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Accelerating ozone layer protection in developing countries
World Development,
0305-750X/92 $5.00 + 0.00 Pergamon Press Ltd
Vol. 20, No. 4, pp. 609-618,1992.
_ Printed in Great Britain.
Accelerating Ozone Layer Protection in Developing Countries MOHAN
MUNASINGHE and KENNETH The World Bank, Washington, DC
KING*
Summary. - The authors argue that the benefits of ozone protection far outweigh the costs. Therefore, the primary objective of international and national action should be benefit maximization via accelerated phaseout of ozone depleting substances across countries and economic sectors. Developing countries abound with opportunities for early low unit abatement cost phaseout through well-designed policies and projects. However, the current international framework provided by the Montreal Protocol tends to focus instead on project-level incremental cost minimization, and does not provide incentives for early action. The authors propose modifications to remedy these shortcomings.
1. INTRODUCTION (a) The ozone problem The depletion of stratospheric ozone is a serious problem for the whole planet. Since this ozone layer shields the earth from harmful ultraviolet light, its thinning exposes all life to severe consequences. Human beings, particularly those in the higher latitudes where ozone thinning is most pronounced, will be exposed to increased risk of skin cancer. People everywhere, however, are at risk because of the effects of disrupted ecological cycles, especially as ultraviolet light kills small terrestrial and marine organisms that provide vital links in food chains. Depletion
of
the
ozone
layer
results
from
a
complex series of reactions catalyzed by certain long-lived atmospheric trace gases that are of recent and human origin. These gases are principally the chlorofluorocarbons (CFCs) and some similar compounds. Although such compounds were first made in the 1930s it is only recently that they have built up to dangerous levels in the atmosphere. It was in 1974 that their critical role became known, and not until 1985 was any international action taken to limit their emission to the atmosphere. Paradoxically, it is the very inertness, nonflammability, and nontoxicity that gave CFCs, halons, and other ozone-depleting substances such a clean bill of environmental health - for the local environment. Their physical properties are also idea1 for their main uses as refrigerants, fire extinguishants, solvents,
foam blowing agents and aerosol propellants. Thus limiting their use to preserve the ozone layer clearly imposes substantial costs on industry and consumers, but it has also stimulated rapid technical development of alternative chemicals and technologies.
(b) The international response In 1985, following scientific assessments of the problem by the United Nations Environmental Program (UNEP), 49 countries met and agreed on the need for action in what became the Vienna Convention for the Protection of the Ozone Layer. Disagreements on exactly how to achieve ozone layer protection were not resolved until 1987, under the Montreal Protocol (MP). The protocol set limits on six groups of ozonedepleting substances (ODSs) and established control measures. The special situation of developing countries was also noted. First, given their small but rapidly growing use of ODSs, it was not deemed fair that they should have to cut ODS use as quickly or as much (in percentage terms) as the industrialized countries. Second, it did not seem fair that they should have to divert scarce development resources to obviate a global *Parts of this paper are based on arguments advanced in two previous publications: Munasinghe and King (1991) and King and Munasinghe (1991). The opinions expressed herein are those of the authors and do not necessarily represent the views of the World Bank.
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problem, especially one created almost entirely by the industrialized world. The protocol made some allowance for these special situations. Developing countries were granted a lo-year grace period on the starting baseline and percentage cuts required, and all signatories (especially donors) were exhorted to extend financial and technical assistance to developing countries. Following a period during which there was evidence of worsening ozone depletion, the protocol was revised and became more restrictive. At the same time, provisions for assisting developing countries were made more formal. Thus in 1990 the Interim Multilateral Fund was established to meet (on a grant or concessional basis), the agreed incremental costs of the transition to non-ODS alternatives in developing countries, i.e. the additional costs of complying with the protocol.
- Switching from ODS-based products in the dominant (i.e., industrialized country) markets is taking place rapidly. A trend noticeable in some industrialized country markets has been the switch in market demand to completely different chemical and raw material inputs (begun in the United States and Japan in the late 1970s for aerosol products). Industrial analysts expect that demand switching and recycling could eliminate about 60% of the 1986 world CFC market. - The specific question of phasing out ODSs in developing countries (principally CFC-11 and CFC-12) is simplified by the fact that few of them are producers. CFC production in Mexico, Brazil, Argentina and Venezuela is controlled by the six major multinational corporations through directly owned subsidiaries. In Asia generally, technologies have been either licensed or sold to local firms (although China has developed its technology indigenously). The African market is serviced mainly by European exporters of CFC products. According to the recently completed country studies, all CFC-producing developing countries (apart from China) are producing less than 9,000 tons of CFCs annually, with most plants reporting considerable unutilized capacity. There are a variety of user industries though, such as refrigerator factories, which depend on either imported or locally made CFCs, and these will need to retool to use the alternatives. Table 2 indicates the size of CFC markets in developing countries. By world industry standards, production in any one developing country appears uneconomic, and is viable only because of protection by trade or tax policies. Tables 1 and 2 together highlight the extent of scale differences between producers in developing and industrialized countries. In Mexico, for example, Allied Signals has two plants with a combined capacity of 14,000 tons per annum, and Du Pont owns a plant with a production capacity of 4,OOO-
(c) The structure of the world ODS industry The problem of phasing out ODSs is made more manageable by the following characteristics of the world ODS industry: - There are very few major manufacturers of ODSs. Production is dominated by six US and European multinational corporations. For example, Du Pont owns 35% of the world production capacity for CFC (the dominant ODSs), followed by Atochem (18%) and Allied Signals (13.8%). Together with three other European multinationals (ICI, Hoechst and Montefluos), these firms control over 80% of world CFC production capacity, with proprietary rights over most processes. (See Table 1 for world CFC production and consumption.) - There are only a few major end uses (refrigerants, foam blowers, aerosol propellants, cleaning agents/solvents, and fire extinguishants) for each of which there are technical substitutes at reasonable cost.
Table
1. World
CFC consumption
Total World United States Western Europe Japan Rest of the world Source:
Chemical
1,139 355 317 182 285 Economics
(in ‘000 tons, 1988) Foams
Refrigeration 342 123 34 45 140 Handbook
319 106 109 37 67 (1990).
Aerosols 216 17 119 12 68
Cleaning 262 111 56 88 9
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Table 2. Production and consumption of CFCs in developing countries (‘000 tons11988)
Production Latin America Asia Africa/Middle East Eastern Europe Others Total Source:
Consumption
40 55 0 55 0 150
7,000 tons per annum.
ACTION and cost effectiveness
The seriousness of the ozone problem implies that the benefits of ozone layer protection are extremely high. Although unquantified at present, it may be assumed that these benefits far exceed the relatively modest costs of the transition to alternatives. This assumption implies that the global imperative should be to maximize benefits rather than minimize costs. A benefit maximization approach would stress primarily the accelerated adoption of alternatives even if this raises the costs of the transition somewhat. Such an approach would focus also on
Developing
__--
10 20 30 5 65
10 5 0 0 0 15
(1990).
maximizing the impact that a given amount of resources would achieve, i.e., by selecting those actions and investments that had the lowest unit abatement costs first, wherever they are. The global community, if it were acting singlemindedly on the phase out task, should thus be indifferent as to the substance which is the source of a given amount of ozone depletion, the sector where phase out is to take place, and the country using the ODS - provided the fastest possible reduction in ozone depleting potential can be achieved with the resources available. Let us set aside the question of how the various ODSs are ranked according to their ozone depleting potential (ODP) and the question of the various sectors, in order to focus on the issue relating to resource transfer from developed to developing countries. The earlier discussion on the relative contributions to ODS use by developed and developing countries suggests that the latter are not major users at present (although consumption is rising
The international optimal plant size, by contrast, is 20,000 tons per annum. These figures suggest that the major adjustment problem in developing countries is likely to be for user industries, rather than for producers.
