policy forum: designing a carbon price policy: is the australian climate plan fair to...

The Australian Economic Review, vol. 45, no. 1, pp. 105–13

Policy Forum: Designing a Carbon Price Policy

Is the Australian Climate Plan Fair to Australia’sEnergy-Intensive, Trade-Exposed Industries?

Harry Clarke and Robert Waschik∗

Abstract

The implications of Australia’s unilateralcarbon-pricing plan for its energy-intensive,trade-exposed industries are analysed. Whilea priori arguments for protecting such indus-tries make good theoretical sense, empiricallysignificant levels of support for such protectioncentre on the non-ferrous metal industry alone.

∗ School of Economics, La Trobe University, Victoria3086 Australia. Corresponding author: Waschik, email<[email protected]>. We thank Peter Lloyd andDavid Prentice for their comments on an earlier draft.

1. Introduction

This article looks at implications of the cur-rent Australian Government’s climate plan(Australian Government 2011) for Australia’senergy-intensive, trade-exposed (EITE) indus-tries. Many countries that Australia trades withdo not price carbon emissions, so to that ex-tent, the proposed Australian plan is a unilateralpolicy action. There are a priori arguments forformulating carbon plans to protect EITE in-dustries from competitiveness losses that arisefrom such unilateral actions. Moreover, theselosses are associated with carbon leakages thatshift polluting production in Australia to pol-lution in other countries. Thus, there are po-tentially harmful economic and environmentalconsequences of unilateral action.

A standard policy prescription is to restrictthe carbon tax base to the domestic consump-tion of carbon and to therefore exempt frompricing exported carbon-intensive goods andto impose border taxes on imported carbon-intensive goods that were produced in coun-tries that did not mitigate their emissions. Thisis destination accounting of carbon emissions(Clarke 2010).

The current Australian plan does not do ex-actly this, but as is shown below, in many re-spects it comes close. We argue too that, insome cases, it goes too far in insulating EITEindustries and in this sense involves unintendedprotectionism.

2. The Climate Plan and theEnergy-Intensive, Trade-ExposedIndustries

From 1 July 2012, 500 of the largest carbonemitters in Australia must purchase a permit for

C©2012 The University of Melbourne, Melbourne Institute of Applied Economic and Social ResearchPublished by Blackwell Publishing Asia Pty Ltd

106 The Australian Economic Review March 2012

every tonne of carbon dioxide (CO2) they gen-erate. The price of such permits is set initiallyat $23 per tonne, with increases of 2.5 per centin real terms each year until 1 June 2015, whenthe carbon price will be market-determined inan emission-trading scheme (ETS). From thisdate, trading in emission permits in ‘credible’international carbon markets will also be per-missible but half of any firm’s compliance obli-gations must be met through domestic permitsor credits. The objective is to cut carbon emis-sions by 5 per cent over year 2000 levels by2020.

We are only concerned here with impactsof this package on Australia’s EITE industries.Substantial assistance has been offered to thisindustry to promote jobs and offset interna-tional competitiveness losses. The governmentis also separately investing to protect jobs insteel and coal.

Around 40 per cent of the carbon taxrevenues will be directed as assistance toAustralian industry. Much goes to manufactur-ing under a Jobs and Competitiveness Program(JACP), with assistance given to firms with asignificant trade exposure and with high carbonintensities in production. The assistance coversdirect and indirect emissions from electricityand steam use. A further $1.2 billion CleanTechnology Program (CTP) will be allocated toimproving energy efficiency in manufacturingand to supporting research and development inlow-pollution technologies. Around $200 mil-lion is targeted to food processing, metal forg-ing and foundry industry. Some firms receivingassistance are in EITE industries, while othersare not.

