German economist Johannes Bachmann explains the so-called ‘Green Paradox’ — when unilateral climate policies accelerate the worldwide extraction of fossil fuels and global CO2 emissions.
Yesterday, 20 September, the so-called “Climate Cabinet” of Germany’s federal government met to set the course of German climate policy for the coming years.
Christoph Kramer spoke with Johannes Bachmann about the so-called Green Paradox and the economic concepts that fuel it. Dr Bachmann is an economist and a member of the Hayek Society. Two years ago he received his doctorate from Michael Bräuninger, a Hamburg economist and former research director of the Hamburg Institute of International Economics (HWWI). In his dissertation Bachmann dealt with the effect of climate policy measures on CO2 emissions.
Christoph Kramer: Mr. Bachmann, if one looks into your dissertation as a layman it’s all Greek to me. Could you please briefly explain exactly what the thesis is about and what methodology you used?
Johannes Bachmann: I can well understand that. On the one hand, there are quite a few technical terms in the work, and on the other, there are many formulas. It is a typical dissertation: a work by an academic for academics.
The aim of the thesis was to examine the effects of climate policy measures on the supply side of fossil fuels. To this end, I calculated how owners of raw materials adjust their production quotas as a result of CO2 taxes or subsidies for renewable energies in order to continue generating as much revenue as possible. Why did I focus on the supply side of all things? The answer is: the quantity of fossil fuels that is extracted from the earth is also consumed.
The term “green paradox” is used in your work when climate policy accelerates the worldwide extraction of fossil fuels and global warming. How can this happen?
First of all, I have to say that the concept of the Green Paradox goes back to Hans-Werner Sinn. The scientific discussion about this, which was initiated about 10 years ago, finally led me to do my doctorate. Sinn’s credo is that climate policy should not only achieve half solutions, i.e. without taking into account the reactions of raw material suppliers.
How can we imagine the emergence of a Green Paradox? Well, here is what we need to be aware of: In contrast to a producer of goods, a raw material owner is basically faced with the question as to whether it is better to extract and offer some of his resources now or rather in the future. He will take into account that an increasing shortage or increased demand in the future will lead to an increase in the value of his property. If he assumes a high increase in value, his current production rate will be comparatively low.
However, if he expects that climate policy measures will greatly reduce the increase in value of his reserves in the future, he will increase his production and invest the proceeds in securities. This automatically leads to an acceleration of both fossil fuel extraction and CO2 emissions. Hans-Werner Sinn comes to the conclusion that the successive promotion of climate policy measures can cause precisely this problem. Climate policy can therefore provide incentives that achieve exactly the opposite of what it actually intends. Hence the term “green paradox”. Since my dissertation was based on market constellations other than those of Hans Werner Sinn, I arrive at more moderate results in some areas and more drastic results in others.
“The cancellation of CO2 certificates is necessary”
Can you give me an example?
For example, I have developed a model that takes into account the fact that the market share of renewable energies is growing faster when prices for fossil fuels are high; conversely, raw material suppliers have the opportunity to make life difficult for renewable energy suppliers by increasing their production quotas. I also come to the conclusion that even the levying of a fixed VAT rate on fossil energy leads to a Green Paradox. On the other hand, in Sinn’s analysis, VAT has no effect.
In a recent lecture, you discussed the climate policy proposals of Germany’s so-called Coal Commission in more detail. How do you assess them?
First of all, it should be mentioned that the Coal Commission was set up by the Federal Government with the clear objective of developing proposals for achieving the German 2030 energy sector target. This target includes an emission reduction of about 60 percent compared to 1990. It is clear that this cannot be achieved without the accelerated decommissioning of coal-fired power plants, which the Coal Commission also recommended. In this respect, the proposals follow the logic of ambitious German climate protection targets, which, incidentally, are far above those of the EU. It is more than unclear whether a CO2 reduction can actually be achieved.
Since the energy sector is covered by the European Emissions Trading Scheme, a CO2 reduction could only be achieved if certificates corresponding to the level of German savings were withdrawn from trading. Otherwise there would be price pressure, so that the certificates would be cheaper to obtain in other countries. Then the CO2 emissions saved in Germany would only be shifted to other European countries. Since the earth’s atmosphere does not care whether an additional CO2 molecule comes from Germany or elsewhere, nothing would be gained. The cancellation of the certificates is therefore a necessary condition.
Does this mean that the effect of the German coal phase-out will be futile, but will not lead to more emissions?