(a) Benefit maximization
Exports
30 60 20 85 5 200
Chemical Economics Handbook
2. INTERNATIONAL
Imports
Industrialized
country
country
S Incremental benefit *----_____-_________ IncrErs;ntal
I
I
E
I I I I
E 2
I
---- ~__-------_____-_ Incrzrsfntal II I
I II
M
I I MAX. ODS substitution
b
s 8
i
L ---_r
-ii E
I I I I I
-:
1 I I
lc,
I I I 1
K
MAX. ODS Substitution
Figure 1. Incremental costs and benefits of ODS substitution.
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rapidly) and that the costs of phasing out ODSs are lower than those in industrialized countries where the low-cost abatement actions have been taken already. In Figure 1, ZCn is the curve of incremental costs for phasing out an ODS in a typical developing country, and IC, is the corresponding curve in a relatively higher cost industrialized country. ZB is the overall benefit to the global community, and this is assumed to greatly exceed incremental costs. MN represents the typical incremental cost that would be incurred by the developing country in eliminating one unit of ODS. The net global benefit of this activity (i.e., global benefit minus the cost of providing compensation) is NS. This large surplus accrues to the global community generally, while only a small fraction represents benefits for the host nation. Since IB is unknown (but large), suppose we use MR (i.e., KL) as a proxy for benefits based on the known, avoided incremental cost in the industrialized country. Even with this conservative assumption, there is still a net global benefit NR associated with the ODS eliminating activity in the developing country. The conclusion from the foregoing is that, if indeed incremental costs such as MN are small compared to net potential benefits, then the reimbursement of just this amount to the developing country is a minimal gesture from the
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global community. To summarize, (i) some part of the significant net global benefit or surplus (e.g., NS, or more conservatively NR) should be used as an added incentive to accelerate ODS phase out (which would maximize benefits); and (ii) the focus should be on the relatively low unit abatement cost projects in developing countries (for cost-effective use of available financial resources). (b) The Montreal Protocol We now examine the Montreal Protocol as it currently stands in relation to the criterion of rapid, cost-effective phase out. For each group of ozone depleting substances, a schedule of reduction has been stipulated (see Figure 2 for the schedule for Group I substances applicable to developing countries). Schedules for developing countries differ from those of developed countries in that there is a lo-year grace period for cutbacks and a later starting baseline year, while different percentage cutbacks apply to different ODS. Conceptually, however, the defined task is similar in each case. Country programs are drawn up, defining the series of actions needed to keep the consumption of ODSs within the protocol bounds, and to meet ancillary obligations such as control of trade with nonsignatory countries, and collection of ODSrelated statistics.
2010
2007
*Percentages are based on whichever value is lower: (a) the average consumption during 1995; or (b) 0.3 kilograms per capita.
Figure 2. Typical
CFC phase-out
profile
for
developing
countries.
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From an economic point of view, schedules of reduction like these are not ideal. First, they do not encourage a globally efficient phase out, i.e., one which would minimize overall costs. It is the global level of ODS pollution that is important since ODSs are mixed indistinguishably in the atmosphere, from wherever they were vented. Therefore the least-cost way of reducing emissions, and hence atmospheric concentrations, would have been to bring in the cheapest forms of abatement first, in whichever country they might be. This process might require some countries to make large cutbacks (that is, to phase out ODSs faster than they would have been required to under the fixed schedule) while allowing those countries with higher cost options to defer action and overshoot the schedule. Second, and far more seriously, the fixed schedules do not encourage countries to undertake the most rapid phase out possible, since “just meeting the targets” and “improving on the targets considerably” are both regarded, equally, as compliance. A third and related aspect is that since phase-out schedules are fixed rigidly for each of the six groups of ODSs, no tradeoffs are possible among groups. Ideally, countries should be able to tradeoff reduction rates among all ODSs until the marginal benefit (in terms of ozone-depleting potential avoided) is the same for each ODS. Because the baseline for the schedules has not yet been fixed for developing countries (this will be a three-year average annual consumption level centered on 1996), these countries actually have a perverse incentive to maximize consumption in the short term. For example, they could stockpile or defer even the easy reduction strategies such as banning CFCs as aerosol propellants. The fact that developing countries do not appear to be undertaking these actions attests to their environmental responsibility and to their expectations that such steps on their part may adversely influence the funding of their incremental costs by developed countries. If we assume that global benefits (B) of ODS reduction exceed the costs (C) of implementation, then the protocol-bounded path (shown in Figure 2), yields significant net benefits over the unbounded base case. Since the protocol specifies a minimum compliance scenario, the basic objective for the country in question is to identify the path such as D which will satisfy the protocol requirements at minimum incremental cost to the country. Suppose we write the global net benefit of ODS reduction as: NB = B-C. If the objective of the world community is to maximize NB, and if the benefits of a unit ODS reduction greatly
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exceed the costs (at least, for initial decreases), then the optimal path may be E which lies inside D. In fact, depending on how high incremental benefits are relative to costs, there will be a family of curves (such as E and F) all of which favor faster ODS phase out than the protocol. This still leaves us with the difficult practical problem of valuing the economic benefits of ODS use reduction. Finally, if we recognize that there are problems (administrative, institutional, human resource etc.) that are very likely to place implementation constraints on the rate of ODS phase out (especially in developing countries) then curve G may be the appropriate limiting scenario. In this case, the valuation of benefits is not required in practice.
(c) Interim Multilateral Fund The parties to the protocol, recognizing the special situation of developing countries, undertook to facilitate their access to environmentally safe alternative substances and technology and to assist them in making expeditious use of such alternatives. The parties also undertook to facilitate, bilaterally or multilaterally, the provision of concessional financing to developing countries for this purpose. They realized, in essence, that the reluctance of developing countries to ratify the protocol was due to the lack of financial resources necessary to meet the obligations without impairing their development efforts. Consequently a special fund (the Interim Multilateral Fund) was set up to provide concessional finance and outright grants, additional to those available from existing aid programs. The fund is jointly administered by the World Bank, the United Nations Development ProNations Environment gram, and the United Program, with the World Bank handling the project financing arrangements. Grant financing is to be made available to eligible countries (i.e., developing countries who are parties to the protocol and who consume less than 0.3 kg of ODS per head per year) for eligible expenditures (the incremental costs of various phase-out projects). The items on which expenditures are reimbursable were determined by the parties in June 1990, in what are known as “the London Agreements.” This list includes things such as incremental costs of production (e.g., to reconfigure a plant to produce substitutes), equipment manufacture (e.g., to retool refrigerator manufacturing to use alternatives to ODS), recycling, technical assistance, and training. Although the fund was set up primarily on
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equity grounds, we can also evaluate it in terms of cost effectiveness. To reiterate a point made earlier, since the criterion of incremental cost is used to calculate the resource transfers (i.e., these are merely reimbursements), there is no added incentive for developing countries to accelerate the adoption of alternative technology. Furthermore, the tendency of the fund to focus mainly on project implementation and installation of hardware may result in the neglect of much more effective national or industrial policy changes that could accelerate the ODS phase out. The latter effect is reinforced by the view in many developing countries that, as a matter of principle, the very modest sums made available through the fund should not be used as leverage by donors to force economywide policy reforms.