There is a separate Coal Sector Package andSteel Transformation Plan and more generousdepreciation provisions for small businessesthat invest in new assets. The coal plan pro-vides assistance of $1.3 billion over 6 yearsto a small number of ‘gassy’ coal mines thatprovide significant ‘fugitive’ emissions. Theassistance involves free quotas to 80 per centof emissions above some minimum level. Thesteel plan provides $300 million over 5 yearsas a response to factors that include the im-pact of carbon pricing but which, in the main,reflect lost competitiveness due to the appreci-

ation of the Australian dollar, increases in rawmaterials’ costs and slow growth in Australianconstruction.

The JACP targets international competi-tiveness and associated carbon leakages. Thepolicy provides free permits to heavy manufac-turing industry such as steel, pulp and paper,glass, cement, aluminium, petroleum-refiningand liquified natural gas (LNG). This occurs intwo categories: a 94.5 per cent shielding fromthe carbon price for very emission-intensiveEITE industries and a shielding of 66 per centfor less-exposed industries. The LNG projectswill also receive effective assistance of 50 percent. The benchmark used to provide assistancein all cases is the ‘historic emissions intensity’(Australian Government 2011), but this is sub-sequently linked to changes in the scale of pro-duction. Assistance is guaranteed for the first5 years with 3 years’ notice being given of anypolicy change. Rates of assistance are reducedannually by a 1.3 per cent ‘carbon productivitycontribution’. New firms setting up operationcan apply for assistance, so the assistance is nota barrier to entry.

Less emission-intensive manufacturing busi-nesses that consume more than 300 MWh ofelectricity or 5 TJ of natural gas are giventransitional support under the CTP. This in-volves grants to identify and implement energy-and carbon-efficient technologies. Firms mustmatch government contributions: $3 for every$1 provided by government. There is a similarprogram for food and foundry investments.

The substantial government assistance pro-vided to the emerging renewable energy indus-try (a $10 billion Clean Energy Finance Corpo-ration will be established) and to the existingelectricity industry (an Energy Security Fund of$5.5 billion will be established) are not EITEindustry concerns since these industries are nottrade-exposed. Electricity inputs used in EITEindustries affect their costs and are accountedfor as indirect emissions in the policy package.

There are numerous tax-and-transfer impactsof the carbon policy package, but as Table 1makes clear, the main features are the signif-icant revenues earned for government and thetax compensations to households, firms and theelectricity industry.

C©2012 The University of Melbourne, Melbourne Institute of Applied Economic and Social Research

Clarke and Waschik: Australian Climate Plan 107

Table 1 Fiscal Impacts of Australian Carbon-Pricing Policy

Fiscal impact ($million)

2011–12 2012–13 2013–14 2014–15 Forward impact ($million)

Revenues from permit sale 0 7,740 8,140 8,590 24,470Household assistance –1,533 –4,196 –4,802 –4,825 –15,356Total assistance for business –26 –3,017 –3,475 –3,773 –10,291

Jobs and Competitiveness Program 0 –2,851 –3,059 –3,312 –9,222Clean Technology Program –19 –142 –245 –312 –717Other –7 –25 –171 –149 –352

Clean Energy Finance Corporation –2 –21 –467 –455 –944Energy Security Fund –1,009 –1 –1,003 –1,042 –3,084

Source: Australian Government (2011, p. 131).

For the next few years, the main use of fundsfrom carbon pricing will lie in providing as-sistance to households and in grants to eligibleEITE industry firms via the JACP. We examinehow that program fits in with objectives of min-imising competitiveness losses and leakages.

3. Destination Accounting andApproximations

If countries unilaterally price their carbon emis-sions, their exports lose competitiveness rela-tive to the similar outputs produced elsewherethat are not subject to carbon pricing. The im-proved competitiveness of substitute productscould mean that more will be produced in un-priced industries or that local industries willrelocate to ‘pollution havens’ where carbon isuncharged. In either case, the associated car-bon emissions accrue elsewhere with this ex-panded production, so carbon leakages arise.Therefore, often carbon-intensive exports areexempted from carbon pricing to prevent lostcompetitiveness and the associated environ-mental costs of carbon leakages.

