Eco-innovation and climate change: The role of fiscal instruments

Main concepts:

• The challenge: investments in eco-innovation hugely growing in China, India and USA — where is Europe? Lazily comfortable at the idea of its 'apparent' supremacy in eco-innovation and environmental approach?
• The potential of Environmental Tax Reform to stimulate eco-innovation and to strengthen the EU economy through investments in strategic areas like environmental technologies and renewable energy, contributing to an ecological industrial policy.

Ladies and gentlemen,

Let me start by offering some quick facts.

According to the International Energy Agency, worldwide emissions of CO₂ from fuel combustion, which had been growing by 1.7 % a year between 1971 and 1999, grew by 3 % a year between 1999 and 2004. This is faster than the most pessimistic projections of the United Nation's Intergovernmental Panel on Climate Change.

It is also faster than economic growth, meaning that eco-efficiency in energy declined between 1999 and 2004.

Over a quarter of the CO₂ comes from electricity production. Given that global electricity demand is projected to grow 50 % by 2030, and that 50 % of the electricity plants in the world are more than 20 years old, the International Energy Agency estimates that investments of EUR 7 500 billion will be needed to meet current and future demand.

In some countries, clean coal and nuclear are being proposed to fill the energy supply gap of fossil fuel, whilst in others wind, biomass, hydro and solar are being proposed as competitive options.

Some researchers have even gone so far as to calculate that a solar panel plant of 250 km² in the Sahara desert, would be able to provide electricity needs of the whole world.

Climate change provides a great driver to develop a broader and more flexible energy infrastructure, with more efficiencies built in and more incentives to innovate.

So, where are today’s leaders in this emerging, some would say, eco-industrial revolution?

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The Chinese company Suntech, which only started in 2001, is now the world’s third-largest manufacturer of solar cells, after Sharp in Japan and Q-cells in Germany. Suntech is listed on the New York Stock Exchange and is worth around USD 5.5 billion. Germany is the principal source of Suntech’s wealth: in 2004 it was buying 90 % of Suntech’s output.

Meanwhile China is also the biggest consumer of solar systems for water heating, where they supply 80 % of demand. In 2006 the industry had a turnover of more than USD 2.6 billion and provided nearly 600 000 jobs. When China acts, because of its size, it tends to generate momentum.

The wind business is also growing, by more than 30 % a year worldwide. And Asia is responding.

According to Suzlon Energy, India's biggest wind company that has just opened the world’s biggest turbine factory in China, China's turbine market has increased sevenfold in two years and is now the world’s fifth-biggest user of wind turbines. All the big foreign makers — including Spain's Gamesa and Denmark's Vestas — have invested in China. And Indian Suzlon Energy has just bought German cutting-edge wind power technology company Repower.

But the Chinese government is also determined to build a local industry. There are already nine Chinese turbine-makers. And local jobs are preserved by the demand that 70 % of parts should be locally produced. Could, or should, EU Member States retain jobs in this way?

Meanwhile, America is also on the move. A tenth of the USA's venture capital is spent on clean energy. It more than doubled in the past two years to USD 2.9 billion, according to the Cleantech Network, an industry research body. That makes it the third-largest recipient of venture money after biotech and Information and Communication Technology.

USA's investment in clean technology is rapidly leaving Europe behind, being four times greater in 2006, according to Cleantech Network. Europe's venture capital investment in clean technology actually declined between 2005 and 2006.

Unsurprisingly Silicon Valley is the early leader, with over USD 600 million invested in 2006, partly in response to California's tough emissions and energy-efficiency standards. After wondering what would be the next big thing after the dotcom boom, many of America’s financiers and businesses are betting on renewable energy and clean technology.

And radical changes are in the air even in the embattled US car industry: Larry Burns, General Motor's vice-president of R&D and strategic planning is recently quoted as saying 'This industry is 98 % dependent on petroleum. That's not sustainable. It's all about displacing petroleum.'

A great leap forward in Europe?

In some areas of energy efficiency, Europe is way ahead of the US in displacing petroleum. For example, the average new passenger car in Europe uses 40 % less fuel than its counterpart in the US, an efficiency that the US will take a decade to reach under the most ambitious of their current plans.

Higher taxation of fuel has played a key role in stimulating fuel efficiency of vehicles in Europe, and had an important effect on protecting the environment.

Europe is already a major player in clean technology, absorbing 10 % of venture capital, according to the latest EU Environmental Technology Action Plan report. European eco-industries represent 2.1 % of EU GDP and still have a leading presence on the global market, with Germany holding 20 %, followed by Denmark and Spain.

The German government has recently estimated that the value of the global market for clean-tech is around EUR 1 000 billion and will more than double by 2020.

So, clean technology and energy seems to be good business. The NEX (the WilderHill New Energy Global Innovation Index), tracking worldwide clean-energy companies, shows an increase in share prices of 100 % between end 2004 and mid 2007 compared to an increase in the share prices of the Standard & Poor's 500 companies of 20 %.

