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Offentligt

Aligning Policies

for a Low-carbon Economy

Secure

Sustainable

Together

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Aligning Policies

for a Low-carbon Economy

SAU, Alm.del - 2016-17 - Bilag 3: OECD publikationer om inklusiv vækst

This work is published under the responsibility of the Secretary-General of the OECD. The

opinions expressed and arguments employed herein do not necessarily reflect the official

views of the member countries of the OECD, the OECD Nuclear Energy Agency, the

International Energy Agency or the International Transport Forum.

This document and any map included herein are without prejudice to the status of or

sovereignty over any territory, to the delimitation of international frontiers and boundaries

and to the name of any territory, city or area.

Please cite this publication as:

OECD/IEA/NEA/ITF (2015),

Aligning Policies for a Low-carbon Economy,

OECD Publishing, Paris.

http://dx.doi.org/10.1787/9789264233294-en

ISBN 978-92-64-23326-3 (print)

ISBN 978-92-64-23329-4 (PDF)

The statistical data for Israel are supplied b180y and under the responsibility of the relevant Israeli authorities. The

use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli

settlements in the West Bank under the terms of international law.

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Cover © Baseline Arts Ltd, Oxford.

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FOREWORD –

Foreword

At the Ministerial Council Meeting in May 2014, ministers and representatives of

OECD member countries and the European Union invited the OECD to work with the

International Energy Agency (IEA), the International Transport Forum (ITF) and the

Nuclear Energy Agency (NEA) “to continue to support the UNFCCC negotiations and to

examine how to better align policies across different areas for a successful economic

transition of all countries to sustainable low-carbon and climate-resilient economies and

report to the 2015 OECD Ministerial Council Meeting.” These areas include economic,

fiscal, financial, competition, employment, social, environmental, energy, investment,

trade, development co-operation, innovation, agriculture and sustainable food production,

regional as well as urban, and transport policies.

This report on

Aligning Policies for a Low-carbon Economy

responds to that request

by identifying where existing policy and regulatory frameworks are at odds with climate

policy, i.e. where existing policies may make climate policy less effective than it could be

otherwise. It reflects the initial diagnosis on where and how existing policy and

regulatory frameworks may not be aligned with a low-carbon economy.

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– ACKNOWLEDGEMENTS

Acknowledgements

This report is the product of a collaborative effort between the Organisation for

Economic Co-operation and Development (OECD), the International Energy Agency

(IEA), the Nuclear Energy Agency (NEA) and the International Transport Forum (ITF).

It has been overseen by OECD Deputy Secretary-General Rintaro Tamaki and co-

ordinated by Richard Baron, Project Co-ordinator, and Virginie Marchal. Amelia Smith

provided continuous editorial and secretarial support. The team is grateful to Simon

Upton, for his very useful guidance and leadership throughout the project, to Andrew

Prag who drafted the chapter on trade and provided valuable advice on the rest of the

report, and to Michael Mullan for the chapter on adaptation.

The authors would also like to thank particularly the following colleagues across the

four organisations for their input throughout the project: Anthony Cox, Nick Johnstone,

Tomasz Kozluk, Alexis Robert, Ron Steenblik and Kurt Van Dender (all from the

OECD), Philippe Benoit (IEA), Jan Keppler (NEA) and Stephen Perkins (ITF). The team

is also indebted to Sarah Finke for guiding the publication through the OECD approval

process. Government officials from different ministries across OECD countries, and

stakeholder representatives, in particular business (co-ordinated through the Business and

Industry Advisory Committee of the OECD), and trade unions (co-ordinated through the

Trade Union Advisory Committee to the OECD) provided extensive feedback on the first

draft of the report during and after a consultation seminar organised in February 2015 at

OECD headquarters.

The main authors of

Aligning Policies for a Low-carbon Economy

were:

Chapters

Executive Summary

Chapter 1:

Core climate policies and the case for policy alignment

Chapter 2: Scaling-up low-carbon investment and finance

Chapter 3: Implementing climate-friendly taxation practices

Chapter 4: Delivering innovation and skills for the low-carbon

transition

Chapter 5: Removing international trade barriers

Chapter 6: Diagnosing misalignments for a more resilient future

Chapter 7: Reframing investment signals and incentives in electricity

Chapter 8: Opting for low-carbon urban mobility

Chapter 9: Strengthening incentives for sustainable land use

Main authors

Richard

Baron

and

Virginie Marchal

Richard Baron

Virginie Marchal

Richard Baron with �½iga

�½arnic

Richard Baron and Nick

Johnstone

Andrew Prag

Michael Mullan

Richard Baron

Virginie Marchal

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ACKNOWLEDGEMENTS –

Many other colleagues provided comments and suggestions and their contributions

are gratefully acknowledged. They include: from the Centre for Entrepreneurship, SMEs

and Local Development: Nathalie Cliquot; from the Centre for Tax Policy and

Administration: Johanna Arlinghaus; Florens Flues, Michelle Harding; from the

Development Co-operation Directorate: Jan Corfee-Morlot and Stephanie Ockenden;

from the Directorate for Financial and Enterprise Affairs: Karim Dahou, Raffaele Della

Croce, Despina Pachnou, Cristina Tebar-Less, David Pinkus, Joel Paula, Gert Wehinger;

from the Economics Department: Silvia Albrizio, Boris Cournède, Alain De Serres,

Balázs Egert, Christian Kastrop, Giuseppe Nicoletti and Mauro Pisu; from the Directorate

for Employment, Labour and Social Affairs: Alessandro Goglio and Paul Swaim; from

the Environment Directorate: Shardul Agrawala, Geraldine Ang, Nils Axel Braathen,

Gregory Briner, Simon Buckle, Jean Chateau, Christopher Kaminker, Kumi Kitamori,

Nicolina Lamhauge, Walid Oueslati, Robert Youngman and �½iga �½arnic, who also helped

on the organisation of an international seminar dedicated to this project; from the

International Energy Agency: Heymi Bahar, Manuel Baritaud, Adam Brown, Pierpaolo

Cazzola, Laura Cozzi, Davide D’Ambrosio, John Dulac, Anselm Eisentraut, Paolo

Frankl, Jean-François Gagné, Timur Guel, Christina Hood, Fabian Kesicki, Ellina Levina,

Simon Mueller, Cédric Philibert, Sylvia Spruck, Laszlo Varro and Matthew Wittenstein;

from the International Transport Forum: Aimée Aguilar-Jaber, Olaf Merk and José

Viegas; from the Nuclear Energy Agency: Thierry Dujardin; from the Public Governance

and Territorial Development Directorate: Rudiger Ahrend, Rolf Alter, Charles Baubion,

Andrew Davies, Claire Charbit, Isabelle Chatry, Ronnie Downes, Catherine Gamper,

Daniela Glocker, Stéphane Jacobzone, Céline Kauffmann, Karen Maguire, Tadashi

Matsumoto, Marissa Plouin, William Tompson and Paolo Veneri; from the Directorate

for Science, Technology and Innovation: Mario Cervantes, Colin Webb, Kirsten Wiebe,

Andrew Wyckoff, Norihiko Yamano; from the Trade and Agriculture Directorate: Ken

Ash, Morvarid Bagherzadeh, Jonathan Brooks, Dimitris Diakosavvas, Jared Greenville,

Guillaume Gruère, Julien Hardelin, Ada Ignaciuk, Franck Jésus, Jean Le Cocguic, Jehan

Sauvage, Frank Van Tongeren and Martin Von Lampe. The report also benefited from

comments of external reviewers: Michael Jacobs and James Rydge (New Climate

Economy), and Ian Cochran (CDC Climat Recherche).

Fiona Hinchcliffe and Jennifer Allain provided editorial support, and Janine Treves,

Katie Kraig-Ernandes, Catherine Bremer, Shayne MacLachlan and Stéphanie Simonin-

Edwards supported the publication and communication processes.

Japan and Korea provided financial contributions to the project.

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TABLE OF CONTENTS –

Table of contents

Acronyms and abbreviations

.............................................................................................................. 11

Preface...................................................................................................................................................

Executive summary..............................................................................................................................

Chapter 1

Core climate policies and the case for policy alignment

................................................ 19

Facilitating the low-carbon transition................................................................................................. 23

Core climate policies: Principles and implementation ....................................................................... 28

Notes .................................................................................................................................................. 40

References .......................................................................................................................................... 41

Part I Reforming cross-cutting policies

........................................................................................... 45

Chapter 2

Scaling-up low-carbon investment and finance

............................................................. 47

The low-carbon investment challenge ................................................................................................ 49

The enabling environment: Aligning investment policies with climate goals ................................... 54

Channelling all sources of finance to low-carbon infrastructure........................................................ 58

Enhancing climate risk disclosure by corporations and investors ...................................................... 61

Mainstreaming climate change goals in public spending ................................................................... 64

Notes .................................................................................................................................................. 72

References .......................................................................................................................................... 73

Chapter 3

Implementing climate-friendly taxation practices

......................................................... 79

The taxing issue of low-carbon economies ........................................................................................ 81

How energy subsidies and taxes undermine climate change action ................................................... 82

Beyond energy taxes: Tax signals hindering low-carbon choices...................................................... 86

Where next for tax revenues and budgets in the context of lower fossil energy use? ........................ 89

Notes .................................................................................................................................................. 91

References .......................................................................................................................................... 92

Chapter 4

Delivering innovation and skills for the low-carbon transition

.................................... 95

Unpacking innovation policy for the low-carbon transition............................................................... 97

Putting the labour markets at work for the low-carbon transition .................................................... 106

Policy misalignments restricting innovation in industry .................................................................. 109

Notes ................................................................................................................................................ 116

References ........................................................................................................................................ 116

Chapter 5

Removing international trade barriers..........................................................................

123

Greenhouse gas emissions and international trade ........................................................................... 125

Potential misalignments with international trade rules .................................................................... 126

Misalignments arising through domestic policies related to trade ................................................... 129

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– TABLE OF CONTENTS

Fuelling international trade: Maritime shipping and aviation .......................................................... 134

Resilience of the modern trade system to climate change ................................................................ 136

Notes ................................................................................................................................................ 137

References ........................................................................................................................................ 138

Chapter 6

Diagnosing misalignments for a more resilient future

................................................ 143

All countries will be affected by climate change ............................................................................. 145

Building resilience to climate impacts ............................................................................................. 147

References ........................................................................................................................................ 152

Part II Aligning policies in specific activities..................................................................................

155

Chapter 7

Reframing investment signals and incentives in electricity

........................................ 157

Electricity in decarbonisation ........................................................................................................... 159

How today’s market structures risk hindering the decarbonisation of electricity ............................ 163

Misalignments in fast-growing and often regulated electricity systems .......................................... 171

Resilience of energy systems to climate change .............................................................................. 173

Notes ................................................................................................................................................ 176

References ........................................................................................................................................ 178

Chapter 8

Opting for low-carbon urban mobility

.......................................................................... 181

The decarbonisation challenge for urban transport .......................................................................... 183

Complementarities across policy sectors, programmes and levels of government .......................... 187

Remove barriers to action by cities .................................................................................................. 189

Removing bottlenecks to energy efficiency and technology breakthrough ..................................... 197

References ........................................................................................................................................ 201

Chapter 9

Strengthening incentives for sustainable land use

....................................................... 205

Land use could be key for tackling climate change ......................................................................... 207

Align food production and low-carbon goals ................................................................................... 210

Sustainable forest management should be at the core of a low-carbon, resilient society................. 225

Moving towards a bio-economy consistent with climate and development objectives.................... 228

Waste and over-consumption need to be tackled ............................................................................. 231

Towards an integrated and holistic approach ................................................................................... 233

Notes ................................................................................................................................................ 234

References ........................................................................................................................................ 234

Tables

Table 1.1. A wide range of energy and climate policies to reduce greenhouse gas emissions .............. 32

Table 2.1. Examples of policy misalignments that undermine low-carbon investment ........................ 53

Table 2.2. How challenges and opportunities for low-carbon, resilient infrastructure

investment vary by national circumstances or institutional context ..................................................... 58

Table 4.1. Clinker-to-cement ratios (inverse measure of clinker substitute use) by region ................. 113

Table 6.1. Climate change projections of insured losses and/or insurance prices ............................... 146

Table 6.2. A range of potential climate risks and response measures.................................................. 149

Table 6.3. Summary of risk management, risk pooling and risk transfer approaches ......................... 150

Table 9.1. Potential environmental impact of Producer Support Estimate and their share

in the OECD area ................................................................................................................................ 215

Table 9.2. Food loss and waste along the supply chain ....................................................................... 232

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TABLE OF CONTENTS –

Figures

Figure 1.1. Greenhouse gas emissions pathways 2000-2100: All scenarios from the IPCC Fifth

Assessment Report ............................................................................................................................. 23

Figure 1.2. Monetary carbon values used for investment projects in the transport sector ......................... 31

Figure 2.1. Investment needs in a 450* Scenario, 2014-35 ....................................................................... 50

Figure 2.2. Assets held by financial intermediaries in the 20 largest economies and euro area ................ 51

Figure 2.3. Global annual energy supply investment, 2000-13 ................................................................. 52

Figure 2.4. Trends in bilateral official development assistance to climate, 2002-13................................. 68

Figure 2.5. Bilateral development finance* to the energy sector, 2002-13 ............................................... 69

Figure 2.6. Sectoral distribution of official development assistance support to private investment in

infrastructure, 2011 ............................................................................................................................ 70

Figure 2.7. Developing countries’ net resource receipts from DAC countries and multilateral

organisations in 2000-11 .................................................................................................................... 71

Figure 3.1. Taxation of energy in the OECD area on a carbon content basis ............................................ 83

Figure 3.2. The difference between gasoline and diesel tax rates for road transport ................................. 85

Figure 4.1. Public sector spending in energy research, development and demonstration in IEA countries

........................................................................................................................................................... 99

Figure 4.2. Tax subsidy rates on R&D expenditures, 2013 ..................................................................... 100

Figure 4.3. Business expenditures on R&D by SMEs and direct government funding, 2012 ................. 101

Figure 4.4. Framework policies and resource flows to patenting firms, 2003-10 ................................... 103

Figure 4.5. Technologies for reducing cement direct CO

emissions between the 4DS and 2DS ........... 111

Figure 5.1. Production-based and consumption-based CO

emissions for selected countries ................. 126

Figure 5.2. STRI* by policy area: Engineering services ......................................................................... 133

Figure 6.1. Economic losses due to disasters in OECD and BRIC countries, 1980-2012 ....................... 145

Figure 7.1. Contributions to annual emissions reductions between a 6°C and a 2°C Scenario ............... 160

Figure 7.2. Electricity generation by technology and CO

intensity in the 450 Scenario, 1990-2035 ... 161

Figure 7.3. Selected climate change impacts on energy .......................................................................... 175

Figure 8.1. A potential contribution of strategies and transport modes to a 2°C future .......................... 184

Figure 8.2. Growth of world urban population in absolute numbers of new urban dwellers (billion

inhabitants), 1950-2050 ................................................................................................................... 185

Figure 8.3. Scenarios of growth in mobility and CO

emissions for Latin American, Chinese and Indian

cities, 2010-50 .................................................................................................................................. 186

Figure 8.4. Functional areas do not match administrative units in urban areas ....................................... 188

Figure 8.5. Inventive activity in technologies included in the “green” patent index, 1990-2010 ............ 199

Figure 8.6. The effect of prices and standards on alternative fuel vehicle innovation............................. 200

Figure 9.1. The role of land use in greenhouse gas emissions and sinks, 2001-10.................................. 208

Figure 9.2. Climate regulation is just one of many services provided by land use .................................. 211

Figure 9.3. Linkages between policies, agricultural driving forces and the state and impact of agriculture

on the environment and human welfare ........................................................................................... 213

Figure 9.4. Changes in producer support estimate (PSE)* in OECD and non-OECD countries, 1995-2012

......................................................................................................................................................... 214

Figure 9.5. Greenhouse gas emissions, GDP and productivity for agriculture in the OECD area, 1990-

2010 ................................................................................................................................................. 216

Figure 9.6. Evolution of producer support by potential environmental impact in the OECD area, 1990-

2012, in USD million ....................................................................................................................... 216

Figure 9.7. Number of countries with export restrictions on food staples, 2007-13 ................................ 218

Figure 9.8. Government expenditures on R&D as a share of total support to agriculture ....................... 222

Figure 9.9. Policy Framework for Investment in Agriculture.................................................................. 223

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ACRONYMS AND ABBREVIATIONS –

Acronyms and abbreviations

2DS

4DS

6DS

APEC

BRT

CBA

CCS

CDM

CfD

CHP

CIS

COP21

DAC

DSM

DSR

EBRD

ECA

EPA

ESG

ETS

FiT

FSB

GATS

GATT

GDP

Energy scenario of the International Energy Agency’s

Energy Technology

Perspectives

compatible with limiting global warming to 2°C

Energy scenario compatible with limiting global warming to 4°C. See 2DS.

Energy scenario compatible with limiting global warming to 6°C. See 2DS.

Asia-Pacific Economic Cooperation

Bus rapid transit

Cost-benefit analysis

Carbon capture and storage

Clean Development Mechanism

Contract for Difference (United Kingdom)

Combined

heat and power

Commonwealth of Independent States

21st Session of the Conference of the Parties to the United Nations

Framework Convention on Climate Change

Development Assistance Committee (OECD)

Demand-side management

Demand-side response

European Bank for Reconstruction and Development

Export credit agency

Environmental Protection Agency (United States)

Environmental, social and governance

Emissions Trading System

European Union

Feed-in tariff

Financial Stability Board

General Agreement on Trade in Services

General Agreement on Tariffs and Trade

Gross domestic product

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– ACRONYMS AND ABBREVIATIONS

GHG

GPP

GVC

ICAO

ICT

IEA

IMO

INDC

IPCC

ITF

LCR

LTA

MPO

MSW

NDRC

NEA

NTB

ODA

PDU

PES

PFI

PFIA

PMR

PPP

PRI

PSE

RCP

RD&D

REDD+

RMV

Greenhouse gas

Green public procurement

Global value chain

Gigawatts

International Civil Aviation Organization

Information and communications technology

International Energy Agency

International Maritime Organization

Intended nationally determined contribution

Intergovernmental Panel on Climate Change

International Transport Forum

Local-content requirement

Land Transport Authority (Singapore)

Metropolitan planning organisation

Municipal solid waste

National Development and Reform Commission (People’s Republic of

China)

Nuclear Energy Agency

Non-tariff barrier

Official development assistance

Urban mobility plan

French:

Plan de déplacements urbains

Payment for ecosystem services

Policy Framework for Investment

Policy Framework for Investment in Agriculture

Product market regulation

Public-private partnership

Public research institution

Producer Support Estimate

Photovoltaics

Representative concentration pathway

Research, development and demonstration

Reduction in Emissions from Deforestation and Forest Degradation

Rhein-Main Transport Association (Germany)

Rhein-Main Verkehrsverbund

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ACRONYMS AND ABBREVIATIONS –

RTA

SCM

SME

SNG

SOE

STRI

T&D

TBT

tCO

-eq

TfL

TISA

TRIMS

UNFCCC

VAT

VET

VRE

WTO

Regional trade agreement

Agreement on Subsidies and Countervailing Measures

Small and medium-sized enterprise

Synthetic natural gas

State-owned enterprise

Services Trade Restrictiveness Index

Transmission and distribution

Agreement on Technical Barriers to Trade

A measure of greenhouse gas emissions, expressed in tonnes of CO

equivalent

Transport for London

Trade in Services Agreement

Agreement on Trade-Related Investment Measures

United Nations Framework Convention on Climate Change

Value-added tax

Vocational education and training

Variable renewable energy

World Trade Organization

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PREFACE –

Preface

Addressing human-induced climate change is one of the most significant challenges

to be undertaken by the international community. The problem has long been identified

but emissions of greenhouse gases keep rising, and the urgency of action increases with

every passing year. Protecting the earth’s climate implies a transformational agenda that

needs a resolute and enduring commitment. The IPCC Fifth Assessment Report tells us

that we need to return global greenhouse gas emissions to a net zero level by the end of

the century. That means a drastic departure from the continuous growth in emissions we

have witnessed in recent years: global emissions have to peak in the coming decade in

order to avoid a global temperature increase above 2°C.

More and more countries are implementing policies to reduce their emissions,

including carbon pricing mechanisms and energy efficiency measures. Governments have

also actively encouraged the research, development and deployment of low-carbon

technologies. These new technologies are starting to make inroads into the share of fossil

fuels, even if the latter still account for more than 80% of total energy supply globally. A

well-balanced package of carbon pricing, energy efficiency measures and targeted

support to low-carbon technologies ought to be at the core of climate mitigation policy.

Their implementation needs broadening and deepening to redirect investment away from

fossil fuels and towards a low-carbon energy mix.

In 2014, OECD Ministers encouraged our four organisations to work together to

answer a fundamental question: are policy frameworks, in areas as diverse as investment,

taxation, energy, labour, agriculture and others, well aligned with the pursuit of the

transition to a low-carbon, climate-resilient economy? And if the answer is no, can they

be better aligned and become new levers for the decarbonisation of the economy? Our

joint work started from the observation that the world economy has grown for well over a

century on the back of convenient fossil sources of energy, and that moving away from

them is a formidable structural challenge. Coal, oil and natural gas have influenced

energy systems, the organisation of our cities and transport networks, and how

governments raise taxes. The regulatory wiring of our economies was designed for a

world powered by fossil fuels long before we identified the impact of rising greenhouse

gas emissions on the Earth’s climate.

This report confirms that a number of policies are not well aligned with climate

policy objectives and are in some cases in direct conflict. Fiscal systems contain a number

of provisions that guide consumers and companies

towards

higher fossil energy

consumption and production. The broad environment for investment is also not always

conducive to investment in the long-term infrastructure needed to fight climate change.

Corporate disclosures still lack transparency on companies’ exposure to climate risks.

Trade measures can also restrict access to low-carbon technologies, increasing the cost of

the transition. The policy environment for innovation is not always conducive to the

emergence of new technologies and business models.

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– PREFACE

We have also studied specific activities that are central to the decarbonisation

challenge: electricity systems, where market design fails to provide signals for investment

in the needed low-carbon, capital-intensive power generation technologies (such as solar,

wind, nuclear, and power plants fitted with carbon capture and storage); urban mobility,

where integration of land-use planning and sustainable transport systems remains

difficult; and rural land use, where too many environmentally harmful subsidies remain,

to name just a few examples. In these cases as well, policy frameworks can be revisited

to ease the transition to low carbon and this report documents actual policy solutions in

developed and developing countries alike.

The sum effect of policy misalignments in an economy can significantly undermine

the effectiveness of climate policy efforts. It is important that governments make their

own diagnosis of policy frameworks that inadvertently hamper decarbonisation to see

what reforms are warranted. All parts of governments, including those outside the usual

climate policy portfolio, can contribute. In many cases, solving misalignments can deliver

on other important policy objectives: more infrastructure investment, a more inclusive

growth, higher energy security and a healthier environment.

Limiting global climate change to within safe boundaries is essential. Effective action

requires a better alignment of policy frameworks with climate goals. Our joint report

shows governments where they should start looking for more policy levers if they want to

ease the transition to a low-carbon economy.

Angel Gurría

Secretary General, OECD

Maria van der Hoven

Executive Director, IEA

José Viegas

Secretary General, ITF

William D. Magwood, IV

Director General, NEA

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EXECUTIVE SUMMARY –

Executive summary

Addressing climate change requires urgent policy action to drive an unprecedented

global infrastructure and technological transformation. More countries are implementing

core climate policies: carbon pricing and market-based instruments, regulatory intervention

and targeted support to innovation in low-carbon sustainable technologies. But global

greenhouse gas emissions have risen rapidly and remain too high to avoid severe and

irreversible climate change impacts.

A number of obstacles stand in the way of effective climate policy. Among the most

important is the fact that existing policy frameworks and economic interests continue to be

geared towards fossil fuels and carbon-intensive activities, as coal, oil and natural gas have

fuelled global economic development for centuries. Inadvertently or not, this creates a

misalignment between existing policy frameworks and climate objectives, hindering low-

carbon investment and consumption choices.

This report presents the first broad diagnosis of misalignments with climate goals in

areas essential to the transition to a low-carbon economy. It points to a number of

misalignments in policy domains, such as finance, taxation, trade policies, innovation and

adaptation, as well as in three specific sectors: electricity, urban mobility, and land-use.

Beyond facilitating climate action, aligning these policies with a low-carbon economy

can contribute to a broader reform agenda for greener, more resilient and inclusive growth,

including more progressive tax codes, pro-growth long-term infrastructure investment, and

energy and transport systems that support cleaner air, better health and a more diversified

energy supply.

Better policy alignment for a better climate and better growth

Scale up sustainable low-carbon investment and finance.

There is an urgent and

unprecedented opportunity to ensure that new investment in infrastructure supports the

climate agenda while fostering economic development. The additional short-term costs of

shifting to low carbon would amount to just a fraction of the finance needed for

infrastructure overall. There is no shortage of capital, but new sources of financing need to

be mobilised. Financial stability is a prerequisite to any kind of investment, including low

carbon. However, financial regulations could unintendedly limit the supply of long-term

finance. Addressing the potential impact of existing financial sector rules could unlock

investment in low-carbon infrastructure. Public finance and investment can also catalyse

the low-carbon transition provided that governments reconsider their support for

investments in greenhouse-gas-intensive activities, and mainstream climate objectives into

public procurement and official development assistance.

Look at taxation beyond energy alone.

Subsidies and tax expenditures favouring the

production and use of fossil fuels slow down low-carbon innovation; however, current low

oil prices also present an opportunity for reform. Other taxes and tax provisions deserve a

closer look (e.g. property taxes, various corporate income tax provisions), as they may

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– EXECUTIVE SUMMARY

encourage carbon-intensive choices. For example, the tax treatment of company cars

encourages more CO

emissions across OECD countries. Governments also need to

anticipate the impact of the low-carbon transition on tax revenues.

Spur low-carbon innovation on a large scale.

Clear and credible government

commitment to ambitious core climate policy instruments is an important spur for

low-carbon innovation. The low-carbon transition could – and in some cases already is –

driving a boom in innovation and emerging businesses, and a parallel shift in skills and the

labour force. Innovation for the low-carbon transition is about the creation of new

businesses, the restructuring or the phasing out of old ones, the emergence of nascent

technologies and business models, and the right support frameworks for innovations to be

widely adopted. This includes addressing potential skills gaps through education, training

and labour market policies.

Promote climate-friendly international trade.

The international trade regime itself

does not prevent governments from pursuing ambitious climate policies, but some

international trade barriers can undermine climate objectives. For example, import tariffs

still penalise trade in some technologies needed for the low-carbon transition. An

Environmental Goods Agreement, currently under negotiation, would help to reduce the

costs of climate mitigation efforts, among other outcomes. Care needs to be taken by the

many countries that are promoting greener growth by favouring domestic manufacturers of

low-carbon technologies. Where these measures restrict international trade, they may well

undermine overall investment and the uptake of sustainable technologies.

Revisit electricity markets.

Electricity lies at the heart of a successful decarbonisation

of energy systems. However, deregulated electricity markets do not deliver the long-term

price signal needed for investment in high capital cost, low-carbon technologies. Ensuring

competitive and timely investment in low-carbon solutions will require new market

arrangements such as long-term supply agreements, as well as a robust and stable CO

price

signal. Jurisdictions with regulated systems that consider introducing greater competition

need to adopt market arrangements that will encourage, rather than hinder, investment in

low-carbon technologies.

Opt for sustainable urban mobility.

Current transport systems, which rely largely on

fossil fuels, impose very high environmental costs (climate change, noise, air pollution),

particularly in urban settings. Policy intervention is needed to provide more energy efficient

and less carbon-intensive mobility. In many cities, land-use and transport planning are

poorly co-ordinated and encourage greater use of private cars. Aligning policy action across

levels of governments and between stakeholders could do much to deliver lower-carbon

mobility. National frameworks and legislation sometimes leave local governments with

little financial or political leeway to make low-carbon choices.

Strengthen incentives for sustainable land use.

Sustainable land-management

practices – reduced deforestation, restoring degraded land, low-carbon agricultural practices

and increased carbon sequestration in soils and forests – can make a large contribution to

reducing greenhouse gas emissions while responding to growing food demands. They could

also improve the resilience of our economies to a changing climate by protecting

ecosystems. This requires an integrated approach that breaks down the silos between

mitigation, adaptation, agriculture, food security, forestry and environmental policies. More

specifically, countries could pursue their efforts to remove environmentally harmful

agricultural subsidies, value ecosystem services, protect forests and minimise food waste.

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EXECUTIVE SUMMARY –

Engaging the low-carbon transition

Climate policy can be more effective if all government ministries identify important

misalignments with low-carbon transition in their respective portfolios. An ambitious

climate action plan will therefore need new approaches to policy making across

government.

Beyond the national level, better alignment of policies across countries could also boost

effectiveness and alleviate concerns about potential distortions of competition. A global

agreement on greenhouse gas reductions would send a strong signal in this direction.

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

Chapter 1

Core climate policies and the case for policy alignment

This chapter presents the scientific basis for climate action and the transformative nature of

climate policy objectives. Action to mitigate climate change must rest on three pillars: an

explicit or implicit price on CO

emissions, regulations to remove barriers to energy

efficiency, and targeted support to bring low-carbon technologies to market. The chapter

highlights the need for stakeholder (consumers, industry) buy-in of these core climate

policies, careful consideration by governments, and alignment of broader policy

frameworks, traditionally hard-wired to fossil fuels, towards a low-carbon economy.

Identifying and reforming misaligned policies can also help the transition while also

supporting other policy objectives.

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities.

The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem

and Israeli settlements in the West Bank under the terms of international law.

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– 1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT

Key messages

Policy makers face a number of structural economic, financial, social and environmental

challenges. Responding to the threat of climate change implies a profound transformation in

order to reduce greenhouse gas emissions over this century, in particular CO

from the

production and consumption of fossil fuels.

The policy framework required to orient the economy away from greenhouse gas-intensive

activities rests on three pillars: 1) sending a robust and credible price signal to internalise the

cost of these emissions; 2) regulatory measures whenever pricing is not effective; 3) bringing

promising low-emission technologies to commercial maturity in anticipation of more ambitious

reductions. More countries are taking action, but implementation is lagging behind in many

regions, as the policy changes required tend to be resisted on social and economic grounds.

Some solutions to enhance the acceptability of climate policies are in the hands of domestic

policy makers and can serve other policy objectives. For instance, compensation systems could

more than offset the distributional impacts on low-income households, and address social

concerns. Solving possible distortions in competition stemming from differences in domestic

climate policies hinges on international collaboration. A global climate change agreement under

the United Nations Framework Convention on Climate Change (UNFCCC) could open the door

to this discussion.

A key obstacle to the effectiveness and acceptability of core climate policies is the number

of regulatory and policy frameworks outside the climate policy portfolio that are not aligned

with climate objectives. Identifying and addressing these misalignments systematically in each

country will enhance the responsiveness of economic and social systems to the climate change

agenda. In developed and developing countries alike, this approach could help governments be

more ambitious in policy implementation and emissions objectives while also achieving greener,

more robust and inclusive growth.

This volume presents the first broad diagnosis of the coherence between overall policy and

regulatory frameworks and climate goals. It identifies a number of opportunities for realigning

policies to enable an efficient and cost-effective shift to a low-carbon economy, across

four policy domains (investment, taxation, innovation and skills, and trade) and three specific

areas that are important for the low-carbon transition (electricity, urban mobility and rural land

use). Adaptation to ongoing climate change can also be enhanced through better alignment. This

agenda will require the engagement of parts of government not usually mobilised in the

development of climate change response strategies.

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

Facilitating the low-carbon transition

Addressing climate change and other structural challenges

Addressing climate change is a transformational agenda. Emissions of greenhouse gases

(GHG), and in particular CO

from fossil fuels, are embedded in the vast majority of human

activities. Carbon-intensive sources have fuelled global economic development and will

continue to do so for some time. Returning global emissions of GHG to net zero by the end

of the century, a requirement for keeping the global average temperature increase below

2°C, will mean profound changes to infrastructures, technologies and behaviours. Failure to

do so will increase the likelihood of severe, pervasive and irreversible impacts for human

activities and ecosystems, threaten water security, the livelihoods of poor people,

agricultural productivity and global economic growth (OECD, 2013a, 2012; and Box 1.1).

Box 1.1.

The scientific basis

The Intergovernmental Panel on Climate Change’s (IPCC) latest projections indicate that the

emissions pathways consistent with limiting warming to below 2°C relative to pre-industrial

levels require substantial emissions reductions over the next few decades, and near zero

emissions of carbon dioxide (CO

) and other long-lived greenhouse gases (GHGs) by the end of

this century (Figure 1.1). The remaining GHG emissions from burning fossil fuels and other

activities (e.g. agriculture) will have to be offset. With present technological knowledge, this

implies the generation of energy from bioenergy in plants fitted with carbon capture and storage

in order to remove CO

from the atmosphere.

Figure 1.1.

Greenhouse gas emissions pathways 2000-2100:

All scenarios from the IPCC Fifth Assessment Report

GHG emission pathways 2000-2100: All AR5 scenarios

140

120

> 1000 ppm CO

720–1000 ppm CO

580–720 ppm CO

530–580 ppm CO

480–530 ppm CO

430–480 ppm CO

Full AR5 database range

90th percentile

Median

10th percentile

RCP8.5

Baseline

Annual GHG emissions [GtCO

eq/yr]

100

-20

2000

RCP6.0

RCP4.5

RCP2.6

2020

2040

2060

2080

2100

Note:

This figure presents all scenarios from the IPCC Fifth Assessment Report, including GHG

representative concentration pathways (RCP). Scenarios in the lowest light-blue band correspond to

concentration ranges of 430-480 ppm, likely to keep temperatures below 2°C by the end of the century;

scenarios in the lowest darker blue band, correspond to concentration ranges of 480-530 ppm are more

likely than not and as likely as not to stay below 2°C. Emission levels for the year 2100 are indicated by the

blocks to the right.

Source:

IPCC (2014a)

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– 1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT

Box 1.1.

The scientific basis

(cont.)

Emissions scenarios that are likely to keep global warming below 2°C (i.e. with at least a

66% probability) are characterised by GHG emissions reductions of between 40-70% by 2050

relative to 2010. This is a daunting challenge in comparison with the continued growth in GHG

emissions – particularly CO

– over the last century or so (IPCC, 2014a). Global energy-related

emissions in 2012 were 50% higher than their 1990 level, at 31.6 billion tonnes of CO

(GtCO

) (IEA, 2013a). According to the OECD

Environmental Outlook,

global GHG emissions

could increase by another 50% by 2050 relative to 2010 unless strong abatement policies are

implemented globally (OECD, 2012).

Cumulative emissions of CO

and other GHG will determine the extent of climate change

(IPCC, 2014b).

Without mitigation efforts beyond those already in place, the IPCC projects

increases in global mean surface temperature of between 3.7°C and 4.8°C by 2100 relative to the

second half of the 19th century (IPCC, 2014a).

The scale and pace of this change would be

unprecedented in human history. Regional changes at high latitudes and over the continents

would be greater still. Precipitation patterns would be significantly affected both by an

intensification of the hydrological cycle and changed atmospheric circulation patterns. The high

latitudes and equatorial Pacific are projected to experience increased precipitation under

high-emissions scenarios while mid-latitude and sub-tropical dry zones are likely to face reduced

precipitation. Extreme precipitation is very likely to become more intense and more frequent

over mid-latitude land masses and the wet tropics. These challenges will be exacerbated by

continued melting of mountain glaciers and sea-level rise, which could reach as high as

one meter by the end of the century in a high-emissions scenario, relative to 1986-2005 levels.

These changes would have strong impacts on the real economy. Concomitant effects on the

financial sector can also be expected if valuable productive assets and infrastructures are

affected on a large scale.

Note:

1. “So-called bio-energy with carbon capture and storage (BECCS) could be used in a wide range of

applications, including biomass power plants, combined heat and power plants, flue gas streams from the

pulp and paper industry, fermentation in ethanol production and biogas refining processes” (IEA, 2013a).

2. According to IEA (2014b) and IPCC (2014a) scenarios, the implementation of currently planned climate

policies will put the world on a path that will have used up, by 2040, the upper estimate of the carbon

budget available to keep the odds of staying below 2°C at 66%. This budget is estimated at

750-1 260 GtCO

for all greenhouse gases. 3. This range is for a median climate response; the full range is

much larger.

Source:

IPCC (2014a),

Climate Change 2014: Synthesis Report

–

Summary for Policymakers,

contribution

of Working Groups I, II and III to the Fifth Assessment Report of the Intergovernmental Panel on Climate

Change [core writing team, R.K. Pachauri and L.A. Meyer (eds.)], Intergovernmental Panel on Climate

Change, Geneva, available at:

www.ipcc.ch/pdf/assessment-report/ar5/syr/AR5_SYR_FINAL_SPM.pdf.

Climate change is part of a broader set of structural challenges faced today by

policy makers: restoring robust economic growth, addressing systemic risk and instability

in finance while ensuring investment in the real economy, slowing productivity, growing

inequality in wealth distribution and persistent poverty, as well as ensuring the

environmental sustainability of global economic development (OECD, 2015a).

These issues fall under different policy portfolios, but are interconnected. For instance,

more long-term finance is needed for low-carbon and climate-resilient infrastructure; the

decarbonisation of industrial products will require disruptive innovations, with possible

implications for jobs; climate impacts will be mostly felt by vulnerable communities,

particularly in developing countries. Reducing GHG emissions (especially CO

from fossil

fuels) can foster a greener growth, provided that policies also address the potential

distributive effects (OECD, 2013a).

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

For most countries, tackling climate change while pursuing greener, more inclusive

growth is achievable (GCEC, 2014). Some investments in low-carbon infrastructure today

can already provide attractive financial returns or energy savings which outweigh the

additional upfront capital costs.

The transition to a low-carbon economy could also mean

cleaner air, better health and a more diversified energy supply, in addition to the avoided

impacts of warmer global climate.

In developing countries relying heavily on natural assets

and particularly vulnerable to climate impacts, the low-carbon transition could also be a

condition for long-term prosperity and well-being (OECD, 2013a).

Changing course to low carbon implies trade-offs in the short term, as some

GHG-intensive activities would decline and others emerge, fossil fuels subsidies would

need to be removed, and additional upfront capital would be needed to finance low-carbon

assets. Understanding these changes will be essential to embark stakeholders on the

necessary transformation of our economies to low carbon. International co-operation will

be needed to help developing countries make the shift and manage short-term trade-offs

associated with a transition to low carbon (see also Chapter 2 for a discussion on financing

the transition).

The case for policy alignment

The policy direction to a low-carbon future has been clear for some time, even if the

necessary concerted action has so far eluded the global community. Effective risk

management demands strong policies to limit GHG emissions across activities and

countries with due consideration to national circumstances. A three-pillar approach can be

most effective in reducing GHG emissions: 1) a clear and robust price signal on GHG

emissions or other market-based instruments; 2) smart regulations to remove market

barriers to low-GHG choices; 3) forward-looking support to low-carbon technologies (see

below). National circumstances, including the level of economic development and natural

resource endowments, will affect the pace and breadth of implementation of these core

climate policies and the potential short-term trade-offs, but this approach can create a

framework to sustain growth over the long term.

The three-pillar approach is essential, and yet not in itself sufficient to effectively tackle

climate change if our policy and regulatory systems continue to be geared towards CO

emitting fossil fuel technologies. Society’s reliance on fossil fuels is responsible for the

majority of global GHG emissions. Coal, oil and gas have fuelled most economic

development for decades; they have influenced everything from the design of our homes,

transport and cities to the way we produce food and manufacture goods. For instance, the

use of natural gas to generate electricity in combined-cycle gas turbines influenced the

liberalisation and design of electricity markets in some OECD countries in the 1990s.

Similarly, today’s urban planning and transport choices are marked by our reliance on

petrol or diesel cars. The same observation applies to GHG-intensive inputs in agriculture

and industry. Unravelling this will require a deep understanding of the policy signals

driving it and an unwavering commitment to change.

This report presents the first broad diagnosis of the misalignments between overall

policy and regulatory frameworks and climate goals. Left unchecked, they risk sending

contradictory signals and hindering the low-carbon transition. Addressing these

misalignments can enhance the responsiveness of economic and social systems to climate

change policy efforts and facilitate the low-carbon transition. This, in turn, could help

governments be more ambitious, both in domestic policies and in their international

contributions.

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– 1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT

Addressing climate policy misalignments forms part of the broader OECD Green

Growth Strategy that seeks to avoid the recognised dangers of a return to business-as-usual

after the financial and economic crisis (OECD, 2011a; 2015b). Climate policy has often not

been at the very top of policy makers’ priority lists globally, and yet this report shows that

the implementation of sound climate policies and the removal of misalignments can

positively contribute to some of policy makers’ priority issues, including more resilient and

inclusive growth.

Better alignment will often facilitate the achievement of other policy objectives and can

make climate policy more acceptable to various stakeholders (e.g. a less polluted urban

environment with more accessible city centres, tax code changes that reduce the most

distortive taxes or more favourable conditions for long-term infrastructure investment in

support of economic growth). Governments should identify and capitalise on these “win-

win” outcomes.

Diagnosing misalignments

The multiple dimensions of misalignment

The analysis highlights policy misalignments across several dimensions:

•

Policy areas and policy objectives.

Is there consistency between goals, objectives or

impacts of existing policy areas and climate policies? For instance, do financial market

regulations have unintended negative consequences for low-carbon investments? Are tax

systems encouraging CO

-intensive development?

Development, economic and industrial policy goals.

Are policies that support

development goals undermining long-term climate goals?

Levels of government.

Are the respective mandates of different levels of government

and different ministries conducive to or hindering climate change objectives?

Stakeholders.

Do public and private actors have the same incentives for moving to low

carbon – e.g. are potential climate risks transparently reflected in corporate disclosures

and investor portfolios?

Borders.

Can one country’s climate policy be undermined by another’s domestic policy

choices? Do international trade rules or unilateral trade remedies hinder the adoption of

stronger climate policies? If so, how?

The policy experience used for this report is based on examples in OECD and, to a

lesser extent on non-OECD countries. Countries present major differences related to their

level of development, governance structure, institutional and financial capacity, natural

resources and regulatory framework for the advancement of domestic climate policy.

However, every country can take a comprehensive look across policy frameworks, make a

diagnosis, and start addressing misalignments with climate goals for a more sustainable,

low-carbon future.

•

Aligning policies across domains and activities

The report gives examples of misalignments of overall policy and regulatory

frameworks with climate goals, and identifies a number of opportunities for realigning

policies to enable an efficient and cost-effective shift to a low-carbon economy. The

findings are presented in two parts:

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

•

Cross-cutting policy domains which offer important channels for transformation:

investment, taxation, innovation and skills, trade and adaptation.

Specific activities that have a direct impact on emissions, and where climate objectives

need to be systematically integrated into public and private decision-making processes:

electricity, urban mobility and rural land use.

It is the sum of signals coming from misaligned policies which risks hindering the low-

carbon transition, e.g. the combination of tax policies and urban planning rules encourage

urban sprawl. Evaluating the effects of a constellation of policy signals on climate policy is

ambitious, but the potential rewards in terms of efficiency and other gains are worth the

effort.

From diagnosis to action

Aligning policies requires the engagement of parts of governments that have not so far

been sufficiently mobilised in the development of climate response strategies, i.e. a better

integration of climate policy with other structural policy challenges.

Climate policy can be made more effective if ministries with portfolios situated outside

the traditional climate agenda can revisit the most misaligned policy instruments in their

domains. A concerted whole-of-government effort is needed to establish a diagnosis, a

mapping of climate policy instruments

and

of underlying policy frameworks that could help

or hinder the transition to a low-carbon economy. The implementation phase of an

ambitious and effective climate action plan, with core climate policies (a three-pillar

approach described below) and the progressive resolution of other policy misalignments

will also require new approaches to policy making across government (see Box 1.2).

Certain misalignments remain challenging, especially as their solutions do not hinge on

national action alone. Concerns about distortions to competition, caused by climate policies

with different levels of stringency across trade partners, continue to undermine climate

policy ambition globally. This issue is limited to energy-intensive and internationally traded

products such as aluminium, steel or chemicals. A global agreement could help in this area,

although much will depend on the details of domestic policy implementation. Opportunities

for more collaborative approaches or international co-ordination should be explored, for

instance to guide innovation internationally rather than through country-specific measures.

Before turning to specific misalignments, the following section discusses the core

package of climate policy that is needed for a transition to a low-carbon economy, and

addresses some essential issues related to its acceptability.

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– 1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT

Box 1.2.

Government co-ordination: Insights from centres of government

A principal issue for governments with respect to aligning policies to promote the transition to a low-carbon

economy is how co-ordinated policies can be implemented in practice given the complexity of the topic, the

mixed track record of most governments in working horizontally, and the need to include an unprecedented

range of public and private actors. The perspective of senior officials working at the centre of OECD

governments, whose role is to provide strategic vision, policy co-ordination and monitoring for complex, cross-

disciplinary policies, is that the low-carbon transition is indeed a unique challenge in terms of scale and time

frame. As such, it requires new approaches to policy making across government. Governments have developed

numerous solutions to establish more strategic co-ordination and better mainstreaming of climate policy

objectives. These include super ministries, policy “tsars”, inter-ministerial committees, independent policy units.

On the policy front, options include legislations mandating national climate change targets (e.g. the

United Kingdom’s Climate Change Act) or impact assessments including guidance on how to include GHG

emissions in these assessments. These can provide insights into the challenges and some of the solutions on

which successful implementation will depend.

An ambitious effort to align policies requires several elements: a clear vision with measurable targets; an

action plan with clear responsibilities and tasks for the different stakeholders; a system for monitoring progress;

a process that has convening power, spans electoral cycles and engages opposition parties, and draws on

co-ordination and substantive expertise.

To get to this degree of climate policy mainstreaming will require an investment in reflection on governance

innovations best suited to this cross-portfolio issue. Overall, this requires the engagement of the head of

government.

Source:

Adapted from OECD (2014b), “Centre stage: Driving better policies from the Centre of Government”,

GOV/PGC/MPM(2014)3/FINAL, OECD, Paris, available at:

www.oecd.org/gov/Centre-Stage-Report.pdf.

Core climate policies: Principles and implementation

Global GHG trends are

prima facie

evidence that existing climate policy instruments

are inadequate in breadth (countries, sectors) and ambition (stringency). At the same time,

there have never been more policy instruments implemented with climate mitigation as a

primary objective or by-product – these provide a wealth of policy experience from which

to draw lessons for more efficient GHG-reduction policy packages.

The variety of starting points and national circumstances precludes any kind of

generalisation. The level and structure of a country’s gross domestic product, its

endowment in various resources, and physical and institutional infrastructure all affect the

cost and feasibility of various policy options to curb GHG emissions. A country’s openness

to other economies and the perception of other countries’ efforts to reduce emissions,

i.e. the fairness of the global distribution of effort, are also critical factors in the willingness

to take ambitious mitigation actions at home. The importance of a global agreement in Paris

in 2015, under the aegis of the UNFCCC, should not be underestimated in this regard. In

the end, however, the effectiveness of any accord hinges on the implementation of well-

suited policies and measures at the level of national jurisdictions.

This section next recalls the basic principles of an appropriate policy package for an

economically efficient mitigation strategy, before turning to important aspects of

implementation, including the need to avoid misalignments or redundancy between policy

tools, issues standing in the way of acceptability of these policies and possible solutions.

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

Basic principles for an efficient climate mitigation policy package

The gap between current and desired GHG emissions trends demonstrates the need for

strong policies to reorient consumption, production and investment choices in our

economies. The magnitude of the effort calls for close attention not just to immediate

choices in the near term, but equally to the way policy settings are likely to influence the

medium- and long-term costs of the transition to a low-carbon economy.

A three-pillar approach would provide a strong signal for the low-carbon transition:

•

A robust price on GHG emissions with long-term credibility is a central pillar of any

low-carbon economy, providing incentives for immediate emissions reductions where

possible, as well as investment and innovation in low-GHG technologies. Market-based

instruments and regulations deterring GHG-emitting activities also put a cost on

emissions. Attempts to price carbon implicitly or explicitly will have distributional

consequences that may be contentious. It requires the determination and creativity of

governments to arbitrage between the economic efficiency and political and social

sustainability of climate policies.

Regulations may be particularly appropriate where a price signal is less effective due to

market barriers or transaction costs – in particular in the household sector. These include

emissions performance standards or measures to encourage energy efficiency.

Targeted technology support (research, development and demonstration, or RD&D) can

help to develop and lower the cost of risky but potentially promising sustainable low-

GHG technologies, reducing the competitive gap with GHG-intensive technologies.

To be effective, these core climate policies must be backed by a clear long-term

commitment by governments to support continuous and systematic efforts towards the

transition to a low-GHG economy, giving private sector and civil society stakeholders the

necessary confidence to take long-term decisions. A global agreement in Paris at COP21 in

December 2015 would provide an essential impetus for countries to create such signals.

The challenge is to strike an appropriate balance between these three pillars, as well as

to base them on efficient policy instruments. There are indeed major differences in the cost

of policies mobilising various GHG mitigation potentials, as shown in

Effective Carbon

Prices

(OECD, 2013b), sometimes a sign that policies have been inefficient.

Special consideration should also be given to possible interactions between the various

policy instruments to ensure they are mutually reinforcing (Hood, 2011; 2013). In principle,

GHG emissions pricing, the removal of market barriers (e.g. to support energy efficiency

improvements in the household sector) and RD&D are complementary and can work to

minimise the cost of GHG reductions better than a single instrument would (see, for

instance, Acemoglu et al., 2012; Fischer and Newell, 2008).

The implementation of this policy package has not proven easy, however, even in

countries that have pledged to reduce their GHG emissions. As described below, a few

carbon pricing legislations have been rejected at various stages of legislative processes, and

governments have had to move forward with other policy instruments. More generally,

especially in developing countries, the question of energy affordability remains a barrier to

ambitious climate action, even if practical solutions exist to mitigate these problems – e.g. a

more efficient use of energy via energy efficiency measures, or cash transfers to reduce

impacts on the poor.

•

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– 1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT

The practice of climate mitigation policies

pricing policies: A rapid overview

At present, carbon pricing policies only apply to a small portion of global GHG

emissions – the list of regulatory measures that put an implicit price on CO

via a barrier to

some uses of fossil fuels is probably far longer, but too diverse to be succinctly covered

here.

Carbon taxes are in place in European countries such as Denmark, Finland, France,

Iceland, Ireland, Norway, Slovenia, Sweden, Switzerland, Spain (with a tax on fluorinated

gases, and carbon taxes in some of the country’s autonomous communities); Costa Rica;

Japan; Mexico; and in the Canadian provinces of Alberta and British Columbia; and a

carbon tax is scheduled for introduction in Chile, Portugal and South Africa. As discussed

in the chapter on taxation of this report (see Chapter 5), fossil fuels were taxed prior to the

introduction of carbon taxes, and the distinction between carbon taxes and other excise

taxes on the same energy products is blurred. The main policy features of carbon taxes are

their coverage of a country’s or region’s CO

emissions, announced evolution, use of the

collected revenues and treatment of distributional impacts. A later section addresses some

of these from the viewpoint of political acceptability.

Emissions-trading systems stemmed initially from the Kyoto Protocol’s flexibility

mechanisms. The largest carbon market in operation is the EU Emissions Trading System,

covering about 2 billion tonnes of CO

equivalent (tCO

-eq) emissions. Several smaller

systems have been implemented, with at least one initiative to link two systems (Quebec

and California).

The systems vary in scope – e.g. few include forestry or agriculture

activities, while almost all include power generation.

Under the auspices of the Kyoto

Protocol, countries’ binding emissions targets have also been used to stimulate emissions

reductions in countries without emissions targets, via the Clean Development Mechanism

(CDM). The CDM created a strong price incentive to reduce emissions in targeted activities

in developing countries (including non-energy related activities, e.g. methane emissions

from landfill), but diminished in importance when demand from EU Emissions Trading

System (ETS) sources declined. Next in the evolution of emissions trading is the possibility

of linking systems.

This would bring efficiency gains by broadening opportunities for

emissions reductions at a lower cost to all participants – as indicated by existing price

differences. The trade-off for domestic policy makers is loss of control over the policy-

driven carbon price, and subsequent effects on other prices.

In addition to energy taxes, a number of OECD governments now systematically apply

an explicit monetary carbon value in their appraisal of proposed policies and infrastructure

decisions, e.g. based on a country’s own assessment of the social cost of carbon (Smith et

Braathen, 2015). As they conduct cost-benefit analyses of policies or projects, governments

can factor in the impact on GHG emissions by applying this standard value (e.g. in

USD/tCO

-eq). This automatically advantages public policy choices that are less carbon-

intensive even where there is no actual price paid for GHG emissions in the economy.

These carbon values can be used in a number of instances, e.g. in a governmental agency’s

decisions on how to prioritise projects and policies; in governmental resource allocation

plans based on social benefit criteria; in value-for-money assessment of public spending by

auditing offices and parliamentary committees; or in independent studies of public policy

choices (ibid.). Figure 1.2 shows carbon values used by some OECD countries for

investment evaluations in the transport sector. The monetary values grow rapidly over time

as their climate change impacts become increasingly severe.

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

Figure 1.2.

Monetary carbon values used for investment projects in the transport sector

USD, 2014 value

2110

2100

2090

2080

2070

Year

2060

2050

2040

2030

2020

2010

2000

NZL DNK ISR NLD

EST HUN

SWE

FRA

GBR DEU

SWE

GBR

ISR NLD EST

NOR

SWE DEU

DNK EU

HUN GBR FRA

DNK

NLD

NZL

ISR EU EST NOR GBR

SWE

DNK ISR EU FRA HUN GBR DEU

HUN

EST NOR

NZL NLD

NZL

100

150

200

250

300

2014 USD per tonne of CO

350

400

450

500

Source:

Smith, S. and N.A. Braathen (2015), “Monetary carbon values in policy appraisal: An overview of

current practice and key issues”,

OECD Environment Working Papers,

OECD Publishing, Paris.

Avoiding misalignments between climate mitigation instruments

In bridging the gap, governments should undertake an inventory of policies that

explicitly and implicitly price carbon, and assess the impact of the policies and their

interactions in order to ensure that they are mutually supportive in achieving CO

reductions as well as other social and economic objectives. (OECD, 2013c)

The vast majority of policy instruments introduced by countries to curb their GHG

emissions are not within the carbon pricing pillar – recent examples include the

United States’ decision to regulate CO

emissions from power plants and possibly methane

emissions from shale oil and gas operations and the People’s Republic of China’s (hereafter

“China”) decision has been made to replace all coal-based electricity generation with gas by

the end of the decade. Table 1.1 gives an overview of the range of policy instruments

(including pricing) in use to limit GHG emissions, primarily in the energy production and

consumption sector.

Not all instruments affecting GHG emissions were introduced with emissions

reductions as their primary goal and so should not be assessed against that metric alone.

They nonetheless constitute the policy environment on top of which more ambitious

climate policies will be introduced. The interactions between these instruments and those to

come are an important element in the definition of an economically efficient mitigation

strategy (Braathen, 2011; OECD, 2011b; Hood, 2011, 2013). These interactions in fact

raise some alignment questions: will policies within the three pillars reinforce or undermine

each other – i.e. will they reduce or add costs? Will interactions facilitate or hinder adoption

by relevant economic agents? It is important to ensure that climate policies themselves are

not in misalignment with one another before considering other policy areas.

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– 1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT

Table 1.1.

A wide range of energy and climate policies to reduce greenhouse gas emissions

Policy type

Price-based instruments

Policy options

– Taxes on CO

directly

– Taxes/charges on inputs or outputs of process (e.g. fuel and vehicle taxes)

– Subsidies for emissions-reducing activities

– Emissions trading systems (cap and trade or baseline and credit)

– Technology standards (e.g. biofuel blend mandate, minimum energy performance standards)

– Performance standards (e.g. fleet average CO

vehicle efficiency)

– Prohibition or mandating of certain products or practices

– Reporting requirements

– Requirements for operating certification (e.g.

Hydrofluorocarbon

handling certification)

– Land-use planning, zoning

– Public and private research, development and demonstration (RD&D) funding

– Public procurement

– Green certificates (renewable portfolio standard or clean energy standard)

– Feed-in tariffs

– Public investment in underpinning infrastructure for new technologies

– Policies to remove financial barriers to acquiring green technology (loans, revolving funds)

– Rating and labelling programmes

– Public information campaigns

– Education and training

– Product certification and labelling

– Award schemes

Command and control

regulations

Technology support policies

Information and voluntary

approaches

Note:

The bottom three categories are in the second and third pillars of climate mitigation instruments (market

barrier removal and technology support).

Source:

Hood (2011), “Summing up the parts: Combining policy instruments for least-cost climate mitigation

strategies”, International Energy Agency Information Paper, OECD/IEA, Paris, available at:

www.iea.org/publications/freepublications/publication/Summing_Up.pdf,

based on de Serres et al. (2010).

The combination of a tax on carbon emissions on the one hand and support to

low-carbon supply technologies and energy efficiency on the other could, if well-designed,

have one of two beneficial effects (Hood, 2013). It could either:

•

increase emissions reductions beyond those achieved by the carbon tax, as the non-price

measures could provide additional options that economic agents can seize to reduce

carbon tax payments, or

decrease the level of tax necessary to achieve a given level of emissions reductions.

In the case of an emissions-trading system in which the emissions limit is set, efficiency

measures and support to low-carbon technologies should lower the market price of

emissions allowances, as the cost of reduction is supported by other programmes. The

question is then whether these other programmes impose a higher overall cost than what

would be achieved with the emissions-trading system alone. The answer needs to take the

following into account:

•

If any of the measures in the other pillars tap into mitigation potentials that are lower than

the market price, they lower the overall cost of meeting the emissions constraint.

By lowering the market price of allowances such measures also lower its downstream

effects, e.g. the increase in wholesale electricity prices via the pass-through of the

allowances by power generators.

The OECD (2013b) identifies instances where the static cost of avoided CO

for certain

support measures has been far greater than the observed CO

market price. While some

subsidies to renewable technologies have been overly generous, these combined measures

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have eventually led to a considerable drop in the global cost of renewable technologies via

learning and economies of scale. This is a clear advantage from a dynamic efficiency

standpoint, as it lowers the price of CO

needed in the future to scale up deployment. While

this dynamic efficiency argument cannot be an excuse for wasteful public policies, it should

not be ignored in the economic assessment of a climate policy package.

6,7

Policy interaction also occurs in the case of non-price policies. A regulation to close

low-efficiency coal power plants would have cost repercussions for electricity users unless

policies simultaneously encourage the uptake of electricity-saving appliances and

behaviour. If not, more new electricity capacity would be necessary to replace coal, which

could push electricity prices up. Interactions ought to be considered for all types of

instruments to ensure that the overall package is in line with the overarching objective,

whether it is a target level of emissions or the cost of avoided emissions.

