Removing trade barriers on selected renewable energy products: A modelling exercise

9 June 2014

This article provides a view of the environmental and economic impacts of domestic energy and trade policies on sustainable energy diffusion and greenhouse gas emissions reduction.

The urgency of tackling climate change in order to prevent or at least minimize the adverse effects of a rise in average global temperatures beyond the 2 degree Celsius mark is a well-recognised international ambition. Equally, a shift away from fossil-fuel energy sources towards low-carbon renewable energy (RE) sources is also acknowledged as being among the most important ways of reducing carbon emissions. But this is not automatic.

While RE sources such as sunlight and wind are usually plentiful and free, the costs of harnessing them are expensive, and require technology deployment. This involves significant upfront investments. Generation costs of RE are also higher, owing to the intermittent nature of renewables and the lack of cost-effective storage options. And while costs are coming down, domestic policies may either encourage or tilt the playing field against renewables. First, explicit trade barriers and restrictions on RE equipment, such as import tariffs, can unnecessarily raise a given firm’s cost of procuring such equipment. Second, incentives for RE generation in one country can affect deployment and trade opportunities for other countries. Third, removing government support provided to fossil-fuels and electricity can have dramatic impacts. Addressing barriers to trade in RE equipment created by these policies could help facilitate the scale up of RE, making it easier for governments to address not only climate change, but also provide access to sustainable energy for millions of people in the developing world who are presently not connected to the grid.

A number of countries presently apply a range of import tariff barriers to such products. They also impose local-content requirements (LCRs), despite the clear prohibition of such under the WTO Agreement on Trade Related Investment Measures (TRIMS) as reaffirmed by a recent WTO dispute settlement panel in the Canada feed in tariffs (FITs) ruling against local-content measures for solar and wind energy introduced in Ontario, Canada.

Addressing barriers to trade in RE equipment often requires governments to negotiate voluntary or binding agreements with each other. Such sustainable energy trade initiatives (SETIs) can take various forms, including a binding regional trade agreement that involves RE goods and/or services; a voluntary environmental goods liberalisation initiative, such as Asia-Pacific Economic Cooperation Forum (APEC)’s September 2012 Vladivostok Agreement to liberalise applied tariffs on environmental goods based on a list of 54 product categories, including RE goods; or a commitment to liberalise environmental goods trade between a willing group of nations, such as that announced at the World Economic Forum’s annual Davos meet this year.

This article is based on a longer paper conceived by the International Centre for Trade and Sustainable Development (ICTSD), the publisher of BioRes. Using a Global Trade Analysis Project (GTAP) modelling exercise, the research aimed to assess the impact of import tariffs for selected groups of sustainable energy goods together with FIT incentives, LCRs, and fossil-fuel subsidies on a number of economic and environmental variables including, trade, energy and electricity prices, emissions, employment, and income. The model specifically incorporates both electricity and energy sources as inputs and outputs in a computable general equilibrium model. The model did not include energy services associated with RE or take account of dynamic technological changes, but is predicated on existing technology. It is also unable to take into account the dynamic effects of subsidies in fostering technological change. Rather, it provides a comparative static analysis of the differential impacts of energy and trade policy reform on some selected countries.

Individual countries covered by this modelling exercise are China, Japan, Germany, France, Italy, US, Canada, Chinese Taipei, Korea, and India, among which are the top five GHG emitting economies and prominent exporters and importers of climate-friendly goods in 2010, according to a list compiled by ICTSD. In addition, other large exporters, such as South Africa and Brazil, have also been included. With this group, over 90 percent of global trade, GDP, employment and other macroeconomic indicators are covered by the exercise, suggesting that policy prescriptions could be more widely extended. One shortcoming is that the country coverage does not extend to oil-exporting countries, which account for the largest share of fossil-fuel subsidies.

Macroeconomic effects examined include gross domestic product (GDP), welfare, emissions, and electricity prices for the economy as a whole. The RE goods include those relevant to renewable electricity generation. Ethanol, which is relevant for sustainable transport systems, is also included as it is an important traded product, and transport accounts for a high proportion of GHG emissions. The goods included in this modeling exercise have been identified based on previous trade analyses conducted by ICTSD and are detailed in Annex III of the research paper. Broadly, they have been classified into three categories of goods. The first, called RE equipment, consists of products used for generating or using solar energy, hydroelectricity equipment, and ethanol. The second category of products consists of wind turbines. The third category of products consists mostly of parts of a wind energy generation system. The reason for choosing this small list is to ensure that the simulation exercises will be meaningful for negotiations conducted in this area and the products have a direct correspondence with RE generation and usage.

