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Geo-economics and power

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After the fall of the Berlin Wall and the collapse of the Soviet Union, the international system witnessed a number of transformations like globalization of trade exchanges, de-industrialization of the Western World and the rise of new powers like China, Brazil and even post-Soviet Russia.

Before then the geo-economic analysis considered the enterprise as the center of the economic balance of power and was mainly focused on competition. At the present stage, this model appears not to be accurate enough to address the contradictions between power politics, market practices and territorial approaches. The chart elaborated by French strategist Christian Harbulot (PMT) allows considering other elements like power, market and territory that better address the complexity of this analysis.

The main challenge is finding a convergence between long-term business interests and state power politics strategies while taking an environmental friendly approach. The enterprises, for example, tend to have a preference for short-term policies, whereas state-led industrial policies are set on a long-term basis.

Nevertheless, there are indeed some cases in which coordination between corporate development strategies and state-led economic policies is successful: for instance, Russian state-led Gazprom as far as the choice of international markets for Russian gas supplies is concerned, and the American Boeing, that refused to open a branch for aircraft assembly in China, in order to avoid transferring sensitive technologies.

On top of business and state policies coordination problems, the economic needs of the territories do not necessarily merge with state-led or business practices, which refer to the logic of competition, like in the case of de-localizations.

The graph below (PMT) highlights the intersection between the three above-mentioned levels (power, market, territory). Its goal is providing a dynamic reading of different economic scenarios, not exclusively centered on the enterprise or on financial actors, whose decisions do not always take into account environmental contexts. This cross-referenced analysis facilitates the drafting of anticipation or corrective economic strategies.

The interpretation of power politics must take into account a political understanding of economic relations, which are promoted especially in developing countries. The interpretation of the market operations, mainly performed by entrepreneurs, must consider a certain amount of detachment from political objectives, especially in the Western world. Lastly, the interpretation of the actions of local stakeholders must consider the fact that the territory has always suffered from the aggressiveness of competition, to which territorial representatives tried to react through innovative management and appealing policies.

Another category that also influences economic decision-making is civil society that does not account to state, business or local stakeholders. Civil society’s stances are progressively boosting a broader reflection on market economy and advocating an ethical regulation of economic affairs through some forms of sustainable development.

The organization and management of strategic provisions is a fundamental feature of any discussion related to strategic economic development and the increase of state power. The strategic decision that are more often taken in order to increase strategic provisions security are: creating a special State-business committee, establishing partnership with other states, research and development investments, relaunching production capacity, adopting a recycle policy.

The creation of a State – Business commission on strategic provisions could better connect the public and the private sector so that services provided by the states in key sectors (defense, foreign affairs, industry, ecology, etc.) are available to the business sector. The Committee for strategic metals (COMES), established in France in 2011, is an example of this synergy even though its high level of specialization sometimes limits its broader efficiency.

Many of the OCSE countries, like the United States and Japan, set up a reserve of strategic raw material provisions to draw from in case of a block in supplies. However, this option presents some problematical aspects: 1) setting aside a certain amount of strategic raw materials to accumulate in the reserve can determine a lack of capital supplies for the entrepreneurs; 2) it is not really clear what is more convenient to fill the stockpile with. Accumulating low-alley materials or semi-finished products can be difficult for a country where the first transformation process of final products does not take place.

In order to keep supplies constant over time, the securitization of strategic provisions must rely on the partnership with foreign countries or companies as well. A good example of partnership could be setting up a mining site in a state possessing a given raw material and working on its production and transformation capacities through transferring capitals and know-how.  In this regard – as many businessmen highlight – the choice of the partner countries depends on geopolitical risk factors. Argentine and Brazil, for instance, are more likely to attract foreign investment compared with the Democratic Republic of Congo that is not considered as a safe country.

Investing in research and development (R&D), instead, is fundamental to find alternative solution to the substances that are either too expensive or toxic, and to decrease the quantities that are needed without affecting the performance.

Relaunching domestic production capacity contributes to the requalification of the abandoned production sites or whose value for some reasons decreased over time. This option can be challenging for a number of reasons: reopening existing plants is expensive, sometimes the know-how of a given district disappeared over the years, and it is difficult to identify what is the best business opportunity to restore (mines, transformation chains, etc.). On top of a cutting waste practices, businessman prefer to adopt a material recycling policy, especially in the automotive and aeronautical sector. However, even recycling has its downsides, like expensive and polluting processes, and cannot be considered as a determined solution because there is still some waste percentage that cannot be fully eliminated.