Enhancing the acceptability of ambitious climate mitigation

In practice, governments have found it difficult to implement the most cost-

effective and efficient policies for growth and reducing climate risk, such as carbon

pricing. (GCEC, 2014)

If a number of countries have moved forward with more or less ambitious policy

packages to curb their emissions, global GHG emissions trends are a reminder that policy

lags behind the aspiration to limit global warming to 2°C, and that the introduction of

instruments aiming at changing the direction of choices made in energy, industry and

agriculture remains politically difficult. This section reviews some of the dimensions

important for ensuring the acceptability of climate policies for economic activities and the

electorate at large. Ensuring widespread buy-in to policies is essential if they are to be

effective.

There are, of course, success stories showing how public opinion accepted, for instance,

a tax on CO

. Ireland introduced a carbon tax in the wake of the financial crisis

(Convery et al., 2013), and British Columbia’s carbon tax was successfully introduced and

remained in place in spite of a lack of action by other North American jurisdictions

(Harrison, 2013). But there are also examples of far-reaching, well-designed climate

policies that have not managed to garner enough support to move forward with

implementation. The failure of the Waxman-Markey proposal to introduce a GHG cap-and-

trade system in the United States is a famous instance. Even where a legislature passes a

measure, it can fail on constitutional grounds (e.g. the carbon tax legislation rejected by

France’s

Conseil Constitutionnel

or Constitutional Council in 2010).

Because climate

policies inevitably run up against private interests, they will be the object of protests by

various groups and lobbies. Governments, mindful of the need to maintain domestic

economic growth and jobs, often significantly dependent on the rents from their own fossil

fuel reserves, and sometimes under severe political pressure from financial backers, have in

many cases pursued weaker climate policies.

From a pure economic perspective, climate policy is justified here and now to limit

climate risks. The issue is how to cope adequately with the inevitable transition costs,

because the transition to low carbon will create winners and losers. The energy and

manufacturing sector will have to adopt new technologies and abandon others. Some

activities may disappear as low-carbon products emerge and out-compete old ones.

Similarly, consumers will face a new set of relative prices as policies steer them away from

GHG-intensive choices. The distributional aspects of these changes, if left unchecked, can

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be a major barrier to reforms and have, in the past, hindered the adoption of ambitious

climate policies.

Eliminating the policy alignment issues identified in the following chapters would

lower the cost of the transition. Before delving into those broader misalignments, it is

useful to dwell on three areas whereby core climate policies can be designed to consider

transition costs: aligning climate efforts internationally, mitigating effects on industrial

competitiveness and minimising distributional impacts for the poorer parts of society.

Building trust through international agreements

GHG emissions accumulating in the atmosphere have global effects, irrespective of

where those emissions were released. This means that the climate impact of any one

country’s GHG reduction policies is dependent on action by others. Given that strong GHG

mitigation policies may have short-term economic costs, the ambition of national policies is

therefore dependent on the perceived impacts on national development that those policies

may create, even if they will deliver longer term economic benefits. In a world of highly

interconnected economies, governments – as well as industry and the general public – seek

reassurance of commensurate action from their trade partners, through treaties or other

forms of international agreement, whether bilaterally or multilaterally.

The UNFCCC remains the central international forum for global negotiations on

climate change and also provides a window for co-ordination of climate policy. Such

co-ordination can play an important role in the development of national GHG reduction

policies in major economies, as it can provide assurance to domestic policy makers that

commensurate efforts are being taken internationally by key trading partners. A global

agreement under the UNFCCC would therefore be instrumental in providing political space

for policy makers to strengthen climate action domestically. Indeed, all countries have been

invited to make intended nationally determined contributions (INDCs) to global mitigation

efforts before the Paris COP. A multilateral agreement may also help mobilise climate

change finance for poor countries, both to help the most vulnerable adapt to climate change

and to facilitate GHG mitigation.

Countries also pursue bilateral and regional agreements on climate change mitigation

and adaptation in parallel to and in support of the UNFCCC negotiations. Decisions can be

taken outside of the UNFCCC that align with and reinforce that process. An important

example is the US-China joint announcement on climate change in November 2014 (White

House, 2014). Such agreements are important to build trust between major economies. This

can provide momentum to the UNFCCC negotiations as well as support domestic policy

processes by demonstrating to stakeholders that climate action is being pursued

internationally. Ideally, a virtuous circle of positive feedback would form between domestic

policy progress and momentum in negotiations. In reality, domestic policy processes are

rarely neatly aligned with the cycles of international negotiations.

The climate challenge is not alone in being a global problem requiring co-ordinated

action from all major economies. In the modern globalised world of interconnected

economies and multinational companies, capital is especially mobile. The OECD Base

Erosion and Profit Shifting (BEPS) initiative has highlighted the extent to which OECD and

other countries are losing revenue through tax evasion (OECD, 2013d).

Addressing BEPS

requires universal action from major economies. If some countries act to close loopholes

but others do not, capital and potential tax revenue will still flee to the latter. Over time, a

consensus has built up that co-ordinated action is required. The OECD, in conjunction with

the G20, is in the process of designing a multilateral agreement and accompanying rules to

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

tackle BEPS internationally. This is a good example of government consensus achieving

powerful objectives despite strong financial interests pulling in the other direction. In some

ways, a similar consensus exists for action on climate change mitigation. However, in many

countries strong opposition to more stringent climate policies has been voiced by energy-

intensive industries.

The impact of CO

mitigation on various parts of the economy

Industrial competitiveness: A thorn in the side of climate ambition

An important aspect of the political acceptability of ambitious climate mitigation policy

is how easily industry can adjust and thrive under this new constraint. The question is

highly relevant for industries with a high-carbon or high-energy content.

Energy-intensive firms in many countries remain concerned that if domestic

climate-related regulation is misaligned with the stringency of regulation in other countries,

this will harm competitiveness at the firm and sector level and could lead to industrial flight

to countries with less stringent climate regulation, with corresponding economic and

employment impacts in the original country. Emissions reduction efforts would also be

undermined, as part of the avoided emissions would now occur somewhere else. This

potential “carbon leakage” to “pollution havens” has been much discussed in the literature

(see examples in Condon and Ignaciuk, 2013; and Arlinghaus, 2015).

Various recent OECD studies have explored the relationship between environmental

policies, in particular climate policies, and economic performance. A detailed analysis of

environmental policy and productivity also shows that such policies have not, so far, been

detrimental for overall growth. On the contrary, stringent environmental policies can

stimulate productivity growth in the short term for technologically advanced countries and

firms (Albrizio et al., 2014). Separately, other OECD work (Sauvage, 2014) found that

greater environmental stringency can lead to increased exports of some environmental

goods.

The literature on competitiveness impacts of climate policy is based on two approaches

whose conclusions differ widely on the seriousness of competitive distortions in climate

policy:

•

empirical studies taking an econometric look at the industry response to climate policy to

date

modelling simulations that project future climate policy in multi-regional frameworks

over the medium to long term.

A review of empirical studies found very little evidence of sector-level competitiveness

effects arising from carbon pricing systems implemented to date (Arlinghaus, 2015). While

the literature is in broad agreement that the EU ETS has stimulated some emissions

abatement, no causal link could be established between carbon pricing – including the EU

ETS and a range of carbon taxes – and carbon leakage. For carbon taxes, while abatement

through decreases in energy intensity was found, only very small impacts on

competitiveness were identified (ibid.). Further, no causal effects of the system on

employment, output or international trade have been found; observed employment

decreases are more likely due to the financial crisis and the decades-long gradual shift away

from manufacturing in OECD countries (Warwick, 2013; Pilat et al., 2006). The review

also found that pass-through of carbon costs to consumers is sometimes higher than

expected, even in industries exposed to international trade (Arlinghaus, 2015). The main

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question looking at empirical evidence is whether conclusions would apply for emissions

reduction levels that are more significant than those observed to date. GHG-intensive

industries consistently argue that their potential for significant emission reductions are

limited in the near to medium term unless they outsource their most GHG-intensive

processes to other regions, leading to carbon leakage.

Macroeconomic modelling studies simulate positive leakage rates, generally below

20%, meaning that one-fifth of emissions reductions achieved in a region would in fact be

offset by higher emissions in another region. This would come as its industry becomes

more competitive, and also as a result of lower international energy prices leading to higher

energy consumption in regions without a greenhouse gas constraint (IPCC, 2014b; Condon

and Ignaciuk, 2013). These rates are computed on the basis of emissions reductions

achieved by whole economies, i.e. not focusing on industry-by-industry leakage, which

could be much higher.

Almost all carbon pricing schemes have included measures to lessen the impacts on

energy-intensive, trade-exposed sectors. These measures include full or partial free tradable

permits, rebates on taxes or other financial measures. In theory, governments could also

implement border-based protection measures such as carbon-based tariffs or border carbon

adjustments, but none have yet done so in practice (Condon and Ignaciuk, 2013). While a

potentially effective tool for reducing competitiveness effects of strong climate policy, such

measures would be fraught with political and technical difficulties. On the political side,

they have a clear impact on international trade and so could be challenged through the

World Trade Organization if they are interpreted as being more about protectionism than

climate change. On the technical side, it would be challenging to accurately assess product-

specific emissions of goods arriving at the border. In the case of an emissions-trading

system with a fluctuating carbon price, setting the precise tariff level would not be easy

(WTO, 2013).

The debate on industrial competitiveness and climate policy remains open and sensitive

as regions undertake mitigation at different paces. The absence of evidence of

competitiveness effects to date can be challenged on the ground that future emissions

reduction levels will need to be much higher than implemented so far, with higher costs and

possible trade distortions as a result. This, of course, hinges on the ambition of future

climate policies in countries that have not yet implemented GHG constraints on their

industry. Further, the industrial competitiveness landscape will also be influenced by the

evolution of domestic energy prices (IEA, 2013b; Flues and Lutz, 2015). The cost of

climate policy is one of many factors in this picture; energy costs, labour costs, exchange

rates, transport costs, product specialisation, and local demand markets and regulations are

important determinants of industrial competitiveness (IEA, 2013b; ECF, 2014). A global

UNFCCC agreement on GHG mitigation could help, although much eventually depends on

details of policy implementation across regions.

Opportunities for more collaborative approaches should be explored, for instance the

possibility of pooling innovation efforts internationally on industrial breakthrough

technologies for the low-carbon transition of these large emitters. How domestic policies

will affect them and what remedies may be applied is also an area where policy makers

could gain from sharing best practice.

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How will household incomes be affected by the low-carbon transition?

Although the taxation of carbon may not be part of the policy toolkit for all countries in

the near term, there is empirical experience on how to cope with the distributional effects of

such taxes. Modelling studies add to this empirical knowledge, especially on how to best

recycle revenues from a new tax on carbon, either to improve economic efficiency or to

mitigate negative effects of the tax on social equity. Tax revenue recycling is only an option

if climate policy instruments raise tax revenues, which is not the case of subsidies and

regulatory approaches (Heindl and Löschel, 2014). This reinforces the case for pricing

carbon through taxation or auctioned emissions allowances.

How climate mitigation policy will affect various segments of the population depends

on a range of factors, including income distribution, the level of emissions of various

household-related activities (e.g. is electricity low- or high-carbon?) and relative prices, but

also on the kind of policy instruments implemented to reduce emissions. Sutherland (2006)

illustrates, for instance, how an energy efficiency standard for appliances can have a

regressive effect, even if less visible than a fuel price increase from a tax.

A recent and comprehensive survey of modelling studies of carbon taxes shows these

instruments to be generally regressive, but the conclusion should not stop here.

The review of literature on distributional effects of energy and carbon taxation

reveals two key findings. Firstly, direct energy and carbon taxation is regressive in

many cases. This implies that low-income households are responsible for

proportionally larger tax burdens compared to wealthier households.

Secondly, such negative effects usually can be fully neutralised or

even reversed if appropriate changes are made to existing tax

and benefit schemes in parallel to the new energy or carbon

tax.

this

case,

poorer

households

could

even

benefit

from the reform. (Heindl and Löschel, 2014)

The overall effect on income for different segments of society results from at least

two mechanisms pulling in different directions (Flues, 2015; Heindl and Löschel, 2014):

•

Some energy goods such as electricity, and gas for cooking and heating, are often a

necessity, and their share in household income and expenditures tends to be higher for

poorer segments of society. A climate policy with a high impact on electricity prices

would tend to be regressive.

Car fuel usage tends to increase with income in OECD countries. At present, taxes on

fuels for car use are not on average regressive when observed for 21 OECD countries,

mostly European. An increase in fuel taxes would rather have a progressive effect. As an

extreme illustration, poor households that do not own a car would not be directly exposed

to an increase in fuel taxes.

Another dimension of the distributive effects of higher energy prices and taxes is the

geographical situation of targeted households. Generally, studies find that taxes fall more

on rural than urban households, as the former rely more on personal vehicles and drive

longer distances; they are also more likely to live in detached houses with higher heating

fuel consumption (Flues, 2015). It is not clear, however, that this warrants special

treatment. If distributional issues are to be addressed, they should eventually be based on

effects on overall income, irrespective of other factors. The question is whether short-term

measures would need to be implemented to facilitate the adjustment of those more exposed

to price changes.

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A number of options to recycle energy and carbon tax revenues have been studied and

implemented, including: income-tested benefits, lump-sum transfers (equal amount per

household or individual); lower social security or other labour charges; a reduction of

value-added tax (VAT); or investment tax credits, with varying effectiveness with respect

to distributional impacts. As indicated above, governments can offset and even reverse the

regressive nature of higher carbon and energy taxes: an income-tested benefit financed by

additional tax revenues can target lower income households, making them better off with

higher energy taxes than without. A lump-sum transfer (i.e. equal amount per household)

would also disproportionally benefit lower income households.

In summary, governments must balance the following considerations in order to address

the distributional issues of the low-carbon transition, as considered through the prism of a

carbon price on energy:

•

The regressive or progressive nature of the increase in energy prices and other regulatory

interventions.

•

Whether and how to enhance the efficiency of the tax system: the reduction of other taxes

can have beneficial impacts on the economy through effects on the productive sector,

lower labour costs and less distortive taxes generally.

Whether the regressive effects of the tax ought to be addressed through specific tax

expenditures, cash transfers and other social benefits.

The main result from analyses to date is that expenditures to offset the negative impacts

on the less well-off are usually lower than the revenues raised by a new carbon tax (Heindl

and Löschel, 2014). In other words, this particular barrier to the acceptability of climate

mitigation policy can be overcome.

•

Properly accounting for co-benefits

The acceptability of low-carbon policies also depends on the set of economic,

environmental and social co-benefits brought by various GHG policy instruments. The IEA

(2014a) recently explored the multiple benefits of energy efficiency measures, beyond

energy savings at end-use level. These benefits range from health to industrial productivity,

to broader macroeconomic effects and climate resilience via a lesser need for potentially

vulnerable energy infrastructure. Capturing the value of all the associated benefits is

difficult, but assigning them a zero value is hardly justifiable. As a striking counter-

example, the OECD (2014a) recently quantified the cost of air pollution from NO

and

particulate matter from diesel use in transport to some USD 850 billion annually in OECD

countries, based on estimated value of lives lost and of ill health; fuel-savings in transport

would therefore have both CO

and health benefits.

GHG mitigation policies will also have indirect effects that may lower their intended

effectiveness. Since the first oil shock and the introduction of policies to save energy,

energy policy analysts have been debating the importance of the rebound effect: the

expected energy savings would be partly offset by some additional energy use enabled by

the primary savings. A very comprehensive study conducted by the UK Energy Research

Centre finds that “the evidence does not suggest that improvements in energy efficiency

routinely lead to economy-wide increases in energy consumption” (Sorrell, 2007). In the

context of a three-pillar approach to climate policy (carbon pricing, energy efficiency

policy, RD&D support), the rebound effect would be further minimised by an increase in

energy costs.

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Box 1.3.

Trade-offs between local pollution and climate change policy goals

The fight against rising GHG emissions can go hand-in-hand with the resolution of local

environmental problems that have very direct impacts on local populations. Policy intervention

in such cases is facilitated by support for policy measures that abate local pollution and GHG

emissions at the same time.

However, this is not always the case. Some solutions to local environmental problems can,

in fact, contribute to higher greenhouse gas emissions: e.g. traditional equipment to remove SO

and NO

from coal-based power generation lowers a plant’s thermal efficiency, and so raises

intensity (the reduction of aerosols to increase the greenhouse effect). It is, however,

possible to combine high-efficiency coal plants with low-NO

burners.

Another example is the simultaneous development of coal-based synthetic natural gas

(SNG) in China and its possible use in city centres to replace coal in order to reduce air

pollution. Recent research shows the impact that this strategy would have on the country’s CO

emissions. The carbon footprint of SNG is estimated to be seven times that of natural gas, and

current plans do not currently include carbon capture and storage, which could significantly

reduce emissions from SNG production. The use of SNG in electricity would release 36-82%

more CO

than coal. “If all 40 or so of the projected facilities are built, the GHG emissions

would be an astonishing ~110 billion tonnes of CO

over 40 years” (Yang and Jackson, 2013).

The country’s plan to introduce a nationwide emissions trading system in the coming years is

likely to contradict such plans. They are nonetheless a vivid example of how a solution to local

environmental problems does not automatically lead to lower GHG emissions (see IEA, 2014d

for a discussion of pollution control in China and expected climate benefits).

With possible interactions and multiple costs and benefits, a systematic methodology is

required to integrate all available information to guide decision making. A thorough multi-

dimensional cost-benefit analysis (CBA), i.e. a regulatory impact assessment, is a useful

starting point. One must recognise that the value used for GHG emissions in such a

methodology will be imprecise given the structural uncertainties related to climate change.

Nevertheless, however imprecise a monetary metric may be to capture dimensions as

diverse as health and environmental impacts, it is far superior to an implicit valuation at

zero of all non-financial dimensions (see OECD, 2006 for a discussion of CBA for

environmental policy). A very useful contribution of the CBA process is the identification

of potential winners and losers from the proposed policy; such understanding is essential

for making a proper case for the introduction of a policy change.

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– 1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT

Notes

On a global scale between 2011 and 2050, the International Energy Agency’s

Energy

Technology Perspectives’

2°C Scenario (2DS) generates fuel savings that outweigh

the additional investment required to keep CO

emissions from energy on a

2°C-compatible path, including when applying a 10% discount rate (IEA, 2014a). See

also IEA (2014b).

See OECD (2014a) for a discussion of air quality effects of fossil fuel use in

transport.

Other systems in place include national-level systems in New Zealand and Korea,

North America’s Regional Greenhouse Gas Initiative, China’s provincial and cities

carbon market pilots (which should evolve into a nationwide system by 2020),

Japan’s Tokyo and Saitama prefectures’ systems, and Kazakhstan’s pilot ETS

(Alberola, 2014; World Bank, 2014a).

The World Bank Partnership for Market Readiness provides a forum for national and

regional policy makers to exchange on the design and implementation details of

carbon market instruments (World Bank, 2014b).

Norway has already linked its system with the EU ETS and Switzerland may follow

soon.

Recent theoretical work supports that an optimal solution to long-term CO

mitigation

should combine a carbon price and R&D expenditures to reduce the cost of

not-yet-competitive CO

-saving technologies. Without directed support it would take

a much higher carbon price to encourage such R&D, with a higher welfare cost

overall (Acemoglu et al., 2012).

Another dynamic effect is mentioned in OECD (2011b): policies that inadvertently

result in additional emission reductions – i.e. a lower price of CO

on the market can

also facilitate the adoption of a more ambitious emission reduction if and when future

emission caps are set by the regulator.

For detailed recommendations on this issue, see Hood (2011; 2013) and OECD

(2013b).

Another carbon tax was introduced in France starting in 2014.

BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to

artificially shift profits to low or no-tax locations where there is little or no economic

activity, resulting in little or no overall corporate tax being paid. BEPS is of major

significance for developing countries due to their heavy reliance on corporate income

tax, particularly from multinational enterprises (OECD, 2013a).

10.

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1. CORE CLIMATE POLICIES AND THE CASE FOR POLICY ALIGNMENT –

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PART I. REFORMING CROSS-CUTTING POLICIES –

Part I

Reforming cross-cutting policies

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I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE –

Chapter 2

Scaling-up low-carbon

investment and finance

There is an urgent need to significantly scale-up investment to low-carbon, more energy

efficient alternatives (e.g. renewable energy, sustainable transport systems, energy

efficiency) and to shift investment away from fossil fuel use. The low-carbon transition will

require mobilising of all sources of public and private sector investment and finance,

including institutional investors. Governments need to use their scarce resources to trigger

large-scale private sector investment in activities otherwise unlikely to attract sufficient

private funding. However, some financial systems regulations hinder the allocation of long-

term finance to low-carbon infrastructure investments. This chapter reviews such barriers

in areas including: regulations related to long-term investment; corporate disclosures on

climate risks; public procurement; and the allocation and delivery of development finance.

It then provides some guidance for governments on how to align principles governing

financial regulations, corporate governance and public spending with the low carbon

transition.

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– I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE

Key messages

The global economy requires around USD 90 trillion of investment in infrastructure between

2015 and 2030 to support economic development (e.g. buildings, transport, energy). Investing in

low-carbon, climate-resilient infrastructure could put the world on a 2°C trajectory and deliver

significant co-benefits, including improvements in air quality, health, energy savings and better

mobility. In contrast, decisions taken today on infrastructure such as transport, power generation

and buildings could lock economies deeper into greenhouse gas-intensive systems, technologies

and innovation and make them vulnerable to a changing climate.

The low-carbon transition investment challenge is twofold, involving:

Scaling-up finance

for long-term investment in infrastructure.

2. Shifting investments

towards low-carbon alternatives.

Investment is not moving significantly away from carbon-intensive technologies and

infrastructure. Current market forces and regulations tend to collectively favour investment in

fossil fuel activities over low-carbon infrastructure, often unintentionally. Governments need to

better understand the regulatory, legal and governance impediments to the supply of long-term

finance, and act rapidly to align market expectations with a low-carbon future.

The following questions highlight some core misalignments:

Is the current investment framework aligned with the low-carbon transition?

Strong,

stable climate policies are necessary to adjust the return on investment of low-carbon

infrastructure projects, but on their own are not enough. Policy makers need to address a range

of policy misalignments in the overall investment framework that collectively favour investment

in fossil fuel-intensive activities. These include conflicting incentives in competition, trade, tax

and innovation policies as well as insufficient institutional settings to enhance co-ordination

between levels of government (explored further in other chapters of this report). Promoting

competitive neutrality and keeping markets open will be key to maximising foreign and

domestic investment, enhancing competitive pressure, promoting innovation and reducing costs.

Is the regulatory framework for investors and financiers conducive to low-carbon,

long-term investments?

Regulatory frameworks implemented to pursue objectives outside the

climate sphere can have unintended consequences. For instance, the financial crisis has

motivated changes to financial stability rules – e.g. Basel III – that are sometimes accused of

inadvertently limiting the ability of institutions such as banks to finance long-term infrastructure

investments. While financial stability is a prerequisite to any kind of investment, including

low-carbon investment, an appraisal of the potential unintended impact of rules governing the

financial sector (accounting, prudential, market) on the supply of long-term finance appears

necessary. In particular, regulatory-induced misalignments between the time horizons of

investors and the need for long-term infrastructure financing would undermine the low-carbon

transition. Greater transparency and harmonisation of corporate disclosures on climate risks and

liabilities could also encourage climate-friendly investments.

Are climate goals mainstreamed in public spending and development policies?

Public

finance and investment could be powerful catalysts for the low-carbon transition, yet they are

not fully aligned with climate goals. Although its share has been rising over time, less than

one-fifth of official development assistance (ODA) is climate-related. Public support to private

investments in coal and gas is still significant. National and international public financial

institutions could more systematically lead the way by reconsidering their support to greenhouse

gas-intensive projects.

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I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE –

The low-carbon investment challenge

Unprecedented economic, social and technological transformation is needed to limit

global warming to 2°C above industrial levels and avoid catastrophic climate change. This

will require a dramatic reallocation of investment away from carbon-intensive

infrastructure to sustainable

low-carbon and climate-resilient infrastructure, such as solar

photovoltaic arrays and wind farms, energy efficient buildings, smart grids, public transport

and electric vehicle charging stations (IEA, 2014). Investment policies need to create the

conditions for this reallocation.

Irrespective of climate change concerns, the global economy requires around

USD 90 trillion of investment in infrastructure (e.g. buildings, transport, energy) between

2015 and 2030 to support economic growth and the broader development agenda (GCEC,

2014). In advanced economies, many ageing infrastructure networks for water, energy and

transport need to be replaced or upgraded. In emerging and developing economies, most of

the infrastructure required to meet development goals is still to be built, particularly in

urban settings (Corfee-Morlot et al., 2012). Historically, the challenge of rising energy

demand and transport needs has mostly been met with fossil fuels. City infrastructure

mainly revolves around the use of private cars.

Today there is an unprecedented opportunity to ensure that new investment in

infrastructure helps to mitigate and adapt to climate change while also ensuring economic

development, energy security and safe and reliable transport for all. While some

investments in carbon-efficient fossil-fuel infrastructure is still needed to support economic

development in the coming decades, there is an urgent need to reallocate and significantly

scale up capital to low-carbon, more energy efficient alternatives. Failing to seize this

opportunity will lock in CO

emissions for decades to come, implying significantly higher

social and economic costs of mitigation action (OECD, 2012a).

The incremental short-term costs of shifting to low carbon would amount to just a

fraction of the finance needed for infrastructure overall (Box 2.1). These additional costs

are limited compared to the potential impacts of climate change if this action is not taken

(Dellink et al., 2014). In addition, low-carbon infrastructure would bring many other

benefits: better mass transport in cities can reduce congestion and air pollution; distributed

renewable energy infrastructure projects can improve access to energy in developing

countries while lowering emissions, improving indoor air quality and stimulating

innovation through technology transfer and international co-operation (OECD, 2011;

2012a; 2015a); and making buildings more energy efficient could reduce energy costs.

These long-term costs and benefits should be fully taken into account.

Closing the financing gap

Irrespective of climate change, many countries are struggling to mobilise long-term

finance to meet infrastructure needs of all kinds. According to the World Economic Forum,

global spending on basic infrastructure – transport, power, water and communications –

amounts to USD 2.7 trillion a year when it ought to be USD 3.7 trillion (WEF, 2014).

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– I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE

Box 2.1.

Investment needs for a low-carbon energy sector under the IEA 450 Scenario

The International Energy Agency (IEA) estimates that cumulative investment of USD 53 trillion

in energy supply and efficiency will be needed by 2035 to achieve the goal of keeping global

warming below 2˚C. This is only about 10% more than the USD 48 trillion that would be needed in

the sector irrespective of climate change.

The composition of this investment shifts away from fossil fuels (USD 4.3 trillion lower) and

towards the power sector, particularly renewables, carbon capture and storage (CCS) technologies

and nuclear. Investments in energy efficiency are higher by USD 5.5 trillion.

Figure 2.1.

Investment needs in a 450* Scenario, 2014-35

Fossil fuels

Power T&D

Low carbon

Energy efficiency

New Policies

Scenario

450 Scenario

USD trillion (2012)

Notes:

* The 450 scenario of the

Word Energy Outlook

(IEA, 2014) is compatible with a 2°C trajectory.

Power T&D is transmission and distribution for the power sector.

Source:

IEA (2014),

World Energy Investment Outlook,

Special Report, OECD/IEA, Paris, available at:

www.iea.org/publications/freepublications/publication/WEIO2014.pdf.

There are different sources of traditional financing for infrastructure investments (IEA,

2014):

•

Governments, companies and households can directly finance investments from their

incomes: in companies, income that is not redistributed to shareholders is available for

investment. Governments can directly invest in infrastructure through their budgets or

through state-owned enterprises (SOEs).

Banks and other financial institutions provide short- or longer-term loans to companies

against an interest rate. Public financial institutions can provide loans and loan guarantee

mechanisms in strategic areas to attract private sector investment.

Capital markets provide a variety of long-term financing options though debt and equity.

Bonds are the main debt instrument available on capital markets, issued by governments,

public financial institutions or, to a lesser extent, companies. Equity usually attracts

investors that are looking for higher risk.

The public sector has traditionally taken the lead in long-term investment in public

goods, particularly in infrastructure projects. However, most OECD governments have had

to tighten their budgets in the aftermath of the 2008 financial crisis; far fewer resources are

•

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I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE –

available for public investment. Public investment per capita in 2012 fell in 15 out of

33 OECD countries, compared to 2007 (OECD, 2014a).

In light of the scale of the climate challenge and the growing fiscal constraints facing

OECD countries, public financing alone will not be enough to meet these investments

needs. The low-carbon transition will require the large-scale mobilisation of all sources of

private sector investment and finance (Corfee-Morlot et al., 2012). Governments need to

target their scarce resources at mobilising large-scale private sector investment and at

activities unlikely to attract sufficient private funding.

Traditional sources of private capital, such as commercial banks, are facing increasing

constraints on their ability to support long-term investment, with tightened financial

regulations and the need to reduce debt. But banks are not the only source of financing –

the low-carbon transition can mobilise new sources of capital and new financial

instruments.

There is no shortage of capital in the economy. The total assets held by financial

institutions – banks, institutional investors, central banks and public financial institutions –

have been steadily increasing over the past ten years, amounting to around USD 305 trillion

(FSB, 2013; see Figure 2.2). Not all of these funds are available for low-carbon

infrastructure investments; central banks have specific mandates and purposes. However,

the allocation of even a small fraction of these assets to low-carbon infrastructure would go

a long way towards achieving the necessary low-carbon transition.

Figure 2.2.

Assets held by financial intermediaries in the 20 largest economies and euro area

Banks

Public financial institutions

Central banks

160

140

120

USD trillion

Insurance companies and pension funds

MUNFI (based on OFIs)

100

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Notes:

MUNFI: Monitoring Universe of Non-bank Financial Intermediation; OFIs: other financial institutions.

Source:

FSB (2013), “Global shadow banking monitoring report 2013”, Financial Stability Board, Basel,

Switzerland, 14 November, available at:

www.financialstabilityboard.org/wp-content/uploads/r_131114.pdf.

With USD 92 trillion of assets under management in OECD countries in 2013,

institutional investors such as pension funds, insurers and sovereign wealth funds could

play a significant role in driving long-term investments in a low-carbon economy. They are

expected to increase in both scale and influence over the next decades due to greater wealth

and the growing need to cater to ageing populations in both OECD and non-OECD

countries. Those with long-term liabilities, such as pension funds, would be natural

candidates to build broad portfolios of low-carbon investments, as they are looking for

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– I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE

long-term, illiquid assets. Institutional investors have traditionally provided long-term

capital with investment portfolios built around the two main asset classes (bonds and

equities) and an investment horizon tied to the often long-term nature of their liabilities

(OECD, 2015g).

Although institutional investors have increased their equity and debt investment in low-

carbon projects in recent years, their investments remain minimal compared to the scale of

their assets. Looking at large OECD pension funds only, direct investment in infrastructure

projects of all types accounted for 1% of their asset allocation in 2013. Green infrastructure,

including clean energy, is estimated to account for an even smaller share (ibid.). Too many

barriers still stand in the way of scaling-up the participation of institutional investors

(Box 2.2).

Overcoming barriers to shifting investment to low-carbon assets

Current levels of low-carbon investment fall short of a development pathway

compatible with a low-carbon economy. Fossil fuels still account for more than 80% of

final energy consumption, a share that has remained almost unchanged since 1990 (IEA,

2013). While investments in renewable energy have grown rapidly in the past ten years,

from USD 60 billion in 2000 to a high point of nearly USD 300 billion in 2011, they have

since fallen back, to USD 217 billion in 2013, and are dwarfed by investments in fossil

fuels (BNEF, 2014). Of the USD 1 600 billion of global energy investments in 2013, 70%

was in the extraction and transport of fossil fuels, oil refining and construction of fossil fuel

power plants (IEA, 2014; see Figure 2.3). The same is true in the transport sector, where the

majority of private investment in developing countries still supports road infrastructure

(WRI, 2014b).

Figure 2.3.

Global annual energy supply investment, 2000-13

Renewables

1 800

Nuclear

Power T&D

Fossil fuels

USD billion (2012)

1 200

600

2000

2005

2010

2011

2012

2013

Notes:

Power T&D is transmission and distribution for the power sector: this cannot be assigned either to fossil

fuel or non-fossil fuel use.

Source:

IEA (2014),

World Energy Investment Outlook,

Special Report, OECD/IEA, Paris, available at:

www.iea.org/publications/freepublications/publication/WEIO2014.pdf.

Our economies encompass a range of market and policy failures that collectively favour

investment in fossil fuel-intensive activities over investment in low-carbon infrastructure,

often unintentionally. These are either linked to the enabling environment in specific

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sectors of the economy, or to the functioning and provisioning of financial markets

(Table 2.1). Together they mean that the risk-return profile of low-carbon investments is

often less attractive than their fossil fuel-based equivalents. Scaling-up financing to a low-

carbon economy will not happen spontaneously. It requires strong policy and price signals

to ensure that low-carbon and energy efficiency investments offer a sufficiently attractive

risk-adjusted return compared to available alternatives (IEA, 2014).

The business environment is affected by policy misalignments in various domains.

These are presented in the shaded part of Table 2.1 and are briefly discussed in the

following section; they are the subject of other chapters in this report. A perspective on

specific misalignments based on country context is also provided.

There are also policy obstacles embedded in financial systems and regulations that

hinder the allocation of long-term finance to long-term low-carbon infrastructure

investments (UNEP, 2014). Such barriers (listed in the non-shaded section of Table 2.1)

include the way long-term investment is regulated, climate risk is valued, corporate

outcomes are reported, public procurement operates and the way development finance is

allocated and delivered. Removing these barriers will require some key architectural

reforms to financial regulations, corporate governance and public spending, including

development assistance policies. These areas are covered in the next three sections of this

chapter.

Table 2.1.

Examples of policy misalignments that undermine low-carbon investment

Fiscal policies

Climate policies

Business environment

Investment policies

– Insufficient carbon pricing and incentives for low-carbon technologies

– Environmentally harmful subsidies and incentives (e.g. fossil fuels)

– Tax policies that unintendedly favour carbon-intensive behaviour (e.g. company cars)

– Lack of ambitious international and national reduction targets or binding objectives

– Lack of climate policy stability: retroactive changes in climate legislation

– Regulatory barriers to international investment in low-carbon projects (e.g. limits on foreign

ownership, restricted access to land, local content requirements)

– Lack of transparency, insufficient investor protection and intellectual property rights protection in

low-carbon technologies, weak contract enforcement

– Lack of open and competitive infrastructure markets (e.g. in the electricity sector)

– Market designs and regulatory rigidities that favour carbon-intensive infrastructure investment in

the energy sector

– Lack of a level playing field in the power sector for existing fossil-fuel producing state-owned

enterprises and independent producers of clean energy

– Trade barriers for low-carbon goods and services

– Lack of long-term goals for low-carbon infrastructure planning and procurement

– Contradictory signals between national and sub-national climate objectives

– Lack of stakeholder consultation in policy design

– Potential unintended consequences of financial regulations on long-term financing

– Financial incentives across the financial system favouring short-termism (remuneration practices,

fiscal measures, performance appraisal)

– Barriers to the deployment of innovative financial instruments for new types of investors

(e.g. institutional investors)

– Corporate reporting that does not reflect the climate risk (e.g. stranded assets)

– Lack of a responsible investment code

– Lack of clarity on fiduciary duty and stewardship with respect to environmental, social and

governance issues

– Ongoing support to carbon-intensive investments, nationally and internationally

– Continued support of carbon-intensive investments in development finance

– Lack of capacity

Competition policies

Trade policies

Public governance

Financial market

policies

Financial system

Business conduct

Public finance and

investment

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The enabling environment: Aligning investment policies with climate goals

Policy makers need to address policy misalignments in the overall investment

framework that collectively favour investment in fossil fuel-intensive activities (identified

in Table 2.1). These include conflicting incentives in competition, trade, tax and innovation

policies, as well as inappropriate institutional settings. These are explored in this section,

which builds on the key elements of the investment framework for green growth of the

OECD Policy Framework for Investment

(OECD, 2015b).

There is no one-size-fits-all strategy when it comes to policy reform – the relative

importance of each barrier depends on the country concerned. For instance, in developing

economies the difficult business environment, lack of government capacity and

low-maturity of financial markets are likely to be prominent obstacles to low-carbon

investment. Broadening international financing avenues while supporting local financing

mechanisms is essential to fill the financing gap (OECD, 2014b; 2013a). In OECD

countries, the lack of stable and strong climate policies, unintended consequences of

international financial regulations and environmentally harmful subsidies are likely to be

more prominent (Table 2.2).

Elements of a policy framework for green investment

Strengthen government commitment to low carbon internationally and nationally

Uncertainty and expectations matter when considering returns on investments with long

time horizons. Strong government commitments at both the international and national level

are necessary to catalyse low-carbon green investment. With clear, long-term and ambitious

signals and emission goals, nationally and internationally, investors and markets will have a

clearer view on where to invest, which in turn could lead others to do so.

Many countries have already developed national climate laws and strategies, some of

which are legally binding. The United Kingdom, for example, has introduced a long-term,

legally binding absolute emissions reduction target in its Low-Carbon Transition Plan,

translated into sequential carbon budgets.

Mexico’s Climate Change Act (2012) also

imposes domestic binding emission reduction targets. Ethiopia developed a green growth

strategy that focuses on climate change and, by extension, food security (OECD, 2013a).

Conversely, confused and changing climate policies deter private investment and raise

the cost of capital. Investors have repeatedly cited unpredictable changes to climate policies

as a prohibitive barrier to low-carbon investment. Erratic changes in support schemes can

also lower investor confidence and place further strain on the system (see Chapter 1).

Align investment incentives and disincentives to support a low-carbon agenda

Strong and stable carbon pricing policies or subsidies are needed to improve the returns

on investment in green infrastructure projects and reflect the true long-term costs of

economic development. Carbon pricing, regulatory interventions and robust support to not-

yet-competitive low-carbon alternatives could provide consistent signals. Shifting

investment incentives away from fossil fuels towards clean energy is also essential (see

Chapter 1). In parallel to implementing a clear, predictable and long-term price on carbon,

removing fossil fuel subsidies is fundamental for correcting distortions in the risk-return

profiles of low-carbon investments (see Chapter 3 for a broader discussion on

misalignments in the tax system).

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Apply the principles of non-discrimination, transparency and property protection

Governments should also make sure that their investment frameworks for low-carbon

investment are consistent with the essential investment principles of non-discriminatory

treatment of cross-border investments, intellectual property and protection of technologies,

and transparency. For example, local-content requirements are likely to increase the cost

and slow the speed of market penetration by clean energy technologies, yet they have been

planned or implemented in at least 21 OECD countries and emerging economies since the

financial crisis (OECD, 2015c). Addressing outstanding barriers to international trade and

investment in environmental goods, services and projects is also important (see Chapter 5).

Reinforce competition policies

Governments need to strengthen competition policy and address market and regulatory

rigidities that favour incumbent fossil fuel and resource-intensive technologies and

practices. Promoting competitive neutrality and keeping markets open will be key to

maximising foreign and domestic investment, enhancing competitive pressure, promoting

innovation and reducing costs. Preferential access to finance for outward investing and

exporting state-owned enterprises can distort clean energy markets (OECD, 2015d).

Ensuring a level playing field between incumbents and new entrants in low-carbon and

climate-resilient infrastructure markets will be critical for the penetration of low-carbon

technologies in the electricity sector (see opportunities for better alignment of innovation

policies in Chapter 4, and electricity markets in Chapter 7).

Facilitate access to financing and attract co-financing for green projects

A wide range of suitable financial instruments (e.g. credit enhancement, leasing,

guarantees, grants and bonds) offered by public financial institutions and by other

companies, by investors via capital markets, and supported by an efficient financial

infrastructure, are required to facilitate the transition to a resource-efficient economy

(Cochran et al., 2014; Corfee-Morlot et al., 2012; OECD, 2015g). The role of public

finance and public financial institutions is also critical, particularly in developing country

contexts. Through consistency in their official development assistance (ODA) policies and

broader development agendas, donor governments can help developing countries to

improve the conditions for lower carbon development (see the last section of this chapter).

Enhance co-ordination and improve public governance at all levels of government

Early engagement by key stakeholders in goal setting and planning, at every level of

government, will help ensure the relevance and consistency of policy objectives and

expectations in markets. Enhanced co-ordination and improved public governance,

especially among environment and natural resource management, energy and investment

authorities, is also a critical factor for low-carbon investment. This will be particularly

important at the metropolitan level to ensure a good integration of transport and spatial

planning policies for low-carbon cities, or in the context of solving trade-offs in rural land

use (see Chapter 8 on urban mobility and Chapter 9 on rural land use).

Establish policies to encourage environmentally responsible business conduct

Companies face increasing pressure to address climate change. Policy support to

climate-friendly practices can leverage companies’ contributions to addressing climate

change over and above the influence of regulatory approaches such as carbon pricing. For

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instance, carbon corporate disclosure is an important element of responsible business, and

should be increasingly encouraged by governments and investors (see section below on

carbon disclosure).

Address other cross-cutting issues

Governments must also co-operate at the multilateral level to address barriers to

international trade and investment in low-carbon infrastructure (see Chapter 5). More

generally, there are a number of barriers preventing institutional investors from moving

more into the low-carbon sector. Governments have a role to play in addressing these

specific barriers (Box 2.2). In this regard, innovative financial instruments – such as green

or climate bonds – could provide the missing link between long-term investments and a

financial system increasingly focused on liquid, short-term securities and stocks (ibid.).

Country context matters

Each country has a distinctive constellation of misalignments in its investment

framework. As in any investment project, the quality and resilience of political institutions

and the legal system, lack of capacity locally and maturity of the financial system could be

important obstacles to scaling-up private sector investment, and will influence the type of

finance available as well as the required policy support. In addition, developing countries

will face challenges, policy choices and trade-offs that are different from those of

developed countries (OECD, 2013a; see also Table 2.2). Their different characteristics and

priorities call for a specific sequencing and mix of policy instruments than from developed

countries to achieve low-carbon and greener growth. For instance, the existence of a large

informal economy that accounts for three-quarters of non-agricultural jobs in sub-Saharan

Africa and over two-thirds in South and South-East Asia does not facilitate the

implementation of economic, fiscal and regulatory policy instruments needed for a low-

carbon transition (OECD, 2013a).

In this context, promising economic tools to promote low-carbon growth in developing

countries include energy subsidy reforms with clear compensation mechanisms in place

(see Chapter 1), environmental tax reforms in the context of a broader tax reform that could

sustain the tax base (see Chapter 3) and payment for ecosystem services with

accompanying capacity development measures (see Chapter 9). Implementing standards

and certifications for sustainable production, mainstreaming sustainable public procurement

and developing well-defined and transparent land tenure rights systems could further help

developing countries integrate climate and a broader development agenda into economic

decision making (OECD, 2013a).

The international community can help developing countries make the shift, especially by

financing the short-term trade-offs that may be involved, such as the additional cost of going

green. Given the scale of the challenge, however, much of the finance will need to come from

domestic sources and international private investment, making it crucial to get the domestic

enabling conditions right, including high-quality policy for low-carbon development. In its report

Putting Green Growth at the Heart of Development

(OECD, 2013a), the OECD proposes an

agenda for international co-operation to support green growth that builds on three pillars:

1) strengthening international and domestic green finance and investment through better targeting

all types of development finance (see below for a discussion on the need to mainstream climate in

ODA and all development co-operation activities); 2) promoting green technology and co-

operation, building capacity for domestic green innovation and adoption, and developing

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intellectual property rights regimes (see Chapter 4); 3) facilitating trade in green goods and

services through the removal of tariff and non-tariff barriers (see Chapter 5).

Box 2.2.

How to unlock institutional investors’ investment in low-carbon,

climate-resilient infrastructure

In addition to creating an adequate policy framework and other essential pre-conditions, there

are a number of specific actions governments can take to overcome barriers and facilitate

institutional investors’ investment in green infrastructure:

•

Build confidence. By developing a national infrastructure strategy, including a roadmap

and project pipeline, investors would feel more confident in governments’ commitment to

green infrastructure.

Develop liquid markets for green infrastructure financing instruments. These could be for

debt in the form of green bonds, and for equity in the form of listed “yield co”-type funds.

They could be tailored to investor risk profiles across the project life cycle and developed

in co-operation with investors.

Create risk mitigation financing tools. Facilitating the development and application of risk

mitigation financing tools could result in more appropriate allocation of risks and their

associated returns. They could include credit enhancements and revenue guarantees,

first-loss provisions, cornerstone stakes and tools targeting challenges at all stages of the

project life cycle.

Reduce transaction costs. The costs associated with managing green infrastructure

investment could be eased by supporting efforts to standardise contracts and project

evaluation structures, and by creating aggregation and “warehousing” facilities.

Promote market transparency and standardisation. This could include improving data on

performance, risks and costs of green investments across available channels while

promoting public-private dialogue.

Clarify the risk profile of green investments. Strengthening requirements for institutional

investors to provide information on green investments, following internationally agreed

definitions, would enhance monitoring and understanding of these investments.

Be innovative in mobilising private investment. For example, a case can be made for

establishing a special-purpose public “green investment bank” or refocusing activities of

existing public financial institutions to mobilise private investment for green

infrastructure.

•

Note:

A yield co is a

publicly

traded company that is formed to own operating assets that produce a predictable cash

flow. Separating volatile activities (e.g. R&D, construction) from stable and less volatile cash flows of operating assets can

lower the cost of capital. Yield cos are commonly used in the energy industry, particularly in renewable energy, to protect

investors against regulatory changes.

Sources:

OECD (2014a), “Annual Survey of Large Pension Funds and Public Pension Reserve Funds”,

OECD, Paris; OECD (2015g),

Mapping Channels to Mobilise Institutional Investment in Sustainable Energy,

Green Finance and Investment, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264224582-en.

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Table 2.2.

How challenges and opportunities for low-carbon, resilient infrastructure investment

vary by national circumstances or institutional context

Category of country

Developed countries

Challenges

– Outdated or poorly maintained infrastructure requiring

renovation

– Lock-in: carbon-intensive infrastructure and urban

development patterns

– Climate policies in place but sometimes fragmented and

partial

– Some adaptation planning but limited policies and actions

to adapt

– Financial crisis put strains on banks and governments

– Rapid economic development and severe environmental

challenges, such as air pollution; inequalities

– Medium adaptive capacity, relatively high and increasing

vulnerability (e.g. slum populations in high-risk areas in

cities)

– Medium institutional capacity for policy reform, legal

enforcement capacity

– Rapid deployment of infrastructure, sometimes

carbon-intensive (e.g. building fossil fuel-fired power plants

to supply rapidly growing power demand)

– Large state-owned enterprises with preferential access to

finance may distort competition

Opportunities

– Renovation of aging infrastructure offers opportunities for

upgrading to more climate-friendly infrastructure

– Strong institutional capacity, certainty and reliability of

the investment environment

– High adaptive capacity, pockets of high vulnerability

(e.g. urban slums)

– High capacity to govern

– New types of investors, such as institutional investors

Emerging economies

Low-income and least

developed countries

– Relatively sound investment conditions and relatively

well-developed capital markets

– Strong economic growth and demographic pressure,

rapid urbanisation, large investments in infrastructure

occurring today

– Strengthening institutional capacity and policies to

address climate change

– Rapid growth in new infrastructure provides opportunity

to “leapfrog” technologically and integrate climate

concerns at design phase at relatively low cost

– Large policy-driven institutions, such as state-owned

enterprises and public development banks (e.g. BNDES

in Brazil)

– Large informal economy

– Growing international donor support for adaptation

planning, mitigation implementation and technology

– High level of poverty and inequality requiring targeted

transfer

policies to avoid negative effects on the poorest

– Weak capacity and resources for innovation and investment – Opportunities to integrate climate change consideration

into development planning and infrastructure planning,

– Lack of basic infrastructure (e.g. transport, energy and

which is largely led by the public sector

water) and urgent need for economic development

– Low-carbon development can contribute to more

– High-dependence on natural resources (both renewable

sustainable management of the natural resources on

and non-renewable)

which developing economies depend and reduce the

– High poverty and high vulnerability to climate change and

pollution that can undermine long-term prosperity

climate-related disasters (including slum populations in

– Provision of basic infrastructure provides opportunity

high-risk areas in cities)

for leapfrogging; also where growth is limited and rural

– Low adaptive capacity, some adaptation planning yet

decentralised infrastructure solutions may deliver

limited implementation or mainstreaming into development

low-cost services (e.g. off-grid electricity) along with

planning

other local development benefits.

– Insufficient financial and technical capacity in government

Sources:

Adapted from OECD (2011),

Towards Green Growth,

OECD Green Growth Studies, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264111318-en;

Corfee-Morlot, J. et al. (2012), “Towards a green investment policy framework:

The case of low-carbon, climate-resilient infrastructure”,

OECD Environment Working Papers,

No. 48, OECD Publishing, Paris,

http://dx.doi.org/10.1787/5k8zth7s6s6d-en;

OECD (2013a),

Putting Green Growth at the Heart of Development,

OECD Green

Growth Studies, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264181144-en.

Channelling all sources of finance to low-carbon infrastructure

Governments need to better understand and monitor the potential unintended impact of

rules governing the financial sector on the availability of public and private long-term

finance for low-carbon projects. These include the way long-term investment is regulated,

climate risk is valued, corporate outcomes are reported, public procurement operates, and

development finance is allocated and delivered. Where negative unintended consequences

are identified for climate, governments should evaluate the need to remedy them while

making sure other fundamental development objectives, such as financial stability or

inclusive growth, are met.

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Ensure that the “rules of the game” for investor behaviour are consistent with a

low-carbon pathway

In the aftermath of the 2008 financial crisis, governments have tightened the regulatory

framework for banks at both the national and international level to discourage excessive

risk-taking behaviour and increase the overall stability of the financial system. The

Basel III accords, aimed at improving and harmonising the supervision and regulation of

banks, strengthen the stringency of capital adequacy requirements.

Some argue that Basel III is having unintended consequences on the ability of private

financial actors to invest in and finance low-carbon, climate-resilient infrastructure. The

concern in the energy sector in particular is that the capital and liquidity requirements of

Basel III may limit the amount of capital available for long-term financing from banks in

the future (IEA, 2014; Narbel, 2013; Spencer and Stevenson, 2013; UNEP, 2014, 2015).

There is to date a lack of data and empirical evidence to support these claims. The

Financial Stability Board (FSB) has been mandated by the G20 to monitor financial

regulatory factors affecting the supply of long-term investment finance. It “finds little

tangible evidence or data to suggest that global financial regulatory reforms have had

adverse consequences on long-term investment” (FSB, 2012). Many FSB members stress

that it is too early to fully assess the effects of reforms still in the early stages of

implementation or being developed, as Basel III only comes into full force in 2019. It can

also be very difficult to disentangle effects of regulatory changes from broader economic

and policy factors that affect supply and demand of long-term investment finance.

Solvency II is also cited as barrier to investors’ involvement in the sector, affecting

European insurance companies in particular. Like Basel III, Solvency II introduces more

stringent quantitative (solvency ratios) and qualitative (risk management and supervision)

requirements for European insurance companies. It increases the quantity and quality of

regulatory capital that insurers have to hold to cover their insurance and investment risk.

The regulation is said to have the effect of inducing insurers to reallocate investments away

from equity – as equity investments are subject to a higher charge than debt – towards more

highly rated securities. The impact on direct infrastructure investment has also been cited as

potentially negative, as Solvency II no longer limits the amount that insurers may invest in

non-listed assets (such as infrastructure, private equity, venture capital; Spencer and

Stevenson, 2013). Solvency II’s calibrations are currently under review.

Financial stability is a prerequisite to any kind of investment, including low-carbon

ones. However, governments need to continue to monitor financial regulatory reform for

unintended consequences on the supply of long-term investment financing, and should

ascertain the extent to which these regulations are consistent with the objective of

transitioning to a low-carbon economy. Such regulations include financial regulation but

also accounting practices and other specific regulations to institutional investors on the

availability of long-term investment finance.

Properly account for climate risks and liabilities in financial markets

While in general financial markets are perceived to be fairly efficient, mispricing of risk

can still occur. For example, there is growing concern that the market risk related to climate

liabilities embedded in corporations’ assets or investors’ portfolios is neither properly

assessed nor managed. Stronger climate policies will have an impact on future investment

decisions, but also on the profitability of existing assets. Some existing fossil fuel assets

might not be able to fully recover their investment due to pricing and profitability changes

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resulting from climate change regulation. Properly accounting for this risk in financial

evaluations could help better allocate capital to low-carbon, climate-resilient assets, or even

encourage divestment from more carbon-intensive assets.

Stronger climate policies will have an impact on the profitability of existing assets.

There are several degrees of climate-related risks that could create “stranded assets”,

i.e. premature devaluation of assets or liabilities in investors’ and corporations’ portfolios

(Carbon Tracker Initiative, 2013):

•

Regulatory stranding due to a change in climate legislation, e.g. an evolution in minimum

standards for greenhouse gas (GHG) emissions reductions from thermal power plants.

Economic stranding due to a change in relative costs and prices, e.g. through the

implementation of a significant carbon price across the economy, or because of a decline

in overall energy prices. The effects of the recent drop in oil prices on investors’

portfolios are a striking example of this phenomenon.

Physical stranding due to extreme weather events, or gradual changes that hinder the

operation of assets (see Chapter 6).

For the energy sector alone, the

World Energy Investment Outlook

(IEA, 2014)

estimates that by 2050, USD 300 billion in assets could be stranded under a scenario

compatible with the 2°C objective:

•

Power sector: 165 gigawatts (GW) of new fossil fuel capacity would have to be retired

before repaying investment costs, with an unrecovered sunk cost of USD 120 billion.

Ninety GW of new power plants would go through early retirement, but after having

recovered their investment costs.

Oil and gas: 5% of proven oil and gas reserves would be stranded, representing

USD 130 billion for oil and USD 50 billion for gas. These reserves are often referred to

as “unburnable carbon”.

Coal: here the risk of stranding assets is relatively low, at USD 4 billion, as the low-

carbon projection implies the closure of older, fully repaid mines.

To date, this risk is not properly disclosed, let alone priced, across investors’ or

governments’ portfolios. As part of their commitment to climate change mitigation,

governments, regulators and central banks should start addressing this market failure

alongside the implementation of core climate policy instruments. Central banks and other

financial regulators, if they have authority, may need to take action to examine the risks that

climate change poses to the real economy. Stock exchange regulations could, for instance,

demand more precise disclosures of carbon content in listings.

Failure or delay to create a clear and stable policy framework could increase the risk of

stranding, as more “dirty” assets would be built only to be shut down or operated at a level

much lower than anticipated by investors. This would increase the overall costs of

implementing ambitious climate policy. In addition, governments could themselves be

financially affected by stranded assets, as they own 50-70% of global oil, gas and coal

resources and collect taxes and royalties on portions they do not own (CPI, 2014).

Public and private investors should increasingly assess climate risks. The

G20/OECD

High-Level Principles of Long-Term Investment Financing by Institutional Investors

state

that “the risks associated with long-term investments should also be carefully assessed,

including market and illiquidity risks (and related portfolio constraints), climate and other

environmental risks, and exposure to potential future climate regulation” (G20/OECD,

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2014). The Bank of England is to conduct an enquiry into the risk of fossil fuel companies

causing a major risk to financial stability if future climate change rules render their coal, oil

and gas assets worthless.

Enhancing climate risk disclosure by corporations and investors

If companies were able to better measure and be more transparent about their liabilities

related to climate change, it would allow investors to evaluate assets more accurately,

increase social accountability and facilitate the design of incentives to encourage climate-

friendly behaviour. Various elements of environmental, social and governance (ESG)

disclosure could help to lower the vulnerability of companies to climate policy and to

climate change risks (i.e. stranding or actual destruction of assets).

Step up standards for environmental, social and governance disclosure

ESG corporate disclosure is an important element of responsible business and is

increasingly in demand by governments and other stakeholders. Corporate disclosure

practices are increasingly supported (or required) by legislation or stock exchange

regulations that make ESG disclosure mandatory. Experience shows that for companies

above a certain size and complexity, ESG disclosure can be an important tool for

identifying business risks and opportunities (Baron, 2014). ESG disclosure usually includes

GHG reporting, which is a first necessary step in creating financial indices that include

information on carbon emissions. Indices such as the

Low Carbon 100 Europe

or the

FTSE4 Good Index Series

permit dedicated tracker funds to offer investment opportunities

for investors interested in financial products with an emissions metric.

Since the late 1990s, a number of mandatory or voluntary government schemes have

emerged that require or encourage enterprises to measure and report their GHG emissions.

The majority of G20 countries now have some kind of corporate reporting scheme in place

that requires disclosure of climate change-related information (Box 2.3).

Box 2.3.

Current status of corporate reporting legislation internationally

In the

European Union,

the EU Emissions Trading System (ETS) covers companies in

energy-intensive sectors, including more than 11 000 power stations and manufacturing plants in

the 28 EU member states and other European Economic Area countries. In total, around 45% of

total EU emissions are covered by the EU ETS (EC, 2013). Installations are required to measure

direct emissions each year, and provide emissions reports verified by an accredited verifier. In

addition, the EU Directive on financial reporting was amended in 2014 to require large public

interest entities with more than 500 employees to also report on non-financial information (EC,

2014). Reporting requirements include disclosure on policies, outcomes and risks, and relevant

non-financial key performance indicators concerning environmental and social matters, human

rights, anti-corruption and bribery issues, and diversity of directors. The Directive will apply to

approximately 6 000 EU entities (up from 2 500 companies currently reporting). The amendment

came into force in 2014; national governments have two years to incorporate it into national law.

The first corporate reports under the scheme will relate to the financial year 2017.

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Box 2.3.

Current status of corporate reporting legislation internationally

(cont.)

The

United Kingdom

moved from voluntary to mandatory reporting for GHG emissions

in 2013. Under this scheme, all UK quoted companies must report on their GHG emissions as

part of their annual directors’ reports. The requirement affects all UK incorporated companies

listed on the main London Stock Exchange, another European market or whose shares are

dealing on the New York Stock Exchange or NASDAQ.

Under

France’s

2010 Grenelle II legislation, companies with over 500 employees are

required to publish a carbon inventory and an emissions reduction, and to include report

information on a broad range of environmental social and governance related issues in their

management plan. As with the United Kingdom, France requires this information to be

third-party verified.

In the

United States,

the Environmental Protection Agency (EPA) issued the Mandatory

Reporting of Greenhouse Gases Rule in September 2009. The rule governs mandatory reporting

of GHG for suppliers of fossil fuels or industrial GHGs, manufacturers of vehicles and engines,

and all facilities that emit more than 25 000 tonnes of GHG every year (US EPA, 2014).

In 2014, the EPA’s Greenhouse Gas Reporting Program released its 4th year of emissions data,

including information from facilities in 41 source categories. In 2010, the Securities and

Exchange Commission issued interpretive guidance on climate change disclosure, but so far it

seems to have had limited effects: 59% of Standard & Poor’s 500 companies do report on

climate but, according to some, their disclosures have been disappointing (Ceres, 2014).