The same argument applies to import-competing industries subject to carbon charg-ing. These will be subject to competitivenesslosses from uncharged imports and associ-ated leakages. The first-best policy to addressthese concerns is to levy a border tax adjust-ment (BTA) on imports that reflects the ex-tent to which they are untaxed. There is an ex-tensive literature examining the World TradeOrganization’s rules legality of such BTA mea-sures (World Trade Organization and United

Nations Environment Programme 2009) andtheir strategic implications have been much dis-cussed (Clarke 2010, 2011).

Exempting exports from charging and levy-ing border taxes on imports amounts to em-ploying a destination base for carbon charging.Charges are levied on the basis of where emis-sions are consumed directly or indirectly bya country’s citizens. An alternative origin taxbase levies charges on the basis of where carbonemissions are produced and falls on exports butnot on imports. An origin base therefore leadsto competitiveness losses and leakages when-ever a unilateral policy is undertaken.

There are two controversial issues associatedwith implementing a destination-based charge.On the export side, it is difficult to provide re-bates to exports alone when output is also soldlocally without providing incentives to divertoutput towards exports, thereby creating carbonleakages. To the extent outputs are also sold lo-cally, they will be liable for a destination-basedcarbon charge while exports are exempt. Thiscreates incentives to divert output into interna-tional markets, disadvantaging local consumersand generating leakages.

Levying BTAs on imports from non-mitigating countries is not inherently protec-tionist. The policy addresses external costs thatwould otherwise be unpaid. However, argu-ments for such measures can be distorted intoan illegitimate case for protectionism. Clarkeand Waschik (2011) and the analysis in Section4 below show that such fears are not ground-less. The claims of some firms in both exportand import-competing industries on damages



done by carbon charging exceed those that ev-idence suggests.

An alternative to BTAs and a way ofaddressing these objections is to issue freetransferable emission quotas to industries thatprimarily export or which are import competi-tors, as the Australian policy does. The freequotas assigned reflect direct and indirect emis-sion charges incurred by exporters and import-competing firms.

Then suppose foreign and local firms selloutput in Australian and in foreign markets.In a first-best world where carbon emitted byany firm (local or foreign) is correctly priced,the carbon use by Australian firms will ide-ally decline from an untaxed, inefficient levelc(0) to a lower efficient level c∗, reflecting theuncharged competition and the industry’s car-bon intensity—in fact, government decisionsare allocated on the basis of historic emissionsintensity (Australian Government 2011), so thisformulation provides an idealised rationale forthe actual policy. If carbon charges are appliedonly to local firms, they will lose competitive-ness, reduce output and deliver increased mar-ket share to foreign firms that generate leak-ages that offset the carbon reductions achievedby Australian firms.

The free quota proposal involves givingAustralian trading firms free permits that, if un-used, can be sold at the prevailing carbon price.The free quota preserving neutrality is c(0) –c∗, which is the smallest quota that leaves thefirm no worse off with first-best pricing thanprior to pricing. If firms were originally will-ing to abate by this amount, given a carboncharge, then the costs of cutting emissions overthis range must have been less than the costof buying a carbon permit. Hence, firms willearn more by reselling the quota than by us-ing it to emit. Firms again drive emissions toc∗. Under the flexible price phase of an ETS,this proposal restores desired emission levelsby providing the firm with an income transferworth p(c(0) – c∗), where p is the carbon price,which compensates them for costs of makingcutbacks, but by confronting them with an op-portunity cost of emissions, provides incentivesto abate. To the extent firms face higher abate-ment costs than the value of the permits they

utilise, the free permits still achieve the desiredlevel of cutbacks.

There are, however, practical difficultieswith this proposal:

(i) It is costly: quotas are given away, whereasBTAs yield revenue. The free quota policyis equivalent to a policy of charging, butmaking cash transfers to EITE industries.

