The government’s emissions reduction plan was revealed last week, but before we dive into the detail let’s briefly summarise the problem.
First, New Zealand signed a commitment to the Paris Agreement aimed at reducing greenhouse gas emissions which are associated with production and consumption. Economics labels the emissions as externalities (which means they are a result of industrial or commercial activities which impact on others not involved in their production) and offers two solutions, taxation or tradable rights.
We now have the emissions trading scheme (ETS), which is a tradable rights-based mechanism that has been recently capped. Not all sectors are in the ETS, agriculture being the exception. Today, there is a price associated with the right to emit CO2 and the units of trade are called NZ emission units.
A distinguishing feature of the benefits associated with the cost of actions aimed at limiting greenhouse gases are non-excludable. For example, a New Zealand business investing in low emission heating bears the cost, while the benefit of the investment is shared by the global community. There are trade and reputation benefits, for example, to the New Zealand economy but there is no clear alignment of costs with benefits.
Finally, as a corollary, there is no reason to expect our efforts – as well intentioned as they might be – to limit the adverse impacts of climate change. This can only come about from coordinated global action such as the Paris Agreement.
Now to the plan. The Government has set ambitious targets to reach net-zero by 2050 with emission budgets ramping down in five-yearly chunks. For example, a reduction of 20 percent from 2021 levels is called for over 2026-2030; and 35 percent from 2031-2035. This is not insignificant.
In the absence of quantifiable benefits, the challenge is to achieve these targeted reductions at least cost to the economy. And economics can help. The idea is to equalise the unit of cost of emissions reduction across all emitters and meet the target. Emitters have a choice: pay the price of NZ units and cover emissions, or reduce emissions.
Turning now to the plan released on May 16 to achieve the reductions targeted for 2022-2025. Financing the plan stands in contrast to previous attempts to transition the economy, develop energy resources and achieve a degree of energy independence. The National Government’s Think Big programme, purported to cost around $7b in 1980 dollars, which went straight onto government debt. Over time, taxation, asset sales and revenue from state-owned enterprises serviced that debt.
Today, we have the ETS in place that generates revenue to support the targeted reduction in emissions. Revenue from the ETS – payments received by Government for the right to emit CO2 – are recycled back to support investment aimed at reducing emissions.
The Government has taken a punt and allocated $2.9b from the Climate Emergency Response Fund (CERF), funded by recycled revenue.
So, that is a brief summary of the problem and the plan. The question now is this: will the allocation and accompanying mandatory policies achieve the targeted reductions? For example, $1 billion has been allocated to transport, of which $569 million is allocated to a “scrap and replace” scheme and $20 million to support low income families to lease low-emission vehicles. A total of $1 billion over seven years directed toward energy, of which $650 million is aimed at decarbonising industry over four years. Agriculture and forestry received $710 million over the next four years. Agriculture, which makes the largest contribution to GHG, has yet to be included in the ETS.
Whether the incentives offered achieve the targeted outcomes depends on behaviour. To illustrate, a firm currently using coal for heating is faced with a choice: pay the market price for NZUs to cover emissions or take advantage of the incentive to decarbonise. Others, including owners of older vehicles, face a similar choice. Back to the earlier question: will these incentives achieve the targeted reductions and at least cost? We don’t know – the punt might find touch. Some might object to businesses financed through overseas investment and oligopolies, of which we have many, receiving funds from the CERF.
The scale and scope of the Emissions Reduction Plan will touch most, if not all, sectors and households in the economy. It will impact capital stock, business profitability, transport and households. The plan is the first step towards transitioning to a low carbon economy. It will become the object of political tinkering. However, over time, we can expect a fundamental change to the structure of the economy and the incentives businesses and households face. There will be additional costs, not included in the financial package, associated with contracting, measuring and monitoring emissions.
Climate response policy will take us into uncharted waters and it would be disingenuous for our political masters to say otherwise. Importantly, the allocation of funds and the results achieved should be available to the public.