That is precisely the question. To find an answer to this question, it helps to take a closer look at the supply side. Despite the massive expansion of renewable energy sources, German lignite production quotas have remained virtually unchanged over the past twenty years and are therefore still the highest in the world. The result is that Germany has developed into the largest electricity exporter in Europe and is pushing down prices elsewhere with very cheap coal-fired electricity. The low electricity prices not only promote an increase in energy consumption abroad. They are also calling on foreign operators of coal-fired power plants to increase their own electricity production in order to counter the loss of market share. The announcement of an accelerated phase-out of coal-fired power generation alone could lead to an even stronger increase overall. Ultimately, this is a good example of a green paradox.
“Another potpourri of measures.”
Apart from that, can the proposals of the Coal Commission be put into practice at all?
I have great doubts about that, too. For example, the Coal Commission recommends the extensive replacement of coal-fired power plants by gas-fired power plants by 2038. However, this alone does not solve the 2050 long-term goal of an almost CO2-neutral energy industry. This requires the complete decoupling of the electricity supply from fossil fuels – including natural gas. On the other hand, electricity production in wind and solar power plants is very volatile due to weather conditions. This raises the question of how a CO2-neutral and at the same time stable power supply can be guaranteed in the long term. Here the Coal Commission is relying on the future production of synthetic natural gas from surplus green electricity. This would make it possible to operate the gas-fired power plants in 2050. I have calculated that the implementation of such a proposal would require eight times as many wind and solar power plants as today. I have not even considered the planned switch in the transport sector to e-mobility or synthetic fuels.
Recently there have been further reports with proposals for improved climate policy. The special report of the five economic experts “Towards a New Climate Policy” stands out in particular. What are the main recommendations?
The report clearly criticises the previous small-scale approach and the strongly constructivist approach to energy system transformation. In addition, one of the core demands is that Germany should distance itself in future from its pioneering role in climate policy. According to the experts, it would be better to implement the EU requirements and not try to outdo them. This recommendation, in my view, at least points in the right direction. Unfortunately, there is every indication that the proposals that will end up on the table of the Climate Cabinet on 20 September are once again a potpourri of measures. Another core demand by the economic experts is that Germany should work towards extending the European emissions trading system to all high-CO2 sectors.
And this is how we achieve the EU targets?
Let us assume that this would indeed be implemented swiftly. Then it would be possible to cap CO2 emissions exactly in terms of quantity. If you did not have a certificate, you would have to leave your car in the garage. In order to meet the 2030 and 2050 targets, the expansion of emissions trading would certainly be the most plannable method from the point of view of the state.
German example a reason for CO2 increase?
So where is the problem?
As good and right as it may be to adhere to international agreements, one thing should not be forgotten: Europe’s share of global CO2 emissions is just ten percent. Effective climate policy does not mean unilaterally implementing measures in Germany or Europe to cut emissions so that they subsequently increase in other regions of the world. And that is precisely the crux of the matter. On the one hand, I cannot see that an expansion of emissions trading in Europe would create incentives for global raw material producers to reduce their production quotas. On the other hand, such a measure will by no means lead to China, India or other emerging economies being persuaded to follow suit. The economic experts are well aware of the latter.
How do you see this?
Since the report explicitly emphasises that a key element of successful climate policy is global coordination. According to the report, Germany should make every effort to push for a global minimum price for CO2. The chances for this would be all the better if Germany were to take on a role model function instead of a pioneering role. According to the report, this would be the case if a highly developed economy such as Germany, which makes intensive use of fossil energy, were able to achieve the internationally agreed targets cost-effectively and without major social distortions.
Does this mean that the costs of the energy system transformation will endanger a possible role model for Germany?
In view of the fact that Germany will only partially meet the EU climate protection targets for 2020, although the energy system transformation has already devoured several hundred billion euros, this must unfortunately be affirmed. I would not, however, attach so much importance to the role model function.
Why do you think that?
The report erroneously gives the impression that the model function could be strictly separated from a pioneering role. Germany is already playing a pioneering role in the world on account of the EU’s international commitments alone. Thus, there is only the possibility of taking advantage of this role in an exemplary manner or not. Although it is known from economic applications of game theory that the rate of global CO2 emissions can be reduced as a result of the advance of one nation or a smaller coalition. But this only happens if the pioneer(s) quickly demonstrates that an effective CO2 reduction is possible at low cost, so that incentives are stimulated in other countries to adopt similar policies. However, “low costs” should not be confused with the term “cost-efficient” in the report in question. “Cost-efficient” simply means that the cheapest instruments are used to achieve climate protection goals. However, it says nothing about the absolute level of costs.
Overall, there is very little to suggest a strategy of rushing ahead makes any sense. Rather, the majority of the results from game theory favour a wait-and-see approach — or, alternatively, a free rider role for those nations that sit on the fence. As a result, global CO2 emissions are expected to rise, bringing us back to the Green Paradox.