A review of cost estimates and methodologies for the post-planned economies

William U. Chandler, Battelle, Pacific Northwest Laboratory, Washington, D.C. USA

Alexander Kolesov, Center for Arms Control, Energy and Environmental Studies, Moscow, Russia

...we have come to rely upon a comfortable time lag of fifty years or a century intervening between the perception that something ought to be done and a serious attempt to do it.

H.G. Wells, The Work, Wealth, and Happiness of Mankind, 1932

1 Introduction

This paper summarizes selected studies of the potential and cost of carbon emissions mitigation strategies in the post-planned economies. (See Appendix i). The economies of the Former Soviet Union and Central and Eastern Europe present significant opportunities and serious difficulties in energy-related carbon dioxide emissions mitigation. This region in 1990 accounted for over one-fifth of global energy consumption and energy-related greenhouse gas emissions.1 (See Figure 1.) The former planned economies rank among the most difficult to model because planning severely distorted their economies. Despite efforts at reform, the countries in transition remain the least energy-efficient in the world. Consequently, they may offer inexpensive opportunities for reducing future emissions. The long tradition of allocating resources away from consumer goods, however, also means that potential growth in transportation and household energy use--and greenhouse gas emissions--remains very high.2

Figure 1.Energy consumption: Profile by Region (percent share).

Much of the economic research on the cost of cutting greenhouse gas emissions has been based in western macroeconomics and has tended to treat planned economies as if their economic behavior approximated that of market economies.3 That approach has led some analysts to conclude that future energy use and greenhouse gas emissions in the planned economies will rise on steep growth curves. Recent studies of the distortions in the planned economies, however, have challenged that view, especially since the revolutions of 1989.

Remarkable political and economic changes, of course, have shaken the planned economies over the past five years. The term economies in transition has come to mark the former Soviet Union and Eastern and Central Europe, implying that market reforms are underway. The extent of the transition varies dramatically by country, however, and is far from complete. While Poland and China produce half or even more of their national economic product in the private sector--loosely defined--Russia produces less than 10 percent privately. The most significant fact in the Former Soviet Union and in Eastern Europe is a depression at least equal to the decline in purchasing power of America's Great Depression of the thirties. The depth and length of Russia's and Eastern Europe's depression will affect greenhouse gas emissions for years to come and will inject profound uncertainty in any projection of future emissions levels.

2 Summary of studies of transition economies

A comparison of emissions reduction cost studies reveals striking differences. (See Table 1.) Manne and Richels4 and Manne5 treated the former Soviet Union as a separate region in their Global 2100 model and estimated the costs of reducing energy-related carbon emissions. Global 2100, a top-down model that has been extensively described elsewhere, was used to produce a set of regional results for a base case and for significant emissions reductions relative to the base line. The results suggested that the cost of emissions reduction would total 3 percent of regional Gross National Product (GNP) in the first half of the next century.

Other top-down assessments of emissions reductions costs in the region have been made by Burniaux et al. and by Martins et al. using the Green model. The Green model is also global in scope and addresses the Former Soviet Union and Central and Eastern Europe as one of 12 regions. For year 2050 emissions reductions (relative to a base case) of 70 percent, the Burniaux effort suggests a GNP loss of 2.3 percent. Martins suggests that a similar reduction in 2020 (compared to a baseline) would cost 3.7 percent of regional economic output. A global trade model utilized by Rutherford much higher costs--almost 6 percent of GNP for the year 2050.

Table 1.Cost of carbon dioxide emissions reduction.


Country            Study                 Forecast      CO2        Cost of   
                                           year     reduction    reduction  
                                                       from     (% of GNP)  
                                                     baseline               
                                                       (%)                  

Former Soviet      Burniaux (1992)        Bur-2020      45          0.9     
Union              Burniaux (1992)        Bur-2050      70          2.3     
                   Burniaux (1992)        Bur-2100      88          3.7     

                   Kononov (1993)         Kon-2005      50          0.3     

                   Makarov et al 1991     Mak-2005      23          0.5     
                   Makarov et al 1991     Mak-2020      44           1      

                   Manne (1992)           Man-2020      45          3.1     
                   Manne (1992)           Man-2050      70          6.4     
                   Manne (1992)           Man-2100      88          5.6     

                   O. Martins et al (1992) OM-2020      45          1.7     
                   O. Martins et al (1992) OM-2020      70          3.7     



                   Rutherford (1992)      Rut-2020      45          1.5     
                   Rutherford (1992)      Rut-2050      70          5.8     
                   Rutherford (1992)      Rut-2100      88          4.1     

