Clean Development through Institutional Reform
EMF 22: Climate Policy Scenarios
for Stabilization and in Transition
December 12-14, 2006
Tsukuba, Japan

Sugandha D TuladharDavid Montgomery
Washington, D.C.

Summary•

Why do some countries have lower (higher) energy use per output than othercountries?
–•

What can we say about determinants of energy intensity? Is there arelationship?
–––•

IA models underestimate costs as these models assume that markets operate
efficiently in all countries leading to equalization of marginal cost along the baseline

How can IA models incorporate these market failures? Is there a policy
framework that can address market failures?
–––•

There is a clear association between market failures and emissions intensity
These failures create obstacles to technology transfer andIncentives for inefficient use of energy that explain some differences in emissions
intensity

Has this been recognized within the modeling context? Does the cost ofIntegrated Assessment (IA) models reflect the true cost?
–•

Comparisons of emissions and energy intensity suggest large opportunities for
reducing emissions from developing countries

In order to model the role of institutional reform new kinds of data and informationneed to be developed
How can Asia-Pacific Partnership (APP) be effectively used to improve energy
intensity through institutional change
A proposal to bring about institutional reform

Role for EMF to improve analysis of governance issues

Energy intensity index for some developing anddeveloped countries
Energy Intensity Index(All series indexed to 100 in 1980)
180
160

Index = 100 in 1980

140120100

Korea, South

India

80

Japan

United States60

United States
BrazilChina
India
Indonesia
JapanKorea, SouthThailand

40
China

2001980

1985

1990

1995

2000Source: EIA,
nternational Energy Annual 2004
Updated 2006

Energy use per GDP$ for developing countries still
higher than developed countries
Energy Intensity( Btu per 2000 U.S. Dollars Using Market Exchange Rates)
120000100000
United States
BrazilChina
India
Indonesia
Japan
Korea, South
Thailand

80000
China
60000

40000

India

20000

01980

1985

1990

1995

2000

Why do we see differences in technology acrosscountries that yields different energy intensity?
Well analyzed approaches:• Bottom up answer– Market outcomes are inefficient if engineering calculations say so– Mandatory caps or regulations will lead to cost-effective mitigation• Top down answer– Market determined outcomes include all mitigation that is cost-effective at zerocarbon price– Technology is chosen optimally given national resources and preferences– Pricing emissions Is necessary and sufficient to achieve efficient outcome

Alternative approach from the development literature• Institutional approach– Market outcome may be inefficient if institutional barriers exist– Market outcome may be inefficient if institutions are inadequate– Institutional reform is required to get markets to work
– We can conjecture under this approach that energy intensity is a function ofmarket failures defined by subcomponents of economic freedom index– We use score of economic freedom index to test this conjecture

Lack of Economic Freedom Explains Much of the
Difference In Energy Intensity
Economic Freedom Compared to Energy per Dollar(Btu per 1995 $) of GDP (2001)
80000
Russia70000

60000
y = 2E+06x-2.666
R2 = 0.3362

Btu per 1995 $

50000
China
40000
India
30000
S. Korea

Singapore

20000
USA10000
Namibia
03.0

4.0

Sources: Frasier Institute, Economic Freedom of the World, 2003,
U.S. Energy Information Administration, International Energy Annual, 2002

5.0

6.0
Freedom Index 2001

7.0

8.0

9.0

Relationship of Subcomponents of Economic Freedom
and Energy Intensity
Variable
Constant
Protection of intellectual property

iprop

Access of citizens to foreign capital
markets/foreign access to domestic capital

accapTime with government bureacracy

burea

Size of government

gsize

Services share of GDP

srvsh

Argriculture share of GDP

agrsh

Dummy - low income

dlow

Dummy - middle income

dmid

Dummy - high income

dhighNumber of Observation
R-squaredStandard errors in parenthesis* Significant at 1%, ** significant at 5%

Model-D1
105439(8132)*-2640(720)*

Model-D4
164021(12625)*-4323.0(1040)*-4194(967)*-2520(907)*-3832(732)*-4006(1038)*-2348(947)*-4184(805)*-338(157)**-1490(226)*

381
0.27-17326.0(4333)*-21275.0(6340)*
3450.38¾ Not all economic freedom subcomponents are important for
explaining variation in energy intensity. Institutional failures matter.

