Efficient Management of Insecure Fossil Fuel Imports through Taxing Domestic Green Energy?

• Published date: 01 October 2015
• Author: RÜDIGER PETHIG,THOMAS EICHNER
• Date: 01 October 2015
• DOI: http://doi.org/10.1111/jpet.12096

EFFICIENT MANAGEMENT OF INSECURE FOSSIL FUEL

IMPORTS THROUGH TAXING DOMESTIC GREEN ENERGY?

THOMAS EICHNER

University of Hagen

R¨

UDIGER PETHIG

University of Siegen

Abstract

A small open economy produces a consumer good as well as

renewable (green) and fossil fuel based (brown) energy. It

imports fossil fuel at an uncertain price and suffers from

carbon emission damages. Unregulated competitive mar-

kets are shown to be inefficient. The implied market failures

are due to the agents’ attitudes toward risk, to risk shifting,

and the uniform price for both types of energy. Under the

plausible assumptions that consumers are prudent and at

least as risk-averse as the producers of brown energy, the

risk can be efficiently managed by placing a tariff on fuel

imports (which is equivalent to taxing carbon emissions in

the model at hand) and taxing green energy. The need to

tax green energy contradicts the widespread view that sub-

sidization of green energy is an appropriate means to en-

hance energy security in countries depending on risky fossil

fuel imports.

1. Introduction

Many countries have adopted policies to discourage carbon emissions

and promote renewable (=green) energy. The pertaining prototype in-

struments, which we will consider here, are carbon emission taxes and

Thomas Eichner, Department of Economics, University of Hagen, Universit¨

atsstr. 41,

58097 Hagen, Germany (thomas.eichner@fernuni-hagen.de). R¨

udiger Pethig, Depart-

ment of Economics, University of Siegen, H¨

olderlinstr. 3, 57068 Siegen, Germany

(pethig@vwl.wiwi.uni-siegen.de).

Received March 18, 2013; Accepted March 19, 2013.

C2013 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 17 (5), 2015, pp. 724–751.

724

Fossil Fuel Imports 725

green energy subsidies.1Basic economic arguments and a large literature,

theoretical as well as applied, suggest that both instruments have an impact

on carbon emissions and green energy production. The emission-reducing

effect of the carbon tax is direct while that of the green subsidy is indirect

and the opposite holds for the green-energy promotion effect.2Answering

the question as to what the economic rationale is of applying such a mix of

instruments appears to be straightforward at first glance. Both instruments

serve to fight climate change via reducing the (not yet internalized) global

carbon emission externality. However, while under idealized conditions the

emission tax does so in a cost-effective way, there is ample evidence and

theoretical support for the proposition that subsidizing green energy is less

cost-effective as a means of reducing carbon emissions than emission taxes

(e.g., Fischer and Newell 2008).3Hence on economic grounds green energy

subsidies are inappropriate as a means for fighting climate change.4

To establish an economic rationale for subsidizing green energy on a rig-

orous welfare economic basis, one would need to identify some market dis-

tortions or imperfections other than the carbon externality and then show

that the green subsidy is capable of restoring efficiency. The theoretical eco-

nomic literature on green energy support focuses on distortions such as im-

perfect property rights or information (e.g., Bennear and Stavins 2007) and,

in particular, on learning-by-doing and technological spillovers (e.g., Fischer

2008, Fischer and Newell 2008, Reichenbach and Requate 2012). Specifi-

cally, Reichenbach and Requate (2012) analyze learning by doing in the de-

velopment of green energy technologies, which generates positive external-

ities on other green energy producers. In a two-period model, they show

that efficiency is restored by internalizing the spillover externality through a

green energy subsidy in the first period. Some studies, e.g., Isoard and Soria

(2001), found learning spillovers to be significant but overall there appears

to be little agreement on whether such market imperfections are empirically

relevant enough to make the case for green energy subsidies.

1Our focus on these two fiscal instruments serves to ease the exposition without compro-

mising the generality of results at the level of abstraction of our analysis below.

2The emission-reducing effect of the green subsidy is indirect because that subsidy en-

hances the competitiveness of green over fossil fuel–based energy, which tends to expand

the production of green energy and tends to shrink the production of fossil fuel–based en-

ergy. Analogously,the green energy-promoting effect of the carbon tax is indirect because

that tax reduces the competitiveness of fossil fuel–based energy over green energy.

3In the absence of uncertainty, our model (below) implies that the carbon tax is more

[less] effective than the green energy subsidy in reducing emissions [promoting green

energy]. See also Pethig and Wittlich (2009) and the discussion in the context of Figure 1

(Section 5).

4In its report to the German Federal Ministry of Economic Affairs, the scientific council to

that ministry recommended discontinuing the promotion of green energy on the grounds

that the introduction of the European emission trading scheme has turned the promotion

of green energy into an ecologically useless and economically expensive instrument.