de Antonia Díaz y Luis Puch. Appeared first in Spanish in the blog “Nada es Gratis”.

In 2018 the European Commission launched the Bioeconomy Strategy update, an initiative that aims to boost research into and adoption of sustainable technologies in the primary sectors (agriculture, forestry, fisheries, food, bioenergy and biological products), along with certain related activities in the chemical, biotechnology and energy industries. The statistics of the sectors concerned can be found in this study; suffice it to say that they have an annual turnover of around 2 billion euros and employ some 18 million people. The EU has already invested 3,850 million euros in applied research in this broad sector in the Horizon 2020 program (2014-2020) and has budgeted 10,000 million euros in the Horizon Europe program (2021-2027). The main objectives of this ambitious plan are (1) to create jobs, (2) to reduce emissions and dependence on fossil fuels, (3) to renew and modernize primary production and (4) to promote a healthy ecosystem and biodiversity. That is, without major discrepancies, the European Commission has opted for a kind of Green New Deal (J.F. Jimeno and M. Jansen already spoke about this in NeG) that comes to complement the EU emissions rights market.

Since we published the post on the CO2 Dividend Tax, we have often been asked what is better: whether a Green New Deal, which bets on massive subsidies to “green” sectors, or the carbon tax that taxes, at source, the use of fossil fuels. Our first reaction was one of caution. Economic theory tells us that we should tax those activities that generate negative externalities and subsidize those that generate positive externalities. A negative externality is a cost that is not supported by those who generate it. Similarly, a positive externality is a benefit that is not received by those who cause it.  Therefore, it is not taken into account when calculating the profitability of the activity and more (negative externality) or less (positive) than socially desirable will be produced. The tax or subsidy is the political tool for the agent to “internalize” that cost or benefit. The problem is that it is easier to identify and measure negative externalities (emissions, congestion, smoke, noise) than positive ones. Moreover, industrial policy has never been easy because it often comes dangerously close to making competition in markets difficult. However, as Professor P. Aghion and co-authors argue, when there are increasing returns to scale and funding for new businesses is scarce, industrial policy is a way to encourage competition. If we also add the environmental impact, the social benefit of industrial policy (well designed not to limit competition) is multiplied. Let us see, first, how the micro-approach to the bio-economy helps us understand, and eventually measure, the externalities that we ultimately want to eliminate or encourage.

Bioeconomics is Economics

Bioeconomics, donut economy,… the media talk about these concepts as if a new economic paradigm were being born (see here, or here, for example). These names are useful because they highlight the need to think about the sustainability of growth and climate change. It should be stressed, however, that they are not new paradigms but concepts that are well known and solidly analyzed in the Theory of Public Economics: the existence of externalities and their effects on market allocation. But let’s go to our case study.

The resin industry is a good example of bioeconomics and what can result from the Bioeconomy Strategy. We recall a documentary (RTVE) that was broadcast a few years ago about the natural resin industry in Castile and Leon, which has been in decline since synthetic resins were first marketed. Resin extraction is at the origin of the Pine Chemicals industry, as it is called internationally. The traditional way of extracting the resin requires a very unsophisticated tooling: axes to puncture the trees, small vessels that are hung from the trees where the resin is collected (raw resin) and little more. Synthetic resins were developed as the chemical and oil industries grew in the late 19th century (it seems that it was the dramatic increase in demand for soap that led to the invention of synthetic resins). The production of this substitute is intensive in physical capital so it is much cheaper than the natural one. The documentary told how the traditional industry was languishing until relatively recently; workers were leaving the forest with the typical consequences when a way of life ends: the elderly become unemployed, young people migrate, and populations empty out. This is what economic progress is like: some sectors are declining, others are rising and, as if it were a law of nature, we must adapt.

In principle, this example seems identical to many other cases of sectoral change where a new, cheaper technology makes an old technology disappear. However, as in many other cases, technological replacement is advantageous only because cost accounting is not well done. As CSIC scientists explain, the social benefit of forest fire control is not included in the costs of traditional industry, since the resin acts, de facto, as a forest guard. When the field is abandoned, it is a field of flames. How much could we save in Civil Protection and Environmental Protection? We do not know. This industry also generates a significant positive externality: it needs trees, which absorb CO2. According to a study by the University of Seville, a mature pine tree can absorb up to 50 tons of CO2 in one year, the equivalent to the emission of almost 30 cars, of average size and running about 10,000 kilometers a year. Forestry fixation of CO2 is not the solution to climate change, but it helps. In addition, specific human capital is indispensable because the key to the industry’s success is sustainability. Resin exudation is the way pine protects itself from dangerous insects. Over-extraction weakens the pine and accelerates its death. An optimal frequency prolongs its life and increases resin production. The Ministry of Agriculture and Environment strictly regulates the acceptable extraction methods. The aim is to avoid predatory techniques that threaten the forests. Moreover, the European Forest Institute is currently coordinating research initiatives to help modernize the sector and make it competitive (the main competitors are Brazil and China). In short, the resin activity is once again making the news, precisely in what has been called the “Empty Spain” (see here, here, or here). How could the activity be subsidized? A very simple way would be with a negative CO2 tax: that activity that directly eliminates or fixes CO2 receives a subsidy depending on the amount of CO2 fixed. This policy can be directed, to a greater or lesser extent, to the entire agri-food sector.