Nevertheless, even in a context of perfect synergy between the investments, the policies presented so far are just the starting point for the securitization of strategic provisions. A successful strategy to address this issue requires an accurate assessment and forecast of the current and the future needs of both enterprises and people of a given community. Before pursuing any kind of policy in this field, the state must necessarily have a clear perspective on its own plan for strategic provisions.

An accurate forecast should envisage future needs and the kind and quantity of the materials that are necessary for the functioning of technologies of the future. Identifying supply chains is another aspect worth considering – especially as far as rare materials are concerned – in light of the possible risks for the industrial plants.

The French government in the early ’70 adopted a similar plan after the oil crisis: assessment of future energy needs, development of technologies to cope with it (nuclear power plants), and identification of uranium supply chains and implementation of a strategy based on a reduction in hydrocarbons provisions. The creation of the COMES is part of this plan.

The issue of provisions can be observed from two different angles. Strategic provisions are mainly raw materials of which the state needs constant supply: energy sources like oil, gas, uranium and rare earth elements that are indispensable for the functioning of information technologies and communication, to “green” energy and defense technologies. The Strategy of provisions, instead, consists in the policies to be adopted to guarantee a sufficient supply of strategic materials to sustain prosperity of the French socio-economic model over time.

The enterprise is the main actor of the economy and plays a significant role vis-à-vis the economic war that is relentlessly replacing traditional conflicts in the international arena at the present moment. An example of the combination between war and economics is the fight in the acquisition of post-war reconstruction contracts, like in Bosnia and Kosovo in the ‘90s but even more in Iraq or Libya. In Africa, especially in the Great Lakes region, great powers compete between each other for the control of strategic raw materials that are vital for the future of industrialized economies.

At this stage of globalization in which the future of the economy is mainly determined by non-state actors, the presence of the State is highly put into question. Nevertheless, it would be impossible to completely cut out the state from the economy because the roles it inevitably plays in a market: client, sponsor and producer all at the same time.

According to the definition provided by British historian and WWII expert Liddel Hart, setting up a “strategy” means coordinating and canalizing all the resources of a given state (political, military, diplomatic, economic, cultural) towards the outcome desired. With the end of the Cold War, the importance of the military element is progressively decreasing, while trade and economic resources became the main domain of competition between states.

This new setting of inter-state competition is also the result of the rise of new actors, the BRICS countries, alongside the West and Japan, which represent the traditional industrial powers. As far as European countries are concerned, there are some less evident elements to rely on in order to draft a more accurate plan for the future: ensuring state control on strategic sectors through providing incentives for domestic enterprises and, most importantly, aiming at economic growth, employment and gaining presence on foreign markets.  

The United States and China are the major great powers that show how state support to the private sector – especially vis-à-vis the protection of strategic sectors and promoting domestic business abroad – is not only possible but also indispensable at power politics.

An interesting feature of the French economy is the difference of treatment – and sometimes the conflict – between multinational and small/medium enterprises. Multinational corporations are the driving force of the economy and although for a long time benefited from the national industrial policies, they are currently trying to weaken the ties with the state. Small and medium enterprises are instead more rooted in the national territory but are often struggling for financing, access to foreign markets, protection of their specific know-how and acquisition of new capacities that are indispensable for their survival. The state should then play a key role in coordinate public and private sphere. However, mutual mistrust between these two sectors – although understandable – turns out to be a hurdle for development in most European countries.

In the United States the situation is quite different: strong ties between public administration, private sector, academia and think tank built up a network that strongly favors communication and obtaining information. This aspect tends to get little attention in Europe, where state power is considered as a limit to overcome rather than an opportunity to take. It is true that public institutions have a significant advantage in terms of intermediation capacities and access to information compared to the private actors. However, if oriented towards the needs of the real economy, multi-level coordination between public and private sector can provide a competitive advantage for both multinational and small/medium enterprises.

Creating competitive clusters allows to use the networks at its full capacity, helps local sharing of good-practices with regard to economic intelligence, protection of intangible heritage of information, and know-how of the enterprises. The state cannot refuse to take this pressing challenge: it must promote the access to good practices especially for small enterprises following the rules of transparency.

