We'll be ruined says OECD; Or do they?

It's amazing what you can find in economic modelling scenarios.

Yesterday The Australian (‘Industry curbed by tax, says OECD’) found the following,

OECD research has backed the Coalition’s claims that Australia’s pioneering carbon pricing is damaging its competitiveness, with energy-intensive industries shifting offshore to countries that do not tax carbon.

According to The Australian this OECD study, co- authored by no less than an Australian Treasury official, found that Australia's exports of energy-intensive goods would fall by 15.9 per cent by 2020 as a result of the carbon tax or emissions trading scheme (ETS). In addition incomes would fall by 1.2% by 2020. The study also found that the carbon price would rise to $75 per tonne if, “as is the case with Australia's emissions scheme, carbon pricing excluded agriculture, emissions from households and government, and other greenhouse gases besides carbon”.

The report apparently found that the, “only effective strategy would be imposing penalty tariffs on imports from countries without carbon taxes. However, it said there was ‘potential incompatibility with the World Trade Organisation’.”

Having myself written two reports on this topic totalling nearly 200 pages, I thought these conclusions rather startling and surprising. Horrified at what I might have missed in my own research, I eagerly downloaded this OECD report to learn more.

As I read the report my horror was replaced with hilarity.

The rather alarming $75 carbon price expected to materialise by 2020 that The Australian interpreted as representative of the Australian ETS missed something rather important – Australia’s ETS does cover gases besides carbon dioxide. The report actually found the carbon price would drop to $35 once these were included in the scheme. In addition while agriculture is not liable under Australia’s ETS, it can supply abatement into the scheme via offsets produced under the Carbon Farming Initiative. Taking this into account drops the carbon price to $20 per tonne of CO2.

What’s more their modelling assumed Australia’s scheme wouldn’t be linked with carbon markets operating overseas – but it is. And it assumed Australia would be unable to use our emissions credits from undershooting our 2008-12 Kyoto Protocol target – but we can.

In terms of the rather scary 15.9% reduction in energy intensive exports and the 1.2% income fall (which is in fact an income gain but not as great as under a zero emission reduction scenario), this was all based on the $75 carbon price that in no way represents “Australia’s pioneering carbon pricing”.

But the gross misrepresentation of the report’s applicability to the Australian ETS didn’t end there.

Yes the OECD report did examine the potential effects of applying a carbon tax to imports while exempting exports, to address international competitiveness (‘imposing penalty tariffs on imports’). Yet it didn’t at all consider the use of free permits for trade-exposed industry, as occurs under the Australian ETS. How the report could be said to have found the “only effective strategy” to prevent carbon leakage was border tax adjustments when it didn’t look at any of the alternatives is rather puzzling. 

My analysis undertaken while at the Grattan Institute found the risk of any carbon leakage was extremely small, once free permits for emissions intensive, trade exposed industry were taken into account. Indeed we found that a number of Australian industrial facilities would end up making money from the ETS because they would be given free permits in excess of their emissions.

What was actually a new and useful contribution from the OECD report was completely missed by The Australian. They found that if countries pricing carbon applied that carbon price to imports and not just domestic production (what they refer to Border Carbon Adjustments of BCAs), it could act to reduce emissions overseas that counteract any carbon leakage effects. The report finds:

“BCAs can not only eliminate the international carbon leakage effect but even lead to a substantial negative leakage rate, i.e. emissions in non-acting countries [countries that don’t price carbon] are below the baseline level. This reflects a key principle of BCAs: they extend the carbon price signal to non-acting countries. Domestic leakage increases a little, but overall effect [is] emissions outside the trading scheme are reduced.”

Australia’s emissions trading scheme entirely relies on free permits to counteract any leakage of emissions intensive trade exposed industry abroad. It will achieve this purpose and the OECD report does not in any way undermine this conclusion.

However what the OECD report does illustrate is that there should have been greater thought given to judicious use of border carbon or tax adjustments as well. That’s because they help send a signal to other countries that they cannot free ride in efforts to counter global warming, and provides an incentive for consumers to reduce use of carbon intensive imported goods.

In the end these can be made compatible with World Trade Organisation (WTO) rules, indeed a report published by the WTO says so. Also our own GST is applied as a border tax adjustment.

Australia’s carbon trading scheme will not send industry flooding overseas, but it could most definitely be improved upon.