Hungary            Jaszay (1990)          Jas-2005      17         -0.1     

Poland             Leach & Nowak (1991)          L&N-2005      37         -0.1     
                        Leach & NowakL&N-2005      53         -0.1     
                                            
                                                   

                        Sitnicki et al (1991)        Sit-2005      44           0      
                        Sitnicki et al (1991)        Sit-2030      62          0.3     

                        Radwanski et al (1993)       Rad-2010      27           0      
                         Radwanski et al (1993)      Rad-2030      39           0      
                   
                                                                   

Czechoslovakia     Kostalova et al        Kos-2005      27           0      
(1991)                 Kos-2030      39           0      
Kostalova et al                                          
(1991)                                                   



NOTE: Bold face denotes a bottom-up study.

Makarov et al. used a dynamic optimization model developed specifically for the Former Soviet Union to the year 2025. Their work suggested that a 44 percent emissions reduction (compared to a baseline) would cost less than 1 percent of GNP.6

Several bottom-up studies have been completed by Eastern European and Russian experts since the revolutions of 1989. Some of this work was conducted using the EPA End-Use Energy Model, while others used indigenous models. The model projected future energy demand to the year 2030 in five year increments, giving results for the major fuel types and future aggregate industrial energy intensity. The model estimates energy demand on the basis of economic growth, structural change, price response, and technical energy-efficiency improvements not attributed to price response. Like Makarov et al., and unlike the top-down studies mentioned above, most of the bottom-up studies incorporated economic restructuring.

Assumptions (or results) for GNP growth and energy prices were not always available. However, when provided, these assumptions or results were similar among the studies. (See Appendix ii.)

A relationship can be seen between the magnitude of the emissions reductions and costs in the above scenarios, but this factor cannot explain the significant variation in cost estimates across the scenarios. And while the discount rate assumed in each study for discounting financial costs varied among the studies, there seems to be little correlation with cost estimates. Indeed, the one major difference in cost estimates in the studies reviewed appears to be that of methodology, specifically the choice of top-down versus bottom-up models. (See Figures 2 and 3 and Table 1.) This result is not surprising given the special nature of planned and post-planned economies.

Figure 2.Cost studies: Emissions reduction in the former Soviet Union.

Figure 3.Cost studies: Emissions reduction in Central Europe.

3 Evaluation of cost estimates

The debate regarding the value of top-down versus bottom-up modelling is perhaps most clearly focussed in application to the transition economies. The key issue is the explicit assumption in top-down models that energy supply and demand are in competitive equilibrium in the planned economies. Equilibrium models assume that planned economies mimic the behavior of market economies, and therefore are optimized. This assumption is not consistent with western economic theory, and is impossible to accept empirically, particularly with regard to energy use.

The most energy-intensive economies in the world--no matter how economic output is measured--are the planned or post-planned economies.7 Non-market economies lack both meaningful energy prices and hard-budget constraints. No existing top-down model is capable of incorporating the disequilibrium in non-market economies or the reduction in cost due to emissions trading with them. Results based on that assumption simply are not credible.8

A short digression on the meaning and importance of energy intensity in the formerly-planned economies may be in order. Energy intensity (energy consumed per unit of economic output) is an important, if controversial, indicator of future emissions. This value is difficult to measure accurately because GNP is difficult to quantify in comparable units such as a common currency. Also, differences in economic structures--the share of output produced by manufacturing, for example--may derive from the logical economics of comparative advantage. For example, if Poland produces more steel because it has abundant and cheap coal (now a questionable assumption), the Polish economy will be more energy intensive than, say, Japan, which must import coal or oil for steel processing.

If energy intensity is interpreted simply as a surrogate for energy efficiency, then the measure can be misleading. However, a vast literature has verified that the planned economies use energy inefficiently both because they use technology that is not optimized and because the structures of their economies--that is, the remarkably heavy reliance on heavy industry--is not economically rational.9 Yet, most models of future energy use in this region imply a) continued high energy intensity, and b) high economic growth. The results are sometimes startling when one realizes that they indicate that the formerly planned economies would be twice as energy intensive in the year 2050 as Japan is today. One should ask why--or how--growing market economies would maintain energy utilization rates peculiar to centrally planned economies. One should also ask whether fast growth is even possible without the restructuring and efficiency improvements necessary to enable formerly planned economies to compete internationally.

4 Towards integration: a combined model for Poland

Most analysts would agree that the ideal solution to the top-down versus bottom-up debate would be the integration of the two approaches. A few laboratories are attempting to produce the methodology to make this possible, and perhaps the leading example in the formerly planned economies is work underway at the Polish Foundation for Energy Efficiency (FEWE). This section describes the Polish work and suggests that it might serve as a model for equilibrium cost analysis that incorporates end-use detail.

