Economics of Sustainable Development and PreliminaryResults of Fossil Fuels Study

Balázs Horváth

Poverty Reduction Practice Leader,

UNDP, Bratislava Regional Center

Roadmap

Economics & political economy of sustainable development• Definition of sustainable development, key considerations• Anatomy of energy prices• Energy pricing is crucial element of sustainable development• Political economy of low-carbon reforms: why so hard?

Results of the fossil fuel subsidy study in Western Balkans• Methodology and coverage• Main subsidization channels• Estimated fossil fuel-related subsidies are large• Health warning: fossil-fuel subsidies are bad for you

Conclusion: Policy considerations

Development is sustainable if human capital, knowledge capital, natural capital and produced capital that society

disposes over do not decline over time (Arrow et al., 2004).

Economic, social & environmental pillars—interdependent

Three-legged stool: topples if any leg wobbles

» Economic: Iceland, Ireland, » Social: Arab Spring, Kyrgyzstan» Environmental: Central Asia, Maldives, China

Gini Coefficients in Some Arab States

Egypt, Arab Rep.

Jordan Morocco Syria Tunisia Yemen, Rep.

29.0

31.0

33.0

35.0

37.0

39.0

41.0

43.0

1995

2000

2005

2007

Sustainable development: some considerations

• Interaction of flows & stocks: e.g., rapidly running down the natural resource base (depleting natural capital) raises ST income flow, but lowers income path & HD level in M<

• Reversing losses costs far more than spending required to avoid them; some losses (e.g., in biodiversity) irreversible;

• Critical, complementary roles of

state, private & civil sectors;• An issue of intergenerational equity.

Anatomy of Energy Pricesfor End-Users

Domestic Price + Subsidies Cost-recovery market price+ Counterpart reflecting externalities Current Cost to Society+ Counterpart reflecting stock depletion Sustainable price level

(reflecting all current & long-run costs)Best practice today: covering first two, and part of externalities

Renewables: no stock depletion—but prices do not reflect this advantage

Sustainable prices positive LR impact on S & D side; on mix.

CURRENT DOMESTIC PRICE

SUBSIDIES

Consumption & production externalities

Counterpart of stock depletion

Higher Energy Prices: Necessary Part of Sustainable Development

* Climate change threat makes prompt collective action worthwhile. 

* Price not reflecting externalities, depletion wrong signal toward CO2-heavy activity

* Coordination problem:

Fundamentally alter decisions of billions

Only appropriate price signals can deliver

phase in CO2 "sin tax", or

charge for traded carbon credits.

* Need globally coordinated, monitored & enforced change with no offsetting subsidies

* Need effective national & global regulation to avoid free-riding & guide massive global reallocation of fossil fuel rents

* Predictable price path over investment horizon facilitates technology diffusion

* In 100 years mankind will have a much smaller GHG footprint, no matter what…

Political Economy of Low-carbon Reforms

• Front-loaded costs• Back-loaded benefits• It’s a no-brainer, right? But• Assume elections in year 2

• Let’s examine time profile:• Net benefits from year 3; • Cum net benefit: year 5• Tech bounce advances break-even

point

II. Results of the fossil fuel subsidy study in Western Balkans

• WB-OECD-IEA methodology (Seoul, 2010 G-20 Report) • Based on data for the period 2005 –2010 for Albania, Bosnia

and Herzegovina, Croatia, FYR Macedonia, Kosovo/1244, Montenegro and Serbia;

• Covers fossil fuel-based thermal power generation & district heating, lignite for power generation, lignite/coal for the retail market, crude oil & petroleum products, & natural gas;

• Includes indirect support and net effects of cross-subsidies;

• Excludes state aid and loan guarantees.

Some subsidy mechanisms • Low-cost hydro generation cross-subsidizing lignite fired power

generation high barrier to entry;

• Regulatory support to commercial players in energy intensive sectors;

• Preferential access to credit;

• Tax breaks;

• Tolerated non-payment by energy-intensive companies;

• Protective trade barriers;

• Low natural resource access / concession fees are assessed;

• No environmental impact costs are assessed.

Preliminary Estimate of Fossil Fuel-related Subsidies: They Are Large

Country Energy related subsidies as % of GDP

Albania 7-8%

Bosnia-Herzegovina 9-10%

Croatia 5-6%

FYR of Macedonia 8-9%

Montenegro 10-11%

Serbia 7-9%

UNMIK / Kosovo 35-36%

Health warning on fossil fuel subsidies

• They distort the price signal (both the price level and relative prices)hinder market entry for efficient fuels and renewable energy lower energy efficiency and thus raise CO2 emissionencourage non-optimal substitution.

• They re-distribute resources regressively and nontransparently • Expected future shift from unsustainable situation dampens investment • They fail to sustainably raise export competitiveness, changing only the

mix of production and exports toward energy-intensive areas

• Same resources could be put to more desirable use (opportunity cost).

Policy considerations—Energy Pricing

• Rule #1 of Challenge Management:

When in a hole, stop digging

(abandon business as usual).

• Global problem global solution• More effective to shape activity through prices than quantities• Effective institutions needed to

– reflect and compare costs & benefits on vastly different horizons; – reconcile politicians’ short horizons with longer one that is socially optimal – facilitate coordinated intervention transcending national borders; and– make transfers that align globally optimal action with local/national incentives.

Policy Considerations—Subsidies

• Upgrade policies toward the EU environmental acquis to reduce environmental damage and fiscal risks.

• Scrutinize subsidies and cross-subsidies in line with the IEA, OPEC, OECD, World Bank Joint Report (June 2010) Decision Tree.

• Pursue regional integration and design National Action Plans to phase out unjustified fossil fuel subsidies.

• Support energy efficiency upgrade and the use of renewable energy

• Devise operational regional arrangements to use energy infrastructure

• Apply State Aid Laws in line with the EU acquis, and adopt the Extraction Industries Transparency Initiative to enhance transparency.

• Thank You for Your Attention

• Questions, Comments Most Welcome