(ii) Incorrect pricing signals continue tobe provided to foreign exporters thatthere is over-supply from the view-point of the global social optimum.Compared to BTAs, local markets areover-provided with socially damagingimports.

(iii) Difficult judgements are required in de-termining free allocations. Reliable esti-mates of c(0) can be determined from his-torical emissions intensity, provided thesehave not been increased in anticipation ofthe carbon policy. But, estimating c∗ re-quires cost information from firms with in-centives to exaggerate. Analysis suggestssuch exaggeration occurs. Fewer problemsarise with respect to imports if equivalentBTAs are used, although then a politicaleconomy struggle will emerge over thesize of required BTAs.

(iv) Judgement is also required in assessingcross-price elasticities. If a firm is sub-ject to almost no foreign competition, thequota transfer has limited compensatoryrationale. Local polluting firms producinglargely non-traded goods should reduceoutput. The difficulty with assessing theextent of competition faced by local firmsis that they, again, have incentives to ex-aggerate their competitive plight.

(v) Both BTAs and free quota provisions mustbe set conditionally based on the tech-nology used by the foreign firm. If for-eign firms export aluminum produced us-ing unpolluting hydropower, there is nocase for offering free entitlements (or in-deed BTA protection!) to EITE industries.



The costs of potential protectionism from ex-aggerated claims for compensation must be lessthan the costs of providing free quotas for thelatter policy to be a better option. The possi-bility of exaggerated claims suggests the needfor investing resources in accurately estimat-ing entitlements to free quotas. Leaving localfirms with some additional incentives to reduceemissions is preferable to giving undeservedsubsidies. Subsidies should accrue only toEITE industry firms facing strong competitionfrom foreign firms utilising carbon-intensivetechnology.

The free quota c(0) – c∗ cannot be estimateddirectly. We can infer that if the impacts ofunilateral pricing on output in an EITE industryare small, that then this free quota is small.If the impact is larger, then qualitatively onewould expect the optimal quota to be largerthe greater is the trade exposure of the industry,the more carbon-intensive its technologies andthe greater the substitutability between foreignand local goods.

4. Empirics

Providing a theoretical setting for devisingpolicies to offset adverse competitiveness andcarbon leakage effects is important. It is alsoimportant to go beyond a priori arguments toassess the appropriate scale of offsets. Theanalysis below draws on Clarke and Waschik(2011), who use a computable general equilib-rium (CGE) model, based on the 2004 GlobalTrade Analysis Project (GTAP7) database, tosimulate the economics of unilateral Australiancarbon charging and compare results from thisunilateral abatement exercise to those in COA(2008), among others. The model in Clarke andWaschik (2011) assumes fixed terms of tradeand takes investment and technical progressas exogenous. Thus, it overstates the costs ofemission abatement by ignoring innovationsthat reduce emissions, but understates costs byignoring increased emissions from economicgrowth.

Production is represented by a series ofnested constant elasticity of substitution (CES)technologies. To accommodate substitutabil-ity between energy inputs, the nesting struc-

ture used by Rutherford and Paltsev (2000)and Fischer and Fox (2007), along with theirassumed elasticities of substitution betweenenergy inputs, is adopted. A representative con-sumer owns the fixed endowment of primaryfactors. Land is a specific factor producingprimary agricultural commodities. Natural re-sources are specific to producing forestry, fish-ing, minerals and the three primary energy in-dustries: coal, oil and gas. The representativeconsumer’s utility is a CES function of energyand non-energy goods.

Trade is modelled by assuming that domes-tic and imported varieties of the same goodare differentiated products: the Armington as-sumption. Substitution elasticities between ho-mogeneous traded goods, like oil and gas, arehigher, while those between more heteroge-neous goods, like iron-and-steel and metals, aresmaller.