3. NATIONAL
ACTIONS
Efforts at the national level in developing countries will respond to the framework for international action established by the Montreal Protocol and the Interim Multilateral Fund, and be constrained by a number of special features of the ozone problem. In order to determine how national actions can accelerate the phase out, it is necessary to see first how these special features influence the choice of policy instruments (regulations, taxes, marketable permits, depositrefund schemes, negotiated agreements, etc.).
(a) Special features of the ozone problem First, there is the incentive framework provided by the fund. Specifically, the Multilateral Fund under the protocol has been created to reimburse the incremental costs of specified projects within the signatory developing countries. Thus the only incentives for governments in these countries to take difficult domestic policy decisions to minimize these incremental costs are moral suasion and international pressure. This is likely to be rather difficult politically, because the ozone problem is seen as largely the result of previous developed country activities. Transfers under the fund are also seen as compensation for the costs borne by developing countries in mitigating a problem which will have its greatest impact in higher latitudes (i.e., fall more heavily on developed countries). Furthermore, the incentives within countries may tend to maximize the transfer of resources by ensuring that no eligible project or incremental cost goes unnoticed. Finally, as indicated earlier, since the
fund currently emphasizes projects and hardware, there is a risk that more effective ODS phase-out policy measures might be neglected or overlooked. One interpretation of the incremental costs that are eligible for reimbursement by the fund is that they are only the private financial costs borne by firms. If so, there is still some incentive for a host government to ensure that those adjustment costs not included in the financial costs are minimized. For example, it is important for a country to get the long-term industrial structure right to avoid misallocation of investment and other resources. This means among other things that further consumer investment in CFC technologies should be limited to prevent long-term welfare losses due to lack of serviceability. Second, there is a complex distributional issue. Supposing a decision were made to speed up the phase out in order to maximize benefits, as suggested in Section 1. In that case, restrictions on CFC production and use would be sudden and severe, and might impose heavy losses on entrepreneurs, e.g., owners of production facilities in the developing countries. Thus if ODS bans are implemented immediately, governments will be tempted to provide adequate compensation to firms penalized by these requirements, rather than to adopt a “polluter pays principle” whereby the losses are simply absorbed where they fall. Reimbursement of a producer’s incremental costs, however, is a subsidy for the new technology (e.g., for the manufacture HCFCs) and may be inefficient if it also subsidizes commercial risk and implicitly penalizes other forms of substitution. For domestic distributional reasons and due to the way the fund is set up, however, this efficiency loss may be unavoidable in the case of a rapid phase out. Less developed countries are not under such time pressure, however, and have been granted a lo-year grace period. In addition, depending on how competitive the various ODS industries are within the country, the benefits of any grant financing for incremental costs may or may not be passed on to final consumers. ODS suppliers and manufacturers may in fact have a windfall gain. Third, it is generally acknowledged that the benefits of CFC phase out (avoided damage due to ozone depletion) far exceed the relatively modest cost of the phase out (see for example, UNEP, 1989). Therefore, a coordinated and balanced set of policies are required to accelerate ODS replacement with, at least initially, greater emphasis on quantitative instruments (bans, percentage reductions, etc.) versus price instru-
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ments. The latter are likely to be less swift and certain in their effects (entailing a risk of significant loss of benefits) even if more efficient (although the efficiency losses due to use of quantity restrictions are likely to be small in comparison to gains in phase-out benefits). Fourth, the urgency of the problem makes it unlikely that a new approach to environmental pollution control can be established for ozonedepleting substances. Historically, pollution has almost always been the subject of “commandand-control” policies, and this is still generally the case today, even in an advanced market economy such as the United States. Sophisticated approaches such as marketable permits should be used to improve economic efficiency, within the framework of quantity emission controls, but there will be few such opportunities in developing countries. Given the short time span availin many cases mandated technology able, standards, bans, reductions, and direct government investments will be more effective. Fifth, there will be minimal concern over the dynamic incentives of the policy instruments. Developing countries are followers in the field of ODSs and ODS substitutes, and the most effective way for them to acquire new technology will be through technology transfer from multinational corporations in the signatory developed countries. Since the protocol itself is a massive intervention in the normal market process, however, two obvious pitfalls need to be borne in mind. On the one hand, windfall gains by an oligopoly of multinational firms who control ODS substitutes should be avoided. On the other hand, sufficient profit margins ought to be provided, as an incentive for the creation of cheap and environmentally benign ODS substitutes, as soon as possible. Sixth, the control of ODS is a transitional problem, not one of constructing an efficient long-run equilibrium. Ozone-depleting substances will have to be phased out completely (i.e., the long-run “optimum discharge rate” is zero or very close to zero). Seventh, the industry structure is such that there are very few producers and importers (sometimes just a couple), several user firms refrigerator manufactures) and vast (e.g., numbers of consumers. Thus requirements of centralized information and ease of enforceability clearly suggest that direct controls be applied on upstream producers and users, while downstream use should be managed through use of incentives and decentralized market forces. Eighth, because of obvious informational and enforcement problems, control must be exercised on the production and disposal of the ODSs, not
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their emissions as such. It is far easier to monitor and control production, import, recycling and disposal of CFCs and halons, rather than their direct release to the atmosphere which occurs after long lag times from millions of point sources.
(b) National strategies There are three broad country types insofar as national ozone policies are concerned, distinguished by import dependency. - Those that import everything, i.e., ODSs and ODS-using equipment. Most of the smaller developing countries are in this category. - Those that manufacture some equipment such as refrigerators, but import ODSs. Several medium-sized developing countries are in this category, such as Egypt, Yugoslavia, and Turkey. - Those that manufacture at least some ODSs (and generally also the equipment). Some larger developing countries are in this category, notably China, India, Brazil and Mexico. Several countries are also linked to external markets through both exports and imports. Many of these linkages are with signatory countries and, to protect their overseas markets, the ODS industries in these countries are likely to retool and adjust anyway. For example, Brazil exports refrigerant compressors to the United States and Tunisia, and hopes to expand into the European market for domestic refrigerators. Adjustments they make for export markets will be available for servicing internal markets as well. In this case, the major national policy issue in adjusting to the protocol is to structure incentives for limiting purely domestic use. The general policy imperative would be to minimize the domestic (economic) costs of adjustment net of any external transfers of technology (from multinational corporations) and resources (through the fund) likely to be available. As a minimum, and in whatever category the country falls a successful National Ozone Policy will entail: (i) giving domestic firms and consumers early warning of the future measures and cutbacks required. In this way, adjustment will be less disruptive and costly; (ii) administering the compensation payments available under the fund, i.e., identifying eligible projects and assisting in quantification of incremental costs; and
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(iii) providing information, and possibly technical assistance and retraining, to facilitate adoption of technologies already cost effective (such as use of alternative aerosol propellants), or adjustment to emerging changes in export markets. It is unlikely that there will be significant employment or other macroeconomic effects of the phase out. In most cases, the ODS industries constitute a very small part of total industrial activity. The general approach suggested in the discussion on policy instruments is one centered on quantities of ODS in circulation, not directly on emissions. This is also in line with the protocol itself which seeks limitations on total ODS consumption, defined as net imports plus production less destruction. Direct regulation on the amounts available upstream provides the certainty needed to meet phase out targets, but allowing consequential price rises to flow onto downstream users provides some of the efficiency of charge-based policy instruments. Other general interventions would be those that facilitate the adjustment, including market responses where appropriate, such as provision of information or technical advice and retraining of service personnel to limit consumers’ welfare losses associated with existing ODS appliances. Some special attention may be needed if there are general economic distortions that interfere with economic adjustment and if there are any “loopholes” due, for example, to imports of equipment containing ODS, stockpiling, or recycling. Controls affecting consumption will have an impact on all three categories of country, from those that are fully import dependent to those with their own production capacity. In this case the primary policy instrument will be a regulation on the ODS supply. While this step will provide sure control over the phase out, there are some problems. First, there may be more than one supplier (importers and producers), and the supply quotas will have to be allocated among them. Auctioning marketable permits may lead to buyer collusion as it is unlikely that there are many importers. This may not matter very much, since the main advantage of these permits is certainty of impact. Allocation could also be done pragmatically, either by voluntary industry agreements (as in Mexico) or by grandfathering, i.e., by an percentage reduction for existing equal importers. Second, price increases resulting from the quantity controls on ODS are likely to give suppliers a windfall profit until the phase out is complete. On equity grounds (and perhaps to
