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«© 2013 The International Institute for Sustainable Development © 2013 The International Institute for Sustainable Development ...»

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IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy Environmental Taxes A well-designed fiscal regime can help tilt market incentives in favour of green industries. By placing a direct cost on environmental damage, taxes and charges both encourage the lowest-cost abatement among polluters and provide incentives for abatement at each unit of pollution. Moreover, they are a source of revenue to governments. Hence economists usually view taxes as economically superior to regulation and control instruments. Environmental taxes and charges are mainly found in high-income countries, and revenues currently account for 2.5 per cent of GDP in OECD countries (of which over 90 per cent come from motor vehicles and fuels) (OECD, 2012b). In other areas, the revenue generation potential of environmental taxes is much less pronounced, but can still be useful. For example, a congestion tax in London has been successful in reducing pollution, while providing funds to invest in public transport (Hallegatte et al., 2012). Reviewing the effect of environmental taxes in several OECD countries on firm innovation, the OECD (2012b) finds that taxes can indeed stimulate the development and diffusion of new technologies, if designed such that they are levied closer to the source of pollution (such as taxes on carbon dioxide emissions rather than on motor vehicles). Such innovations happen across different sizes of firms and in different ways. For example, small and medium enterprises in Sweden that do not engage in R&D have been found to gradually improve production methods through incremental, trial-and-error changes in their production processes (GEA, 2012).

Developing countries are usually hesitant to implement environmental taxes, mainly because they fear the negative impact of such taxes on industry competitiveness, as well as distributional consequences. To date, however, there is no conclusive evidence of such negative competitiveness effects, which might also be due to the fact that even in OECD countries these taxes do not focus on energy-intensive sectors (OECD, 2012b). Nevertheless, as environmental taxes are likely to become more stringent in OECD countries in the near future, there is growing concern over “carbon leakage”: the relocation of polluting firms to countries with more lax regulations. In that case, levying more stringent environmental taxes would both weaken the domestic economy and encourage pollution elsewhere, with a possibly negative net impact for environmental protection globally. In that context, it has been proposed that carbon-taxing countries levy import fees on goods manufactured in non-carbon-taxing countries (so called border tax adjustments) to narrow the regulatory gap internationally (Wooders, Cosbey & Stephenson, 2009).

Industry Protection We have already explored in chapter 3 the link between international trade and technology transfer embodied in traded products. On average, the environmental goods sector appears to be subject to less tariff protection than were infant industries during the catch-up phase of major rapidly industrializing economies after World War II. OECD countries typically apply very low tariffs on manufactured goods in general. The picture is somewhat different for developing countries, where average applied tariffs on environmental goods amount to 10 per cent, which is roughly five times greater than the most-favoured nation rates of the United States, Japan, Canada and the European Union (Golub, Kauffmann & Yeres, 2011).

Let us recall that there is evidence for positive growth effects of tariffs on products from industries whose promotion is likely to have positive national spillover effects. Therefore, import restrictions could be an appropriate tool for countries attempting to promote proficiency in such a sector. For example, China and Brazil maintain high tariffs on solar thermal panels (35 per cent and 20 per cent, respectively). India has achieved almost complete self-sufficiency in the manufacture of wind turbines within less than 10 years, using customs and excise taxes to favour importation of components over complete turbines (Popp, 2012). In general, the wind power manufacturing sector relies less on IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy trade than on international investment flows, due to the high costs associated with cross-border transport (Kirkegaard, Hanemann & Weischer, 2009). Consequently, protective industrial policy in the sector comes in the form of investment restrictions. For example, the Chinese government has long maintained local content requirements for its state-run wind farms, amounting to an obligation to source at least 70 per cent of the value of equipment to be domestically manufactured. Because of this, foreign investors seeking access to the Chinese wind power market contributed significantly to the development of local expertise in ancillary supplier industries (Carbaugh & Brown, 2012). Following a U.S. challenge, China has recently revoked this program, but in all likelihood with little damage, as China now controls about half of the global wind market.

However, such restrictions run counter to efforts for international technology transfer and adoption, by artificially raising the cost of products and hence discouraging their adoption. This finding applies in particular to the renewable energy industry, which is still facing strong cost-competitiveness challenges, for example with respect to fossil fuel– based energy provision. A number of studies find that removing trade distortions increases adoption of energy-efficient technology and can even substitute for other barriers, such as intellectual property rights (Popp, Newell & Jaffe, 2009).

Moreover, the same caveats for using restrictive trade policy in environmental goods applies as in traditional industrial policy sectors, most notably the threat of government failure to appropriately design these policies to suit the countryspecific context.

