Skeptical Of Subsidies? Me Too. (What To Do With That Messy System?)

By now most of us have agreed that to make a change and transition onto a more sustainable path we need to start sending stronger signals through the price system. The economic framework should be designed to incentivize what is good and disincentivize what is bad, in particular if the social value isn´t reflected in market prices. Working with taxes and subsidies to push development in the desired direction is therefore necessary, as the social value of lower GHG emissions isn´t reflected in the current prices for different types of energy.

However, the situation we face is even more troublesome than one might think at first glance. Recent numbers show that globally, subsidies to production and consumption of fossil fuels far exceed subsidies to renewable energy. According to the International Energy Agency (IEA), in 2010, the subsidies to fossil fuels amounted to $409bn, six times the $66bn in subsidies given to renewable energy technologies! Sure enough the renewable energy share of total energy production is smaller, and most of the subsidies to fossil fuels are given in developing or transitional countries, but this is the exact opposite of what we agreed is a desirable incentive pattern. There is no doubt there is something fundamentally wrong with this system.

And it isn´t even about distributional effects. Whereas parts of the industrialized world use more subtle measures (such as exempting boat and air traffic from fuel taxes), fuel prices are subsidized more directly in many developing countries. Several oil exporters lower the price of imported gasoline and justify it by claiming poverty alleviation. How ironic then that a large share of the poor population the subsidies are said to benefit don’t even have access to cars… Not to mention how disturbing it is that the money spent on subsidies could have been used for investments necessary for economic development.

The IEA suggests that phasing out subsidies can result in up to half of the cuts in GHG emissions necessary to curb global warming. However, attempts to cut subsidies have been met with strong and sometimes violent protests, for example in Bolivia last year and in Nigeria a couple of weeks ago. Despite expected long-run benefits of redistributing money from energy subsidies to investments in infrastructure, health care and education, the short-run effect of drastically higher energy prices are a hard hit to the population.

The problem described above is only one example of how complex and messy the global system is. It already was, but is even clearer now that meeting the challenge will require a strong global framework, so that creating the right incentives can be accomplished as soon as possible. As a final note I´d like to share an example posed by Swedish social liberal think tank Fores – an interesting suggestion of a new global framework to deal with climate challenges, a sort of Bretton Woods system for the climate. A core group of major emitters, accounting for more than 90 percent of emissions, would form a binding agreement on a fixed cap and a global trade system, coupled with sanctions for non-compliers and incentives for outside countries to adhere. Surely there are objections against the proposal too, but avoiding the seemingly mandatory crippling and game theoretical stalemates of international negotiation rounds, providing an exchange rate system to link regional emission trading systems and establishing a Green Fund for mitigation and adaption projects which builds on redistribution from rich countries that historically have been high-emitters to poor countries that otherwise would “need” to emit to develop economically are indeed appealing features.

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