raise revenue), the government could introduce a windfall profit tax, or impose a compensating excise duty on the ODS. Note that this fiscal measure is a secondary instrument, it merely corrects for some of the bluntness of the primary regulatory instrument. Third, although the protocol stipulates a few target dates for specified reductions, it is otherwise silent on the required reductions in any given year. National Ozone Policy can also fill in the targets for the intervening years. In fact this would help to minimize overall adjustment costs, since doing nothing until the target date would make the transition abrupt and costly, with steep consequential price changes flowing onto downstream users. Fourth, the broad approach advocated above assumes that the market downstream will allocate restricted supplies of ODS among users and induce switches in a cost-effective manner rising ODS prices will cause substitution by those users who can switch most cheaply. While this is a reasonable presumption, it does not necessarily assure a cost-effective outcome for the country. Major distortions in the ODS market may affect the result and negate its economic cost effectiveness. For example, taxes and/or subsidies may affect the relative prices of substitutes for various users. If there are such large distortions, some corrective action may be needed. Small distortions could be ignored since the time and cost of information gathering may make it not worthwhile pursuing. Fifth, the control of supplies alone does not ensure that ODS use is reduced. The quota could be partly circumvented by stockpiling ODS in the years before the quotas take effect (not only creating an alternative source of supply, but also building up a bigger baseline of imports), or by importing goods with ODS incorporated in them (such as aerosol cans and refrigerators). If these appear to be anything other than minor or temporary flaws, then these sources of ODS should be included in the total sources of supply, and be subjected to the same supply reductions. For a given consumption target, there are supplementary means by which a government can reduce welfare losses. One is to promote conservation of ODS. For example, large quantities of CFCs are vented during the servicing of domestic refrigerators in developing countries. Appropriate training and technical assistance to service personnel can reduce such losses dramatically and help sustain the economic life of existing ODS-dependent appliances. A second approach is for recovery of ODS from old appliances for recycling, as recycled supplies arc not part of consumption controlled by the pro-
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tocol. Even if it is uneconomic to recycle recovered ODSs, they should be destroyed (by incineration for example), because destruction increases the allowable level of imports (the protocol target is net of destroyed ODSs). A third method is to encourage retrofits on large equipment to make it suitable for using alternatives. The costs of training, technical assistance, recovery, recycling, destruction and retrofits are “incremental” and eligible for grant financing under the Montreal Protocol. Ideally, recovery and recycling schemes should be instituted to the extent that they are cost effective. The benefits are either that a greater amount of ODS can remain within the system for any given target on net consumption, thereby reducing adjustment costs, or that ODS consumption undershoots the target. These benefits are difficult to quantify, but clearly some criterion of “reasonable cost” needs to be applied to such schemes. Other supplementary regulations would be restrictions on the importation of ODS equipment and appliances so as to discourage both the build-up of capital stock that will become prematurely obsolete when ODS is unavailable, and the bidding up of the price of the available ODS supply. Alternatively, this might be left to the market with the government requiring only full disclosure to potential buyers. In the case of controls affecting equipment manufacturing, the primary controls over ODS supply are assumed to be in place. There are, however, additional considerations for the efficient adjustment of manufacturing industry. Allowing the increased scarcity of ODS to be reflected in prices will encourage those who can minimize ODS use at low cost to do so. Users (such as refrigerator manufacturers, firms engaged in foam blowing, etc.) would receive additional encouragement because they would be eligible for funding under the Montreal Protocol to cover their incremental costs. such as retooling. The higher cost of ODS lessens any advantage that delaying such retooling might have given. The grant financing is also an effective subsidy for the equipment that uses ODS alternatives. In those countries that produce ODS, a supply constraint is needed that includes not only imports and stockpiles, but also local ODS production. Supply quotas (whether grandfathered or auctioned, and preferably marketable) could be the primary instrument, with downstream price rises allowed to take effect as before.
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4. CONCLUSIONS Policies and strategies to implement the Montreal Protocol have become more urgent in the light of recent evidence that the ozone depletion problem is more serious than had been believed, even at the time the Multilateral Fund was established in 1990. As the benefits of ozone layer protection far exceed the costs of control, acceleration of the phase out should be the first priority of the parties to the Montreal Protocol. Fixed schedules for reduction of ODS use in each group may be useful as indicative upper bounds, but do not by themselves encourage a rapid, cost-effective phase out. Far better would be to use whatever financial resources are available for the phase out to finance the lowest unit abatement cost projects first, whatever ODS is involved and irrespective of sector or country. In developing countries, such projects could begin immediately even in the absence of comprehensive country programs (which may also introduce delays to effective action and add to administrative costs of the fund). At the same time, supportive policy measures should be used to accelerate the speed of phase-out investments. Overemphasis on incremental costs, as a criterion for transferring resources to developing countries, results in a minimalist approach with no incentive for early cost-effective action. It would be far better to recognize the large global surplus that can result from developing country actions and to adopt a more generous mechanism that rewards rapid phase out. National action to accelerated phase out is currently constrained by the incentive framework of the fund, and by certain other special features of the ozone problem. If concern about efficiency (meaning cost minimization in meeting prescribed phase-out schedules) were lessened, countries would be free to adopt policy instruments that stress immediate effectiveness (which would maximize benefits in comparison with “efficient” policies that took a long time to develop and institute). In the short term this means that developing countries with policy traditions of the “command and control” variety should not be deterred from taking immediate action on the grounds that more efficient approaches can be developed. It also means that international funding should be as generous as necessary to encourage rapid action, even to the extent of tolerating some duplication and inefficiency that would otherwise be eliminated by a more cautious approach. The elements of an effective strategy would be a more “market-based” approach internationally (favoring incentives for speedy national action
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and immediate action on low unit abatement cost projects wherever they are) combined at the national level with a balance between “command and control” measures (where these guarantee quick and effective phase-out action), and more market-oriented policies. Instead, what we have in the Montreal Protocol is the reverse a
technically based international framework (comprised of fixed schedules, country programs and calculations of “incremental” cost) combined with excessive reliance, in some cases, on idealized market-based systems with which the developing countries may be unfamiliar. These circumstances are likely to lead to confusion and delay.
REFERENCES
Chemical Economics Handbook,
“Marketing research
report on fluorocarbons,” (Stanford, CA: SRI International, 1990). King, K., and M. Munasinghe, “Incremental costs of phasing out ozone depleting substances,” ENV Working Paper No. 47 (Washington, DC: The World Bank 1991).
Munasinghe, M., and K. King, “Issues and options in implementing the Montreal Protocol in developing countries,” ENV Working Paper No. 49 (Washington, DC: The World Bank, 1991). United Nations Environmental Program, “Economic panel report: Montreal Protocol on substances that deplete the ozone layer” (Nairobi: UNEP, 1989).