Econometric analysis confirms a robust relationshipbetween institutional failures and energy intensity• Quality of institutions yield statistically significant difference in energyintensity• Overall economic freedom matters, because the process of growth itself
leads to lowering energy intensity– High income countries have lower carbon intensity than mid-income, and mid-income than low• Differences in energy intensity within each income level are explained by–––––Protection of intellectual capital
Access of citizens to foreign capital markets
Foreign access to domestic capitalTime with government bureaucracySize of government• Improving governance results in lowering energy intensity for developingcountries.
• China and India can improve energy intensity by as much as 40%-60% byimproving intellectual rights alone.
• Room for improvement in energy intensity for developing countries withweak economic freedom by addressing market failures

How much improvement can be realized withinstitutional reform at the level of high income
countries?
Percentage Change in Energy Intensity
if institutional barriers are improved
0-10-20-30(%)

CHNIND-40-50-60-70
accaphighbureahighiprophighHow are institutional aspects treated in integrated
assessment models?
• Market failures due to institutional deficiencies are generally omitted frommodeling exercises• Assumption in IA models that marginal costs of abatement are equalized
across countries requires the assumption that all markets are equallyefficient• Clear institutional failings in major developing countries make thatoutcome unlikely to result from market-based policies• IA models underestimate the cost of emission reduction policies that do
not address market failures• IA models neglect the potential for reducing emissions throughinstitutional reform¾ Institutional and governance issues are added costInstitutional barriers impose transaction cost

Why do we need to account for institutional barriers?
•Institutional barriers results in transaction cost
– These cost are nontrivial in countries that have deep rooted market failures– Cost due to inefficient market along with the resource cost would give a true cost

Modeling challenges• How to find a place in the model– Can represent as inefficient use of resource• How to parameterize the model instrument– It is difficult to pin down which market failures inhibit energy intensity improvements

Some key steps needed to move forward on institutionaland governance issues?
• Magnitude of “technology gap”
– Estimate potential by sector with real data on carbon intensity of new investment– Bottom up approach focus on technology and opportunity but does not identify policy
levers, but– Realistic bottom up analysis comparing technologies currently in use to those that
could be economic can help to define potential• Identification of governance issues relevant to carbon
emissions– Cross-sectional analysis establishes hypothesis that institutional failings with aplausible theoretical relationship to emissions intensity matter– Next step must be identification of specific institutional problems in specificeconomies with buy-in from the country involved• Policy levers that can bring about changes in institutions– To prioritize reform, governments can start by measuring regulatory costs andidentifying the biggest opportunities for improvement.
– How can these be identified?
– How can incentives¥willingness¥ability to reform institutions be changed?

Asia-Pacific Partnership a framework for China and India
to attract technology transfer and efficient use of energy
Asia-Pacific Partnership
Energy Intensity and Economic Freedom (1980-2003)

Btu per 2000 dollars

90000
China

60000
India
Australia

Korea

30000

USAJapan

04567

8910

Economic Freedom Index

Countries whose emissions growth concerns us are precisely the countries
lacking the institutional characteristics that lead to sustained economic growthWhat avenues exist to develop enough information toassess the potential emission benefits of institutional
reform and to design appropriate changes?

• Asia-Pacific Partnership– Provides framework for involving business, experts and governments– Potential for sponsoring studies and developing country-specific data
– Engagement of governments could lead to buy-in on the nature andimportance of reform and identify ways that advanced countries could
encourage reform• EMF– Opportunity to bring institutional economists and modelers together– Could draw on studies done by World Bank and US AID– Not suitable for generating new data on specific institutions in specificcountries– Bring research institutions from developing countries to better understandthe linkage of institutional and governance reform and energy use.

Conclusions• Institutional development theory provides understanding of why energy
use differs across countries• Real opportunities exist for clean development in developing countries• Addressing institutional reforms and market failures that inhibit
technology transfer is a win-win approach for developing countries• Institutional reform can produce emission reductions without additional
measures and make market based policies feasible• Empirical work especially IA modeling work should focus in accounting
these market inefficiencies• EMF can play a role in bringing institutionalists and modelers to get abetter understanding of institutional issues and how to represent it withinenergy-economic models.