electricity would probably make little immediate difference to the amount
used. Similarly, when people buy houses, they rarely know how much energy
they need for heating. Toughening up the building regulations, together
with support for energy audits of houses, which spell out energy needs and
losses, may have more immediate impact.

By contrast, electricity generators already know the thermal efficiencies
and polution emissions of their power stations. They can calculate the financial
impact of taxes on emissions of greenhouse gases and, over time, can invest
in less polluting technologies. Indeed, the current switch from coal to
gas in the British electricity industry is of considerable significance
to the achievement of the government’s target of carbon dioxide limits.
Here, then, market mechanisms would be expected to work well.

Balancing the two sides of the market – the ill-informed consumer and
the well-informed producer – would need a mix of market-based and command-and-control
policies. Taxes must be longer term and they must be credible, to encourage
major shifts in behaviour and technology. Setting and enforcement of standards
can be more immediate, even if they have to be crude as a consequence.

At first reading, the government’s new White Paper, Our Common Inheritance,
takes just such a pragmatic approach, combining both market and command-and-control
ideas. But closer examination reveals that this document consists of a collection
of over 300 different policies, lacking a clear set of underlying principles.
It is more like a dictionary of current measures, together with a hotch-potch
of suggestions, from cleaning up cathedrals to enforcing speed limits and
building nuclear power stations. On the critical issues of energy policy,
it explicitly rules out any increase in the real price of energy for fear
of inflation and upsetting the privatisation of electricity.

The White Paper provides little evidence that any serious thought has
been directed as to how the 2005 target will be met. Taking transport as
an example, the Department of Transport’s proposal to spend 8 billion Pounds
to cater for the anticipated doubling of the number of vehicles on the roads
by 2025 remains unaltered. Marketable permits and carbon taxes are consigned
to the appendices for ‘further study’ – civil service jargon for suffocation-by-committee.

Reducing emissions of carbon dioxide is inevitably going to be costly.
The environment like everything else, has a price. But the setting of targets
and the policies adopted to achieve them should be based on the least cost.
Inefficiency is as much the enemy of the environment as it is of the economy.
The central task is to devise a strategy which alters the supply technologies
and the level of demand for energy as efficiently as possible. Economic
analysis plays a vital role in creating the strategy, but policymakers have
yet to give the issues serious consideration.

* * *

Lessons from the past, what people do when energy costs more

There have been more than 50 studies so far on the role that carbon
taxes could play in reducing carbon dioxide emissions. Despite the use of
a wide range of assumptions and models, the conclusions all point to the
same thing – significant reductions in carbon emissions require extremely
high carbon taxes. This is because of the link between prices and demand.
The demand for energy drops by only a fraction of the rise in price, less
than 20 per cent in the long run in most of the studies. So for every 10
per cent increase in prices, the demand decreases by only 2 per cent.

Two studies by the London Business School and the Henley Centre for
Forecasting looked at carbon emissions in Britain. They found that, when
the demand for energy is rising, energy prices would have to double over
the next ten years just to keep carbon emissions constant. A study by the
Technical University of Athens for the European Commission earlier this
year showed that a tax of as high as 421 per cent on fossil fuel prices
would be needed to reach the target of 20 per cent carbon reductions approved
at an international conference – The Changing Atmosphere – held in Toronto
in 1988. These are not realistic objectives. Important though it is for
the price of fossil fuels (and nuclear power for that matter) to reflect
the long-term environmental damage they cause, a much smaller carbon or
energy tax, generating income for research or tax incentives seems to be
a more feasible option.

There are other policies available to politicians to reduce consumption
and encourage people to switch to fuels that release less carbon dioxide.
The International Energy Agency has highlighted nearly 20 such options,
covering regulation, economic methods and information programmes. A carbon
tax tends to be a fairly crude choice amongst these, according to work carried
out by the government energy Efficiency Office. Consumers do not all rush
out and install thicker building insulation, or switch to more advanced
boilers or cars as soon as the price of energy increases. For many industrial,
commercial and domestic consumers, energy is a small component of their
overall costs, less than 4 per cent on average. People living on low incomes,
who spend as much as 10 per cent of their income on energy (because of bad
housing and inefficient appliances and heating systems), cannot respond
to carbon taxes by cutting back the energy they use, short of freezing in
the dark.

The best thing about price increases is the attention that they attract
from the consumer. But there must be other strands to a policy that will
turn this awareness of the cost of energy into specific action and capital
investment. General and technical information programmes, affordable finance,
technical expertise and confidence in the stability of fuel prices in the
long term are just some of the necessasry components. Without them, there
is a barrier to the uptake of the huge scope for improvements in energy
efficiency. The British government estimates this potential at 70 per cent
for British buildings over the next ten years, 50 per cent for lighting,
40 per cent for electrical appliances and between 30 and 40 per cent for
industry as a whole.

Researchers at the Lawrence Livermore Laboratory at Berkeley in California
evaluated the energy conservation policies that worked in response to the
1973 and 1979 oil price hikes. Exhortation and short-lived general information
campaigns had little long-term effect on consumer behaviour. Rules and regulations,
such as minimum efficiency standards for buildings and cars had a long-term
and growing effect, reducing energy use.

Japan has been one of the biggest success stories, combining efficient
use of energy with economic growth. From 1973 to 1985, Japan’s Gross National
Product grew by 46 per cent, while final energy consumption hardly changed
– a reduction of 34 per cent in the energy needed to produce one unit of
economic output. The comprehensive package which delivered these energy
savings included a long-term research and development programme, a series
of minimum efficiency standards, fiscal incentives, the seting up of a core
of trained energy managers in most organisations and a wide-ranging and
sustained information campaign, in addition to high energy prices*.

Another success story has been Denmark, where energy demand per unit
of GNP has fallen to 70 per cent of the 1972 value; energy consumption per
unit of floor area in houses and flats has fallen by 5 per cent per year.
The key ingredients here were high efficiency standards for buildings, fiscal
incentives and grants, active encouragement or efficient heat and power
supply, energy labelling and other information schemes, plus sustained high
energy prices, except in industry.

So the question is not whether carbon taxes are a good or bad policy
option. They are only part of a comprehensive package of measures needed
to deliver the deep cuts in greenhouse gases that we need. Instead, we must
ask whether governments will consider developing such a widespread energy
strategy.

*Lessons from Japan: Separating economic growth from energy demand,
Association for the Conservation of Energy, 1990.

Dieter Helm is a Fellow of New College, Oxford and director of Oxford
Economic Research Associates.

Stewart Boyle is director of the energy and environment programme of
the Association for the Conservation of Energy.