Some limitations of the original paper need to be emphasised. It should also be understood that the GTAP model, like all general equilibrium models, provides a comparative static analysis and is indicative of the general trends. The model cannot take technology choices of electricity producers or changes in technology into consideration. It also does not include energy services, except for electricity, which enters as a good in the GTAP model. The model does however include both production and consumption energy subsidies and is able to detect changes in prices.

Levelling the playing field?

In order to better understand the contribution that trade reforms can make for RE, the research began by setting the context and exploring what would happen in another non-trade related sphere of domestic policy reform, namely the removal of fossil-fuel subsidies. The removal of such subsidies is likely to have wide-ranging effects that could also impact RE equipment. For example, the production of most metals is energy intensive, and wind turbines in turn require a high volume of metal. Subsidy removal will also affect the competitiveness of goods on global markets.

We therefore sought to examine what would happen if import tariffs on RE products were reduced to zero, alongside the removal of fossil-fuel subsidies. Several arguments for removing subsidies on fossil-fuels are presaged on levelling the playing field by increasing fossil-fuel energy prices and making RE more competitive. The research conducted shows that this may not necessarily be the case. The most important reason for this is that 76 percent of the global total fossil-fuel subsidies go to oil and petroleum (generally not used for electricity generation); only six percent goes to coal (used for electricity generation); and a little less for natural gas (sometimes used for electricity generation). Hence, removing fossil-fuel subsidies alone may not level the playing field for RE. The results suggest that removing fossil-fuel subsidies does affect electricity and energy prices, but price rises are much higher in countries where coal is widely used for electricity generation, such as India and South Africa.

The changes with tariff reform alone were much more significant for the RE sector in all countries than the combination of fossil-fuel subsidy elimination and trade reform. However in countries where tariff reduction leads to a significant fall in output such as Brazil and India, removing fossil-fuel subsidies somewhat mitigates these effects.

To the extent that renewables can be substituted for fossil-fuels, the model showed a greater likelihood for the deployment for solar photovoltaic (PV) and hydro-equipment. These results make sense, as hydro represents one of the lowest-cost sources of RE, and solar-PV has reached close to grid parity in a number of locations. Solar PV can also be deployed in an off-grid, de-centralised manner without necessarily investing in grid connections. According to a Navigant research report, distributed solar – the kind put up on rooftops and carports and other small-scale installations, and which Navigant defines as less than one megawatt in capacity – accounted for 69 percent of all solar PV installed in 2012. [Ref 1] 

While the effects of removing fossil-fuel subsidies may be somewhat limited for the RE sector, emissions would be reduced significantly for most countries. Clearly, the largest emission reductions would be for countries that are intensive users of fossil fuel energy. Emission reductions do not only include those generated by lowered electricity usage, but also those achieved through lower usage of oil and petroleum, including for transportation. The countries that provided the largest subsidies, mostly developing countries, stand to see the largest declines in GDP and welfare. In most cases, welfare losses caused by liberalisation cannot be compensated by welfare gains from emission reduction. Should carbon prices rise or reflect all externalities, the calculations of welfare gains and losses would be entirely different.

Trade policy and renewable energy expansion

Although eliminating fossil-fuel subsidies remains an important long-term goal, trade reforms may be more easily achievable. Trade policies, such as tariffs and local-content measures are often part of the overall mix of policies aimed at increased deployment of RE expansion. Trade policies have also sometimes been used to protect domestic renewables industries. While some clean energy and trade policies may have a positive effect on the development of specific forms of RE in the country employing them, others may, depending on their design, have adverse effects on other economies as is shown by the spate of dispute settlement panels related to RE in the WTO.