Carbon emissions arise with the usage ofcarbon-producing energy goods in fixed pro-portions. Initially, the economy has an endow-ment of carbon permits equal to total emissions,so the carbon price is zero. Then, the supplyof permits is reduced by from 0–30 per cent tosimulate the effects of CO1 emission abatementof 0–30 per cent. Permits are freely tradeablebetween industries. The effects of abatementare analogous to the effects of an exogenousreduction in the endowment of the carbon fac-tor. Abatement leads to a mild macroeconomiccontraction, but these effects spread asymmet-rically through the economy, with those indus-tries using carbon intensively contracting themost.

COA (2008, p. 10) found that ‘. . . an ab-solute reduction of 5 per cent (in the CPRS[Carbon Pollution Reduction Scheme]-5 sce-nario) by 2020 corresponds to a 27 per centreduction in per capita emissions’. This was ac-complished with an initial carbon price of $23per tonne in 2010 ($20 in 2005 dollars), risingto $35 per tonne in 2020 (COA 2008, p. 19).Daley and Edis (2010) also evaluated effectsof a carbon tax of $35 per tonne that reducedAustralian emissions by 5 per cent below 2000levels by 2020.

To compare results to those in COA (2008)and Daley and Edis (2010), Clarke and Waschik



(2011) simulate the effects of a 27 per centreduction in Australian CO2 emissions. Withno compensation, free quota or BTA for anyEITE industry, the resulting carbon price is $37.While this carbon price is comparable to that inCOA (2008) and Daley and Edis (2010), it is de-termined in a setting where carbon permits arenot internationally traded and where Australiais assumed to be the only country with carboncharges. We are interested in modelling the ef-fects of Australia’s unilateral adoption of a car-bon abatement policy. The carbon price in COA(2008) is determined in a global market whereall countries reach a pre-determined level ofabatement and carbon permits are freely tradedinternationally. Since Australia is a small econ-omy on world carbon markets, this carbon priceis unaffected when COA (2008) introduce com-pensation to shield EITE industries in Australiafrom the adverse effects of carbon charges oncompetitiveness. But, in Clarke and Waschik(2011), when compensation is subsequently in-troduced in the non-ferrous metal industry, thecarbon price must rise to clear the Australianmarket for carbon permits.

With abatement of 27 per cent and withouteither BTAs or compensation for EITE indus-tries, the CGE model in Clarke and Waschik(2011) suggests a loss of 0.4 per cent of baseperiod national economic welfare. This welfaremeasure excludes benefits of emission reduc-tions. By comparison, COA (2008) predicts areduction in gross domestic product of 1.1 percent by 2020 in the CPRS-5 and Garnaut-10scenarios.1 To explain the difference betweenthese changes in welfare, note that the abate-ment exercise simulated in Clarke and Waschik(2011) is very different to that in COA (2008). Ifwe repeat the simulation in Clarke and Waschik(2011) but have Australia and all other AnnexB countries reduce emissions by 27 per centand allow carbon permits to be traded betweenabating countries, Australia’s welfare loss risesto 0.75 per cent. This larger welfare loss is ob-tained due to the negative terms-of-trade andvolume-of-trade effects of the abatement poli-cies in other Annex B countries on Australianwelfare, which are present in COA (2008) butabsent in the unilateral abatement exercise inClarke and Waschik (2011). COA (2008) also

assumes that some developing countries (in-cluding China) abate emissions by 2020, al-beit by less than 27 per cent. There is alsoan important difference between the datasetsused in Clarke and Waschik (2011) and COA(2008). The former uses the GTAP7 database,which does not include greenhouse gas emis-sions from agriculture and land-use change,while these are included in COA (2008). Hence,initial (2004) CO2 emissions in Clarke andWaschik (2011) are 353.7 Mt, while the cor-responding figure in COA (2008) for 2005 is579.1 Mt.

Specific industry effects are now analysed.

