Energy and Climate Change CommitteeMemorandum submitted by the Grantham Research Institute

Submission from Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Political Science.

About the authors: Alex Bowen is principal research fellow at the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science Baran Doda is research assistant (post-doctoral researcher) at the Grantham Research Institute on Climate Change and the Environment. Sam Fankhauser is acting co-director at the Grantham Research Institute on Climate Change and the Environment. The work of the Grantham Research Institute is integrated with the activities of the Centre for Climate Change Economics and Policy (CCCEP), hosted by LSE and the University of Leeds. CCCEP is funded by the UK Economic & Social Research Council and Munich Re.

This submission provides input to the inquiry by the Energy and Climate Change Committee which seeks to study:

“… whether there is a case for the adoption of consumption-based emissions reporting in the UK, whether it is feasible to do this in practice, whether emissions reduction targets might be adopted on a consumption basis, and what the implications for international negotiations on climate change might be if the UK, and others, took this approach.”

It addresses the three specific questions put forward by the committee.

1.How do assessments of the UK’s greenhouse gas emissions differ when measured on a consumption rather than a production basis?

2.What are the benefits and disadvantages associated with taking a consumption-based rather than production-based approach to greenhouse gas emissions accounting?

3.Would it be (a) desirable and (b) practicable for the UK to adopt emissions reduction targets on a consumption rather than production basis?

The arguments set out in the paper are those of the authors and not necessarily of the Grantham research Institute for Climate Change and the Environment

Submission Summary

The following bullets summarize the central arguments of this submission:

There is a growing gap between the UK’s consumption- and production-based emissions, driven mostly by a substantial increase in the former. Consumption-based emissions associated with net imports from the rest of the world to the UK more than quintupled, from about 29 MtCO2 in 1990 to almost 160 MtCO2, in 2008.

The counterpart to the UK’s experience is that of China, where the difference between production- and consumption-based emissions increased more than fivefold to 1330 MtCO2 between 1990 and 2008.

The UK’s experience of persistently widening difference between consumption and production-based emissions is broadly similar to that of the US, G7 and Annex I countries.

The driving forces behind these trends are complex and intertwined. They include globalization, non-carbon distortions that have a bearing on trade patterns, structural change associated with development and carbon leakage. More research is needed to understand fully the relative contributions of each mechanism.

Given these discrepancies, there would be substantial informational benefits from adding a consumption-based emissions-accounting approach to the existing production-based method.

However, moving to pure consumption-based accounting is not advisable. There is much more uncertainty in consumption-based accounts than production-based accounts, and the accuracy of reporting would suffer.

Nor are consumption-based carbon targets the way forward. Consumption-based targets only make sense if policy-makers are given the levers to reduce the carbon embedded in imports (eg through border adjustments). At the moment, this is not realistic.

1. How do assessments of the UK’s greenhouse gas emissions differ when measured on a consumption rather than a production basis?

1.1 Recent research is unambiguous that there exists a sustained divergence between UK’s consumption- and production-based CO2 emissions (CBE and PBE hereafter).1 This submission draws on the empirical results for CO2 emissions in Peters et al (2011) to illustrate this divergence and place it in a broader international context.2 In particular:

1.1.1Whereas UK’s PBE has declined between 1990 and 2008, its CBE has increased by 16.8% over the same period. The excess of CO2 emissions associated with UK consumption over emissions actually located in the UK, ie the quantity (CBE-PBE), more than quintupled to almost 160 MtCO2. In other words, the UK’s imports embodied increasingly greater quantities of CO2 relative to its exports, and the net balance of CO2 increased from about 5% to 30% as a share of PBE. This is illustrated in Figure 1 below.

1.1.2The counterpart to the UK’s experience is that of China, where both PBE and CBE have increased between 1990 and 2008, but the former by much more than the latter. The net difference also increased by more than fivefold to 1330 MtCO2. As a share of PBE, the net difference increased from 10% to 19%. This is shown in Figure 2 below.