Australia,

the National Greenhouse and Energy Reporting Act of 2007 introduced a

national framework for the reporting and dissemination of information on GHG emissions, GHG

projects, energy use and production by companies. This reporting requirement has not been

changed in spite of the July 2014 repeal of the 2011 Climate Tax.

Japan

has a long history of regulation and incentives to reduce energy consumption and

increase energy efficiency. GHG emission is part of the system and a range of governmental

schemes are in place to support energy and climate change policies, including the

2006 Mandatory Greenhouse Gas Accounting and Reporting System, Japan’s Voluntary

Emissions Trading Scheme and the Experimental Emissions Trading Scheme.

Carbon reporting is also required in emerging economies

The

People’s Republic of China’s

(hereafter “China”) National Development and Reform

Commission (NDRC) has developed GHG Accounting and Reporting Guidelines for

ten industries, using the GHG Protocol (WRI, 2014a). In March 2014, the NDRC announced a

new regulation requiring all firms emitting more than 13 000 tonnes (CO

-eq) to begin reporting

their annual GHG emissions. It is expected to be enforced from 2015 (Reuters, 2014).

India

the National Voluntary Guidelines on Social, Environmental and Economic

Responsibilities of Business, adopted in 2011, encourage companies to disclose non-financial

information, but no specific GHG emissions reporting scheme is currently in place. In 2013, the

India GHG Program was established by Indian companies and think tanks in co-operation with

the World Resources Institute to increase the capacity of Indian companies in measuring and

disclosing GHG emissions (India GHG Program, 2014).

In its White Paper on a Climate Change Response,

South Africa

is planning to make carbon

reporting mandatory by large emitters: those emitting over 0.1 Mt of GHGs annually or that

consume electricity which results in more than 0.1 Mt of emissions from the electricity sector.

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In parallel, a range of tools (principles, guidelines or certification-based standards) now

exists to facilitate ESG reporting by companies (Baron, 2014):

•

The Global Reporting Initiative guidelines: a leading ESG reporting framework providing

a clear structure and set of metrics, including on GHG emissions, that companies can

apply and adjust to their business areas (GRI, 2013).

The Climate Disclosure Standards Board: designed to help companies disclose

information about their climate change-related risks and opportunities, carbon footprints,

carbon reduction strategies and implications for shareholder value in mainstream

financial reports (CDSB, 2013).

The Climate Disclosure Project: the largest organisation collecting voluntary corporate

reports on climate data. Over 11 000 companies worldwide reported to it in 2013 (CDP,

2014).

•

Ensure climate disclosures provide a full view of a company’s future in the face

of climate change risks

Although progress has been made in corporate ESG disclosure, there is clearly room for

more, including on climate. While homogenisation is growing via the widespread use of the

Global Reporting Initiative guidelines, corporate reports are still difficult to compare,

increasingly weighty (sometimes running to hundreds of pages) and not always satisfactory

in terms of the quality of information provided (WBCSD, 2013). In a survey conducted by

the Association of Chartered Certified Accountants to feed into the European discussion on

mandatory corporate reporting of non-financial elements (ACCA and Eurosif, 2013), 92%

of investors surveyed found the information provided by companies not sufficiently

comparable.

ESG reporting is not internationally harmonised. It exists in some jurisdictions, but is

voluntary or non-existent in others. With the exception of Denmark, the Netherlands and

the United Kingdom, board responsibility is not mandated in most countries. Some carbon

disclosure schemes cover the largest GHG emitters; others cover the largest firms (e.g. in

terms of employees) but leave out a large majority of companies. Some focus on emissions,

others also cover climate risks. Some schemes provide a reporting framework, others leave

latitude in the choice of a reporting framework and indicators.

Another major critique, certainly in relation to climate-related information, is a lack of

clarity about what is and is not material to a company’s business, which limits the

usefulness of a company’s report for investors. For instance, Ernst and Young (2014) found

that institutional investors are often unable to identify what issues presented in ESG

disclosures could materially affect shareholder returns. Similarly, investors have difficulty

connecting non-financial and financial performance, and comparing across companies.

Use integrated reporting as a framework for climate disclosure

A better alignment of corporate reporting schemes with the low-carbon transition would

require greater harmonisation of ESG reporting requirements and greater coherence among

scope, risk disclosure and reporting requirements on climate-related information while

minimising bureaucratic burdens for small and medium-sized enterprises and avoiding

distorting competition.

More fundamentally, it is argued that climate disclosures do not provide a full view of a

company’s future in the face of climate change risks, let alone broader social and

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environmental issues. For instance, the scope of climate-related information to be disclosed

under government schemes is generally limited to GHG emissions, and only a few require

reporting of emissions reduction targets or climate risk management plans.

The Carbon Tracker Initiative (2014) provides a list of disclosures that would increase,

in their view, fossil fuel companies’ transparency about climate risks. These include

scenario analyses and more direct measurements, e.g. of carbon embedded in coal, oil and

gas reserves and resources. Reports on the vulnerability of assets to climate change impacts

can also be relevant. However, they also raise questions about comparability and

methodologies used to measure and report vulnerability. Are companies relying on the

same baseline climate change scenarios? How are extreme events treated? If a materiality

filter is applied, how are various risks evaluated (is probability of occurrence factored in, or

should a company be reporting on risks even in the absence of a probability function)?

Looking further ahead, the end goal seems relatively clear: concise corporate disclosure

that links financial and ESG performance, both to foster action in companies that have so

far ignored climate change risks and may be at risk as a result, and to encourage

investments in companies with highly integrated performance.

This is the goal pursued by companies supporting “integrated reporting”, the disclosure

by a company of information on its near-, medium- and long-term capacity to generate

value, including material risks and opportunities related to all its capitals: financial,

manufactured, intellectual, human, social and relationship, and natural (IIRC, 2013). While

a common statistical basis is still needed, good practice is emerging: integrated reports are

now mandatory for listed companies in South Africa, and in France publicly listed and

other companies must issue a report combining financial and ESG information.

Mainstreaming climate change goals in public spending

Domestic and international public financial institutions and development agencies can

be instrumental in providing risk mitigation instruments and refinancing guarantees to

bridge the long-term financing gap, provided they have a clear mandate and mainstream

climate change into their economic decisions.

Mobilise public financial institutions

Public financial institutions, including national banks, development agencies and export

credit agencies, are all engaged in decisions that could either lock in more carbon or

facilitate the transition away from fossil fuel use. As policy-driven institutions, they were

originally created to address market failures or externalities which limit private sector

investment, and to deliver financial services that meet a public policy objective and are not

provided by the market. In some cases, these institutions are mandated to provide long-term

financing independent of market cycles and in line with policy priorities; they are also able

to leverage capital at advantageous, below-market rates for targeted investments, as they

benefit from government support (Cochran et al., 2014).

These characteristics and objectives of public financial institutions fit well with the

need to step-up private investment in low-carbon projects. Public financial institutions can

be instrumental on three levels:

1. facilitating access to long-term financing

2. reducing project and financial risks

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3. filling the capacity gap (i.e. providing expertise to support low-carbon investments

and market development).

Some PFIs already have an explicit mandate and authority to invest in green

infrastructure (e.g. KfW) – often with established guidelines on which technologies or

markets to address. Others have a much less precise mandate, with “sustainability” being

part of their overarching objectives (Cochran et al., 2014). Export credit agencies have also

started exploring to what extent they could support the climate agenda (Box 2.4).

Box 2.4.

The role of export credit agencies in the low-carbon transition

The main objective of export credit agencies’ (ECAs) is the promotion of trade. ECAs are

demand-driven public institutions that provide funds and guarantees to domestic companies to

facilitate exports, including for fossil fuel investments. Export credit terms are regulated by the

OECD Arrangement on Officially Supported Export Credits.

OECD countries have taken active steps to introduce and maintain environmental

accountability in official export credits and to address climate change. Following the

introduction of a Sector Understanding on Export Credits, Renewable Energies and Water

Projects for a trial period in December 2005, participants agreed in 2012 to a Sector

Understanding on Renewable Energy, Climate Change Mitigation and Water Projects, to

complement the arrangement and provide adequate financial terms and conditions to projects in

sectors significantly contributing to climate change mitigation, including renewable energy and

energy efficiency projects.

In 2014, OECD member countries agreed a Ministerial Statement on Climate Change, which

affirmed members’ commitment to “continuing discussions on how export credits can contribute

to our common goal to address climate change”. Discussions are ongoing in the OECD Working

Party on Export Credits on how export credits might help address climate issues.

Source:

OECD (2012b), “Arrangement on officially supported export credits”, TAD/PG(2012)9, OECD,

Paris, available at:

www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?doclanguage=en&cote=ta

d/pg(2012)9.

In the last ten years, countries have complemented their mainstreaming efforts by

establishing special purpose banks to finance the low-carbon transition. Known as green

investment banks,

these are “domestically focused public institutions that use limited

public capital to leverage or ‘crowd-in’ private capital, including from institutional

investors, for low-carbon and climate resilient infrastructure investment” (Eklin et al.,

2014). They are hence scaling-up private investment in green infrastructure, and creating a

track record for investment in clean energy. While these efforts should be encouraged, all

public financial institutions should mainstream climate change aspects in their investment

decisions.

Strengthening the climate mandate of public financial institutions would facilitate the

low-carbon transition. In particular, public banks could play an important role in supporting

the refinancing required for long-term low-carbon projects, as traditional commercial banks

are less willing to lend long term. Public banks could develop low-carbon refinancing

guarantee facilities to overcome this bias (Spencer and Stevenson, 2013).

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Make use of green public procurement and expenditure

Public procurement is essential to the commissioning and delivery of infrastructure

projects. General government procurement accounts for 13% of gross domestic product

(GDP) and nearly one-third of government expenditures in OECD countries (OECD,

2013b). As low-carbon projects can be more expensive than alternatives, especially if

carbon emissions are not explicitly valued, there is no incentive for the private sector to

include them in public bidding processes unless it is required (Corfee-Morlot et al., 2012).

This is where green procurement policies come in. Sustainable public procurement could

shape consumption and production to support low-carbon objectives, generate new markets

and provide examples of good practice for business and consumers (OECD, 2013a).

OECD countries increasingly recognise how procurement can be used for different

objectives, not only value for money and integrity, but also wider objectives such as

sustainable development and greening public infrastructure. Green public procurement is

defined in the OECD

Recommendation of the Council on Improving the Environmental

Performance of Public Procurement

(OECD, 2002) as “the procurement of products and

services which are less environmentally damaging when taking into account their whole

life cycle”. The OECD further adopted the

Recommendation of the Council on Public

Procurement

(OECD, 2015e) to encourage the use of procurement as a smart governance

tool, including recommendations on how to integrate secondary policy objectives, such as

sustainable green growth. Today, 72% of OECD countries already have policies

encouraging green procurement at the central government level. Some developing countries

are starting to adopt green procurement practices: Colombia has attached a green criterion

to procurement policy including life-cycle analysis of products (OECD, 2013a).

To contribute to the OECD Green Growth Strategy and provide concrete examples for

countries wishing to invest in green public procurement, the OECD’s Public Governance

Committee has developed a compendium of good practices (OECD, 2015f; see also

Box 2.5). The compendium presents case studies across six dimensions which correspond

to green public procurement challenges reported by countries to the OECD.

Challenges include procurement officials’ perceptions that green products and services

are more expensive than conventional ones, lack of technical knowledge on how to

integrate environmental standards in the procurement process, challenges in accurate life-

cycle costing and the absence of reliable monitoring mechanisms to evaluate if green public

procurement achieves its goals.

Governments should encourage the use of procurement to ensure effective public

service delivery while pursuing the goal of a low-carbon economy at all levels of

government. To do so, the low-carbon objective of procurement should be clearly

articulated and prioritised. Consideration should be given to which means are best able to

achieve this objective: traditional procurement, public-private partnerships (PPPs),

concessions, etc. In addition, systematic life-cycle analysis should be undertaken to

properly account for the costs and benefits of low-carbon procurement. While 79% of

OECD countries identify the cost of green projects as a key barrier to further

mainstreaming green procurement, only 16% of countries implement a life-cycle cost

evaluation systematically (Box 2.5).

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Box 2.5.

Compendium of green procurement good practices

The compendium of green procurement good practices aims at helping countries implement

green public procurement (GPP) across six areas:

GPP legal and policy framework.

Certain OECD countries such as Germany, Japan

and the United States have put in place a clear legal framework which has allowed them

to direct purchasing activities to achieve set green goals. Non-OECD member countries

such as Colombia and China are moving fast to put GPP policies in place.

Planning GPP, assessing life-cycle costs and understanding market solutions and

capacity.

Only 16% of OECD countries evaluate life-cycle costs systematically when

purchasing. Such analysis should be systematically mainstreamed into green

procurement practices. It is also important to understand what green solutions are

available and industry appetite to provide green products, otherwise tender procedures

may fail.

Environmental standards in the design, selection and award of projects and

contract performance.

In 2010, 24 OECD countries included environmental

considerations in technical specifications for products and 18 in the award criteria for

contracts, but only 13 in contract performance, for example with a bonus if a contractor

achieves or exceeds certain standards in performance.

Professionalisation, multidisciplinary procurement teams and GPP training.

Multidisciplinary means teams that include procurement officials, lawyers and

professionals with technical GPP capacity, such as engineers. Procurement knowledge

and skills are essential. In the case of GPP, which adds the environmental angle to all

other procurement complexities, bureaucratic and otherwise, this is even more relevant.

Raising the awareness of buyers, the market and citizens of GPP solutions and

benefits.

There is little data on awareness campaigns and communication strategies

undertaken in OECD countries to raise the visibility of GPP.

Mechanisms to monitor the impact of green procurement.

Source:

OECD (2015f), “Smart procurement: Going green – Best practices for green procurement”,

GOV/PGC/ETH(2014)1/REV1, OECD, Paris, available at:

www.oecd.org/officialdocuments/publicdisplay

documentpdf/?cote=GOV/PGC/ETH%282014%291/REV1&docLanguage=En.

Improve the use of discount rates in economic valuation

The use of high discount rates in the financial sector can exclude resilience and values

of natural and social capital from financial investment decisions and arbitrages. Time

horizons of investments, even those labelled as long-term, do not match those of

low-carbon and climate resilience investments. This is true of public investments also.

Governments should review their use of discount rates to ensure they are not resulting in

bias towards carbon-intensive infrastructure. The use of unique discount rates in public

project evaluation can create a bias, as the positive externalities of low-carbon projects are

often long-term and could be implicitly excluded from the valuation. More work is needed

to investigate best practices for project valuation mechanisms at the government level,

including the incorporation of a proxy for the monetised value of externalities (see

Chapter 3). More work is also needed to understand how to better align time horizons from

public and private sector perspectives.

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Mainstream climate change across all development co-operation policies

Development and environment, including climate change, are inextricably linked:

without further policy action, local and global climate risks threaten to reverse development

gains made to date by exacerbating water, food and other resource scarcity, as well as

increasing the risk of extreme weather disasters (OECD, 2014b).

Development finance for climate change is on the increase, largely driven by

international commitments and financial mechanisms under the Rio conventions

(Figure 2.4).

Total bilateral and multilateral climate-related development finance

commitments to developing countries reached USD 37 billion in 2013.

This represents up

to 17% of bilateral official development assistance (ODA) and 19% of multilateral

development finance flows in 2013 (OECD-DAC Statistics, 2014). The majority of finance

targets climate change mitigation objectives, with USD 23 billion (74% of the

USD 37 billion) targeting mitigation only or mitigation together with adaptation objectives,

while USD 9.6 billion (39%) targeted adaptation (either alone or together with mitigation

activities). Key infrastructure sectors – energy, transport and water – received over two-

thirds of climate-related development finance in 2013.

Bilateral climate-related ODA commitments from members of the OECD Development

Assistance Committee (DAC) have been rising, reaching USD 21.9 billion in 2013

(Figure 2.4). Of this, USD 12.4 billion targeted climate change as a principal objective,

meaning that these development co-operation activities would not have taken place in the

absence of a climate change objective (OECD-DAC Statistics, 2014).

Figure 2.4.

Trends in bilateral official development assistance to climate, 2002-13

3-year annual averages

Notes:

The figure presents a trend based on averages over three years to smooth fluctuations from large multi-

year projects programmed and committed in a given year, such as observed in 2010. Development co-operation to

adaptation activities was only measured from 2010 onwards, so this aspect is underestimated before that point.

Activities marked as having a “principal” climate objective (mitigation or adaptation) would not have been

funded but for that objective; activities marked “significant” have other primary objectives but have been

formulated or adjusted to help meet climate concerns.

Source:

OECD DAC Statistics (2014),

Climate-related development finance in 2013: Improving the statistical

www.oecd.org/dac/environment-development/Climate-

picture,

OECD,

November

2014.

related%20development%20finance%20FINAL.pdf.

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While climate-focused development finance has been steadily increasing, much more

can be done to further integrate and mainstream climate change across all bilateral and

multilateral development co-operation providers and sectors. To date, less than 20% of

development finance targets climate change objectives. There is no guarantee that the 80%

of ODA that is not targeted to climate is not increasing GHG emissions or climate

vulnerability. Assessments suggest that a sizeable share of development assistance activities

might be affected by climate risk, with estimates ranging from 10-40% per country

depending on the development co-operation portfolio in each country context, when

measured as a share of total ODA .

This is particularly important as the share of ODA targeting infrastructure is increasing,

with a sizeable portion disbursed to support private sector investment through loans and

equity by bilateral and multilateral institutions (Miyamoto and Biousse, 2014). In the

energy sector, bilateral development finance (ODA and other official flows, or OOF) nearly

doubled, from USD 5.4 billion a year over 2002-04 to USD 10.3 billion a year over 2011-

13. Within this, development finance targeting renewable and nuclear energy has also

grown steadily, and at a faster rate – peaking at 40% in 2008-10 before falling slightly to

35% in 2011-13 (Figure 2.5). While the share of development finance to non-renewable

energy has fallen steadily, finance to non-renewable energy did increase between 2008-10

and 2011-13 in absolute value.

Figure 2.5.

Bilateral development finance* to the energy sector, 2002-13

3-year averages

Notes:

*Development finance includes official development assistance and “other official flows” (transactions by

the official sector which are not eligible as official development assistance, either because they are not primarily

aimed at development or because they have a grant element of less than 25%).

“Renewable” encompasses biomass, geothermal energy, hydro-electric power plants, ocean power, solar energy,

wind power and power generation from renewable sources.

Source:

OECD-DAC Creditor Reporting System, December 2014.

Traditional development co-operation providers need – and are increasingly aiming – to

be smarter in their use of development finance to ensure that the private sector and private

finance are mobilised towards developing a low-carbon economy. A recent analysis of

ODA support to private investment in infrastructure shows that 58% of support to private

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sector energy investment goes to renewable energy sectors (Figure 2.6; Miyamoto and

Biousse, 2014). Beyond renewable energy, no reference to low-carbon and climate-resilient

infrastructure in the transport sector is found in donors’ strategies for supporting the private

sector, except for the European Bank for Reconstruction and Development (EBRD), which

has a specific focus on environmentally sustainable transport.

Figure 2.6.

Sectoral distribution of official development assistance support

to private investment in infrastructure, 2011

a. Total

Water, 5%

b. Within energy

Other non- Oil, 3%

renewable, 2%

Coal,

Transport, 20%

Gas, 33%

Hydro, 17%

Energy, 60%

ICT, 15%

Wind, 7%

Solar, 3%

Geothermal, 2%

Other

renewable, 29%

Source:

Miyamoto, K. and K. Biousse (2014), “Official support for private sector participation in developing

country infrastructure”,

OECD Development Co-operation Working Papers,

No. 19, OECD Publishing, Paris,

http://dx.doi.org/10.1787/5jz14cd40nf0-en.

Middle-income countries receive 80% of climate mitigation-related development

finance. These are where most mitigation leverage exists, and well-developed financial

markets create good conditions for mobilising the private sector. However, it does raise the

question of whether in this case ODA may be substituting for private investment

(Miyamoto and Biousse, 2014).

More generally, greater integration and mainstreaming of climate change considerations

across development co-operation activities requires a better understanding of the new

development finance landscape, with new actors, geographies and forms of innovative

financial support. The traditional image of donor countries and aid recipients is now out of

date.

Development finance is now much more dynamic and increasingly driven by new

providers participating in South-South co-operation and engaging with provider countries

in triangular co-operation. Private sources of finance in the form of equity, bonds, loans and

risk mitigation instruments, as well as philanthropic sources, could become transformative

agents (OECD, 2014e). ODA only represents 6% of external finance in many upper middle-

income countries; here ODA could move away from traditional concessional finance to the

use of credit enhancement mechanisms such as guarantees, hybrid debt/equity, insurance

schemes and securitisation (OECD, 2014e). Many large emerging economies have

well-developed financial systems, with stock exchanges and debt markets that help them

mobilise domestic and international private investments (Figure 2.7). For least developed

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countries, however, ODA still represents 70% of their total external finance as grants, and

is still very important.

Figure 2.7.

Developing countries’ net resource receipts from DAC countries

and multilateral organisations in 2000-11

ODA grants

Foreign direct investment

1 000

900

800

ODA loans

Bonds and other securities

Other official flows excl. export credits

Private grants

Official export credits

Remittances

USD 2011 billion

700

600

500

400

300

200

100

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Notes:

Total external financial resources include bilateral official development assistance (ODA), other official

flows (OOF), private grants, private flows at market terms and remittances from Development Assistance

Committee (DAC) member countries, and concessional and non-concessional outflows from multilateral

agencies. Since 2005, private grants have been based on estimates from the Hudson Institute’s Center for Global

Prosperity, which uses a more generous definition than DAC statistics, including, for example, the imputed value

of volunteer time.

Source:

OECD (2014b),

Development Co-operation Report 2014: Mobilising Resources for Sustainable

Development,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/dcr-2014-en.

The lack of data is an obstacle to enhancing the effectiveness of climate finance. At the

international level, while significant progress has been made in monitoring and reporting

public flows, there is no integrated measurement, reporting and verification system for all

climate-specific flows, as they come from various sources (North, South), through bilateral

or multilateral channels and various instruments (offset finance, grants, concessional loans,

capital, guarantees, risk mitigation tools). One very specific data challenge is the tracking

of climate finance linked to international negotiations on climate change under the United

Nations Framework Convention on Climate Change (UNFCCC). At the UNFCCC

Conference of the Parties in Cancun in 2010 (COP16), member states:

•

recognised that developed country parties commit, in the context of meaningful

mitigation actions and transparency on implementation, to a goal of mobilising jointly

USD 100 billion per year by 2020 to address the needs of developing countries

agreed that, in accordance with paragraph 1(e) of the Bali Action Plan, funds provided to

developing country parties may come from a wide variety of sources, public and private,

bilateral and multilateral, including alternative sources.

Since then, the issue of measuring, reporting and verifying the USD 100 billion has

tended to overshadow the more important and fundamental question of how to mobilise the

trillions necessary for the low-carbon transition.

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•

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– I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE

But the scale of investment required is an order of magnitude or more than the Cancun

commitment to mobilise USD 100 billion per year by 2020. Much of the finance will need

to come from domestic sources and international private investment, underlining the

importance of getting the domestic enabling conditions right, including high-quality policy

for low-carbon development.

More generally, understanding the impact of ODA on leveraging private investment

would enable governments to design appropriate tools and mechanisms to do so. To date,

there is very limited understanding of private climate flows to climate change mitigation

activities beyond large-scale renewable energy projects, with critical data gaps in transport,

water, land-use, energy efficiency and adaptation (Caruso and Jachnik, 2014). Key

elements for governments to consider in developing a comprehensive framework for the

measurement, reporting and verification of climate change support are: consistent

definitions (such as what counts as low-carbon, climate-resilient activities); clear

methodologies, (i.e. to estimate private climate finance mobilisation); robust and integrated

data management systems; and transparency (Caruso and Jachnik, 2014). They should also

build the capacity of individual entities, countries and international data systems for more

systematic data collection and reporting (e.g. on private co-financing for publicly supported

climate activities).

The OECD-led Research Collaborative on Tracking Private Climate Finance brings

together research organisations, international finance institutions and governments. It is

investigating and testing options for estimating the mobilisation by developed countries of

private finance for climate action in developing countries, as well as ways to improve the

underlying availability of data on private climate finance beyond large-scale renewable

energy projects.

Notes

Throughout this report, “sustainable” is meant as environmentally sound and socially

acceptable.

The Policy Framework for Investment (PFI) is a comprehensive and systematic

approach for improving investment conditions. It helps governments and regions to

design and implement policy reforms to create an attractive, robust and competitive

environment for domestic and foreign investment.

See:

www.gov.uk/government/uploads/system/uploads/attachment_data/file/228752/9

780108508394.pdf.

The United Kingdom’s Green

(www.greeninvestmentbank.com).

Investment

Bank

one

example

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I.2. SCALING UP LOW-CARBON INVESTMENT AND FINANCE –

The case studies together give a comprehensive view of what may constitute good

approaches to successful green procurement, see:

www.oecd.org/gov/ethics/best-

practices-for-green-procurement.htm.

The United Nations Framework Convention on Climate Change (UNFCCC), the

Convention on Biological Diversity (CBD) and the United Nations Convention to

Combat Desertification (UNCCD), collectively known as the Rio conventions, were

established following the 1992 United Nations Conference on Environment and

Development in Rio de Janeiro. The developed countries that signed the three Rio

conventions in 1992 committed themselves to assist developing countries in

implementing them.

As recorded in OECD-DAC statistics (OECD-DAC Statistics, 2014).

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I.3. IMPLEMENTING CLIMATE-FRIENDLY TAXATION PRACTICES –

Chapter 3

Implementing climate-friendly

taxation practices

Taxation is an important lever of economic policy. Taxes and tax expenditures on energy

can greatly influence energy-related CO

emissions. After an overview of existing fossil fuel

subsidies, this chapter first describes the diversity of taxes applying to fossil fuels, including

the differences between gasoline and diesel fuels in transport. It then identifies other tax

provisions that can have a strong influence on emissions, such as the fiscal treatment of

company cars and commuting expenses, and the design of property taxes. The role of tax

provisions in driving investments in specific activities should also be assessed against the

objective of the low-carbon transition.

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– I.3. IMPLEMENTING CLIMATE-FRIENDLY TAXATION PRACTICES

Key messages

Taxation is an important determinant of economic choices. Fiscal policy is also an important

element of a country’s economic strategy, including social equity. In the wake of the financial

crisis and with budget consolidation needs, governments have been looking for new tax

revenues, including taxes on greenhouse gases and other environmental externalities.

Are energy-related taxes and tax expenditures conducive to low-carbon choices?

One of

the obvious misalignments with the low-carbon transition is the existence of subsidies and tax

expenditures favouring the production and use of fossil fuels. These instruments are increasingly

hard to justify if their goal is to bring more fossil fuel to the market. Where their goals are social,

they are often poorly targeted and lead to higher greenhouse gas emissions and other external

costs. Fossil fuel subsidies can adversely affect the greenhouse gas implications of international

trade, e.g. by distorting markets and harming the competitiveness of renewables and energy

efficient technologies. Reform in this area is not easy, but possible: Indonesia has increased the

price of diesel by 67% and that of gasoline by 89% through subsidy cuts since 2013. The current

trend of low oil prices can facilitate such policy reform, as well as the introduction of higher

taxes on oil products where suitable.

Energy taxes, when expressed on a per-tonne-of-CO

basis, vary significantly across fuels

and end-uses, indicating potential for increased tax revenues and a more homogenous price on

emissions. Tax differentials between diesel and gasoline, or lower value-added tax rates

applied to energy products, continue to encourage higher energy use with negative impacts on

the local and global environment. Fuels used for heating and electricity generation are often

lightly taxed, if at all.

Are there policy misalignments in tax provisions outside energy?

Another misalignment is

found in the favourable personal tax treatment of company cars (19% of OECD countries’ total

car fleet) and commuting expenses in many countries. These tax provisions encourage a higher

number of cars that are used more intensively, resulting in increased CO

emissions and other

external costs.

Property taxes and related instruments can also influence future CO

emissions, especially in

countries with rapidly growing urban areas. Taxes on property can encourage urban expansion, a

problem that can be fixed by changing the tax base. The role of tax provisions favouring home

ownership over other household investment is also under scrutiny for its possible effects on

employment and mobility needs. As is the case with tax policy more generally, this issue should

be cast in light of the broader economic benefits of such tax measures, in country-specific

contexts.

Taxes and tax expenditures on corporate income are powerful drivers of economic choices,

including investment. A preliminary survey of tax provisions in G20 countries favouring

investment in specific activities or regions indicates occasional biases in favour of

energy-intensive activities. These could inadvertently enhance the risk of stranding assets and

warrant closer examination.

How would the low-carbon transition affect future tax revenues?

The low-carbon

transition sometimes raises concerns about future tax revenues from fossil fuel use. If a CO

tax

were introduced to reduce emissions, projections show that its revenues would more than offset

the reduction in energy tax revenues for some time to come. Governments nevertheless need to

anticipate the impacts of the low-carbon transition on tax revenues. The possible reform of

specific tax provisions to better align incentives with the low-carbon transition would need to be

integrated into this discussion.

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I.3. IMPLEMENTING CLIMATE-FRIENDLY TAXATION PRACTICES –

The taxing issue of low-carbon economies

Tax systems influence firms’ and individuals’ choices. The broad structure of most tax

systems emerged at a time when scarcity of natural capital and environmental and health

damage were low on the agenda. While taxes were levied on natural resources (e.g. fossil

fuel royalties and land taxes), and sometimes on goods with large environmental impacts

(e.g. transport fuel), their revenue-raising role was much more prominent than resource

management or environmental protection.

An increasing number of countries have made progress in environmental tax reform,

loosely defined as the use of market-based instruments – including taxes and tradable

permits – to improve the extent to which prices reflect all of the social and environmental

costs of economic activities.

Using taxes or charges to incorporate these “external” costs

leads to a more efficient economy.

This chapter investigates traits of the tax system that will need reform if carbon pricing

and other climate policy instruments are to effectively drive the low-carbon transition.

However, wider market barriers and failures (see Chapter 1) may mean that environmental

tax reform is a necessary (but not always sufficient) condition for efficient use of natural

resources, protection of the environment and transition to a low-carbon economy.

Taxes are said to be efficient when they raise revenues without distorting economic

decisions. Environmental taxes and the reforms identified in this chapter play a different

role: they seek to improve efficiency by bringing prices more in line with marginal social

costs and changing economic decisions accordingly. In addition, the productive use of tax

revenues or subsidy reform enables governments to reduce other, possibly less efficient,

types of taxes. For example,

Tax Policy Reform and Economic Growth

(OECD, 2010)

ranks taxes according to their impact on long-run per capita gross domestic product (GDP)

as a proxy for well-being: recurrent taxes on immovable property are the least harmful,

followed by consumption taxes (including environmental taxes) and other property taxes,

personal income taxes and corporate income taxes. An environmental tax reform could

therefore reduce the tax system’s negative impact on growth if it were combined with

reduced reliance on personal and corporate income taxation (Box 3.1).

Box 3.1.

A second look at taxing carbon: Beyond budget consolidation

What could be the role of carbon pricing in the context of the broader tax policy reform? In principle,

carbon taxes are introduced to restore economic efficiency by reflecting the social cost of carbon in relative

prices. The effects on long-run GDP are through reduced damage from climate change.

A new carbon tax would also bring additional revenues. Cournède et al. (2013) assess environmental

taxes alongside other possible sources for fiscal consolidation, but find them to be mildly harmful for

short-term equity and growth. Flues (2015) shows how the equity impact of carbon and energy taxes can be

more than compensated through the recycling of a portion of these taxes’ revenues. The growth effect, which

does not take the long-term reduction of climate impacts into account, can be mitigated by the reduction of

other, more distortive taxes.

The role of a carbon tax should be considered in the context of a broader fiscal reform agenda. Recent

modelling work on 35 developed and developing countries finds that carbon tax revenues, recycled through

either lump-sum transfers, deficit reduction, labour taxes or government investment, can lower or more than

compensate the short-run effects of the carbon tax on growth. Such modelling exercises tend to overestimate

negative GDP impacts, as they cannot capture all distortions embedded in the tax system (GCEC, 2014).

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The distributional aspects of the low-carbon transition and how taxation can address

any negative impacts (see Chapter 1) are essential elements of a successful low-carbon

policy strategy. Without a clear and comprehensive strategy for dealing with distributional

impacts, policy makers may not be in a position to push low-carbon policy forward.

This chapter first identifies negative features of tax systems for the low-carbon

transition. It then investigates to what extent the tax code at large is or is not neutral with

respect to low-carbon investment choices.

How energy subsidies and taxes undermine climate change action

This section explores several misalignments between energy taxes and subsidies and the

low-carbon transition, looking beyond the lack of explicit CO

prices in many jurisdictions.

Tax expenditures and fossil fuel subsidies

A number of tax expenditures

encourage the economy to produce or consume more

fossil fuels than it would in the absence of such measures. While such an approach may

have been justified on grounds of energy independence, it will be increasingly inconsistent

with governments’ aspirations for climate change mitigation. The OECD’s

Inventory of

Estimated Budgetary Support and Tax Expenditures for Fossil Fuels

lists a total of

550 measures supporting coal, oil and gas production and use across the 34 OECD

countries (OECD, 2013a). Together these were worth USD 55-90 billion every year

between 2005 and 2010. As OECD countries remain mostly fossil fuel importers, more than

two-thirds of this support goes to the consumption of fossil fuels, sometimes in the form of

a price-fixing mechanism, which can become a large subsidy when international prices

soar.

While not all these expenditures mean lower fossil fuel prices for consumers, they

enhance the profitability of activities related to fossil fuels. This generally contradicts the

need to direct the economy away from CO

-emitting fossil fuels, and also affects

governments’ budgets.

Outside the OECD, several countries also maintain domestic energy prices below

international benchmark prices. The International Energy Agency (IEA) estimates that

fossil fuel subsidies, based on a price-gap analysis, had reached USD 548 billion in 2013

(IEA, 2014). The IEA lists over 40 countries, representing well over half of global fossil

fuel consumption, where at least one fossil fuel is subsidised when compared to its

benchmark international price. Most of these subsidies are found in developing countries.

Some reform has been undertaken or is underway to reduce and replace them with other

social transfers when necessary, but these estimates indicate that more could be done to

remove unjustified support for fossil fuel production and use. The impacts of fossil fuel

support are indeed quite striking in terms of climate policy costs. For instance, without

subsidies to oil use in power generation in the Middle East, oil-fired power plants could not

compete with any of the main renewables or nuclear technologies (IEA, 2014).

The piecemeal approach to energy taxes is harmful

Policy instruments to price greenhouse gas emissions (GHGs) are generally applied on

top of existing taxes which already affect production and consumption patterns,

e.g. different tax rates applied to gasoline and diesel. Many countries’ energy tax rates vary

considerably for similar fuels across sectors. “Many differentials may, however, have

simply arisen out of the piecemeal design and introduction of taxes on different energy

products at different points in time” (OECD, 2013b).

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These differences result from policy choices made on grounds including resource

availability, social justice (limited taxes on fuel oil for residential heating), competitiveness

considerations (low or zero taxes on coal use in industry or exemptions for agriculture),

local externalities (lower taxes on energy used in mass transport) or fiscal efficiency (high

taxes on transport fuels, where price elasticity is low and tax revenues more stable) (OECD,

2013b). The result is that there is no uniform price signal on CO

emissions in OECD

countries that would be consistent with a social cost of carbon (Figure 3.1). Despite being

averaged across OECD countries, the figure shows that the differences are still significant.

The above evidence shows that there are opportunities to lower energy-related CO

emissions at a low cost by raising the lowest tax rates or levying taxes on sectors which are

untaxed as of now. One should not infer that transport fuels should be “let off the hook”

given their high tax rate: the high effective CO

price reflects, in fact, many other

externalities such as local pollution or the cost of road infrastructure. CO

emissions

reductions are still required in the transport sector as well, which a price signal could help

achieve.

Figure 3.1.

Taxation of energy in the OECD area on a carbon content basis

Tax

Tax rate expressed in EUR per tonne of CO

TRANSPORT

HEATING AND PROCESS USE

Tax rate expressed in EUR per tonne of CO

ELECTRICITY

Biofuels and waste

Coal and peat

Oil products

Natural gas

2 500 000

5 000 000

7 500 000

10 000 000

12 500 000

Tax base – energy use – expressed in thousands of tonnes of CO

Source:

OECD

(2013b),

Taxing

Energy

http://dx.doi.org/10.1787/9789264183933-en.

Use:

Graphical

Analysis,

OECD

Publishing,

Paris,

Value added taxes on energy

Value added taxes (VAT) often make up a substantial part of the end-use energy price

and, as such, deserve close scrutiny. OECD (2015) considered VAT rates on energy

products for OECD countries and Argentina, Brazil, the People’s Republic of China

(hereafter “China”), India, Indonesia, the Russian Federation and South Africa. It tested

whether these rates differ from standard VAT rates – an undifferentiated VAT rate would

not change relative prices between energy and other goods. A differentiated VAT rate,

however, affects relative prices; a reduced rate, in particular, partly offsets the impact of

specific excise taxes on energy products.

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Out of the 41 countries studied, 16 have lower VAT rates for energy products: “the

reduced rates are either set at approximately half the standard VAT rate or are substantially

reduced to rates between 3% and 7%. Reduced or zero VAT rates are most frequently

applied to electricity (13 countries), firewood (9), heating oils (9), natural gas (8), liquefied

petroleum gas (3), coal (3) and, kerosene or aviation fuel (3), crude oil (3), diesel (2) and

gasoline (1). Differential rates may apply only to specific users, e.g. all or some households,

or small businesses” (ibid.).

Lower VAT rates tend to be explained politically by the high share of energy

expenditures in lower income household budgets, or specific economic activities

(agriculture, fisheries). However, higher income households often benefit more from low

rates in absolute terms than lower income households. There are more effective means of

transferring resources to poor households in a way that does not encourage the use of fossil

fuels (see Chapter 1, and Flues, 2015).

The ups and downs of international energy prices

Even if taxes sometimes account for the majority of the final price of energy (e.g. for

gasoline or diesel in some OECD countries), end-user prices also reflect the underlying

commodity prices, although in a less immediate fashion in markets with price regulation.

The ups and downs of international energy prices clearly affect incentives to reduce

GHG emissions, and to invest in exploration and production of marginal oil and gas fields.

A good example is the current case of car users experiencing a drop in gasoline prices. All

things being equal, the lower prices are likely to lead to greater car use, and therefore more

emissions. It also means people are less inclined to buy more efficient vehicles,

locking in high emissions for some time. International prices also affect the cost of low-

carbon policies. In the case of electricity plants capped under an emissions trading system,

a drop in coal prices would encourage more coal use. For a given emissions cap, this

automatically triggers an increase in the price of CO

allowances paid by sectors beyond

electricity (Braathen, 2011). International energy price movements therefore have a bearing

on the effectiveness of low-carbon policies and their cost.

A drop in international energy prices raises the possibility of increasing taxes or

removing subsidies on fossil fuels, with less impact on the incomes of those benefiting from

the subsidies. Tax revenues can be redistributed through cuts in other distortive taxes used

for budget consolidation or earmarked for low-GHG technologies. Policy makers could flag

to the general public that the increase in tax is to: 1) reduce other distortive taxes or

increase other transfers; 2) keep emissions under control as part of climate policy. It is

important, however, to keep this arrangement stable over time, especially from a budget

perspective. The new tax should therefore not be adjusted downward if international prices

go back up.

Generally speaking, countries that are keen on taxing carbon should prepare for

situations where the price falls on international markets, inadvertently undermining their

efforts to reduce CO

emissions and other externalities – recognising, at the same time, the

advantages of low-energy import prices on trade balances and households’ available

income. There can be both a carbon and a growth dividend during such episodes, provided

policies are in place and the general public understands the strategy underlying the carbon

tax.

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The diesel-gasoline tax differential makes little sense

Of the 34 OECD countries, 30 have lower tax rates on diesel than on gasoline (Harding,

2014a). This tax differential is at odds with the environmental effects of each fuel,

including CO

emissions. A litre of diesel emits about 18% more CO

than a litre of

gasoline. All OECD countries, with the exception of the United States, tax diesel less (and

often much less) than gasoline when measured on a per unit of energy basis or a tonne of

basis. This differential is of course even more pronounced in countries with a tax

preference for diesel (Figure 3.2).

Figure 3.2.

The difference between gasoline and diesel tax rates for road transport

EUR per litre

Diesel tax rate as % of gasoline tax rate

140%

EUR per Gigajoule

EUR per tonne CO2

120%

100%

80%

60%

40%

20%

Notes:

France reduced the gasoline-diesel tax differential by EUR 0.02 from its initial level of EUR 0.18.

New Zealand levies a per kilometre road user charge, with higher charges for larger vehicles; although the

charges are not on fuel

per se,

they essentially equalise the costs of diesel and petrol in New Zealand. Tax rates

are as of 1 April 2012 (except for Australia for which it is 1 July 2012). Figures for Canada and the United States

include only federal taxes. OECD-S is the simple OECD average; OECD-W is the weighted OECD average.

Source:

Harding, M. (2014a), “The diesel differential: Differences in the tax treatment of gasoline and diesel for

road

use”,

OECD

Taxation

Working

Papers,

No.

21,

OECD

Publishing,

Paris,

http://dx.doi.org/10.1787/5jz14cd7hk6b-en.

The tax differential tends to be justified as a support to users of diesel in the agriculture,

fisheries and road freight industries, which also compete internationally, making it more

difficult to reduce the differential. It is sometimes justified by the belief that greater

efficiency of the diesel engine would mean fewer CO

emissions overall. However, the

efficiency advantage does not warrant a lower tax because the environmental and social

costs are, in fact, higher per unit of energy for diesel than for gasoline (especially given

diesel’s higher nitrous oxide and particulate emissions; OECD, 2014). The higher fuel

efficiency of diesel cars may mean lower CO

emissions per kilometre travelled, but only if

the diesel vehicle is at least 15% more efficient than the gasoline vehicle it displaces, which

is not always the case (Harding, 2014a). Moreover, the economic benefit of better fuel

economy of diesel vehicles is entirely captured by their owners – not society at large –

meaning that no subsidy is needed. A lower diesel price may encourage the greater use and

purchase of larger diesel vehicles, resulting in more CO

emissions.

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The tax differential on diesel is not justified on environmental nor other grounds. Its

gradual removal would mean a cleaner environment and fewer CO

emissions. Instead, the

tax rate would need to include a CO

component per litre, i.e. a higher rate on diesel per

litre. In parallel, the impact of existing purchase or registration taxes on vehicle choice,

vehicle characteristics and driving behaviour should be carefully considered alongside the

levels of fuel tax in each country (ibid.).

Beyond energy taxes: Tax signals hindering low-carbon choices

Tax treatment of company car use and commuting expenses

Company cars represent a substantial share of the car stock in many OECD countries.

Tax regimes on company car use and commuting expenses can favour certain modes of

transport over others and influence how much employees travel; in addition, few countries

tax the benefit of free parking provided by employers. The implications for CO

emissions

are clear (Harding, 2014b).

The carbon impact of company car tax regimes depends on incentives provided to

employers and employees to increase the number of cars on the road, their fuel efficiency

and distances driven. Under-taxation of the capital cost of a car may increase the number of

cars in a country. The favourable tax treatment of fuel expenditures discourages the

purchase of more efficient company vehicles. And the distance travelled is likely to be

higher where the tax treatment of the private use of company cars is favourable.

One study finds considerable aggregate taxable benefits for company cars across

27 OECD countries and South Africa (ibid.). Based on a benchmark tax treatment, the

study estimates that the weighted average subsidy per company car per year is EUR 1 600.

The total value of the tax expenditures related to company cars and their use across

countries studied ranges from EUR 19.0 billion to EUR 33.7 billion, with a midpoint

estimate of EUR 26.8 billion.

As the taxable benefits measured are largely insensitive to distance driven, these tax

regimes encourage individuals to increase the distance driven in company cars. Moreover,

they tend to provide a greater subsidy to cars that are less fuel efficient, leading to higher

associated CO

emissions than would be the case with a neutral tax treatment. Company

cars also tend to be larger and less efficient than private cars (ibid.).

The signal sent by tax breaks for company cars tends to contradict the aim of reducing

emissions and other external costs of transport. Governments could tip the balance in

the other direction – towards environmentally motivated company car taxation – to

encourage energy efficient vehicles. However, the efficiency of such measures should be

assessed against that of other instruments and policies more closely related to CO

emissions, such as fuel taxes.

Corporate income taxes: Carbon neutral?

To date, the implications of countries’ corporate tax codes for the low-carbon transition

remain uncharted territory, with a few exceptions (Box 3.2).

An initial survey of corporate tax provisions in G20 countries, which was conducted by

PricewaterhouseCoopers LLP for the OECD and for this project, identifies tax provisions

that governments use in support of specific, carbon-intensive activities. These vary in

nature:

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•

Accelerated depreciation of capital: assets are depreciated more rapidly for tax than for

accounting purposes, with a benefit for capital-intensive activities, which can be more

energy-intensive than average activities. For instance, Australia has tax depreciation rates

that may exceed accounting depreciation rates for assets such as aircraft, buses, trucks,

tractors and harvesters, as well as some oil and gas-related activities.

Spain also has

accelerated depreciation on mining assets.

Other investment incentives and tax holidays are also used: Hungary, Israel and

South Africa have investment incentives that are available to all industries but which tend

to be used by heavy industry. Indonesia has inbound investment incentives available to

specific industries, many of which are GHG-intensive. Some countries provide incentives

for investments in economic development or less-developed zones; although they are not

specific to an activity, they tend to benefit capital-intensive heavy industry.

Box 3.2.

Accelerated depreciation of capital:

Insights from a US National Academy of Sciences study

•

One of the major tax expenditures is the possibility to depreciate equipment and machinery faster than the

economic life of these assets would suggest. A recent US study by the Committee of the Effects of Provisions

in the Internal Revenue Code on Greenhouse Gas Emissions indicates the important effect of accelerated

depreciation on the economy and greenhouse gas emissions (Nordhaus et al., 2013). Accelerated depreciation

can influence emissions in the following ways:

•

“Positive effects of accelerated depreciation on economic growth could raise GHG emissions, simply

because a larger economy, with all other things unchanged, will require greater use of fossil fuels.

A more capital-intensive economy could raise or lower GHG emissions per unit of output, depending

on whether capital and energy are substitutes or complements in production.

Shifts in output among industries (from those that use less to those that use more machinery and

equipment) could increase or decrease fossil fuel use, thereby raising or lowering GHG emissions per

unit of output.

Accelerated replacement of old capital could reduce GHG emissions per unit of output if new capital

is more energy efficient than the capital it replaces.” (ibid.)

•

A simulation of the removal of accelerated depreciation finds a small downward impact on the GHG

intensity of the US economy, with a low impact on overall emissions as the impact on national output is

slightly positive. While the study concludes that the effect may be too small to matter at that resolution of

economic model, it seems nonetheless worthwhile to explore how common such tax expenditures are in other

countries and how they influence various activities, especially the high capital-intensity of low-carbon power

generation technologies.

Further, the interaction between tax provisions and climate objectives ought to be tested in a low-carbon

policy, not in a business-as-usual scenario, as was done in the cited study.

Source:

Nordhaus, W.D. et al. (eds.) (2013),

Effects of U.S. Tax Policy on Greenhouse Gas Emissions,

Committee of the

Effects of Provisions in the Internal Revenue Code on Greenhouse Gas Emissions, Board of Science, Technology, and

Economic Policy, Policy and Global Affairs, National Research Council of the National Academies, The National

Academies Press, Washington, DC, available at:

http://sites.nationalacademies.org/PGA/PGA_084888.

However, there are instances of the use of tax provisions to promote low-carbon or

high-efficiency investments (in Ireland,

Japan, Mexico and the United Kingdom, among

others). Some countries, such as Canada, have taken steps to realign tax depreciation rates

for the mining and energy sectors with those for other industries. In the European Union,

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state aid guidelines do not authorise development tax incentives for activities such as ship-

building, steel, coal or investment in energy supply infrastructure.

The above list is not conclusive evidence of widespread corporate tax misalignments

with climate policy objectives. These measures are, however, powerful drivers of

investment and economic activity – and indeed are sometimes part of a country’s industrial

policy. Their differentiated use across activities could therefore be evaluated from a climate

policy perspective. Any assessment should consider the combined effects of all corporate

tax signals. For instance, a mining company may be granted accelerated capital

depreciation but pay high levies and royalties on its output.

Property and land taxes need to be better designed

Property taxes, if properly designed, can encourage denser cities that contribute to less

private car use (see Chapter 8). A study of the United States finds that a higher property tax

reduces city size, all other things being equal (Brandt, 2014). The devil is in the details,

however: taxes on land and especially on the value of buildings can hinder renovation and

have been said to be the cause of inner city deterioration and urban sprawl (Land, 1967;

Carey, 1976; Wyatt, 1994, cited in Brandt 2014). Property taxes are also sometimes

designed to encourage single-occupancy housing; this should be avoided if denser housing

infrastructures are desired (Merk et al., 2012). This goal is best achieved by combining a

two-tier property tax based more on the value of land than on buildings, with low taxes on

renovation (Brandt, 2014).

A (higher) property tax could also allow the reduction of other more distortive taxes

and make the overall tax system more efficient. In China, sub-national governments raise

only a small amount of revenue from property taxes (and more from property sales taxes).

They often resort to land conversion fees to balance their budgets. The resulting conversion

of agricultural land into urban land, then sold at higher price to developers, generates urban

sprawl (Van Dender, 2015). More recurrent taxes on immovable property may be better

both for large Chinese cities and the country as a whole (Brys et al., 2013).

France recently introduced an insufficient density payment (Avner et al., 2013). The

system does not yet cover the whole country, but can be applied by local governments that

have developed urban mobility plans (see Chapter 8). The goal is to limit urban expansion

by increasing the construction cost of buildings with lower built-to-land area ratio. This tax

on land value has a number of attractive features: it does not affect already built areas, only

new developments; it can encourage higher density and more built-floor area, in so doing

lowering average rents; and it could also raise significant tax revenues. To achieve these

benefits, the minimum threshold has to be carefully calibrated, and the tax should apply

across neighbouring jurisdictions.

Rebalancing tax revenues to make greater use of property tax would bring other

benefits. In general, investment in housing is under-taxed compared with other investments

and savings instruments that would yield higher returns. The under-taxing of housing may

also have contributed to housing price bubbles. Another advantage of property taxes is the

stability of their tax base, which means more predictable revenues for governments

(Brys et al., 2013).

To be efficient, however, property taxes must be regularly updated to reflect the market

valuation of real estate: “In many countries cadastral values have become outdated, often

by a large margin (by way of example, Austria, Belgium and France last carried out a

housing valuation exercise three or four decades ago)” (Cournède et al., 2013). Updating

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registered property values will also make property taxes less regressive and promote

inclusive growth.

Property taxes can also be effective instruments for encouraging low-carbon investment

by homeowners. For example, property tax rebates can be offered to encourage energy

efficiency or renewable energy investment (Brandt, 2014). However, evidence of the

effectiveness of such measures is scant or ambiguous, as they have only been introduced

recently. In the United States, the Property Assessed Clean Energy programme (PACE)

adds a charge on the property tax that is used to reimburse energy efficiency and renewable

energy improvements. This links the renovation investment to the property rather than its

occupant and allows for a longer period to repay the investment. Essential steps in

designing such taxes involve: 1) checking for any overlaps with other incentives and

policies to decarbonise the buildings sector; 2) assessing if they could undermine the other

positive effects of the property tax on housing density, etc. highlighted above.

Taxes on property transactions can have a negative, indirect effect on the environment

by encouraging the purchase of undeveloped land for new housing far from city centres and

infrastructures. Taxes on property transactions also hinder the relocation of homeowners

and job mobility, with negative effects on overall productivity (OECD, 2010), leading some

to argue for the property sales tax to be abolished (Brandt, 2014). The link between these

taxes and reduced workforce flexibility may increase transport use and associated

emissions. Statistical analysis across all OECD countries finds that “higher transaction

costs in buying a property are associated with lower residential mobility […] transaction

taxes, notarial and legal fees have a negative and significant effect on mobility” (Caldera

Sánchez and Andrews, 2011).

The favourable tax treatment of owner occupation over rental in almost all OECD

countries may also have knock-on effects on car use in some cases. A study of the impact

of home ownership on unemployment rates in the United States finds statistical evidence

that “rises in home ownership lead to three problems:

lower levels of labour mobility;

ii) greater commuting times;

and

iii)

fewer new businesses” (Blanchflower and Oswald,

2013; our emphasis). Evidence is needed from other countries to check whether similar

mechanisms are also at play or if home ownership systematically brings these important

side effects. In addition, home ownership can also have positive effects, as it encourages

home energy efficiency improvements, in contrast with landlord-tenant situations.

Where next for tax revenues and budgets in the context of lower fossil energy use?

The low-carbon transition will lead to lower fossil fuel use over the course of the

21st century. In the long run, this may have adverse effects on countries endowed with

these resources, which are a source of economic dividends, tax revenues and royalties. The

recent fall in international oil prices reveals the significant dependence of these countries on

such revenues, including for balancing budgets. The strategic question for these economies

is the design of a policy package and broad-based incentives to diversify their structure

away from fossil fuels, if they are to cope with the low-carbon transition. Tax changes will

not be enough.

In other countries, tax and budget experts worry that environmental taxes will not

ensure stable budgetary resources, as they are meant to reduce their own base – unlike

property taxes or taxes on profits. In reality, the effect of any new tax on energy

consumption is likely to be progressive. In the near term, the instability of energy-related

revenues comes mostly from economic cycles, which affect other tax revenues as well.

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Further, this issue is of lesser importance, as carbon and other environmentally related taxes

do not account for a large share of government revenues in OECD countries (equivalent to

1.57% or 2.25% of GDP in 2013, on a weighted average and arithmetic average basis,

respectively).

With much lower CO

emissions anticipated in the second half of the

century, and therefore lower fossil fuel use, the question will gain importance.

For countries that decide to rely on a CO

tax as the main price signal to reduce

emissions from fossil fuels, the overall impact on tax revenues would be as follows:

•

revenues from energy taxes would fall as the use of CO

-emitting fuels decline

revenues from the CO

tax would increase because the carbon price is projected to rise

faster than the reduction rate of emissions.

The scenarios from the OECD model (known as ENV-Linkages) provide useful insights

into this issue over the period to 2050. They indicate that revenues from GHG taxes would

more than offset the decline in energy taxes as fossil fuel energy demand falls in a scenario

compatible with the 2°C Scenario.

Obviously, if no taxes are raised on CO

and other

greenhouse gases – i.e. if other policy instruments are used to achieve the same

environmental outcome – governments would need to raise other taxes to compensate for

the fall in fossil fuel-energy tax revenues. New energy sources may be taxed at that point.

There may be other competing uses for carbon tax revenues, such as compensating poor

households for increased energy prices, recycling them into lower more distortive taxes

such as taxes on labour, funding the low-carbon transition with carbon tax revenues or other

subjects given priority in ordinary general budget consolidations. All these considerations

should be included in projections of future tax revenues and expenditures under a low-

carbon scenario. These discussions should also take into account the other tax measures that

countries may reform for a more inclusive and pro-growth tax system.

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Notes

See the recent example of the Green Tax Reform adopted by Portugal in the context

of its strategy to come out of the economic and financial crisis.

Further, recent OECD work on inequality has shown its direct effects on economic

development (Cingano, 2014).

A tax expenditure broadly refers to a tax exemption, deduction or credit for selected

groups or specific activities. It is a relative preference within a country’s tax system

that is measured with reference to a benchmark tax treatment set by that country. A

tax expenditure implies foregone tax revenues (OECD, 2013a).

This was the case in Mexico in 2008. As a result of Mexico’s 2013 Tax Reform, the

country established, since 2014, a positive tax on hydrocarbons and their derivatives,

based on the fuels’ carbon content, regardless of the oil price level. With this

mechanism, the “negative tax” on fuels has been effectively eliminated.

Note that this analysis predated the 2014-15 drop in international oil prices.

There is no agreement on whether different VAT rates on energy sources would

constitute a subsidy; there is also no internationally agreed definition of fossil fuel

subsidies.

The median share of company cars in total number of registered cars in 2009-11 was

32% for 26 countries (19% when measured as a weighted average). Sweden (48%),

Austria (46%), Hungary (42%) and Belgium (41%) had the largest shares, but these

fleets perform relatively well in terms of CO

ratings. In terms of the total number of

company cars, France, the United Kingdom, Germany and the United States stand

out.

In Italy, solar and wind-powered electricity generation assets have a tax depreciation

rate of 4%, whereas fossil fuel-based generation assets are depreciated at 9%. This is

not an explicit decision, but results from wind and solar-powered installations being

classified as immovable rather than movable assets.

In Ireland, the Accelerated Capital Allowances for Energy Efficient Equipment

allows companies to deduct 100% of expenditures incurred on eligible equipment in

computing taxable trading profits in the year of purchase rather than over the usual

eight-year period for plant and machinery.

Various models for property taxation are being discussed for Germany’s planned

reform of property taxes.

Preliminary numbers for 31 OECD countries, not including Australia and Greece, are

available in the OECD database on instruments used for environmental policy.

ENV-Linkages modelling team, based on

OECD Environmental Outlook 2012

scenarios.

10.

11.

12.

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– I.3. IMPLEMENTING CLIMATE-FRIENDLY TAXATION PRACTICES

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market?”,

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Brandt, N. (2014), “Greening the property tax”,

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residential mobility rates in the OECD?”,

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Carey, G.W. (1976), “Land tenure, speculation, and the state of the aging metropolis”,

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Geographical Review,

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Cournède, B. et al. (2013), “Choosing fiscal consolidation instruments compatible with

growth and equity”,

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Flues, F. (2015), “The distributional effects of energy taxes”,

OECD Taxation Working

Papers,

OECD, Paris, forthcoming.

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Harding, M. (2014a), “The diesel differential: Differences in the tax treatment of gasoline

and diesel for road use”,

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Harding, M. (2014b), “Personal tax treatment of company cars and commuting expenses:

Estimating the fiscal and environmental costs”,

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Inventory of Estimated Budgetary Support and Tax Expenditures for Fossil

Fuels 2013,

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OECD (2013b),

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OECD Publishing, Paris,

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Van Dender, K. (2015), “Environmentally related taxes and sprawl: A review of research

findings”, paper presented at the Joint Meetings of Tax and Environment Experts,

6 June 2014, COM/ENV/EPOC/CTPA/CFA(2014)23, OECD, Paris, forthcoming.

Wyatt, M.D. (1994), “A critical review of land value taxation as a progressive strategy for

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I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION –

Chapter 4

Delivering innovation and skills

for the low-carbon transition

There is a wide range of policy instruments that drive innovation. Strong climate policies

are essential to pull innovation in the right direction, but other instruments play a role, and

may inadvertently hamper change. This chapter describes the trends in public research,

development, and deployment (RD&D), the incentives for private RD&D and innovations,

as well as the labour and capital attractiveness of innovative firms in different policy

settings. It also touches on whether countries have the right set of skills for the low-carbon

transition. Last, specific industries may face regulatory hurdles to innovate to lower their

emissions, as illustrated by a case study on cement manufacturing.