4.1 Electricity

The coal-intensive electricity industry isAustralia’s largest carbon emitter, accountingfor 54 per cent of total emissions in 2004. Elec-tricity is not traded and is not an EITE indus-try. It is discussed here because of the indirectrole of electricity in determining EITE indus-tries’ competitiveness. The current Australiancompensation scheme accounts for indirect car-bon costs on EITE industries, so policy-makersrecognise electricity’s role. However, compen-sation for the non-traded electricity industry isnot, in itself, a concern of EITE industries.

With abatement of 27 per cent, electric-ity prices rise by 22 per cent and produc-tion declines by 18 per cent. By comparison,COA (2008, p. 34) predicts increased electric-ity prices of 17–24 per cent. Carbon chargescause the electricity industry to substitute coal,the usage of which falls by 40 per cent, withgas, the usage of which decreases by only23 per cent.

4.2 Coal and Gas

Fugitive carbon emissions associated with min-ing coal and gas were 0.7 and 0.2 per cent of to-tal emissions in 2004, respectively. Virtually allunexported coal was used to produce electric-ity, while gas was also distributed as pipelineor utility gas. Because of coal-fired power’sgreater emission intensity, a carbon tax createsa larger drop in domestic demand for coal thanfor gas.



With abatement of 27 per cent, domestic de-mand for coal and gas falls by 37.5 and 22.7 percent, respectively. The decrease in domestic de-mand for coal and gas causes their price to fall,making it more advantageous for firms to ex-port, leading to increased coal and gas exportsof 7 and 15 per cent, respectively. Since sucha large share of Australian coal is exported,this 7 per cent increase in coal exports almostcompletely offsets the 38 per cent decrease indomestic demand for coal, so the overall de-crease in coal production is only 1.5 per cent.Since a smaller share of gas is exported, overallgas production falls by 4.3 per cent.

These results in Clarke and Waschik (2011)suggest that it is difficult for the coal and gasindustries to argue for overall compensation tooffset the effects of carbon charges on competi-tiveness grounds. There is no scope for leakagethrough imports since Australia does not importcoal or gas and exports increase. Carbon charg-ing will reduce domestic demand for coal andgas, which puts some downward pressure onprices of Australian coal and gas, but the ensu-ing increase in Australian coal and gas exportsshould almost completely offset this decreasein domestic demand.

These results contradict coal industry pre-dictions of competitiveness losses and carbonleakage effects. There will be a small decreasein Australian coal production but coal exportsincrease, which decreases coal production inother countries. The effect on global emissionsdepends upon leakages arising from Australia’simposition of carbon charges and the behaviourof other coal-producers. If increased Australianexports supplant production that would havecome from China (where fugitive emission in-tensities are high), then global emissions woulddecrease. But, if the supplanted productioncame from the United States (where the emis-sion intensity in coal production is much lowerthan in Australia), global emissions would in-crease.

4.3 Metals

This industry includes aluminum, nickel, cop-per, zinc and other metals. Clarke and Waschik(2011) show that a carbon charge of $37 on

this industry’s direct emissions is equivalent toa production tax of 1.1 per cent. More impor-tant, however, is the indirect effect of the car-bon charge on electricity prices, since electric-ity represented 16 per cent of the value of metalproduction in 2004. While production in themetal industry resulted in direct emissions ofCO2 of 11.9 Mt, indirect emissions amountedto 79.3 Mt. The carbon charge of $37 and theensuing increase in the price of electricity willlead to a loss of competitiveness of Australianmetals on world markets, which translates intoa drop in exports of 38 per cent and an increasein imports of 17 per cent. Since 66 per centof metals produced in Australia are exported,the leakage through decreased exports and in-creased imports results in a large drop in metalproduction of 33 per cent. Direct (embodied)emissions of CO2 fall to 6.6 Mt (63.9 Mt). Theimpact of carbon pricing on this industry isthe largest of all the EITE industries due to thehigh exposure to trade and the large share ofelectricity used.