1.1.3In an international context, the UK’s experience of a widening excess of CBE over PBE is broadly similar to that of the US, G7 and Annex I countries. This can be observed in Figure 3 below.

1.2 Another way of viewing these trends is to note that if all international trade ceased tomorrow, the UK, and Annex I countries more generally, would not have enough domestically produced carbon-intensive goods and services to satisfy their domestic demand. Conversely, China and non-Annex I countries would have too much.

1.3 Most Annex I and non-Annex I countries have increased their CBEs since 1990. Consequently, global emissions have risen. In contrast, PBEs have remained stable or even declined in some countries (like the UK), indicating a profound reshuffling of production patterns where carbon-intensive production has migrated away from rich countries.

1.4 The driving forces behind these trends are complex and intertwined. First, globalization and increased trade flows have played a key part and to the extent that this reorganizes production based on comparative advantage, it must be welcomed. Second, economic distortions which are neutral with respect to CO2 embodied in trade (eg the alleged undervaluation of the Chinese currency) as well as those that may have non-neutral effects (eg tax rebates to support production in China’s energy-intensive sectors)3 have an important bearing on the resulting configuration of production across countries. Third, structural change associated with the economic development process will increase the CO2 intensity of production in developing countries as these countries’ productive inputs are allocated away from agriculture and towards industry.

1.5 Another mechanism that is consistent with the above trends is carbon leakage.4 Without making a judgement regarding the relative importance of this channel, it is important to note that the trends described above start before there was any significant policy intervention directed at reducing CO2 emissions. Furthermore, the patterns observed for the regulated UK and the unregulated US are broadly similar, suggesting that carbon leakage cannot be the only, or even the main, channel at work.5

2. What are the benefits and disadvantages associated with taking a consumption-based rather than production-based approach to greenhouse gas emissions accounting?

2.1 A production-based approach to emissions accounting has several benefits. Most importantly, the data it requires are relatively easy to collect and uncontroversial to measure, particularly for energy-related emissions. It also allows the tracking of emissions intensity over time. By using a production-based method, it is possible to gain a deeper understanding of the implications of production technologies on emissions, and construct policies that incentivise directly the development and adoption of the clean technologies we need in a carbon-constrained world.

2.2 However, the production-based approach is uninformative about the consequences of alternative cross-country consumption patterns in a globalizing world. In fact, it obscures the mounting imbalance in the system. For example, under the trends identified above even if/when Annex I countries decarbonise their production completely, the climate change problem will not be solved unless non-Annex I countries achieve substantial decarbonisation of their production on behalf of both Annex I and non-Annex I consumers.

2.3 Against this backdrop, a consumption-based emissions accounting method has significant informational benefits when used as a complement to the existing production-based system. It links the CO2 emitted during the production process of a good with the ultimate beneficiary of those emissions, the consumer, who may be far removed from the production process. It raises public awareness and encourages consumers to take responsibility for the emissions associated with their consumption regardless of where those emissions take place. Finally, it highlights the necessity of additional research to establish the relative contribution of the driving mechanisms identified in paragraphs (1.4) and (1.5), which is crucial for the design and implementation of efficient and equitable climate-change mitigation policies.

2.4 The main disadvantage of a consumption-based accounting method relates to measurement. The calculation of emissions embodied in trade is inherently complex. They require assumptions based on aggregate data which may not hold for individual exporters. For example, how do we account for the carbon content of an imported Chinese machine if the firm which produced it used intermediate inputs and technologies that are less carbon-intensive than the industry average in China?

3. Would it be (a) desirable and (b) practicable for the UK to adopt emissions reduction targets on a consumption rather than production basis?

3.1 It is important to understand the difference between the adoption of an accounting method (a way to measure emissions) and the adoption of emissions reduction targets based on consumption emissions (a framework to reduce emissions). Although there are significant benefits associated with accurately measuring and reporting consumption emissions, there are a number of practical obstacles to the design and implementation of consumption-based emissions reduction targets.