In recent years, investment funds became a popular topic in the debate around economic power as possible threat to the survival of western corporation model, especially as far as middle-eastern and Chinese sovereign funds are concerned. However, Chinese investments in European companies are still quite low and mainly concentrated in sectors like raw materials, energy resources and other operations that does not lead to a real control the enterprise.

In some cases, however, some acquisitions are deemed to gain technological (or other) competences, without a real interest to invest in the local development of the acquired undertaking, as the cases of Intel (investment fund with CIA connections), Carlyle Group (in the aerospace industry) and TPG (that from 2006 controls the main French company producing smart cards) demonstrate. In this framework, there are several instruments aiming at protecting State’s sovereignty, which is threatened by massive purchasing of economic activities by sovereign funds. Firstly, a screening of foreign investment in strategic fields can be put in place, especially to protect Small and Medium Enterprises. Secondly, a change of attitude is needed, in order to accept that developing countries will control more and more European companies. In these cases, however, the principle of reciprocity shall be respected.

Particular relevance has to be granted to standard and rules, which are normally set out at the international level. Accordingly, lobbying within international organizations, as the United States knows very well, is of the highest importance. Otherwise States could elaborate their own standards or invest, for example, in the International Organization for Standardization, as China is doing.

In this subject matter, the European Union is not able to “speak with one voice”. In particular, the lack of a Union’s comprehensive strategy, and thus the predominance of national interests, is particularly evident. In accordance with the Treaties, in fact, in the internal market, the protection of competition takes precedence over an effective industrial policy. In light of the foregoing, new priorities should be set out, in order to enhance the coordination that could increase the penetration in non-EU markets (especially concerning some strategic sector, i.e. the defense one) and improve the existing competition. Nevertheless, it should be noticed that these changes might not be possible without the creation of real “United States of Europe”.

The current debate often focuses on energy security, not only from an economic point of view. The need to swift from “energy security” to the “energy supply” has been underlined, as well as the importance of securing the energy flows. This is demonstrated by the so-called “oil wars”, as the two Gulf wars, the war in Afghanistan and in Libya could surely be defined. However, despite the fact that the oil supply is one of the main causes of these conflicts, delicate international geopolitical balances are crucial elements to be take into account.

Along with the control of the “black gold”, the “gas issue” should be given a great importance for several reasons. Research demonstrates that the increasing in energy demand in the next years (from developing countries in particular) could not be satisfied by oil only. Furthermore, it is necessary to find alternative solutions in order to overcome difficulties stemming from extraction techniques in newly discovered oil fields.

Accordingly, States are trying to revise their energy policy, by reducing consumption and improving the quality of their infrastructures to avoid leaks, by diversifying their energy sources, especially by increasing the use of renewable energy (i.e. wind, sun and wave power), and by controlling the use of national resources (as France does with hydropower and nuclear energy).

Moreover, security of supplies is related to raw materials, where the interplay between economic and geopolitical aspects is evident. Agricultural products, minerals and rare earths elements are only few examples.

China holds more than 90% of rare earth elements and uses this monopoly to achieve its political purposes, against Japan for instance, towards which the Chinese government applies restrictions on exports in light of their territorial disputes. Furthermore, conflicts arise in relation to abundant resources, such as cultivable lands (as it happens with land grabbing) or common goods, such as water, air, biodiversity and the genetic heritage. In this framework, countries, in a globalized word, have to deal with the scarcity of resources, caused by demographic growth, as well as by the increasing of material and immaterial trade flows, flows of goods and people, information and money. In particular, supplies are granted only when flows are safe and this implies several economic and military consequences.

On the one hand, different economic elements shall be protected: the ownership of infrastructures, the technical control of the exploitation of resources, the choice of transport routes (such as pipelines for the European supply) and the control on access routes (such as harbours).

On the other hand, security depends on military capacity to oversee production and export areas, as well as on seaway’s extension and control. Examples are the protection of the Gulf of Aden by EU’s Atlanta and NATO’s Ocean Shield operations.