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– I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION

Key messages

Policy measures to spur innovation include public investment in basic research, various

support measures to encourage private investment in applied research, development and

demonstration (RD&D), procurement, protection of intellectual property and support for

public-private co-operation, to name just a few.

A strong policy signal to reduce greenhouse gas (GHG) emissions is essential to create the

market pull eventually needed to deploy low-carbon innovations. There is evidence that

environmental policy can result in higher productivity through innovation, but that certain policy

designs can have the opposite effect and hinder competition by favouring incumbents. This is

one area of potentially fruitful policy alignment.

Are public RD&D expenditures measuring up against the low-carbon transition

challenge?

In light of the role of the energy sector in the low-carbon transition, the declining

share of publicly funded energy-related research in the International Energy Agency’s country

RD&D budgets appears problematic – even if other research domains such as information and

communication technologies or nanotechnologies can also lead to low-GHG innovations.

Are innovation incentives conducive to competition by new entrants?

Countries

increasingly use tax incentives to leverage private research and development (R&D). To

encourage new entrants and challenge incumbents, tax incentives should be designed so that

young and not-yet-profitable companies are eligible for these benefits. This is not yet the case in

all countries. Carry-over provisions can fix this problem. Direct support for R&D through grants

and awards can be an important complement. The more general policy context also drives the

growth performance of young firms. Reforming regulations that inhibit competition or create

barriers to exit can be beneficial to these firms.

Could public procurement policy be a better driver of innovation?

Demand-side measures

can also spur climate-friendly innovation. Public procurement represents around 13% of gross

domestic product in OECD countries, though little of this addresses innovation. Certain policy

failures in public expenditure management can also prejudice climate-friendly innovation, such

as split responsibilities for capital and operating costs.

An important alignment challenge in the area of low-carbon innovation arises from the fact

that effective demand measures such as standard-setting are sometimes defined at the national

level. International co-ordination in this area would align signals for businesses on a broader

basis.

Are labour markets, education and training systems able to address skills gaps for the

low-carbon transition?

Efforts may be needed to ensure the adoption of innovations by

consumers and businesses. The question arises whether the right skills are available both to

generate technological change for the transition and to serve the new markets spurred by

climate-related policy measures. There is evidence that significant skills gaps exist. A few

countries have established monitoring systems to evaluate skills needs related to the low-carbon

economy in the broader context of their employment policy.

Misalignments with low-carbon innovation are also found in regulations affecting inputs,

products and services. Innovation in resource efficiency and potential CO

reductions is often

hindered by regulations that have not caught up with technology. Much effort will be required to

inventory these regulatory hurdles and revisit them in light of the carbon constraint.

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I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION –

Unpacking innovation policy for the low-carbon transition

The interplay between policies and innovation in the context of climate policy is

multi-dimensional. It is about the creation of new businesses and the end of old ones, the

emergence of nascent technologies and business models, and how the policy and regulatory

environment must adapt to let them thrive. Clear and credible government decisions to

move forward with ambitious core climate policy instruments is an important spur for low-

carbon innovation within companies and sectors that are directly targeted by such policies,

but also by their suppliers and new entrants, whose products may have a competitive

advantage in a low-carbon economy. Overall, low-carbon innovation will also be driven by

robust economic signals to business, beyond innovation policy strictly speaking.

It is important to emphasise that direct government support to low-GHG technological

change can make economic sense in combination with GHG-pricing policy

(Acemoglu et al., 2012; see also OECD, 2012a for a discussion). In effect, two failures

need to be addressed simultaneously. On the one hand, carbon emissions generate negative

environmental externalities. On the other hand, innovation is a positive externality, as

elements of the information and knowledge generated by innovation are public goods.

In general, different instruments should be used to address these two distinct market

failures. Therefore, a two-pronged strategy is motivated by the existence of market failures

and barriers which constrain both invention and adoption of new technologies. Policy

measures to spur innovation include public investment in basic research, various support

measures to encourage private investment in applied R&D, protection of intellectual

property, support for public-private co-operation and a host of other measures.

In the context of this report the issue is whether the types of policies that governments

have introduced to address the latter (i.e. investment in basic research, intellectual property

rights, tax incentives and direct support for business R&D, public-private co-operation and

networks) are aligned or misaligned with efforts to bring about a transition to a low-carbon

economy. More indirect policy conditions, such as those which support or hinder the entry

and growth of young and innovative firms, may play an important indirect role. Skills are

also a critical link in the transition and deserve policy attention as well.

As case study material, this chapter presents another example of policy misalignment,

related to regulations applied to specific industries, which could hinder the uptake of new

industrial practices that would lead to greater efficiency of material conversion and energy

use, and lower GHG emissions. These inadvertent regulatory barriers warrant more in-

depth analysis across all sectors of importance in the low-carbon transition, which is

beyond the scope of the present report.

Public investment in research

The financial crisis did not spare innovation policy. Since 2008, OECD countries’ gross

public expenditures on R&D have been growing at half the annual rate observed in 2001-

08. Public R&D budgets have levelled off or started to decline with some exceptions

(e.g. Germany and Sweden). Business expenditures on R&D have been growing since 2008

at a pace that is about a quarter of what it was in 2002-08.

Nonetheless, investment in

knowledge-based capital overall (i.e. including other intangibles) was more resilient than

investment in physical capital (OECD, 2015c).

However, it is important to distinguish between basic and applied research – although

the distinction is often more a question of degree and not kind – and the important role that

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– I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION

the public sector plays in the former. Public research plays a key role in innovation systems

by providing new knowledge and pushing the knowledge frontier. Universities and public

research institutions (PRIs) often undertake longer term, higher risk research and

complement the research activities of the private sector. Although the volume of public

R&D is less than 30% of total OECD R&D (OECD, 2014a), universities and PRIs perform

more than three-quarters of total basic research. Ensuring a balance between pure basic

research, driven by excellence, and more focused, mission-oriented research is therefore an

important challenge for public funding. One potential source of misalignment in the context

of climate-related innovation is the greater focus on applied research with shorter term

objectives (see OECD, forthcoming).

Another important phenomenon is the growth of public R&D activities in emerging

economies: non-OECD countries have seen their share in global R&D rise from 10% to

30% of the global total within ten years (OECD, 2014a). As emerging economies make an

effort to switch to higher value-added activities, with a parallel R&D effort, it will be

important to ensure that this occurs in a way that supports rather than hinders the

low-carbon transition.

The case of climate change also highlights the need for new interdisciplinary and

trans-disciplinary research environments. The diverse sources of knowledge upon which

“climate” innovation, and environmental innovation more generally, draws makes this

particularly important in the context of policy alignment for the low-carbon transition (see

Chapter 4 of the

OECD Innovation Strategy,

forthcoming). Nanotechnology is a case in

point (OECD, 2013a). While the initial spur for research on nanotechnology was not related

to environmental considerations, “green” nanotechnology is increasingly being applied in

fields such as green chemistry, sustainable manufacturing, and monitoring and control

applications (e.g. nano-sensors).

The role of information and communication technologies (ICTs) is another case in

point. Decentralised production of energy, which has seen a massive surge in the last few

decades, has become possible because of ICTs. Other applications of ICT that can yield

environmental benefits include transport logistics and environmental monitoring. For

example, with respect to the latter, satellite technologies are essential to the monitoring of

atmospheric (e.g. pollution concentrations, wind speed, temperature), oceanic (e.g. sea

salinity, level, temperature) and terrestrial (e.g. glaciers and ice caps, ice sheets, albedo,

vegetation type, soil moisture) data.

Bearing in mind the wide breadth of research domains which can yield benefits in terms

of climate mitigation and adaptation, it is instructive to examine trends in public spending

RD&D in the energy sector. While the share of RD&D has fallen from over 10% to less

than 5% in the last four decades, the composition has changed. In particular, the past few

years have witnessed a remarkable increase in support to renewable energy sources and

energy efficiency (Figure 4.1). The surge in fossil fuel-related expenditures in 2009 is

explained by US spending on coal, including high-efficiency combustion technology.

Overall, in an earlier assessment, the IEA (2013) indicated that global government spending

on energy RD&D should triple to match countries’ aspirations for low-carbon technologies

in particular. A detailed country-level analysis for IEA countries also revealed “some

significant discrepancies between stated energy RD&D priorities and actual funding” (IEA,

2013: 129).

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I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION –

Figure 4.1.

Public sector spending in energy research, development and demonstration in IEA countries

Energy efficiency

Hydrogen and fuel cells

Share of energy R&D in total R&D (right axis)

Fossil fuels

Other

Renewable energy sources

Nucle ar

15%

13%

USD billion (2013 prices and PPP)

Including American Recovery and

Reinvestment Act of 2009 (stimulus) spending

Share of energy R&D in total R&D

11%

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

-1%

Source:

IEA databases, 2014 cycle.

Private and public RD&D spending in activities outside the energy sector may also help

the low-carbon transition, not to mention public spending outside IEA countries. This trend

is therefore not the full picture of ongoing RD&D that may bring about breakthrough

technologies for the low-carbon transition. It is nonetheless one useful indicator of these

countries’ intent to embark on the transition.

Moreover, R&D expenditures are an inadequate indicator of innovation, as they reflect

inputs to innovation and not outcomes. However, evidence based on patent statistics –

which suffer from their own shortcomings as a measure of innovation – indicates that there

has been a global acceleration in technological progress in areas such as lighting, electric

power, electric and hybrid vehicles, energy generation and electricity storage, observed in

so-called patent bursts (OECD, 2014b). The penetration of these technologies and the

emergence of new ones will require sustained innovation efforts. Policies in support of

innovation deserve a closer look to ensure consistency with the low-carbon transition.

Inducing private R&D

Governments can choose among various tools to leverage business R&D. On the supply

side, they can offer direct support via grants or procurement or use fiscal incentives such as

R&D tax incentives. Indeed, more countries are now using tax incentives than in the past;

in many countries the schemes are more generous than ever. R&D tax incentives are

present in 28 OECD countries and also in Brazil, the People’s Republic of China (hereafter

“China”) and South Africa.

Tax incentives for R&D are often considered to have certain advantages over direct

support such as procurement or grants. As a market-based tool aimed at reducing the

marginal cost of R&D activities, they allow firms to decide which R&D projects to fund.

They do have shortcomings, however. Figure 4.2 shows a variety of country situations in

terms of the generosity of R&D tax incentives. Depending on design, the benefits can be

restricted. Most obviously, the benefits do not depend only on R&D expenditures, but also

on profitability (e.g. in case of a credit on corporate income tax). This restrictive practice

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100

– I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION

may be an impediment for small new companies that may need a few years to become

profitable. However, some countries do allow firms to benefit from the subsidy when they

are not profitable. For example, this can be addressed through the use of carry-over

provisions, which allow loss-making firms to benefit from the credit once they become

profitable (this is the case in Japan). It can also be addressed by allowing firms to claim an

equivalent and immediate refund for unused credits or allowances, as in Australia, Canada,

France and the United Kingdom.

Figure 4.2.

Tax subsidy rates on R&D expenditures, 2013

1-B-Index, by firm size and profit scenario

1-B index

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0.0

-0.1

Large, profitable firm

SME, profitable firm

Large, loss-making firm

SME, loss-making firm

Note:

SME: small and medium-sized enterprise. The B-index is a measure of the level of pre-tax profit that a

representative company needs to generate to break even on a marginal, unitary outlay on R&D (Warda, 2001),

taking into account provisions in the tax system that allow for special treatment of R&D expenditures. It is

customary to present this indicator in the form of an implied subsidy rate, namely

one

minus the

B index.

generous provisions imply a lower breakeven point and therefore a higher subsidy.

Sources:

OECD R&D Tax Incentives Indicators; based on the 2013 OECD-NESTI data collection on tax

incentives support for R&D expenditures,

www.oecd.org/sti/rd-tax-stats.htm;

OECD (2013c),

OECD Science,

Technology and Industry Scoreboard 2013: Innovation for Growth,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/sti_scoreboard-2013-en.

To the extent that the low-carbon transition should encourage the birth and growth of

many new entrants, there may be a policy misalignment to be corrected (i.e. in countries to

the bottom right-hand of Figure 4.2). Solutions exist to support R&D in young loss-making

firms via an immediate refund for expenditure on R&D personnel wages, or strengthening

support for the commercialisation of public research and start-ups, and enhancing access to

finance. Keeping in mind the importance of enhancing competition with innovative new

entrant companies, the design of R&D tax incentives ought to be reconsidered to avoid a

bias towards incumbents.

Irrespective, direct R&D support is an important complement to R&D tax incentives,

allowing governments to target particular technological domains or firm types. The

potential benefits of “targeting” raises its own problems, not least the identification of

promising technologies and sources of innovation. Many countries focus on specific groups

of firms, and particularly small and medium-sized enterprises (SMEs). In the OECD area,

they carry out about one-third of total business R&D. In most countries, over 50% of direct

R&D public funding (e.g. grants, loans or procurement contracts) goes to finance R&D for

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I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION –

101

SMEs. However, in Japan, Sweden, the United Kingdom and the United States about 90%

of government direct funding goes to larger firms (see Figure 4.3).

Figure 4.3.

Business expenditures on R&D by SMEs and direct government funding, 2012

Share of BERD financed by goverment

18.0

16.0

14.0

12.0

10.0

8.0

6.0

4.0

2.0

0.0

Share of BERD financed by government and performed by SMEs, as a percentage of total BERD

Source:

OECD (2013d), “Business enterprise R-D expenditure by size class and by source of funds”,

Research

and

Development

Database,Error!

Hyperlink

reference

not

valid.

http://stats.oecd.org/Index.aspx?DataSetCode=BERD_SIZE

(accessed March 2015).

In addition to the challenges associated with the identification of promising

technologies, attention must be paid to the realisation of both short- and long-term policy

objectives. On the supply side, support for basic research will remain important for radical

(and riskier) innovations with potential long-term benefits. More generally, programmes

that foster co-operation between firms (both small and large) with universities are likely to

be important in bridging the gap between basic and applied research.

Demand-side innovation policy measures such as public procurement, information

dissemination, advanced market commitments and technology prizes can be an important

complement to supply-side measures (OECD, 2011a). The concept of fostering innovation

through demand-side policy – particularly public procurement – is not new. Indeed, some

countries have pursued active technology procurement policies for decades. In terms of

climate objectives, this has been particularly important in the areas of energy and transport.

Nonetheless, even though public procurement represents around 16% of gross domestic

product (GDP) in OECD countries, little of this spending explicitly addresses innovation.

More generally, there may be “policy failures” in public expenditure management which

can prejudice climate-friendly innovation. Issues such as single-year budget frameworks,

split responsibilities for capital and operating costs, and the nature of accounting procedures

(i.e. treatment of capital charges) can result in investment in technologies which are more

climate-intensive

(OECD, 2003).

Facilitating entry and exit and the development of knowledge-based capital

It will be essential to remove barriers to trade in clean technologies as well as to

the entry of new firms, and to improve conditions for entrepreneurship, especially

in light of growing evidence that young firms represent an important

source of more radical innovations. (OECD, 2014b)

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– I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION

At the level of firms, innovation rests on a competitive environment. New firms are

important vehicles through which much innovation is brought to the market, and firm entry

and post-entry growth is essential. In the specific context of this report, this implies that

carbon-intensive incumbents are also challenged to improve and change their technologies

by newcomers providing low-carbon alternatives. This is best fostered by a policy

environment that encourages risk-taking – i.e. does not unduly penalise failure. Against this

backdrop, the sharply declining rate of start-ups in OECD countries over the past decade is

a cause for concern (Criscuolo et al., 2014).

Differences in firm dynamics and demographics across OECD countries indicate where

progress is possible. In particular, there are striking cross-country differences on the growth

performance of young firms (Criscuolo et al., 2014). This is a function of incentives that

encourage or discourage the allocation of resources to the most dynamic firms. The policy

context is crucial. Figure 4.4 illustrates how estimated resource flows to patenting firms

vary with different policy settings in OECD countries.

The results indicate significant benefits from increased access to seed and early-stage

financing, as well as from increased efficiency in the judicial system. In addition, benefits

arise from reforming product market regulations (PMRs) which inhibit competition, as well

as reducing policy-induced barriers to exit (e.g. excessively strict bankruptcy codes).

Reducing such barriers will accentuate competitive pressures, encouraging inefficient firms

to exit and channel resources to firms that are best able to make use of the resources. The

latter effect can also be encouraged by less stringent employment protection legislation.

While these and other measures listed in Figure 4.4 are typically implemented with other

policy objectives in mind, their unintended implications for innovation should be taken into

account. In any event, recommendations in this area should also consider countries’ broader

social and economic context. For instance, less stringent employment protection legislation

may be more politically acceptable in jurisdictions with higher unemployment benefits.

There is also a broader question about an economy’s ability to drive a transformative

agenda such as the low-carbon transition without a strong social contract (see Galgoczi,

forthcoming, for a discussion of the industrial transition of Germany’s Ruhr region).

The above examples suggest that framework policies could significantly affect the

extent to which patenting firms attract the tangible resources required to implement and

commercialise new ideas. This can have important implications for climate innovation. For

example, addressing failures associated with early-stage financing may have particular

benefits due to the preponderance of cases in the climate domain which involve the co-

existence of novel technologies with uncertain performance characteristics and young firms

with little track record or collateral. Moreover, market and technology risk is compounded

by policy risk, with important implications for access to finance. Considerable work has

been undertaken on the central role of policy settings on the provision of finance for

“clean” technologies in OECD economies.

However, more work is required to assess the

effectiveness of targeted financial policy interventions (e.g. public investment in “green”

venture capital funds) relative to more general policies associated with the functioning of

capital markets.

While a successful low-carbon transition should be accompanied by the birth – and

growth – of new firms, the role of incumbents should not be strictly juxtaposed with those

of entrants, as the former also produce radical innovation from their cumulative incremental

innovations (as has been the case with LED technologies). In addition, some large

incumbent companies such as Toyota have opened their patents in low-carbon

technologies – in this case, fuel cells – to other firms to enable them innovate in the same

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area. Tesla announced in June 2014 that it would offer its proprietary technology to other

car manufacturing companies with an interest in electric vehicles (Wall Street Journal,

2014).

Figure 4.4.

Framework policies and resource flows to patenting firms, 2003-10

A. Change in firm employment associated with a 10% change in the patent stock

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

Maximum

(Portugal)

EPL

Early stage VC

Regulation of

professional services

Judicial inefficiency

Stock market

capitalization

Mean

(Norway)

Minimum

(Greece)

Minimum

(USA)

Maximum

(Sweden)

Minimum

(Sweden)

Mean

(France)

Maximum

(Italy)

Maximum

(Japan)

Minimum

(Poland)

Maximum

(Switzerland)

Mean

(Switzerland)

Mean

(Belgium)

Mean

(Belgium)

Minimum

(Slovak Republic)

B. Change in firm capital associated with a 10% change in the patent stock

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

EPL

Early stage VC

Regulation of

professional

services

Barriers to Trade

& Investment

Bankruptcy

Legislation

Strength of

Investor Rights

Maximum

(Portugal)

Minimum

(USA)

Mean

(Belgium)

Mean

(Norway)

Minimum

(Greece)

Maximum

(Italy)

Mean

(France)

Maximum

(Sweden)

Minimum

(Sweden)

Minimum

(GBR)

Minimum

(Norway)

Maximum

(USA)

Mean

(France)

Mean

(GBR)

Mean

(Japan)

Maximum

(Italy)

Maximum

(Slovak republic)

Minimum

(Austria)

Notes:

This figure shows that the sensitivity of firm employment and capital to changes in the patent stock varies

according to the policy and institutional environment. To calculate policy effects, coefficient estimates are

combined with the average values of the policy indicators for each country over the sample period. The labels

“minimum” (“maximum”) denote the country with the lowest (highest) average value for the given policy

indicator over the sample period. EPL: Employment Protection Legislation; VC: Venture Capital.

Source:

Andrews, D. and C. Criscuolo (2014), “Knowledge-based capital, innovation and resource allocation”,

OECD Economics Department Working Papers,

No. 1046, OECD, Paris, available at:

www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=ECO/WKP%282013%2938&docLanguage=

En.

Environmental policy design can also influence firm dynamics and competition

(Albrizio et al., 2014). Many environmental regulations are differentiated by plant vintage,

with less stringent regulations for existing facilities relative to new facilities. Such

“grandfathering” regulations are well documented in the case of power plants.

This

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– I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION

generates a bias against investment in new sources (“new source bias”), but also

discourages plant exit, as the opportunity cost of closure is too high.

Any regulatory scheme (e.g. health and safety rules, building regulations, access to

networks, etc.) which favours incumbent firms or facilities relative to entrants will

discourage exit, and to the extent that older vintage correlates with technologies with lower

environmental performance there will be negative implications in terms of carbon

emissions. In some countries the debate has gone further, with discussions about “payments

for closure”.

However, such a strategy raises the potential for strategic behaviour, with

managers delaying closure in anticipation of receiving compensation for doing so.

Should government support specific technologies for the low-carbon transition?

The sheer breadth of domains which can generate environmentally benign innovations

complicates the task of policy makers. The kinds of breakthrough innovations that can

generate significant environmental benefits can come from fields as diverse as ICT,

materials sciences and biotechnology. Breakthroughs could come from new infrastructures

but also from innovations in the way existing systems are used (i.e. reconfiguration

processes such as those underway with the use of smart meters in electricity systems). As

noted above, this uncertainty strengthens the case for greater public investment in basic

research, particularly with respect to transformative technologies.

However, in practice in a number of fields, governments have made policy bets on

specific technologies in a more directed manner, including on the basis of their low-carbon

attributes, assumed future contribution to reducing emissions, and their potential for future

cost reductions – analyses such as the IEA Technology Roadmaps facilitate the positioning

of today’s technology policy efforts in a longer run process towards large-scale

deployment.

This has been most visible in the power generation sector, with government

programmes in support of nuclear, subsidies to wind farms and solar photovoltaic (PV)

installations, carbon capture and storage, or infrastructure for electric vehicles.

Although increasingly ambitious technology-neutral market signals should be the core

of future climate policy developments if countries are serious about addressing climate

change, governments are likely to continue supporting the research, development and

deployment of specific technologies that can facilitate the transition to a low-GHG world.

This can be justified by factors such as imperfect commitment and path dependency, for

instance in the case of infrastructure supporting the deployment of breakthrough

technologies. This is illustrated by the findings of Acemoglu et al. (2012) on the economic

efficiency advantage of directing technical change towards low-carbon paths in response to

climate change.

It is therefore legitimate to ask whether it is possible to identify technologies that are

most likely to deliver the needed breakthroughs, and as such represent a good investment of

public monies. Given the hazards associated with identifying promising technologies at an

early stage of development, governments often support a “portfolio” of technologies,

hedging their policy bets in the face of uncertainty.

This still begs the question of which technologies to include in the portfolio. One

possible risk-averse strategy is to support innovation which has broad potential

applications. For example, OECD work has indicated that support for research in energy

storage and grid quality was very valuable in terms of patents generated, compared with

support for specific renewable energy technologies. Arguably, there has been a temporal

misalignment with insufficient attention paid to the technological characteristics of the

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supporting technologies required to accommodate the rapid increase in the penetration of

intermittent renewable energy (Johnstone and Haš i , 2012).

More generally, a methodology has been developed to “uncover attributes of inventions

(as reflected in patent data) which may serve as “leading indicators of subsequent

technological and market development” (OECD, 2014b). Such indicators include the

breadth of industrial sectors in which the technology is subsequently applied (industrial

generality), the extent to which it builds on previous inventions (radicalness), the spatial

breadth of the markets in which it is protected (patent family size) and the degree to which

it draws upon basic rather than applied research (closeness to science). If robust, this can

help policy makers to prioritise public support in various technological fields.

However, provision of targeted support for specific technologies requires continuous

evaluation, not least as any direct policy support raises the question of rent-seeking

behaviour by beneficiaries. This can eventually lead to excessive government expenditures

whenever support is granted that is no longer justified because the policy objective has been

met or, to the contrary, when support has not delivered the expected technological

breakthrough. Some effort is needed in innovation policy to avoid such situations, e.g. with

the development of criteria to determine whether beneficiaries are in one or the other

situation. Sunset clauses can also be useful, but can still be open to negotiation and

lobbying by rent-seeking companies. It is preferable to develop clear and non-discretionary

criteria for policy exit, and to communicate these criteria

ex ante

so that beneficiaries can

foresee future policy developments.

The governance of innovation

An important alignment challenge in the area of climate innovation arises from the fact

that the benefits associated with the development and adoption of technologies cross

borders. The externality is trans-frontier, and as such there is an additional channel through

which incentives may be misaligned which is absent from other domains. Moreover, the

areas of the world in which the potential benefits of their adoption are greatest may not be

the sources of innovation. This has been shown to be the case in terms of innovation related

to climate adaptation (Dechezleprêtre et al., 2015).

This raises issues of international co-ordination if global challenges – including climate

change – are to be addressed (see Chapter 5 of the

OECD Innovation Strategy,

forthcoming). OECD analysis of the challenges in establishing international research

infrastructures, including shared financing, governance and legal frameworks, suggest there

is no one-size-fits-all model for such facilities. Increasingly, and partly a consequence of

the broader move towards more open science and innovation, international distributed

research infrastructures have become more prevalent. These are located across several

countries, share a common purpose and are co-ordinated in some way, but otherwise can be

of very variable geometry.

The inclusion of countries with weaker science, technology and

innovation capacities as full partners is necessary and may require specific actions to build

capacities (Poirier et al., 2015).

Issues of co-ordination and alignment also arise within individual countries. This is

hardly surprising, as both fostering innovation and addressing climate change are issues

requiring policy responses that do not fit neatly with the competencies of any single

governmental department or agency, or even with a single level of government. Multi-level

governance requires that authorities at various levels possess not only the right capabilities

and resources to effectively run their own competencies, but also the capacity and means to

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enter into negotiations, align their policies and conclude agreements with authorities from

other levels.

Another complementary dimension is that of co-ordination between policy domains at

the same level of government, i.e. horizontal governance. One specific example of the need

for better governance related to innovation with climate implications concerns systems

innovation. Although many national governments have included climate objectives in their

economic development strategies, achieving this goal will require wide-ranging changes to

transport, energy, buildings and other systems. The “smart city” initiatives that mobilise

technological and social innovations to make the production and consumption of a city’s

goods and services less climate-intensive illustrate this point. At the national level also,

improved governance mechanisms and better means of engaging a range of stakeholders

are needed to facilitate system innovation. Finland and the Netherlands, for example, have

developed public-private partnerships to foster co-ordination and alignment.

A final issue related to governance which can affect innovation in the climate domain is

the treatment of risks above and beyond those associated with climate risks themselves.

Uncertainty in science policy is pervasive. Innovation in some of the areas which have the

potential to yield significant potential climate benefits may also carry important potential

risks (i.e. biotechnology, nanotechnology). R&D is a probabilistic investment and the

direction of science and innovation and their ramifications involve elements of randomness

and often long-term and hard-to-foresee outcomes. Governments need to deploy a range of

tools – foresight studies, technology assessments, formal cost-benefit analyses – to help

steer policy and reduce unnecessary risks. But all such techniques have strengths and

weaknesses. Getting the balance right is an open research question, and ongoing

discussions about providing support for geo-engineering technologies is a reflection of the

need for further work in this area.

Putting the labour markets at work for the low-carbon transition

To the extent that it can be predicted, it does not appear that the transition towards

green growth is likely to imply rates of labour reallocation or rates of change in job

skill demands that are outside of historical experience. However, that conclusion

may say more about how difficult it is to predict the labour market consequences of

decoupling economic growth from harmful environmental impacts than how easily

green growth-driven structural change can be managed. (OECD, 2012b)

Can we anticipate skills needs for the low-carbon transition?

The transition to a low-carbon economy requires a parallel evolution of skills and shifts

in the labour force. Under a 2°C Scenario, most carbon-intensive activities will have

decarbonised or will have been out-competed by low-carbon substitutes. The following are

illustrations of changes with implications on skills and labour:

•

The extraction of coal, oil and gas should be reduced significantly in volume from today’s

levels in the course of the century, even if a successful carbon capture and storage

technology could make their use more climate-friendly. These sectors have already

witnessed impressive labour productivity gains in the past decade, but the low-carbon

transition could result in further labour force reductions in decades to come. Alternative

energy sources (e.g. renewables) should witness very rapid employment growth rates,

albeit from a relatively small base.

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•

The imperative of more efficient buildings implies the use of new materials and skills. In

most OECD countries, the deep renovation of existing buildings could represent an

important new market for the construction sector (OECD, 2012b).

In the automotive sector, the possible penetration of the electric engine would trigger

change of skillset in downstream activities (car repairs and mechanics). Lighter vehicles

to improve fuel economy will require the use of new materials (lighter ultra-strength

steel, aluminium, plastics or carbon fibre), with new skills needed on the factory floor and

in repair shops.

The circular economy, often presented as an important structural change to improve

resource efficiency and lower greenhouse gas emissions, may also create new jobs, but

eliminate jobs in the extraction of virgin resources.

Last but not least, skills policies also need to support the innovation process itself

(e.g. workers with advanced science, technology, engineering and mathematics skills

(STEM).

The labour force and skills will have to accompany these and similar changes in a range

of activities. One of the preconditions for a smooth decarbonisation of the overall economy

is that the vocational education and training system adapt in a timely way to changing skill

demands. Another is that labour market institutions and policies support the necessary

reallocation of labour from shrinking to growing firms and activities. This is all the more

important as there are concerns about job destructions related to the shift to a low-carbon

economy connected to threats of carbon leakage (see Chapter 1).

•

Is there a policy alignment issue?

The fundamental alignment question is whether labour markets and education and

training systems will be able to respond to the new demands of the low-carbon economy, or

whether governments should intervene to remove barriers to change. The analysis is

complicated by the uncertainty on future evolutions: which new activities will want to enter

the market, and what will be the demand on the labour force to develop them?

Good practice in employment policy could also support the low-carbon transition:

[…] countries which have better reconciled labour mobility with income security

(achieving so-called flexicurity) are likely to have an advantage managing an efficient

transition, while also limiting political opposition to green growth policies grounded in

concerns about the economic dislocation they could imply. Similarly, countries with

education and training systems that perform particularly well in developing high-level

STEM skills are likely to be better placed to become leaders in eco-innovation, while

national systems of continuing vocational training that are particularly responsive to

employers’ evolving job skill requirements may help to foster faster and more efficient

diffusion of green technologies and working practices across the economy. However,

there is as yet little systematic evidence on these questions. [OECD, 2012b]

The evidence on job shifting from high- to low-carbon activities is scant at present and

probably not representative of economy-wide changes. For instance, “spotty evidence

suggests that a significant share of the conversion of the electricity sector from fossil fuels

to renewable sources is occurring within large electrical utilities, a number of which are

actively retraining their workforces as part of their implementation of a transition to clean

energy” (ibid.). In this example, companies adjust to the new market opportunities resulting

from the deliberate action by governments to support low-carbon technologies; no

particular public policy change seems required to accompany this change in workforce

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competence. One can easily think of industrial basins and communities with a fossil fuel

basis, where lower demand would have visible disruptions and could need accompanying

measures.

There are instances, however, of policy-driven new markets that stumble over a lack of

appropriately skilled workers or the absence of a skills certification scheme that allows

employers and customers to distinguish between workers who have the required capabilities

and those who do not (Box 4.1). Training programmes can be put in place to overcome

such problems when identified. These issues are more likely to occur in activities

characterised by a large number of SMEs with less training capacity, such as the

construction sector.

Box 4.1.

If you build it, they will come? Certification in the construction sector

Policy makers are increasingly mindful that skills gaps may undermine the effectiveness of certain

policies: in and of itself, the creation of a new market by policy does not guarantee that an adequately

skilled workforce will emerge to serve this market in a timely manner. Such policies should be devised

with a parallel assessment of required skills sets and their availability. Certification can be an instrument to

ensure that the workforce on the supply side of a policy-driven market is adequate.

The skills of construction workers is often pointed out as a possible weak link in the implementation

of building codes introduced to improve the energy efficiency of housing and commercial buildings.

France introduced a certification system with a specific label for companies that conducted specific

training of their staff on energy efficiency (the RGE label, which stands for recognised environmental

guarantee). Several public awareness campaigns run by the French energy efficiency agency (ADEME)

encouraged consumers to ask for trained professionals with RGE labels. Since 2014, public financial

assistance for renovating buildings is conditioned to the employment of RGE-labelled companies. In 2008,

France also launched FEEBAT, a programme of continuous vocational training partly financed with a

contribution of Électricité de France, a French utility, through the white certificates system. Between 2008

and 2012, the scheme trained 48 000 construction professionals. The programme has been prolonged

until 2017.

The United Kingdom has established licensing programmes to address a market barrier to the

renovation of buildings, specifically in response to its Green Deal programme. Through the UK

Accreditation Service, criteria are developed for the accreditation of Green Deal assessors which builds on

pre-existing qualifications, and of Green Deal installers. The profession sees the Green Deal certification

“as a way of driving ‘cowboys’ out of the industry” (Lane and Power, 2010, in OECD/Cedefop, 2014).

Source:

OECD/Cedefop (2014),

Greener Skills and Jobs,

OECD Green Growth Studies, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264208704-en.

Given the many uncertainties on the sectoral and regional evolutions that the

low-carbon transition will generate, the possible challenge for employment policy is to be

able to identify and quantify both the creation of jobs requiring new skills,

and to provide

appropriate incentives for training where it may be lacking. While this can be seen as a

good policy across the board, the fact that governments, not markets, are giving the primary

impetus to the low-carbon transition puts responsibility on governments rather than market

forces alone, to ensure a proper labour market response.

There is policy experience in this area that could be replicated in other countries to

anticipate workforce and skills challenges in their transition to low carbon (Box 4.2). The

European Commission established an initiative to train Europe’s workforce for the energy

efficiency renovation of buildings (EC, 2014). BUILD UP Skills started from the

observation that craftsmen and on-site workers are not always trained to properly

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implement energy efficiency and renewable energy solutions in the building sector. This

initiative started with country-level evaluations of skills needs and gaps, revealing that

more than 3 million workers in Europe will require training by 2020, most of it in the form

of continuous vocational education for existing workers. In a second phase, BUILD UP

Skills will extend funding for large-scale qualification and training schemes. The skills gap

identified in this programme is a signal to other countries that low-carbon improvement

measures in the buildings sector must be accompanied by information and training

programmes in the construction sector.

Policy misalignments restricting innovation in industry

Innovation may arise from, or be hampered by, detailed regulations applying to

economic activities. Regulations may have been established some time ago on the basis of

past technical knowledge that may now be outdated, and will not automatically catch up

with policy priorities such as climate change or technological progress. In other instances,

regulations favour incumbent technical solutions and implicitly bar competition. While core

climate policy instruments should spur innovation, certain regulations clearly stymie it.

This section examines some policy misalignments (in particular regulatory barriers)

associated with the flow of resources in, out and within the industrial sector.

Improved resource efficiency – for the use of energy, materials, water, biomass, waste

and land – is fundamental to reducing industrial sector GHG emissions. Market forces and

many government policies already encourage resource efficiency in individual industrial

facilities, but there are often missing incentives and sometimes disincentives – arising from

policy misalignments – that inhibit wider-scale efficiencies involving interactions among

plants in different activities. Regulations governing industrial and end-use products, by-

products and wastes (of all resource types: energy, materials, etc.) can sometimes preclude

their most efficient use in the industrial system.

The potential GHG reductions from efficiency improvements are particularly

pronounced when their resource flows are associated with the production of basic materials

such as cement, steel, chemicals and paper. The products, by-products and wastes (and the

resource streams they compete with) of these industries all contain large amounts of

embedded energy and GHG emissions, so resource efficiency gains in these activities can

result in proportionally large GHG emission reductions.

This section begins with two particular examples from the cement and concrete sectors.

Not because cement and concrete production are particularly resource inefficient, but

because their production processes have great flexibility in the use of raw materials

(including by-products from other industries) and energy (including many alternative fuels).

IEA (2012) provides estimates of the GHG emissions reductions of two of the items

considered in this chapter – alternative fuels and clinker substitutes in the cement sector

(Figure 4.5).

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– I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION

Box 4.2.

Skills anticipation

Is the workforce properly trained to implement the various changes that the low-carbon transition requires?

If not, can governments play a constructive role in anticipating emerging skills needs and meeting them in a

timely fashion? The OECD has launched an inquiry in labour ministries to find out how they identify skills needs

and take measures to remedy possible gaps, including whether these initiatives take account how environmental

policy will change future job skill requirements. While all OECD countries attempt to be forward-looking in

their educational and training policies, only six report having undertaken substantial efforts to forecast and meet

new job skills requirements related to the low-carbon transition: Austria, Canada, France, Greece, Ireland and

Italy. To date, three types of approaches have been followed, all of which have the potential to minimise the

misalignment between skills and the green transition.

•

Episodic studies of green economy skills.

Canada and Ireland have conducted occasional studies of the

emerging skills requirements associated with the transition towards a low-carbon economy. Ireland

carried out a 2010 study of the skills requirements of firms working in the “green economy sector”

(Expert Group on Future Skills Needs, 2010), and information from this study fed into Ireland’s Action

Plan for Jobs (Government of Ireland, 2013). Canada's low-carbon goods and services activities

indicated that they have experienced or anticipate a lack of skilled labour (NRTEE, 2012).

Co-ordination of vocational education and training (VET) planning with the implementation of

environmental policies.

In Italy, local governments regularly adapt VET programmes at the

post-secondary education level in light of new job skill requirements stemming from environmental

policies (e.g. to enforce regulations on environmental quality and intervene in the management of waste

water).

Systematic forecasting of emerging demands for “green skills”.

The Austrian and French

governments regularly forecast the future skill requirements resulting from the transition to low-carbon

growth and feed this information into education and training policy:

The Austrian New Skills framework monitors trends in skill demands via its Standing Committee on

New Skills. This group recently concluded that “energy efficiency, the use of alternative sources of

energy, resource-saving production, the identification of cause-effect relationships, recycling and

ecologically sound disposal of materials, etc. are increasingly becoming a business necessity for all

companies. In this connection the development of environmentally efficient production processes,

service processes and products constitute an increasing challenge for employees from many

different areas and at all qualification levels, both technically and in terms of awareness-raising and

understanding” (Bliem et al., 2011: 2)

In line with the national strategy and national pact to transition towards a green economy, France

has established

L’Observatoire national des emplois et métiers de l’économie verte

(National

Observatory for Green Economy Jobs and Skills), which forecasts the sectoral and macroeconomic

impact of the green transition, with special attention to its implications on the numbers of jobs and

skills requirements (Commissariat Général au Développement Durable, 2014). In developing these

forecasts and assessing their implications for training policies, partnerships have been developed

with trade unions, employer organisations and Pôle Emploi (the public employment service).

Pôle Emploi, for example, has studied the supply and demand for green skills to guide the design of

its programmes to up- or re-skill job-seekers to better meet the requirements of this transition

(Pôle Emploi, 2011a; 2011b).

•

As part of the initiatives of the G8 Deauville partnership, Tunisia is implementing a pilot to address green

skills needs in the context of a youth employment programme. Special attention is being paid to the creation of

clean tech solutions in areas such as renewable energy, waste and recycling, agriculture, tourism and

construction, and training is being organised in anticipation of “green jobs” in these sectors.

Sources:

OECD (2015b),

Anticipating and Responding to Changing Skill Needs,

OECD Publishing, Paris; OECD (2015c),

Investing in Youth Tunisia: Strengthening the Employability of Youth During the Transition to a Green Economy,

OECD

Publishing, Paris,

http://dx.doi.org/10.1787/9789264226470-en.

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Possible misalignments are also identified in two more general industry examples

outside of the cement sector: the development of industrial symbiosis and increased

deployment of combined heat and power (CHP).

Figure 4.5.

Technologies for reducing cement direct CO

emissions between the 4DS and 2DS

Energy efficiency

1 200

1 000

800

Low-demand

1 200

1 000

800

600

400

200

2010

Other fuel switching (thermal)

Alternative fuels

High-demand

Clinker substitutes

CCS

MtCO

600

400

200

2010

2020

2030

2040

2050

2020

2030

2040

2050

Notes:

CCS: carbon capture and storage. Alternative fuels account for 22-24% of total cement sector emission

reductions between 2DS and 4DS scenarios (4DS and 2DS refer to the IEA 2°C and 4°C scenarios for GHG

mitigation) in 2020, 15% in 2030 and 8-9% in 2050. Clinker substitutes account for 33-34% in 2020, 29-32%

in 2030 and 19-23% in 2050. Together, these measures could reduce CO

emissions by 45-46 MtCO

-eq in 2020,

117-118 MtCO

-eq in 2030 and 260-282 MtCO

-eq in 2050.

Source:

IEA (2012),

Energy Technology Perspectives 2012: Pathways to a Clean Energy System,

OECD/IEA,

Paris,

www.iea.org/publications/freepublications/publication/industry2009.pdf.

Case study: Co-processing energy needs for cement production

The majority of cement kilns are fuelled by coal, but other fossil and alternative fuels

can also be burned (IEA/WBCSD, 2009). While alternative fuels have a lower CO

intensity depending on their exact composition (Sathaye et al., 2011) and can lead to

reduced overall CO

emissions from the cement industry (CEMBUREAU, 2009), their use

can also increase overall energy use per tonne of clinker produced if the fuels require pre-

treatment such as drying (Hand, 2007).

Where alternative fuels are used at high substitution rates, tailored pre-treatment and

surveillance systems are needed. Municipal solid waste (MSW), for example, needs to be

screened and processed to homogenise calorific values and feed characteristics.

well-designed regulatory framework for waste management is an important factor in

facilitating the use of waste (IEA, 2009).

Waste fuels have been used in cement production for the past 20 years in Europe,

Canada, Japan and the United States (GTZ/Holcim, 2006; Genon and Brizio, 2008); the

Netherlands and Switzerland use 83% and 48% waste, respectively, as a cement fuel

(WBCSD, 2005). Outside the OECD, the use of alternative fuels is not widespread. In

developing countries, although interest is growing, substitution rarely exceeds 1% of the

cement industry’s fuel needs. There is significant scope to increase waste substitution

globally with benefits for profits and the environment (IEA, 2009). Many developing

countries such as China and nations in Southeast Asia are initiating programmes to promote

co-processing of wastes in the cement industry. However, regulations, standards and the

technical infrastructure in these developing countries are less mature than in those that have

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a long experience with co-processing waste in the cement industry (Hasanbeigi et al.,

2012).

It is important that wastes are burned in accordance with strict environmental guidelines

to avoid adverse environmental impacts such as extremely high concentrations of

particulates in ambient air, ground-level ozone, acid rain and water quality deterioration

(Karstensen, 2007; Schorcht et al., 2013). If MSW and sewage sludge are co-processed

correctly and according to stringent environmental and emissions standards and regulations,

there are no additional health and environmental risks compared to those that result when

coal is used as a fuel (Rovira et al., 2011; Zabaniotou and Theofilou, 2008; Karstensen,

2007, 2008).

Hasanbeigi et al. (2012) examined international best practice in this area and found that

effective regulatory and institutional frameworks are critical to ensure that cement industry

co-processing practices do not have negative health or environmental impacts (see also

Schorcht et al., 2013). The research also enumerated barriers to co-processing of MSW and

sewage sludge in the cement industry, some of which could be streamlined:

•

Permitting; Although the cement industry prefers uniform emissions standards for

co-processors rather than case-by-case permitting of waste co-processing at plants,

case-by-case permitting is necessary for hazardous waste, for environmental and health

reasons.

Regulations and standards: Some countries lack specific regulations and standards for

co-processing of waste in the cement industry. Inadequate enforcement of waste

management regulations in many developing countries is also one of the key barriers.

Supportive policies: In many cases, co-processing may not be financially viable if its

larger societal (waste management) benefits are not taken into account. Municipalities

and governments that wish to pursue co-processing should design programmes and

incentives based on co-processing’s full benefits to the local community and

environment.

Public acceptance: Local residents and groups often perceive waste co-processing to be

the same as waste incineration and automatically resist co-processing of MSW and

sewage sludge in cement kilns. The major concern is usually the emissions from waste

combustion, especially dioxin. Authorities should openly and publicly communicate

emissions monitoring data and information from co-processing cement plants.

Infrastructure: For example, existing infrastructure for sewage sludge is largely based on

applying sludge to land or landfilling. Alternative infrastructure is needed for transport

and pre-processing to cement plants.

Lack of qualified workforce: The co-processing of waste in cement plants requires highly

qualified experts to install and set up the equipment and trained personnel to operate the

equipment. This capacity is presently limited in most developing countries.

•

Clinker substitutes in cement and concrete production

Clinker production is the most energy- and GHG emissions-intensive stage of cement

making. Yet clinker can be substituted with materials that are by-products of coal power

plants (fly ash) or iron and steel facilities that would lower GHG emissions from cement

manufacturing. There are wide differences in the production and use of clinker substitutes

(i.e. blended cements) around the world (Table 4.1). South America, India, China and

Europe are the largest users of clinker substitutes. Cement makers in the United States use

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relatively little clinker substitution (at the cement level), but do most of their blending in

concrete, not cement. This variation is due to historical preferences among the architectural

and construction professions, which are slow to change. They also result from differing

regulations on material specifications.

Table 4.1.

Clinker-to-cement ratios (inverse measure of clinker substitute use) by region

In percent

1990

Africa

Asia (excluding China, India, CIS) + Oceania

Brazil

Central America

China (People’s Republic of)

Commonwealth of Independent States (CIS)

Europe

India

Middle East

North America

South America excluding Brazil

89.4

89.6

80.1

84.3

79.6

81.5

78.6

86.2

84.9

89.9

76.5

2012

76.6

80.2

66.5

73.2

72.0

79.6

72.7

70.5

80.6

82.1

69.5

Share of cement production

included in statistics, 2012

Source:

Cement

Sustainability Initiative

(2015),

Getting the

Numbers

Right

www.wbcsdcement.org/GNR-2012/geo/GNR-Indicator_3213-geo.html

(accessed 8 January 2015).

database,

The US Environmental Protection Agency (EPA) explored the benefits and barriers to

increased use of clinker substitutes in federal construction projects. Its report found that use

of recovered mineral substitutes (RMC) yields positive environmental benefits through

lower resource consumption. It also found that the main regulatory barriers to increased

uptake were prescriptive technical standards for cement, air pollution regulations and solid

waste regulations (US EPA, 2008).

In the United States, there is insufficient recognition, by states’ Departments of

Transportation, of performance-based (as opposed to prescriptive- or ingredients-based)

technical standards for cement. Prescriptive standards favour status quo materials, at the

expense of innovative blends that would also bring about lower CO

emissions. In some

cases, regulations governing an activity that produces a substitute create barriers as well

(i.e. mercury and NO

control in power generation in the United States, which affects the

ability to use fly ash from coal plants; the US EPA is looking at technology options to

overcome this barrier).

There are no uniform, national regulations in the United Sates for the beneficial use of

recovered materials such as fly ash and blast furnace slag. Each state has its own solid

waste regulations. Although many states act to facilitate the use of these materials in

concrete, some state solid waste regulations governing the management of recovered

materials may make it more difficult to beneficially use these materials.

Industrial symbiosis

Industrial symbiosis involves sharing the use of resources and by-products amongst

industrial actors on a commercial basis through inter-firm recycling linkages. In industrial

symbiosis, traditionally separate industries engage in an exchange of materials and energy

through shared facilities (Beltramello et al., 2013). Successful co-siting and reuse of

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– I.4. DELIVERING INNOVATION AND SKILLS FOR THE LOW-CARBON TRANSITION

by-products as inputs provides clear environmental benefits through improved resource

efficiency, leading to lower overall GHG emissions. Economic and social benefits can also

be identified.

A well-known example of industrial symbiosis is Kalundborg, Denmark, where the first

exchanges took place in the 1970s. Two other key examples are described in

Beltramello et al. (2013): Kwinana Regional Synergies Project in Australia and Ulsan in

Korea. In both cases, demand seems to have played an important role in kick-starting the

symbiotic relationship. Demand came from both direct users of the industrial symbiosis

process, i.e. companies wishing to save costs and generate new revenue streams, and from

local communities concerned about local air and water emissions.

Policy has also played an important role in establishing the site. Beltramello et al.

(2013) note:

In the case of the Kwinana industrial symbiosis project in Australia, regulatory

pressure from the Department of Environment and Conservation (DEC) and the Water

and Rivers Commission was considered as a key factor. The air emission quality and

water discharge quality standards helped to encourage the adoption of the innovation...

However, regulations were also considered barriers that prevented or delayed the

implementation of synergies, e.g. existing water and energy utility regulations and

environmental regulations requiring intensive approval procedures for by-product reuse.

(Beltramello et al., 2013)

Salmi et al. (2011) found similar barriers when investigating the potential of organising

a system of metallurgical industries in an industrial symbiosis around the Gulf of Bothnia

between Finland and Sweden. There are potentially three main forms of symbiosis to be

found between the industries involved (carbon and stainless steel mills, a zinc plant and

iron regeneration), none of which faces significant technological challenges.

However, developing this symbiosis would require changing the status of material from

non-waste to by-product status. Typically this requires the company to apply for a new

environmental permit, which can be a lengthy process. For example, a steelmaking plant in

Finland needed six years to remove the waste status of slag and scrap metals.

Article 5 of

the EU Waste Framework Directive

sets out four cumulative conditions

for a substance

object resulting from a production process

to be considered as a by-product, including that it

can be used directly without further processing other than normal industrial practice.

Industrial combined heat and power

In many industrial situations, electricity, heat (steam), and sometimes cooling can be

produced via a single process – combined heat and power (CHP), or cogeneration – much

more energy efficiently and less emissions-intensively than via two (or three) separate

processes. As such, many governments actively promote, and some even mandate, the

implementation of CHP as a fundamental energy efficiency and climate change mitigation

measure in many industries (China in the cement sector, for instance).

The economic attractiveness of CHP depends on an individual plant’s own needs for

electricity, heating and cooling; the external markets for any excess production of these

energy streams; the quantity and quality of waste heat available; the prevailing tariffs for

electricity and fuel (usually natural gas, coal or biomass); and the cost of capital. Some of

these factors – especially access to external markets and energy tariffs – can be heavily

influenced by policy. Examples where policies make the implementation of CHP difficult

include (IEA, 2013, 2014; Kowalczyk, 2009):

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115

•

In India, lack of centralised data – on the amount of installed capacity, its distribution

among sectors, the types of fuel used, the amount of power and heat/cooling generated –

to help understand the potential for CHP and required efforts to support a substantial

deployment programme. There is also a lack of pipeline networks for delivering

heat/cooling to external users.

In Korea, a hindrance to CHP deployment is misalignment in regulated natural gas prices

(set high to recoup losses in the liquefied natural gas market) and electricity tariffs (set

below the full cost of electricity generation).

In the United States, emissions limits based on heat input or exhaust concentration can

penalise CHP for its on-site generation of both electricity and thermal energy (as opposed

to output-based emissions limits (emissions per unit of electricity or thermal energy

output, which would support CHP).

Lack of uniformity among states and regions in grid interconnection standards makes it

difficult for equipment manufacturers to design and produce modular packages that can

easily connect to the grid in various applications in the United States.

In the United States, a variety of barriers relating to the treatment of CHP by utilities have

been identified. These include utility tariff structures, excessive charges by local utilities

for future lost revenue or as compensation for continued access to the distribution

networks.

Disparate tax depreciation policies for CHP installations which may discourage CHP

project ownership arrangements, thereby increasing the difficulty of raising capital and

discouraging development in the United States.

•

Revisiting industry regulations

In light of the narrow scope adopted in what precedes and of the identified

misalignments, every opportunity should be taken to revisit regulations applying to

industrial activities that represent large GHG sources and to screen these regulations for

their inadvertent consequences on low-GHG innovations. This is, no doubt, a significant

task for regulatory and standard-setting bodies, but is necessary if climate policy signals are

to trigger the intended technical changes. In the alternative, a number of industrial activities

will be hindered in their ability to contribute to climate change mitigation.

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Notes

1.1% a year against 4.2% earlier, although it accelerated in 2012.

See also OECD (2013b) on the contribution of biotechnology.

See Cárdenas Rodríguez et al. (2014), Criscuolo and Menon (2014), and

Criscuolo et al. (2014). See also OECD (2015a).

See Lerner (2011) for a discussion.

For example see Ellerman (1998); Levinson (1999); Bushnell and Wolfram (2007).

See Riesz et al. (2013).

See:

www.iea.org/roadmaps

for technology specific roadmaps as well as guidelines

for countries seeking to develop their own roadmaps.

The OECD has facilitated the establishment of several such distributed

infrastructures, most recently in relation to Scientific Collections (SciColl, 2013), and

analysed the lessons learnt, including different governance options (OECD, 2014c).

Strategic centres for science, technology and innovation (SHOKs) in Finland and the

Top Sectors approach in the Netherlands.

For example, OECD (2012b) already points out a lack of green ICT-related skills in

many OECD countries.

Another example of a response to a policy-driven market creation is the training

organised by the regional government of Extremadura, Spain to provide renewable

energy specialists and project managers as it was rapidly developing its solar energy

capacity. The solar programme created approximately 3 000 jobs.

The high temperatures and sufficiently long residence time in cement kilns and other

characteristics of cement production make co-processing of waste materials a viable

strategy (Hasanbeigi et al., 2012).

10.

11.

12.

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Chapter 5

Removing international trade barriers

Although international trade contributes directly to GHG emissions, increased trade can

help to achieve economic goals in a GHG-efficient manner, provided that GHG emissions

are correctly priced everywhere. Given that emissions are not universally priced, this

chapter examines where policies related to trade may be in misalignment with climate

change objectives. While concluding that the multilateral agreements of the World Trade

Organization do not generally prevent governments from pursuing strong domestic climate

policy, the chapter does identify potential misalignments. These include import tariffs on

environmental goods, barriers to trade in services and domestic policies designed to

support local low-carbon industry but which are restrictive of international trade and

therefore potentially counter-productive. The chapter concludes by looking at pricing

policies for the machinery of international trade, aviation and shipping fuel, as well as

resilience of the global trade system.

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli

authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights,

East Jerusalem and Israeli settlements in the West Bank under the terms of international law.

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– I.5. REMOVING INTERNATIONAL TRADE BARRIERS

Key messages

Trade itself is not the climate villain. If greenhouse gas (GHG) externalities were correctly

priced globally, increased trade would lead to a more GHG-efficient global economy. However,

not all GHG externalities are correctly priced. Given the importance of trade for shifting goods

(and their embodied GHG emissions) internationally, it is important to assess how trade is likely

to affect global GHG emissions – directly and indirectly – and where policy misalignments

could lead to higher levels.

The international trade rules agreed through the World Trade Organization (WTO) do not

generally impede governments from pursuing ambitious climate policies, even though they were

not designed with the global climate challenge in mind. Nevertheless, other policies related to

international trade should be designed to avoid misalignments with climate objectives.

How do tariff-based trade barriers affect the low-carbon transition?

In many countries,

particularly outside the OECD, import tariffs still exist for environmental goods, including goods

important for climate change mitigation. Reducing these tariffs would help increase market

access and promote the global transition to a low-carbon economy. Recent negotiations by a

group of WTO members seeking an Environmental Goods Agreement are a promising

development.

How can trade in services enhance the transition?

The growth of global value chains has

made international deployment of services a key part of modern trade, yet barriers to services

trade still exist. Services are important for the low-carbon transition because more efficient

services sectors contribute to improved productivity throughout the economy, often leading to

lower energy and emissions intensity. Also, goods important for climate change mitigation are

often new to markets and require highly skilled personnel to install, operate and maintain them.

This means that widespread diffusion of such technologies, particularly in developing countries,

could be particularly sensitive to barriers to trade in services. Removal of barriers such as

restrictions on firm ownership and temporary movement of professionals could therefore be

beneficial for the transition.

Are domestic support measures conducive to international trade?

Many countries are

promoting greener growth through the stimulation or creation of domestic industries

manufacturing low-carbon power generating equipment. If unduly restrictive of international

trade, however, these measures can undermine overall investment and uptake of the technology.

One example is the recent prevalence of local-content requirements in the wind and solar energy

sectors, aimed at supporting local mid-stream manufacturers. Such measures can increase overall

costs due to the global nature of renewable energy value chains. Support measures should be

designed to be respectful of international trade so as not to hinder international investment.

Are policies for aviation and maritime fuel aligned with climate objectives?

GHG

emissions from international merchandise transport may increase by 290% by 2050, with

shipping and aviation accounting for more than 40% of freight emissions. Yet the international

nature of these industries means that fuel destined for international shipping and aviation is often

not covered by countries’ core climate policies. Progress is being made in agreeing

GHG-reduction measures at the multilateral level, however. For example, the International

Maritime Organization has agreed energy efficiency standards and in 2016 the International

Civil Aviation Organization will consider adopting a global market-based mechanism for pricing

emissions from aviation. Pursuing multilateral efforts in these two domains is likely to be the

most cost-effective means of ensuring full alignment with international climate change

objectives.

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Greenhouse gas emissions and international trade

International trade exerts an important influence on global efforts to tackle climate

change. The interconnectedness of the global economy through trade means that countries’

core climate policies do not operate in isolation. Short-term costs imposed by climate

policies could lead to “carbon leakage” in cases where imports of carbon-intensive goods

increase in response to more stringent mitigation efforts (see Chapter 1). Regardless of the

effects of climate policies, international trade means that emissions generated in the

production of exported goods (or intermediate products) will essentially be “consumed” in

another country where the final good is purchased, presenting challenges for emissions

accounting (Box 5.1). Trade is also an important driver of economic growth through the

diffusion of technologies and know-how, including some that are important for the low-

carbon transition. This chapter considers how policies relating to international trade could

in some cases be misaligned with efforts towards the low-carbon transition.

Trade itself is not the climate villain. International trade does of course have direct

emissions implications due to GHG emissions from transport (as well as other direct

environmental impacts such as invasive alien species in containers and ballast water).

However, when the life-cycle emissions of goods are taken into account, overseas

production may still have lower emissions despite the international transport – how a

product is produced is often more important than where it is produced. Further, the

principle of free trade and comparative advantage suggests that over the long term, free and

fair trade should lead to a more efficient outcome for the same level of economic output,

assuming that climate-related externalities are correctly priced everywhere. In 2050,

feeding 9 billion people all striving for wealthier lifestyles will be less resource-intensive

with free trade than it would be without it, again assuming that GHG externalities are

correctly priced.