3.2 The efficient implementation of consumption-based targets would require the taxation (or equivalent policies) of all final goods and services, including imports, according to their carbon content. It would require accurate measurement of embodied carbon emissions at a high resolution, a complex border adjustment system with regular updates based on technological innovation in origin countries and sectors, and would have to be resilient to challenges at the WTO. Regarding the latter, Atkinson et al (2011) report average border adjustment rates of about 10% for key developing country exporters such as China, India and South Africa based on a carbon price of $50/tCO2.

3.3 An administratively less demanding alternative would be to focus on those internationally traded goods and services that embody large quantities of carbon, and pursue regional and sectoral agreements specifically and narrowly for these goods. This solution is not without its own drawbacks. Although it may be easier to reach an agreement within a smaller group, such an agreement may be inefficient (compared to a truly global deal) and likely be challenged at the WTO as well.

3.4 Given these obstacles, carbon policies based on emissions at the point of production offer significant advantages. They make effective use of information by providing incentives to those with the power to make the emissions reductions decisions. Also they have relatively low monitoring and enforcement costs.

3.5 Consequently, in the current economic, institutional and political landscape, it is neither desirable nor practicable to adopt consumption-based emissions reduction targets. That said, the current system which is built around production-based emissions targets needs improvement because it is not optimized for the extent and pace of globalization. In other words, the key aspect of the current system that needs strengthening is not the accounting basis of the targets, but the degree of international agreement around the targets that will allow us to address climate change in an increasingly globalized world.

October 2011

Figures

References

Atkinson G; Hamilton K; Ruta G; van der Mensbrugghe D (2011). Trade in virtual carbon: Empirical results and implications for policy. Global Environmental Change, vol. 21, p 563–574.

Baiocchi G; Minx J C, (2010). Understanding changes in the UK’s CO2 emissions: A global perspective. Environ Sci Technol, vol 44, p 1177–1184.

Caldeira K; Davis S J (2010). Consumption-based accounting of CO2 emissions. PNAS, vol 107, p 5687–5692.

Caldeira K; Davis S J; Peters G P (2011). The supply chain of CO2 emissions. PNAS, Early edition.

Carbon Trust (2010). Tackling carbon leakage—Sector-specific solutions for a world of unequal prices (CTC767).

Wiedmann T; Wood R; Lenzen M; Minx J C; Guan D; Barrett J (2008). Development of an Embedded Carbon Emissions Indicator—Producing a Time Series of Input-Output Tables and Embedded Carbon Dioxide Emissions for the UK by Using a MRIO Data Optimisation System, Report to the UK Department for Environment, Food and Rural Affairs by Stockholm Environment Institute at the University of York and Centre for Integrated Sustainability Analysis at the University of Sydney, June 2008. DEFRA, London, UK.

Helm D; Smale R; Phillips J (2007) Too good to be true? The UK’s climate change record; Technical Report.

Peters G P; Minx, J C; Weber C L; Edenhofer, O, (2011). Growth in emission transfers via international trade from 1990 to 2008. PNAS, vol. 108(21), p 8903–8908.

Wiedmann T; Wood R; Minx J C; Lenzen M;Guan D; Harris R, (2010). A carbon footprint time series of the UK—results from a multi-region input–output model, Economic Systems Research, 22:1, 19–42.

1 See, for example, Baiocchi and Minx (2010), Wiedmann et al (2008 & 2010), and Helm et al (2007) for research focusing on the UK only. Other recent studies which work with a larger sample of countries but include the UK include Atkinson et al (2011), Peters et al (2011), Davis et al (2011) and Caldeira and Davis (2010). Wiedmann et al (2010) is unique among these to analyse trends in GHG emissions other than CO2.

2 Emissions in this submission refer to CO2 emissions only.

3 See Pan et al (2008).

4 Carbon leakage refers to the process whereby emissions in one country increase as a result of industries relocating there from a second country with a stricter climate policy.

5 On the implications of carbon leakage for the UK see Carbon Trust (2010).

Prepared 17th April 2012