Select Committee on Environmental Audit Minutes of Evidence

Memorandum from Brian Pearce, Director, Centre for Sustainable Investment, Forum for the Future

  The following note has been written for in response to a request for oral evidence to the House of Commons Environmental Audit Committee inquiry on aviation's environmental costs.

  By way of background Brian Pearce is an economist. Now director of the Centre for Sustainable Investment at the sustainable development think-tank Forum for the Future, he was formerly head of global economic research at the investment bank SBC Warburg and before that Chief Economist at Ernst & Young. An environmental as well as a financial and international macro economist he was the author of the research on aviation's environmental costs that formed the basis for Pearce and Pearce (2000)[8] and parts of the more recent Department for Transport and HM Treasury papers. In the past four years he has been heavily involved in the debate about valuation and the use of economic instruments in the aviation industry, including taking the chair of the recent expert group workshop on aviation's climate change impacts for the HMT/DfT consultation.

Can the full environmental costs of aviation be identified?

  1.  The first point I would like to make is that, in the HM Treasury/DfT document Aviation and the Environment: Using economic instruments, we are considering the economic valuation of environmental costs. This is the economist "lens" on the issue, which may or may not coincide with costs estimated using the "lens" of the biologist or another discipline. It measures economic efficiency. For example there would be an increase in economic efficiency if the sum of the benefits to the travelling public (and the industry), who gain by airport capacity expansion, exceeds the sum of the costs to those who lose (including the environment, local residents and those affected by climate change). In this context, since it is possible for individuals to have preferences over all changes that are likely to take place, full environmental costs can be identified in principle.

What are the main issues of principle and methodological difficulties in attempting to do so?

  2.  One issue of principle is that economic valuation measures a particular version of environmental cost. Economic efficiency is the best use of resources in terms of individual preferences. It does not however measure other objectives of policy such as distributional objectives of fairness or equity, nor does it measure sustainability, or wider concerns regarding the transport infrastructure, regional balance etc. Policy-makers may wish to consider that aviation's environmental costs in terms of these policy objectives in addition to, or perhaps offsetting, the loss to economic efficiency.

  3.  Another issue is the extent to which economic valuation captures the preferences of all the individuals policy-makers wish to take into account. An important point to note is that individual preferences measured under economic valuation techniques do not just include issues of personal wealth. They may also include concerns about health, for others, for future generations and for the environment. However, they are the preference of today's population. These preferences may not coincide with the preferences of future generations nor be fully representative of the preferences of low-income countries in southern latitudes, who are the major groups affected by climate change for example.

  4.  The morality of using money as a measuring rod if often seen as a major issue for the use of economic valuation of impacts such as environmental costs. However, in any decision of public policy with finite public funds and national resources there is always an issue of opportunity cost and a trade-off between objectives. The economic valuation of environmental costs enables this trade-off with economic benefit to be made explicit.

  5.  Uncertainty of the estimates is another issue. Economic valuations of many environmental costs, particularly climate change, seem to be extremely wide and imprecise. However, using expert-determined scores instead may just lead to spurious accuracy. Social science data is by its nature more probabilistic that natural science data.

  6.  One important issue is that economic valuations can really only be made of individuals' preferences at the margin, for relatively small changes. At the extreme it makes little sense to try to measure the total value of the climate—clearly it is of infinite value to all individuals. What economic valuation measures is what resources or goods and services would compensate individuals for a marginally poorer climate. Another example is the value of life—clearly of infinite value to the individual. However, every time we cross the road or fail to take sufficient exercise we have made an implicit valuation of a slightly shorter lifespan or a risk to our life. The point I would like to make here is that figures for the total value of aviation's contribution to climate change or noise do not, perhaps cannot, represent the total environmental cost in economic terms (These would be much higher for the reasons already discussed).

How comprehensive and accurate are the environmental costs included in Aviation and the Environment: Using economic instruments, and in the Department for Transport's consultation The Future Development of Air Transport in the United Kingdom?