One of the main geopolitical issues in the current debate concerns rare earth elements These include 17 elements that are fundamental for high-tech industries, even though they are used in small quantities. For instance, lanthanum can be found in electric vehicle batteries and in sonar; samarium in some missiles’ elements; gallium in night vision devices; indium in flat panels. These specific Raw materials are actually at the center of the dispute between China and the United States, which are two of the main actors in international relations of XXI century. Evidence supports the predominance of China in this field: the country holds between 34 and 50% of world reserves and produced, in 2010, 95% of rare earth elements (130,000 tonnes out of 133,000). This was possible after having progressively abandoned the exploitation of western sites and the complete integration in the global economy system. Therefore, Pekin is able to use this leverage in its dialogue with western countries, by imposing very high prices or, even worse, by breaking their supply chain. There is no doubt, however, that a problem of dependence exists and that it is not clear how to solve it. Nevertheless, China’s position seems not to be so safe. The country should become an importer of rare earth elements by the end of the current decade.

Between 2006 and 2010 China reduced its export share of these metals from 5 to 10% per year. Furthermore, their production was limited, to avoid the depletion of reserves. However, China-Japan tensions of September 2010 (following the Japanese inspection of a Chinese vessel in “contested” waters) have worsened their relationship. As a result, the Chinese Trade Minister set 30% reduction of export share.

China was trying to use rare earth metals as an economic weapon, which led to a real embargo on its exports towards the European Union, Japan (representing one fifth of its final demand) and United States, whose diplomats were able to obtain by their Chinese colleagues full assurance concerning liability in the future. This demonstrated that Sino-US relations are of the highest importance in the American politics. Currently, 87% US imports of rare earth elements come from China, while the remaining 13% is from domestic reserves.

The Chinese embargo forced the United States to implement a strategic vision that was missing so far, because of the dependence of the country form external resources. Therefore, the US needed to undertake some measures stimulating mining, refining and transformation of this kind of raw materials.. As a result, the US pursued a policy of differentiation of trade partners.

Nevertheless, the exploitation of mines in order to obtain rare earth elements is rather difficult, both at the administrative (the re-opening of one of these mines takes 9 years) and at the political level (environmental organisations are often against these projects). Molycop case represents a successful story in this field. The enterprise, in fact, owned Mountain Pass mine, which is the biggest site of non-Chinese rare earth metals in the world, and obtained in 2010 (few months after the above-mentioned diplomatic tensions with China) the authorization to relaunch the activity. Molycorp’s efforts ended at the end of 2012 and the company increased its production from 3.000 tonnes to 20.000 tonnes per year and received 531 million dollars of funds. Currently, the company is the only one that extracts these materials outside China. The step of this process will be summarised in the following paragraph.

In June 2010 Molycorp signed an agreement with Canadian company NeoMaterial, which provides technical assistance and know-how on the production of rare earths elements. Moreover, in December of the same year, Molycorp set up a joint-venture with the Japanese Hitachi, in order to create several associated enterprises producing alloys and magnets in the United States. Furthermore, Molycor signed a memorandum of understanding with Sumitomo Corporation trough which Molycorp completed its supply chain of rare earth metal-manufacturing products. These products are then delivered to Sumitomo Corporation. In April 2011 Molycorp acquired the American branch of the Japanese enterprise Santoku for 17.5 million dollars and the Estonian Silmet for 89 million dollars. Therefore, Molycorp can actually count on a network of customers that goes from the Far East to Europe.

Molycop has secured funds, mines, know-how, logistical cooperation and a network of buyers, and became the only western enterprise with a full control of the entire supply chain of rare earth elements, from the mining to the sale process . The United States could thus avoid direct conflicts with China, after the threat of embargo and the increase in prices.

Despite the fact that China could not be excluded from rare earth elements-market, its power shall be controlled, as tensions arisen in 2010 showed. The idea of an embargo in September 2010 stimulated competition and pushed western countries to diversify their supply sources. As a result, the offer increased and Chinese power decreased.

Economy

US Economic Turmoil: The Paradox of Recovery and Inflation

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The US economy has been a rollercoaster since the pandemic cinched the world last year. As lockdowns turned into routine and the buzz of a bustling life came to a sudden halt, a problem manifested itself to the US regime. The problem of sustaining economic activity while simultaneously fighting the virus. It was the intent of ‘The American Rescue Plan’ to provide aid to the US citizens, expand healthcare, and help buoy the population as the recession was all but imminent. Now as the global economy starts to rebound in apparent post-pandemic reality, the US regime faces a dilemma. Either tighten the screws on the overheating economy and risk putting an early break on recovery or let the economy expand and face a prospect of unrelenting inflation for years to follow.