However, all GHG emissions are not yet correctly priced. This means that it is

important to assess how international trade is likely to affect global GHG emissions, and

where policy misalignments could lead to higher GHG emissions. The environmental

impacts of trade have often been framed in terms of their scale, composition and technique

effects (Grossman and Krueger, 1993; Copeland and Taylor, 2003). When applied to GHG

emissions, the scale effect refers to changes in emissions due to the increased economic

activity from trade, including increased transport – which usually leads to increased

emissions. The composition effect refers to changes in a country’s emissions profile as

relative prices and resource allocation between sectors adjust in response to international

trade. As trade increases, some sectors will expand and others will contract in line with a

country’s comparative advantage, which could lead to either an increase or decrease in its

overall emissions intensity, all else constant. The technique effect refers to improvements in

emissions intensity due to innovation in the way goods and services are produced, such as

through the diffusion of lower carbon goods and services.

Policy settings can influence how trade, through these three effects, influences GHG

emissions. This chapter begins by looking for misalignments within international trade

agreements and trade rules themselves. It then focuses on where domestic policies –

including those intended to foster green growth – may be hindering the diffusion of

low-carbon goods through international trade, influencing the technique effect. This chapter

also assesses policies relating to international transport of goods, given their importance for

influencing the direct emissions resulting from international trade. Finally, the role of

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– I.5. REMOVING INTERNATIONAL TRADE BARRIERS

policy in improving the resilience of the trading system in the face of physical climate

impacts is briefly considered.

Box 5.1.

Traded emissions: Calculating emissions based

on production and consumption

A comparison of countries’ production and consumption emissions can be visualised using

data from the OECD’s input-output tables combined with IEA data on CO

emissions.

Intellectually it might appear more appropriate to consider consumption-based emissions

when assessing countries’ efforts to reduce GHG emissions. If perfect information were

available, it would be interesting to determine how a global carbon budget could be carved up

based on the real emissions influenced by the consumption in each country. This would in theory

remove any concerns about “carbon leakage” and allow each country to take responsibility for

the emissions its economic activity really generates. In practice, at least two issues need to be

considered. First, even though it can be claimed that a country is responsible for the emissions

along global production chains generated by its economic activity, that country’s possibilities to

influence the emissions intensity abroad are limited. This is where an international agreement on

territorial emissions continues to play an important role. Second, all GHG data are far from

perfect, and agreeing on methods for measuring and comparing consumption-based emissions

remains challenging (Lenzen et al., 2013; Nakano et al., 2009; Peters et al., 2011). Nevertheless,

estimates such as those presented in Figure 5.1 provide a useful illustration of the importance of

international trade for GHG emissions allocation. The data are similar to those presented for net

export and import by region in the Intergovernmental Panel on Climate Change’s (IPCC) Fifth

Assessment Report (Agrawala et al., 2014).

Figure 5.1.

Production-based and consumption-based CO

emissions for selected countries

Consumption-based (2009)

7 000

6 000

5 000

Production-based (2009)

Consumption-based (1995)

Production-based (1995)

MT CO

4 000

3 000

2 000

1 000

Source:

Authors, based on OECD input-output tables and IEA CO

emissions data. See

www.oecd.org/sti/inputoutput/co2.

Potential misalignments with international trade rules

The international trade regime includes rules agreed multilaterally under the WTO,

rules agreed bilaterally or plurilaterally through regional trade agreements (RTAs), and

jurisprudence from prior disputes relating to trade rules. Taken as a whole, does the trade

regime act to restrict governments’ ability to pursue ambitious climate policies? The

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following sections suggest that, in general, the trade regime is not in itself misaligned with

climate objectives.

Multilateral agreements under the World Trade Organization

The WTO’s primary agreement governing goods trade, the General Agreement on

Tariffs and Trade 1994 (GATT), does not in itself prevent countries from pursuing climate

policies. The GATT lays out the core principles for free trade. Key among these are the

principles of non-discrimination between “like products” from different trading partners

(most-favoured nation treatment) and between “like products” of foreign and domestic

origin (national treatment). The question of whether products that differ only in the way

they are produced – such as differences in GHG emissions during production – should be

considered “like products” has been extensively debated by commentators and in ongoing

WTO case law.

However, the GATT also allows for countries to justify policies on environmental (and

other) grounds through Article XX, even if the measures partly violate one or more of the

core principles.

Although the exemptions do not specifically mention climate change (the

text dates from 1947), there is no clear evidence that the GATT in itself has acted to

discourage countries from pursuing policies relating to climate change. In the few instances

that WTO case law has tested whether climate change is an appropriate reason for

justification under Article XX, opinions have generally been favourable (Tran, 2010).

One key and as yet untested question is the potential WTO conformity of border carbon

adjustments that some countries may consider implementing as an economic disincentive

targeted at controlling carbon leakage or limiting competitiveness concerns associated with

mitigation policies (discussed in Chapter 1). No such measures have yet been introduced by

any government, though examples have been considered in draft legislation and extensive

academic literature on the issue exists (for a review see Condon and Ignaciuk, 2013). If

such measures were to be introduced in the future and were subsequently challenged

through the WTO, the interpretation of what constitutes a “like product” and the

applicability of Article XX exceptions would again be important. But in general the WTO

system does not explicitly forbid border carbon adjustments, whether in the form of taxes or

through the purchase of emissions permits at the border.

Several of the more specific WTO agreements are also relevant to policies and

measures targeting climate change objectives. One particular example is the Agreement on

Subsidies and Countervailing Measures (SCM). Subsidies for the deployment of

low-emitting technology have been one of the few policy tools readily available for

governments seeking to take fast action on the low-carbon transition, given the barriers

often faced when seeking to implement carbon pricing systems (described elsewhere in this

report).

The SCM divides domestic subsidies into those prohibited for WTO members

(i.e. contingent on export performance or on the use of domestic over-imported goods) and

those that are “actionable” (not contingent on exports but potentially injurious to other

WTO members, or contingent on domestic content). Although some observers have

suggested revising the SCM’s list of “non-actionable” subsidies to facilitate countries’

efforts in implementing environmental subsidies (Charnovitz, 2014; Rubini, 2012), the

prevalence of such measures already introduced by governments in recent years indicates

that the SCM as it stands does not prevent action on “green” subsidies. Further, the SCM

actually provides a means to ensure environmental subsidies are not trade-distorting or do

not constitute disguised barriers to investment by foreign firms. Subsidies with these

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characteristics are potentially counterproductive for the low-carbon transition as they raise

the costs of low-carbon technologies. These are further discussed below in the section on

green industrial policy.

In general, the WTO Dispute Settlement Mechanism has allowed for jurisprudence to

build up on an as-needed basis, with the application of trade rules to particular cases being

clarified through emerging case law, including for measures related to climate change. In

the case of subsidies, the dispute settlement process can lead to authorised unilateral trade

remedies adopted by WTO members. Remedies such as anti-dumping and countervailing

duties are legitimate, WTO-sanctioned responses to injuriously dumped or subsidised

imports.

Recently, unilateral remedies have been applied in two directions within the same

low-carbon industry. For example, the United States first imposed anti-dumping and

countervailing duties on finished solar panels from the People’s Republic of China

(hereafter “China”). In response, China imposed similar measures on polysilicon precursors

from the United States. The result of this escalation is reduced overall trade and increased

costs in the supply chain (see review of studies in OECD, 2015). Although policy options

for de-escalating trade remedies exist,

the costs incurred all across value chains and the

uncertainty created for investors reinforce the importance of ensuring that domestic

subsidies are designed in accordance with WTO principles, including the SCM.

Regional trade agreements

Outside of the WTO, governments have for many years pursued bilateral or plurilateral

trade and investment agreements, often with the aim of creating closer ties with trade

partners or moving towards deeper regional economic integration. Increasingly, these RTAs

include specific environmental provisions (or environmental side agreements) which can be

used to encourage more stringent environmental action (OECD, 2007; George, 2014). For

example, provisions can include agreements to not weaken environmental laws in order to

seek increased incoming international investment, and agreements to ensure that judicial

enforcement capacity is available (e.g. the Peru-US and CAFTA-DR-US agreements; see

US GAO, 2014 for a review). The effectiveness of these provisions depends on their degree

of ambition, the extent to which they are binding on the parties, the stringency of their

enforcement, and the nature and extent of co-operation between or among the parties to

implement the provisions.

More recent RTAs aim to tackle behind-the-border barriers to trade in a more profound

way than the WTO’s Agreement on Technical Barriers to Trade (TBT). As well as chapters

related to environment or sustainable development, these RTAs tend to include provisions

on regulatory co-operation aiming to streamline regulations to reduce the cost of doing

business internationally. Although this co-operation may cover environmental regulations,

including those relevant to climate change mitigation, co-operation does not impede each

party’s sovereign right to regulate. Concerns have also been raised that investor-protection

clauses, if included in RTAs where all parties have robust domestic investor protection

laws, could be detrimental to the development of climate change policy measures.

However, investor protection clauses have been used for many years and no conclusive

evidence of this effect has been documented (Australian Productivity Commission, 2010;

Tietje et al., 2014; BIAC, 2015).

Environmental goods trade liberalisation

Increased trade in environmental goods can help to mitigate environmental problems

while also supporting economic growth – a manifestation of the “technique effect”

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described above. Most OECD countries have, over time, reduced their import tariffs for

environmental goods, including those relevant to climate change mitigation. However,

formal tariff-based trade barriers still exist for environmental goods, in particular outside

the OECD area, with the result that the diffusion of some technologies important for

addressing GHG emissions is hindered and costs in those countries are higher than they

should be. Non-tariff barriers (NTBs) also hinder environmental goods dissemination

sometimes to a larger extent than tariff barriers. Addressing NTBs as a source of policy

misalignment could be explored further.

These barriers to trade can have a disproportionate effect on emerging technologies,

including climate mitigation goods. With the rise of global value chains, intermediate

products may cross borders many times before final assembly, meaning that even low

tariffs can be amplified to a significant cost increase of the final product (OECD, 2013).

Recent OECD work also showed that, in the case of some environmental goods, import

tariffs can be detrimental to a country’s exports, thereby hurting domestic industry

(Sauvage, 2014). Furthermore, some low-carbon goods can face trade barriers because they

are more capital-intensive than their fossil fuel counterparts, and import tariffs on fossil

fuels are generally lower than on capital equipment.

The prospect of a multilateral agreement at the WTO with commitments on

environmental goods tariffs has been discussed many times since 2001, so far with little

progress in formal negotiations (Steenblik, 2005; Sauvage, 2014). Progress has been made

outside of the WTO on a plurilateral basis. The Asia-Pacific Economic Cooperation

(APEC) countries took a leading role in environmental goods trade by agreeing on the

APEC List of Environmental Goods and committing to reduce applied tariff rates of the

listed products to 5% or less by the end of 2015. In 2014, a group of WTO members,

including OECD and non-OECD countries (among them China), commenced new

plurilateral negotiations towards an Environmental Goods Agreement that is likely to

include goods that are important for climate change mitigation (or are components thereof).

If concluded successfully, such an agreement could potentially be formalised under the

WTO in due course. Technical challenges remain, including reaching agreement on which

goods should be considered for tariff liberalisation, given that many goods also have clearly

non-environmental uses and are not separately identified in the Harmonized System (HS),

the international classification and coding system used to track international trade

(Steenblik, 2005; Sauvage, 2014).

Misalignments arising through domestic policies related to trade

Within the framework of the international trade regime, the trade effects of some

domestic policies can have an important bearing on their effectiveness to support the

low-carbon transition. These policies are examined in this section.

“Local-content requirements” for renewable energy

As part of their recovery from the financial crisis, many countries have implemented

various forms of industrial policy, albeit often under different names (Evenett et al., 2009;

Warwick, 2013). Where such policies directly support emissions-intensive investment, such

as new subsidy arrangements favouring fossil fuels, misalignments with the low-carbon

transition may exist that also distort international markets. These are covered in other

chapters of this report.

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A number of these newly introduced policies aim to promote green growth through the

stimulation or creation of domestic industries manufacturing low-carbon power generation

equipment. This trend has been referred to as the rise of “green industrial policy” (e.g. Wu

and Salzman, 2014; Rodrik, 2013). Such measures may initially appear to be beneficial for

the low-carbon transition. But various analyses have highlighted that if the measures are

designed to be overly restrictive of international trade, they are likely to lead to higher

prices for both domestic and international suppliers, with the overall effect of hindering

uptake of low-carbon electricity-generating technologies.

Box 5.2 considers the specific and highly visible example of local-content requirements

(LCRs) for renewable energy. These can be considered a policy misalignment for the low-

carbon transition because they can raise the overall costs of downstream activities

(e.g. installation). New OECD work indicates that LCRs have hindered both

competitiveness and international investment in solar photovoltaics (PV) and wind energy.

The increasingly globalised nature of value chains for wind and solar technology means

that intermediate products cross borders many times. LCRs are usually intended to support

mid-stream manufacturers, and the resulting market distortions can increase costs for actors

further down the value chain. If these actors are in the same country, the policy may have a

net negative effect for the domestic sector it is trying to support. Overall, such policies are

likely to raise costs all across the production chain (Bahar et al., 2013; OECD, 2015).

The risk of higher overall costs also exists in relation to other trade-impacting “behind

the border” measures in the same sectors. These include measures with more direct trade

implications (such as local-equity requirements and export quotas) and those that deter

international investment and therefore lead to overall less efficient supply chains

(e.g. national standards that favour domestic producers or more informal measures that

favour local enterprises over foreign ones). The prevalence of these measures – and the

WTO disputes associated with them – highlights the need for policy makers to better align

and take a more holistic approach to trade and investment policies in order to provide

effective policy support to achieve the low-carbon transition.

Barriers to trade in services

Over time, the global importance of trade in services has risen significantly. Global

value chains and highly streamlined international logistics networks have made

international deployment of services a key part of modern trade. The value created by

services as intermediate inputs now represents over 30% of the total value added in

manufactured goods. The international trade regime addresses services trade through the

General Agreement on Trade in Services (GATS), agreed in 1994. However, negotiations

on specific liberalisation commitments under the agreement have faltered over time and

many barriers to trade in services remain in the form of domestic regulations.

Some of

these are important for the low-carbon transition.

Trade in services is important for climate change mitigation in a number of ways. In

general, more efficient services sectors contribute to improving productivity and enhancing

competitiveness across the whole economy – in manufacturing as well as in services sectors

themselves (OECD, 2014). Greater productivity will often lead to lower energy use and

emissions intensity. Also, as economies become ever more interconnected through value

chains, a trend towards “servicification” can be identified, with companies increasingly

turning to provision of services attached to the delivery of goods. For example, a jet engine

manufacturer is more likely to lease its engines to airlines, and an industrial turbine

manufacturer is more likely to lease its turbine. This usually leads to better maintenance

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Box 5.2.

Local-content requirements in renewable energy markets

Local-content requirements (LCRs) have increasingly been used to support the development

of renewable energy. OECD research shows that LCRs linked to wind and solar PV have been

planned or implemented in at least 21 countries, including 16 OECD countries, mostly since

2009. LCRs are typically imposed as a precondition for access to financial support schemes such

as feed-in tariff (FiT) programmes or as part of eligibility requirements in renewable energy

public tenders. Some countries have also designed LCRs as eligibility criteria for direct financial

transfers such as subsidised loans and loan guarantees from government agencies and national

development banks, such as in Brazil. In some cases, different LCR ratios are used depending on

the technology used in downstream installations, such as India (OECD, 2015; OECD et al.,

2013; Bahar et al., 2013).

To highlight the effects of LCRs on international investment, new OECD research based on

empirical analysis indicates that while FiT policies play an important role in attracting

international investment in solar PV and wind energy, LCRs have a detrimental effect on global

international investment flows in these sectors and hinder the effectiveness of FiT policies when

attached to them. The estimated detrimental effect of LCRs is slightly stronger when both

domestic and international investments are considered. This indicates that LCRs do not have

positive impacts on domestic investment flows (OECD, 2015). At the same time, recent OECD

Computable General Equilibrium (CGE) modelling has shown an array of expected negative

impacts of LCRs on trade across different sectors (Stone et al., 2015).

The rise of LCRs for renewable energy has led to at least five WTO disputes since 2010,

highlighting the importance that governments place on new renewable energy industries. In one

example, the Canadian province of Ontario was found to be in breach of GATT (General

Agreement on Tariffs and Trade) and TRIMS (Agreement on Trade-Related Investment

Measures) commitments, though the FiT subsidy itself was not found to be in breach of the SCM

(Agreement on Subsidies and Countervailing Measures).

Ontario’s FiT programme (introduced in 2010) required developers of wind and solar

installations benefiting from the FiT to have a certain percentage of project costs incurred in

Ontario. Japan launched a complaint at the WTO and a similar complaint was later lodged by the

European Union. The claimants argued that the “Minimum Required Domestic Content Level”

adopted under the FiT Programme unfairly discriminated against foreign renewable-energy

equipment and therefore placed Canada in violation of: 1) the national treatment obligation

under Article III:4 of the GATT 1994; 2) the prohibition set out in Article 2.1 of the TRIMs

Agreement on the application of any trade-related investment measures that are inconsistent with

Article III of the GATT 1994; 3) the prohibition on import substitution subsidies prescribed in

Articles 3.1(b) and 3.2 of the SCM.

In 2013 the WTO’s Appellate Body confirmed that the LCR was inconsistent with

international trade rules. The Appellate Body supported the panel’s conclusions that LCRs

accorded preferential treatment to products made in Ontario by requiring the purchase or use of

products from domestic sources, placing Canada in breach of its national treatment obligation

under GATT Article III and TRIMS Article II. Following the ruling, Canada proceeded to bring

its measure into conformity with the recommendations of the WTO’s Dispute Settlement Body

(DSB). On 5 June 2014, Canada informed the DSB that the Government of Ontario was: 1) no

longer subjecting large, renewable-based electricity procurements to domestic requirements;

2) had significantly lowered its domestic-content requirements for small and micro-FiT

procurement relating to solar- and wind-powered electricity installations under the FiT

Programme.

Source for final two paragraphs: Based on

www.wto.org/english/tratop_e/dispu_e/cases_e/ds412_e.htm.

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– I.5. REMOVING INTERNATIONAL TRADE BARRIERS

and performance of the equipment, resulting in lower fuel use and lower emissions. It is

also likely to lead to better overall utilisation rates of physical capital, thereby contributing

to a more energy efficient economy. But to be effective, this “servicification” of the

economy requires smooth international trade in services (Swedish National Board of Trade,

2014).

Concerning specific technologies important for climate change, such as renewable

energy, the deployment of technology is dependent on a wide range of services, many of

which are imported and are not necessarily strictly environmental in nature – particularly in

the context of developing countries. Business services, telecommunications services, and

construction and related engineering services figure prominently (Steenblik and Geloso

Grosso, 2011). Low-carbon goods tend to be newer, high-tech goods requiring highly

skilled personnel to install, operate and maintain. Training of local users can also be

important. Overall this means that widespread diffusion of such technologies, particularly

in developing countries, is likely to be more affected by barriers to services trade than

“conventional” more highly emitting goods.

Finally, services that are traditionally

considered to be “environmental services”, such as pollution remediation, may also be

important for climate mitigation.

Tracking and understanding trade in services is difficult due to data constraints.

Recently, the OECD developed the Services Trade Restrictiveness Index (STRI) to shed

light on barriers to services trade across different sectors and countries (Box 5.3). Although

it has not developed an index specifically for environmental services, those for other

service industries highlight where some countries could do more to remove barriers to

services trade that would help their efforts toward the low-carbon transition. Of the

four modes of services trade identified in the GATS,

Steenblik and Geloso Grosso (2011)

document examples of all four being relevant to climate change. These range from

consulting services for energy efficiency (Mode 1); to ecotourism services consumed

abroad (Mode 2); to the establishment of foreign subsidiaries to manage low-carbon

projects (Mode 3); to temporary movement of personnel such as to carry out wind turbine

repairs (Mode 4). The Swedish National Board of Trade (2014) identified a list of services

indispensable to trade in environmental goods; these also cover all four modes but with

Mode 3 (commercial presence) and Mode 4 (natural movement of persons) predominating.

Barriers to cross-border trade in electricity

As described in Chapter 7, the uptake of renewable energy is an important means for

mitigating CO

emissions from the electricity sector, but the variable output of some

renewable energy technologies can introduce instability into electricity systems. The risk of

instability increases with higher shares of intermittent power sources connected to the

electrical grid. Chapter 7 delves into detail on electricity market structures that may be

poorly aligned with the transition to a low-carbon economy. Barriers to cross-border trade

in electricity appear to be another potential misalignment. An examination of European

electricity markets confirms the importance of cross-border electricity trade in increasing

the effective capacity factor of intermittent plants in the context of a growing share of

intermittent renewables in the power sector (Bahar and Sauvage, 2013).

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Box 5.3.

Services Trade Restrictiveness Index (STRI)

Since 2014, the OECD has been tracking barriers to services trade across countries and sectors through

the Services Trade Restrictiveness Index (STRI). The STRI contains a regulatory database of laws and

regulations in existence today, and composite indices that quantify identified restrictions across

five standard categories, with values between zero and one. A score of zero corresponds to complete

openness to trade and investment, while being completely closed to foreign services providers yields a score

of one.

The STRI provides a unique diagnostic tool, generating a picture of services restrictiveness at the

national level and by sector, covering 18 sectors in 40 countries. It allows benchmarking for individual

countries and relative to global best practice, and enables countries to quickly see where the outlier

restrictions are and where potential bottlenecks exist.

For the first time, comprehensive and comparable information is available for policy makers to scope

out reform options and assess their likely effects; for trade negotiators to clarify those restrictions that most

impede trade; and for businesses to understand entry requirements for foreign markets. The knock-on

consequences for downstream users of these services are demonstrable. The STRI in combination with the

OECD-WTO TiVA-GVC database are powerful tools for further analysis of regulatory spillovers in global

value chains and the interdependence between sectors in an interconnected and increasingly digital world.

Figure 5.2 shows an example of STRI data for engineering services, a key service area relevant to

climate change technology. Engineering services are labour-intensive, particularly at the high-skill level.

Therefore, measures categorised under “Restrictions to movement of people” have the strongest impact in

the restrictiveness levels for these services. The other policy category that affects the degree of

restrictiveness in engineering services relates to “Restrictions on foreign entry”. Some countries maintain

ownership restrictions on the basis of qualifications and licensing, at times coupled with residency and

licensing requirements for board members and managers of engineering firms. More open services markets

improve competitiveness and productivity both in the services sectors in question and downstream

industries using services as inputs. Engineering services underpin the infrastructural development of the

economy and the smooth functioning of essential public services. Hence, promoting the cost-effectiveness

and quality of these services can represent a source of economic growth and create significant spill-over

effects.

Figure 5.2.

STRI* by policy area: Engineering services

Restrictions on foreign entry

Barriers to competition

0.6

0.5

0.4

0.3

0.2

0.1

AUS

AUT

BEL

BRA

CAN

CHE

CHL

CHN

CZE

DEU

DNK

ESP

EST

FIN

FRA

GBR

GRC

HUN

IDN

IND

IRL

ISL

ISR

ITA

JPN

KOR

LUX

MEX

NLD

NOR

NZL

POL

PRT

RUS

SVK

SVN

SWE

TUR

USA

ZAF

Restrictions to movement of people

Regulatory transparency

Other discriminatory measures

Average

Note: *The

STRI indices take values between zero and one, one being the most restrictive.

Source:

OECD (2014), “Services Trade Restrictiveness Index: Policy brief”, OECD, Paris, available at:

www.oecd.org/tad/services-trade/STRI%20Policy%20Brief_ENG.pdf.

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– I.5. REMOVING INTERNATIONAL TRADE BARRIERS

The primary constraint for cross-border trade is availability of physical infrastructure in

the form of interconnectors joining national grids. However, even in the presence of

sufficient interconnection capacity, other barriers may still exist. The existence of an

efficient cross-border electricity trading regime takes on particular importance to address

the variability problem. Addressing those regulatory and administrative measures that

inhibit cross-border trade and the smooth operation of regional electricity markets would

therefore help increase the potential for trade in electricity to facilitate the uptake of

renewable energy (Bahar and Sauvage, 2013).

Fuelling international trade: Maritime shipping and aviation

Although not trade policies

per se,

policies relating to international freight transport are

considered here because of their importance to both international trade and global GHG

emissions. The movement of goods in international trade predominantly relies on fossil

fuels, mainly fuels derived from petroleum. The impact that increased international trade

will have on global GHG emissions trends – via the scale and direct effects described

above – depends in part on the policy incentives in place internationally for freight

transport.

Transport as a whole accounts for 23% of global CO

emissions from fuel combustion

(30% in OECD countries). The majority of this is road transport (of which only about one-

third is attributable to freight and international trade), with shipping and aviation making up

about 3% and 2% respectively of total global CO

emissions from fuel combustion

(OECD/ITFb, 2015). However, projections by the International Transport Forum (ITF)

suggest that in the base case, GHG emissions from international merchandise transport may

increase by 290% by 2050 (OECD/ITF, 2015a). Although the majority of international

merchandise trade is still expected to travel by sea, road transport accounts for around 50%

of total CO

emissions from international trade-related freight movements; the share is

projected to increase to 56% by 2050.

Shipping and aviation are for the most part international industries, governed by

specific international conventions.

The United Nations has multilateral organisations

devoted to both domains: the International Civil Aviation Organization (ICAO) and the

International Maritime Organization (IMO). The international character of these industries

makes it difficult for individual governments to take action on pricing or regulating GHG

emissions for bunker fuels consumed on their territories or under their flag. However, some

progress has been made through both international conventions, as described in the

following sections.

Policies relating to emissions from international aviation

The multilateral Chicago Convention (1944) originally granted tax exemptions to fuel

carried on-board planes arriving within the territory of an ICAO member. In 2000, the

ICAO Council agreed to broaden the scope of the exemption to also cover fuel taken

on-board prior to leaving a country’s airspace, reflecting what many countries had already

agreed in bilateral air services agreements (ICIS, 2005).

Countries originally sought international agreement on reciprocal exemption of aviation

fuel from tax because the mobile nature of aviation may otherwise have resulted in tax

competition across countries. If one country’s tax rate was notably higher than others, it is

possible that airlines would refuel in other countries with lower taxes, a practice known as

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I.5. REMOVING INTERNATIONAL TRADE BARRIERS –

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“tankering”. Depending on relative fuel costs, this could result in suboptimal fuel loads

leading to overall increases in fuel use, and therefore emissions.

Despite these tax exemptions, progress has been made regionally and internationally on

improving technical standards and pricing emissions. As a result of rising fuel costs over

the past decade, airlines and states have invested in technologies, equipment and operations

to lower the overall consumption of fuel. Through the ICAO, a CO

metric has been

developed with a view to agreeing an international CO

standard for aircraft. National and

regional technical initiatives also exist.

In 2012, the EU sought to introduce carbon pricing for aviation by bringing aviation

within the EU ETS and requiring all departing and incoming flights to surrender emissions

permits (some of which are allocated free of charge to operators). The strong international

reaction, including a questioning of the legality of the EU’s move and threats of retaliatory

trade measures aimed at EU aviation industries, led to a reduction in scope of the measure

to cover only intra-EU flights, pending progress on an international market-based

mechanism under the ICAO.

In 2013, ICAO members formally agreed to explore a multilateral market-based

solution. The 2016 ICAO Assembly is due to take a decision on this proposal shortly after

the important UNFCCC COP21 in December 2015. Should the decision on and

implementation of the multilateral mechanism be subject to delays, governments seeking to

take strong action on climate change may need to explore interim solutions bilaterally or on

a plurilateral basis. The 2000 decision by the ICAO Council is a “recommended practice”

and as such is not legally binding on parties and does not preclude members, individually or

jointly, from introducing environmental taxes on aviation fuel.

Policies relating to emissions from international maritime transport

Maritime transport generates the lowest GHG emissions per tonne-km compared with

the other modes of commercial transport, yet the vast quantity of goods transported by sea

means that overall emissions have grown quickly (faster than road transport, against a 1990

baseline; IEA, 2014). However, according to the 3rd IMO GHG Study, global shipping

emissions were relatively flat between 2007 and 2012, totalling 972 Mt CO

-eq in 2012

(IMO, 2014).

On a multilateral basis, countries have made progress through the IMO to reach

agreements on improving the fuel efficiency of ships and on agreeing progressive

reductions on the maximum limits for air pollutants for ships, including SO

and NO

In 2011, the IMO successfully amended MARPOL Annex VI when it introduced the

Energy Efficiency Design Index, which established a mandatory efficiency standard for the

design of new ships (measured in terms of GHG emissions per tonne-mile), and also the

Ship Energy Efficiency Management Plan, an operational measure that establishes a

mechanism to improve ships’ energy efficiency. Together these measures could reduce

shipping GHG emissions by 180 Mt annually by 2020 (Lloyds Register and DNV, 2011).

Air pollution controls can also have a GHG effect. Given that the main way to reduce

air pollutants from ships is currently through purchasing higher quality fuel (distillate as

opposed to residual fuels), air pollution controls have the effect of raising fuel costs,

thereby creating an incentive to reduce GHG emissions in line with local air pollutants.

Although exhaust filters (scrubbers) are increasingly used in maritime transport, stricter air

pollution controls would also act as an incentive to reduce GHG emissions.

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While no agreement has yet been reached to develop a market-based or other pricing

mechanism for GHG emissions from ships, the IMO is working on the development of

further technical and operational measures. The current focus is on the development of a

global data collection system for GHG emissions from ships, but it is hoped that in the long

term a global market-based measure to address GHG emissions from shipping will be

developed.

Resilience of the modern trade system to climate change

Modern global value chains (GVCs) have become increasingly international, connected

and reliant on domestic policies that are open to international trade and fair to international

investors. Intermediate goods may cross borders many times in their journey from primary

material to finished goods. Expedient movement of goods, machinery and people is

essential to ensure that the global production machine has a sufficient supply of services

and materials to keep it running smoothly.

Recent OECD work on global value chains (OECD, 2013) points out that increasingly

the “just-in-time” nature of value chains makes them quite vulnerable to external shocks.

The OECD defines global shocks as “rapid-onset events with severely disruptive

consequences covering at least two continents” (OECD, 2011). Two recent examples are

highlighted in OECD (2013), where major physical events in one part of the world caused

measurable knock-on effects for global industries. One example, not climate-related, is the

earthquake and tsunami in Japan in 2011, which had considerable knock-on effects on the

global electronics and automotive industries. Another example is flooding in Thailand

in 2012, which at its peak covered areas accounting for 45% of the world’s manufacturing

capacity of computer hard disk drives and led to global disruptions not only in the computer

industry but also the automotive industry (OECD, 2013).

Climate-related events such as flooding and severe storms are likely to intensify due to

climate change, thus increasing the systemic risk inherent in GVCs. Companies are already

responding by complementing “just-in-time” with “just-in-case” contingency plans and

seeking trade-offs between cost minimisation and security of supply. Companies are

seeking to diversify risks geographically and between different suppliers, and there is some

evidence of a trend towards “back-shoring” or “near-shoring” with GVCs being splintered

into shorter chains. The OECD has helped countries understand their vulnerability to

shocks via the TIVA database (OECD et al., 2013), and is helping governments to better

understand GVC risks through the G20-OECD Framework for Disaster Risk Management

and the

OECD Principles for Country Risk Management

(OECD, 2013).

When considering alignment issues in national strategies for climate change adaptation

and resilience, it will be increasingly important to consider how each country’s position and

role in GVCs – and the national policies shaping the participation of firms in those value

chains – could be developed to ensure resilience in the face of increasingly frequent and

severe weather-related shocks.

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Notes

If a policy measure related to climate change mitigation seeks exemption from goods

trade rules as a necessary measure for the low-carbon transition, the measure must

satisfy the content of one of the paragraphs of Article XX. In most environmental

cases this means the measure must be “relating to the conservation of exhaustible

natural resources” or be “necessary to protect human, animal or plant life or health”.

The measure seeking exemption must also satisfy the chapeau of the article – that is,

not to constitute an “arbitrary or unjustifiable discrimination between countries where

the same conditions prevail” or a “disguised restriction on international trade”.

For countervailing duties, the implementing party must demonstrate that “specific”

subsidies were provided that caused “injury” to the domestic complaining industry

before countervailing duties can be imposed. Export subsidies and local content

subsidies – which are generally prohibited – are deemed specific. For all other

subsidies, the subsidy must be shown to be limited to a specific company or industry,

or group of companies or industries. Subsidies that are not prohibited, are not specific

or do not cause injury are permissible under WTO rules.

These include reductions in the level of the duty imposed (not seeking to counter the

full value of the dumping), reducing the scope (e.g. to specific product or import

value) or targeting only companies with a dominant anti-competitive market position

(Wu and Salzman, 2014; Swedish National Board of Trade, 2013).

Progress is being made on a plurilateral basis, In 2013, a group of 23 WTO members

started plurilateral negotiations on a specific Trade in Services Agreement (TISA)

that follows GATS principles and aims to establish commitments between signatories

in areas such as licensing, financial services, telecoms, e-commerce, maritime

transport, and professionals moving abroad temporarily to provide services.

Exceptions do of course exist, such as technologies to convert coal to liquids and for

extracting and refining oil sands, both of which involve higher life-cycle emissions of

GHG than producing petroleum from many conventional wells.

Mode 1, cross-border trade (the supplier is not present in the country in which the

service is supplied); Mode 2, consumption abroad (an individual travels to a foreign

country where the service is supplied); Mode 3, commercial presence (a service is

supplied through a subsidiary established in the host country); Mode 4, movement of

natural persons (an individual travels abroad to supply a service in a host country or

to work as an intra-corporate transfer under Mode 3).

Policies concerning road transport are covered in Chapters 3 and 8.

Domestic flights and shipping routes tend to be treated separately in domestic

policies; these are not covered here.

See, for example, efforts through NextGen in the United States

(www.faa.gov/nextgen) and SESAR in the European Union (www.sesarju.eu).

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OECD

Publishing,

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OECD/ITF, Paris, available at:

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OECD, WTO and UNCTAD (2013), “Implications of global value chains for trade,

investment, development and jobs”, paper prepared for the G20 Leaders Summit, Saint

Petersburg (Russian Federation), September, available at:

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Global-Value-Chains-2013.pdf.

Peters, G.P. et al. (2011), “Constructing an environmentally extended multi-regional input-

output table using the GTAP Database”,

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Vol. 23, No. 2,

pp. 131-152,

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“Green Growth and the New Industrial Revolution”, available at:

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Rubini, L. (2012), “Ain’t wastin’ time no more: Subsidies for renewable energy, the SCM

Agreement, policy space, and law reform”,

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Sauvage, J. (2014), “The stringency of environmental regulations and trade in

environmental goods”,

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No. 2014/03,

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(eds.),

Effective Crisis Response and Openness: Implications for the Trading System,

Centre for Economic Policy Research, London, pp. 249-262.

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considerations”,

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An exploratory analysis”,

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I.6. DIAGNOSING MISALIGNMENTS FOR A MORE RESILIENT FUTURE –

143

Chapter 6

Diagnosing misalignments for

a more resilient future

Climate change increases the risk of severe, pervasive and irreversible impacts such as

species extinctions, threats to food security, changing patterns of weather-related mortality

and rising sea levels. All countries are or will be affected; yet, many are not well adapted to

this new reality. This chapter first reviews misalignments between existing policies and

climate adaptation objectives, such as regulatory barriers in infrastructure financing,

poorly designed planning policies and lack of pricing of natural resources. It then provides

guidance on how countries could better manage the risk linked to climate change.

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– I.6. . DIAGNOSING MISALIGNMENTS FOR A MORE RESILIENT FUTURE

Key messages

Adapting to an already changing climate will also mean addressing policy

misalignments. In the same way the economic fabric and regulatory environment have

been marked by the convenient and pervasive use of fossil fuels, the climate experienced

to date has partly locked societies and ecosystems in patterns that make them vulnerable to

a changing climate. This century could witness a rate and scale of change unprecedented

in human history. All countries will be affected, with the poor and socially marginalised

being the hardest hit.

Misalignments with climate adaptation include: regulatory regimes for infrastructure

that deter investment in resilience; planning policies that encourage development in

vulnerable areas; and under-pricing of natural resources. Although there would be benefits

from addressing these issues in any case, climate change strengthens the urgency of doing

so. Many countries are now developing strategic, national approaches to adaptation to

systematically address these barriers.

Adaptation will not remove all the risks from climate change. Managing the financial

impact of remaining risks is essential for building resilience. There is also a need to ensure

that risk-sharing and risk-transfer arrangements do not exclude the needs of the poor.

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All countries will be affected by climate change

Adaptation has become an increasingly important component of the policy response to

climate change, as the world is now committed to some degree of global warming

irrespective of future emissions. The Intergovernmental Panel on Climate Change (IPCC)

projects increases in global mean surface temperature of between 3.7°C and 4.8°C by 2100

relative to the second half of the 19th century in the absence of strengthened mitigation

policies (IPCC, 2014). This would represent a pace and scale of climate change

unprecedented in human history. The IPCC notes that higher warming increases the risk of

“severe, pervasive and irreversible impacts”. These include species extinctions, threats to

food security, changing patterns of weather-related mortality and rising sea levels.

Yet, in many cases, countries are not well-adapted to current climate variability. This is

illustrated by the toll of weather- and climate-related disasters. Munich RE, a re-insurance

company, estimated that these events led to 19 000 deaths and economic losses of

USD 125 billion in 2013 alone (Munich RE, 2014). In the last ten years, OECD and BRIC

(Brazil, Russian Federation, India and China) countries have experienced an estimated

USD 1.5 trillion in economic damages from disasters including storms or floods (OECD,

2014a). Table 6.1 summarises how each component of these total losses could be affected

by climate change.

All countries will be affected by climate change, but they will not all be affected

equally. Climate risks will depend upon of the extent of climate change, the location of

people and assets, and the extent to which societies and ecosystems are able to adapt to a

changing climate. The scale of the adaptation challenge is largest for developing countries,

where resources and capacity to respond to climate risks are most clearly constrained.

Urbanisation entailing the construction of infrastructure and assets is an integral part of the

development process. However, depending on where they occur, the ensuing concentration

of people and assets in high-risk locations can in some cases ultimately increase

vulnerability to effects of climate change such as flooding (OECD, 2014a).

Figure 6.1.

Economic losses due to disasters in OECD and BRIC countries, 1980-2012

350

300

Annual economic losses in USD billion

250

200

150

100

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source:

OECD (2014b),

OECD Reviews of Risk Management Policies: Boosting Resilience through Innovative

Risk Management,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264209114-en.

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2012

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– I.6. ALIGNING POLICIES FOR A MORE RESILIENT FUTURE

Table 6.1.

Climate change projections of insured losses and/or insurance prices

Region

Europe

Hazard

Insurance line

Winter storm

Homeowners’ insurance

River flood, marine flood,

flash flood from rainfall,

melting snow

Property and business

interruption insurances

Europe, North America

Tropical cyclone

Foremost property

insurance lines

Asia, North America

Hailstorm

Homeowners’ insurance, Europe

agricultural insurances

Storms, pests, diseases

Paddy rice insurance

Asia

Projected changes in future time slices relative to current climate

(spatial distribution and vulnerability of insured values assumed to be unchanged over time)

– Projected increases in mean annual loss ratio (e.g. Belgium, France, Germany, Ireland, Netherlands, Poland and the

United Kingdom) lie in a range of 1-to-2 digit percentages before and around 2050, with larger increases at the end of

the century. In southern Europe (e.g. Portugal and Spain) losses are expected to decrease.

– Today’s 20-year, 10-year and 5-year return periods will for all of Europe be roughly halved by the end of the century.

– Canada: losses from heavy precipitation in property and business interruption insurances in three city areas are

projected to rise by 13% (2016-35), 20% (2046-65) and 30% (2081-00).

– Germany: projected increases in mean annual insured flood loss are 84% (2011-40), 91% (2041-70) and 114%

(2071-00).

– The Netherlands: expected annual property loss caused by increasing river discharge and sea-level rise with an

assumed flood insurance system is projected to lie 125% higher in 2040 relative to 2015 (with a 24 cm sea-level rise)

and by 1 784% higher in 2100 (85 cm sea-level rise).

– Norway: in three counties across southern Norway precipitation and snow melt insurance losses are expected to be

higher by approximately 10-21% and 17-32% at the end of the century.

– United Kingdom: projected increases in mean annual insured flood loss are 8% for a 2°C global mean temperature rise

and 14% for a 4°C rise, with the 1-in-100-year loss higher by 18% and 30%, respectively.

– China: projected increases of insured typhoon losses are 20% (for a 2°C Scenario) and 32% (for a 4°C Scenario), with

the 1-in-100-year loss higher by 7% and 9%, respectively.

–United States: Florida’s hurricane wind insurance is projected to change by –20% to +5% (2020s) and –28% to +10%

(2040s) (under the assumptions of strained reinsurance capacity).

– Germany: projected increases in mean annual loss ratios from homeowners’ insurance due to hail are 15% (2011-40)

and 47% (2041-70).

–The Netherlands: losses from outdoor farming insurance and greenhouse horticulture insurance are projected to increase

by 25-29% and 116-134%, respectively, in a 1°C Scenario. For a 2°C Scenario, projected increases are 49-58% and

219- 269%, respectively.

– Japan: paddy rice insurance payouts are projected to decrease by 13% by the 2070s, on the basis of changes in

standard yield and yield loss.

Source:

Adapted from IPCC (2014),

Climate Change 2014: Impacts, Adaptation, and Vulnerability,

Contribution of Working Group II to the Fifth Assessment Report of the

Intergovernmental Panel on Climate Change, Field, C.B. et al. (eds.), Cambridge University Press, Cambridge, United Kingdom and New York, New York, United States.

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OECD countries have much higher inherent adaptive capacity, but the consequences of

extreme weather events have illustrated that they remain vulnerable. Long-time horizons

and diffuse responsibility can prevent the allocation of finance and capacity development

required to manage climate risk (Mullan et al., 2013). This is a particular issue at the local

level, where responsibility for implementing adaptation actions frequently lies.

Furthermore, in an interconnected world the effects of climate change do not stop at

national borders: knock-on effects can be felt though trade links, financial markets and

movements of people (OECD, 2011; 2014b).

Conversely, international links also represent an opportunity. Diversification of supply

chains can aid systemic robustness to localised shocks. The transfer of ideas and innovation

policy can help with the development and diffusion of climate-resilient technologies.

International co-operation will be essential for overcoming the effects of climate change.

Official development assistance (ODA) and other forms of development co-operation have

increasingly mainstreamed climate change adaptation across their portfolios, although gaps

remain.

Uncertainty represents an overarching challenge for an effective adaptation to climate

change. There is reasonable confidence in likely global average temperature increases, but

much less certainty about how precipitation patterns and intensity will change regionally,

and about the incidence and severity of extreme weather events. This uncertainty about the

climate is compounded with uncertainty about where, when and how climate events will

affect economic, social and environmental systems. The greater the degree of climate

change, the higher the probability of tipping points with potentially severe economic and

social consequences.

Box 6.1.

Definitions of key terms

Climate resilience

is the capacity of individuals and social, economic or environmental

systems to absorb and recover from climate-induced shocks, while adapting and transforming

their structures and means of living in the face of long-term stresses, change and uncertainty

(Mitchell, 2013; UNISDR, 2013).

Adaptation

is “the process of adjustment to actual or expected climate and its effects to

moderate harm or exploit beneficial opportunities” (IPCC, 2012).

Risks

are “the potential for consequences due to climate change where something of value is

at stake and where the outcome is uncertain, recogni[s]ing the diversity of values. Risk is often

represented as probability of occurrence of hazardous events or trends multiplied by the impacts

if these events or trends occur” (IPCC, 2014).

Disaster risk management

is the systematic process of using administrative directives,

organisations and operational skills and capacities to lessen the adverse impacts of hazards and

the possibility of disaster. It involves activities and measures for prevention, mitigation and

preparedness (UNISDR, 2009).

Source:

Adapted from OECD (2014a),

Climate Resilience in Development Planning: Experiences in

Colombia and Ethiopia,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264209503-en.

Building resilience to climate impacts

Mitigation policies are primarily designed to solve a single market failure: the negative

externality of greenhouse gas (GHG) emissions. The issue is more complex for building

resilience to climate change, where there is no single metric or outcome to target. People

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– I.6. ALIGNING POLICIES FOR A MORE RESILIENT FUTURE

and ecosystems will inevitably respond to a changing climate, but the form that this

response takes will be affected by institutions, infrastructure and the information that they

are faced with. Market failures, physical and cultural constraints, and policy misalignments

can all act as barriers to efficient and equitable adaptation. Governments have an important

role to play in overcoming these barriers to private sector adaptation, while also ensuring

that public sector actions contribute to resilience (Cimato and Mullan, 2011).

Government action to facilitate adaptation can take a wide variety of forms, including

providing information, strategic planning, regulatory and fiscal measures (de Bruin et al.,

2009). However, broadly speaking, two policy areas will be crucial for adaptation: reducing

risks and managing those that remain. These two policy areas are closely interconnected in

practice. For example, the availability of insurance (a mechanism for managing residual

risks) can affect people’s incentives to reduce risks, while the extent of risk reduction

affects the affordability of insurance (G20/OECD, 2012). Risk reduction measures (such as

protective infrastructure) can provide protection from recurrent events and reduce insurance

costs, while the cost efficiency of insurance tends to improve with decreasing frequency

(OECD, 2014b).

Countries are increasingly taking action to systematically bring together risk reduction

and improve their risk financing in the face of climate change. For example, national

adaptation plans or strategies have been developed in 23 out of 34 OECD countries (OECD,

2015). Other countries are implementing strategic national approaches without developing

specific plans. Meanwhile, 50 least developed countries laid the foundation for a co-

ordinated approach to adaptation through the development of national adaptation plans of

action. Following the Cancun agreement in 2011, developing countries are being supported

to develop national, strategic approaches to climate change.

Risk reduction

Climate change will result in a diverse and extensive range of risks, and the scope of

measures to reduce those risks is correspondingly broad. As well as “hard” infrastructure

measures, such as the construction of coastal and flood defences, “soft” measures are also

necessary to manage risks (de Bruin et al., 2009). These measures include information

provision, regulatory reforms and institutional capacity building. Even though there can be

direct benefits to the people implementing these measures, market failures and policy

misalignments can prevent them from being implemented. Table 6.2 illustrates the range of

potential impacts of climate change and their corresponding risk reduction measures.

Only a small set of policies are solely motivated by the desire to adapt to climate

change: these tend to focus on institutional reforms and the provision of evidence of climate

risks (Mullan et al., 2013). The implementation of specific adaptation responses is

increasingly being mainstreamed, i.e. systematically integrated into the policy development

process (de Bruin et al., 2009; OECD, 2015). This enables climate risk to be considered in

concert with other trends, facilitating a co-ordinated and effective response.

Although the concept of mainstreaming risk reduction is straightforward,

implementation remains at an early stage in many areas (OECD, 2015). Examples of areas

where reforms may be needed are discussed in more detail in the thematic chapters, but

examples include:

•

planning policies that encourage, or implicitly subsidise, development in high-risk areas

water management plans that fail to consider the potential for ecosystem-based

approaches to water supply and flood risk management

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I.6. ALIGNING POLICIES FOR A MORE RESILIENT FUTURE –

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•

infrastructure regulations that can lead to underinvestment in resilience.

Table 6.2.

A range of potential climate risks and response measures

Sector

Agriculture

Examples of risks

– Reduced crop yields/quality

– Heat stress

Risk reduction measures

– Alter crop species

– Alter timing

– Irrigation

– Plant breeding

– Relocate vulnerable infrastructure

– Sea wall construction

– Beach enrichment

– Invest in water efficiency

– Divert/store more water

– Flood zoning

– Prepare for extreme weather

– Control disease carriers

– Increase surveillance of infectious diseases

– New cooling capacity

– Changes in insulation

– New building codes

Coastal areas

– Damage to infrastructure and buildings

from sea-level rise

– Drought

– Ecological damage

– Flooding

– Reduction in winter mortality/increase in

summer mortality

– Changing incidence of disease

– Changing patterns of demand

– Supply disruption

Water

Health

Energy

Source:

Adapted from de Bruin, K. et al. (2009), “Economic aspects of adaptation to climate change: Integrated

assessment modelling of adaptation costs and benefits”,

OECD Environment Working Papers,

No. 6, OECD

Publishing, Paris,

http://dx.doi.org/10.1787/225282538105.

As is the case with GHG emissions for mitigation, mispricing of natural resources and

subsidies can distort market adaptations. For example, they can soften the incentive for

farmers to adjust practices, or encourage the use of inputs (such as freshwater) that may

become scarcer in the future.

In many cases, policies to address existing challenges can also support longer term

resilience, for example by increasing the efficiency of water use by households. More

generally, and given uncertainties over climate impacts, OECD guidance recommends that

policy be designed to achieve flexibility, give rise to co-benefits or perform well under a

wide range of possible climate outcomes (OECD, 2013; Agrawala and Fankhauser, 2008).

Managing residual risks

It is not cost-effective, nor feasible, to reduce the risks from climate change to zero. The

management of the risks that remain after risk reduction measures is crucial for building

climate resilience. Some risks will have to be accepted, while others can benefit from

financial management. The G20/OECD methodological framework,

Disaster Risk

Assessment and Risk Financing

(2012) framework publication on risk assessment and risk

financing identifies how the financial management of residual risks can be improved.

Adverse climate shocks have direct impacts on households and businesses, but the effects

are also felt by national governments and throughout the financial system. Putting measures

in place

ex ante

can increase efficiency, provide clarity of incentives and help to dampen

the effects of negative shocks. These efforts can be implemented domestically or through

international co-operation. Table 6.3 summarises the available tools for

ex ante

risk

financing and lists the

ex post

responses that would have to be used to address impacts

where

ex ante

measures are unavailable or insufficient. In countries with under-developed

financial systems, these

ex post

responses can magnify the negative impact of negative

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– I.6. ALIGNING POLICIES FOR A MORE RESILIENT FUTURE

shocks. For example, the forced sale of livestock in the face of drought will erode

households’ future earnings potential.

Table 6.3.

Summary of risk management, risk pooling and risk transfer approaches

Level of risk transfer

National

Ex ante

measures

– Insurance pools

– Contingent credit

– Catastrophe bonds

– Diversification

– Capital reserves

– Re-insurance

– Transferring risks to capital markets through

securitisation

– Savings and credit

– Informal risk sharing

– Micro-insurance

Ex post

responses

– Budget reallocation

– Debt financing or borrowing

– Humanitarian relief

– Insolvency/bail-out

– Reduction in credit

Domestic financial

institution

Household

– Selling productive assets

– Reducing food consumption

– Borrowing money (often at very high interest rates)

– Migrating

– Taking on additional work

Source:

Revised from G20/OECD (2012), “Disaster risk assessment and risk financing: A G20/OECD

methodological framework”, OECD, Paris, available at:

www.oecd.org/gov/risk/G20disasterriskmanagement.pdf.

Policies towards risk financing and insurance are not always conducive to strengthening

resilience, however. Common challenges include:

•

an inability of traditional mechanisms to reach the poorest and most vulnerable

lack of incentives to reduce risk – e.g. premiums not linked to exposure

unclear and

ad hoc

policies regarding the possibility of

ex post

indemnification.

As an example, experience with the US National Flood Insurance Program, in which

reforms to encourage risk reduction ended up being reversed due to political opposition,

illustrates the barriers to reform even if the defects of current arrangements are well

understood (Box 6.2).

There will be consequences of climate change that remain after the implementation of

risk-reduction and risk-transfer measures. The consequences of these residual impacts will

depend upon underlying determinants of resilience such as gross domestic product (GDP)

per capita, quality of institutions and social cohesion.

Economic resilience has historically been strong for OECD countries, but this could

change as the scale of losses increase. In contrast, negative climate shocks in developing

countries can have lasting negative impacts on growth and poverty (OECD, 2014a).

Additional challenges include:

•

impacts on some local and regional economies will be more pronounced than at the

national level, particularly where there is a lack of risk-sharing between levels of

government

the effects of impacts could spread out in unpredictable ways due to global value chains,

e.g. the Bangkok flooding in 2011

if extreme weather events become more severe or frequent, historical experience may not

hold in the future.

•

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Box 6.2.

Reform of the US National Flood Insurance Program

The US National Flood Insurance Program (NFIP) was created in 1968 to help property

owners to financially protect themselves against floods associated with hurricanes, tropical

storms, heavy rains and other climate events. Participation in the programme is mandatory for all

properties with mortgages from federally regulated or insured lenders located in high flood-risk

areas (defined as a one-in-four chance of flooding during a 30-year mortgage). Participation is

not required for properties in moderate- to low-risk areas, but they account for nearly 25% of

flood insurance claims and one-third of Federal Disaster Assistance for flooding.

A 2010 report from the Government Accountability Office identified a number of design

features that constrain the fiscal soundness of the programme and impede the efficient

management of flood risk. They include: statutory limits on rate increases, the inability to reject

high-risk applicants, the mismatch between NFIP premiums and the real flood risks for almost a

quarter of property owners, the use of “grandfathered” rates for some properties not taking into

account reassessments of flood risk, and the inability of the programme to deny coverage to

repetitive loss properties accounting for 25-30% of insurance claims while only making up 1%

of policies. It is estimated that a series of disasters including Hurricanes Sandy and Katrina have

contributed to a negative balance of close to USD 24 billion.

To address these challenges, in 2012 the US Congress passed the Biggert-Waters Flood

Insurance Reform Act (BW-12). The objective of the reform was to target the fiscal soundness

of the programme, promote more efficient risk management and assess future changes to flood

risk based on the best available scientific evidence. This resulted in annual premium rate

increases for policy holders of up to 20% (twice the previous limit) based on calculations of an

“average historical loss year”, including catastrophic loss years. Subsidies were also phased out

for a number of properties, severe repetitive loss properties in particular. Further, flood insurance

rate maps were updated to include,

inter alia,

data and information on changes in sea levels,

precipitation and hurricane intensity.

Political opposition against BW-12 ultimately led to the passage of the Homeowner Flood

Insurance Affordability Act in March 2014, which repeals and modifies certain provisions of

BW-12. For example, instead of an immediate premium increase to full-risk rates, the

Affordability Act requires (with a few exceptions) that the increase be gradual, but no less than

5% and no more than 18% annually. Further, the act reinstates the use of “grandfathered” rates

that enable policy holders of new properties to benefit the first year from premium rates offered

to properties located outside the Special Hazard Area. Policy holders in high-risk areas required

to pay their full-risk rate under BW-12 are also entitled to refunds, while policy holders that face

an 18% premium increase may be entitled to refunds. Despite these amendments, the objective

of the Affordability Act is to make the NFIP self-sufficient by gradually moving towards

actuarial rates. All policies for primary residences will also be subjected to a USD 25 surcharge,

while all other policies include a USD 250 surcharge.

Sources:

GAO (2010),

National Flood Insurance Program. Continued Actions Needed to Address

Financial and Operational Issues, Testimony Before the Subcommittee on Housing and Community

Opportunity, Committee on Financial Services,

House of Representatives, United States Government

Accountability Office, Washington, DC; FEMA (2014), Homeowner Flood Insurance Affordability Act,

US Federal Emergency Management Agency, Washington, DC; OECD (2013),

Water and Climate Change

Adaptation: Policies to Navigate Uncharted Waters,

OECD Studies on Water, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264200449-en.

Social resilience (the resilience of people and communities), is less easily quantified,

but is also a challenge for all countries. Part of the difficulty is that many social impacts

cannot be readily transferred or shared, so there is no intermediate layer between resilience

and risk reduction – e.g. the mental health impacts of flooding, injuries and deaths from

heat waves. These are also harder to quantify, but the impacts can be significant, including

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– I.6. ALIGNING POLICIES FOR A MORE RESILIENT FUTURE

an erosion of trust in government, looting and anti-social behaviour. The trend changes

caused by climate change, such as loss of ecosystem services due to shifting climatic zones,

may also weaken resilience, and the effects of this will be felt when extreme events occur.

Addressing the pervasive policy misalignments affecting adaptation is an essential step

for building resilience. Substantive progress has been made in areas with clear

accountabilities and visible costs of maintaining the status quo, e.g. management of flood

risks (OECD, 2013). However, as the reforms to the US flood insurance programme have

demonstrated, even in these areas the political economy can be challenging. The situation is

more difficult where misalignments cross sectoral boundaries or are likely to arise mainly

in the longer term, such as development in vulnerable areas. In addressing these areas,

strategic approaches to adaptation (e.g. the development of national adaptation plans) can

help to identify where there is the greatest need for reform. To be effective, these should be

accompanied by the development of robust mechanisms to monitor and assess progress in

building resilience, though most countries are at an early stage in defining and measuring

success (OECD, 2015).

References

Agrawala, S. and S. Fankhauser (eds.) (2008),

Economic Aspects of Adaptation to Climate

Change: Costs, Benefits and Policy Instruments,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264046214-en.

Cimato, F. and M. Mullan (2011), “The role of government in adapting to climate change”,

Defra Economics Working Paper 1,

Department of Environment, Food and Rural

Affairs, London.

de Bruin, K. et al. (2009), “Economic aspects of adaptation to climate change: Integrated

assessment modelling of adaptation costs and benefits”,

OECD Environment Working

Papers,

No. 6, OECD Publishing, Paris,

http://dx.doi.org/10.1787/225282538105.

FEMA (2014),

Homeowner Flood Insurance Affordability Act,

US Federal Emergency

Management Agency, Washington, DC.

G20/OECD (2012), “Disaster risk assessment and risk financing: A G20/OECD

methodological

framework”,

OECD,

Paris,

available

at:

www.oecd.org/gov/risk/G20disasterriskmanagement.pdf.

GAO (2010),

National Flood Insurance Program. Continued Actions Needed to Address

Financial and Operational Issues,

Testimony Before the Subcommittee on Housing and

Community Opportunity, Committee on Financial Services, House of Representatives,

United States Government Accountability Office, Washington, DC.

IPCC (2014),

Climate Change 2014: Synthesis Report,

Intergovernmental Panel on Climate

Change,

available

at:

www.ipcc.ch/pdf/assessment-

report/ar5/syr/SYR_AR5_FINAL_full.pdf.

IPCC (2012), “Summary for policymakers”, in: Field, C.B. et al. (eds.),

Managing the Risks

of Extreme Events and Disasters to Advance Climate Change Adaptation,

A Special

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Report of Working Groups I and II of the Intergovernmental Panel on Climate Change,

Cambridge University Press, Cambridge, United Kingdom and New York, New York,

United States, pp. 1-19.

Mechler, R. et al. (2014), “Managing unnatural disaster risk from climate extremes”,

Nature

Climate

Change,

Vol.

No.

pp.

235-237,

April,

www.nature.com/nclimate/journal/v4/n4/full/nclimate2137.html.

Mitchell, A. (2013), “Risk and resilience: From good idea to good practice”,

OECD

Development Co-operation Working Papers,

No. 13, OECD Publishing, Paris,

http://dx.doi.org/10.1787/5k3ttg4cxcbp-en.

Mullan, M. et al. (2013), “National adaptation planning: Lessons from OECD countries”,

OECD Environment Working Papers,

No. 54, OECD Publishing, Paris,

http://dx.doi.org/10.1787/5k483jpfpsq1-en.