  7.  The difficulties of estimating total environmental costs noted above are illustrated in the numbers quoted by the Treasury paper for the total cost of aviation's impact on climate change and noise. The estimate for total aviation noise costs in the Treasury paper of £25 million appears to have been based summing up the value of marginal noise outputs from aircraft of varying types at various airports, using the calculation shown in Pearce and Pearce (2000). If, as I believe, the environmental cost of an extra aircraft movement is much higher at a quiet airport than a noisy airport, other things such as population exposed being equal, then the average environmental cost of an aircraft movement will be higher than the marginal cost. Pearce and Pearce (2000) go on to say "Therefore the £19 million total [for Heathrow only] is likely to be a significant underestimate of the total damage at Heathrow airport each year". An alternative technique described in the same paper, based on noise measured on the ground and average rather than marginal measures of noise quantity, is the source of the £66 million figure quoted by Professor Pearce.

  8.  However, even the latter estimate suffers from the same methodological problem associated with trying to estimate the value of total rather than marginal changes. The total figures do not show the extent of total environmental costs from aviation. However, they do represent the likely scale of financial cost to the aviation industry should a tax or permit be levied at the marginal (per passenger) environmental costs quoted.

  9.  The marginal (per passenger) environmental cost estimates are the most accurate numbers quoted in the consultation papers. However, there are a number of factors that affect the accuracy and comprehensiveness of these marginal costs which are considered in the following paragraphs.

  10.  The climate change costs are perhaps as comprehensive and accurate as possible given the current state of knowledge. The major area of uncertainty are the 2.7x "dose-response" multiplier used in the Treasury estimates to account for the impact of NOx emissions and condensation trail formation. Another major uncertainty is the economic valuation of climate change costs. A practical issue is whether to adjust for different income levels, as in the valuation used. Professor Pearce argues in his much lower estimates that "equity-weighting" is inappropriate. A point of principle is doubt as to whether individuals are able to express preferences for a poorly understood scientific phenomenum, plus the other points of principle noted above.

  11.  The noise estimates are based on the methodology used in Pearce and Pearce (2000). Local residents should be able to express very informed preferences about aircraft noise, even if climate change is more difficult. A fairly sophisticated methodology was used to measure these preferences based on the difference in house prices in quiet and noisy areas around Heathrow airport. The major uncertainty with these numbers is that house price differentials do not capture the environmental costs suffered by the environment, the community or non home owners. Stated preference techniques (questionnaire surveys) usually reveal higher valuations in noise studies, but we do not yet have this evidence for UK airports.

  12.  The major missing element in terms of economic valuation of environmental costs is local air quality. No consideration at all is given to the valuation of recreation and visual intrusion (related to landscape impacts), or impacts on biodiversity, cultural heritage, water quality, land drainage and flooding or community severance. However, these latter impacts are usually very site specific and may be managed better using planning tools rather than economic instruments.

Has the Government defined the correct environmental policy objective for aviation—that, where appropriate, the industry should pay for its environmental costs? How does this relate to the Government's primary objective for airports—to maximise the significant social and economic benefits, whilst seeking to minimise the environmental impacts? What additional measures, if any, would need to be taken if this were to have little impact on rates of growth?

  13.  The point I would like to make here is that paying for environmental costs is quite a separate issue from minimising environmental impacts. "Polluter Pays" is quite often seen as an issue of equity or responsibility rather than creating the incentive for economic efficiency for which economic instruments are ideal. For instance it is sometimes claimed that Air Passenger Duty (APD) represents the aviation industry's payment for its environmental costs. That may or may not be the case, depending on the cost estimates discussed above. It is clear however, that APD does not promote economic efficiency. It does not create the incentive for aviation to minimise its environmental impacts.

  14.  APD is a poor environmental tax because it is not designed to create the incentives for better aircraft operations or better technology ie supply-side responses. The only way it could work is to suppress demand. Since demand for air travel appears to have a strong underlying response to rising income and the DfT are forecasting substantial underlying falls in the cost of air travel, any rise in ticket prices from APD or other charges look like having a minimal impact on numbers flying. This emphasises the need for good design if an economic instrument both pays for and minimises aviation's environmental costs.

Would the incorporation of environmental costs be sufficient to achieve sustainability in the air transport sector?