0305-750X/92 $5.00 + 0.00 Pergamon Press Ltd
Vol. 20, No. 4, pp. 609-618,1992.
_ Printed in Great Britain.
Accelerating Ozone Layer Protection in Developing Countries MOHAN
MUNASINGHE and KENNETH The World Bank, Washington, DC
KING*
Summary. - The authors argue that the benefits of ozone protection far outweigh the costs. Therefore, the primary objective of international and national action should be benefit maximization via accelerated phaseout of ozone depleting substances across countries and economic sectors. Developing countries abound with opportunities for early low unit abatement cost phaseout through well-designed policies and projects. However, the current international framework provided by the Montreal Protocol tends to focus instead on project-level incremental cost minimization, and does not provide incentives for early action. The authors propose modifications to remedy these shortcomings.
1. INTRODUCTION (a) The ozone problem The depletion of stratospheric ozone is a serious problem for the whole planet. Since this ozone layer shields the earth from harmful ultraviolet light, its thinning exposes all life to severe consequences. Human beings, particularly those in the higher latitudes where ozone thinning is most pronounced, will be exposed to increased risk of skin cancer. People everywhere, however, are at risk because of the effects of disrupted ecological cycles, especially as ultraviolet light kills small terrestrial and marine organisms that provide vital links in food chains. Depletion
of
the
ozone
layer
results
from
a
complex series of reactions catalyzed by certain long-lived atmospheric trace gases that are of recent and human origin. These gases are principally the chlorofluorocarbons (CFCs) and some similar compounds. Although such compounds were first made in the 1930s it is only recently that they have built up to dangerous levels in the atmosphere. It was in 1974 that their critical role became known, and not until 1985 was any international action taken to limit their emission to the atmosphere. Paradoxically, it is the very inertness, nonflammability, and nontoxicity that gave CFCs, halons, and other ozone-depleting substances such a clean bill of environmental health - for the local environment. Their physical properties are also idea1 for their main uses as refrigerants, fire extinguishants, solvents,
foam blowing agents and aerosol propellants. Thus limiting their use to preserve the ozone layer clearly imposes substantial costs on industry and consumers, but it has also stimulated rapid technical development of alternative chemicals and technologies.
(b) The international response In 1985, following scientific assessments of the problem by the United Nations Environmental Program (UNEP), 49 countries met and agreed on the need for action in what became the Vienna Convention for the Protection of the Ozone Layer. Disagreements on exactly how to achieve ozone layer protection were not resolved until 1987, under the Montreal Protocol (MP). The protocol set limits on six groups of ozonedepleting substances (ODSs) and established control measures. The special situation of developing countries was also noted. First, given their small but rapidly growing use of ODSs, it was not deemed fair that they should have to cut ODS use as quickly or as much (in percentage terms) as the industrialized countries. Second, it did not seem fair that they should have to divert scarce development resources to obviate a global *Parts of this paper are based on arguments advanced in two previous publications: Munasinghe and King (1991) and King and Munasinghe (1991). The opinions expressed herein are those of the authors and do not necessarily represent the views of the World Bank.
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problem, especially one created almost entirely by the industrialized world. The protocol made some allowance for these special situations. Developing countries were granted a lo-year grace period on the starting baseline and percentage cuts required, and all signatories (especially donors) were exhorted to extend financial and technical assistance to developing countries. Following a period during which there was evidence of worsening ozone depletion, the protocol was revised and became more restrictive. At the same time, provisions for assisting developing countries were made more formal. Thus in 1990 the Interim Multilateral Fund was established to meet (on a grant or concessional basis), the agreed incremental costs of the transition to non-ODS alternatives in developing countries, i.e. the additional costs of complying with the protocol.
- Switching from ODS-based products in the dominant (i.e., industrialized country) markets is taking place rapidly. A trend noticeable in some industrialized country markets has been the switch in market demand to completely different chemical and raw material inputs (begun in the United States and Japan in the late 1970s for aerosol products). Industrial analysts expect that demand switching and recycling could eliminate about 60% of the 1986 world CFC market. - The specific question of phasing out ODSs in developing countries (principally CFC-11 and CFC-12) is simplified by the fact that few of them are producers. CFC production in Mexico, Brazil, Argentina and Venezuela is controlled by the six major multinational corporations through directly owned subsidiaries. In Asia generally, technologies have been either licensed or sold to local firms (although China has developed its technology indigenously). The African market is serviced mainly by European exporters of CFC products. According to the recently completed country studies, all CFC-producing developing countries (apart from China) are producing less than 9,000 tons of CFCs annually, with most plants reporting considerable unutilized capacity. There are a variety of user industries though, such as refrigerator factories, which depend on either imported or locally made CFCs, and these will need to retool to use the alternatives. Table 2 indicates the size of CFC markets in developing countries. By world industry standards, production in any one developing country appears uneconomic, and is viable only because of protection by trade or tax policies. Tables 1 and 2 together highlight the extent of scale differences between producers in developing and industrialized countries. In Mexico, for example, Allied Signals has two plants with a combined capacity of 14,000 tons per annum, and Du Pont owns a plant with a production capacity of 4,OOO-
(c) The structure of the world ODS industry The problem of phasing out ODSs is made more manageable by the following characteristics of the world ODS industry: - There are very few major manufacturers of ODSs. Production is dominated by six US and European multinational corporations. For example, Du Pont owns 35% of the world production capacity for CFC (the dominant ODSs), followed by Atochem (18%) and Allied Signals (13.8%). Together with three other European multinationals (ICI, Hoechst and Montefluos), these firms control over 80% of world CFC production capacity, with proprietary rights over most processes. (See Table 1 for world CFC production and consumption.) - There are only a few major end uses (refrigerants, foam blowers, aerosol propellants, cleaning agents/solvents, and fire extinguishants) for each of which there are technical substitutes at reasonable cost.
Table
1. World
CFC consumption
Total World United States Western Europe Japan Rest of the world Source:
Chemical
1,139 355 317 182 285 Economics
(in ‘000 tons, 1988) Foams
Refrigeration 342 123 34 45 140 Handbook
319 106 109 37 67 (1990).
Aerosols 216 17 119 12 68
Cleaning 262 111 56 88 9
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Table 2. Production and consumption of CFCs in developing countries (‘000 tons11988)
Production Latin America Asia Africa/Middle East Eastern Europe Others Total Source:
Consumption
40 55 0 55 0 150
7,000 tons per annum.
ACTION and cost effectiveness
The seriousness of the ozone problem implies that the benefits of ozone layer protection are extremely high. Although unquantified at present, it may be assumed that these benefits far exceed the relatively modest costs of the transition to alternatives. This assumption implies that the global imperative should be to maximize benefits rather than minimize costs. A benefit maximization approach would stress primarily the accelerated adoption of alternatives even if this raises the costs of the transition somewhat. Such an approach would focus also on
Developing
__--
10 20 30 5 65
10 5 0 0 0 15
(1990).
maximizing the impact that a given amount of resources would achieve, i.e., by selecting those actions and investments that had the lowest unit abatement costs first, wherever they are. The global community, if it were acting singlemindedly on the phase out task, should thus be indifferent as to the substance which is the source of a given amount of ozone depletion, the sector where phase out is to take place, and the country using the ODS - provided the fastest possible reduction in ozone depleting potential can be achieved with the resources available. Let us set aside the question of how the various ODSs are ranked according to their ozone depleting potential (ODP) and the question of the various sectors, in order to focus on the issue relating to resource transfer from developed to developing countries. The earlier discussion on the relative contributions to ODS use by developed and developing countries suggests that the latter are not major users at present (although consumption is rising
The international optimal plant size, by contrast, is 20,000 tons per annum. These figures suggest that the major adjustment problem in developing countries is likely to be for user industries, rather than for producers.