The Consumer Price Index, the core measure of inflation, has been off the radar over the past few months. The CPI remained largely over the 4% mark in the second quarter, clocking a colossal figure of 5.4% last month. While the inflation is deemed transitionary, heated by supply bottlenecks coinciding with swelling demand, the pandemic-related causes only explain a partial reality of the blooming clout of prices. Bloomberg data shows that transitory factors pushing the prices haywire account for hotel fares, airline costs, and rentals. Industries facing an offshoot surge in prices include the automobile industry and the Real estate market. However, the main factors driving the prices are shortages of core raw materials like computer chips and timber (essential to the efficient supply functions of the respective industries). Despite accounting for the temporal effect of certain factors, however, the inflation seems hardly controlled; perverse to the position opined by Fed Chair Jerome Powell.

The Fed already insinuated earlier that the economy recovered sooner than originally expected, making it worthwhile to ponder over pulling the plug on the doveish leverage that allowed the economy to persevere through the pandemic. The main cause was the rampant inflation – way off the 2% targetted inflation level. However, the alluded remarks were deftly handled to avoid a panic in an already fragile road to recovery. The economic figures shed some light on the true nature of the US economy which baffled the Fed. The consumer expectations, as per Bloomberg’s data, show that prices are to inflate further by 4.8% over the course of the following 12 months. Moreover, the data shows that the investor sentiment gauged from the bond market rally is also up to 2.5% expected inflation over the corresponding period. Furthermore, a survey from the National Federation of Independent Business (NFIB) suggested that net 47 companies have raised their average prices since May by seven percentage points; the largest surge in four decades. It is all too much to overwhelm any reader that the data shows the economy is reeling with inflation – and the Fed is not clear whether it is transitionary or would outlast the pandemic itself.

Economists, however, have shown faith in the tools and nerves of the Federal Reserve. Even the IMF commended the Fed’s response and tactical strategies implemented to trestle the battered economy. However, much averse to the celebration of a win over the pandemic, the fight is still not through the trough. As the Delta variant continues to amass cases in the United States, the championed vaccinations are being questioned. While it is explicable that the surge is almost distinctly in the unvaccinated or low-vaccinated states, the threat is all that is enough to drive fear and speculation throughout the country. The effects are showing as, despite a lucrative economic rebound, over 9 million positions lay vacant for employment. The prices are billowing yet the growth is stagnating as supply is still lukewarm and people are still wary of returning to work. The job market casts a recession-like scenario while the demand is strong which in turn is driving the wages into the competitive territory. This wage-price spiral would fuel inflation, presumably for years as embedded expectations of employees would be hard to nudge lower. Remember prices and wages are always sticky downwards!

Now the paradox stands. As Congress is allegedly embarking on signing a $4 trillion economic plan, presented by president Joe Bidden, the matters are to turn all the more complex and difficult to follow. While the infrastructure bill would not be a hard press on short-term inflation, the iteration of tax credits and social spending programs would most likely fuel the inflation further. It is true that if the virus resurges, there won’t be any other option to keep the economy afloat. However, a bustling inflationary environment would eventually push the Fed to put the brakes on by either raising the interest rates or by gradually ceasing its Asset Purchase Program. Both the tools, however, would risk a premature contraction which could pull the United States into an economic spiral quite similar to that of the deflating Japanese economy. It is, therefore, a tough stance to take whether a whiff of stagflation today is merely provisional or are these some insidious early signs to be heeded in a deliberate fashion and rectified immediately.

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Carbon Market Could Drive Climate Action

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Authors: Martin Raiser, Sebastian Eckardt, Giovanni Ruta*

Trading commenced on China’s national emissions trading system (ETS) on Friday. With a trading volume of about 4 billion tons of carbon dioxide or roughly 12 percent of the total global CO2 emissions, the ETS is now the world’s largest carbon market.

While the traded emission volume is large, the first trading day opened, as expected, with a relatively modest price of 48 yuan ($7.4) per ton of CO2. Though this is higher than the global average, which is about $2 per ton, it is much lower than carbon prices in the European Union market where the cost per ton of CO2 recently exceeded $50.

Large volume but low price

The ETS has the potential to play an important role in achieving, and accelerating China’s long-term climate goals — of peaking emissions before 2030 and achieving carbon neutrality before 2060. Under the plan, about 2,200 of China’s largest coal and gas-fired power plants have been allocated free emission rights based on their historical emissions, power output and carbon intensity.