  15.  Incorporating environmental costs is not the same thing as a sustainable aviation industry. I would take the latter to mean that the industry is not depleting stocks of assets, such as its balance sheet tangible assets, a stable climate, local peace and quiet, local air quality, as well as community goodwill.

  16.  The first point is that if the economic instrument leading to an "incorporation of environmental" costs is poorly designed (like APD) it may have very little impact on whether or not the industry maintains or degrades key assets. A well designed economic instrument that created the incentive for supply-side operational and other changes might achieve sustainability.

  17.  The second point is that economic valuation is based on people's preferences. It may be that today's population does not care enough, relative to other issues, to value aviation's environmental costs at a level high enough to stop the industry degrading these environmental assets. Since many of the impacts (for climate change) fall on future generations and low-income countries in southern latitudes, economic valuations will not fully capture their preferences. The relatively low estimates of environmental costs in the Treasury paper would appear to support this view.

To what extent is there a tension between the policy of incorporating environmental costs (especially of carbon) and the Government's long-term objective of a 60% reduction in CO2 by 2050?

  18.  There is no necessary connection between incorporating carbon costs in prices and the objective of a 60% reduction in CO2 by 2050. Simulations carried out by ICAO suggest a fuel tax of several thousand Euros would be necessary to reduce aviation's CO2 emissions to 5% below 1990 levels. Economic valuations of environmental costs are no where near that level, and so incorporation of these costs by the aviation industry would do little more than dampen the forecast increase in the contribution of aviation to UK CO2 emissions (noting that international emissions remain outside national inventories at present).

Given the international context, what practical options for incorporating environmental costs are readily available to the Treasury and the Department for Transport, and how should any revenues be used?

  19.  What economic instruments could be used to tackle climate change?

    —  The main focus should be on integrating international aviation into the greenhouse gas trading schemes under the Kyoto Protocol;

    —  An international cap and trade scheme would be environmentally effective compared to a tax;

    —  High estimated abatement costs in aviation suggest an open scheme would substantially reduce the resource cost of emissions abatement;

    —  Competitive distortions would be eliminated under a regional or global scheme (remember airline hub airports cannot be shifted to low cost developing countries), and a scheme based on emissions rather than fuel would prevent "tankering" distortions;

    —  The feasibility of such a scheme is high. An emissions-based scheme avoids the legal problems with a tax or restriction on fuel. Administration could be undertaken by the UNFCCC infrastructure. Under ICAO the industry has already agreed this is the best option;

    —  An EU-level charge should be considered as an interim measure on CO2 and as a separate instrument for the regional effects of NOx and condensation trails;

    —  The second Kyoto commitment period is a decade away. The EC has already designed an EU aviation environmental charge that could be used as an interim measure to encourage the industry to manage its CO2 and other Kyoto Protocol greenhouse gases;

    —  NOx and condensation trails are responsible for taking aviation's radiative forcing to 2.7 times the impact of CO2 alone. However, these emissions are not linked to CO2 and they are not in the Kyoto group of greenhouse gases. Therefore, a separate economic instrument is necessary. Since they have regional climate effects an EU-wide charge is an ideal economic instrument.

  20.  Should there be a priority to reduce one particular aspect of aviation's contribution to climate change, such as CO2?

    —  No. Total radiative forcing of aviation's emissions is 2.7 times that of CO2 alone. Prioritising CO2 alone could lead to a weak environmental impact at best, and a perverse one at worst.

  21.  What would the advantages and disadvantages of including international aviation in national totals for the second Kyoto commitment period be?

    —  The major advantage is one of feasibility. It is the only international agreement in town;

    —  It also has the advantage of including aviation in an open trading system which could substantially reduce the resource costs of CO2 mitigation;

    —  As an international cap and trade system, if ratified, it will also be effective at achieving the target reduction in emissions. A tax or charge would not be certain to do this;

    —  The major disadvantage is that the second commitment period is a decade away. It could be used as an excuse to do nothing, which is why an EU charge as an interim measure would be sensible in the absence of transport being part of the EU emissions trading scheme.