In addition, of course, the costs of synthetic resin production are not well calculated either. Most of these resins are derived from hydrocarbons. Many of the varieties share the characteristics of plastics. Therefore, there are at least two types of costs that do not appear in the companies’ operating accounts: (1) the emissions derived from the production process and (2) the social costs of recycling the waste. Petrochemical companies are obliged to buy emission rights with which they partly internalize these costs. But the price of the rights is currently far below what is estimated to be necessary to address climate change: about 29 euros per ton, instead of the 40 dollars proposed by the Carbon Tax-Dividend. This is because the EU Emissions Trade System follows a well-designed auctioning system that gets companies to disclose the production costs they have previously internalized. In other words, it does not get companies to internalise their contribution to climate change. That is why the price of the emission right is so cheap and why the EU Emissions Trade System must be reformed by a good carbon tax-dividend. If a carbon tax, of the kind explained in our previous post, were to come into force, it would lead to an increase in the production costs of synthetic resins, prompting a change in the technologies used. If, in addition, companies have market power, they will have the ability to pass on the tax in prices. In other words, the carbon tax may not be an implicit subsidy to natural resin. That will depend on the industry’s ability to grow, which in turn depends on its cost structure.

The Franco-German proposal for a carbon tax

Very recently, the French Council of Economic Analysis and the German Council of Economic Experts have jointly proposed (why only French and German?), a European system of Carbon Tax. We believe that the proposal has several problems in designing incentives to reduce emissions, which we present below.

1. The proposal suggests extending the EU Emissions Trade Scheme to more sectors, but it still does not solve the problem we have already pointed out above: a system of auctioning emission rights does NOT make companies internalize the negative externality, i.e. the emissions. Companies will ALWAYS bid for a LOWER price than the socially efficient one. Furthermore, by taxing the sectors and not directly the input (fossil energy) at source (as the American proposal does) it distorts the cost structure of the companies. The tax at source does not have a collection purpose but a dissuasive one: its objective is that its taxable base disappears over time as companies respond by changing their technologies. The business tax is levied on a much less elastic base and is therefore more distortionary. On the other hand, the tax at source (it is levied on refineries and companies where fossil energy enters the economy) is much more effective in preventing “carbon leakage”, as companies change their location based on the taxes paid (or subsidies received).

2. The French-German proposal implicitly incorporates that the tax will be accompanied by subsidies, which is in part a redundant initiative to the Bioeconomy Strategy, which has a clear focus and a defined program, and which in turn could be expanded.

3. The proposal highlights the expected increased effectiveness of the carbon price in the “poor countries of the EU. The reason: the costs of mitigation (abatement) of CO2 emissions in these countries tend to be lower”. This hypothesis is wrong and does not take into account dynamic and general equilibrium effects. In this regard we would like to draw attention to a recent article published in Energy Economics, in which we analyzed the relationship between energy use and economic growth. The article studies the interaction between the evolution of the real GDP per capita of the different countries, and the changes in their energy intensity and in the participation of clean energies in their primary energy mix. There we show that the substitution of fossil fuels by renewable energies in the primary energy mix does not seem to be associated with higher economic growth at a global level in general. Only when fossil energies are replaced by “frontier” renewable energies (solar, wind, waves, geothermal; as opposed to “conventional”: hydroelectric and biomass) and without increasing energy intensity, we find that the growing use of renewable energies, and therefore reducing CO2 emissions, is associated with higher GDP growth. In other words, our results suggest that the carbon tax may have a “multiplier effect” if demand is oriented towards “frontier” renewable energies, a task that may not be easily achievable for countries facing difficulties in managing their energy mix, which are the poorest countries. In other words, the French-German proposal does NOT favour the poorest countries of the EU, not to mention the complexity of the compensations suggested in this scenario.

4. It is also proposed that the dividend – the transfer that makes the carbon tax neutral – be settled at the national level; that is, that there be no cross-subsidies between European Union states. This causes a great distortion in a large economic space where there is freedom of movement of capital and companies and makes it more difficult to accept politically. Moreover, one can expect major distortions and low dividends in countries that have to face major technological changes, as opposed to small distortions (or even comparative profits) and major dividends to be distributed domestically in those countries that have been mitigating their emissions for years.

5. A uniform sectoral tax, as mentioned in points 1 and 3, is much more difficult to accept politically than the tax at source. Recent events of mobilization of the so-called “yellow vests” could be clouding this strategy of directed-shared climate effort that may result in a south-north transfer.

As opposed to the “north-(south+east) strategy” that the French-German proposal seems to suggest, with the usual and wavering balances of sovereignties, we are betting on the combination of the Bioeconomy Strategy (possibly extended) and a well-designed CO2 Tax-Dividend. The two measures are complementary: the Bioeconomy refers to initiatives aimed at sectoral modernization (primary at this time, but in the spirit of the Green New Deal) while the ideal carbon tax affects fossil energy extractors. One measure is aimed at positive externality and the other at negative externality.