Poland, an industrial nation of almost 40 million people, provides a good case study for assessing technological options in economies in transition. That nation now produces more than half its national economic product in the private sector, uses coal to satisfy three-fourths of its energy needs, and still suffers from the high energy-intensity levels inherited from its communist past. It is very likely that the policy and technical options for reducing greenhouse gas emissions are similar to those elsewhere in Eastern Europe.10

The Polish Foundation for Energy Efficiency has developed a new model for a country study effort being funded by the U.S. government to support developing and transition economies' assessments of climate response strategies. The purpose of the effort was to assess current greenhouse gas emissions, project emissions reduction options and changes in sinks, estimate the cost of options for reducing emissions, and indicate strategies and criteria for reducing emissions.

Methodology

Almost as interesting as the results of this case study prototype was the methodology employed. If one accepts that planned economies cannot be modelled like market economies, then one is forced to devise an altogether new way of modelling a transition economy. If the Polish economy is in serious disequilibrium, then some way must be found of ascertaining future economic activity that approximates equilibrium, assuming the economy makes a successful transition to market mechanisms. It is important to note that disequilibrium is used in the more fundamental sense than simply that supply does not equal demand, but that the economy does not approach any Pareto optimum for economic welfare.

FEWE created a compound model to remedy these methodological problems. Demographic and economic variables drive the model results, but are modified by sub-models which incorporate sectoral detail about, for example, heavy industry and energy production. The latter involved a major sector-by-sector assessment of the future of heavy industry and energy producers given the need to rationalize state-owned operations. That is, expert groups were formed to determine possible answers to questions such as: How much of the steel industry will be competitive on the international market (assuming the market is open to Poland)? How much of the coal industry can produce coal at a cost less than the world price? How much chemical demand can the national and international market support, and can Poland's producers compete? These estimates were used to constrain the macroeconomic variables.

Two major problems arise with this approach. The first is the danger that the modelling effort becomes a "black box," with hidden assumptions that are not reproducible. The only solution to this problem is to detail the assumptions. The second problem is more difficult. Incorporating exogenous constraints on energy demand will affect energy prices. For example, fuel economy standards in the United States reduced gasoline demand and helped drive down gasoline prices. Reduced prices due to higher technical efficiency leads to the "take back" effect--higher demand due to lower prices. People may commute longer distances and drive long distances on vacations. Research generally suggests that on a global scale, regulation-induced demand reduction can significantly reduce energy prices and therefore offset the demand reduction achieved by, for example, fuel economy standards. Rationalization of an economy--elimination of wasteful demand caused by central planning--can have the same effect. No model yet exists to solve this problem.

The FEWE model consists of four major components:

A national macroeconomic simulation model.

An Energy Demand Model that is driven by the macroeconomic model and serves to establish a demand balance.

An Energy Supply Model which receives energy demand from the energy demand module component and chooses supply options on the basis of exogenous costs. This model produces output for energy supply and demand and greenhouse gas emissions.

A Technological Options Model, which calculates the levelized cost of a number of practical emissions reduction measures, and estimates their potential and cost for reducing emissions, given the supply and demand schedules received from the three previous components of the model. These options are assumed to be measures that will not be captured by market mechanisms or price effects consistent with the demand and supply levels estimated in a base case. Several base cases are estimated, however, based on varying rates of structural change, productivity improvements, and investment.

The model is thus driven primarily by labor force participation and investments, and, using exogenously specified parameters, estimates value added, labor productivity, and personal consumption. The values of these parameters are adjusted over a ten-year period to reflect an assumption that a transition to a market economy will require that amount of time. At the end of the period, the modelers assume that macroeconomic relations in Poland compare with current levels in Western Europe. Energy prices are determined exogenously and are taken from projections of world levels.

Within the bounds of accuracy defined by these constraints, the Polish case study evaluated the benefits (emissions reductions) and costs (net) of selection of 25 energy carriers in 25 branches of the economy. In the latter, both changes in activity levels and energy-efficiency levels were estimated and incorporated.

The most difficult work included estimating costs per gigajoule (GJ) of demand reduction--and carbon dioxide reduction--for each of the technical options. (See Figure 4.) Options able to reduce emissions by up to 100 million tons per year in the year 2010 are available at a cost ranging from little or no cost to over $200 per ton of carbon reduced. Most options, however, cost less than $25 per ton.

Figure 4.Efficiency potential in Poland (total consumption = 4,125 PJ/year).