Facilities that cut emissions quickly will be able to sell excess allowances for a profit, while those that exceed their initial allowance will have to pay to purchase additional emission rights or pay a fine. Putting a price tag on CO2 emissions will promote investment in low-carbon technologies and equipment, while carbon trading will ensure emissions are first cut where it is least costly, minimizing abatement costs. This sounds plain and simple, but it will take time for the market to develop and meaningfully contribute to emission reductions.
The initial phase of market development is focused on building credible emissions disclosure and verification systems — the basic infrastructure of any functioning carbon market — encouraging facilities to accurately monitor and report their emissions rather than constraining them. Consequently, allocations given to power companies have been relatively generous, and are tied to power output rather than being set at absolute levels.

Also, the requirements of each individual facility to obtain additional emission rights are capped at 20 percent above the initial allowance and fines for non-compliance are relatively low. This means carbon prices initially are likely to remain relatively low, mitigating the immediate financial impact on power producers and giving them time to adjust.

For carbon trading to develop into a significant policy tool, total emissions and individual allowances will need to tighten over time. Estimates by Tsinghua University suggest that carbon prices will need to be raised to $300-$350 per ton by 2060 to achieve carbon neutrality. And our research at the World Bank suggest a broadly applied carbon price of $50 could help reduce China’s CO2 emissions by almost 25 percent compared with business as usual over the coming decade, while also significantly contributing to reduced air pollution.

Communicating a predictable path for annual emission cap reductions will allow power producers to factor future carbon price increases into their investment decisions today. In addition, experience from the longest-established EU market shows that there are benefits to smoothing out cyclical fluctuations in demand.

For example, carbon emissions naturally decline during periods of lower economic activity. In order to prevent this from affecting carbon prices, the EU introduced a stability reserve mechanism in 2019 to reduce the surplus of allowances and stabilize prices in the market.

Besides, to facilitate the energy transition away from coal, allowances would eventually need to be set at an absolute, mass-based level, which is applied uniformly to all types of power plants — as is done in the EU and other carbon markets.

The current carbon-intensity based allocation mechanism encourages improving efficiency in existing coal power plants and is intended to safeguard reliable energy supply, but it creates few incentives for power producers to divest away from coal.

The effectiveness of the ETS in creating appropriate price incentives would be further enhanced if combined with deeper structural reforms in power markets to allow competitive renewable energy to gain market share.

As the market develops, carbon pricing should become an economy-wide instrument. The power sector accounts for about 30 percent of carbon emissions, but to meet China’s climate goals, mitigation actions are needed in all sectors of the economy. Indeed, the authorities plan to expand the ETS to petro-chemicals, steel and other heavy industries over time.

In other carbon intensive sectors, such as transport, agriculture and construction, emissions trading will be technically challenging because monitoring and verification of emissions is difficult. Faced with similar challenges, several EU member states have introduced complementary carbon taxes applied to sectors not covered by an ETS. Such carbon excise taxes are a relatively simple and efficient instrument, charged in proportion to the carbon content of fuel and a set carbon price.

Finally, while free allowances are still given to some sectors in the EU and other more mature national carbon markets, the majority of initial annual emission rights are auctioned off. This not only ensures consistent market-based price signals, but generates public revenue that can be recycled back into the economy to subsidize abatement costs, offset negative social impacts or rebalance the tax mix by cutting taxes on labor, general consumption or profits.

So far, China’s carbon reduction efforts have relied largely on regulations and administrative targets. Friday’s launch of the national ETS has laid the foundation for a more market-based policy approach. If deployed effectively, China’s carbon market will create powerful incentives to stimulate investment and innovation, accelerate the retirement of less-efficient coal-fired plants, drive down the cost of emission reduction, while generating resources to finance the transition to a low-carbon economy.

(Martin Raiser is the World Bank country director for China, Sebastian Eckardt is the World Bank’s lead economist for China, and Giovanni Ruta is a lead environmental economist of the World Bank.)

(first published on China Daily via World Bank)

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The EU wants to cut emissions, Bulgaria and Eastern Europe will bear the price

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In the last few years, the European Union has been going above and beyond in dealing with climate change. Clearly, this is far from being a case of disinterested endeavour to safeguard the planet and the environment. On the contrary, the EU’s efforts aim at reinforcing its “normative power”.  In effect, the EU has gained some clout on the international stage, even vis-à-vis faraway countries like Vietnam and China. Yet, in doing so the Union embroiled in the apparent rush for more and more ambitious climate standards and targets. Therefore, Brussels needs to start acting and deliver on its promises to keep staying ahead of the pack. Even more so given US President Biden’s strengthened engagement with friends and foes alike on the climate and human rights.