Around 24 000 jobs were created in the renewable energy sector in Germany alone in 2006, according to Allianz, the German insurance company, bringing the nationwide total to over 200 000. Investments in environmental technology were EUR 60 billion in 2006 and are estimated to be almost seven times greater in 2030, providing the same kind of economic stimulus as the car industry once did.

Denmark's wind company Vestas, which is the world’s biggest turbine producer, has a global market share of 28 % and a capitalisation of about EUR 10 billion, which is now roughly the same as the Ford motor company. Spain's Games and Germany's Enercon each have 17 % of the global market.

The early stimulus of clean-tech and renewable energy that came from EU and Member States' environmental policies, has helped to create European leadership in the market. But perhaps now it is time for Europe to take an even bigger initiative and generate a long-term policy framework.

One example of this is the German Renewable Energy Sources Act with its innovative feed-in system which ensures investment certainty for 20 years, thus creating an encouraging business environment for the renewable energy industry to invest with confidence.

Are we not missing great opportunities for solar in Southern European countries by not providing similar ambitious policy initiatives?

Europe has some institutional support to stimulate eco-innovation, for example the renewed EU Lisbon Agenda, the 2007 Spring Council, the Competitiveness and Innovation framework Programme, the planned European Institute of Technology, ETAP — the EU Environmental Technology Action Plan.

But do we have the right economic incentives to implement this strategic vision?

Incentives for eco-innovation

Businesses need the stimulation that well designed technological forcing regulations, taxes or investment incentives can bring. Our reports on market-based instruments, the recent State of the environment report 2005 and the joint work with OECD on market-based instruments draw attention to the potential of environmental taxes for boosting eco-innovation.

A recent survey by the OECD on patenting renewable energy illustrates this; by showing that public policy (especially tax measures, obligations and tradable certificates) plays a significant role in stimulating innovation in renewable energies. Examples are the introduction of tariffs in Germany, obligations and taxes in Denmark and investment credits in Japan, which stimulated patent activity in these three countries.

But big new markets need bold policy measures to exploit them. Even one tax can make a difference. For example, the Norwegian Statoil company started capturing and storing its carbon dioxide (CCS) under the sea in 1997, stimulated by Norway's tough carbon tax — which now stands at EUR 50 per ton.

Norway is seen as the leader in this technology as a possible option in mitigation packages. However, for CCS to be viable, there needs to be a carbon tax of at least EUR 30 per ton.

In addition to the size of the tax incentive, two design features of taxes are critical: gradual but predictable increases over several years and intelligent use of revenues. For example, the 'soft signalling' of staged increases of some German environmental taxes in the late 1980s brought greater reductions in emissions than originally planned.

A good example of intelligent use of revenues from pollution is given in the EEA report on the implementation of the EU Urban Wastewater Treatment Directive in six contrasting Member States.

The comparison between the policy measures adopted in the Netherlands and Denmark brings out the clearest lessons. The Netherlands achieved a greater pollution reduction per euro spent than Denmark, by devoting some of the revenues from their higher pollution charges to support clean technology measures, while Denmark mainly focused on building wastewater treatment plants.

Much bolder and comprehensive environmental tax reforms with challenging incentives are needed if Europe is to capture and retain significant shares in the global market for renewable energies and clean technology. Long term trends in labour, energy and resource productivity illustrate the scope for using an environmental tax reform to shift the main focus of innovation from labour to nature. Between 1960 and 2000, labour productivity in the EU-15 rose by 270 % whilst materials productivity and energy productivity rose by only 100 % and 20 % respectively. If eco-innovation is to be achieved, nature productivity has to receive top priority.

Furthermore, some tax revenues can be used to provide investment incentives for eco-innovation. In addition, complementary policies to encourage flows of money from pension funds towards investments in eco-innovation, could also help. California is beginning to point the way, with its two biggest public-employees pension funds investing USD 1.5 billion in environmentally friendly sectors in 2007.

Environmental tax reform can also help deal with three big implications of Europe's ageing population: 1) the potential for economic decline; 2) a relatively shrinking working population and hence labour tax base; and 3) the increasing burden on public expenditure of pensions and health care.

Shifting sources of tax revenues from labour to life-long consumption can help stabilise the tax base and locate its burden more equitably across the whole population, but without necessarily raising the total tax burden.

Bold tax reform can meet big barriers: but work by many in the field including the EEA and OECD shows that the usual arguments about equity, competitiveness and declining tax revenues can be overcome by well-designed and integrated measures.

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Ladies and gentlemen,

I started my speech today citing the increasing activity in clean tech and renewable energy, both in Europe and elsewhere. If we are to meet our global responsibilities and retain European leadership on tackling climate change, we have to match our technological ambitions with much bolder and more integrated policy packages, including environmental tax and fiscal reform.

Progress on tax reform is not easy: it depends to a great extent on how society sees the role of taxes. Taking the high moral ground for their intelligent use is crucial to winning a mandate for radical tax reform.

Franklin D. Roosevelt illustrated this when introducing a US income tax for the first time in the 1940s, declaring that: 'Taxes are the price of a civilised society'.

Maybe environmental tax reform is the price of a sustainable society?

Thank you for you attention.