Energy subsidies from a climate and trade perspective

A short paper for dissemination based on a research piece published by the E15Initiative: Subsidies, Clean Energy, and Climate Change, February 2015. Implemented jointly by ICTSD and the World Economic Forum, the E15Initiative convenes world-class experts and institutions to generate strategic analysis and recommendations for government, business, and civil society geared towards strengthening the global trade and investment system. The paper is also published in Spanish and Portuguese.

Subsidies, Clean Energy, and Climate Change

Estimates show that fossil fuel subsidies average USD 400–600 billion annually worldwide while renewable energy (RE) subsidies amounted to USD 66 billion in 2010 and are predicted to rise to USD 250 billion annually by 2035. Domestic political rationales for energy subsidies include promoting innovation, job creation and economic growth, energy security, and independence. Energy subsidies may also serve social and environmental goals. Whether and to what extent subsidies are effective to achieve these goals or instead lead to market distortions is a matter of much debate and the trade effects of energy subsidies are complex. This paper offers an overview of the types of energy subsidies that are used in the conventional and renewable energy sectors, and their relationship with climate change, in particular greenhouse gas emissions. While the WTO’s Agreement on Subsidies and Countervailing Measures (ASCM) is mostly concerned with harm to competitors, this paper considers the extent to which the Agreement could also discipline subsidies that cause harm to the environment as a global common. Beyond the existing legal framework, this paper surveys a number of alternatives for improving the ability of subsidies disciplines to internalize climate change costs of energy production and consumption. One option is a new multilateral agreement on subsidies or trade remedies (with an appropriate carve-out in the WTO regime to allow for it if such an agreement is concluded outside it). Alternatively, climate change-related subsidies could be included as part of another multilateral regime or as part of regional agreements. A third approach would be to incorporate rules on energy subsidies in sectorial agreements, including a Sustainable Energy Trade Agreement such as has been proposed in other ICTSD studies.

CAP Subsidies and the Productivity of EU Farms. Factor Markets Working Paper No. 37, March 2013

This paper investigates the impact of subsidies from the common agricultural policy on the total factor productivity of farms in the EU. We employ a structural, semi-parametric estimation algorithm, directly incorporating the effect of subsidies into a model of unobserved productivity. We empirically study the effects using samples from the Farm Accountancy Data Network for EU-15 countries. Our main findings are clear: subsidies had a negative impact on farm productivity in the period before the decoupling reform was implemented; after decoupling the effect of subsidies on productivity was more nuanced, as in several countries it turned positive.

Influence of Agricultural Support on Sale Prices of French Farmland: A comparison of different subsidies, accounting for the role of environmental and land regulations. Factor Markets Working Document No. 51, June 2013

This paper investigates the determinants of agricultural land price in several regions in France over the period 1994-2011, using individual plot transaction data, with a particular emphasis on agricultural subsidies and nitrate zoning regulations. It found a positive but relatively small capitalisation effect of the total subsidies per hectare. The data revealed that agricultural subsidies capitalised, at least to some extent, but the magnitude of such a capitalisation depends on the region considered, on the type of subsidy considered, and on the location of the plot in a nitrate surplus zone or not. Only land set-aside premiums significantly capitalise into land price, while single farm payments have a significant positive capitalisation impact only for plots located in a nitrate-surplus zone.

Simulation Results of AgriPoliS about Diminishing Capital Subsidies and Restrictions. Factor Markets Working Document No. 55, June 2013

This paper investigates the impacts of high interest rates for borrowed capital and credit restrictions on the structural development of four European regions. The method used is the model AgriPoliS which is a spatial-dynamic agent-based model. It is able to provide aggregated results at the regional level, but very individual results as well by considering farms as independent entities. Farms can choose between different investment options during the simulation. Several scenarios with different interest rates for borrowed capital on the one hand as well as with different levels of credit restrictions on the other hand are tested and compared. Results show that higher interest rates have less impact on declining production branches than on expanding ones. If they have the possibility farms invest in the most profitable production branch which relative profitability might have changed with high interest rates. Credit restrictions lead farms to choose smaller and cheaper investments than expensive and large ones. Results also show that income losses in both cases due to under-investment compared to the reference situation are partially compensated by lower rental prices. The impacts on structural change also differ depending on the region and the initial situation. In summary, credit subsidies or imperfections on credit markets might have indirect impacts on the type of dominant investment and therefore on the whole regional agricultural sector as well.

The Economics of Subsidies for R&D: The Intrinsic Difficulty of Determining Optimum Subsidies and Implications for Reform of EU State Aid Rules on R&D. Bruges European Economic Research (BEER) Papers 26/February 2013

The European Commission is reforming state aid rules. An important element of the reform is to prevent the granting of excessive subsidies. This paper shows that the determination of the optimum subsidy for research is difficult. What appears to be the socially optimum level of research effort depends on the benchmark of comparison and whether this benchmark is the situation before subsidies or the situation after subsidies. In the presence of asymmetric information, policy makers should induce firms to reveal their true costs and should grant subsidies to the relatively more efficient firms by allocating subsidies not on a first-come-first- serve basis but through a competitive process. However, competitive selection of subsidy recipients is not a panacea as it may not be possible to be effectively used in all cases and for all research programmes. This is because in principle public subsidies should support those programmes with the largest value for society, rather than with the lowest costs. Although this paper focuses on R&D, its findings are relevant to any subsidy whose aim is to remedy market failure caused by positive externalities.