Last week, the European Commission manifested its acknowledgment of this need by unveiling the Fit for 55 (FF55) growth strategy. Overall, this new, beefed-up Green Deal should reduce greenhouse gas emissions to 55% of their 1990 level by 2030. In some analysts’ view, the FF55 plan is a game changer in the long-term race towards climate neutrality alas. In fact, it could “both deepen and broaden the decarbonisation of Europe’s economy to achieve climate neutrality by 2050.” Moreover, they expect the FF55’s 13 measures to generate a number of positive ripple effects across EU economies.

True, wanting to reduce greenhouse gases significantly by 2030 and reaching net-zero-emission by 2050 goal is commendable under many regards. Still, the FF55 includes a number of measures that could impact ordinary people’s life massively across Europe. Nevertheless, the 27 Member States of the EU are responsible for as little as 8% of global emissions. As such, it is necessary to take a deeper look at how the FF55 will affect different countries and demographics.

The transition’s social cost

The realisation that reduction of capitalism’s dependence on fossil fuels will have serious socio-economic consequences is not at all new. Contrariwise, scholars and politicians have been outspoken about an indisputable “conflict between jobs and the environment”, since the early 1990s. Together, the pandemic-induced recession and the signing of the Paris Accord have brought the notion back on the centre stage.

Factually, pushing the energy transition entails facing mass lay-offs, generalised workforce retraining and taxes hikes on ordinary consumers. For instance, these hardships’ seriousness is evident in the progressive abandonment of coal mining for energy generation in the US. Moreover, the energy transition requires strong popular backing in order to be effective. Yet, measures pursued to achieve environmentally friendly growth tend to generate strong, grassroot opposition. Most recently, France’s gilets jaunes protests shows that environmental policies generate social discontent by disfavouring middle and lower classes disproportionately.

The poorest families and countries will bear the costs

One of the FF55’s main policy innovation regards the creation of a carbon trading market for previously exempt sectors. Namely, companies working int the transport and buildings sectors, be they public or private, will have to follow new rules. As it happened in the energy industry before, each company will have to respect a “carbon allowance”. Basically, it is an ‘authorisation to pollute’ which companies can buy from each other — but the total cannot increase. Despite all claims of just transition, this and other measures will have a gigantic, re-distributional effect within and between countries. And it will be of markedly regressive character, meaning that poorer families and countries will pay more.

Taxing transport emission is regressive

Historically, these sectors were trailing behind most others when it comes to decarbonisation for a variety of reasons. First of all, the previous emission trading system did not include them. Moreover, these are far from being well-functioning markets. As a result, even if the cost of emissions was to rise, enterprises and consumer will not react as expected.

Thus, even as they face higher costs, companies will keep utilising older, traditional vehicle and construction technologies. With taunting reverberations on those poorer consumers, who cannot afford to buy an electric car or stop using public transport. Hence, they “will face a higher carbon price while locked into fossil-fuel-based systems with limited alternatives.” Moreover, the EU could worsen these effects by trying to reduce the emission fees on truck-transported goods. Indeed, the commission is proposing a weight-based emission standard that would collaterally favour SUVs over smaller combustion-engine car and motorbikes. 

In a nutshell, higher taxes and fee will strike lower-class consumers, who spend more of their incomes for transportation. Even assuming these households would like to switch to low-emission cars and buildings, current market prices will make it impossible. In fact, all these technologies ten to have low usage costs, but very high costs of acquisition. For instance, the cheapest Tesla sells at over €95,000, whereas a Dacia Sandero “starts at just under €7,000.”

Eastern Europe may not be willing to pay

At this point, it is clear that the FF55 plan will deal a blow to ongoing efforts to reduce inequalities. In addition, one should not forget that EU Member States are as different amongst them as they are within themselves. Yet, the EU is not simply going to tax carbon in sectors that inevitably expose poorer consumers the most. But in doing so it would impose a single price on 27 very diverse societies and economies. Thus, the paradox of having the poorest countries in the EU (i.e., Central- and South-Eastern Europe) pay the FF55’s bill.

