Europe’s Economic Recovery Could Be Hit by Own Goal

The last time I wrote about Europe’s economy, it was in the context of global economic recovery, jobs and employment and how many people who had been furloughed were back to full-time work. Now that we know that the European economy has grown healthily in the second quarter of 2021, we must remember that it is due to a base effect. The Euro area in particular has grown at an annualized rate of 8.2%, with year-on-year growth at 13.6%. This, even if Europe like many western countries measures real GDP growth quarter-on-quarter annualized, is encouraging. You can see it in The Economist’s Table of Indicators.

The Covid pandemic still lingers, though, and with the Delta variant spreading around the world, Britain and most European countries are affected. Britain’s economy grew at an annualized rate of 4.8% in the second quarter of this year, and it is attributed to the gradual relaxation of lockdown conditions. I am sorry if I tend to club Britain with Europe even after Brexit, but I still believe that that is where the country truly belongs. So, do bear with my political incorrectness, if you will, at least for the sake of this piece.

In fact, there is a very good reason for me to bring up Britain. And it is in the context of Brexit. There is plenty to still sort out in the negotiations between UK and the EU, especially on the Irish border, which has infuriated the Northern Irelanders no end. And there is unfinished business in the negotiations on the trade agreement itself, especially on services, which hasn’t even begun yet, it appears. As I have written before, Britain’s surplus in trade with the EU is in services, so it is in its interests to conclude negotiations on the matter soon.

Besides the issues of the pandemic and Brexit-related negotiations, there is yet another issue that could become a hindrance to growth in both Europe as well as UK, affecting all other countries as well. It is one of the EU’s creations: a carbon border tariff that seeks to equalize carbon emissions reductions within and without EU countries. C-BAM, or Carbon Border Adjustment Mechanism, as it being called is a policy designed to make European countries’ efforts at carbon emissions reduction equal to those outside of the EU. In principle, it is a carbon tariff that will be imposed on imports into the EU that do not follow similar standards of carbon emissions reduction. And it is targeted to go into effect, in the spring of 2022.

I think it is a flawed policy in terms of both its effect and its timing. The European Union which has always been at the vanguard of long-term policies that seek to bring about greater inclusion, equity and sustainability is sadly falling short on this latest carbon emissions policy. I think it might have been carried away by the enthusiasm and success of the Paris Climate Accord of 2015 and is probably attempting to go one better. However, while the intent is right, the policy itself will not only not achieve its stated objectives, it will jeopardise economic recovery in the region and around the world.

Some industries pollute more than others; Image: Patrick Hendry on Unsplash

Granted, there needs to be a sense of urgency on tackling climate change and reducing carbon emissions is a big part of that action. But when we examine the policy in relation to the objectives that we are trying to achieve, we find little or at best, a very weak link between them. The EU has a great opportunity to reform its existing emissions trading system (ETS) which, although it has been in existence for more than two decades, has not done enough to make industry shift to cleaner and greener technologies. One can also tell its low adoption by the price of the EU carbon ETS, which hardly budged beyond € 4-€ 6 in at least a decade, that I can remember. I read recently that carbon prices in Europe’s ETS have soared this year, to over € 50 thanks to greater investor interest in carbon emissions and climate change.

Imposing a carbon border tariff is perhaps not the best solution to lowering carbon emissions. For one thing, it does not meet the objective, nor does it help engender any change in production processes or behaviour by industry. What it does instead is impose a kind of tax (for the carbon border tariff is a kind of import tax) on industry on what it imports from countries that don’t meet the same standards or carbon emission levels as EU countries. Why should the onus fall only on importers and not on all of industry to improve their carbon-emission reduction levels at home? Then, consider the externalities; why should consumers have to pay higher prices for goods/services because industry has failed to keep its end of the bargain? And finally, isn’t C-BAM a form of protectionism for European industry by another name? It legitimizes state-aid for European businesses – even if it isn’t any one country – something the EU has always fought against.

And then, of course, there is the timing. There can’t possibly be a worse time than now, to launch a protectionist measure that will increase prices of most goods and services for European consumers. Europe had barely recovered from the 2010 Euro crisis, when the pandemic hit last year. One good sign of greater European cooperation during this crisis, was the agreement to mutualise all member countries’ debt and to set up a European Recovery Fund of € 750 billion.

Unfortunately, going from plan to implementation has taken inordinately long. By the time the recovery fund tranches actually make their way to the countries that need them most, especially the southern European economies that are too dependent on tourism, the worst of the pandemic crisis might be well past us. Expediting matters on that front ought to be the focus right now. People are slowly returning to work, with millions still out of work, and many sectors of the economy are still down. At a time when you want to keep consumer demand buoyant and encourage investment in the economy, the last thing one needs is another tariff!  