The government’s climate plan providescompensation for higher costs both of directemissions and emissions embodied in the in-termediate inputs used in the metal industrydue to the introduction of carbon charges. But,the implications of such compensation dependcrucially upon whether or not there exists aglobal market on which carbon permits can beimported. COA (2008) presumes such a marketexists, so that when Australian EITE industriesare shielded from the negative effects of car-bon charges through the granting of free per-mits, these permits can be imported at a pricethat clears the global market for CO2. Underthe abatement scenario in Clarke and Waschik(2011), the government’s climate plan wouldinvolve granting permits to the metal industryfor [63.9 + 6.6] × 0.945 = 66.6 Mt of CO2. Theeffect of shielding Australian metal producerswould have virtually no effect on the worldprice of traded CO2 permits since the abate-ment effort in this industry without compensa-tion accounts for such a small share of globalemissions. Nor will the issuance of free permitshave any effect short term on the price of car-bon permits in Australia. But, without a globalmarket for traded permits, this shielding will



have to be accommodated longer term in theAustralian permit market. These free permitsinvolve a large transfer to the metal industry, sothat the entry or the absence of exit consequenton compensation could increase output of themetal industry. Also, the economy-wide priceof CO2 will have to increase. In this event, assimulated in Clarke and Waschik (2011), theprice per tonne of CO2 will have to rise from$37 to over $56 per tonne of CO2.

Providing such compensation should onlyoccur if other countries that export products,such as aluminum, generate comparable car-bon emissions that are not subject to carbontaxes. Garnaut (2011, p. 84) questions this:

Australian aluminum is among the most emissionsintensive as it is based on coal. The expansion ofthis sector elsewhere is likely to generate muchlower (or even zero) emissions.

One can test this claim using data on emis-sion intensities from GTAP. Are there signifi-cant carbon leakages? Australia’s emission in-tensity in production of metals is lower onlythan that of the former Soviet Union. So, with-out BTAs in the metal industry, the scope ofleakages through an increase in metal importsdepends upon where imports are sourced. Ifmost come from the former Soviet Union orChina (where emission intensities in produc-tion are high), leakage will be considerableand compensation will be warranted. If mostof the increased imports come from the Eu-ropean Union (where emission intensities arelow), leakage through imports is not a problemand compensation should not be given. Giventhat China (16.8 Mt) and Russia (3.85 Mt) ac-counted for half of global aluminum produc-tion in 2009, while Australia’s production was1.95 Mt, Garnaut’s claim is questionable.

4.4 Other Energy-Intensive, Trade-ExposedIndustries

Two EITE industries for which the AustralianGovernment’s climate plan provides compen-sation are the ferrous metal industry, whichcomprises mainly iron and (stainless and al-loy) steel, and the mineral product industry,

which includes production of cement. Clarkeand Waschik (2011) suggest that a carboncharge of $37 per tonne (to achieve a levelof abatement of 27 per cent in the Australianeconomy) would lead to a drop in iron andsteel exports of only 1.9 per cent and an in-crease in iron and steel imports of 3.4 per cent.The effect on exports of mineral products iseven smaller, while imports would actually fallby 0.8 per cent. These results suggest that thescope for leakage in these two EITE industriesis very limited. The impact of the carbon chargeon competitiveness of these industries is suffi-ciently small that we argue that compensationfor these industries is not warranted.

Our claims regarding these industries contra-dict those of Daley and Edis (2010), who findthat a carbon charge of $35 per tonne wouldhave a significant negative effect on the globalcompetitiveness of Australian iron and steelproducers, leading to the possibility that Aus-tralian steel production could move offshoreand that Australia could substitute cement pro-duced offshore with locally produced cement.Clarke and Waschik (2011) argue that Daleyand Edis (2010) overstate the effects of their$35 carbon charge on the iron and steel in-dustry by overstating the share of electricity(whose price rises) and understating the priceof primary factors (whose price falls) on thecost of production. They also argue that theircarbon charge amounts to a carbon tax of 14.3per cent on the cement industry, which is muchhigher than the effective carbon tax of 0.9 percent implied by the carbon charge of $37 pertonne of CO2 in Clarke and Waschik (2011).