  22.  What measures could be introduced to encourage airlines to purchase assets which are less environmentally damaging?

    —  The advantage of an economic instrument is that it leaves the way in which emissions are reduced up to the economic agent, unlike a BAT or BATNEEC regulation;

    —  So airlines would be encouraged to purchase cleaner assets. They would also be encouraged to save money by operational improvements which may include pressuring air traffic control and the airports to improve air and ground management;

    —  An extremely important point to make is that the economic instrument must be designed well to create these supply-side incentives. This means a tax or permit on the emission. A fuel duty or a passenger charge such as APD will be environmentally ineffective because it creates no incentive for the supply side, relying on rather weak impacts on demand.

  23.  What other measures might be effective at tackling climate change?

    —  Information or disclosure-based measures should be considered;

    —  The implementation of informed consumer choice could be improved by a labelling scheme for the "greenhouse gassiness" of flights;

    —  Investor groups are an influential force for improvement. Disclosure would help their investment process, possibly through changes to the London Stock Exchange listing requirements.

  24.  Should domestic or EU-level measures be pursued in the short-term ahead of long-term international agreements?

    —  Environmental effectiveness for a global pollutant such as CO2 is reduced but there would be advantages in adopting a leadership position and likely learning benefits. An EU-level measure would minimise competitiveness distortions;

    —  Certainly an EU-level charge should be pursued as a separate instrument for the regional effects of NOx and contrails

  25.  What economic instruments could be used to tackle impacts on local air quality and noise?

    —  Setting tradable caps or "budgets" would create new markets in aircraft noise and LTO emissions;

    —  These would guarantee environmental targets are achieved (unless enforcement is difficult which may be the case with local air quality where, for instance, NO2 emissions also come from surface transport);

    —  Abatement costs for the industry would be minimised because of trading allowances;

    —  Cost of airport use would be higher which may lead to some loss of competitive advantage over other airports. However, these pollutants are local and should be paid for under "polluter pays". Moreover, the levels of charge are not likely to be excessive and, unlike, other industries, an airline cannot transfer its hub to a low cost developing country.

  A charge is another option which has been explored in the literature both for the UK and at the EU level;

    —  A charge would create the financial incentives required to bring about the supply-side changes required in the long-run, but it would not guarantee achievement of the environmental target;

    —  A charge would guarantee the cost but have similar competitiveness impacts as a cap or "budget".

  26.  Should economic instruments vary by emissions, or noise, or both?

    —  Both;

    —  One of the key points to emphasise here is that to be effective an economic instrument must be designed well to create supply-side incentives (such as a better fleet mix), because demand effect may be weak. This means a charge or allowance on emissions and not fuel or passengers (this way APD is ineffective as an environmental charge).

  27.  On which type of emission would it make most sense to base economic instruments?

    —  On those with significant environmental impacts.

  28.  Should economic instruments vary by aircraft type, or location, or both?

    —  Both;

    —  It has been shown to be feasible to design a charge that varies by aircraft type and location. The same methodology could be used to allocate permits;

    —  There is considerable variation in emissions by aircraft type and location, because of different populations exposed around airports. The economic instrument should give an incentive to fly to less populated regional airports, giving both environmental and regional development benefits.

  29.  Is there a role for economic instruments to help meet mandatory EU limits for NO2 and PM10?

    —  Possibly;

    —  A tax would not be suitable since there would be no guarantee of holding the limit;

    —  A tradable cap or air quality "budget" may work and reduce compliance costs. However, it may be that the source of NO2 emissions from surface transport as well as aviation may make such an economic instrument impractical;

    —  Regulatory instruments may be best for this issue.

  30.  Should economic instruments be based on estimates of external costs?

    —  Only if the best instrument is a charge;

    —  A cap and trade scheme looks the best instrument for most pollutants. In this case the price will depend on the cost of preventing further pollution and not the damage cost;

    —  The external costs in the consultation paper are low. This implies economic instruments can be used without serious financial difficulty for the aviation industry.

June 2003

8   Pearce, B and Prof D Pearce, 2000, "Setting Environmental Taxes for Aircraft: A Case Study of the UK", CSERGE Working Paper GEC 2000-26. Back

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