(a) Benefit maximization
Exports
30 60 20 85 5 200
Chemical Economics Handbook
2. INTERNATIONAL
Imports
Industrialized
country
country
S Incremental benefit *----_____-_________ IncrErs;ntal
I
I
E
I I I I
E 2
I
---- ~__-------_____-_ Incrzrsfntal II I
I II
M
I I MAX. ODS substitution
b
s 8
i
L ---_r
-ii E
I I I I I
-:
1 I I
lc,
I I I 1
K
MAX. ODS Substitution
Figure 1. Incremental costs and benefits of ODS substitution.
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rapidly) and that the costs of phasing out ODSs are lower than those in industrialized countries where the low-cost abatement actions have been taken already. In Figure 1, ZCn is the curve of incremental costs for phasing out an ODS in a typical developing country, and IC, is the corresponding curve in a relatively higher cost industrialized country. ZB is the overall benefit to the global community, and this is assumed to greatly exceed incremental costs. MN represents the typical incremental cost that would be incurred by the developing country in eliminating one unit of ODS. The net global benefit of this activity (i.e., global benefit minus the cost of providing compensation) is NS. This large surplus accrues to the global community generally, while only a small fraction represents benefits for the host nation. Since IB is unknown (but large), suppose we use MR (i.e., KL) as a proxy for benefits based on the known, avoided incremental cost in the industrialized country. Even with this conservative assumption, there is still a net global benefit NR associated with the ODS eliminating activity in the developing country. The conclusion from the foregoing is that, if indeed incremental costs such as MN are small compared to net potential benefits, then the reimbursement of just this amount to the developing country is a minimal gesture from the
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global community. To summarize, (i) some part of the significant net global benefit or surplus (e.g., NS, or more conservatively NR) should be used as an added incentive to accelerate ODS phase out (which would maximize benefits); and (ii) the focus should be on the relatively low unit abatement cost projects in developing countries (for cost-effective use of available financial resources). (b) The Montreal Protocol We now examine the Montreal Protocol as it currently stands in relation to the criterion of rapid, cost-effective phase out. For each group of ozone depleting substances, a schedule of reduction has been stipulated (see Figure 2 for the schedule for Group I substances applicable to developing countries). Schedules for developing countries differ from those of developed countries in that there is a lo-year grace period for cutbacks and a later starting baseline year, while different percentage cutbacks apply to different ODS. Conceptually, however, the defined task is similar in each case. Country programs are drawn up, defining the series of actions needed to keep the consumption of ODSs within the protocol bounds, and to meet ancillary obligations such as control of trade with nonsignatory countries, and collection of ODSrelated statistics.
2010
2007
*Percentages are based on whichever value is lower: (a) the average consumption during 1995; or (b) 0.3 kilograms per capita.
Figure 2. Typical
CFC phase-out
profile
for
developing
countries.
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From an economic point of view, schedules of reduction like these are not ideal. First, they do not encourage a globally efficient phase out, i.e., one which would minimize overall costs. It is the global level of ODS pollution that is important since ODSs are mixed indistinguishably in the atmosphere, from wherever they were vented. Therefore the least-cost way of reducing emissions, and hence atmospheric concentrations, would have been to bring in the cheapest forms of abatement first, in whichever country they might be. This process might require some countries to make large cutbacks (that is, to phase out ODSs faster than they would have been required to under the fixed schedule) while allowing those countries with higher cost options to defer action and overshoot the schedule. Second, and far more seriously, the fixed schedules do not encourage countries to undertake the most rapid phase out possible, since “just meeting the targets” and “improving on the targets considerably” are both regarded, equally, as compliance. A third and related aspect is that since phase-out schedules are fixed rigidly for each of the six groups of ODSs, no tradeoffs are possible among groups. Ideally, countries should be able to tradeoff reduction rates among all ODSs until the marginal benefit (in terms of ozone-depleting potential avoided) is the same for each ODS. Because the baseline for the schedules has not yet been fixed for developing countries (this will be a three-year average annual consumption level centered on 1996), these countries actually have a perverse incentive to maximize consumption in the short term. For example, they could stockpile or defer even the easy reduction strategies such as banning CFCs as aerosol propellants. The fact that developing countries do not appear to be undertaking these actions attests to their environmental responsibility and to their expectations that such steps on their part may adversely influence the funding of their incremental costs by developed countries. If we assume that global benefits (B) of ODS reduction exceed the costs (C) of implementation, then the protocol-bounded path (shown in Figure 2), yields significant net benefits over the unbounded base case. Since the protocol specifies a minimum compliance scenario, the basic objective for the country in question is to identify the path such as D which will satisfy the protocol requirements at minimum incremental cost to the country. Suppose we write the global net benefit of ODS reduction as: NB = B-C. If the objective of the world community is to maximize NB, and if the benefits of a unit ODS reduction greatly
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exceed the costs (at least, for initial decreases), then the optimal path may be E which lies inside D. In fact, depending on how high incremental benefits are relative to costs, there will be a family of curves (such as E and F) all of which favor faster ODS phase out than the protocol. This still leaves us with the difficult practical problem of valuing the economic benefits of ODS use reduction. Finally, if we recognize that there are problems (administrative, institutional, human resource etc.) that are very likely to place implementation constraints on the rate of ODS phase out (especially in developing countries) then curve G may be the appropriate limiting scenario. In this case, the valuation of benefits is not required in practice.
(c) Interim Multilateral Fund The parties to the protocol, recognizing the special situation of developing countries, undertook to facilitate their access to environmentally safe alternative substances and technology and to assist them in making expeditious use of such alternatives. The parties also undertook to facilitate, bilaterally or multilaterally, the provision of concessional financing to developing countries for this purpose. They realized, in essence, that the reluctance of developing countries to ratify the protocol was due to the lack of financial resources necessary to meet the obligations without impairing their development efforts. Consequently a special fund (the Interim Multilateral Fund) was set up to provide concessional finance and outright grants, additional to those available from existing aid programs. The fund is jointly administered by the World Bank, the United Nations Development ProNations Environment gram, and the United Program, with the World Bank handling the project financing arrangements. Grant financing is to be made available to eligible countries (i.e., developing countries who are parties to the protocol and who consume less than 0.3 kg of ODS per head per year) for eligible expenditures (the incremental costs of various phase-out projects). The items on which expenditures are reimbursable were determined by the parties in June 1990, in what are known as “the London Agreements.” This list includes things such as incremental costs of production (e.g., to reconfigure a plant to produce substitutes), equipment manufacture (e.g., to retool refrigerator manufacturing to use alternatives to ODS), recycling, technical assistance, and training. Although the fund was set up primarily on
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equity grounds, we can also evaluate it in terms of cost effectiveness. To reiterate a point made earlier, since the criterion of incremental cost is used to calculate the resource transfers (i.e., these are merely reimbursements), there is no added incentive for developing countries to accelerate the adoption of alternative technology. Furthermore, the tendency of the fund to focus mainly on project implementation and installation of hardware may result in the neglect of much more effective national or industrial policy changes that could accelerate the ODS phase out. The latter effect is reinforced by the view in many developing countries that, as a matter of principle, the very modest sums made available through the fund should not be used as leverage by donors to force economywide policy reforms.
