Nordic Economic Policy Review 2023

John Hassler

Climate policy contains a wide array of measures. These can be classified into three different groups, each containing a specific aim:

A successful climate policy must consist of measures from all the above areas. Measures directly aimed at reducing CO₂ emissions (group 1) can likely not be replaced by subsidies to green technologies (group 2). While such subsidies do increase the use of green and climate-friendly products, it is far from clear that older ‘dirty’ products will be out-competed by these policies, at least not at a sufficiently fast pace (IMF, 2020 and Hassler et al., 2020) At the same time, policies aiming to create a smooth transition (group 2) are necessary for maintaining political legitimacy for regulation that increase the cost of emissions. Finally, future emissions reductions in the Nordic countries, and the EU as a whole, will be pointless if other countries cannot be successfully persuaded to introduce ambitious climate policies.

For some time, the Nordic countries have aimed at being forerunners in adopting ambitious climate policies. This has resulted in the introduction of CO₂ taxes and ambitious (at least in a relative sense) national targets for CO₂ emissions, i.e., policy measures pertaining to group 1. When the Fit for 55 package comes into effect, EU legislation will have substantially narrowed the gap between policies in the Nordic Region and in the EU in relation to measures for phasing out CO₂ emissions. However, some important differences remain. According to Fit for 55, in 2030, Sweden will receive ESR quota units corresponding to 50% of its emissions in 2005. In each year leading up to 2030, a linearly falling number of units are received. The Swedish national emissions target for the ESR sector in 2030 is more rigorous, requiring an emission reduction of 61% by 2030.

Swedish law states the required emission reduction relative to 1990 at 63%. This translates to a reduction of 61% relative to 2005. To facilitate comparisons, I will express all emission reductions relative to 2005.

Under EU regulations, Sweden is allowed to purchase ESR quota units from other member states to satisfy the required reductions if domestic emissions are larger than the quota units received. The reason for allowing such trade is the same as for EU ETS allowances trading, namely that such trade enables the marginal cost of emission reductions to equalise across member states, despite the fact that the requirement for emission reductions may differ quite significantly between countries (from 10% in Bulgaria to 50% in the Nordic countries, Germany and Luxembourg). However, Swedish law permits only limited use of such trade and other supplementary measures, including, for example, increased uptake of CO₂ in land and forestry and the creation of negative emissions using carbon capture and storage (CCS) in heat and power plants using non-fossil fuels. 

The article by von Below et al. discusses both the costs of setting stricter domestic targets for emission reductions and the associated costs of non-uniform emissions pricing. The latter includes variations between emitters within a country and between countries. The main aim of the article is to quantify these costs in the Swedish context. To this end, the authors use a detailed general equilibrium model to analyse the economic consequences of four different scenarios for achieving the nationally targeted 61% ESR reduction. Under current national policies (including the planned step-by-step increase in mandatory blend-in of biofuel in diesel and petrol to 66 and 28%, respectively, by 2030), ESR emissions will fall by 48%. Therefore, this scenario is a good reference point, although some additional policies may need to be enacted in order to achieve the 50% reduction required under Fit for 55.

The first of the four scenarios (A1) uses an increased CO₂ tax to reach the target of 61% emission reductions. The second scenario (A2) also uses a higher CO₂ tax but, in addition, removes the regulation on biofuel blend-in, instead setting it at a predicted minimum level of 15%. In the third scenario (B), a more uniform CO₂ taxation is introduced, implying, in particular, that the biofuel component in diesel and petrol is not taxed, while some other green subsidies are removed. In the fourth scenario (C), the uniform CO₂ tax is set exogenously and purchases of ESR quotas from other countries are used to reach the targeted emission reductions. The CO₂ tax and the ESR price are both set to SEK 2,000 per/ton CO₂, which is slightly lower than twice the current CO₂ tax rate. It should be noted that the final scenario requires changes to Swedish climate law since, as noted above, the law includes a self-imposed restriction on the number of such purchases allowed.

The model results show that quite significant increases in CO₂ tax levels are required to reach the Swedish target unless purchases of ERS quota units are used. In scenarios A1 and B, the CO₂ tax must be increased to SEK 8,300 and 7,476 per tonne of CO₂, respectively. This is six to seven times the current CO₂ tax rate which is approximately SEK 1,190/tCO₂. The latter figure is also close to the current price of EU ETS allowances. Given that petrol and diesel produce 2.3 and 2.7 kg CO₂ per litre, the tax rate would be in the order of SEK 20 per litre if no non-taxed biofuel is included in the fuel mix. In scenario A2, the required CO₂ tax is more than twice as high at SEK 18,906/tCO₂, close to twenty times the current price of EU ETS allowances. Although the tax increase is approximately the same in scenarios A1 and B, the reduced blend-in of biofuel in the latter implies that price increases at the pumps would be much lower. Relative to the reference scenario, the diesel price doubles in scenario A1 but increases only by 27% in scenario B.

Scenario C presents strong evidence that emission reductions in Sweden will come at a considerable cost. If ESR quota units can be bought at SEK 2,000 per tonne, close to half (42%) of the emission reduction required under Swedish climate law (61%) could be achieved by paying for emission reductions in other countries through purchasing ESR quota units. Given the uneven distribution of quota units, this is not a surprising result.