5 Implementation and assistance

Mitigating greenhouse gas emissions through energy efficiency will require realistic energy pricing, hard budget constraints, financing, and technical expertise. These prerequisites have been adequately met in none of the post-planned economies.

Significant progress has been made in rationalizing energy prices in Poland, the Czech Republic, Hungary, and parts of the Former Soviet Union, where prices have nearly reached replacement levels. (See Figure 5.) The record elsewhere in the region is less impressive.

Figure 5.Fuel and heat price trends: Poland, 1989-94.

Financing for energy efficiency remains very difficult to obtain in virtually every post-planned economy, regardless of the level of effort in price and structural reform. Even in Poland, commercial banks prefer to finance the emerging stock market, trade, and the national debt.11 The multilateral development banks have not made significant financing available for demand-side management, which is where the largest and most cost-effective energy-efficiency options are found.12 Indeed, a review of World Bank lending in the Former Soviet Union and in Eastern Europe suggests that demand-side efficiency investments have been given low priority. Most loans have been made to enhance energy supply. Though some of these projects have been intended to improve the efficiency of energy supply systems, most of them have little effect on efficiency and may even subsidize the price of energy because they provide lower-cost capital than would be available to the energy sector without the sovereign guarantees available to and required by the World Bank for its loans.13 (See Figure 6.)

Figure 6.World Bank lending in Central Europe.

The availability of energy-efficiency technologies and services varies widely, often as a function of financing. For example, when the Polish government provided tax incentives for energy-efficient windows, a wide variety of state-of-the-art windows, manufactured and serviced locally, became available. At the same time, locally manufactured efficient motors, heating controls, and lighting were being exported but not sold locally. Myriad assistance programs have been targeted to help deliver efficiency, but by most estimates, they are not working well.14 Implementation of efficiency in the post-planned economies will thus succeed or fail on the strength of the performance of the private sector and nascent national energy-efficiency promotion programs.

A relatively new effort in joint implementation projects has been launched in the region. Under joint implementation, companies from foreign countries could share emissions reduction credits with local firms under a future greenhouse gas emissions convention. While this approach has significant potential for helping capture emissions reduction potential in the region, it is a relatively new idea and can for the present only be used in a demonstration mode.15

6 Conclusion

This paper has reviewed a selected set of studies of the greenhouse gas emissions reduction potential and associated costs for the post-planned economies. Marked differences are noted in the results for top-down bottom-up models. However, it is suggested that conventional top-down modelling is inappropriate for the formerly planned economies because most such models implicitly assume that the economies they model mimic market economies and are thus in competitive equilibrium. This assumption obviously does not fit the situation of the economies in transition.

Appendix i

Selected cost assessments and reviews:

Central Europe and the former Soviet Union

Baron, R., 1992. "Dynamic Cost Estimates of Carbon Dioxide Emissions Reduction in Eastern Europe and the Former Soviet Union: An Evaluation," Pacific Northwest Laboratory, Advanced International Studies Unit, Global Studies Program, Richland, Washington.

Bashmakov, I., and V. Chupiatov. 1991. " Energy Conservation: The Main Factor for Reducing Greenhouse Gas Emission in the Former Soviet Union." Pacific Northwest Laboratory, Advanced International Studies Unit, Global Studies Program, Richland, Washington.

Bashmakov, I. "World Energy Development and CO2 Emission." Perspectives in Energy, 1992, Volume 2, pp. 1-12.

Bashmakov, I. "Russia: Energy Related Greenhouse Gas Emissions, Present and Future." International Workshop on Integrated Assessment of Mitigation, Impacts and Adaptation to Climate Change, IIASA, October 1993.

Burniaux, J.-M., G. Nicoletty, J. Martins. 1992. "GREEN: A Global Model for Quantifying the Costs of Policies to Curb CO2 Emissions." OECD Economic Studies, 19--Winter.

Chandler, W., and S. Kolar. 1990. "Carbon Emissions Futures for Eight Industrialized Countries." The Fridtjof Nansen Institute.

Chandler, W., and S. Kolar. 1991. "Energy and Energy Conservation in Eastern Europe: Two Scenarios for the Future." Battelle, Pacific Northwest Laboratories. Prepared for U.S. Agency for International Development Global Energy Efficiency Initiative.

Grubb, M., J. Edmonds, P. ten Brink and M. Morrison. 1993. "The Costs of Limiting Fossil-Fuel CO2 Emissions: A Survey and Analysis." Annual Reviews of Energy, 18:397-478.

Kononov, Yu. 1991. "The Cost of Reducing Soviet CO2 Emission." Siberian Energy Institute, Irkutsk, Russia.