Munich

(2014),

Loss

Events

Worldwide

2013,

NatCatSERVICE,

www.munichre.com/site/touch-

naturalhazards/get/documents_E1193185391/mr/assetpool.shared/Documents/5_Touch/

Natural%20Hazards/NatCatService/Annual%20Statistics/2013/MunichRe-

Natcatservice-Naturaldisaster2013-Perc-Distrib-Event-by-Type.pdf

OECD (2015),

Economics of Adaptation,

OECD Publishing, Paris, forthcoming.

OECD (2014a),

Climate Resilience in Development Planning: Experiences in Colombia

and Ethiopia,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264209503-en.

OECD (2014b),

OECD Reviews of Risk Management Policies: Boosting Resilience through

Innovative

Risk

Governance,

OECD

Publishing,

Paris,

http://dx.doi.org/10.1787/9789264209114-en.

OECD (2013),

Water and Climate Change Adaptation: Policies to Navigate Uncharted

Waters,

OECD

Studies

Water,

OECD

Publishing,

Paris,

http://dx.doi.org/10.1787/9789264200449-en.

OECD (2011),

Towards Green Growth,

OECD Green Growth Studies, OECD Publishing,

Paris,

http://dx.doi.org/10.1787/9789264111318-en.

OECD (2008),

Economic Aspects of Adaptation to Climate Change: Costs, Benefits and

Policy Instruments,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264046214-

en.

UNISDR (2013),

From Shared Risk to Shared Value: The Business Case for Disaster Risk

Reduction,

United Nations Global Assessment Report on Disaster Risk Reduction,

United Nations Office for Disaster Risk Reduction, Geneva, available at:

www.unisdr.org/we/inform/publications/33013.

UNISDR (2009),

2009 UNISDR Terminology on Disaster Risk Reduction,

United Nations

Office

for

Disaster

Risk

Reduction,

Geneva,

available

at:

www.unisdr.org/we/inform/publications/7817.

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PART II: ALIGNING POLICIES IN SPECIFIC ACTIVITIES –

155

Part II

Aligning policies in specific activities

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Chapter 7

Reframing investment signals

and incentives in electricity

Electricity generation and uses are critical to the decarbonisation of energy systems. In

some countries, power generators compete on wholesale electricity markets that optimise

the near-term power supply. This chapter describes how such design may limit the market’s

ability to guide future low-carbon investments, including in presence of a price on CO

New arrangements are needed to lock-in investment in capital-intensive low-carbon

technologies, while reflecting their specific costs and benefits for electricity system. The

incentives in regulated electricity systems are also not always aligned with the

decarbonisation of power generation. Beyond generation, there are examples of regulatory

barriers that could be addressed to facilitate climate-friendly innovations, such as demand-

side response and electricity storage. The chapter also touches on the impacts of climate

change on energy systems.

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– II.7. REFRAMING INVESTMENT SIGNALS AND INCENTIVES IN ELECTRICITY

Key messages

Electricity, an increasingly widespread and convenient energy carrier, is essential to the

decarbonisation of the energy sector and of the economy as a whole. It can substitute for fossil

fuels in many end-uses. Low-carbon substitutes are also available in generation, although

national endowments and technology choices mean that not all options are available in all

countries. Global CO

emissions from electricity (and heat) still account for 25% of total

greenhouse gases (GHGs) and are on the rise.

The regulatory framework for electricity systems is critical, as it eventually determines the

investment context, cost and reliability of the system. The question is whether current regulatory

frameworks and markets can adequately reflect the CO

constraint in investment and operational

decisions.

Should electricity market design be revamped for the low-carbon transition?

Current

designs of wholesale electricity markets in many OECD countries are not strategically aligned

with the low-carbon transition. They do not deliver the long-term price signal that investment in

high capital cost, low-carbon technologies such as hydro-electricity, nuclear power, wind

turbines, solar technologies and geothermal installations or fossil fuelled-plants fitted with

carbon capture and storage (CCS) would require.

A standard energy-only wholesale electricity market would require a high CO

price, periods

of very high electricity prices and risks of rolling brown-outs before investors would unlock

financing in low-carbon technologies. The associated risks would lead to higher capital costs and

higher-than-necessary electricity costs. The result would be ongoing investment in CO

-emitting

generation.

Ensuring competitive and timely investment in low-carbon capacity and competition in

electricity supply among existing plants requires new market arrangements as well as a robust

price. At present no general model exists, but options are being tested in OECD and

non-OECD countries.

Low-carbon technologies play different roles in electricity systems. Hydropower and nuclear

plants, biomass-fuelled plants and CCS-fitted plants are dispatchable – i.e. can generate when

required. Variable sources such as wind and solar PV are not fully dispatchable. More flexible

power systems are thus needed for a high penetration of variable sources. The costs of system

transformation vary widely in different countries and should be allocated fairly and transparently

to avoid distortions.

Potential misalignments also exist which prevent a broader engagement of the demand side

of electricity markets and the deployment of storage. Both constitute areas of dynamic

development and could enhance the flexibility of electricity systems in the future.

Will regulated systems do better in the transition?

Regulated electricity systems (e.g. with

no liberalised market structure) also face challenges such as fair grid and market access for new

low-carbon sources and their adequate remuneration. Further, the experience of decarbonisation

in wholesale electricity markets should provide useful lessons for governments seeking to

introduce competition in regulated electricity systems. The adoption cost of low-carbon

technologies will be strongly influenced by the nature of contracts awarded through competition.

Are policies helping the resilience of the energy sector?

Energy systems and infrastructures

are exposed to extreme weather events as well as gradual changes driven by climate change.

This is a serious consideration for fossil-fuelled and low-carbon power plants. Energy

companies, users and policy makers are only starting to explore the policy aspects of climate

impacts.

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Electricity in decarbonisation

The energy path to decarbonisation

The latest energy and climate scenarios of the International Energy Agency (IEA) give

several indications on the features of global energy supply and demand apt to respond to

climate change (IEA, 2014a). Two major differences in the global energy picture in 2050

appear when comparing a business-as-usual scenario – a 6°C Scenario (6DS) – with a

scenario compatible with the 2°C goal (2DS):

•

A much more efficient use of energy: the same energy services (i.e. mobility, heat and all

the specific uses of electricity) would be provided with 27% less primary energy.

A reduced share of fossil fuels in primary energy supply, with biomass and waste, hydro-

electricity, nuclear power and other renewables accounting for roughly 60% of the total.

In volume, non-fossil energy would nearly quadruple between 2011 and 2050.

As presented in Chapter 1, putting the energy system on a path consistent with the 2°C

objective requires a combination of the core climate policy instruments mentioned earlier: a

growing price on CO

emissions, targeted measures to improve energy efficiency and

support measures for the deployment of low-carbon technologies. Alternative scenarios

were also run by the IEA assuming a higher penetration of renewables (making up for

lower contributions from nuclear power and carbon capture and storage, or CCS), a higher

electrification of transport and a higher penetration of electricity in end-uses in buildings.

The central role of electricity in decarbonisation

A view of a decarbonised electricity system in 2050

Electricity is called on to play a prominent role in the global decarbonisation of energy,

as shown in Figures 7.1 and 7.2. This phenomenon would be common to all world

regions,

1,2

with several trends at play in this particular scenario (IEA, 2014a):

•

On the supply side, fossil-based thermal plants become more efficient; an important share

of the remaining capacity using fossil fuels is fitted with CCS, removing CO

from

plants’ emissions. Renewable supply (based on biomass, hydro, wind, sun, geothermal

heat) accounts for 65% of electricity supply by 2050, against 20% today. With the

contributions of nuclear and CCS-equipped plants, low-carbon technologies produce 94%

of global electricity demand in this scenario (this is a global aggregate picture; national

endowments and technology choices mean that not all options are available in all

countries).

On the demand side, electricity-using appliances and equipment become more efficient.

Some of the other end-uses switch from fossil fuel to electricity use (e.g. transport, with

plug-in hybrids or electric vehicles with a lower CO

content than conventional vehicles

as electricity gets decarbonised).

The annual electricity demand in the IEA’s 2°C-compatible scenario is projected to grow

at three times the rate of total demand over the period 2011-50: by 2050, electricity

becomes the largest energy carrier, ahead of oil products, with more than 25% of the total

final energy use, against 18% today (IEA, 2014a).

•

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– II.7. REFRAMING INVESTMENT SIGNALS AND INCENTIVES IN ELECTRICITY

Figure 7.1.

Contributions to annual emissions reductions between a 6°C and a 2°C Scenario

Renewables 30%

Power generation efficiency and fuel switching 1%

End-use fuel and electricity efficiency 38%

Carbon capture and storage (CCS) 13%

End-use fuel switching 10%

Nuclear 8%

GtCO

2012

2020

2030

2040

2050

Source:

IEA (2015a),

Energy Technology

http://dx.doi.org/10.1787/energy_tech-2015-en.

Perspectives

2015,

OECD

Publishing,

Paris,

Electricity therefore appears to be a driver of the low-carbon transition in the energy

sector. Its expected role can be explained by: 1) electricity’s credible aspiration to zero

GHG emissions on the basis of existing technologies; 2) a strong government oversight of

this activity; 3) the high value of electricity-related services to society, which may facilitate

the acceptability of price increases. Other activities are also crucial for the low-carbon

transition of the energy sector, such as mobility (see Chapter 8), industry and buildings.

Heat is also an important energy carrier for the transition, including the potential it

represents for energy efficiency improvements. Much of the energy used globally is still

wasted in the form of heat, e.g. in thermal power generation but also in industrial uses; heat

could also play a role in energy storage (IEA, 2014b). However, electricity presents an

already visible strategic misalignment between regulatory frameworks in certain regions

and their climate policy objectives.

Electricity is also an important source of human and economic progress through the

many services it provides: lighting, refrigeration, water pumping, the operation of

machinery, etc. as emphasised by the Sustainable Energy for All programme (SE4ALL,

2015). Giving access to this and other modern forms of energy is essential to bring people

out of poverty and trigger development. Many solutions today are provided in a

decentralised fashion (solar lamps, photovoltaic installations, etc.) but the urbanisation

trend in developing countries hints at the growing role of centralised power systems in the

future. Front-running regions and jurisdictions will set important examples if they can

effectively trigger the required low-carbon generation investment.

How low-carbon technologies challenge the organisation of competition in

electricity

The decarbonised electricity system in 2050 will depart from that of the 20th century.

Recent trends and projections from the IEA and others indicate a growing share of variable

renewable energy (VRE) i.e. based on solar and wind technologies, combined with so-

called dispatchable, low-carbon sources (hydro-electricity, nuclear power, geothermal,

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161

biomass-fuelled thermal plants or storage) and, for some years to come, some fossil fuel

capacity. While VRE technologies will not be alone in driving the decarbonisation of

electricity systems, the fact that their supply varies and cannot be programmed puts some

strain on electricity systems and markets, and demands in particular a more flexible and

integrated system.

Another important feature of today’s low-carbon generation

technologies is their higher capital cost; these technologies, with the exception of biomass-

fuelled and CCS plants, also have lower operational expenditures than fossil fuel generation

technologies (standard coal, oil or gas plants).

Figure 7.2.

Electricity generation by technology and CO

intensity

in the 450 Scenario, 1990-2035

OECD

China

Other non-OECD

1.2

1.0

0.8

0.6

0.4

0.2

2010

2030

1990

2010

Renewables

Nuclear

2030

1990

2010

2030

Thosuand TWh

1990

Fossil-fuel plants fitted with CCS

Fossil-fuel plants without CCS

CO2 electricity emission intensity

(right axis)

Note:

CCS: carbon capture and storage.

Source:

IEA (2014c),

World Energy Investment Outlook,

Special Report, OECD/IEA, Paris, available at:

www.iea.org/publications/freepublications/publication/WEIO2014.pdf.

Today’s markets and organisations of electricity systems may not be appropriate to

drive an effective and least-cost transition toward a low-carbon electricity system. In

particular, there may be a strategic conflict between the prevailing approach to electricity

market liberalisation and CO

emissions reductions.

Under deregulated wholesale markets, the price is set by the variable cost of the

marginal plant, i.e. the most expensive running plant mobilised to meet the full demand.

With a market dominated by fossil fuel technologies with high variable costs and low fixed

costs (such as gas turbines), new investments in baseload efficient plants benefited from

higher electricity prices set by older, less efficient technologies. This has worked for new

investment in baseload technologies, but to unlock future investment in plants that run

fewer hours in the year, the system needs to experience periods with very high prices

during scarcity hours.

However, a deregulated market left to its own devices will be unable to finance

investments in low-carbon technologies with high fixed costs, which require long-term

stability of electricity prices (see Keppler and Cometto, 2015). The price to pay would be

very high carbon taxes and volatile prices with a substantial number of scarcity hours and

price uncertainty, leading to higher-than-otherwise financing costs. Of course, core climate

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policies must step in to encourage low-carbon technologies, through market push (lowering

technology costs) and pull (an increasing price on CO

). In the medium to long term, the

question is what kind of market-based electricity system could guide the decarbonisation of

the electricity system on the basis of a CO

price signal, as opposed to

ad hoc

support

measures in use today. The question is a useful starting point to identify misalignments in

electricity system arrangements that could challenge the decarbonisation objective.

How is low-carbon electricity supported today?

The ultimate target is to create conditions for market-based investments

in low-carbon generation. (IEA, 2014a: 289)

In recent years, the decarbonisation agenda, combined with import dependency,

diversity of supply and air quality concerns and innovation policy, have encouraged

governments to support rapid deployment of low-carbon technologies. Wind plants and

photovoltaic (PV) panels were the principal beneficiaries of out-of-market mechanisms

such as feed-in-tariffs (FiT; a fixed price paid by rate-payers for the electric output of

renewable installations, combined with priority access to the grid), or tax credits for

investment in renewable energy capacity (i.e. a capital subsidy). Combined with a stagnant

or declining electricity demand in Europe and the United States, the growth in renewable

energy supply has led to the stranding of some conventional power plant capacity (IEA,

2014c).

Feed-in-tariffs have also been criticised on cost grounds and adjusted downward.

This government-induced policy uncertainty has had detrimental impacts on investment

(Baron, 2013). Governments have since introduced new instruments to better control costs

and encourage a growing integration of variable renewables in electricity markets. On the

upside, renewable support measures have triggered a noticeable change “from the classical

electricity utility paradigm to a much less concentrated industry widely composed of highly

speciali[s]ed firms” (Benatia, 2014).

The growing contribution of variable renewable energy requires a sufficiently flexible

electricity system to accommodate these sources without jeopardising security of supply. In

time, this means mechanisms providing for investment in flexible generation sources,

demand-side management and response, and in grid management and interconnection, as

well as in electricity storage, which could offer an important breakthrough.

Without out-of-market arrangements, which can include FiTs or long-term power

purchase agreements (both of which may or may not include a subsidy element, i.e. a tariff

higher than average costs), electricity markets today may only generate the following low-

carbon investments: life-extension of nuclear or hydro-electric plants, and the conversion of

a coal plant to biomass.

One can point to examples such as unsubsidised onshore and

offshore wind farms and geothermal plants in New Zealand, but they correspond to

exceptional resource conditions – including the absence of thermal fuel input in that

country. Otherwise, investments in renewable, but also in nuclear capacity, are based on

mechanisms that provide long-term income security in the form of a power purchase

agreement, and not just through the operation of the wholesale market.

Mature market-based system vs. fast-growing “regulated” systems

The need for a rethinking of electricity market arrangements to facilitate a least-cost

decarbonisation of electricity systems is elaborated in the following sections. The electricity

market liberalisation initiated in the late 1980s has mostly occurred in some, but not all,

OECD jurisdictions. These countries have also implemented very different policy

instruments to engage the low-carbon transition of the electricity sector, ranging from the

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European Union’s Emission Trading System (EU ETS) combined with renewable energy to

the regulation of GHG emissions from power plants in the United States.

In fact, much of the investment in electricity worldwide is undertaken by vertically

integrated utilities or under regulatory arrangements that do not rely on wholesale

electricity markets. For this analysis, a distinction is drawn between mature, market-based

systems (most of the OECD) which sometimes face urgent investment needs to renew

capacity, and fast-growing “regulated” systems whose primary challenge is to match a

rapidly increasing demand for electricity.

How today’s market structures risk hindering the decarbonisation of electricity

Diagnosing misalignment in regulatory arrangements

Market liberalisation – A brief history

While vertically integrated utilities still play an important role in some OECD

countries, many adopted market approaches in the early 1990s, generally involving the

unbundling of generation, transmission and distribution, and the opening up of competition,

with the creation of wholesale electricity markets (sometimes called “energy-only”

markets).

This competition benefited in part from the emergence of a new, flexible and more

energy efficient technology: the combined cycle gas turbine (CCGT), with a low cost of

capital and a smaller size than incumbents such as coal, nuclear power or hydro-electric

plants.

Overall, liberalisation has improved the economic efficiency of the power generation,

transmission and distribution sectors, even if competition is not as broad in the retail market

as anticipated when reforms began. Wholesale electricity markets, however, have become

critical in ensuring a flexible supply of electricity, in tandem with transmission system

operators that manage the main electric trunks. These ensure that electricity is supplied at

the lowest cost possible, as plants compete on the basis of their marginal cost of generation.

Deregulated wholesale electricity markets are designed to optimise short-run dispatch. They

allow maximising the use of existing assets and reducing overcapacity, which was one of

the motivations behind liberalisation in the 1990s. They have, however, not been properly

designed to ensure adequate investment in generation in order to ensure security of supply,

especially in a context of uncertainties on climate policy. In the EU, the carbon price has

not been enough to curtail investments in thermal fossil-fuelled power generation or to

bring forward investment in low-carbon generation without government support of some

sort.

The misalignment of wholesale electricity markets with decarbonisation

Regarding the long-term decarbonisation target by 2050, Energy Technology

Perspectives scenarios envision a share of zero or low marginal cost electricity of

more than 80%. The current design of wholesale electricity markets might not

provide the signals needed to trigger such investments. (IEA, 2014a)

Core climate policy instruments are critical to move power generation in the right

direction. However, the cost of doing so may be significantly higher unless the

underpinning market arrangements are aligned to reflect the nature of low-carbon

technologies and their impact on electricity systems.

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Wholesale electricity markets as we know them today no longer provide an adequate

signal to investors in new capacity. This is generally referred to as the problem of “missing

money”, historically due to restrictions on electricity prices and well-known to electricity

market policy analysts (see Finon, 2013; Baritaud, 2012):

•

Pricing electricity on the basis of the variable cost of a marginal power plant does not

guarantee the full recovery of capital costs for all power plants.

Allowing prices to reach very high levels when capacity is scarce is a possible way to

recover capital costs, but these episodes may be too few and uncertain to trigger

investment in new capacity (IEA, 2014e).

By definition, during such episodes of

scarcity, demand may not be fully met. In the absence of sufficient availability of flexible

demand response, this will lead to politically and socially unpopular rolling brown-outs.

At present, some governments seem keen to avoid such situations by preventing the

closure of otherwise unprofitable plants (an arrangement referred to as “strategic

reserves”).

The missing money problem is greatly exacerbated by the profile of leading

technologies for the decarbonisation of electricity: their higher capital-to-operations cost

ratio than today’s fossil-fuelled plants. Further, there are decreasing returns in the

deployment of VRE plants, as they often operate at the same time (when the wind blows

and the sun shines). Since they carry essentially zero marginal costs, VRE plants bring

prices down precisely when they come into operation and could draw revenues from the

market. This situation is sometimes described as wind turbines and solar-based

technologies cannibalising their own market – the higher their deployment, the lower their

market returns. With some exceptions, investment in low-carbon technologies largely

hinges on out-of-market arrangements which frequently contain a subsidy element. The

problem of price declines in the presence of VRE extends to other technologies which see

their average revenue and load factors erode, leading to early retirements and temporary

shutdowns (NEA, 2012). However, this would also occur with any technology supported

outside the market.

Will a higher CO

price be enough to fix these problems? In principle, in the near to

medium term it would increase electricity prices, as fossil-based plants will continue to be

marginal suppliers on the market, granting a cost advantage to carbon-free sources. There

is, however, a lack of visibility about electricity prices over the lifetime of a new plant.

This is an important barrier for investment in low-carbon, high capital cost technologies if it

is to be paid back by wholesale electricity markets only. Again, the problem would also be

exacerbated by the penetration of low-carbon technologies characterised by low or zero

marginal costs, with depressing effects on market prices. Wholesale markets with the

highest shares of variable renewable sources sometimes record zero or negative electricity

prices when wind and solar power plants produce more electricity than the load.

The regulatory challenge for a decarbonised electricity system is therefore the

organisation of competition in the future to ensure that the constraint on CO

emissions is

reflected in both investment and operational choices of power generation, alongside other

equally important constraints such as security of electricity supply. It is unlikely that such

competition can be solely organised on the basis of variable-cost pricing and carbon

pricing. The cost structure of low-carbon electric power technologies changes the

requirements demanded of electricity systems, raising the question of how such structure

should be reflected in the incentives provided by this sector.

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Sketching the elements of a low-carbon electricity system

Pricing carbon

A price on CO

is necessary to ensure that operational decisions on the market reflect

the cost of climate change, and discourage plants with a high CO

content from running.

This is particularly important for dispatchable plants that will be required for baseload

power generation when VRE plants do not generate power. A price on CO

will also give a

cost advantage to these other low-carbon technologies, be they hydro-electric, nuclear,

geothermal or biomass-fuelled thermal plants or fossil fuel plants fitted with CCS.

Sending the right investment signal

What market mechanism would be best suited to trigger investment in high capital cost

and low operational cost technologies? A simple first answer could be to organise

competition for the investment in new power plants, e.g. on the basis of the average cost of

generated electricity, whereas today’s investors take decisions based on the expected

evolution of wholesale prices as set by the variable costs of different plants setting prices at

different points in time.

An example of such an arrangement is the auction mechanism used in Brazil to procure

new capacity in a specific location. Winners can be awarded a price for their electricity in a

long-term contract, giving some certainty on expected returns during the lifetime of the

investment. The Brazilian auction allows bidders to be compared according to their average

cost of power: in the presence of a carbon price, a gas- or coal-fired power plant would bid

with the CO

cost included, putting bidders using low-carbon technologies at an advantage.

Bidders would also have to allow for fuel price risk, which could not be passed on to

consumers in such an auction.

South Africa also adopted an auction mechanism for new capacity, including a contract

for concentrated solar power with different prices paid depending on the time of supply, to

reflect the cost difference between baseload and peak-time generation.

Some of the policy solutions to secure low-carbon capacity at least cost follow a similar

logic. For instance, the European Commission’s new state aid guidelines on renewable

energy encourage reliance on tendering as an alternative to administratively set payment

levels such as feed-in-tariffs, which have not always responded to rapid cost reductions and

may not encourage the technical and financial innovation that can lead to cost reductions.

Efforts are also made to integrate variable renewable generation in the electricity

market by asking generators to put their electricity on the wholesale market – as opposed to

granting priority access to the grid and guaranteeing out-of-market payment. For instance,

feed-in premium systems demand that producers sell their power on the market and provide

a payment on top. The UK Contract for Difference (CfD) is a variation on this arrangement:

low-carbon technologies receive a variable premium on top of the received electricity price,

up to an agreed price level. A CfD is also under elaboration to secure investment in new

nuclear capacity. At this stage, however, CfDs are set on a negotiated basis and on a

technology-by-technology basis. The first CfDs offered by the British government have

been for nuclear power and offshore wind.

The deployment of large amounts of VRE such as wind or solar PV also requires that

the right balance be struck between two priorities: a strong signal for investors, which can

be based on average cost pricing, and an incentive for low-carbon generators to deliver their

electricity when its value to the system is highest – as opposed to maximising total output.

In the case of solar in regions relying heavily on air conditioning, this may include

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positioning panels to maximise production during times of peak demand. As individual

households that consume and produce electricity from PV (so-called “prosumers”) are not

exposed to dynamic electricity prices, achieving this requires an adjustment in the support

mechanism. One way of achieving the same result is to structure power purchase

agreements with payments differentiated according to time of production, as in

South Africa’s auctions.

Securing flexibility and reflecting system costs

Effort is therefore still required to align investment signals with the need for fair

competition across low-carbon and other electricity technologies. Low-carbon technologies

play different roles in electricity systems. Hydropower, nuclear, biomass-fuelled and CCS-

fitted plants are dispatchable – i.e. can generate when required. Variable sources such as

wind and solar PV are not fully dispatchable. How easily they can be integrated depends on

the degree of flexibility of the underlying electricity system and on the share and speed of

deployment of VRE technologies (Box 7.1). If electricity demand is high in times without

wind and sunlight, other capacity must be brought on. Incentives must be present for such

capacity to remain available and be built in a timely fashion, whereas, as shown earlier, the

penetration of VRE can lead to reduced revenues for these plants.

According to the IEA (2014d), if local concentrations (“hotspots”) are avoided, VRE

deployment has a negligible impact, at shares of around 2-3% of annual generation. Apart

from small island systems, shares of 5-10% in annual generation will not lead to technical

integration challenges if operations are adapted and VRE deployment patterns are well co-

ordinated. For higher levels of penetration (25-40%), a system-wide transformation is

necessary if excessive costs are to be avoided (ibid.). The magnitude of the system costs of

a growing share of VRE is in debate, however (NEA, 2012; IEA, 2014d).

Jurisdictions have developed various instruments that could be used to complement

variable resources with flexible plants. One widely discussed and increasingly implemented

option is a capacity mechanism that secures revenues for plants to remain available. Other

jurisdictions have adopted more targeted contracting to trigger new investments or relieve

congestion in the system. So far, these mechanisms are used to ensure that generation can

meet the peak of electricity demand, a legitimate issue for the low-carbon transition as

carbon-intensive plants are being retired. The contributions of the demand side and storage

to the integration of VRE plants are touched on below.

The integration of VRE plants also brings costs related to: 1) the short-term balancing

of power, as variable plants come in and out; 2) the cost of backing up power: dispatchable

capacity (i.e. power plants using fossil fuels, nuclear energy or dispatchable renewable-

energy sources such as hydro-electric power, geothermal power or biomass-fuelled thermal

plants) needs to be available when there is neither wind nor sun; however, this capacity is

made less economic by the growing market share of variable plants; 3) the costs of

connecting the best production sites to consumption centres and strengthening distribution

grids to accommodate individual rooftop photovoltaic panels (NEA, 2012; IEA, 2014d).

Given different resources and technology mixes envisioned in different countries, the

cost of an electricity system transformation will vary widely, but it should be allocated

fairly and transparently to avoid distortions.

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Box 7.1.

Adapting technical security of supply standards

The initial appearance of variable renewable energy in power systems necessitated the

development of specific grid-connection requirements for these technologies to reflect their

different capabilities and impacts on the electricity system. Early requirements were characterised

by a “do-no-harm” approach, sometimes in the form of a simple disconnection of the variable

resource, e.g. whenever frequency was too high. This initial response began to pose a problem for

the system as the installed capacity of variable energy technologies increased significantly.

Under the grid code for German solar photovoltaic (PV) power plants, all plants were

required to disconnect from the system if grid frequency rose above a level of 50.2 hertz, which

may occur during a system disturbance. While such a rule allowed secure system operation at low

penetration levels, as capacity increased, the disconnection of all solar PV at the same moment

can put system security at risk. After this issue was identified, a retrofit programme was put in

place to ensure that no sudden losses of generation through the disconnection of all solar PV

capacity would occur as a result of grid code requirements.

Source:

IEA, Renewable Energy Division, 2014.

Looking for misalignment beyond electricity generation

Transmission and distribution: How to mobilise least-cost potentials?

Transmission and distribution (T&D) networks and their regulation are a critical

component of the security of electricity supply, including the deployment of VRE at least

cost. Wherever variable energy resources will be called on significantly to reduce CO

emissions, T&D networks and their operations will need to adjust. A widespread

transmission system is a clear asset to maximise the use of variable generation resources in

broad geographical areas, and to ensure security of electricity supply in periods without

wind and sunshine. Benatia et al. (2013) analysed the factors behind the productivity of

wind plants based on a sample of 31 OECD countries. Beyond the obvious importance of

each country’s wind resource endowment, transmission capacity and cross-border trade are

two of four elements of critical importance, and need to catch up with the deployment of

new VRE and other low-carbon capacities (see also Bahar and Sauvage, 2013):

•

the availability of dispatchable generation capacity, i.e. plants that can deliver electricity

to the grid quickly to compensate for times when there is less wind

electricity transmission capacity, i.e. the ability to move generated electricity over long

distances inside a country

energy storage, i.e. hydroelectric pumped storage has an increasing positive impact when

wind capacity grows

the possibility of cross-border electricity trade.

The IEA projects that USD 5.9 trillion must be invested in T&D between 2011

and 2035 in a 2°C-compatible scenario, of which 8% would be in infrastructure for the

integration of variable renewables (IEA, 2014c). These investments are crucial for the

success and cost effectiveness of the decarbonisation of electricity generation.

The policy alignment issue in the case of T&D stems from the more complex role of the

grid in the low-carbon transition. A cost-effective response should reflect “the competitive

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interplay between network asset costs, network operational costs, electricity supply costs

and other solutions such as demand response” (Volk, 2013).

In other words, a new planning framework is required to evaluate the cost and benefits

of several technical solutions. A specific challenge for variable renewables is the proper

allocation of the costs they impose on T&D. The unbundling of generation, transmission

and distribution can sometimes complicate decision making in this area. An indicative

planning, such as integrated resource planning in Australia and the United States can

facilitate co-ordination.

It is clearly important to reduce the policy costs associated with the move to low-carbon

generation. Co-ordination of renewable and flexible resources over large geographic areas

is one essential measure that can reduce the overall cost. The Agency for the Cooperation

of Energy Regulators quantified the potential benefits associated with cross-border flows in

Europe at several hundred million of euros per year (ACER/CEER, 2013). Power market

integration, however, will require dedicated efforts, and strong policy commitments are

needed to allow the development of more efficient markets over large geographic areas.

Electricity and heat storage

A potential breakthrough in electricity systems may come from the development of

energy storage technologies for both electricity and heat services. The IEA’s

Energy

Storage

indicates the various technologies, uses and contribution of storage solutions to

decarbonisation. The question is whether these storage solutions could seamlessly integrate

today’s electricity systems.

The current installed capacity of electricity storage, mostly in the form of pumped

hydro-plants, is not new to electricity systems and amounts to 2.4% of the total installed

capacity in power generation worldwide. In the specific European case, the pumped-hydro

storage plants operated at night, absorbing excess power from nuclear plants and were

remunerated through the sale of electricity at high prices during the day. This business

model has been eroded by the drop in daily prices caused by overcapacity as demand

stagnated and wind and solar power were deployed. There is in this case a gap between the

private value of electricity storage – which decreased – and the public value of storage,

which should increase as more variable resources are deployed. Policy makers must thus

think about whether they want to provide added incentives to electricity storage for

security-of-supply reasons.

Small-scale storage solutions are now commercially viable, e.g. in off-grid applications

in combination with photovoltaic panels. Water heaters have been used in France, including

through remote control, to both lower peak demand and store energy in off-peak times. This

particular form of storage contributes significantly to lower peak demand in winter

(5 gigawatts) which would otherwise be served by fossil fuel plants. New innovative

storage solutions such as flywheels, the transformation of excess electricity into hydrogen

and storage of heat in the form of molten salts in concentrated solar power plants are at

various stages of development and commercialisation (IEA, 2014e).

Various storage

solutions provide different services to the electricity system: some will store electricity

across seasons, others from night to day, or for a few minutes or hours.

Storage solutions do not always mesh easily with pre-existing policy frameworks. For

some time in the United States, transmission assets were forbidden to participate in

wholesale electricity markets to avoid market manipulation. “This distinction between

transmission and generation assets results in unintended negative consequences for energy

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storage technologies that can supply services in both the transmission and generation

portions of the energy system.” (IEA, 2014e: 12) The US Federal Energy Regulatory

Commission has since made amendments to allow storage to receive compensation for

supplied services. Also a lack of transparency on the cost of various electricity services

prevents storage solutions from competing with generators.

Another key element for a cost-effective scaling-up of storage is time-of-use electricity

pricing: storage can support the integration of variable resources by absorbing their supply

when demand is relatively low (and so too electricity prices) and by selling the stored

electricity at peak times. The possibility of using electric car batteries for this purpose is

also being researched. The IEA (2014e) provides further recommendations on policy

interventions to level the playing field for energy storage solutions, including heat. Indeed,

much energy is still wasted in the form of heat, in industry or in thermal power plants,

including nuclear plants.

The demand-side: In need of new policy frameworks

A more efficient use of energy is an essential element of the low-carbon transition, as

discussed in Chapter 1. The global improvement in energy efficiency will come in response

to: higher electricity prices; policies to address other market barriers to rational energy use,

especially where price signals are imperfectly “received” by end-users; and structural

changes away from more energy-intensive activities and behaviours.

These aspects will influence electricity systems over time. There are, however,

opportunities for the demand side of electricity systems to become more responsive to the

specific dynamics of a low-carbon energy system. Demand-side response (DSR, the active

participation of end-users in electricity markets), demand-side management (DSM, the

management of demand to lower energy supply investments) or energy efficiency could

allow electricity systems to:

•

Improve security-of-supply and decrease overall capacity by finding financial incentives

to induce electricity users to either forego consumption (via demand reduction) or

postpose consumption (via demand shifting) at times of peak demand.

Avoid locking in new generation to respond to peak demand levels, traditionally supplied

by natural gas or fuel oil-based turbines.

There is an actionable potential for both supply and demand in the residential and

buildings sector, e.g. with space-heating, water heating and air conditioning. Battery

storage in cars could also become a sizeable contribution of the demand side. Industrial

actors ought to be well placed to respond to price incentives; it is less clear for households

or small businesses, although there have been successful experiences with time-of-use

pricing. Generally speaking, these electricity users are less exposed to changing electricity

prices in real time or exposed to contradictory signals (Box 7.2). There are, however,

technical solutions based on smart meters and automatic control devices that would go a

long way towards increasing DSR in the residential and buildings sectors.

This particular area is not devoid of regulatory barriers, for example in the machine-to-

machine communication essential for the deployment of smarter energy uses related to

mobile-enabled applications (OECD, 2012).

Further, electricity retailers are sometimes

reluctant to let consumers access the data from smart meters, preventing the connection to

other systems that could facilitate electricity savings. There may be a regulatory gap to be

closed in this area as well.

•

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Box 7.2.

When high electricity tariffs discouraged low-carbon alternatives

Standard electricity tariffs in Italy are progressive – the higher the level of consumption, the

higher the price per kWh. This system was put in place to encourage an efficient use of

electricity at a time when it was derived primarily from fossil fuels. Italy has achieved one of the

lowest per capita consumption levels of electricity in the domestic sector.

In its recent energy strategy, Italy has identified home heating as a key area for

decarbonisation of the economy and increased uptake of renewable energy – including electricity

from wind and solar generation. Using heat pumps for space heating would be a way to use clean

electricity for space heating while increasing overall energy efficiency. However, the

progressive nature of electricity tariffs is an economic barrier to the penetration of heat pumps,

as customers are charged a higher price of electricity upon installation. The Italian government

has identified this problem and is now working to reform tariff structures.

Source:

Italian regulator; IEA (forthcoming),

Italy 2015 Review: Energy Policies of IEA Countries,

OECD

Publishing, Paris, forthcoming.

At the moment, DSR consists mostly of large industrial users that withdraw part of their

demand against a market payment. Dynamic electricity pricing, a more direct instrument to

encourage demand response, has been slow to develop in many countries. New business

models have emerged, e.g. to aggregate and co-ordinate the response of several electricity

users with the help of information and communication technologies. These companies work

with industrial users to identify equipment that can adjust electricity demand at times of

high electricity prices, leading to cost savings, and also provide other remunerated services

to the electricity system. This market innovation is present in very few markets today and

regulations often create barriers for its deployment (CEEM, 2014).

It is also important to

ensure an efficient competition between DSR and generation capacity resources.

The IEA notes that legal and regulatory frameworks, retail markets and products are

still not allowing full participation of the demand side, a clear case of policy misalignment

(IEA, 2013b), all the more so as technical solutions now exist to exploit this potential.

Furthermore, decentralised power generation (especially rooftop solar PV panels) is

changing the status of some consumers into “prosumers” who may also want to maximise

revenues from their generation equipment, including through better management of both

their instantaneous end-uses and electricity output.

In summary: A regulatory transition underway?

Wholesale electricity markets born from the wave of electricity sector liberalisation will

be increasingly challenged as the decarbonisation of electricity systems becomes an

imperative. The high capital cost of low-carbon technologies, ranging from nuclear to VRE

sources and CCS, requires a more stable price signal than that provided by marginal cost

pricing. A price on CO

, necessary in any case to discourage the operation of dispatchable

fossil-fuel plants, cannot by itself deliver the robust signal for investments via wholesale

markets. Investors will demand risk premiums that would add to the cost of capital and to

the overall cost of the low-carbon transition. New arrangements are necessary to allow an

efficient competition in investment on the basis of full generation costs – including the cost

of CO

emissions and all other external costs.

As the new decarbonised electricity system will include a growing share of VRE

installations, it must reflect the new costs these installations carry in terms of flexibility,

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grid strengthening, etc. to ensure an efficient allocation of resources. Transmission and

distribution grids, the demand side, and in the longer run storage technologies, all face

some policy barriers, i.e. misalignments hindering their contribution to the low-carbon

transition. A systematic review of regulatory arrangements governing these activities and,

when needed, regulatory reform will be important to facilitate the transition.

Misalignments in fast-growing and often regulated electricity systems

With higher population and gross domestic product (GDP) growth, emerging and

developing countries will record much faster growth in electricity demand than OECD

countries overall (Figure 7.2). Supplying affordable electricity to communities without

access continues to be an international priority, as illustrated by Sustainable Energy for All

and the proposed energy items in the Sustainable Development Goals (UN, 2015). To be

consistent with lower global emissions in this century, countries outside the OECD will

have to install the lion’s share of low-carbon generation in coming decades. About two-

thirds of capacity in nuclear, onshore wind and solar (photovoltaic and concentrated)

power, and nine-tenths of coal plants fitted with CCS, would be built outside the OECD

in 2050 in the IEA’s 2°C-compatible scenario (IEA, 2014a).

The vast majority of electricity systems in fast-growing regions remain vertically

integrated and do not rely on wholesale electricity markets as known in some OECD

regions, even if some degree of electricity unbundling has occurred. In the People’s

Republic of China (hereafter “China”), the State Grid Corporation and the Southern Grids

operate independently from power generation. There is also competition for new projects

among several large generation companies, including companies that specialise in

hydro-electric projects or nuclear. Most of the capacity remains state-owned. In India, about

two-thirds of the generation capacity is government-owned (IEA, 2014c).

An appropriate alignment of incentives with the multiple goals of the electricity system

will be critical if these regions are to achieve this transition at the lowest cost possible.

What follows is a short, broad-brush description of how regulated and fast-growing

electricity systems also face policy misalignments in spite of the centrally planned nature of

their regulatory frameworks.

Fostering investment

Investors in low-carbon technologies (hydro, nuclear, new renewables) need an

additional incentive when these technologies are not cost-competitive with fossil-based

technologies. In many cases, subsidies are provided on a per-MWh basis, i.e. a payment for

every unit of electricity delivered to the grid (equivalent to the feed-in-tariffs used in many

OECD regions). In certain countries, investors can also access funding at relatively low

interest rates, which constitutes an important cost advantage given the weight of capital

expenditures in low-carbon technologies.

There are, however, potential disadvantages for regulated fast-growing power systems

specific to the low-carbon transition: the tendency to invest in excessive capacity, locking

in fossil-fuel plants, and the difficulty for smaller companies to compete with vertically

integrated utilities, whereas smaller projects based on wind or solar capacity could be borne

by independent power producers and create a healthy competition on costs. These problems

can be solved through specific legislation for independent power provision and a simple

regulatory framework for new entrants (OECD, 2013b).

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Investments in clean energy often take place in a situation of imperfect competition

where a state-owned enterprise (SOE) is the incumbent. That context alone may not be a

barrier to low-carbon investment, but there may be opportunities for enhanced cost

competition. Governments can establish a level playing field between SOEs and private

actors – including independent power producers and network operators – as well as

between foreign and national actors in the electricity sector, in order to attract investment in

low-carbon generation. In particular, policy makers need to ensure that:

•

producers of low-carbon electricity benefit from non-discriminatory access to the grid, as

uncertain grid access increases project risk

investment in the grid is open to private investment

private developers benefit from non-discriminatory access to finance, e.g. from state-

owned banks

tenders for public procurement are carefully designed with clear and transparent bid

evaluation and selection criteria (OECD, 2013b).

Recent examples of successful tender auctions in countries with regulated markets,

including Brazil, South Africa and the United Arab Emirates, show how well-designed

competitive processes can be very effective in securing renewables generation capacity, and

at record-beating low prices, in the mentioned examples.

Examples of misaligned incentives in operations

While there is a policy in place to guarantee priority dispatch [of wind and solar

power in China], grid companies do not always apply this in practice.

(IEA, 2014d)

Where system operation and ownership of existing generation plants coincide there can

be a significant conflict of interest: adding wind and solar PV to the system may

compromise the economic value of existing assets. Permitting and grid-connection issues

are likely to face lower barriers where generation, transmission and distribution have been

unbundled. Furthermore, there is evidence that low-carbon resources may not always be

used to their full capacity because not all stakeholders have incentives aligned with this

objective. For instance, in China and India, the grid or utilities must purchase VRE at the

premium price set by the government. As this electricity is more expensive than coal-based

generation, a growing share of renewables implies a direct cost for the grid, as this cost is

not automatically passed on to end-users through higher electricity tariffs. This creates a

disincentive to accepting more VRE supply on the system.

The price that Chinese power generators receive for their output is determined

administratively on a per MWh level. The general objective of such pricing is that

generators can recover their average costs. However, this requires that generators produce

the quantity of electricity planned for the year, such that total revenues match average costs.

A similar approach is taken for the remuneration of land-based wind energy in China. The

quantities of wind and coal electricity generation that have been procured in China with this

remuneration scheme have not been fully aligned, however, and this creates competition.

When wind generation is particularly high, the output of coal power plants is sometimes not

reduced to the maximum extent possible, as this would reduce the sales of coal-based

electricity and jeopardise the cost-recovery for coal generation. Wind generation is then

curtailed, which affects its economics. This further results in an efficiency loss, given the

much lower short-run costs of wind.

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These are examples of misalignment between a policy goal (in this particular case, a

growing share of wind power in overall supply) and the incentives generated by the existing

regulatory structure. Utilities that are financially vulnerable will resist the integration of

more expensive low-carbon sources of generation. Baron et al. (2012) have illustrated a

similar conflict in the case of the now likely introduction of an emissions trading system in

China’s power generation sector, in which power plants generate on the basis of a

negotiated annual output and receive a set price for the electricity that they put on the grid.

The regulated structure of power generation will not deliver the efficiency gains expected

from the CO

market mechanism unless some adjustment is made to the planning of power

plants. In particular, it would be necessary to allow: 1) a pass-through of the CO

cost onto

the price received by plants, to encourage competition from less carbon-intensive plants;

2) some flexibility for plants to adjust their running time to match their CO

emissions

decisions.

Preliminary view on misalignments in fast-growing regulated systems

A much more systematic review would be necessary to identify whether vertically

integrated electricity systems feature significant policy misalignments with the low-carbon

transition, and determine whether more competition could facilitate the transition. The

previous section indicated that not all forms of competition will necessarily send the right

signal for investment in low-carbon, high capital-cost technologies. Further, if unbundling

of generation, transmission and distribution delivers efficiency gains, it appears to make it

more difficult to define an economically efficient strategy for the decarbonisation of power

systems in which all options (generation, transmission, distribution, demand side) would

contribute. This is clearly an area where jurisdictions with deregulated and regulated

frameworks could usefully share experience.

Resilience of energy systems to climate change

An important exposure to gradual climate change and extreme weather events

Energy sector infrastructure stands to be affected by climate change, whether via

extreme events, gradual temperature increases, sea-level rise or changes in precipitation,

albeit with differences across regions (Figure 7.3). Recent extreme weather events have

exposed the vulnerability of energy activities, but long-term projections indicate more

wide-ranging effects:

•

Energy demand: changes in heating and cooling demand, especially in air conditioning,

which relies overwhelmingly on electricity. This may lead to peak electricity demand in

the summer; the IEA underlines that this could cause stress to the electricity system

during heat waves. Increased irrigation needs caused by a warmer, drier climate will also

drive up energy demand (IEA, 2013b).

Oil and gas exploitation is often exposed to challenging weather conditions, and will need

to adapt to gradual changes including: temperature increase (e.g. directly affecting the

efficiency of natural gas liquefaction facilities); a sea-level rise; increased storm

intensities; water stress (refineries and coal mines consuming large quantities of water);

or permafrost thaw (leading to shifting pipelines and more limited use of ice roads).

Climate change will therefore have a direct impact on infrastructure costs in this sector,

not to mention possible losses of production. Although long ice-free summers in the

Arctic open up exploration and shipping opportunities, “the technical and environmental

challenges are already significant and a number of projects have either been held back by

the complexity of operations and by environmental concerns, or suspended due to

•

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– II.7. REFRAMING INVESTMENT SIGNALS AND INCENTIVES IN ELECTRICITY

escalating costs” (ibid.). Extreme weather events, as illustrated by Hurricane Katrina’s

damage to the oil and gas industry in the Gulf of Mexico, can also severely affect this

sector, all the more so as 45% of recoverable conventional oil

is located in offshore

fields.

•

Electricity generation and networks are vulnerable to a warmer climate, but also to

extreme cold weather (as experienced during so-called polar vortex incidents in

North America in 2014 or the Canadian ice storm of 1998). Warmer air and water reduce

the output of thermal power plants, whether they are fossil fuel-based or nuclear. Water

cooling needs at power plants can be reduced, e.g. with dry cooling, but at additional cost.

Electricity losses in transmission and distribution also increase with temperature, not to

mention the vulnerability of these networks to extreme weather events. Recent research

indicates that in the 2040s, a 1°C warming will reduce available electricity capacity

during summers by up to 19% and 16% in Europe and North America respectively (ibid.).

Turning to renewables, hydroelectricity will also be impacted, though sometimes

positively (in Canada, Nordic countries and the Russian Federation). However, warming

is more often associated with droughts, which drive massive reduction of hydropower

generation in some locations. Wind patterns may change, affecting the productivity of

existing farms; the occurrence of extreme wind and icing events is also a factor. PV-based

electricity is also affected by increased air temperature and of course snow cover. Like

other crops, biomass-based fuels will be affected by changes in yields driven by climate

change, as well as by extreme weather events.

•

Can policy enhance the energy sector’s resilience?

The energy “industry” is routinely confronted with weather-related incidents, which

have increased in frequency and severity in recent years. Through experience, companies

have developed contingency plans. They have been investing to either make their

infrastructure more robust or ensure the ability of a facility to quickly come back on line

after an incident (the choice between the two options being driven by cost considerations).

At the same time, there is no certainty that the energy sector as a whole is taking into

account the full measure of climate change impacts over the lifetime of its assets, or fully

incorporating this dimension in investment choices.

The energy sector is explicitly addressed in some countries’ adaptation strategies. For

instance, policy measures are adopted to: 1) reduce climate risks (support for burying

power lines, building sea walls, elevating or relocating important equipment like

substations, establishing early warning systems, etc.); 2) transfer risks (e.g. public-private

insurance); 3) absorb risks (a compensation scheme after an extreme event happens). An

open question at this stage is whether there is a role for regulatory policy to steer energy

sector stakeholders towards an enhanced resilience in the face of global warming impacts.

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II.7. REFRAMING INVESTMENT SIGNALS AND INCENTIVES IN ELECTRICITY–

175

Figure 7.3.

Selected climate change impacts on energy

Source:

see IEA (2013b) for full references.

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– II.7. REFRAMING INVESTMENT SIGNALS AND INCENTIVES IN ELECTRICITY

Zoning, insurance and water-use policies and technical standards

are sometimes used in

this domain. The incentive to adapt effectively, however, hinges on other regulatory

questions. For example, who bears the risk of supply disruption? What are the contractual

arrangements in case of supply disruption? Do current forms of price regulation enable an

efficient level of investment in resilience (e.g. burying transmission lines, ensuring

sufficient redundancy)?

At this stage, some governments are engaged in discussions with the energy sector and

related stakeholders (e.g. water utilities and users) to come to a better understanding of

foreseeable impacts and response measures (see e.g. Zamuda, 2014). Canada’s Adaptation

Platform has engaged various public and private sector stakeholders to share and discuss

climate and hydrology information, outcomes from risk assessments, best practices and

tools, and policy drivers and barriers (Wilson, 2014).

There is mounting pressure on energy companies to report on the vulnerability of their

assets to climate policy and climate change, although more with a view to attracting

investors’ attention to related risks than to fostering adaptation of those companies to

climate change.

In short, more work is needed to identify policy misalignments in the energy sector’s

resilience to current and future climatic change. The IEA is addressing this aspect through

its Climate and Energy Security Nexus Forum (IEA, 2015b).

Notes

By 2050, according to the IEA’s

Energy Technology Perspectives

2DS Scenario, the

power sector achieves similar levels of decarbonisation in the OECD, China and

India, with reductions of 96-97% in CO

emissions from business-as-usual levels

(IEA, 2014a).

These results are corroborated by the Deep Decarbonisation Pathway Project, which

also emphasises the importance of decarbonising power generation and of electricity

end-uses substituting fossil fuel uses to improve efficiency (SDSN and IDDRI, 2014).

With more decentralised sources of generation (PV rooftop panels), and the

emergence of electricity-producing consumers (“prosumers”), the system also needs

to change from a unidirectional to multi-directional mode. See also IEA (2013a).

In Europe, natural gas plants have stopped operating as the price of CO

allowances is

too low to make gas plants competitive against coal plants. In Germany, coal plants

also benefited from the closure of nuclear plants, with higher CO

emissions as a

result.

The use of biomass in coal-based power plants has been supported in the EU, via the

EU ETS, as have domestic support mechanisms for renewable energy.

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II.7. REFRAMING INVESTMENT SIGNALS AND INCENTIVES IN ELECTRICITY–

177

The investment in gas and coal plants that took place in Europe in the last decade

were motivated by then higher electricity prices and an underestimation of the share

of renewable energy capacity going forward. The lower demand for electricity

combined with a rapidly growing share of renewables have made baseload plants

much less economical than anticipated.

This is illustrated by the drop in natural gas prices in the United States, or the recent

drop in international oil prices. Such market surprises blur market expectations about

electricity prices.

“Market instruments, such as auctioning or competitive bidding process open to all

generators producing electricity from renewable energy sources competing on equal

footing at the European Economic Area level, should normally ensure that subsidies

are reduced to a minimum in view of their complete phasing out” (EC, 2014). The

Netherlands has already introduced a feed-in-premium based on tendering (SDE+).

The shift to “prosumers” has a huge potential of mobilising goodwill and commitment

at the grassroots level, but again poses the question of cost arrangements: should the

cost of new investments needed in the distribution grid to include distributed

generation be covered by prosumers or through generalised network tariffs? The

answer could be important in determining the competitiveness of rooftop PV

installations.

Resource means generation, demand response and networks.

A molten salts heat storage facility equips a 1 GW solar plant in Spain, for instance.

Other barriers of a technical nature stand in the way of DSR. One issue relates to

machine-to-machine communication, which is an enabler for many “smart” systems

such as smart grids and transport. A major barrier for machine-to-machine enabled

mobile applications (and users) is the lack of competition once a mobile network

provider has been chosen. The problem is the SIM card, which links the device to a

mobile operator. By design, only the mobile network that sells an SIM card can

designate which networks and devices a user can connect to. Changing SIM cards can

be very costly; in some cases the user could be locked in a 10- to 30-year contract

(OECD, 2012).

Examples include the Pennsylvania-Jersey-Maryland (PJM) system in the

northeastern United States, and France and Norway.

It has been argued that wind turbines compete more easily with natural gas plants in

Brazil’s auction because they have access to low cost of capital via the country’s

development bank .

The IEA has also conducted several discussions among policy makers and the private

sector on the Energy Security and Climate Nexus.

Excluding light tight oil.

The European Union has undertaken a mapping of technical standards related to

infrastructure resilience (Paunescu, 2013).

In the United States, the Securities and Exchange Commission’s interpretive guidance

on climate disclosure seems to have had limited effects, with 59% of Standard &

Poor’s 500 companies reporting on climate. The quality of climate disclosure for

those that do report is measured around 5 on a scale of 100 (Ceres, 2014).

10.

11.

12.

13.

14.

15.

16.

17.

18.

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– II.7. REFRAMING INVESTMENT SIGNALS AND INCENTIVES IN ELECTRICITY

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ation_IEA_slides.pdf.

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II.8. OPTING FOR LOW-CARBON URBAN MOBILITY –

181

Chapter 8

Opting for low-carbon urban mobility

Current transport systems rely largely on fossil fuels and impose very high environmental

costs (climate change, noise, air pollution), particularly in urban settings. Policy

intervention is needed to provide more energy efficient and less carbon-intensive mobility.

These measures should focus on shifting away from the use of individual cars to mass

transport modes, reducing the need for travel through land-use planning, as well as

improving fuel and vehicle efficiency.

Sub-national governments are critical decision makers for low carbon mobility, but they

face institutional, organisational and financial barriers to pursue ambitious climate action.

These include co-ordination issues, contradictory incentives in the fiscal framework and a

lack of capacity. Aligning policy action across levels of governments and between

stakeholders could do much to deliver lower-carbon mobility. National frameworks and

legislation should also give more financial and political leeway to local governments to

pursue low-carbon choices.

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

Key messages

The reliance on fossil fuel-based transport systems has a very high local and global

environmental price tag. The transport sector produces roughly 23% of global CO

emissions

and is the fastest-growing source globally. Without further policy action, CO

emissions from

transport could double by 2050.

Reducing emissions from transport could also mean cleaner air and less congestion, but this

will not happen without proactive and joined-up policy action to:

•

avoid

unnecessary travel and reduce the demand for total motorised transport activity

promote the

shift

to low-emission transport modes

improve

the carbon and energy efficiency of fuels and vehicle technologies.

These measures should be embedded in a strategy for urban development that makes more

efficient use of space and takes into account environmental costs, well-being and economic

development needs. This would mean refocusing urban transport policies on access rather than

mobility itself, providing safe infrastructure for walking and cycling, shifting to mass transport

modes where demand is concentrated and developing cities along mass transit corridors,

improving fuel efficiency and promoting electric and fuel cell vehicles in concert with

low-carbon electricity (or hydrogen) production.

Many cities in OECD countries are already designed around the private car. They will need

very low – or even zero – emission fuels and vehicles, more efficient public transport systems,

land-use planning that reduces the need for personal vehicles and alternatives to transport

demand (such as teleworking) if they are to reduce CO

emissions significantly. In cities in

developing and emerging economies, where much of the infrastructure is yet to be built, urban

expansion needs to be managed in a way that limits the demand for energy-intensive mobility

while promoting safe, affordable, accessible and sustainable transport systems for all.

Sub-national governments are critical decision makers for urban transport planning, but

co-ordination, general framework and capacity are generally barriers to sub-national

governments making greater efforts toward climate action.

The roadmaps are reasonably clear, but several policy misalignments need to be corrected to

allow urban mobility to develop while reducing its carbon footprint.

Are land-use planning and transport policies integrated at the metropolitan level?

Land-use and transport planning are often the responsibility of separate authorities whose

co-ordination mechanisms are limited or informal. This may result in development patterns that

do not sufficiently account for transport needs, increasing inhabitants’ reliance on personal

vehicles. Mismatches between administrative boundaries and the functional extent of built-up

areas also undermine joined-up planning. Solutions for better alignment range from the creation

of metropolitan governance bodies that integrate land-use and transport planning to looser forms

of inter-municipal and inter-sectoral collaboration such as contracts, platforms for dialogue and

co-operation, and specific public investment partnerships.

Do cities have enough financial or political leeway to make low-carbon choices?

A review

of policy misalignments should involve a rigorous analysis of the impact of national policies on

urban action. National legislation typically defines cities’ and sub-national governments’

responsibilities and revenue sources. The fiscal system dictates to a great extent what cities can

and cannot do – as well as their incentives for action. How these revenue sources are designed

can either enable or hinder sub-national governments’ action towards low-carbon development.

Some national tax provisions and regulations encourage further carbon-intensive development.

Capacity building is also essential to help city governments design low-carbon cities, engage

with the private sector and access funding.

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II.8. OPTING FOR LOW-CARBON URBAN MOBILITY –

183

Key messages

(cont.)

Are policy signals aligned to facilitate the penetration of low-carbon breakthrough

technologies?

Our reliance on fossil fuel vehicles is perpetuated by the widespread use of fossil

fuel-oriented infrastructure, innovation policies that support fossil fuels and the relatively low

cost of road transport for consumers in some jurisdictions. These signals will need to be reversed

for breakthrough low-carbon solutions to be rapidly deployed. Innovation in electric and hybrid

vehicles is progressing, but a number of market failures and barriers are hindering the scaling-up

of alternative fuel vehicles. Experiences with electric vehicles in the Netherlands and Norway

show that combining battery-charging infrastructure, rebates on electric vehicle purchases and

priority lanes on main access roads can lead to very rapid uptake. Such breakthroughs will

require governments to provide the policy mix needed to challenge existing infrastructure based

on fossil fuels.

The decarbonisation challenge for urban transport

Our modern and global economy has developed thanks to our ability to construct

reliable and interconnected transport networks. For the vast majority of transport needs, this

has entailed reliance on fossil fuels and the internal combustion engine. However, fossil

fuel-based transport systems come with very high local and global environmental costs, and

change is needed to achieve the low-carbon transition. If reducing emissions from aviation

and shipping requires international co-operation (see Chapter 5), achieving low-carbon

terrestrial transport systems will largely depend on how cities develop and how much more

energy efficient transport systems will become. Sub-national governments are key actors in

this low-carbon future, provided that their incentives are aligned with the climate challenge.

A lack of co-ordination and of capacity, alongside other general framework conditions,

creates barriers to sub-national governments making the most of public investment. These

obstacles are particularly relevant for low-carbon mobility, which involves new

technologies, skills and functions that often go beyond individual jurisdictions’

prerogatives.

Transport is the fastest-growing source of CO

emissions globally

Greenhouse gas (GHG) emissions from transport represented 14% of global emissions

in 2010 (IPCC, 2014), and 23% of CO

emissions from global fossil fuel combustion.

Transport is the sector with the fastest-growing consumption of fossil fuels, and is also the

fastest-growing source of CO

emissions globally (IEA, 2014). The number of individual

cars increased from 625 million to 850 million between 2000 and 2013, mainly in

developing countries (IEA, 2013). Aviation is also growing at a fast rate, though its share of

global emissions is still limited to 2%. In 2012, road transport emissions represented more

than 70% of CO

emissions from the entire transport sector. In the absence of policy action,

emissions from transport could double by 2050 (OECD, 2012c).