In COA (2008), Australian iron and steelproducers are shielded from the negative ef-fects of the carbon charge through the grant-ing of free carbon permits, which are importedfrom overseas. They find that the cost of suchshielding is negligible. But, if a global marketfor tradeable carbon permits did not exist, thenthe cost of shielding Australian iron and steelproducers from the negative competitivenesseffects of carbon charges through free permitswould be much higher. We would argue thatcurrent concerns over the competitiveness ofAustralian iron and steel producers are not re-lated to carbon charges, as our modelling shows



that the effects of a carbon charge on the ironand steel industry would be very small. Instead,current competitiveness concerns more likelyarise from the recent large appreciation of theAustralian dollar. As such, we would argue thatany compensation to the Australian iron andsteel industry should not be in the form of freecarbon permits, but should be structured to as-sist this industry in dealing with the decreasein competitiveness arising from the strongAustralian dollar.

5. Conclusion

From the viewpoint of competitiveness con-cerns and the desire to reduce carbon leak-ages, there is an a priori case for insulatingthe most emission-intensive, trade exposed in-dustries from unsought effects of a unilateralcarbon tax. There remains the empirical ques-tion of whether such insulation policies arenecessary, given the scale of the underlyingproblems.

We used a CGE model of the Australianeconomy to examine this issue. While otherstudies conclude that many industries inAustralia (including coal, cement, steel and alu-minum) should qualify for compensation, wefind this is only warranted in the Australianmetal industry that includes aluminum. This isa broad-brush finding since analysis is posed atthe industry level, rather than at the individualfirm level.

For most industries, carbon charges withoutthe insulating properties of BTAs and compen-sation for exporters do not result in signifi-cant cost impacts and do not impact adverselyon competitiveness. Even compensation in thenon-ferrous metal industry is conditional on ex-ports being sourced from countries or regionswhere the emission intensities are higher thanin Australia.

November 2011

Endnote

1. Here, the welfare loss is measured in Hicksian equiva-lent variations, while that in COA (2008) is the percentage

change in real per capita gross national product relative tobaseline.

References

Australian Government 2011, Securing a CleanEnergy Future: The Australian Govern-ment’s Climate Change Plan, Common-wealth of Australia, Canberra.

Clarke, H. 2010, ‘Carbon leakages,consumption-based carbon taxes andinternational climate change agreements’,Economic Papers: A Journal of AppliedEconomics and Policy, vol. 29, pp. 156–68.

Clarke, H. 2011, ‘Some basic economics ofcarbon taxes’, Australian Economic Review,vol. 44, pp. 123–36.

Clarke, H. and Waschik, R. 2011, ‘Australia’scarbon pricing strategies in a global con-text’, paper presented to 40th AustralianConference of Economists, Canberra, 10–14July.

Commonwealth of Australia 2008, Aus-tralia’s Low Pollution Future, The Eco-nomics of Climate Change Mitigation,Summary, Commonwealth of Australia,Canberra.

Daley, J. and Edis, T. 2010, Restructur-ing the Australian Economy to Emit LessCarbon: Main Report, Grattan Institute,Melbourne.

Fischer, C. and Fox, A. K. 2007, ‘Output-basedallocation of emissions permits for mitigat-ing tax and trade interactions’, Land Eco-nomics, vol. 83, pp. 575–99.

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Rutherford, T. F. and Paltsev, S. V.2000, ‘GTAPinGAMS and GTAP-EG:Global datasets for economic researchand illustrative models’, Working Paperno. 00-02, University of Colorado atBoulder.

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