3. NATIONAL
ACTIONS
Efforts at the national level in developing countries will respond to the framework for international action established by the Montreal Protocol and the Interim Multilateral Fund, and be constrained by a number of special features of the ozone problem. In order to determine how national actions can accelerate the phase out, it is necessary to see first how these special features influence the choice of policy instruments (regulations, taxes, marketable permits, depositrefund schemes, negotiated agreements, etc.).
(a) Special features of the ozone problem First, there is the incentive framework provided by the fund. Specifically, the Multilateral Fund under the protocol has been created to reimburse the incremental costs of specified projects within the signatory developing countries. Thus the only incentives for governments in these countries to take difficult domestic policy decisions to minimize these incremental costs are moral suasion and international pressure. This is likely to be rather difficult politically, because the ozone problem is seen as largely the result of previous developed country activities. Transfers under the fund are also seen as compensation for the costs borne by developing countries in mitigating a problem which will have its greatest impact in higher latitudes (i.e., fall more heavily on developed countries). Furthermore, the incentives within countries may tend to maximize the transfer of resources by ensuring that no eligible project or incremental cost goes unnoticed. Finally, as indicated earlier, since the
fund currently emphasizes projects and hardware, there is a risk that more effective ODS phase-out policy measures might be neglected or overlooked. One interpretation of the incremental costs that are eligible for reimbursement by the fund is that they are only the private financial costs borne by firms. If so, there is still some incentive for a host government to ensure that those adjustment costs not included in the financial costs are minimized. For example, it is important for a country to get the long-term industrial structure right to avoid misallocation of investment and other resources. This means among other things that further consumer investment in CFC technologies should be limited to prevent long-term welfare losses due to lack of serviceability. Second, there is a complex distributional issue. Supposing a decision were made to speed up the phase out in order to maximize benefits, as suggested in Section 1. In that case, restrictions on CFC production and use would be sudden and severe, and might impose heavy losses on entrepreneurs, e.g., owners of production facilities in the developing countries. Thus if ODS bans are implemented immediately, governments will be tempted to provide adequate compensation to firms penalized by these requirements, rather than to adopt a “polluter pays principle” whereby the losses are simply absorbed where they fall. Reimbursement of a producer’s incremental costs, however, is a subsidy for the new technology (e.g., for the manufacture HCFCs) and may be inefficient if it also subsidizes commercial risk and implicitly penalizes other forms of substitution. For domestic distributional reasons and due to the way the fund is set up, however, this efficiency loss may be unavoidable in the case of a rapid phase out. Less developed countries are not under such time pressure, however, and have been granted a lo-year grace period. In addition, depending on how competitive the various ODS industries are within the country, the benefits of any grant financing for incremental costs may or may not be passed on to final consumers. ODS suppliers and manufacturers may in fact have a windfall gain. Third, it is generally acknowledged that the benefits of CFC phase out (avoided damage due to ozone depletion) far exceed the relatively modest cost of the phase out (see for example, UNEP, 1989). Therefore, a coordinated and balanced set of policies are required to accelerate ODS replacement with, at least initially, greater emphasis on quantitative instruments (bans, percentage reductions, etc.) versus price instru-
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ments. The latter are likely to be less swift and certain in their effects (entailing a risk of significant loss of benefits) even if more efficient (although the efficiency losses due to use of quantity restrictions are likely to be small in comparison to gains in phase-out benefits). Fourth, the urgency of the problem makes it unlikely that a new approach to environmental pollution control can be established for ozonedepleting substances. Historically, pollution has almost always been the subject of “commandand-control” policies, and this is still generally the case today, even in an advanced market economy such as the United States. Sophisticated approaches such as marketable permits should be used to improve economic efficiency, within the framework of quantity emission controls, but there will be few such opportunities in developing countries. Given the short time span availin many cases mandated technology able, standards, bans, reductions, and direct government investments will be more effective. Fifth, there will be minimal concern over the dynamic incentives of the policy instruments. Developing countries are followers in the field of ODSs and ODS substitutes, and the most effective way for them to acquire new technology will be through technology transfer from multinational corporations in the signatory developed countries. Since the protocol itself is a massive intervention in the normal market process, however, two obvious pitfalls need to be borne in mind. On the one hand, windfall gains by an oligopoly of multinational firms who control ODS substitutes should be avoided. On the other hand, sufficient profit margins ought to be provided, as an incentive for the creation of cheap and environmentally benign ODS substitutes, as soon as possible. Sixth, the control of ODS is a transitional problem, not one of constructing an efficient long-run equilibrium. Ozone-depleting substances will have to be phased out completely (i.e., the long-run “optimum discharge rate” is zero or very close to zero). Seventh, the industry structure is such that there are very few producers and importers (sometimes just a couple), several user firms refrigerator manufactures) and vast (e.g., numbers of consumers. Thus requirements of centralized information and ease of enforceability clearly suggest that direct controls be applied on upstream producers and users, while downstream use should be managed through use of incentives and decentralized market forces. Eighth, because of obvious informational and enforcement problems, control must be exercised on the production and disposal of the ODSs, not
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their emissions as such. It is far easier to monitor and control production, import, recycling and disposal of CFCs and halons, rather than their direct release to the atmosphere which occurs after long lag times from millions of point sources.
(b) National strategies There are three broad country types insofar as national ozone policies are concerned, distinguished by import dependency. - Those that import everything, i.e., ODSs and ODS-using equipment. Most of the smaller developing countries are in this category. - Those that manufacture some equipment such as refrigerators, but import ODSs. Several medium-sized developing countries are in this category, such as Egypt, Yugoslavia, and Turkey. - Those that manufacture at least some ODSs (and generally also the equipment). Some larger developing countries are in this category, notably China, India, Brazil and Mexico. Several countries are also linked to external markets through both exports and imports. Many of these linkages are with signatory countries and, to protect their overseas markets, the ODS industries in these countries are likely to retool and adjust anyway. For example, Brazil exports refrigerant compressors to the United States and Tunisia, and hopes to expand into the European market for domestic refrigerators. Adjustments they make for export markets will be available for servicing internal markets as well. In this case, the major national policy issue in adjusting to the protocol is to structure incentives for limiting purely domestic use. The general policy imperative would be to minimize the domestic (economic) costs of adjustment net of any external transfers of technology (from multinational corporations) and resources (through the fund) likely to be available. As a minimum, and in whatever category the country falls a successful National Ozone Policy will entail: (i) giving domestic firms and consumers early warning of the future measures and cutbacks required. In this way, adjustment will be less disruptive and costly; (ii) administering the compensation payments available under the fund, i.e., identifying eligible projects and assisting in quantification of incremental costs; and
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(iii) providing information, and possibly technical assistance and retraining, to facilitate adoption of technologies already cost effective (such as use of alternative aerosol propellants), or adjustment to emerging changes in export markets. It is unlikely that there will be significant employment or other macroeconomic effects of the phase out. In most cases, the ODS industries constitute a very small part of total industrial activity. The general approach suggested in the discussion on policy instruments is one centered on quantities of ODS in circulation, not directly on emissions. This is also in line with the protocol itself which seeks limitations on total ODS consumption, defined as net imports plus production less destruction. Direct regulation on the amounts available upstream provides the certainty needed to meet phase out targets, but allowing consequential price rises to flow onto downstream users provides some of the efficiency of charge-based policy instruments. Other general interventions would be those that facilitate the adjustment, including market responses where appropriate, such as provision of information or technical advice and retraining of service personnel to limit consumers’ welfare losses associated with existing ODS appliances. Some special attention may be needed if there are general economic distortions that interfere with economic adjustment and if there are any “loopholes” due, for example, to imports of equipment containing ODS, stockpiling, or recycling. Controls affecting consumption will have an impact on all three categories of country, from those that are fully import dependent to those with their own production capacity. In this case the primary policy instrument will be a regulation on the ODS supply. While this step will provide sure control over the phase out, there are some problems. First, there may be more than one supplier (importers and producers), and the supply quotas will have to be allocated among them. Auctioning marketable permits may lead to buyer collusion as it is unlikely that there are many importers. This may not matter very much, since the main advantage of these permits is certainty of impact. Allocation could also be done pragmatically, either by voluntary industry agreements (as in Mexico) or by grandfathering, i.e., by an percentage reduction for existing equal importers. Second, price increases resulting from the quantity controls on ODS are likely to give suppliers a windfall profit until the phase out is complete. On equity grounds (and perhaps to