The analysis also shows that welfare and GDP fall substantially, relative to the outcome in the reference scenario if the 61% target is met without using the option of buying ESR quotas abroad. In scenarios A1 and A2, the loss is equivalent to around 0.6% of income and GDP losses amount to 0.7% and 0.9% in 2030. If a more uniform policy is applied (scenario B), losses are about half as large (0.35% of income with a GDP loss of 0.4% in 2030). If purchases of ESR quotas are used instead, there is a resulting welfare gain of 0.49% and a GDP increase of a similar size.

The article provides a comprehensive analysis of the domestic costs of setting stricter targets for emission reductions and how these costs can be reduced by applying more uniform CO₂ taxation and through purchasing emission reductions from other EU countries. The authors' analysis is thorough, and although modelling necessarily represents a simplification of reality, they provide credible answers to the important questions raised.

As noted by the authors, the more rigorous Swedish emission reduction targets imply that emissions in 2030 should be around five million tons lower than the Fit for 55 package requirements. The costs of these reductions are considerable relative to the amount of emission reductions. The reported GDP decrease of 0.7-0.9% implies that SEK 9,000 – 12,000 is lost for every ton of CO₂ abated.

GDP in 2030 in 2019 prices is SEK 6,135 billion in the analysis. 0.7 and 0.9% of GDP thus corresponds to SEK 42.9 and 55.2 billion.

The welfare losses are of a similar order of magnitude. These costs could be reduced if a more uniform taxation system is applied, but they are still substantial – many times greater than the expected cost of emission reductions abroad.

Are there benefits associated with the higher Swedish targets for emission reductions and the restrictions imposed on accessing the flexibility mechanisms? This is a difficult question to answer, in particular, if seeking quantitative answers. An oft-cited benefit is the demonstration effect – a forerunner may inspire others to introduce more ambitious climate policies. The authors clearly state that although such benefits may exist, they are not analysed in the article. Despite the difficulty involved, let me nevertheless provide a brief qualitative discussion about the potential demonstration effect of current Swedish policy.

As discussed above, climate policy is highly multifaceted, with many complementary parts. Given this, a strategic use of the demonstration effect should focus on areas of policy where the potential gain is high relative to the associated cost.

In the introduction to this publication, we noted that the Fit for 55 package sets binding limits for EU emissions for the entire future. Emissions from the old and the new emission trading systems, covering almost all fossil CO₂ emissions in the EU, will be in the order of 60 tonnes per EU citizen if the current and proposed rules are kept in place. After 2035, the sale of fossil fuel cars and vans will be banned. After 2044, no more emission allowances will be released to the market, meaning that at that point, the EU will have phased out the fossil fuel economy. With regards to domestic reduction of CO₂ emissions, the EU and all its member states do what is required under the Paris agreement. After the Fit for 55 package, there is, therefore, little remaining value in being forerunners when it comes to limiting domestic CO₂ emissions.

Note, however, that I focus here on reductions of CO₂ emissions. To stabilise the global climate, we need to greatly reduce emissions of other greenhouse gases, too, in particular methane. The Fit for 55 package does not include tools to reduce methane emissions from agriculture, which remain outside the sectors coved by emission trading. We also need to increase the uptake of CO₂ in land and forests and increase carbon capture and storage. To achieve this, systems providing economic incentives to households, forestry owners, farmers and industrial power plants need to be put in place. Despite the importance and undoubted potential of such measures, Sweden is here a laggard rather than a forerunner. Arguably, Swedish climate policy, with its strong focus on emission reductions in the transport sector and restrictions on the use of supplementary measures, is a reason for the laggardness. I believe this must change.

Group 2 of the climate policies outlined above contains measures to facilitate a smooth transition to climate neutrality. The Fit for 55 package forces a phasing out of the fossil fuel economy. But it must be replaced by a durable new green economy. Although the structural transformation is arguably not of historic proportions, it does require a policy. Sweden and the other Nordic countries may well have the ability to be forerunners here. However, in Sweden, slow processes for providing permissions for building infrastructure and new production facilities, such as in the mining industry, effectively act as a brake on the transition to climate neutrality. Lack of competent labour resources and housing in areas where new green industries are intended has a similar knock-on effect. In these cases, I believe that efficient legislation and governance are far more important than industrial subsidies.

Delivering a smooth transition is crucial. I am far more worried that the risk of popular dissatisfaction might lead to an unravelling of the Fit for 55 regulation, than that the Nordic countries will fail in their ambition to push the EU to adopt even more ambitious policies. The former could be catastrophic, the latter is not important in the overall picture.

Are there benefits to not using ESR quota trading with other countries? I find it difficult to see any. Clearly, the EU ETS is a success story, and few now think it is important to have policies targeting the distribution of emissions across countries within the system. The same approach should apply to emissions within the ESR sector. On grounds of fairness, Sweden and the other Nordic countries are obliged to be economically responsible for greater emission reductions. However, this does not presume that emission reductions are cheaper and can be achieved faster within their national borders. If Sweden and Bulgaria (for example) make a deal whereby Sweden pays for emission reductions in Bulgaria, then it represents a win-win situation. By reducing the overall costs of the transition, the risk that the Fit for 55 regulation unravels is also reduced. Within the EU ETS, an efficient market for trade in emission allowances has emerged. The ESR regulation requires that the emission quotas traders are the respective governments of the member states. Sweden and the other Nordic countries should actively develop a functioning and transparent market for trade in ESR quotas. This is another area where we could be forerunners.

IMF. (2020). World Economic Outlook, October 2020: A long and difficult ascent, Chapter 3.

Hassler, J. (2020). A global CO2 price – necessary and sufficient, Journal of the Finnish Economic Association, 1(1).