Kononov, Yu. "Impact of the Economic Reforms in Russia on Greenhouse Gases Emissions, Mitigation and Adaptation." International Workshop on Integrated Assessment of Mitigation, Impacts and Adaptation to Climate Change, IIASA, October 1993.

Kostalova, M., J. Suk, and S. Kolar. 1991. "Reducing Greenhouse Gas Emissions in Czechoslovakia." Pacific Northwest Laboratory, Advanced International Studies Unit, Global Studies Program, Richland, Washington.

Leach, G. and Z. Nowak. 1991. "Cutting Carbon Dioxide Emissions from Poland and the UK." Energy Policy, 19(10).

Makarov, A., and I. Bashmakov. 1990. "The Soviet Union: A Strategy Development with Minimum Emission of Greenhouse Gases." Energy Policy, December 1991.

Manne, A. 1992. "Global 2100: Alternative Scenarios for Reducing Emissions." OECD Working Paper 111.

Martins, Olivera, J.-M. Burniaux, J. Martin, G. Nicoletti. 1992. " The Cost of Reducing CO2 Emissions: A Comparison of Carbon Tax Curves with Green." OECD Economic Working Paper No. 118.

Rutherford, T. 1992. "The Welfare Effects of Fossil Carbon Reductions: Results from a Recursively Dynamic Trade Model." Working Papers, No. 112. OECD/GD(92)89: Paris.

Sinyak, Yu., K. Nagano. "Global Energy Strategies to Control Future Carbon Dioxide Emissions," Status Report, IIASA, Laxenburg, Austria, 1992

Sitnicki, S., K. Budzinski, J. Juda, J. Michna, and A. Spilewicz. 1990. "Poland: Opportunities for Carbon Emissions Control." Energy Policy, December 1991.

Tonkal V., N. Gnedoy, M. Kulik, M. Mints, M. Raptsoun. "Case Study an the Potential of Energy Conservation in Ukraine," Battelle, PNL, Richland, Washington, 1992.

Notes and references

1. Carbon Dioxide Information Center, Oak Ridge National Laboratory.

2. See William U. Chandler, Carbon Emissions Control Strategies: Case Studies in International Cooperation (Washington: Conservation Foundation: 1990).

3. Manne, A.S., and R.G. Richels, Buying Greenhouse Insurance: The Economic Costs of CO2 Emission Limits (Cambridge: MIT Press, 1992).

4. Manne, A.S., and R.G. Richels, Buying Greenhouse Insurance: The Economic Costs of CO2 Emission Limits (Cambridge: MIT Press, 1992).

5. Manne, A.S., Global 2100: Alternative Scenarios for Reducing Emissions (Paris: OECD Working Paper 111).

6. Makarov, A., and I. Bashmakov. 1990. "The Soviet Union: A Strategy Development with Minimum Emission of Greenhouse Gases". Energy Policy, December 1991.

7. William U. Chandler, Alexei Makarov, and Zhou Dadi, "Energy for the Soviet Union, Eastern Europe, and China," Scientific American, September 1990.

8. See, for example, William U. Chandler, "Carbon Emissions Control Strategies: The Case of China," Climatic Change, No. 4, 1989.

9. See Janos Kornai, The Economics of Shortage; William Chandler, Alexei Makarov, and Zhou Dadi, "Energy for the Soviet Union, Eastern Europe, and China, Scientific American, September 1990.

10. Edward Radwanski, Andrzej Gromadzi_ski, Ewaryst Hille, Pawe_ Skowro_ski, and Stanis_aw Szukalski, Case Study of Greenhouse Gas Emission in Poland: Final Report (Polish Foundation for Energy Efficiency), prepared for the Pacific Northwest Laboratory under Contract 144889-A-Q2, March 1993.

11. William U. Chandler, Confidential Report to the International Finance Corporation on Energy-Efficiency Investment Opportunities and Constraints in Poland, DRAFT, February 1994.

12. Janusz Michalik, S_awomir Pasierb, Jerzy Piszczek, Micha_ Pyka, and Jan Surówka, "Evaluation of the Feasibility and Profitability of Implementing New Energy Conservation Technologies in Poland," Polish Foundation for Energy Efficiency, October 1992.

13. Office of Technology Assessment, 1993; Office of Technology Assessment, 1994; Truman Semans, Memorandum on the European Bank for Reconstruction and Development, Johns Hopkins University masters degree course requirement, June 1994; Radwanski et al.

14. Office of Technology Assessment, 1994.

15. Meredydd Evans, "The Status of Joint Implementation Programs in the Countries of Central and Eastern Europe and the Former Soviet Union," DRAFT, Battelle, Pacific Northwest Laboratories, June 1994.


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