A radical and comprehensive approach to reducing emissions from transport is required

(IEA, 2015) (Figure 8.1). This should simultaneously seek to:

•

reduce the demand for total motorised transport activity (avoid)

promote the use of “low-emission” transport modes such as walking, cycling and public

transport (shift)

use the most efficient fuel-vehicle technology system possible for all trips (improve).

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

Figure 8.1.

A potential contribution of strategies and transport modes to a 2°C future

a. Strategies

Innovation areas

Modes

b. Transport modes

GtCO

2012

2020

2030

2040

2050

2012

Rail

2020

2-,3- and 4-wheelers

2030

Light-duty vehicles

Aviation

2040

Shipping

2050

Heavy-duty vehicles

Avoid

Shift

Low carbon fuels

Efficient vehicles

Source:

IEA

(2015),

Energy

Technology

http://dx.doi.org/10.1787/energy_tech-2015-en.

Perspectives

2015,

OECD

Publishing,

Paris,

Low-carbon transport strategies should be embedded within a strategy for development

that makes more efficient use of space and takes into account environmental costs, well-

being and economic development. The challenge is particularly urgent in the context of the

rapid pace of city growth in emerging economies, which is accompanied by high levels of

air pollution. The latest estimates from the World Health Organization show that outdoor

air pollution kills more than 3.5 million people per year globally, far more than previously

estimated. The cost of air pollution in OECD countries plus the People’s Republic of China

(hereafter “China”) and India is estimated at USD 3.5 trillion per year in premature deaths

and ill health (OECD, 2014a).

Low-carbon mobility could mean cleaner air, less congestion and better growth. But

this will not happen without proactive policy action and integrated approaches, particularly

at the urban level.

Sustainable transport for low-carbon cities

Urban areas play an important role in current and future trends in transport emissions.

By 2050, an estimated 66% of the global population is expected to live in urban areas (UN,

2014). Cities in the developing world are seeing the most rapid growth in car fleets, and it is

here where population and income growth will be concentrated in the coming decades

(Figure 8.2). For instance, 40% of the total global growth in CO

emissions from land-

based passenger transport will be generated in urban agglomerations in Latin America,

India and China (OECD/ITF, 2015a).

A city’s low-carbon pathway will require a multi-dimensional approach, as it depends

on several factors such as socio-economic variables, resource endowment, geographical

settings, and financial and institutional capacities, and has specific challenges.

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II.8. OPTING FOR LOW-CARBON URBAN MOBILITY –

185

Figure 8.2.

Growth of world urban population in absolute numbers

of new urban dwellers (billion inhabitants), 1950-2050

Developed countries

0.9

0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

1950-70

1971-90

1991-2010

2011-30

2031-50

Developing countries excluding Asia

Non-OECD Asia

China (People's Republic of)

Source:

UN (2014),

World Urbanization Prospects: The 2012 Revision,

United Nations, Department of

Economic and Social Affairs, Population Division, Population Estimates and Projections Section, available at:

http://esa.un.org/wpp.

For cities whose infrastructure is already locked in, very low – or even zero – emission

fuels and vehicles will be key to a low-carbon strategy. This is the case in many OECD

countries, where urban development has often involved low-density expansion, apart from

some exceptions where it was geographically impossible (OECD, 2010). However, the

need for integrated land-use planning is still a vital element of any policy mix aimed at

minimising the predominance of automotive mobility in pre-existing urban settlements and

reducing congestion. Complementary measures such as encouraging more efficient public

transport systems, land-use planning or reducing transport demand through greater

teleworking will further facilitate the low-carbon transition in these cities, while also

contributing to reducing congestion and improving well-being (IEA, 2013).

In developing countries, where most of the infrastructure still needs to be built, there is

more opportunity to influence the carbon signature of cities through land-use planning.

Urban development needs to urgently limit the demand for mobility and be compatible with

public transport while preserving well-being and economic growth and ensuring access to

safe, affordable, accessible and sustainable transport systems for all, in line with sustainable

development goals. “Avoid” and “shift” policies for passenger transport have the greatest

potential in growing cities, where land-use planning and investment can still have an impact

on the distance between homes and workplaces and the choice of transport on offer. Sprawl

can be minimised and well-being maximised through carefully planned dense, mixed-use

development with good mobility choices, while preserving green infrastructure. The

International Transport Forum’s (ITF) analysis shows that promoting transit-oriented

development could reduce the carbon intensity of urban mobility by 31% in Latin America,

26% in China and 37% in India, compared with a business-as-usual scenario (see

OECD/ITF, 2015a; Box 8.1).

Policy makers will have to adapt their policy mixes to the physical characteristics and

maturity of urban settings, as well as well-being and economic development factors. While

compact city development can lead to fewer or shorter motorised trips and a greater use of

public transport (OECD, 2012a), it can also have local negative impacts, such as increased

congestion creating local concentrations of air pollution (Melia et al.,

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

Box 8.1.

Promoting transit-oriented development would reduce the carbon intensity of cities

An ITF analysis shows that promoting transit-oriented development could reduce the carbon intensity of

urban mobility by 26% in Latin America, 31% in China and 37% in India by 2050.

Transit-oriented development involves building mass transit corridors that serve as the main transport axes

of cities while encouraging high-density development along them. As transit-oriented development increases the

value of land along these corridors, it offers a better opportunity to finance investment through land-value

capturing. Transit-oriented development also typically fosters mixed land use that tends to reduce the average

distance of trips and facilitates non-motorised transport. By increasing the financial viability of public and

non-motorised transport, as well as improving conditions for its use, transit-oriented development encourages the

greater use of these less carbon-intensive transport modes in total urban mobility.

Two alternative policy pathways were modelled:

•

A private transport-oriented urbanisation scenario was constructed involving policy trends that intensify

the shift to private transport use. These are high sprawl, low expansion of public transport and low fuel

prices. This scenario is combined with a scenario of rapid expansion of road infrastructure (high roads).

A public transport-oriented urbanisation scenario involves policy trends that increase the role of public

transport in urban mobility. This scenario combines low sprawl, high public transport expansion and high

fuel prices. The policy pathway is modelled in a context of urban road infrastructure lagging behind urban

population growth (low roads).

•

These pathways were compared to a baseline scenario constructed on the assumption that current trends in

each of the contexts will continue in the future. Overall, aligning policies towards public transport-oriented

urbanisation reduces the carbon intensity of urban mobility. This would cut transport-related CO

emissions

growth by 31% in urban Latin America, 26% in China and 37% in India by 2050.

Figure 8.3.

Scenarios of growth in mobility and CO

emissions for Latin American,

Chinese and Indian cities, in 2050

2010=100

a. Growth in passenger kilometres

b. Growth in CO

emissions

Transit-oriented development for new suburban areas must be carefully planned so that it does not create

additional demand for development on land not served by the new public transport system and eventually lead to

auto-dependent urban sprawl.

Sources:

OECD/ITF

(2015b),

ITF

Transport

Outlook

2015,

OECD

Publishing,

Paris,

http://dx.doi.org/10.1787/9789282107782-en;

OECD (2012a),

Compact City Policies: A Comparative Assessment,

OECD

Green Growth Studies, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264167865-en.

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2011), increasing heat island effects that can exacerbate climate change impacts, or

destroying green urban infrastructure and ecosystems. Compact development can also face

strong social opposition, as city dwellers may value green space and low-density housing.

Where densification is deemed the way forward, it must be accompanied by measures to

mitigate these local negative impacts. Such measures might include increased coverage by

public transport systems or additional green spaces (OECD, 2012a).

Complementarities across policy sectors, programmes and levels of government

National governments have two clear roles to play in enabling sub-national

governments to achieve their potential for advancing green growth: 1) to create favourable

environments for sub-national action; 2) to integrate national and sub-national actions to

improve coherence, promote learning, seek complementarities and reduce conflicts among

sectoral strategies (GGBP, 2014).

Adopt a co-benefit approach to transport planning

Climate change concerns are rarely the catalyst of transport infrastructure decisions.

These are usually driven by economic imperatives such as reducing congestion, improving

accessibility and improving air quality in cities. Yet switching to low-carbon transport often

has benefits for other policy goals. Such complementarities should be facilitated at higher

levels of government by developing an integrated long-term infrastructure plan (Ang and

Marchal, 2013).

Transport systems should also be adopted on the basis of cost-benefit analyses of

alternative transport options and land uses which consider all the environmental, social and

economic externalities of development. Economy-wide measures (e.g. carbon pricing) are

critical to the response to climate change and for developing low-carbon transport. A strong

national framework based on a carbon tax or price will broaden the range of

environmentally effective options available to cities (OECD, 2014d). Many OECD

countries have started using a price on carbon in their national cost-benefit analyses, albeit

with very different values and methods (Smith and Braathen, 2015; see also Chapter 1).

Engage stakeholders and integrate transport and spatial planning to ensure

effective provision of infrastructure

Whatever the city context, transport and spatial planning policies need to be

co-ordinated across metropolitan areas to ensure that transport modes and land use work

together to reduce GHG emissions. Co-ordinating land use and transport planning is also

crucial to increase the climate resilience of new or existing transport infrastructure: land use

and zoning can worsen or reduce its exposure and vulnerability to climate change impacts.

Climate risk assessments and adaptation strategies need to be integrated into transport and

land-use planning (Ang et Marchal, 2013).

Given the multiplicity of stakeholders and authorities involved in transport, aligning

policy goals and integrating transport planning require systems of governance and

institutional integration across levels of government and between stakeholders. Engaging

key public, private and civil society stakeholders early in the decision-making process of

transport infrastructure investment is essential to ensure effective provision of sustainable

transport infrastructure.

However, in the vast majority of cities, land use and transport planning are the

responsibility of separate authorities whose co-ordination mechanisms are limited or

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

informal. The result is suboptimal infrastructure design. In Bogotá, for example, limited

planning for the optimal location of bus stations for the Transmilenio bus rapid transit

(BRT) system and a lack of incentives for private property owners to redevelop land along

corridors have hindered a low-carbon shift in urban development (OECD/ITF, 2015a). In

order to reduce costs, bus stations were located in the medians of busy roadways, often with

poor pedestrian access and in economically depressed and marginalised urban areas with

minimal development potential. In Ahmedabad, land-use planning around bus stations was

also absent in the planning process for the Janmarg BRT system. This has resulted in low

pedestrian accessibility to BRT stops and limited land-use change around stations (Cervero

and Dai, 2014).

The institutional structure and administrative boundaries of a metropolis often do not

allow all aspects of public transport to be conceived and operated in a way that is designed

to complement other modes and minimise overall environmental impact. Often functional

areas – e.g. key commuting zones – do not match administrative units in urban areas

(Figure 8.4). Such fragmentation can be a significant barrier to integrated transport

strategies and promote increased car use. In Chicago, for example, approximately 36% of

the population works outside the city, and 46% of city workers live in the suburbs. Yet the

division of the public transport system into urban (Chicago Transit Authority, or CTA) and

suburban (Pace and Metra) authorities means that CTA bus services typically end abruptly

at the city limits where Pace services begin, and none of Metra’s downtown commuter rail

services connect directly to the CTA rail network (Merk, 2014). The result is greater car

dependence. Fragmentation can be overcome through appropriate governance

arrangements. In Paris, for instance, transport planning is developed at the regional level

rather than at the city level, through the Syndicat des transports d’Île-de-France (STIF,

Box 8.2).

Figure 8.4.

Functional areas do not match administrative units in urban areas

Note:

The

OECD Metropolitan Database

identifies 1 148 urban areas, defined as integrated labour markets with

at least 50 000 inhabitants in 28 OECD countries.

Source:

OECD (2012b),

Redefining Urban: A New Way to Measure Metropolitan Areas,

OECD Publishing,

Paris,

http://dx.doi.org/10.1787/9789264174108-en.

Misalignment of pricing frameworks with low-carbon policy objectives also limits

opportunities to cross-subsidise lower carbon-intensive modes with revenues collected from

higher carbon-intensive modes. Cross-subsidising has proven a good way to increase the

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acceptability of transport demand management policies and increase funding availability. In

other cases, fare structures are not integrated. In Jakarta, passengers often buy a new ticket

every time they transfer BRT lines (Hidalgo, 2010). Weaknesses in the public transport

system also reduce residents’ mobility and limit the perimeter of their potential job markets,

thus exacerbating inequality of access to employment within the metropolitan area.

Misalignment of objectives across different levels of government further increases

complexity for integrated urban development planning. In Mexico, for example,

municipalities are responsible for urban planning and development, whereas state

governments are in charge of mobility and transport policy, transport infrastructure and

operation of public transport. In the metropolitan area of Puebla-Tlaxcala, limited

co-ordination between levels of government and a lack of integration between transport and

urban development have contributed to the suboptimal siting of some BRT routes (OECD,

2013b).

Overcoming government fragmentation

Experience shows that there is no one-size-fits-all strategy for overcoming these

administrative difficulties. Solutions for better alignment range from the creation of a single

entity with authority over transport and land-use planning to looser forms of collaboration

(OECD, 2010). Many urban agglomerations have created metropolitan governance bodies

to integrate land-use and transport planning (Ahrend et al., 2014; OECD, 2015; see Box 8.2

for examples of successful transport and land-use integration). Other modes of co-

ordination include contracts, platforms for dialogue and co-operation, specific public

investment partnerships, joint authorities, or regional or municipal mergers (OECD, 2013c).

Consolidating independent authorities on a metropolitan scale and building multi-modal

planning and management capacity could help make significant progress towards an

integrated transport and planning framework that fosters less carbon-intensive urban

mobility.

To help resolve this functional mismatch, the OECD, in collaboration with the

European Union, has constructed a new definition of cities that is comparable across

countries and corresponds to their functional economic areas rather than administrative

boundaries. The Functional Urban Area methodology uses information on density and

commuting patterns in order to identify boundaries that approximate a city’s functional

labour market, relevant scale to plan transport and land-use planning (OECD, 2012b).

Remove barriers to action by cities

Sub-national governments have a fundamental role to play in the low-carbon transition.

They are typically in charge of decisions that affect the carbon signature of cities, and can

influence the total level of urban transport activity by changing the distribution of activities

in space (for example, by changing land-use patterns, densities and urban design). In 2012,

sub-national governments were in charge of 72% of total public investment (in terms of

volume) across the OECD area. While not all of this is transport-related, 37% is allocated to

economic affairs (transport, communications, economic development, energy,

construction, etc.), around 23% is used for education, a further 11% is dedicated to housing

and community amenities, and around 4% is dedicated to the environment (OECD, 2013f).

All of these areas can be influential in transitioning to low-carbon cities. For example,

education programmes can influence greener behaviours, and housing programmes can

focus on energy efficiency.

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Sub-national government budgets are under pressure following fiscal consolidation

across all OECD countries. After a wave of “green” stimulus packages in 2008-09,

resources for public investment have been reduced significantly, as they are one of the more

flexible items in budgets. The challenge is not only to finance investments, but also to make

the best of investment funds through appropriate governance arrangements. For instance,

neither national nor sub-national governments may have had the appropriate tools or

capacities to make the most of green stimulus funds.

The low-carbon transition requires that sub-national governments’ financial incentives

are aligned with the need to limit urban sprawl, encourage higher densities and provide

public transport systems. As transport infrastructure investments are long-term, revenue

needs to be predictable. Public transport infrastructure is also generally capital-intensive.

Supportive national frameworks are vital for allowing cities to raise the revenue they need

to create and maintain low-carbon infrastructure. These frameworks can also create the

conditions – both in terms of legal competences and actual capacities – to enable cities to

seek funding from the private sector and financial markets (OECD, 2010; 2014c).

Removing fiscal and regulatory impediments

National legislation typically defines cities’ and sub-national governments’

responsibilities, powers and, crucially, revenue sources. The fiscal system structures to a

great extent what cities can and cannot do – and their incentives for action (OECD, 2014c).

Despite local planning efforts to tackle urban expansion, some national tax provisions

encourage carbon-intensive development (OECD, 2014d). These perverse incentives are

discussed in more detail in Chapter 3, but the key steps needed to remove them follow.

•

Remove fossil fuel subsidies.

Fossil fuel subsidies favour and encourage the use of

individual cars. In 2013, they amounted to USD 548 billion in developing countries (IEA,

2014). In OECD countries, between USD 55 and 90 billion was spent by OECD country

governments annually between 2005 and 2010 to support coal, oil and gas production and

use (OECD, 2013a).

Remove the tax differential between diesel and gasoline.

In 30 out of 34 OECD

countries tax rates for diesel are lower than for petrol. This tax differential is at odds with

the environmental effects of each fuel, including CO

emissions (Harding, 2014a).

Change the tax treatment of commuting expenses and company cars.

Company cars

represent a substantial share of the car stock in many OECD countries. Tax regimes for

company car use and commuting expenses can favour certain modes of transport over

others, influencing how much, and how, employees travel (Harding, 2014b).

Fuel taxation: an incentive to sprawl?

Governments could investigate the extent to

which fuel taxation has an influence on the type of urban forms. Fuel taxation is very

different across countries, and can be an important driver behind the type of urban form

(e.g. densely populated vs. sprawled metropolitan areas).

Reform property taxes to limit urban sprawl.

Property tax levied on buildings and

other land improvements rather than on land values can make greenfield development

more attractive to cities than infill, hence encouraging urban sprawl (Merk et al., 2012).

In several countries, the design of property taxes promotes urban sprawl by favouring

single-family, owner-occupied housing over multi-family or rental housing, or limiting

incentives to move closer to work.

•

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•

Remove perverse housing and zoning regulations.

Individual cities’ housing and

zoning policies (including restrictions on density, floor-to-area ratios and the construction

of multi-family housing) can strongly influence GHG emissions (Glaeser and Ward,

2009). Limits on building height in cities and zoning that blocks denser development in

the suburbs can raise housing prices. This can cause workers to seek housing further away

from their jobs where it is more affordable. This then tends to increase carbon emissions

from transport unless significant investments in public transport are made. In many

countries, e.g. Chile or Mexico, national urban housing authorities also commonly

provide low-income housing on city peripheries, where land is cheaper but access to

public transport is poor and financially unsustainable (OECD, 2013c).

Ensure a resilient and stable tax base

For cities in the OECD, taxes are the most important source of revenue, representing

more than half of all revenues on average. Sub-national governments need a broad and

diverse tax base if they are to be resilient to economic fluctuations. Local revenues most

often come from highly volatile taxes, such as corporate profits. Corporate tax revenues are

mobile, highly cyclical, geographically concentrated and prone to shift the tax burden onto

non-residents (Blöchliger and Petzold, 2009). Property taxes are more stable than corporate

taxes, and their design can be instrumental for limiting sprawl. For example, split-rate

property taxes – in place in Sydney; Hong Kong, China; and cities in Denmark and

Finland – tax land more heavily than buildings (see also Chapter 3). Alternatively, some

countries have transfer mechanisms that incorporate automatic stabilisers, such as those

used in northern Europe to finance social services (Council of Europe, 2011).

Box 8.2.

Examples of integrated land-use planning and transport at the metropolitan level

United Kingdom: Transport for London

Transport for London (TfL) is a statutory body created by the Greater London Authority (GLA) Act

1999. This act gives the Mayor of London a general duty to develop and apply policies to promote and

encourage safe, integrated, efficient and economic transport facilities and services to, from and within the

Greater London area. TfL is in charge of the operation of public transport, highway construction and

management including congestion charging and vehicle licensing. In order to align an increasing

population with more sustainable low-carbon transport, TfL investments range from introducing cleaner

buses to encouraging alternatives to motorised travel such as cycling and walking, as well as improvements

to the urban environment. The financial capacity for continuous investment and improvements comes from

six main sources: income from fares and the congestion charging scheme; central government funding; a

proportion of London business rates; prudential borrowing; commercial development of its estate,

including advertising and property rental; and development and third-party funding for specific projects

(TfL, 2014; ITF, 2013).

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

Box 8.2.

Examples of integrated land-use planning and transport at the metropolitan level

(cont.)

United States: Metropolitan Planning Organisation

In the United States, urban areas with more than 50 000 residents must have a designated metropolitan

planning organisation (MPO) in order to qualify for federal transport funding. To obtain federal funding, MPOs

are required to produce long-term transport plans based on a comprehensive analysis of demographic, travel and

employment trends for their regions, as well as to propose a series of transport improvements to meet projected

needs. Each decision on major investments planned for the region must be evaluated against a set of alternatives

in order to ensure that the most cost-effective solutions are chosen. The long-term plans are then translated into

rolling five-year transport improvement programmes, which list all projects to be funded in the MPO’s

jurisdiction over the next five years and identify the sources of funding that have been allocated to each. This

certain (long-term) funding stream relieves the financial strain on metropolitan authorities in their quest to meet

increasing needs for metropolitan-wide mobility and encourages co-ordinated decisions (OECD, 2015).

Singapore: Land Transport Authority

In Singapore, the Land Transport Authority (LTA) is a statuary board under the Ministry of Transport,

established in 1995 as a result of a merger of four government agencies. A higher degree of integration was

achieved by removing administrative boundaries. The LTA is responsible for planning, operating and

maintaining land transport infrastructure and systems, including road safety, vehicle licensing and electronic road

pricing. In order to reduce carbon emissions, the LTA constantly improves and expands its current public

transport network, complementing it with parking policies and electronic road pricing. This has seen a shift from

private to public transport use over recent years. In 2012, 63% of trips during morning and evening peak times

were on public transport, compared to 59% in 2008. To increase this number even further, the LTA aims to make

the transport system even more accessible and competitive. By 2030, 80% of households should be within a

10-minute walk of a train station, 85% of public transport journeys (less than 20 kilometres) will be completed

within 60 minutes and 75% of all journeys in peak hours will be via public transport (LTA, 2013). The LTA’s

investments mainly stem from government grants and operating income, such as management fees from the

government (taxes, fees and charges relating to land transport services) (LTA, 2014).

Germany: Rhein-Main-Verkerhsverbund

In Germany, every large urban agglomeration is covered by a transport authority. These transport authorities

usually bring together all sub-national governments located in the metropolitan area as well as the relevant

federal government departments. They manage public transport provision across the various modes of transport,

provide strategic planning and co-ordinate pricing schemes for tickets that are valid across different modes of

transport and different service providers. Typically, the transport authorities cover the full extent of the

metropolitan area, but in some cases they reach significantly beyond their borders. In the Frankfurt metropolitan

area, the Rhein-Main Transport Association (Rhein-Main

Verkehrsverbund,

RMV), brings together 3 levels of

government: 15 counties, 11 cities and the federal state of Hesse. All key decisions on policy and strategy are

taken by the Supervisory Board of the RMV, which agrees on the range of services on offer and the fare system.

Its members are delegates of the shareholders, with each having one vote in order to adequately represent the

different ideas and needs of the individual regions in the RMV network area. To achieve low-carbon emissions,

the RMV also invests in cleaner trains and buses; in 2011 hybrid buses were introduced to the transport network.

The RMV is financed by fare revenues, federal funding transferred via the state governments and municipal

funds (OECD, 2015; RMV, 2014).

France: Syndicat des transports d’Île-de-France

Organising transport authorities (known as AOT in French) have existed in France since 1980 with the aim

of promoting urban transport alternatives to private cars. The STIF is the organising transport authority for the

Île-de-France and is integrated by the Region of Île-de-France, “departments” (counties) within the region and

the city of Paris (CEPAL, 2009).

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Box 8.2.

Examples of integrated land-use planning and transport at the metropolitan level

(cont.)

The institutional setting of the STIF is similar to other metropolitan areas of France, but it has had more

success than most other transport authorities in achieving institutional co-ordination to advance low-carbon

mobility goals. For example, between 2001 and 2010 total public transport trips in the Île-de-France region rose

21%, while car trips only grew by 0.6% (STIF, 2012).

The STIF “defines general operational and service level targets, sets fares and negotiates performance-based

contracts with public service providers”. The STIF is responsible for negotiating contracts with the national

government (contrat

de project État-region,

or CPER) in which they agree upon a programme for capital

investment and set funding responsibilities between national and regional governments. The STIF also develops

an urban mobility plan (plan

de déplacements urbains,

PDU) that includes land-use and transport plans that

guide all subordinate levels of government. The PDU includes precise objectives that should be met in order to

contribute to the national CO

emission mitigation target (20% reduction by 2020) and establishes a programme

of actions that will help attain such objectives.

This programme of actions is subject to opinions from regional, general and municipal councils; transport

users; experts and environmental associations (the STIF approves the plan after one month of public

consultation). This framework has been important in fostering consensus over future plans among all actors and

has also facilitated public support. It has been important in giving coherence to the multiplicity of projects

implemented by different authorities (since only those that are coherent with the plan can be financed) (CEPAL,

2009).

Curitiba, Brazil: Urban Transport Planning Authority

The Curitiba Metropolitan area comprises 26 municipalities with a total population of over 3.2 million.

Curitiba’s bus rapid transit system (BRT) is renowned as a pragmatic, integrated, cost-effective and efficient

transport system. The city’s success is thanks to close co-operation between its urban transport planning

authority (URBS), responsible for transport, and the urban development authority (IPUCC), which is in charge of

land-use planning. Since its launch in 1974, the Curitiba BRT has been notable for its careful alignment with the

1965 Curitiba Master Plan, which focused the city’s growth along major corridors through land-use and zoning

regulations. Building on this core concept, the Curitiba BRT has continually improved efficiency and expanded

access. The integrated transport network (RIT) brings together feeder and inter-district buses, with transfer

stations and a single fare, and has considerably improved the system’s coverage and utility. Today, the RIT

covers 14 of the 26 cities which make up the metropolitan area (URBS, 2014). The RIT was conceived around

structural axles that provide the backbone of a transit-oriented development initiative through relatively low-cost

and high-impact interventions (ITDP, 2014). Despite Curitiba’s above-average rate of car ownership, the BRT

service combined with parking policies has reduced automobile trips per year and ambient air pollution is among

the lowest in Brazil (Lindau et al., 2010). The URBS is responsible for the planning, management, operation and

control of the transport system in Curitiba. It defines routes, capacity and schedules; regulates and controls the

bus system; and collects all fares. Bus operations are contracted to private sector operators. Fare revenues are

pooled and paid to the contracted operators on the basis of the services provided. The complete RIT system, with

its range of buses and integrated flat passenger fare, is reported to operate without subsidy (Lindau et al., 2010).

Source:

OECD/ITF (2015a), “Shifting towards low carbon mobility systems”, Discussion Paper No 2015-17, May 2015

OECD/ITF, Paris.

Increase cities’ autonomy

Transfers from national governments are another significant source of revenue for sub-

national governments, but they have pros and cons. Low-carbon transport investments

would typically be eligible for earmarked grants and matching, as they generate positive

spillovers for neighbouring areas (OECD, 2014b). Government transfers are also useful

when risk sharing is needed, or when guidance from higher levels of governments is needed

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to improve co-operation and align different policy objectives (OECD, 2009), and when it is

desirable to align priorities across levels of government.

However, reliance on transfers from higher levels of government often limits cities’

scope for medium- to long-term planning means they relinquish part of their fiscal

autonomy, and renders them vulnerable in times of economic difficulty (OECD, 2014c).

Problems can also arise from a lack of co-ordination among funding from a variety of

national funds or between these and local funds. In Mexico, for example, 13 funds are

available to finance urban mobility, but there is no co-ordination among them. Federal

grants to local projects do not include sustainable urban mobility objectives, which means

investment in urban roads is prioritised. In 2013, 74% of federal funds for urban mobility in

59 metropolitan areas were spent on road infrastructure (ITDP, 2014). Conditioning the

allocation of grants to environmental objectives could facilitate the shift to a low-carbon

economy. For instance, some

Länder

(states) in Germany have included ecological

functions in their calculations of the fiscal transfer from

Länder

to sub-national

governments (OECD, 2010).

Since the financial crisis, many cities around the world have had to cut budgets

following a fall in intergovernmental transfers (Merk et al., 2012; OECD, 2013f). Between

2007 and 2012 in the OECD area – especially Iceland, Ireland, Italy, Portugal and Spain –

sub-national governments’ direct per capita investment contracted sharply (-7% in real

terms between 2007 and 2012 and -15% in the three years since). In most countries, sub-

national governments decided to preserve current expenditure on welfare, health or

education and cut public investment (OECD, 2014c).

Reform fees and charges to discourage sprawl and encourage public transport

use

Fees and charges are a third source of revenue for sub-national governments. For

example, development charges can be levied on project developers to help fund the

underlying infrastructure. The design of these charges can also encourage certain types of

development (such as brownfield projects in city centres to avoid urban sprawl; OECD,

2010). While in some municipalities development fees increase with distance from the

urban core, more often their rates are similar across the city, which does nothing to

discourage sprawl.

Transport-related fees and charges can play an important role in reducing car use,

particularly congestion charges, parking fees and taxes. Congestion pricing and other forms

of road user charges (e.g. highway tolls) can help reduce congestion, vehicle use, local air

pollution and GHG emissions. Such concepts have been implemented in London,

Stockholm and Singapore. Congestion pricing is usually handled locally, imposed for entry

to downtown and business districts, and sometimes calculated based on the congestion level

or time of the day (Ang and Marchal, 2013). Road pricing systems (e.g. fixed road network

access charges, tolls and electronic kilometre charges) can also target trucks to encourage

freight efficiency improvements and shift from trucks to rail. Such policy should be part of

an integrated strategy that proposes alternatives to the use of individual cars such as mass

transport systems and promotes teleworking practices. Carbon and congestion pricing

schemes are typically set to internalise external costs such as GHG emissions or travel time

costs resulting from congestion. As such, those tools are designed to be demand

management systems rather than revenue-generating instruments. However, revenues are

often earmarked: parking charges are also frequently used as sources of revenues by sub-

national governments, e.g. to finance public transport (Ang and Marchal, 2013).

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Land sales are a large source of revenue for certain cities, particularly in India and

China (Box 8.3). For example, land sales represented 80% of local revenues for the city of

Shenzhen in the 1990s (OECD, 2013e; Merk et al., 2012). However, these policies can

encourage cities to convert arable land into urban land with a view to selling it, thereby

encouraging low-density urban expansion. A more environmentally friendly urban planning

framework would require this type of funding arrangement to be reformed.

Box 8.3.

How sub-national governments’ fiscal frameworks influence urban

development in China

In China, municipal finance depends heavily on land-related income such as land leases,

auctions and development. This has created strong financial incentives for sub-national

governments to build excessive quantities of scattered, low-density urban development.

Moreover, cities have a financial incentive to make a large amount of land available for

industrial development in order to attract investment. This restricts land availability for

residential and service sectors and contributes to unchecked urban sprawl, high housing density

coupled with an oversupply of land available for industrial development. A tradition of

functional separation in zoning, in turn, leads to longer commutes and more congestion.

Sources:

OECD (2013c),

Green Growth in Cities,

OECD Green Growth Studies, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264195325-en;

OECD (2013f),

OECD Regions at a Glance 2013,

OECD

Publishing, Paris,

http://dx.doi.org/10.1787/reg_glance-2013-en;

Merk, O. et al. (2012), “Financing green

urban infrastructure”,

OECD Regional Development Working Papers,

No. 2012/10, OECD Publishing,

Paris,

http://dx.doi.org/10.1787/5k92p0c6j6r0-en.

Facilitate informed access to financial markets

The new context of fiscal austerity means that it is fundamental for cities to be able to

access capital markets to fund low-carbon development. When funding is limited,

investment in transport systems, in particular public transport facilities, is often the first to

suffer. Several large urban areas throughout Europe and North America have relatively

mature public transport networks whose operation and upkeep is expensive. The Chicago

region, home to the largest rail and bus networks in the United States, illustrates the

downward spiral that occurs when budgets run low: its public transport infrastructure has

suffered such major underinvestment in maintenance that existing and future services are

compromised. Financial sustainability has also been elusive, and the current system – based

largely on fare and sales tax revenue – will struggle to keep up with rising expenses (ITF,

2013).

To overcome this shortage of funding, sub-national governments need to be able to

leverage private sector investment and access international financial markets. However, the

ability of cities to raise financing on international markets is limited. Sometimes national

frameworks do not allow sub-national governments to issue bonds, and undermine local

financial stability by restricting sub-national governments’ ability to raise taxes and borrow

from the private sector. In addition, sub-national governments often have lower credit

ratings than the national government, as their default risk is considered to be higher

(Merk et al., 2012; see Box 8.4).

Box 8.4.

Improving cities’ access to credit and finance

Access to credit and finance is a key challenge for cities in financing their infrastructure

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

base. The nature of the challenge varies with country conditions, and the instruments and tools

used to facilitate access to finance will differ also. In low-income developing countries, grants,

loans and other development finance instruments could be relevant.

One of the key problems for developing country cities is their poor creditworthiness. The

World Bank estimates that only a small percentage of the 500 largest cities in developing

countries are deemed creditworthy – about 4% on international financial markets and 20% on

local markets. The World Bank and its partners have designed a City Creditworthiness Program

to help city financial officers conduct thorough reviews of their municipal revenue management

systems and take the first steps to qualify for a credit rating. To address immediate financing

needs, cities, with the support of national governments or international financing institutions, can

access new or innovative financing arrangements such as loans, bonds, specific investment

funds, tax arrangements or market-based mechanisms that may be particularly useful to finance

green investments. For example, the US federal government financially supports municipal

bonds (through tax exemptions and subsidies), and the World Bank offers green bonds for cities

in low- and middle-income countries as part of the project financing component within a

country’s assistance portfolio. Sub-national governments should use innovative financing

instruments with an understanding of the capacities needed, as in some cases they could

compromise local finances and cause risky dependence on financial markets.

Sources:

Based on Word Bank City Creditworthiness Program; Merk, O. et al. (2012), “Financing green

urban infrastructure”,

OECD Regional Development Working Papers,

No. 2012/10, OECD Publishing,

Paris,

http://dx.doi.org/10.1787/5k92p0c6j6r0-en;

OECD (2013g,

Government at a Glance 2013,

OECD

Publishing, Paris,

http://dx.doi.org/10.1787/gov_glance-2013-en.

Between 2007 and 2012, sub-national gross debt per capita in the OECD area grew by

14%, corresponding to an increase of around USD 1 000 per capita. Only Israel,

Switzerland and the United States saw sub-national government debt decrease on average

during that period (OECD, 2013g). When monitoring municipal debt, national governments

face a trade-off. On the one hand, cities need room for manoeuvre, especially in times of

financial stress, to invest in infrastructure. On the other hand, many countries have run into

difficulties over sub-national government debt.

The main challenge, therefore, is to create mechanisms that ensure economic stability

and sound fiscal management while ensuring sub-national governments have sufficient

financial capacity to deliver public services and finance essential investment (OECD,

2014d). So that national governments can ease the way for city governments to develop and

implement their own financing strategy (OECD, 2014b), clear policies on prudential and

macroeconomic limits to borrowing will be needed and subjected to processes of public

scrutiny. Clear rules and procedures are also needed to govern cases of municipal

insolvency (Council for Europe, 2011).

Build capacity for working with the private sector

Involving the private sector in urban transport infrastructure can contribute to the

success of the low-carbon transition. For example, many mass rapid transit systems require

close collaboration between public and private actors. While public-private partnerships

(PPPs) and other frameworks for private participation in the supply of local public goods

and services are increasingly important in many OECD cities, experience to date with PPPs

has been mixed. While they should deliver better value for money if properly designed,

they have sometimes been used to finance projects that would not have been approved

otherwise. An OECD survey found that the lack of adequate capacity by sub-national

governments for managing PPPs was seen as a significant challenge by 16 of 19 responding

OECD country governments (OECD, 2013d).

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Governments wishing to expand the role of private finance in urban public investment

may therefore need to address these capacity issues. They could do so, for example, by

establishing dedicated PPP units to work with local authorities, establish guidelines for

lower level governments or create explicit incentives to engage the private sector, such as

minimum private sector funding to access national funds (OECD, 2014c).

Removing bottlenecks to energy efficiency and technology breakthrough

Our reliance on fossil fuel vehicles is perpetuated by the widespread use of fossil fuel-

oriented infrastructure, innovation policies that support fossil fuels and the relatively low

cost of road transport for consumers. These signals will need to be reversed for

breakthrough low-carbon solutions to be rapidly deployed. Innovation in electric and hybrid

vehicles is progressing, but a number of market failures and barriers are hindering the

scaling-up of alternative fuel vehicles. Such breakthroughs will require governments to

provide the policy mix needed to challenge existing infrastructure based on fossil fuels.

Experiences with electric vehicles in the Netherlands and Norway show that combining

battery-charging infrastructure, rebates on electric vehicle purchases and priority lanes on

main access roads can lead to very rapid uptake. However, these efforts come at a high cost.

There is a need for a thorough cost-benefit assessment of those programmes. Policy

flexibility is also advised in order to avoid technological “lock-in”.

Energy efficiency could be the most important contribution to low-carbon

transport sector

Energy efficiency from technology improvements could be the most important

contribution to GHG emission reductions in transport by 2050 (IEA, 2015). A strong and

stable price on carbon would be the first best solution to move towards more efficient

transport modes, but many other barriers stand in the way of energy efficiency. Policies to

improve road vehicle fuel economy should address market failures, information gaps and

the higher upfront costs associated with more innovative technologies.

An integrated approach to improving the efficiency of new cars combines three policy

elements: information measures such as fuel economy or CO

emissions labelling; vehicle

fuel economy and CO

emission standards; and fiscal measures such as vehicle taxes and

tax incentives and fuel taxes (IEA, 2012).

Many OECD and non-OECD countries have started developing policy support for fuel

efficiency, but their policies are not always in line with the climate objective. The

appropriate mix of policies depends on a particular country’s circumstances, such as the

overarching policy setting, infrastructure, and market and behavioural failures that need to

be addressed (IEA, 2012).

Fuel efficiency standards are useful tools for delivering fuel efficiency and generating

the technological changes needed for a low-carbon transition, provided that they are

technology neutral. Fuel economy standards have been implemented in most OECD

countries, as well as in China and India. But countries should investigate whether these

standards are in line with long-term climate goals. Because of an expedient policy process

and strong vested interest, targets may be set at the most feasible level rather than the

optimal level necessary to meet the objective. Standards can also sometimes be designed to

favour national car industry. In addition, some gaps remain for heavy duty road vehicles.

Note should be taken of the multiplication of different standards internationally – this could

create fragmented markets for the private sector, limiting incentives to investment.

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

Aligning vehicle taxes with the fuel efficiency or CO

emissions values of vehicles can

make fuel-efficient vehicles more fiscally attractive, strongly encourage consumers to buy

such vehicles and incentivise manufacturers to improve their fuel efficiency. While in the

past vehicle taxes were mostly based on engine capacity, power or vehicle mass, in the last

few years many countries have switched their vehicle tax system to account for CO

emissions. Some countries combine vehicle taxes with a rebate to customers purchasing

lower fuel-consuming vehicles, such as the

bonus-malus

system in France (IEA, 2012).

Overcoming infrastructure lock-in: the case of alternative fuel vehicles

It is impossible to predict the technology mix that will achieve the low-carbon

transition. But it is clear that while existing technologies offer potential for further

improvements in environmental performance, new low-carbon solutions and more radical

innovations will have to enter the mass market (Beltramello, 2012). This will require

governments to remove support to existing carbon-intensive technologies and bring

economic, legal and regulatory frameworks in line with the demands of new technologies

and business models.

Governments should consider implementing a range of policy interventions, depending

on the maturity of the technology considered (IEA, 2013a: Box 2). For high-potential and

lower maturity technologies, technology push policies could be justified in a context where

urgent climate action is needed: such policies include research, development and

demonstration (RD&D) support and support to the deployment and development of energy

distribution infrastructure, particularly in urban contexts. They would also lead to reduced

fuel tax revenues, making the political economy of implementation challenging.

Innovation in electric and hybrid vehicles has been progressing more rapidly than other

green innovation (Figure 8.4), but a number of market failures and barriers hinder the

scaling-up of these alternative fuel vehicles. These include the lock-in created by the

existence of infrastructure network effects to fuel different vehicle types; consumer

reluctance to adopt “innovative” vehicles whose characteristics have not been fully

demonstrated in the market; and limited financing for high-risk investments (such as those

associated with R&D in alternative fuel vehicles; Haš i and Johnstone, 2012).

The Netherlands and Norway have very actively promoted electric cars and have

achieved the highest penetration of electric cars in the EU. With already more than 31 000

electric vehicles as of 2014, the Netherlands’ programme to promote electric cars was well

ahead of its objective of 15 000-20 000 electric vehicles on the road by the end of 2015. In

Norway, 14% of all new cars registered were electric in 2014. Incentives to facilitate the

take-off of electric cars include: financial incentives to equalise the price between electric

cars and conventional vehicles, information initiatives to reduce potential perception

barriers and increase social acceptance, and other benefits such as access to bus lanes, free

road tolls or ferry charges, and free public parking (OECD/ITF, 2015c). Still, these efforts

come at a high cost and the effectiveness in terms of GHG emission reductions is relatively

low. More work is needed to evaluate the overall effectiveness in terms of cost-effective

climate solutions of such policies.

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II.8. OPTING FOR LOW-CARBON URBAN MOBILITY –

199

Figure 8.5.

Inventive activity in technologies included in the “green” patent index, 1990-2010

World total, change on 1990, high-value inventions PF2

Wind energy

Electric road vehicles

Marine energy

4 500

4 000

3 500

3 000

2 500

2 000

1 500

1 000

500

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Electric vehicle charging

Solar PV energy

ENVIRONMENT-RELATED TECH.

Hybrid road vehicles

Energy efficient ICT in buildings

ALL TECHNOLOGIES

Note:

Only patents for which protection has been sought in at least two international patent offices (PF2) are

included. This has been found to be a good proxy measure for high-value patents.

Source:

Haš i , I. and M. Migotto (2015), “Measuring environmental innovation using patent data: Policy

relevance”,

OECD Environment Working Papers,

OECD Publishing, Paris.

To overcome these barriers, government policies need to provide incentives along the

spectrum from invention to commercialisation and diffusion. Policy support is critical,

especially to ensure that vehicles become cost-competitive, to provide adequate recharging

infrastructure and to influence consumer behaviours to change vehicle purchase and travel

behaviour. A multi-pronged approach is required, targeting both the supply side

(technology push) and the demand side (market pull), but this could be costly.

Policies to support technological development:

•

Tailor government support policies to different stages of technology development and

base them on assessments of expected costs and expected benefits – taking any

interactions with other instruments into account (OECD, 2012c).

Ensure environmental standards are sufficiently stringent to “force” technological change

(Box 8.5).

Design policies that provide incentives for innovators to drive emissions down to zero.

Such policies have the potential to encourage “radical” and hitherto unforeseen

innovations.

More research, development and deployment is needed to reduce battery costs for electric

vehicles, as well as into “smart” grids (IEA, 2009).

Avoid using policy to “pick winners” (e.g through public procurement, R&D support

standards) and instead ensure policy flexibility to keep open a wide spectrum of

technological options, including for alternative fuel vehicles relative to other types. This

will avoid early technological lock-in. It may be more efficient to support general

infrastructure or technologies which benefit a wide range of applications, such as

improved energy storage and grid management in the electricity sector.

•

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– II.8. OPTING FOR LOW-CARBON URBAN MOBILITY

•

Ensure that design of incentives allows for a competitive selection processes, focuses on

performance, avoids vested interests and includes evaluation of policies (Haš i and

Johnstone, 2012).

Maintain continuous commitment to the policy objective: to take the risks required,

innovators need a credible and predictable policy framework.

Public procurement could play an important role in scaling-up sales in electric vehicles. It

would help overcome barriers such as network effects, economies of scale, demonstration

effects and consumption externalities (Erdlenbruch and Johnstone, 2003).

Box 8.5.

A mix of policies is required to force technological change

Haš i and Johnstone (2012) analysed the relative impact of prices and standards on

environmental innovation in motor vehicles. The analysis found that while changes in relative

fuel prices encouraged innovation in hybrid propulsion, performance standards were necessary to

drive the development of technologies related to purely electric vehicles. For example, in order to

induce a 1% increase in electric vehicle innovations, the stringency of California’s Zero Emission

Vehicle (ZEV) standard would have to be increased by 2%, while to induce a 1% increase in

hybrid vehicle innovations, fuel prices would have to increase by 5% (Figure 8.6).

Figure 8.6.

The effect of prices and standards on alternative fuel vehicle innovation

Public R&D

Electric

Hybrid

Standards

Fuel prices

•

Note:

The histogram shows empirical elasticities, evaluated at sample means and normalised in terms of the

effect of “public R&D spending” (R&D = 1.0). Bars shown “without fill” represent estimates that are not

statistically significant at the 5% level.

Source:

Haš i , I. and N. Johnstone (2012), “Innovation in electric and hybrid vehicle technologies: The role

of prices, standards and R&D”, in: OECD,

Invention and Transfer of Environmental Technologies,

OECD

Publishing, Paris,

http://dx.doi.org/10.1787/9789264115620-5-en.

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201

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des

RMV,

www.rmv.de/de/Verschiedenes/Informationen_zum_RMV/Der_RMV/Wir_ueber_uns/S

truktur_des_RMV

(accessed November 2014).

Smith S., and N.A. Braathen (2015), “Monetary carbon values in policy appraisal: An

overview of current practice and key issues”,

OECD Environment Working Papers,

OECD Publishing, Paris.

STIF

(2012),

“Enquête

globale

transport”,

www.iauidf.fr/fileadmin/Etudes/etude_954/Enquete_globale_transport_HD.pdf.

Transport for London (TfL) (2014), Standing Orders from 1 October 2014,

www.tfl.gov.uk/cdn/static/cms/documents/tfl-standing-orders.pdf

(accessed November

2014).

URBS (2014),

www.urbs.curitiba.pr.gov.br

(accessed November 2014).

UN (2014),

World Urbanization Prospects: The 2012 Revision,

United Nations,

Department of Economic and Social Affairs, Population Division, Population Estimates

and Projections Section, available at:

http://esa.un.org/wpp.

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

205

Chapter 9

Strengthening incentives

for sustainable land use

Sustainable land-management practices – reduced deforestation, restoring degraded land,

low-carbon agricultural practices and increased carbon sequestration in soils and forests –

can contribute to significant greenhouse gas emission reductions while responding to

growing food demand. They could also improve the resilience of our economies to a

changing climate by protecting ecosystems. Achieving this will require an integrated

approach that breaks down the silos between climate change, agriculture, food security,

forestry and environment policies. This chapter explores misalignments arising from the

existence of environmentally harmful agricultural subsidies, the lack of valuation of

ecosystem services and forest protection, and the incentives leading to food waste across

the agriculture value chain.

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities.

The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem

and Israeli settlements in the West Bank under the terms of international law.

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

Key messages

By 2050, land use will have to supply 60% more food than today to feed a growing

population, in a way that does not harm soil, water, biodiversity, ecosystem services or the

climate upon which human well-being and development depend. Yet current land use – mainly

agriculture and deforestation – is responsible for around 25% of man-made global greenhouse

gas (GHG) emissions.

It need not be this way. Sustainable land-management practices – reduced deforestation,

restoring degraded land, better agricultural practices and increased carbon sequestration in soils

and forests – could make a large contribution to the global climate change effort while delivering

the productivity improvement needed to respond to growing food demands. It could also

improve the resilience of our economies to a changing climate by protecting ecosystems.

Achieving this will require an integrated approach which breaks down the silos between

climate change, agriculture, food security, forestry and environment policies. As a first step, this

chapter explores the following specific questions:

Are agricultural support policies consistent with a low-carbon economy?

Agricultural

input subsidies and price support policies can reduce the environmental and climate performance

of agriculture. Since 1990, concerted efforts by OECD countries have reduced the most

environmentally harmful subsidies – such as for nitrogen fertilisers and fossil fuels – from over

85% of all agricultural subsidies to 49% in 2010-12. Governments should continue these efforts,

while redirecting support to practices, skills and infrastructure that reduce the carbon and

resource-use intensity of farming in a way that is compatible with continued productivity

improvement.

Is the trade regime for agricultural products supportive of climate goals?

Liberalising

trade measures is important for climate change mitigation, adaptation and food security.

Reducing tariffs and subsidies on agricultural products could optimise land use and reduce the

overall demand for land, reducing pressure on forested areas. A well-functioning trade system

would also support adaptation, compensating regional changes in productivity induced by

climate change. Open trade also enhances the four pillars of food security: accessibility,

availability, utilisation and stability. Yet across each dimension there is a mixture of positive and

negative effects resulting from trade openness, such as concerns over import dependence for

countries without a comparative advantage. These effects need to be managed.

Do policies undermine agriculture’s resilience to climate change?

Agriculture will likely

be very hard-hit by climate change, possibly reducing yields by 25% compared to current levels

in some regions, with drastic consequences for developing and emerging economies that depend

on agriculture. Contradictory policy signals, as well as a general lack of capacity to access and

make use of relevant climate data, can prevent farmers from integrating climate risk into their

daily practices. For example, crop insurance subsidised beyond the premiums needed to see

farmers take into account the climate threat could induce more risky farming practices. More

support is needed to help farmers adapt to drought, flooding or other climate impacts,

particularly in developing countries.

Are services provided by forests and ecosystems properly valued in economic decisions?

Decisions on land-use allocation, such as between agriculture, forest and infrastructure uses, are

guided by market forces, government incentives and regulations that do not always fully

consider environmental costs and benefits. For instance, forests provide a wide range of climate

and environmental services that are largely unpriced. Designing incentives that encourage

activities with dual benefits of emissions abatement and natural asset sustainability, such as

REDD+ and Payments for Ecosystems Services, has the potential to facilitate a transition to a

low-carbon economy, provided that national governments help local communities address their

capacity gaps.

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Key messages

(cont.)

Towards a sustainable bio-economy?

An economy based on bio-energy and bio-products

could drive significant low-carbon transformation. But without well-aligned policies it also risks

diverting even more biological resources to purposes other than food and leading to even higher

emissions. Climate-friendly bio-energy policies would imply as a start that decisions are taken

on the basis of the quantification of carbon flows and other environmental impacts throughout

the entire life cycle of bio-products.

Are policies joined-up enough to get to the roots of food waste?

Reducing food losses and

waste from field to household could help ease environmental pressures and climate impacts by

improving efficiency along the agricultural supply chain. Governments need to better understand

the drivers of loss and waste, and respond with co-ordinated policies that bring together the

ministries of agriculture, economy, environment and health.

Land use could be key for tackling climate change

The global challenge over the coming decades will be to raise agricultural production

and productivity to meet ever-growing global demand for food, feed, fibre and energy,

while at the same time minimising GHG emissions and broader environmental impacts

(OECD, 2014a). The relationship between land use and climate change is complex,

involving important feedback loops, both positive and negative, between mitigation,

adaptation and the need to increase food security and protect ecosystem services. While

current land-based activities are on balance increasing emissions of GHGs, modifications

could turn rural land into a net carbon sink. This chapter explores this potential in the areas

of agriculture, forestry, bio-economies and food waste. Enabling these policy areas to fulfil

their low-carbon potential will require an integrated approach that breaks down the silos

between climate change, agriculture, food security, forestry and environment policies

(OECD, 2014a).

Current land use is a major source of emissions

Land use (mainly agriculture and forestry) is responsible for around 25% of global

GHG emissions. These mainly arise from deforestation and livestock, soil and nutrient

management (IPCC, 2014).

Every year between 2000 and 2010, GHG emissions from agriculture represented

10-12% of all man-made emissions. The agricultural sector is the largest contributor of

global anthropogenic non-CO

GHGs, accounting for 56% of total emissions in 2005. The

main culprits are nitrous dioxide – largely derived from the application of fertilisers,

manure and crop residues and the cultivation of organic soils, and methane from livestock

enteric fermentation and rice cultivation. Animal agriculture is an important source of GHG

emissions, and many developments in the animal sector affect potential shifts in future

GHG emissions. Actual CO

emissions represent another 15% of total GHG emissions from

agriculture, mainly from the combustion of fossil fuels in farm machinery and for powering

irrigation pumps (IPCC, 2014; Figure 9.1). Between 1990 and 2011, agricultural emissions

in more advanced economies decreased by 20%, while they increased by 37% in

developing and emerging economies. In 2012, 76% of agriculture emissions came from

developing economies (FAO, 2014a).

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

Figure 9.1.

The role of land use in greenhouse gas emissions and sinks, 2001-10

Notes:

O: nitrous oxide; CH

methane; CO

carbon dioxide

Source:

IPCC (2014), Intergovernmental Panel on Climate Change, Working Group III, Summary for

Policymakers,

www.ipcc.ch.

Annual GHG flux from land use and land-use change, mainly deforestation of tropical

forests and the domestic use of biomass, represents 9-11% of total man-made GHG

emissions. Global emissions from deforestation declined by 3% between 2000 and 2010

(IPCC, 2014). Most net forest conversion takes place in developing countries: of total forest

conversion, 54% takes place in the Americas, 6% in Africa and 15% in Asia (FAO, 2014a).

Well-managed land can make a unique contribution to the low-carbon future

Land offers unique climate change mitigation potential: it can enhance the removal of

GHGs through carbon sequestration and reduce emissions through sustainable approaches

to managing land and livestock. It also plays an important role in adapting to climate

change. The climate mitigation and adaptation services provided by ecosystems will

become increasingly important in the low-carbon transition and should be valued

appropriately. Policy makers will need to adapt available instruments to their country

contexts (Box 9.1).

Land offers unique climate change mitigation potential

Modelling suggests that cost-effective pathways for keeping the global average

temperature increase below 2°C would require land to become a net sink of CO

emissions

by the second half of this century (IPCC, 2014; OECD, 2012). This would compensate for

hard-to-reduce emissions in other sectors. However, the role of land as a CO

sink relies on

biological processes which are also difficult to control. Whether a particular ecosystem acts

as a sink or source of GHGs may change over time. Nevertheless, the Intergovernmental

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

209

Panel on Climate Change (IPCC) estimates that land-related mitigation strategies could

account for 20-60% of total cumulative GHG reductions to 2030, and 15-40% to 2100

(IPCC, 2014).

Box 9.1.

Examples of policy approaches to greenhouse gas

emission reductions in agriculture

There is a range of instruments governments can use to reduce greenhouse gas (GHG)

emissions from agriculture. The mix of instruments will have to be adapted to specific social,

institutional and economic contexts, as well as to objectives beyond climate.

•

Environmental standards and regulations: Standards and rules for land management,

controls on excessive use of agrochemicals and fertilisers.

Support measures: Decouple farm support from commodity production levels and prices,

remunerate provision of carbon sequestration and flood and drought control, increase

investment in technologies, target environmental outcomes or production practices

favourable to climate.

Economic instruments: Impose a price on carbon and other GHG gases through taxes or

trading schemes for carbon emissions.

Trade measures: Lower tariff and non-tariff barriers on food and agriculture (bearing in

mind the environmental concerns such as biodiversity and sustainable resource use),

eliminate export subsidies and restrictions on agricultural products.

Research and development: Increase public research and development on sustainable food

and agriculture, promote private R&D, undertake public-private partnerships for green

agricultural research.

Development assistance: Allocate more development aid for reducing carbon emissions

from agriculture.

Information, education, training and advice: Increase public awareness for more

sustainable patterns of consumption through certification and eco-labelling, particularly to

reduce food waste, incorporate sustainable approaches in training, education and advice

through the entire food chain.

•

Source:

OECD (2011),

Food and Agriculture,

OECD Green Growth Studies, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264107250-en.

Land-use mitigation opportunities lie on both the supply and demand side. On the

supply side, terrestrial ecosystems can help improve the global GHG balance through

four main mechanisms:

1. Avoiding emissions by reducing deforestation and land degradation.

2. Reducing non-CO

emissions from the agricultural sector, including livestock,

through improved agricultural practices (see OECD, 2015b). New technologies can

reduce emissions – including improved manure storage (e.g. structures, lagoon

covers), manure management (e.g. rate, timing, field incorporation), improved feed

management and power generation (e.g. methane capture, manure as a biomass

feedstock).

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

3. Enhancing CO

removal by increasing carbon sequestration in soils and vegetation

through improved cropland and livestock management, conservation tillage

practices, forestry and agroforestry, and restoration of degraded land.

4. Reducing GHG emissions in the energy, construction and transport sectors through

the expanded use of low-carbon renewable and sustainable bioenergy, biofuels and

bio-based materials (OECD, 2012; IEA, 2014).

On the demand side, GHG emissions could be mitigated by reducing food loss and

waste, changing diets and changing behaviours in wood consumption. In the construction

sector, greater use of wood from sustainably managed forests (in place of concrete,

steel, etc.) could also contribute to lowering GHG emissions. However, quantitative

estimates of the potential of demand-side options are few and highly uncertain (IPCC,

2014).

Beyond improving mitigation, sustainable land management practices such as

conservation agriculture, intercropping and sustainable forestry can also improve the

climate resilience of agriculture through the multiple benefits ecosystems provide, such as

reducing erosion, building soil fertility and structure, improving water quality and buffering

against drought (OECD, 2014c).

Delivering these mitigation options involves considerable challenges. A key factor will

be ensuring that all costs associated with climate change are reflected in production and

consumption decisions. Governments can achieve this through market-based instruments

such as environmentally related taxes, charges and fees; tradable permits and subsidies for

reducing pollution; or through non-market approaches such as regulations and voluntary

approaches (Box 9.1). Market instruments have proven difficult to implement in agriculture

due to the lack of definition of property rights, difficulties in identifying sources of

pollution and agriculture’s location-specific environment externalities. Regulations and

payments have been easier to implement (OECD, 2013a).

There are also many potential barriers to implementation of known mitigation practices,

particularly in developing countries. These include accessibility to land-use financing;

poverty; institutional, ecological and technological development; diffusion and transfer

barriers (IPCC, 2014). Aligning policies towards low-carbon goals would facilitate and

reduce the cost of implementation of these mitigation options.

Align food production and low-carbon goals

Climate regulation through mitigation and adaptation options is just one of the many

ecosystem services, goods and benefits provided by land (Figure 9.2). Land is fundamental

for feeding the world’s 7 billion people, supporting the livelihoods of billions of people

worldwide and as a critical resource for sustainable development in many regions (OECD,

2014a). Mitigation and adaptation options in the land-use sector therefore need to be

assessed, as far as possible, for their potential impact on all other services provided by land,

and vice versa.

Agriculture is also vital to the livelihoods of many people, especially in developing

countries, where the agricultural sector constitutes a substantial portion of gross domestic

product (GDP) and of employment: 23% of GDP in Africa, 22% in Asia and 10% in

Latin America, compared to around 3-4% of GDP in developed countries (World Bank,

2013). Demand for agricultural products is expected to grow by 60% by 2050 compared

with 2005, in response to growing levels of per capita consumption, greater demand for

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

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protein-based diets and a world population that is expected to reach 9 billion (Alexandratos

and Bruisna, 2012). The way this demand is met will have a significant impact on the

climate and on the broader green growth agenda. If agriculture were to continue on a

business-as-usual path to meet the rising demand for food, energy and infrastructure,

natural resources would be exploited beyond their ecological carrying capacity (OECD,

2013a).

Figure 9.2.