I am assuming that making industry shift to low-carbon, cleaner technology is still the objective. If that is so, and if the adoption of clean and green tech has not grown significantly within EU countries under ETS, then we need to understand the reasons why and change tack to a more effective measure than ETS. The ways in which power utilities and industry can cut carbon emissions are:

  • To cut fossil-fuel as feedstock and rely more on renewables
  • To improve efficiencies and cut down on fuel consumption overall
  • To adopt cleaner, greener technologies that use less fuel/per unit of output

The biggest stumbling block could be the third – adopting cleaner technologies – for which the reasons are perhaps their high costs. This has also been the biggest bugbear as far as poorer, developing countries are concerned, who would like to invest in cleaner technologies, but the prices are prohibitive.

I would imagine that as far as incentivising industry is concerned, a carbon tax would be far more effective than a cap-and-trade system. As appears from this World Bank Report, many countries in Europe indeed have already implemented or have planned for a carbon tax in addition to the ETS. These are the Scandinavian countries, Switzerland, Iceland as well as France, Spain and Portugal. Britain is believed to be developing its own ETS and will perhaps link to the EU ETS, as Switzerland has recently done.

China, India and all of Asia need to do more to reduce carbon emissions; Chart: Our World in Data website

Britain will be hosting the next Climate Summit in November 2021, at Glasgow, where I am sure Europe’s C-BAM will be under discussion. That’s just a couple of months away and so the more ideas there are around this subject, the better it will be. Around the time of the Copenhagen Climate Summit in 2009, I remember reading that China had mooted the idea of calculating a country’s contribution to reduction in carbon emissions, based on the carbon-intensity of its GDP. This seemed to me perfectly reasonable and just, for it increases the responsibility of countries whose GDP is formed of more polluting industries, rather than on historical precedence or on per-capita calculations. While there is no getting away from historical precedence, since the cumulative effect of decades of pollution by a few industrialised countries has taken a toll on the entire world and lingered in the atmosphere for decades thereafter, the per-capita argument is weak and specious, letting populous countries like China, India, and Indonesia off the hook.

If we could adopt the carbon-intensity argument and use it for calculating a carbon tax for industry as well, it would be fair, effective and would perhaps be more impactful in bringing about change. Therefore, the carbon tax on certain more polluting industries would be more than on less polluting ones, prompting the former to shift to cleaner and greener technologies.

There is yet another side to the problem of reducing emissions and shifting to cleaner tech: the exorbitant costs. A carbon tax could help raise more revenue for governments to then plough back into subsidizing some of the costs of clean technology. This is where more research and development are required and where the higher costs need to be defrayed. An ecosystem of being able to raise capital for such ventures as well as multilateral financial assistance, including from the World Bank as well as other development banks, needs to be developed.

There is also an issue with intellectual property on these technologies and I suspect most of the high costs of the technology transfer to poorer countries are to do with this. I have been arguing in my blog posts for a while that the world needs to develop a more relaxed, sustainable patent regime in general – with lower durations and better terms for licensing – as I think this will spur innovation. And on tackling carbon and GHG emissions, as much urgency is needed as in tackling the Covid pandemic.

The world’s pharmaceutical companies and vaccine researchers spared no time in coming up with vaccines, testing their efficacy and in producing them. Sure, there were hiccups along the way, but this is the fastest the world has ever produced vaccines. Unfortunately, the world couldn’t agree on waiving the IPR on these vaccines so that many more producers could have produced them worldwide, at lower costs. This is where rich, advanced countries of the West have to balance their desire to see improvement, with what they are willing to give up in the short term, in order to achieve those changes and improvements. Unfortunately, on Covid vaccines IPR, European countries proved to be as short-term and intransigent as the US.

There are also more long-term solutions being developed on carbon, such as carbon capture and storage, but once again, the costs are prohibitive right now. The way forward would be to enable the shift towards cleaner and greener technologies. By making industry prioritise cleaner production and pay a tax for what pollution it causes. As well as by incentivizing greater research and development on clean tech and bringing down the costs.

Renewables are the future; Image: Karsten Wurth on Unsplash

A decade ago, one couldn’t imagine renewables would ever replace coal as the energy for the power industry. Today, it is the energy source of choice, particularly in the US, because the economics of it have won over carbon.

So, while we have enough problems already to contend with – not least Afghanistan – let us not erect new barriers, including of the carbon border tariff kind, hoping that it will change industry’s behaviour. We should know by now, tariffs rarely ever do, and it is always consumers who end up paying for it.

We also have elections in Germany in a few days and the EU has traditionally always been led by a Franco-German alliance at its core. The region has seen relative stability, not least on policy matters, with Angela Merkel at the helm in Germany for the past 15 years. We need to watch how that cooperation now pans out, especially on economic and climate change issues, as she leaves office.

Instead of hurting its own growth prospects at this critical stage, perhaps Europe could devise a solution that works for the entire world. They need to look beyond their shores and formulate a carbon tax that all countries can agree to, based on how much their businesses contribute to pollution.

Here’s looking forward to more progress at the Climate Summit in Glasgow!    

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