Using the same GTAP-E model we analysed the macroeconomic effects of reducing import tariffs to five percent, as well as eliminating tariffs, FITs, and LCRs altogether, in selected countries where the liberalisation is undertaken by themselves or by their trading partners. The research found that the distributive effects of removing tariffs, subsidies, or LCRs would differ across the 12 countries studied. Nevertheless, on the whole, removing trade distortions would rebalance the RE industry and move it towards higher levels of deployment. If tariffs and FITs were removed simultaneously the global RE industry would increase by $US2.3 billion. It should be specified, however, that the RE industry examined in this paper is based on a small group of single-use products that constitute a large volume of the total trade between the countries studied here. These products are also relevant to most of the issues that are currently covered by dispute settlement panels. Governments could be also be more favourably inclined towards tariff reduction for “single use” goods that are easier to identify from an environmental end-use perspective.

Of course, innovations in RE should continue until it reaches grid parity. A realistic picture, however, of the overall effect of deployment of RE should be admitted into policy discourse. As far as RE is concerned, trade reforms must be explored as an option to improve their deployment. Most countries see a welfare gain with import tariff reform for RE products as well as an income gain. While the effects will not be spread uniformly across all RE sectors or all countries, there is little to suggest that any particular group of countries would be consistent losers.

Both FITs and LCRs have been used by countries as policies to deploy RE. LCRs, however, were trade distorting and FITs based on their design could have trade impacts. FITs by themselves have minor effects on trade except in the case of solar energy, where removing  FITs was generally positive for the industry. When combined with LCRs, they may have a trade distortive effect. The effects of removing LCRs on the production of RE equipment are at best ambiguous. While most countries see a rise in output and employment, some see small decreases. LCRs are not trade neutral. In fact the trade effects are far more important than output effects. Developing countries such as China, India, and Brazil actually see an increase in their output, employment and trade as LCRs are removed in all these countries. This is especially true for wind turbines and components suggesting that LCRs in these industries are particularly trade distorting. Removal of LCRs in other countries would naturally stimulate increase in exports from competitive countries.

In terms of options, countries could consider retaining FITs while phasing out LCRs, except with respect to solar energy, where there is a good case in a number of locations for phasing out FITs as well. However, given the fiscal deficits in the global economy, the reverse is likely to be the case. This would imply that RE objectives would be pursued in an inefficient and trade distortive manner. Phasing out LCRs would shift production to countries that are more competitive in the production of RE products. FITs are in a grey area, as the way they are implemented will determine their trade neutrality. They are also expensive to implement. LCRs, on the one hand, may help create jobs in the RE sector, but they may take jobs elsewhere in the economy, for instance in downstream industries. Other similarly trade restrictive policies, such as anti-dumping duties, have been shown to have this effect. For instance, according to a study carried out by the German consultancy Prognos and flagged by the Alliance for Affordable Solar Energy, a coalition of mainly European companies, a 60 percent duty on Chinese solar panels could cost 240,000 European jobs over 3 years. Therefore, RE measures with potential trade impacts need to be implemented carefully, keeping long-term environmental, economic, and trade goals in mind.

Low hanging fruit

There is no clear case to change WTO rules on LCRs and FITs. However, the industry is still evolving; the players are changing and the role of supportive policies in the global economy is far from clear. The process of fossil-fuel subsidy reform may require carefully designed and targeted policies that take the needs of the local population into account over the longer term. When energy prices rise, policymakers in every country, but particularly in many developing countries, will need to maintain a good balance between spurring economic growth through improved energy efficiency and safeguarding the supply of energy services to vulnerable sectors of society. One way to provide energy and related services more efficiently is by ensuring the financing of upfront investments in more efficient appliances and that the wider population is aware of the economic return of those appliances in the long run.

Trade policy reforms are easily available and accessible to policymakers and can be implemented fairly rapidly, so they should be pursued as a low hanging fruit. In addition, trade liberalisation is of systemic importance as it can have positive spill-over effects on investment, innovation, and increased opportunities for cooperation and coordination of policies.

This article is based on a longer research paper published by ICTSD: Removing Trade Barriers on Selected Renewable Energy Products in the Context of Energy Sector Reforms, ICTSD, December 2013

[Ref 1] Navigant Research (2013), Distributed Solar Energy Generation: Market Drivers and Barriers, Technology Trends and Global Market Forecasts accessible at http://bit.ly/1ksOovY. Also see http://bit.ly/1kuOiJ4

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