Climate regulation is just one of many services provided by land use

Water regulation

Water quality

Storm protection

Pollution control,

regeneration

• Climate regulation

•

• Soil formatting

• Nutrient cycles

• Water cycles

Regulating

services

Food

production

Provisioning

services

• Food, feed, fibre

• Water, energy,

biochemical,

medecine

• Biodiversity

Cultural

services

• Recreation

• Tourism

• Spiritual and religious

values

• Cultural heritage value

Source:

Adapted from Millenium Ecosystem Assessment (2005),

Ecosystems and Human Wellbeing: Current

State and Trends,

Island Press, Washington, DC.

How to reconcile food security, adaptation and mitigation agendas?

There are synergies and trade-offs between adaptation, mitigation and the broader food

security agenda (OECD, 2014a). Agricultural expansion and intensification could have a

negative impact on the climate agenda, which could in turn undermine efforts to increase

food production.

•

Changes in land use (from pasture to crop area, forest to agriculture) has an impact on

GHG emissions, either directly when annual crops are grown on land that was previously

forested, or indirectly when it displaces production of other commodities which are then

produced elsewhere (indirect land-use change). Agricultural expansion is the primary

cause of deforestation in tropical landscapes. In the absence of appropriate incentives to

protect forests, the various pressures to expand agriculture – food demand, bioenergy

policies – could lead to further deforestation (DeFries and Rosenweig, 2010).

In the last decades, 70% of the increase in food production has come from agricultural

intensification, using higher yielding varieties of seeds, synthetic fertilisers, irrigation and

mechanisation. Projections estimate that 80% of future production increases will have to

come from further intensification (FAO, 2002). While intensification on existing land can

reduce deforestation and forest degradation and therefore carbon emissions, it can also

involve higher emissions from chemical inputs and increased livestock densities.

•

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

•

On the other hand, agriculture is itself one of the most vulnerable sectors to climate

change (Box 9.2).

Box 9.2.

The impact of climate change on agriculture

The agricultural sector is likely to be strongly affected by the increased variability in temperature and rainfall

patterns, changes in water availability, increased frequency of extreme weather events and changes in

ecosystems brought about by climate change (IPCC, 2014; OECD, 2015a).

Some regions will benefit from a changing climate, with longer growing periods in cool regions and

increased carbon fertilisation. But recent analysis shows that, overall, yields will still increase globally, but less

than they would have without climate change.

Climate change could cause yields of maize, wheat and rice to decline by 10%, 7% and 6% respectively on

average in OECD countries, compared to a scenario without climate change. Some regions will be affected

worse than others: yields of certain crops could fall by as much as 25% (for example, maize in North America

and wheat in Australia).

Climate change may also have direct implications for land availability. Some areas could drop out of

production altogether, while higher temperatures may see others (e.g. in Canada and in the Russian Federation)

increase their arable land. The net effect of these developments is unclear, but farmers will need to continuously

adapt their farming practices to changing rainfall patterns and temperatures to maintain or increase their

productivity (IPCC, 2014).

Sources:

IPCC (2014), Intergovernmental Panel on Climate Change, Working Group III, Summary for Policymakers,

www.ipcc.ch;

Ignaciuk, A. and D. Mason-D’Croz (2014), “Modelling adaptation to climate change in agriculture”,

OECD

Food, Agriculture and Fisheries Papers,

No. 70, OECD Publishing, Paris,

http://dx.doi.org/10.1787/5jxrclljnbxq-en

Understanding the drivers of agricultural production choices, impacts on farmers and

potential unintended consequences for the environment is a prerequisite to identifying

misalignments between agricultural policies and climate objectives. But doing so is

complex. A wide range of policies, market forces and environmental factors drive

agricultural systems, practices, input use, farm outputs and the ecosystem services provided

by agriculture. This in turn has implications for the state of the environment (soil, water,

air, biodiversity), which then affects human activities including health, social values,

agriculture, industry and urban centres (OECD, 2013b; Figure 9.3). This complexity

requires a holistic and well-integrated decision-making process (Sayer et al., 2013).

In addition, these drivers vary significantly depending on the country context.

Subsistence farmers in sub-Saharan Africa do not face the same constraints, nor do they

have the same ability to respond to policy signals, as major global agribusinesses. Climate

change impacts will also vary widely by region and will have to be addressed locally.

However, there are some common areas of misalignment which should be tackled,

highlighted in the sections which follow: the composition of policy support to farmers,

insurance policy design, trade restriction measures for agricultural products and investment

in technology and knowledge.

Move away from environmentally harmful support to agriculture

Governments support farmers and agribusinesses for several reasons: to manage the

supply of agricultural commodities, to influence their cost, to supplement farmers’ incomes,

and to achieve other social and environmental goals such as water conservation, poverty

reduction and climate change mitigation. In OECD countries, support to farmers

represented USD 248 billion between 2009 and 2011 (OECD, 2013a). This involved

keeping prices above market levels, making direct payments to farmers and subsidising

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

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inputs. Since the 1980s, overall support to farmers has declined from 37% to 18% in real

terms and in proportion to their other receipts. While direct support to agriculture is still

relatively low in emerging and developing countries, the use of subsidies to protect

agricultural sectors is increasing, driven by food security and poverty agendas (Figure 9.4).

Figure 9.3.

Linkages between policies, agricultural driving forces

and the state and impact of agriculture on the environment and human welfare

Policies, markets

environment

Agriculture

driving forces

State of

environment

•

Soil erosion

•

Water quality:

-- Nutrients in water

-- Nutrients and

pesticides in

drinking water

•

Air emissions:

-- Ammonia

-- Greenhouse

gases

-- Methyl bromide

•

Biodiversity:

-- Farmland bird

populations

Impacts on

human welfare

•

Human health

•

Social values

e.g. recreation,

fishing, visual

•

Agriculture

and commercial

fisheries

e.g. water pollution

•

Industry and urban

centres

e.g. air

pollution

•

Policies:

Agricultural:

e.g. commodity

support

Agri-environmental:

e.g. payments for

riparian buffers

Environmental:

e.g. national water

policy framework

•

Farm systems:

e.g. integrated farming

systems (greater precisions

and resource efficiency)

and organic farming

systems

•

Farm practices:

e.g. nutrient and pesticide

application, tillage and

irrigation practices

•

Farm input use:

e.g. nutrients (nitrogen and

phosphate), pesticides,

water, resources, energy

•

Farm outputs:

e.g. crops, transgenic

crops, livestock, land cover,

land use

•

Markets:

Commodity markets,

economy, technology

•

Environment:

Soils, weather, slope

Climate change

Note:

The bullet points in each box are illustrative and some are interchangeable. Soil erosion, for instance, is

included in the “state of environment” list, but could also be listed as a “driving force” behind soil sedimentation.

Source:

OECD (2013b),

OECD Compendium of Agri-environmental Indicators,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264186217-en.

The way governments design their support may have unintended consequences on the

environment, allocation of resources and GHG intensity of agriculture (OECD, 2013a;

Table 9.1).

Market price-support mechanisms and payments based on inputs create incentives for

greater production. When they do not impose environmental constraints on farming

practices, these are potentially the most harmful type of support for the environment. For

instance, fossil fuel and fertiliser subsidies can lead to the suboptimal use of inputs and

increase GHG emissions. Price support mechanisms mask market signals to farmers and

can lead to inefficient use of fertilisers and pesticides, with negative climate and

environmental consequences.

•

Payments based on cropped land, animal numbers, historical entitlements or overall

farming income are likely to be less harmful in environmental terms, as they place

limits on the level of production supported (OECD, 2013a).

Payments based on non-commodity criteria, or payments linked to constraints on

resource use – such as biodiversity conservation; flood, drought and soil erosion

control; and the creation of carbon sinks – are beneficial for the environment and

potentially for the climate. Such payments might be made to farmers for retiring fragile

•

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

land from production, planting trees or changing tillage practices to reduce climate

change impacts. These types of support payments make up a very low share of current

payments across the OECD.

Figure 9.4.

Changes in producer support estimate (PSE)*

in OECD and non-OECD countries, 1995-2012

1995-97

-5

-10

-15

OECD

Indonesia

Russian

Federation

China (People's

Republic of)

Kazakhstan

Brazil

South Africa

Ukraine*

% PSE

2010-12

Notes:

* This is based on the Producer Support Estimate (PSE), which measures support to individual farmers

provided through supporting prices above market levels, by making direct budgetary payments to farmers or

subsidising inputs (OECD, 2014d).

Source:

OECD (2013a),

Agricultural Policy Monitoring and Evaluation 2013: OECD Countries and Emerging

Economies, OECD Publishing,

Paris,

http://dx.doi.org/10.1787/agr_pol-2013-en.

The actual impacts of those policies will depend on the many factors that determine

farmers’ overall decisions. In addition, there may be some trade-offs and conflicting

objectives between the climate agenda and other environmental goals. For instance, using

grazing animals to maintain a wildlife habitat can affect water quality and increase GHG

emissions (OECD, 2013a).

However, low-carbon agriculture would mean shifting away from the more

environmentally harmful types of support and regulations linked to climate benefits

(OECD, 2013b). This would increase the effectiveness and reduce the cost of mitigation

policies in agriculture, through aligning farmers’ incentives and signals in the same

direction (OECD, 2013a).

Since 1990, OECD countries have reduced the most environmentally harmful

subsidies (those based on prices and output levels, such as for nitrogen fertilisers and

fossil fuels) from over 75% of all agricultural subsidies in 1995 to 49% in 2010-12. Some

domestic price support mechanisms have been replaced by direct payments based on past

entitlement levels or farm income. These represent one-third of total support today, and

have less production-distorting and environmental impacts. Some countries are making

support increasingly conditional on environmental objectives: the EU, Switzerland and

the United States link more than 50% of their support to some environmental

cross-compliance.

In Switzerland, farms need to provide proof of ecological performance

in order to be eligible for general direct payments, for example.

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

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Table 9.1.

Potential environmental impact of Producer Support Estimate

and their share in the OECD area

% of total PSE payments

Potential

Type of support measure

environmental impact

Potentially most

Market price support

harmful

Payments based on commodity output, without imposing environmental

constraints on farming practices

Payments based on variable input use, without imposing environmental

constraints on farming practices

Total

Potentially less

Payments based on current cropped area/number of animals/receipts or

harmful

income, without imposing environmental constraints on farming practices

Payments based on historical entitlements/receipts or income, without

imposing environmental constraints on farming practices

Payments based on fixed capital formation, without imposing environmental

constraints on farming practices

Payments based on on-farm services, without imposing environmental

constraints on farming practices

Total

Potentially more

Payments subject to environmental cross-compliance

beneficial

Potentially most

Payments based on non-commodity criteria that impose environmental

beneficial

constraints on farming practices

Payments based on fixed capital formation that impose environmental

constraints on farming practices

Payments based on on-farm services that impose environmental

constraints on farming practices

Payments based on variable input use that impose environmental

constraints on farming practices

Payments based on current cropped area/number of animals/receipts or

income that impose environmental constraints on farming practices

Payments based on historical entitlements/receipts or income that impose

environmental constraints on farming practices

Payments based on commodity output that impose environmental

constraints on farming practices

Total

1995-97

2009-11

Note:

1. Includes payments from various PSE categories which are subject to environmental cross-compliance.

Source:

OECD (2013a),

Policy Instruments to Support Green Growth in Agriculture: A Synthesis of Country

Experiences,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264203525-en.

The emergence of agri-environmental and environmental policies since the early

1990s – e.g. payments to remove land from production or to provide financial incentives

to encourage certain types of production practices considered beneficial for the

environment – has encouraged farmers in many OECD countries to use fewer chemicals

on their land (OECD, 2013b). These policies have been accompanied by an overall

decrease of GHG emissions from agriculture and an improvement in the environmental

efficiency of agricultural GHG emissions (i.e. GHG emissions have risen more slowly

than increases in agricultural production) (Figure 9.5).

However, reform has been uneven across OECD countries. While some countries

have taken clear steps to decouple support from output and price levels, others have not

yet begun to address the problem. Further, the most environmentally beneficial type of

support, agri-environmental schemes, only represent 2% of total agricultural support in

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

OECD countries (Table 9.1 and Figure 9.6). The use of cross-compliance mechanisms is

better than providing direct income support without environmental conditionality

attached, but is not as cost-efficient as targeted measures.

Figure 9.5.

Greenhouse gas emissions, GDP and productivity for agriculture

in the OECD area, 1990-2010

Greenhouse gases

1990=100

120

115

110

105

100

GDP

Productivity

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Note:

Excluding LULUCF (land use, land-use change and forestry).

Source:

OECD (2014d),

Agricultural Policy Monitoring and Evaluation 2014: OECD Countries,

OECD

Publishing, Paris,

http://dx.doi.org/10.1787/agr_pol-2014-en.

Figure 9.6.

Evolution of producer support by potential environmental impact

in the OECD area, 1990-2012, in USD million

Most harmful

300 000

Least harmful

Other

250 000

200 000

150 000

100 000

Potentially most environmentally harmful support

50 000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Note:

The source of the classification is OECD (2013a),

Policy Instruments to Support Green Growth in

Agriculture:

Synthesis

Country

Experiences,

OECD

Publishing,

Paris,

http://dx.doi.org/10.1787/9789264203525-en.

Source:

OECD (2014h),

Green Growth Indicators for Agriculture: A Preliminary Assessment,

OECD Green

Growth Studies, OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264223202-en.

In emerging economies, agricultural support generally relies heavily on

production-distorting policies such as market price support and input subsidies. Net

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

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exporters such as Brazil and South Africa provide limited levels of subsidies, but of the

more distortive types (i.e. price support and input subsidies). In the People’s Republic of

China (hereafter “China”) and Indonesia, grain prices (wheat and rice, respectively) are

regulated and local producers are either supported or taxed depending on the levels of

international prices. Both countries provide input subsidy support, and China provides

direct payments by unit of land (OECD, 2014d). India provided roughly USD 28 billion

in input subsidies to nitrogenous fertilisers and electricity for pumping agricultural water

in 2010 (GCEC, 2014). Fertiliser subsidies in India alone represented USD 8 billion

in 2007, or 0.8% of GDP (Von Lampe et al., 2014). Removing such subsidies would

allow more efficient input use and reduce associated GHG emissions (GCEC, 2014).

The use of input subsidies has seen a resurgence in least-developed countries, in

Africa in particular, driven by the belief that subsidising the cost of inputs would create a

virtuous circle of higher yields and less hunger and poverty. However, as in any other

country, the costs and benefits of input subsidies must be compared with conventional

best practices of addressing market failures directly, such as using social policies

(e.g. cash transfers, support to investment and risk-mitigation tools) to tackle poverty and

food insecurity (Brooks, 2014).

Avoid trade restrictions for more efficient and resilient global food markets

Liberalising trade measures is important for climate change mitigation, adaptation and

food security. However, in the absence of adequately priced externalities, the potentially

negative side-effects of open trade (see Chapter 5) need to be managed.

Trade and mitigation

Reducing tariffs and subsidies on agricultural products could optimise land use and

reduce the overall demand for land, reducing pressure on forested areas. As these

subsidies distort price signals, they could create misallocation of land uses: e.g. land

currently used for wheat might be more suitable for livestock (OECD, 2013a).

However, as GHG externalities are not properly priced in the market, opening trade

barriers could, in some cases, mean a geographical shift of agricultural production.

Without appropriate measures, the result could be additional GHG emissions (if the shift

implies additional deforestation in tropical zones, for instance).

In a globalised world, national strategies for forest protection may also have

unintended consequences. In particular, national conservation measures to protect forests

and promote reforestation could lead to deforestation in other areas via the trade in

agricultural and wood products, undermining the effectiveness of those measures

(Meyfroidt and Lambin, 2011). Within a given country, this could be ameliorated by a

national land-use plan which includes restoration of degraded land and increased

productivity of existing land under cultivation. Without harmonised sustainability

standards, the availability of cheap and sometimes unsustainable timber from abroad can

also lower domestic prices, providing a barrier to investment in reforestation and

sustainable forest management at home. In Viet Nam, policies restricting forest

exploitation combined with the rapid development of the wood-processing industry have

shifted forest extraction to the neighbouring countries of Cambodia and Laos. Evidence

suggests that in the seven developing countries whose forests are increasing overall,

additional emissions from land-use change embodied in their net wood trade offset 74%

of the emission captured in reforested areas, 52% when both agriculture and forestry

sectors are included (Meyfroidt and Lambin, 2011).

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As local land-use decisions are increasingly driven by trends in distant markets,

governments should develop appropriate regulations and economic incentives to ensure

that trade in wood and agricultural products yields benefits for natural ecosystems, the

climate and local communities (Lambin et al., 2014). The EU has sought to restrict the

flow of illegally harvested timber into the EU through the EU Timber Regulation and its

bilateral agreement programme with developing countries (EC, 2013). This legislation

requires importers of wood products to demonstrate that the timber was legally harvested

in its country of origin (EU, 2013).

Voluntary and incentive-based instruments, often designed by private actors, could

also have an important role to play, provided that they are well-designed, easy to

implement and come with monitoring and verification mechanisms (Lambin et al., 2014).

They include eco-certification schemes, geographical indications, commodity

roundtables, and moratoria on certain product types.

Trade and adaptation

A well-functioning trade system would also support adaptation, compensating

regional changes in productivity. Open trade is an important vehicle to fully reflect

shifting comparative advantages due to climate change, while also pooling the risk so that

yield losses in a given region can be offset through imports (OECD, 2014c). However, in

an attempt to improve food security and adjust to price volatility and food shortages

linked to weather-related events, some developing and emerging economies have recently

shown a renewed willingness to implement trade-distorting policies such as export

restrictions and export taxes (Figure 9.7).

Figure 9.7.

Number of countries with export restrictions on food staples, 2007-13

Export tax

2007

2008

2009

2010

2011

2012

2013

Export quota

Export ban

Notes:

Established at the request of the agriculture ministers of the G20 in 2011, the Agricultural Market

Information System (AMIS) is an interagency platform to enhance food market transparency and encourage the

co-ordination of policy action in response to market uncertainty. Overall, AMIS countries represent 80-90% of

global production, consumption and trade volumes.

Source: AMIS policy database.

This approach runs counter to the need to adapt to climate change, which will actually

require greater land-use flexibility. The potential for “transformational adaptation”

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

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(shifting to land use more suitable to the changing climate) will be limited by these bans

on exports or imports of products. With a projected increase in the incidence and

magnitude of severe weather events, the implementation of these trade-restrictive policies

raises future risks (Clark et al., 2012).

In addition, restrictive trade policies are not the most efficient way to address the

needs of consumers and producers. Targeted social programmes, including cash transfers,

favouring investment and developing risk-mitigation tools, can improve farmers’

resilience to international price shocks. Safety nets (food vouchers or cash transfers)

targeted at poor households are more efficient and effective than price support measures,

which mainly benefit large farmers and landowners (OECD, 2013d).

Trade and food security

Open markets are also instrumental for raising output and income, enabling

production to be located in areas where resources can be used most efficiently (OECD,

2013d) and improving food security. On balance, open trade enhances the four pillars of

food security (Box 9.3).

Box 9.3.

The dimensions of food security

The 1996 Food and Agriculture Organization (FAO) World Food Summit stated that: “food

security exists when all people at all times have physical and economic access to sufficient, safe

and nutritious food that meets their dietary needs and food preferences for an active and healthy

life”. People are food secure when sufficient food is

available,

when they have

access

to it, and

when it is well

utilised.

The fourth element of food security is

stability

of these

three dimensions over time.

Ensuring food security is not simply a question of producing more food. It requires tackling

availability, accessibility, utilisation and stability at the same time. The main obstacle to food

security is poverty, as low incomes constrain people’s access to food. As half of the world’s poor

today depend directly or indirectly on agriculture, agricultural reforms need to consider their

impact on farmers’ incomes. Increasing availability requires increasing productivity, improving

the management of supply chains and reorienting demand. Stability requires less volatile

markets (OECD, 2013d).

Source:

World Food Summit (1996),

Rome Declaration on World Food Security,

Food and Agriculture

Organization, Rome, available at:

www.fao.org/docrep/003/w3613e/w3613e00.HTM.

Yet across each dimension there is a mix of positive and negative effects resulting

from trade openness, such as concerns over import independence for countries without a

comparative advantage. These effects need to be managed (Brooks and Mathews, 2015):

•

In terms of

availability,

open trade would allow products to flow from surplus to deficit

areas; however, there are concerns about import dependency for countries without a

comparative advantage in food production. There is also a risk that food supplies could

be interrupted.

With regard to

access,

open trade can reduce overall commodity prices. However, there

are concerns about the impact of greater openness on the incomes of those who were

formerly protected.

•

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

•

Rising incomes may increase the

utilisation

of food, but also contribute to a “nutrition

transition”, meaning a shift to diets with more animal products, under which not all

effects are positive.

Regarding

stability of supply,

open markets reduce the risks associated with poor

domestic harvests, particularly in a context of climate change, as risks are pooled in the

international food market, but they make international instability a more relevant issue.

While governments should encourage more open markets and the removal of

trade-restrictive measures, they should also properly assess the positive and negative of

trade openness, and specifically address any negative trade-offs (Brooks and Mathews,

2015).

•

Remove insurance subsidies that discourage climate-resilient behaviours

With increased exposure to market forces and fluctuations, risk management has

become an essential tool to help farmers better adapt and be more resilient to shocks. Risk

management practices influence the ability of the agriculture sector to both mitigate GHG

emissions and adapt to a changing climate. Well-designed risk management practices

should lead to more efficient use of resources, higher productivity and potentially lower

GHG emissions.

One risk management practice is to insure crops against catastrophic events,

especially drought. However, markets for this type of insurance rarely develop without

significant government support in OECD countries (notably through crop insurance

subsidies and public reinsurance of last resort). Subsidised insurance is one way of

providing disaster assistance to farmers. However, insurance premiums that do not

adequately reflect the underlying risks can impede climate change adaptation or even

promote maladaptation, for instance by reducing incentives to change to more resilient

crops or by inducing farming in risky locations or with risky practices (OECD, 2015a).

Instead, governments should create an enabling environment that allows farmers to

make timely, well-informed and efficient responses to the risk they are facing (OECD,

2011; 2015a). This means:

•

Taking a holistic approach to risk management rather than focusing on a single source

of risk, such as prices: Risks in agriculture are interconnected and compound or offset

each other. Prices of inputs and outputs can move in the same direction, and lower

yields often mean higher prices in a market-driven economy.

Defining boundaries between layers of risks: While government intervention can be

justified for catastrophic risk, coping with normal business risks should be left to the

farmer. Government interventions should not crowd out private insurance schemes for

risks such as those related to weather fluctuations, price movements or yield variations.

Efficient insurance systems should be based as far as possible on risk-based premiums

to provide incentives for better adapted production choices that limit the exposure and

vulnerability of farm systems to climate change impacts, such as droughts and floods

(OECD, 2015d). Hence there is a need to define boundaries between layers of risks as a

prerequisite to government intervention. Innovative tools such as catastrophe bonds and

weather index-based insurance could also be developed as a complement to market and

policy responses.

Facilitating information, regulation and training on climate change risks: Insurance

markets are often under-developed due to information asymmetries between insurance

•

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companies and farmers. Developing databases and information-sharing mechanisms

will increase the options for private sector intervention. For example, governments

could invest in weather forecast technologies and early-warning systems to support the

emergence of index insurance covering risky events. The World Bank and the

International Finance Corporation have contributed to weather risk insurance schemes

in India and Africa (OECD, 2014c).

Increase investment in technological innovation and knowledge

The level of technological development and innovation in agriculture has a direct

impact on its capacity to produce adequate supplies of food and feed in an

environmentally sound manner (OECD, 2014b). While innovation played a significant

role in the increased gains of productivity of the second half of the 20th century,

continuing to focus on productivity alone may lead to natural resource depletion. A

paradigm shift is needed from increased productivity to sustainably increased

productivity. Sometimes called the “double Green Revolution” (OECD, 2013b), this will

rely on the emergence of new technologies and the adoption of innovative farming

practices that will encourage economic efficiency and environmental performance. There

is a broad consensus that this transformation will not be possible without considerable

investment in agricultural innovation systems. Agricultural innovation is important in

two respects: disseminating improved agricultural inputs and developing new techniques,

practices and technologies that address new challenges being faced by agriculture, such as

climate change (OECD, 2014c; 2015a). Hence, innovation is not only about technological

improvements but also about education, training and organisational improvements.

Farmers will only adopt new technologies if the investment is expected to be profitable,

and if they have adequate information, skills and training (OECD, 2013b).

Most OECD governments need to scale up their public budgets for agriculture-related

research and development (R&D). Only 4% of public and private R&D spending in

OECD countries is oriented towards agriculture, despite the importance of R&D in food

security agendas. R&D support represents a very small share of total support for

agriculture – around 2% in the OECD area in 2009-11. Even though government funding

for R&D is permitted under international trade agreements, it accounts for just a small

share of total support to agriculture (Figure 9.8) (OECD, 2013b).

In a context of limited government financial resources, encouraging the participation

of the private sector in green agricultural R&D, and in agriculture more generally

(Box 9.4), is essential (OECD, 2013a). This will not only increase funding opportunities,

but will also ensure that research programmes meet private sector demand (OECD,

2014f). Governments can promote private R&D investments through targeted support

such as tax credits and public-private partnerships (OECD, 2013a). Successful examples

of private sector involvement in R&D include the Australian Rural Research and

Development Corporation (funded through compulsory levies on industries and matching

public contributions). Similar co-operative research programmes are in place in Canada,

Denmark, the Netherlands, the United Kingdom and the United States. Tanzania has

managed to heavily involve the private sector in R&D for export crops, through the Tea

Research Institute of Tanzania, and institutes dedicated to tobacco and coffee (OECD,

2014f). Research costs can be reduced through greater R&D regional co-operation and

with increased collaboration on training, technology transfer and knowledge-sharing

across borders. This is the objective of the First Agricultural Productivity Programme for

Eastern Africa, 2009-15 (ibid.).

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

Figure 9.8.

Government expenditures on R&D as a share of total support to agriculture

1995-97

Percent

2009-11

Source: OECD Producer and Consumer Support Estimates Database

(2012),

www.oecd.org/tad/agricultural-

policies/producerandconsumersupportestimatesdatabase.htm#browsers.

Investing in knowledge is also commonly perceived to be a key driver of innovation

processes in agriculture. Agricultural advisory services, training and extension initiatives

play an important role in supporting green growth in agriculture and enabling farmers to

meet new challenges, such as adopting environmentally sustainable farming practices and

improving competitiveness (OECD, 2015c). Better trained and educated farmers are more

likely to use resource-efficient practices and reduce the GHG emissions resulting from

their farming practices. Learning by doing is the main form of training for the majority of

farmers across OECD countries (OECD, 2015c). In the European Union, less than 10% of

farm managers have completed full agricultural training. An important structural change

is also the general ageing of farming population due to a low exit rate from farming of

elderly farmers and a low entrance rate of young farmers. Attracting new entrants is a

challenge for governments (OECD, 2014b). In developing countries, where poor and

smallholder farmers are more numerous, efforts are needed to bridge the gap between the

creation of innovation and its adoption.

OECD work indicates that predictable, flexible and stringent environmental policies

often lead to higher investment in innovation (OECD, 2013b; see Chapter 3). On the

other hand, poorly designed regulations can limit the effectiveness of investment in

agricultural R&D. In the European Union, impact assessments of new regulatory

proposals are now mandatory, and take into consideration the promotion of greater

productivity and resource efficiency and their impacts on R&D and on intellectual

property rights (OECD, 2014b). Defining an intellectual property rights regime conducive

to green innovation is particularly challenging: on the one hand, governments have to

provide strong protection to enable a secure environment for foreign and local firms to

invest in innovation. On the other hand, they should ensure that small investors can afford

valuable technologies (OECD, 2014c; 2014b).

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Box 9.4.

OECD Policy Framework for Investment in Agriculture

The FAO estimates that an average net investment of USD 83 billion a year will be

necessary to raise agricultural production by 60% and feed the global population of more than

9 billion expected by 2050. This represents a 50% increase on current investments, and does not

include the investment needed in infrastructure, storage facilities, market development or R&D.

The OECD has developed a Policy Framework for Investment in Agriculture (PFIA) to

support countries in evaluating and designing policies to mobilise private investment in

agriculture for steady economic growth and sustainable development. Attracting private

investment in agriculture relies on a wide set of supply-side policies and on sector-specific

public goods. A coherent policy framework is an essential component of an attractive investment

environment for all investors, be they domestic or foreign, small or large. The PFIA is a flexible

tool proposing ten policy areas to be considered by any government interested in creating an

attractive environment for investors and in enhancing the development benefits of agricultural

investment.

Figure 9.9.

Policy Framework for Investment in Agriculture

1. Investment policy

10. Sustainable use of natural

resources and environmental

management

9. Responsible business

conduct

2. Investment promotion

and facilitation

3. Infrastructure development

Policy Framework

for Investment in Agriculture

4. Trade policy

8. Risk management

7. Tax policy

6. Human resources, research

and innovation

5. Financial sector

development

In 2014, governments from around the world approved the

Principles for Responsible

Investment in Agriculture and Food Systems,

aimed at assuring that cross-border and corporate

investment flows lead to improved food security and sustainability and respect the rights of farm

and food workers. The principles are voluntary and non-binding, but represent the first time that

governments, the private sector, civil society organisations, UN agencies and development

banks, foundations, research institutions and academia have been able to come together and

agree on what constitutes responsible investment in agriculture and food systems.

Sources:

OECD (2014f),

Policy Framework for Investment in Agriculture,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264212725-en;

FAO (2014c),

Principles for Responsible Investment in

Agriculture and Food Systems,

Food and Agriculture Organization, Rome, available at:

www.fao.org/3/a-

ml291e.pdf.

While technology and innovation offer huge potential, new technology can also

generate additional environmental pressures or put a strain on material availability. It

often involves new or substitute materials whose consequences may not yet be known

(OECD, 2013b).

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Break down the silos between adaptation, mitigation and food security policies

There are important synergies and trade-offs among mitigation, adaptation and food

security, as well as the conservation of natural resources such as water and terrestrial and

aquatic biodiversity (OECD, 2014a). Realising them requires co-ordination.

Unfortunately, there is currently a lack of co-ordination between sectoral agricultural

development plans and climate change policies. This can lead to inefficient use of

funding, and could block the integrated management required to address climate issues

while also ensuring productivity improvement and provision of food (Sayer et al., 2013).

Climate-smart agriculture, through the promotion of production systems that

sustainably increase agricultural productivity and incomes while adapting and building

resilience to a changing climate and reducing or removing GHG emissions, could be part

of the solution (FAO, 2013; OECD, 2014a). Several global initiatives have emerged

around this concept, including the Global Alliance on Climate-Smart Agriculture

(Box 9.5) and the Global Research Alliance on Agricultural Greenhouse Gases.

Box 9.5.

The Global Alliance on Climate-Smart Agriculture

The Global Alliance on Climate-Smart Agriculture was launched in September 2014 by the

United Nations Secretary General, the World Bank and the United Nations Food and Agriculture

Organization (FAO), together with 46 countries including 9 OECD countries and multiple other

institutions (Climate Summit, 2014). It aims to pursue the “triple win” of sustainable and equitable

increases in agricultural productivity and incomes; greater resilience of food systems and farming

livelihoods; and reduction and/or removal of greenhouse gas emissions from agriculture (including

the relationship between agriculture and ecosystems), where possible. The Alliance seeks to

improve people’s food security and nutrition in the face of climate change. It will help

governments, farmers, scientists, businesses and civil society, as well as regional unions and

international organisations, to adjust agricultural, forestry and fisheries practices, food systems and

social policies so that they take better account of climate change and the efficient use of natural

resources. Members will work toward sustainable increases in the productivity of food systems, by

a sustainable management of natural resources – including soil, water and biodiversity, the

adaptation of livelihoods threatened by climate change, and agricultural practices that contribute to

reduced emissions and less deforestation/land degradation. The Alliance will enable governments

and other stakeholders to make these transformations in ways that bridge traditional sectoral,

organisational and public/private boundaries. Other initiatives contribute to the same agenda, such

as the Global Research Alliance on Agricultural Greenhouse Gases.

Source:

Climate Summit (2014), “Global Alliance for Climate-Smart Agriculture: Action plan”, available at:

www.un.org/climatechange/summit/wp-content/uploads/sites/2/2014/09/AGRICULTURE-Action-Plan.pdf.

The concept of “landscape approaches” is also increasingly gaining traction. This

“seeks to provide tools and concepts for allocating and managing land to achieve social,

economic and environmental objectives in areas where agriculture, mining and other

productive land uses compete with environmental and biodiversity goals” (Sayer et al.,

2013; Box 9.6). Landscape approaches are location-specific strategies for sustainable land

use which take a whole-landscape, multi-sector perspective and are based on principles of

adaptive management and stakeholder engagement (DeFries and Rosenweig, 2010). They

could help break down the silos between different stakeholders and objectives, and help

solve the trade-offs.

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II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE –

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Box 9.6.

Ten principles of a landscape approach

Principle 1: Continual learning and adaptive management.

Landscape processes are dynamic. Despite

the underlying uncertainties in causes and effects, changes in landscape attributes must inform decision making.

Learning from outcomes can improve management.

Principle 2: Common concern entry point.

Solutions to problems need to be built on shared negotiation

processes based on trust. Trust emerges when objectives and values are shared. However, stakeholders have

different values, beliefs and objectives. Totally aligned objectives are unlikely, costly to establish or devoid of

immediate significance. Identifying immediate ways forward through addressing simpler short-term objectives

can begin to build trust.

Principle 3: Multiple scales.

Numerous system influences and feedbacks affect management outcomes, but

these impacts unfold under the influence of a diverse range of external influences and constraints.

Principle 4: Multifunctionality.

Landscapes and their components have multiple uses and purposes, each of

which is valued in different ways by different stakeholders. Tradeoffs exist among the differing landscape uses

and need to be reconciled.

Principle 5: Multiple stakeholders.

Multiple stakeholders frame and express objectives in different ways

(Principle 2). Failure to engage stakeholders in an equitable manner in decision-making processes will lead to

suboptimal, and sometimes unethical, outcomes. All stakeholders should be recognised, even though efficient

pursuit of negotiated solutions may involve only a subset of stakeholders. Solutions should encompass a fair

distribution of benefits and incentives.

Principle 6: Negotiated and transparent change logic.

Trust among stakeholders is a basis for good

management and is needed to avoid or resolve conflicts. Transparency is the basis of trust (Principle 2).

Transparency is achieved through a mutually understood and negotiated process of change and is helped by good

governance.

Principle 7: Clarification of rights and responsibilities.

Rules on resource access and land use shape

social and conservation outcomes and need to be clear as a basis for good management. Access to a fair justice

system allows for conflict resolution and recourse.

Principle 8: Participatory and user-friendly monitoring.

Information can be derived from multiple

sources. To facilitate shared learning, information needs to be widely accessible. Systems that integrate different

kinds of information need to be developed.

Principle 9: Resilience.

Wholesale unplanned system changes are usually detrimental and undesirable.

System-level resilience can be increased through an active recognition of threats and vulnerabilities. Actions

need to be promoted that address threats and that allow recovery after perturbation through improving capacity to

resist and respond.

Principle 10: Strengthened stakeholder capacity.

People require the ability to participate effectively and

to accept various roles and responsibilities. Such participation presupposes certain skills and abilities (social,

cultural, financial).

Source:

Sayer, J. et al. (2013), “Ten principles for a landscape approach to reconciling agriculture, conservation, and other

competing land uses”,

Proceedings of the National Academy of Sciences,

Vol. 110, No. 21, pp. 8 349-8 356,

http://dx.doi.org/10.1073/pnas.1210595110

Sustainable forest management should be at the core of a low-carbon, resilient

society

Degradation and loss of the world’s tropical forests are together responsible for about

10% of net global GHG emissions (GCEC, 2014; IPCC, 2014). Tackling the destruction

of tropical forests is therefore fundamental to any concerted effort to combat climate

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

change. Forests contain vast carbon stocks – destroying them emits CO

into the

atmosphere and removes an important carbon sink. Forests are also important from an

adaptation perspective, as they prevent soil erosion, protect watersheds, regulate water

flow and generate rainfall. Forests provide other ecosystem services such as the

regulation of diseases, livelihoods (providing jobs and local employment), food and

nutrient cycling.

Protecting forests is therefore vital for the continued provision of essential

life-sustaining services and for the transition to a low-carbon economy. Over the past

50 years in OECD countries, the area of forests and wooded land has remained stable or

has slightly increased. However, on a global scale, forest cover is decreasing due to

continued deforestation in tropical countries (IPCC, 2014).

Globally, agriculture and poorly managed timber extraction are still the most

important driving forces behind deforestation, with commercial and subsistence activities

accounting for 40% and 33% respectively. Mining, infrastructure and urban expansion are

responsible for the remainder (IPCC, 2014). During the 1980s and 1990s, rainforests were

the primary sources of new agricultural land throughout the tropics. Lower production

costs and limited environmental regulations allowed forest-rich tropical countries such as

Brazil, Indonesia and Malaysia to respond quickly to increased demand for crops,

particularly sugar cane, soybeans and palm oil. More than 80% of new agricultural land

came from intact forests (Gibbs et al., 2009). Though the rate of deforestation is

decreasing, it is still a major source of GHG emissions globally.

The global restoration and protection of forests is required for the low-carbon

transition. This requires simultaneous alignment among several policy areas:

•

domestic regulatory instruments that protect forested areas (protected areas, zoning and

land-use restrictions)

domestic agricultural and forestry policies that promote technological innovation and

the sustainable use of land

macroeconomic, trade and fiscal policies, and property law that indirectly affect land

use

policies that enable consumers to have an increasing influence on the future of the

forest.

The following sections highlight misalignments in policies that indirectly affect forest

land use. Other obstacles stand in the way of limiting forest degradation and

deforestation, such as corruption and vested interests around forest exploitation. These

governance failures call for increased policy intervention but are not the subject of this

chapter (GCEC, 2014).

Financial incentives for forest countries are not yet compelling enough to drive

forest-friendly development

As with agriculture, preserving forest areas requires first and foremost that land is

priced in a way that reflects its true social and environmental costs and benefits. Failing

to adequately value these services can lead to rapid and large misallocations of land use.

Ecosystems accounting and the concept of valuing natural capital are useful

approaches for pricing forest and land-use externalities. They can help countries to assess

the value of competing land uses, providing a basis for cost-benefit analysis and help

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governments take into account distributional impacts when designing green growth

policies (OECD, 2010). Several initiatives exist at the global level: the UN Statistical

Commission has developed an internationally agreed method, the System for

Environmental Accounts (SEEA), and the World Bank has launched a global partnership

to help countries implement natural capital accounting. In practice, however, these

methods are complex to implement and often require a tailor-made approach.

REDD+ (Reduction in Emissions from Deforestation and Forest Degradation) has the

potential to facilitate a transition to a low-carbon economy.

It is a framework through

which developing countries are rewarded financially for forest protection actions which

lead to a measured decrease in the conversion of forests to other land uses. The financial

rewards they receive depends on the extent of the emissions reductions they achieve.

Adjustments to the framework in 2007 mean that REDD+ now takes a more

comprehensive approach to include the role of conservation, sustainable management of

forests and the enhancement of forest carbon stocks in developing countries.

REDD+ has driven significant progress in recent years, including developing an

appropriate international policy framework

building the necessary capacity for

implementing REDD+ programmes and piloting performance-based REDD+ (e.g. the

World Bank’s Forest Carbon Partnership Facility Readiness Fund and Carbon Fund). As

a result, payments for verified emissions reductions are increasing, and REDD+ offsets

now account for 80% of all transactions of forest carbon offsets (Ecosystem Marketplace,

2014).

However, experience to date suggests the need for a better alignment of international

and national support to the scheme. Human and technical capacity at the local level is

often still lacking, despite significant investment. While some forest nations may be

self-motivated to take action to protect forests, for a range of economic, environmental

and social reasons, realising the full mitigation potential of REDD+ will require a

significant increase in financial incentives, and for interventions to be designed in a way

that reinforces and supports sustainable approaches in those countries, including

agricultural subsidies, rural development programmes and tax policies (Fishbein and Lee,

2015).

Another approach – payments for ecosystem services (PES) – could be instrumental

in reflecting the true value of ecosystem services. PES often provide uniform per-hectare

payments for protecting an important natural habitat. Reverse-auction mechanisms, as

used in Australia for old-growth forests, in Indonesia to reduce soil erosion and in the

United States to improve agri-environment practices, can help to improve the

cost-effectiveness of PES. For example, the use of a reverse auction by the Tasmanian

Forest Conservation Fund resulted in a 52% gain in cost-effectiveness compared with

traditional approaches on a first-come, first-served approach (OECD, 2010). The OECD

has developed a list of 12 key criteria essential for increasing the cost effectiveness of

PES (Box 9.7).

Ensure clear land rights

Appropriate regulations, such as land-use zoning policies, are important for putting

countries on the path to net reforestation. But they have limits, including the need for

strong enforcement capacity. This is often lacking in least-developed economies where

land-use zoning policies also often conflict with informal customary land tenure systems.

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

Box 9.7.

Towards cost-effective payments for ecosystem services (PES)

1. Remove perverse incentives such as environmentally harmful subsidies.

2. Clearly define property rights to empower communities.

3. Clearly define PES goals and objectives to enhance transparency and avoid

ad hoc

political influence.

4. Develop a robust monitoring and reporting framework to assess the performance of

PES.

5. Identify buyers and ensure sufficient and long-term sources of financing.

6. Identify sellers and target ecosystem service benefits.

7. Establish baselines and target payments at ecosystems that are at risk of loss or to

enhance their provision.

8. Differentiate payments based on the opportunity costs of service provision.

9. Consider bundling multiple ecosystem services.

10. Address leakages.

11. Ensure permanence.

12. Deliver performance-based payments and ensure adequate enforcement.

Source:

OECD (2010),

Paying for Biodiversity: Enhancing the Cost-Effectiveness of Payments for

Ecosystem Services,

OECD Publishing, Paris,

http://dx.doi.org/10.1787/9789264090279-en.

Communities have more incentive to manage natural capital sustainably, in particular

forests and fisheries, if their ownership rights are properly defined, monitored and

enforced (Ostrom, 1990). Land rights, including collective land rights, tend to encourage

better land management even if there is no profit. Poorly defined property rights and

weak enforcement in such cases leads to open-access exploitation (OECD, 2014e).

Community resource management requires support mechanisms at the national level,

such as education and training.

Establishing well-functioning land registration systems can reconcile the interests of

large investors and smallholders provided that they are developed on the basis of

inclusive consultation processes and consider the social, cultural and environmental

values of land as well as its economic value (OECD, 2014g).

The observance and respect of land policy in each country is important for avoiding

conflict over land-based investment, especially in less developed countries. The

Voluntary Guidelines on Responsible Governance of Tenure of Land, Fisheries and

Forests in the Context of National Food Security

(FAO, 2012), endorsed by the

Committee on World Food Security in 2012, guide governments in establishing a

well-defined land-rights system.

Moving towards a bio-economy consistent with climate and development objectives

Several countries have published their plans for the development of a future

bio-economy, an economy in which bio-based materials and production techniques will

contribute significantly to economic and environmental sustainability. Such plans

typically involve building a bio-based production industry in which fuels, energy and

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materials such as chemicals and plastics, usually generated from fossil resources such as

oil and natural gas, are incrementally replaced by equivalent or novel products generated

from renewable resources (OECD, 2014g). The bio-economy is often associated with the

concept of a recycling economy that aims at reusing raw materials. Bioenergy and

biofuels policies are part of a bio-economy.

A shift to a bio-economy could have significant transformative potential for the

low-carbon agenda and deliver the “negative” emissions required to meet the 2°C target

(IPCC, 2014). For example, sound bio-energy choices, sourced from afforestation on

marginal agricultural land or sustainably managed forest and combined with carbon

capture and storage, can contribute to a net sequestration of carbon. But there may be

some potential unintended policy conflicts between this and the need for food security

and environmental sustainability. Without well-aligned policies, shifting to a

bio-economy risks diverting biological resources to purposes other than food, without

necessarily significantly reducing GHG emissions.

There are two main areas where a better alignment of policies would allow a

bio-economy to really contribute to the challenge of food security and the climate agenda.

First, the key issue is how to ensure the sustainability of the entire value chain,

including primary production and inputs, logistics and transport, the conversion of the

bio-resources into multiple products, and finally the distribution, sale and end-use of the

product. Whether a bio-economy helps or hinders a low-carbon and sustainable future

depends on rigorous accounting of the carbon flows along the whole chain. Governments

must quantify emissions at each stage and compare them to alternative sources. Research

has shown that GHG emissions over the entire life cycle of bio-products can be worse

than for fossil fuels if the feedstock is grown on previously non-cultivated areas (OECD,

2014g). For instance, GHG emissions can arise either by growing the biomaterial on land

that was previously forest, or indirectly by displacing the production of other

commodities which are then produced elsewhere (IEA, 2012). There is still much

uncertainty associated with the models meant to account for this latter effect, so more

research is needed to allow for more rigorous accounting of these emissions. Sourcing

biomaterials from recycled products or food waste could avoid those emissions.

Second, the synergies and trade-offs between a bio-economy and other goals, such as

food security, biodiversity conservation and resource management, need to be properly

assessed.

Making sure that a bio-economy approach delivers on all these crucial areas will

require aligned policy signals and the following elements (IEA, 2012):

•

Internationally aligned certification schemes that promote the sustainable production of

energy crops, ensure GHG benefits and avoid competition for land with growing food

demand (Box 9.8).

Considerable investment in agriculture: For example, investment is needed in feedstock

and production R&D to accelerate the development of technologies that do not interfere

with food production.

More open biomass and biofuels trade: Trade will play a crucial role in matching

supply and demand in different regions, calling for a reduction of existing tariffs on

biomass products. Some countries’ import tariffs, especially for ethanol, remain very

high (greater than 30%) and should be reduced or eliminated. Internationally agreed

technical standards for biomass and biomass intermediates would remove an important

current impediment to trade.

•

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– II.9. STRENGHTHENING INCENTIVES FOR SUSTAINABLE LAND USE

Box 9.8.

Biofuels and food prices

In 2007-08, major food staples saw their biggest increase in prices since the 1970s. Many

blamed the impact of biofuels policies, which they believed were encouraging the growth of

biofuels instead of food. A number of studies and experts attempted to quantify the real impact

of biofuel mandates on the 2007 food crisis, but were unable to reach a consensus. For instance,

in 2010 the World Bank revisited a statement published in 2008 claiming that biofuels were

responsible for 70% of the price increase (Mitchell, 2008). The later research found that trade

policies were likely to be the more significant driver (World Bank, 2010).

Recent studies assessing plausible futures for agricultural markets, large-scale bioenergy and

biofuels use and global food security are also contradictory. Lotze-Campen et al. (2014) used

five agro-economic models to analyse the impact on food prices of a scenario in which global

bioenergy would be consistent with a 2°C pathway. The authors estimate that the global impact

on food prices of “an ambitious mitigation scenario with high bioenergy demand” (+5% average

across models) would be much lower than price impacts of climate change on crop yields in a

high-emissions scenario (25% average across models).

•

Biofuel support policies that are conditional on their life-cycle GHG performance:

Many countries are increasingly mainstreaming sustainability criteria into their biofuels

policy and practices. For example, under its Renewable Energy Directive, the EU

demands that sustainability criteria for biofuels be met to be eligible to satisfy binding

national targets. The criteria include at least 35% GHG emissions savings compared

with fossil fuels – this will rise to 50% in 2017 and 60% in 2018 for biofuels produced

from new facilities. The United States Environmental Protection Agency’s Renewable

Fuel Standard II programme states that advanced biofuels must demonstrate that they

meet minimum GHG reduction standards of 50% and 60% along the entire life cycle.

Biofuel environmental impact assessment which accounts for emissions from indirect

land-use changes: Some governments have already tried to account for indirect land-use

change. For example, the state of California’s low-carbon fuel standard adds an overall

GHG penalty to calculations to account for them. Other policies to reduce the impact of

land-use change include zoning policies. For example, Brazil’s Agro-Ecological

Sugarcane Zoning Programme limits the areas in which sugar cane production can be

expanded. The programme limits access to development funds for non-compliers (IEA,

2011).

A focus on using waste and residues, perennial energy crops and maximising land-use

efficiency through improved productivity or the use of specific high-yielding feedstock

in order to avoid emissions from biofuel-driven land-use change.

Beyond bioenergy, many technical barriers also stand in the way of the deployment of

a bio-based economy. For example, complex and time-consuming regulations can

drastically affect the small bio companies that are so often sources of innovation

(Box 9.9). Governments should undertake an assessment of their regulatory framework

and more develop appropriate tools and methodologies to make sure the bio-economy can

support growth while preserving climate, food security and a broader development

agenda.

•

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Box 9.9.

Barriers to a bio-economy

The fast pace at which bio-chemicals have developed has made it hard for governance and

regulatory frameworks to keep up. Though the idea of “bio-refineries” – locations which group

the production of fuels, chemicals and plastics from bio-feedstock – is gaining ground, decades

of research in bio-chemicals have not led to commercial progress. One problem is that bio-based

production has not received much policy attention and is undermined by complex and

time-consuming regulations that have a drastic impact on small bio companies.

A study for the government of the Netherlands (Sira Consulting, 2011) identified around

80 regulatory barriers to the bio-based economy.

•

Fundamental constraints: These call for a political and policy approach (e.g. import

duties, level playing field, certification and financial feasibility).

Conflicting objectives: These barriers cannot be removed, but governments can help

companies to meet the regulations (e.g. REACH regulations).

Structural constraints, requiring adjustments to regulations: These require adjustment to

regulations, but do not demand policy or political action.

Operational constraints: Here the regulations themselves are not the problem but rather

their implementation, for example by local authorities. This leads to substantial barriers

to investment in the bio-economy, especially for small and medium-sized enterprises.

Source:

Extracted from OECD (2014g), “Biobased chemicals and bioplastics: Finding the right policy

balance”,

OECD Science, Technology and Industry Policy Papers,

No. 17, OECD Publishing, Paris,

http://dx.doi.org/10.1787/5jxwwfjx0djf-en

based on Sira Consulting (2011), Botsende belangen in de

biobased economy. Een inventarisatie en een analyse van de belemmeringen in de transitie naar een

biobased economy, Sira Consulting, The Hague.

Waste and over-consumption need to be tackled

One of the final pieces of the low-carbon land-use puzzle is how to reduce losses and

waste of food and other products derived from the land (more broadly, any type of waste

derived from land). The FAO defines food loss as “the decrease in the quantity or quality

of food,” and food waste as the part of food loss which is fit for consumption but

removed from the food supply chain “by choice, or which has been left to spoil or expire

as a result of negligence by the actor – predominantly, but not exclusively the final

consumer at household level.” While the term “food loss” encompasses food waste, the

FAO uses the term food loss and waste “to emphasi[s]e the importance and uniqueness of

the waste part of food loss” (FAO, 2014b).The FAO estimates that roughly one-third of

the food produced globally for human consumption is lost or wasted every year (FAO,

2009).

The worldwide loss and waste of food could have a significant impact on GHG

emissions, by increasing the need for more land-clearing, more fertiliser and pesticide

applications, more fuel used in farm equipment and to bring the food to market, and more

methane emitted from rotting food in landfills. The FAO (2013) estimates that 3.3 billion

tonnes of GHG are added to the atmosphere from food that is produced but not eaten,

making it the third-highest emitter after the United States and China. Food losses and

waste also imply a number of other economic, environmental and social impacts, such as

the inefficient use of resources and inefficient supply chains for agricultural products. The

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direct economic cost of food wastage could add up to USD 650 billion a year (FAO,

2013).

The OECD’s Green Growth Strategy targets reducing food waste as a means to

increase food supply and reduce pressures on land (OECD, 2013d). But doing so means

identifying and addressing the root causes. In developing and low-income countries, food

waste and losses mainly occur at the early stages of the food supply chain through

inefficient harvesting techniques, storage and cooling facilities, transport, packaging and

marketing systems (Table 9.2). Addressing these inefficiencies will require investments

in infrastructure, and technical and financial support to farmers and along the supply

chain.

Table 9.2.

Food loss and waste along the supply chain

Definition

During or immediately

after harvesting on the

farm

Includes

Fruits bruised during

picking or threshing

Crops sorted out

post-harvest for not

meeting quality

standards

Crops left behind in

fields due to poor

mechanical harvesting

or sharp drops in

prices

After produce leaves

the farm for handling,

storage and

transport

Edible food eaten by

pests

Edible produce

degraded by fungus

or disease

Livestock death

during transport to

slaughter or not

accepted for

slaughter

During industrial or

domestic processing

and/or packaging

Milk spilled during

pasteurisation and

processing

Edible fruit or grains

sorted out as not

suitable for processing

Livestock trimming

during slaughtering

and industrial

processing

During distribution to

markets, including

losses at wholesale

and retail markets

Edible produce sorted

out due to quality

Edible products

expired before being

purchased

Edible products spilled

or damaged in market

Losses in the home

or business of the

consumer, including

restaurants/caterers

Edible products sorted

out due to quality

Food purchased but

not eaten

Food cooked but not

eaten

Sources:

Extracted from Bagherzadeh, M. et al. (2014), “Food waste along the food chain”,

OECD Food,

Agriculture and Fisheries Papers,

No. 71, OECD Publishing, Paris,

http://dx.doi.org/10.1787/5jxrcmftzj36-en,

based on Lipinski, B. et al. (2013), “Reducing food loss and waste”, Installment 2 of “Creating a Sustainable

Food Future”, Working Paper, World Resources Institute, Washington, DC, available at:

www.wri.org/sites/default/files/reducing_food_loss_and_waste.pdf.

Losses at the consumer level, both household and out-of-home eating, are high and

growing in urban areas of developing countries. In OECD countries, it seems that food is

mainly wasted at later stages of the supply chain; raising awareness and consumer

engagement are key. Governments can also improve collaboration between different

segments of the value chain through a better alignment of different policies. For instance,

the Good Samaritan Act in the United States and similar legislation in several EU

countries protect donors from liability, hence encouraging donation to food banks. Other

countries send contradictory signals by exempting discarded food from value-added tax

but not donated food (Bagherzadeh et al., 2014).

Several areas require a better alignment of policies (OECD, 2013a):

•

Improve data and reporting: The availability of household data on food waste is

relatively good in OECD countries. However, there is very little national information

on food waste in other parts of the food chain, particularly manufacturing, distribution

and out-of-home eating. Adopting common definitions of food waste and developing

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accurate reporting of food waste by economic activity and commodity groupings would

contribute to a better understanding of the challenge and allow tailored

recommendations (OECD, 2013a). As the cost of food loss and waste data collection

could be very high, a systematic analysis of the food supply chain to identify the major

drivers of food loss and waste could provide actionable information in the absence of

quantity data.

•

Improve the legal and institutional framework for food waste: Most countries have a

legal framework for food waste, but it is usually embedded in a broader waste

framework under the authority of the Ministry of Environment or local governments

and municipalities responsible for waste collection management and recycling services.

Food waste is only implicitly included in general overarching objectives relating to

waste, such as avoiding the generation of waste, managing waste as a resource,

ensuring safe and environmentally friendly waste treatments, and efficient waste

management. The legal and institutional setting does not favour co-ordination between

different ministries and does not address the root causes of waste: the Ministry of

Agriculture or Economy is in charge of farming activities and food industry oversight,

while the Minister of Environment regulates waste management, the Ministry of

Economy administers tax incentives for food donation and the Ministry of Health

oversees the safety aspects of food, usually through a Food Safety Authority under its

control. This fragmented approach to food waste creates potential conflicts of interests

between different authorities and government bodies and is hindering the transition to a

more efficient management of the food supply chain.

Strengthen collaboration with the private sector: The government has an important role

to play in avoiding food waste while providing safe food. However, the private sector

can influence many aspects of the management of the value chain, from innovation in

production processes to a more informed use of labels. For instance, the “best before”

label does not come as a recommendation from governments, but is an industry practice

to adapt to expected business liabilities or maximise taste and flavour. National

governments should provide the right policy framework and incentives to facilitate

partnerships between industries and raise awareness; and develop education campaigns.

Several platforms for co-operation have been implemented to facilitate this dialogue, as

part of the FAO’s Save Food initiative.

•

Towards an integrated and holistic approach

There are many synergies – and some trade-offs – between the climate agenda and the

pursuit of other environmental goals, such as reducing water pollution and conserving

biodiversity. A number of policy instruments need to be better aligned to achieve a

low-carbon, resilient economy without compromising other fundamental policy goals.

International, national and local policies can create synergies between the different

agendas if they explicitly factor in multiple goals in policy formulation. For instance, at

the international level, some policies could promote synergies between reduced

deforestation and enhanced agricultural production, including: agricultural soil carbon

credits in carbon markets, strengthening development assistance for projects pursuing the

three objectives, developing guidelines for the participation in global value chains that

encourage the production of commodities on land that has already been cleared (DeFries

and Rosenzweig, 2010). More work is needed to identify how policy makers could help

manage synergies and trade-offs between the different agendas, for a more inclusive

green growth (OECD, 2014a).

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Notes

Environmental cross-compliance criteria aim to address several environmental

objectives, including reduction of nitrogen and phosphorus runoff and leaching, soil

erosion and sediment runoff, conservation and promotion of farmland biodiversity,

reduction of pesticide runoff and residues, and improved animal welfare.

See:

www.globalresearchalliance.org.

For details see

www.un-redd.org/aboutredd.

UNFCCC’s Warsaw Framework on REDD+.

See:

www.save-food.org.

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(03 2015 02 1 P) ISBN 978-92-64-23326-3 – 2015-02

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Aligning Policies for a Low-carbon Economy

This report produced in co-operation with the International Energy Agency (IEA), the International Transport

Forum (ITF) and the Nuclear Energy Agency (NEA) identiﬁes the misalignments between climate change

objectives and policy and regulatory frameworks across a range of policy domains (investment, taxation,

innovation and skills, trade, and adaptation) and activities at the heart of climate policy (electricity, urban

mobility and rural land use).

Outside of countries’ core climate policies, many of the regulatory features of today’s economies have been

built around the availability of fossil fuels and without any regard for the greenhouse gas emissions stemming

from human activities. This report makes a diagnosis of these contradictions and points to means of solving

them to support a more effective transition of all countries to a low-carbon economy.

Contents

Chapter 1. Core climate policies and the case for policy alignment

Part I. Reforming cross-cutting policies

Chapter 2. Scaling-up low-carbon investment and ﬁnance

Chapter 3. Implementing climate-friendly taxation practices

Chapter 4. Delivering innovation and skills for the low-carbon transition

Chapter 5. Removing international trade barriers

Chapter 6. Diagnosing misalignments for a more resilient future

Part II. Aligning policies in speciﬁc activities

Chapter 7. Reframing investment signals and incentives in electricity

Chapter 8. Opting for low-carbon urban mobility

Chapter 9. Strengthening incentives for sustainable land use

Consult this publication on line at

http://dx.doi.org/10.1787/9789264233294-en.

This work is published on the OECD iLibrary, which gathers all OECD books, periodicals and statistical databases.

Visit

www.oecd-ilibrary.org

for more information.

ISBN 978-92-64-23326-3

03 2015 02 1 P