raise revenue), the government could introduce a windfall profit tax, or impose a compensating excise duty on the ODS. Note that this fiscal measure is a secondary instrument, it merely corrects for some of the bluntness of the primary regulatory instrument. Third, although the protocol stipulates a few target dates for specified reductions, it is otherwise silent on the required reductions in any given year. National Ozone Policy can also fill in the targets for the intervening years. In fact this would help to minimize overall adjustment costs, since doing nothing until the target date would make the transition abrupt and costly, with steep consequential price changes flowing onto downstream users. Fourth, the broad approach advocated above assumes that the market downstream will allocate restricted supplies of ODS among users and induce switches in a cost-effective manner rising ODS prices will cause substitution by those users who can switch most cheaply. While this is a reasonable presumption, it does not necessarily assure a cost-effective outcome for the country. Major distortions in the ODS market may affect the result and negate its economic cost effectiveness. For example, taxes and/or subsidies may affect the relative prices of substitutes for various users. If there are such large distortions, some corrective action may be needed. Small distortions could be ignored since the time and cost of information gathering may make it not worthwhile pursuing. Fifth, the control of supplies alone does not ensure that ODS use is reduced. The quota could be partly circumvented by stockpiling ODS in the years before the quotas take effect (not only creating an alternative source of supply, but also building up a bigger baseline of imports), or by importing goods with ODS incorporated in them (such as aerosol cans and refrigerators). If these appear to be anything other than minor or temporary flaws, then these sources of ODS should be included in the total sources of supply, and be subjected to the same supply reductions. For a given consumption target, there are supplementary means by which a government can reduce welfare losses. One is to promote conservation of ODS. For example, large quantities of CFCs are vented during the servicing of domestic refrigerators in developing countries. Appropriate training and technical assistance to service personnel can reduce such losses dramatically and help sustain the economic life of existing ODS-dependent appliances. A second approach is for recovery of ODS from old appliances for recycling, as recycled supplies arc not part of consumption controlled by the pro-
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tocol. Even if it is uneconomic to recycle recovered ODSs, they should be destroyed (by incineration for example), because destruction increases the allowable level of imports (the protocol target is net of destroyed ODSs). A third method is to encourage retrofits on large equipment to make it suitable for using alternatives. The costs of training, technical assistance, recovery, recycling, destruction and retrofits are “incremental” and eligible for grant financing under the Montreal Protocol. Ideally, recovery and recycling schemes should be instituted to the extent that they are cost effective. The benefits are either that a greater amount of ODS can remain within the system for any given target on net consumption, thereby reducing adjustment costs, or that ODS consumption undershoots the target. These benefits are difficult to quantify, but clearly some criterion of “reasonable cost” needs to be applied to such schemes. Other supplementary regulations would be restrictions on the importation of ODS equipment and appliances so as to discourage both the build-up of capital stock that will become prematurely obsolete when ODS is unavailable, and the bidding up of the price of the available ODS supply. Alternatively, this might be left to the market with the government requiring only full disclosure to potential buyers. In the case of controls affecting equipment manufacturing, the primary controls over ODS supply are assumed to be in place. There are, however, additional considerations for the efficient adjustment of manufacturing industry. Allowing the increased scarcity of ODS to be reflected in prices will encourage those who can minimize ODS use at low cost to do so. Users (such as refrigerator manufacturers, firms engaged in foam blowing, etc.) would receive additional encouragement because they would be eligible for funding under the Montreal Protocol to cover their incremental costs. such as retooling. The higher cost of ODS lessens any advantage that delaying such retooling might have given. The grant financing is also an effective subsidy for the equipment that uses ODS alternatives. In those countries that produce ODS, a supply constraint is needed that includes not only imports and stockpiles, but also local ODS production. Supply quotas (whether grandfathered or auctioned, and preferably marketable) could be the primary instrument, with downstream price rises allowed to take effect as before.
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4. CONCLUSIONS Policies and strategies to implement the Montreal Protocol have become more urgent in the light of recent evidence that the ozone depletion problem is more serious than had been believed, even at the time the Multilateral Fund was established in 1990. As the benefits of ozone layer protection far exceed the costs of control, acceleration of the phase out should be the first priority of the parties to the Montreal Protocol. Fixed schedules for reduction of ODS use in each group may be useful as indicative upper bounds, but do not by themselves encourage a rapid, cost-effective phase out. Far better would be to use whatever financial resources are available for the phase out to finance the lowest unit abatement cost projects first, whatever ODS is involved and irrespective of sector or country. In developing countries, such projects could begin immediately even in the absence of comprehensive country programs (which may also introduce delays to effective action and add to administrative costs of the fund). At the same time, supportive policy measures should be used to accelerate the speed of phase-out investments. Overemphasis on incremental costs, as a criterion for transferring resources to developing countries, results in a minimalist approach with no incentive for early cost-effective action. It would be far better to recognize the large global surplus that can result from developing country actions and to adopt a more generous mechanism that rewards rapid phase out. National action to accelerated phase out is currently constrained by the incentive framework of the fund, and by certain other special features of the ozone problem. If concern about efficiency (meaning cost minimization in meeting prescribed phase-out schedules) were lessened, countries would be free to adopt policy instruments that stress immediate effectiveness (which would maximize benefits in comparison with “efficient” policies that took a long time to develop and institute). In the short term this means that developing countries with policy traditions of the “command and control” variety should not be deterred from taking immediate action on the grounds that more efficient approaches can be developed. It also means that international funding should be as generous as necessary to encourage rapid action, even to the extent of tolerating some duplication and inefficiency that would otherwise be eliminated by a more cautious approach. The elements of an effective strategy would be a more “market-based” approach internationally (favoring incentives for speedy national action
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and immediate action on low unit abatement cost projects wherever they are) combined at the national level with a balance between “command and control” measures (where these guarantee quick and effective phase-out action), and more market-oriented policies. Instead, what we have in the Montreal Protocol is the reverse a
technically based international framework (comprised of fixed schedules, country programs and calculations of “incremental” cost) combined with excessive reliance, in some cases, on idealized market-based systems with which the developing countries may be unfamiliar. These circumstances are likely to lead to confusion and delay.
REFERENCES
Chemical Economics Handbook,
“Marketing research
report on fluorocarbons,” (Stanford, CA: SRI International, 1990). King, K., and M. Munasinghe, “Incremental costs of phasing out ozone depleting substances,” ENV Working Paper No. 47 (Washington, DC: The World Bank 1991).
Munasinghe, M., and K. King, “Issues and options in implementing the Montreal Protocol in developing countries,” ENV Working Paper No. 49 (Washington, DC: The World Bank, 1991). United Nations Environmental Program, “Economic panel report: Montreal Protocol on substances that deplete the ozone layer” (Nairobi: UNEP, 1989).