Much research has focused on tariffs on environmental goods, as data on tariffs is easily available. Emerging research focuses instead on the prevalence of non-tariff barriers to trade, which are much harder to trace and most likely much more substantial than tariff barriers, which are under tighter scrutiny within the WTO. Examining imports of certain clean energy technologies in 18 developing countries, the World Bank (2007) estimates that eliminating both tariff and non-tariff barriers would result in increases in trade volumes from 4.6 per cent for clean coal to 63.6 per cent for energy-efficient lighting. Steenblik and Kim (2009) identify the lack of harmonization of technical standards in importing countries as one of the main impediments to increased adoption of imported climate change–mitigation technology.

A lot of research on green industrial policies focuses on China and India. While such research certainly adds value to this new field of activity, it is unclear to what extent one can distil robust generalizations that would also hold for other industrializing nations (Popp, 2012). Both countries offer investors access to huge, dynamic markets and hence have more leverage in negotiating specific obligations, for example for technology transfer. And as small industrializing countries are likely not able to compete in the production of major advanced technologies, analysts suggest that such countries would be better advised to open up to green technology imports and engage in adaptive R&D that is focused on modifying or enhancing technologies to local needs (Copeland, 2011). In fact, this is a strategy that larger nations have employed as well. Kristinsson and Rao (2008) show how India’s wind turbine industry needed to adapt existing turbine design in order to generate electricity, as wind speeds in India are lower than in Europe. Similarly, De La Tour, Glachant and Ménière (2011) describe how Chinese photovoltaic manufacturers have adopted production processes by replacing capital with labour, effectively taking advantage of its comparative advantage in labour costs vis-à-vis Western competitors.

The extent to which technology transfer and adoption occur hinges critically on a country’s absorptive capacity, which describes a country’s ability to do research to understand, implement and adapt technologies that arrive in the country (Popp, 2012). Industrial policies hence need to go beyond the liberalization of key imports to ensure that such positive spillovers happen.

IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy Also, environmental goods are only a fraction of the environmental sector as a whole. Indeed, environmental services account for about 65 per cent of the sector’s value added (OECD, 2012a). Moreover, it is often very difficult to distinguish between goods and services in the sector, as both are often closely intertwined. Looking at a range of key greenhouse gas mitigation and adaptation technologies, Steenblik and Grosso (2011) find that the deployment of those technologies is often heavily dependent on the availability of specialized quality services. While developing countries often lack such expertise, project sponsors in developed countries also often prefer to import services when international service providers can meet their needs more effectively. The key modes of delivery of such international services require local commercial presence and the temporary movement of natural persons. Hence, industrial policies targeting technology transfer and adoption need to ensure the complementary free movement of trade in services. Barriers to the latter most likely come in the form of restrictions on international investments (such as foreign equity limits) or impediments to the temporary movement of service-providing natural persons (such as quotas or restrictions on the stay of foreign providers) (Steenblik & Grosso, 2011). Indeed, 80 per cent of the environmental services market is composed of infrastructure environmental services, which require local commercial presence and are hence best delivered through FDI (Golub et al., 2011). Paradoxically, foreign ownership is most limited in exactly those industries, such as transport, electricity, telecommunications and, to a lesser extent, waste management (United Nations Conference on Trade and Development, 2011).

Industry Support A central question of the traditional industrial policy literature, how to pick winning sectors, persists equally in the area of green industrial policy. While this question is relevant for all kinds of industrial policies, including those described above, the costs of picking “losers” are most visible when government subsidies are involved, as these are ultimately paid by taxpayers.

While there is generally consensus on the need to move toward provision of renewable energy, there is much uncertainty about exactly which sources will provide the world’s future energy mix. And even then, it is far from obvious which countries will be the competitive providers of the respective technologies. As mentioned earlier, China and India have both managed to establish a competitive wind power industry within a short time. China has taken the lead in (downstream) solar photovoltaic manufacturing, taking over this role from Germany and the United States, which had to observe major concomitant bankruptcies of former domestic champions. The most publicized example is probably the case of Solyndra, a California-based company making solar panels, which defaulted on a US$535 million, government-guaranteed loan in 2011, as it found it impossible to compete with the surge of Chinese products. This surge was helped by generous subsidies from European governments for solar installations, FITs, and, perhaps more importantly, an effective Chinese industrial policy of industry support that provided manufacturers with a number of advantages such as access to low-cost capital, subsidized electricity rates, free access to land and a shortened permitting process for factories (Carbaugh & Brown, 2012).

After having found Chinese subsidies to be harmful to the U.S.’s domestic solar industry at the WTO, the U.S.

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