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Australia's international role
As previously noted, Australia is a large producer and exporter of fossil fuels and fossil fuel intensive commodities, notably primary metals, which depend on the use of coal and coal-fired electricity. For example, less than 10 per cent of Australian aluminium smelting capacity relies on hydro-electricity. The imposition of a carbon tax would have a drastic effect on the cost of energy used in the production of these commodities, and hence on the cost structures of producers.
Australia is an efficient, low cost producer of these commodities. It is expected that continued and growing output of these commodities will be very important for the country's economic future. Hence, policy makers are concerned that a carbon tax imposed only in Australia would damage possibly severely - the competitive position of Australian producers in world markets. That is why the Australian government qualified its adoption of the Toronto target as an 'interim' planning target with reference to net adverse economic impacts and trade competitiveness. The potential effects of a multilateral carbon tax are less clear, however. For example, such a tax would probably suppress international demand for thermal coal, but, as a result of fuel substitution, might increase demand for LNG. For primary metal exports, the effect of a multilateral carbon tax depends on both the demand for metal and the effect of the tax on competing producers.
To examine this question, the Industry Commission (IC) developed a model which focused on Australia's place in the global economy. Again, a carbon tax was the chosen policy instrument to achieve emission reductions. The IC concluded that a global carbon tax of the size estimated to be required to achieve a 40 per cent reduction in emissions by 2005 (estimated to be somewhat less than the abatement corresponding to the Toronto target) would reduce Australian GDP by between 1 and 3 per cent. The range depends on assumptions about substitution elasticities. The effect on GDP is thus roughly the same as that generated by applying a similar sized carbon tax to Australia only. However, the modelling results suggest that many other countries might suffer somewhat smaller GOP reductions than Australia.
The effects of such a carbon tax on individual industry sectors in Australia was highlighted in a study released in early 1992 (London Economics 1992). This study concluded that both the steel and aluminium industries would be driven into irreversible unprofitability and forced to shut down by a carbon tax, whether imposed unilaterally by Australia, by OECD countries or globally. A number of the assumptions used in this study appear dubious, notably those relating to international demand, and alternative, competing international suppliers of aluminium. However, the broad thrust of the conclusion is not unexpected, given the choice of a carbon tax as the policy instrument for achieving emission abatement.
Carbon taxes, externalities and other policy instruments
Aggregate economic models typically assume a uniform price elasticity of demand for energy across broad groups of energy users, if not the whole economy, and also assume a uniform elasticity across all sizes of price changes. The case of the aluminium industry demonstrates the invalidity of these assumptions. Aluminium smelters typically embody state-of-the-art technology at the time they were built. Apart from trivial adjustments, efficiency improvements can only be made by building a new smelter. Thus a smelter's price elasticity of demand for electricity is virtually zero up to a certain size price increase, while beyond that size, the elasticity becomes infinite. That is, the smelter shuts down because it is uneconomic to operate.
It is important to distinguish between a carbon tax which is imposed as a proxy for environmental costs not yet internalized; and a carbon tax imposed as an instrument to achieve a pre-determined level of emission abatement to respond to climate change. The two are identical only in a world of perfect markets. It is difficult to argue in principle against the full internalization of environmental costs. But the cost of climate change is potentially so pervasive that the costs of the greenhouse effect (and the economic benefits of avoiding it) simply cannot be expressed in monetary units. These fundamental issues cannot be pursued here, where the point is simply that different criteria may be used to assess policy instruments and options for achieving greenhouse gas abatement.
Given the nature and extent of the 'efficiency gap' in the market for energy services, it is quite likely that a level of carbon tax sufficient to put half of Australia's aluminium smelters out of business would still not be sufficient to induce some small-scale industrial and commercial businesses to make efficiency improvements having a payback of only a few months. Such an outcome would be neither fair to the aluminium smelters nor efficient for the Australian economy. Carbon taxes have many advantages (Pearce 1991), particularly when careful consideration is given to their place in overall fiscal policy But in the real, imperfect world, the carbon tax should be combined with other, more precisely aimed policy instruments to achieve emission abatement of greenhouse gases.
ACIL Australia, 1992. 'An assessment of the achievability of an Australian commitment to stabilise energy-related CO2 emissions.' in Two studies pertinent to Australia's decision on the terms of participation in A global convention on climate change. ACIL Australia, Canberra
Australian Commission for the Future, 1991. Energy futures. Melbourne grinner, Roger E, Shelby, M G. Yanchar, J M and Cristofaro, A, 1991. 'Optimizing tax strategies to reduce greenhouse gases without curtailing growth'. The Energy Journal 12 (4), 1-14
Ecologically Sustainable Development Working Groups, 1991a. Final report energy use. Canberra
Ecologically Sustainable Development Working Groups, 1991b Final report transport. Canberra
Ecologically Sustainable Development Working Groups, 1991c. Final report energy production. Canberra
Ecologically Sustainable Development Working Groups, 1992. Greenhouse report. Canberra
Grubb, M, 1990. Energy policies and the greenhouse effect. Volume one: Policy appraisal. Dartmouth Publishing Company, Aldershot
Industry Commission, 1991. Costs and benefits of reducing greenhouse gas emissions (2 vole). Canberra
Jones, B P. 1992. 'The UN Convention on Climate Change: effects on Australia's energy sector'. Agriculture and Resources Quarterly 4 (2), 186-95
London Economics, 1992. The impact of global warming control policies on Australian industry. London
McGlynn, G. Newman, P and Kenworthy, J. 1991. Transport energy scenarios for Australian cities. Institute for Science and Technology Policy, Murdoch University, Perth
Manne, Alan S and Richels, R G. 1990. 'CO2 emission limits: an economic analysis for the USA'. The Energy Journal 11 (2), 51-74
Nordhaus, William D, 1991. 'The cost of slowing climate change - a survey'. The Energy Journal 12 (1), 37-66
Pearce, D, 1991. 'The role of carbon taxes in adjusting to global warming'. The Economic Journal 101, 938-48
Warren Centre for Advanced Engineering, University of Sydney, 1991. Energy management in the process industries. Sydney
Williams, Robert H, 1990. 'Low cost strategies for coping with CO2 emissions limits'. The Energy Journal 11 (4), 35-60
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