To substantiate this claim, one needs to look no further than at a few publicly available data. First, as Figure 2 shows, there is an inverse relation between a country’s wealth and consumers’ expenditures on transport services. Thus, not only do poorer people across the EU spend more on transport, poorer countries do as well. Hence, under the FF55, Bulgarians, Croatians, Romanians and Poles will pay most of the fees and taxes on carbon emission.

Additionally, one should consider that there is also a strict inverse relation between carbon emissions and the minimum national wage. In fact, looking at Figure 3 one sees that countries with lower minimum wages tend to emit more carbon dioxide. On average, countries with a minimum salary of €1 lower emit almost 4.5mln tonnes of carbon dioxide more. But differences in statutory national wages explain almost 32% of the cross-country variation in emissions. So, 1.5 of those extra tonnes are somehow related to lower minimum salaries and, therefore, lower living standards.

The EU’s quest for a just transition: Redistribution or trickle down?

Hence, the pursual of a ‘just’ transitionhas come to mean ensuring quality jobs emerge from these economic changes. However, many of the FF55’s 13 initiatives may worsen disparities both within countries and, more importantly, between them. Thus, the EU has been trying to pre-empt the social losses that would inevitably come about.

From the Just Transition Fund to the Climate Social Fund

In this regard, the European Union went a step forward most countries by creating the Just Transition Fund in May. That is, the EU decided to finance a mix of grants and public-sector loans which aims to provide support to territories facing serious socio-economic challenges arising from the transition towards climate neutrality [… and] facilitate the implementation of the European Green Deal, which aims to make the EU climate-neutral by 2050.

Along these lines, the FF55 introduces a Climate Social Fund (CSF) that will provide “funding […] to support vulnerable European citizens.” The fund will provide over €70bln to support energy investments, and provide direct income support for vulnerable households. The revenues from the selling of carbon allowances to the transport and building sectors should fund most of the CSF. If necessary, the Member States will provide the missing portion.

The EU Commission may give the impression of having design the CSF to favour poorer households and countries. However, it may actually be a false impression. In fact, it is clear that the entire carbon pricing initiative will impact poorer household and countries more strongly. However, only a fourth of the carbon pricing system’s revenues will go to fund the CSF. The remaining portion will finance other FF55 programmes, most of which have a negative impact on poorer communities. Thus, despite the CSF, the final effect of the entire FF55 will be a net redistribution upwards.

Stopping a redistribution to the top

Nevertheless, there is a way to fix the FF55 so that it can work for poorer households and lower-income countries. Given that the CSF is too small for the challenge it should overcome, its total amount should be increased. In fact, the purpose of higher carbon pricing is in any event not to raise revenue but to direct market behaviour towards low-carbon technologies—there is thus a strong argument for redistributing fully the additional revenues

Hence, the largest, politically sustainable share of carbon-pricing revenues from transportation and housing should ideally go to the CSF. In addition, the Commission should remove all the proposed provision that divert CSF money away from social compensation scheme. In fact, poorer families will not gain enough from subsidies to electric car, charging stations and the decarbonisation of housing. One contrary, “using the fund to support electric vehicles would disproportionally favour rich households.”

Finally, the allocation of CSF money to various member states should follow rather different criteria from the current ones. In fact, the Commission already intends to consider a number of important such as: total population and its non-urban share; per capita, gross, national income; share of vulnerable households; and emissions due to fuel combustion per household. But these efforts to look out for the weakest strata in each country could backfire. In fact, according to some calculations, a Member State with lower average wealth and lower “within-country inequality could end up benefiting less than a rich member state with high inequality.”

Conclusion

A number of well-known, respected economist have been arguing that environmental policies should account for social fallouts attentively. Goals such as emission reduction and net-zero economies require strong popular support in order for the transformation to succeed. Or at least, the acquiescence of a majority of the public. Otherwise, the plans of well-intentioned and opportunistic governments alike will derail. After all, this is the main lesson of the currently widespread protest against the mandating of ‘Covid passes’ and vaccines.

If the FF55 will deal poorer households a devastating blow, social unrest may worsen — fast. But as long as it will also hurt Eastern European countries as a whole, there is a chance. Hopefully, European parliamentarians from riotous Hungary or Poland will oppose the FF55 in its current shape. Perhaps, in a few years everyone will be thankful for these two countries strenuous resistance to EU bureaucracy. Or else, richer countries may force Central- and South-Eastern Europe to swallow a bitter medicine. Even though, whatever happens, Europe alone cannot and will not save the planet.

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