Towards a Re-Orientation of National Energy Policies in the EU? - Germany as a Case Study:
Chapter 1
Energy and Research Series ENER 110

1. Energy Policy as a Strategic Element of Economic Policy in Dynamic Open Economies

Energy policy is an element of infrastructure policy and thus is important for competitiveness and growth, at the same time it is a crucial element of environmental policy since the generation and use of fossil and nuclear fuels goes along with negative national and international external effects. Following the EU electricity liberalization initiative Germany has not chosen to implement the minimum gradual liberalization required by the EU, rather it fully liberalized the electricity market in April 1998 which will lead to falling electricity prices and industry restructuring in a more competitive European market. Since natural gas is an important input — with a competitive edge vis-à-vis alternative inputs - in electricity generation the liberalization of the gas market in the EU initiated by the European Commission will reinforce the liberalization of the energy market. Energy generation and use are in turnkey elements for several emissions, most notably CO2 and SO2. These gaseous emissions naturally create transboundary pollution problems, other international aspects of ecological tax reforms concern competitiveness of the tradable goods industry and trade in energy resources and electricity. Moreover there will be effects on international capital markets to the extent that there will be relocation of energy intensive industries or intensified merger and acquisition activities in the energy sector or in energy-intensive industries facing sharper price and cost competition.

In 1994 the German federal government confirmed its objective of cutting CO2 emissions by 25-30% between 1987 and 2005. More importantly, the government announced at the COP1 conference in Berlin (1995) that it would reduce CO2 emissions by 25% over the period 1990-2005. As regards the EU Germany made an important commitment in the European Council of Environment Ministers of March 1997 when the German government agreed to cut its greenhouse gas emissions — that is the three gases CO2, CH4 and N2O — by ¼ between 1990 and 2010; this commitment was part of the proposal of the European Union for the Kyoto conference in December 1997. The broader emission reduction target concerns the year 2010 which for macroeconomic adjustment — and computer simulations — therefore is the relevant time range. There have been several reports on the reduction of the CO2 emission target. In our analysis we will focus both on CO2 emissions and other ecological and economic aspects of energy policy in Germany — including the issue of phasing out nuclear energy. Selected developments in other EU countries also will be considered (including the UK with its liberalized electricity markets whose dynamics offer basic lessons for the EU with its phased-in liberalization).

The Kyoto protocol has called for considerable reduction of CO2 emissions by all major OECD countries. Raising energy prices in some form thus becomes a natural strategy for many market economies, and a so-called ecological tax reform — including energy/ CO2 taxes - is one possible option for policymakers. Energy pricing and ecological tax reforms are core elements of sustainable energy policies in industrialized countries. While nuclear power generation has no CO2 emissions there are serious problems with potential contamination and with nuclear waste management. Clearly, energy policy has not only ecological aspects at the national level, it also concerns cost competitiveness of firms and prices for electricity, gas and heating in private households. Energy policy therefore is a politically and economically sensitive issue.

Economic globalization (WELFENS, 1999a), i.e. the increasing competitive pressure in goods markets has stimulated companies´ activities in cost cutting, including in the field of energy costs. With respect to electricity Germany´s prices were among the highest in the EU in 1997/98 — with east-Germany´s prices being even somewhat higher than those in West Germany (mainly due to high capital allowances in the context of new power stations constructed within the framework of regional monopolies). Scandinavian electricity prices are relatively low in the EU.

In accordance with the Federal Constitutional Court, which had declared the so-called Kohlepfennig — a duty imposed on electricity to subsidize the German coal industry — illegal, the Kohlepfennig, a special charge on households’ electricity bills, was eliminated. Instead, subsidies for the hard coal industry were directly disbursed from the federal tax revenues. Government discussed replacing the Kohlepfennig with revenues of DM 4 bill. with a general energy tax, but it turned out that the conservative-liberal coalition government could not get broad support in the Parliament for such fiscal reform. The new government of Germany which took office in autumn 1998 — a coalition government of social democratic and green parties — decided that it would pursue a so-called ecological tax reform which would consist of two elements, namely imposing new energy taxes, while reducing social security contributions; this measure should reduce wage costs and thereby help to raise the demand for labour and to cut the unemployment rate, respectively.

The German government under Chancellor Schröder decided to introduce a phased ecological tax reform, which would raise energy prices. While the experience of the OPEC price shocks of the 1970s gives reasons to expect OECD market economies to react flexibly on the demand and supply side to a new vector of energy prices the plans for an ecological tax reform will bring some additional elements for policymakers and the business community, respectively. An ecological tax reform would bring an additional revenue source; more precisely the revenue ecological taxes would rise. It amounted to roughly 2.5% of GDP in Germany and OECD countries, respectively, in the 1990s. One has to consider to what extent isolated national energy policies and ecological tax reforms are adequate in the framework of the single market and increasing global competition. For the business community a national ecological tax reform implies differential adjustment pressure depending on the energy intensity of technologies and products. Moreover, to the extent that an ecological tax reform allows the reduction of wage costs — here employers´ social security contribution — one will have a temporary cost advantage, which could improve international competitiveness while stimulating employment and thus aggregate domestic demand at the same time. Given high unemployment rates in most continental EU countries in the 1990s an ecological tax reform can only be one element of a much broader strategy to restore full employment. Deregulation and more wage differentiation as well as more mobility are needed in any case (ADDISON/WELFENS, 1998). For Germany and some other EU countries the second big challenge of modern energy policy concerns options to shift from nuclear energy towards a bigger role for renewable energy sources as well as more conventional alternatives.

An ecological tax reform basically will raise energy prices and thus give incentives — at given technologies - for firms and consumers to save energy by adjusting the input structure on the one hand, and the output mix on the other. At the same time there will be incentives for industry to come up with energy-saving innovations and new technologies. Given the diverging energy intensities of industries, raising energy prices is likely to have different impacts across sectors both in terms of output and employment — in the case of tradable products also in the field of exports. Moreover, for an open economy the changing incentives to import energy and to export energy-intensive products will have effects on the trade balance. The sectoral output effects and the parallel impact on income and normal tax revenues will bring about crucial employment and government revenue effects. It is clear that the revenue effect from imposing higher energy taxes normally is positive for the budget. But how will the economy react if output is falling as a consequence of higher energy prices — an effect typically found in most model simulations on ecological tax reform? Will there be accentuated conflicts over income, increasing long-term budget deficits or major exchange rate effects? The very purpose of the ecological tax reform, namely to improve the environment and to raise employment could be seriously undermined if there were strong adverse secondary effects of an ecological tax reform. An ecological tax reform which would mainly rely on an input substitution effect of the tax reform — namely replacing capital by the now cheaper labour — but would go along with negative long term output effects is unlikely to be sustainable. Hence, to the extent that there are potentially considerable negative output effects of an ecological tax reform, one has to discuss opportunities to mitigate the negative output impact. Here lies a major policy problem for which we will suggest empirically founded solutions for the case of Germany, but our innovative policy proposals should also work in other OECD countries.