There is no single answer to the question of where it’s cheapest to cut emissions.
But when more than one country shares a common carbon price or tax, the total cost of the climate policy is higher in the countries whose economies are more carbon intensive; for example, Australia. This is despite these countries actually having more low-cost opportunities to cut carbon emissions than greener economies such as Sweden.
This is the main finding of an article by my Australian National University colleagues Jack Pezzey and Ross Lambie and myself in the current edition of the Australian Journal of Agricultural and Resource Economics.
This issue became very relevant in the last week. The Australian government announced that it would link the Australian emissions trading scheme (ETS) to the European ETS. This means that the price of carbon will be the same in both markets from 2015.
It’s well-known that the costs of cutting carbon emissions will be different in different countries and regions. But which countries have high costs and which have low costs depends on how these costs are defined.
There are two main ways of thinking about the cost of cutting emissions. We can look at the cost of cutting a single extra tonne of carbon emissions. Economists call this the marginal cost of abatement. Alternatively, we can try to measure the total cost of carrying out a climate policy.
Our theory is that there are more “low-hanging fruit” - low cost or easy options for cutting emissions - in countries like the US and Australia which have had less-aggressive energy efficiency policies. Economists would say that the marginal cost of abatement is low in these countries.
But when we think about the total costs of cutting carbon emissions, these less-efficient countries will bear higher costs. To use the same analogy, this is because the more fruit there is below a given height, the bigger the total crop will be. A common carbon price is like an agreement that all countries harvest emissions reductions up to the same height on the trees. The total cost of such a policy should, therefore, be higher in countries like Australia whose economies are more emissions intensive, because it requires a larger total cut in emissions than countries like Sweden would.
Another twist is that how much a dollar buys depends on where you are spending your money. As shown by the Economist magazine’s Big Mac Index, a dollar buys much more in India and China than in America. And more in America than in Switzerland. This means that cutting a tonne of carbon emissions in India might look cheap in terms of US Dollars but actually be quite costly in terms of Rupees.
To test our theory, we need information on the costs of climate policies in different countries. Obviously we don’t actually know how much policies that don’t yet exist will cost. But we can use computer simulation models to try to estimate these costs and test our theory.
We used the results of a recent simulation exercise called EMF-22. Ten modelling teams from around the world took part. The models - called integrated assessment models - can simulate the effects of policies on the world economy and the climate. Each team used their model to simulate the effects of ten different future climate policy scenarios.
The results of the EMF-22 exercise broadly confirm our hypotheses. They show that the marginal abatement cost is highest in the European Union, lowest in China and India with the US in the middle. But when all countries adopt a common global carbon price, the total costs as a percentage of gross domestic product (GDP) are lowest in the European Union and highest in the two developing countries.
We also found that a Kyoto treaty-style agreement where countries cut emissions by a common percentage has similar results. However, if instead the common target is set for reductions in emissions per dollar of GDP then China and India are the countries with the lowest total costs.
These findings might explain why different countries favour different climate policies and why some are more enthusiastic about action than others. The European Union has been the most enthusiastic about taking action on climate change. And it has advocated policies establishing a Kyoto treaty-style agreement, which would impose the least cost on itself. On the other hand, China and India have announced targets for reducing their emissions per dollar of GDP, which we found imposed relatively low costs on these developing countries.
Our findings also emphasise the complexity of communicating climate change policies. There is no single answer to the question of “Where is it cheapest to cut carbon emissions?” and the choice of answer makes a difference.