STERN & BERGLOF: A heavy price
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Emerging Markets

STERN & BERGLOF: A heavy price

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Emerging Europe risks being left behind unless it embraces the transition to a low-carbon world, write climate economist Lord Nicholas Stern and EBRD chief economist Erik Berglof

The regions from central Europe to central Asia have long had the lowest levels of public awareness of climate change in the world. This was undoubtedly a legacy of central planning, which offered cheap energy but featured chronic environmental neglect.

Yet despite the limited attention once paid to climate change, no region has reduced its output of greenhouse gases more radically over the last two decades than the countries in transition. Since 1990 regional greenhouse gas emissions from fuel combustion have fallen by 28%.

A new report on ‘The Low-Carbon Transition’ published jointly by The European Bank for Reconstruction and Development and the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science points out that to reap the benefits of tackling climate change, transition countries will have to reduce emissions even further over the coming decades.

Global emission reductions on the scale required will be impossible unless all major regions are involved. However, the interest of transition countries in fighting climate change goes beyond international solidarity; EBRD countries have much at stake themselves.

The world is embarking on a new energy-industrial revolution that will see wholesale changes in economic activity, from what we consume to the ways in which we produce our goods. Established and emerging markets alike see new business opportunities in clean energy, low-carbon transport and carbon-efficient manufacturing.

It is in the long-term self-interest of the EBRD countries to be part of this revolution, adapt their economies and avoid being left behind. The risk is not just falling behind technologically, but also in a decade or so of being shut out of markets if products are seen as “dirty” by countries and regions taking strong action.

The report shows that with thoughtful policies it is possible to make emission reductions financially attractive and turn low-carbon technology into an opportunity for domestic and international investment. Implementing what is required includes broader economic reforms such as cost-reflective energy pricing, a better business environment and reduced transaction costs for investments in energy efficiency.

The most basic climate change policy is putting a price on carbon. Emissions trading and carbon pricing are powerful measures, not just to encourage emission reductions but to turn emission reduction into an engine for clean energy innovation. Businesses in the new European Union (EU) member states are already becoming accustomed to carbon pricing as members of the EU Emissions Trading Scheme (ETS).

In the absence of well-functioning global carbon markets at the present time, an international carbon financing architecture is needed to encourage countries to start undertaking the necessary investments. The international financial institutions like the EBRD will play an important role in implementing these schemes and ensuring that the money is well spent.

But the political feasibility of climate investment-related grants from high to middle-income countries is limited and, as large as these grant funds may seem today, they are just a drop in the ocean if the EBRD region is to achieve mitigation objectives consistent with limiting global temperature increases to no more than 2°C. Without functioning carbon markets or other mechanisms to generate predictable global prices for carbon emissions and dramatically improved policies the region will inevitably fall short.

While these carbon markets and associated policies may be weak today, it would be unwise and risky to make investments with 10- or 20-year horizons on the assumption that policy structures will stay like this. Indeed, it is more likely than not that over the next decade carbon markets and regulations will strengthen and tighten across the world, and dirty producers may find themselves shut out of markets. Both economically and environmentally, high-carbon is a risky route to follow.

Good policy to make markets work well must, however, go way beyond carbon pricing. There are fundamental market failures, which good policy can correct, including on research and development, networks and infrastructure, capital markets and risk, property markets and information.

Political economy challenges can make some of the necessary reforms difficult to achieve. In particular, there are strong vested interests among incumbent industries. The short-term social costs of reform and economic adjustment costs due to higher energy prices can also be significant in the absence of well-functioning social support. It is important to recognize these problems, as they will require strong political leadership to overcome.

The public debate about climate change in the transition region is still at a relatively early stage. There are many misconceptions and the low-carbon agenda brings back memories of the painful early years of economic transition. Other countries, both established and emerging economies, are rapidly positioning themselves in the coming low-carbon world. But the report emphasizes that the EBRD region has the great advantage of understanding, through direct experience, the challenge and opportunity of a transition and the deep social and economic change it brings.



Erik Berglof is Chief Economist of the European Bank for Reconstruction and Development. Nicholas Stern (pictured) is Chair of the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science.

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