UNDP presentation, Balazs Horvath, Poverty Reduction Practice Leader, UNDP, Bratislava Regional Center

1. Economics of Sustainable
Development and Preliminary
Results of Fossil Fuels Study
Balázs Horváth
Poverty Reduction Practice Leader,
UNDP, Bratislava Regional Center

2. Roadmap
Economics & political economy of sustainable development
• Definition of sustainable development, key considerations
• Anatomy of energy prices
• Energy pricing is crucial element of sustainable development
• Political economy of low-carbon reforms: why so hard?
Results of the fossil fuel subsidy study in Western Balkans
• Methodology and coverage
• Main subsidization channels
• Estimated fossil fuel-related subsidies are large
• Health warning: fossil-fuel subsidies are bad for you
Conclusion: Policy considerations

3. Development is sustainable if human capital, knowledge
capital, natural capital and produced capital that society
disposes over do not decline over time (Arrow et al., 2004).
Economic, social & environmental pillars—interdependent
Three-legged stool: topples if any leg wobbles
» Economic: Iceland, Ireland,
» Social: Arab Spring, Kyrgyzstan
» Environmental: Central Asia, Maldives, China
Gini Coefficients in Some Arab States
43.0
41.0
39.0
1995
37.0
2000
35.0
2005
33.0
2007
31.0
29.0
Egypt, Arab Rep.
Jordan Morocco Syria Tunisia Yemen, Rep.

4. Sustainable development: some considerations
• Interaction of flows & stocks: e.g., rapidly running down the
natural resource base (depleting natural capital) raises ST
income flow, but lowers income path & HD level in M<
• Reversing losses costs far more than spending required to
avoid them; some losses (e.g., in biodiversity) irreversible;
• Critical, complementary roles of
state, private & civil sectors;
• An issue of intergenerational equity.

5. Anatomy of
Energy Prices
for End-Users CURRENT DOMESTIC PRICE
SUBSIDIES
Consumption & production externalities
Counterpart of stock depletion
Domestic Price + Subsidies  Cost-recovery market price
+ Counterpart reflecting externalities  Current Cost to Society
+ Counterpart reflecting stock depletion  Sustainable price level
(reflecting all current & long-run costs)
Best practice today: covering first two, and part of externalities
Renewables: no stock depletion—but prices do not reflect this advantage
Sustainable prices  positive LR impact on S & D side; on mix.

6. Higher Energy Prices: Necessary Part of Sustainable Development
* Climate change threat makes prompt collective action worthwhile.
* Price not reflecting externalities, depletion  wrong signal toward CO2-heavy activity
* Coordination problem:
Fundamentally alter decisions of billions
Only appropriate price signals can deliver
 phase in CO2 "sin tax", or
 charge for traded carbon credits.
* Need globally coordinated, monitored & enforced change with no offsetting subsidies
* Need effective national & global regulation to avoid free-riding & guide massive global
reallocation of fossil fuel rents
* Predictable price path over investment horizon  facilitates technology diffusion
* In 100 years mankind will have a much smaller GHG footprint, no matter what…

7. Political Economy of Low-carbon Reforms
• Front-loaded costs
• Back-loaded benefits
• It’s a no-brainer, right? But
• Assume elections in year 2
• Let’s examine time profile:
• Net benefits from year 3;
• Cum net benefit: year 5
• Tech bounce advances
break-even point

8. II. Results of the fossil fuel subsidy
study in Western Balkans
• WB-OECD-IEA methodology (Seoul, 2010 G-20 Report)
• Based on data for the period 2005 –2010 for Albania, Bosnia
and Herzegovina, Croatia, FYR
Macedonia, Kosovo/1244, Montenegro and Serbia;
• Covers fossil fuel-based thermal power generation & district
heating, lignite for power generation, lignite/coal for the
retail market, crude oil & petroleum products, & natural gas;
• Includes indirect support and net effects of cross-subsidies;
• Excludes state aid and loan guarantees.

9. Some subsidy mechanisms
• Low-cost hydro generation cross-subsidizing lignite fired power
generation  high barrier to entry;
• Regulatory support to commercial players in energy intensive sectors;
• Preferential access to credit;
• Tax breaks;
• Tolerated non-payment by energy-intensive companies;
• Protective trade barriers;
• Low natural resource access / concession fees are assessed;
• No environmental impact costs are assessed.

10. Preliminary Estimate of Fossil Fuel-related Subsidies: They Are Large
Country Energy related subsidies as
% of GDP
Albania 7-8%
Bosnia-Herzegovina 9-10%
Croatia 5-6%
FYR of Macedonia 8-9%
Montenegro 10-11%
Serbia 7-9%
UNMIK / Kosovo 35-36%

11. Health warning on fossil fuel subsidies
• They distort the price signal (both the price level and relative prices)
hinder market entry for efficient fuels and renewable energy
lower energy efficiency and thus raise CO2 emission
encourage non-optimal substitution.
• They re-distribute resources regressively and nontransparently
• Expected future shift from unsustainable situation dampens investment
• They fail to sustainably raise export competitiveness, changing only the
mix of production and exports toward energy-intensive areas
• Same resources could be put to more desirable use (opportunity cost).

12. Policy considerations—
Energy Pricing
• Rule #1 of Challenge Management:
When in a hole, stop digging
(abandon business as usual).
• Global problem  global solution
• More effective to shape activity through prices than quantities
• Effective institutions needed to
– reflect and compare costs & benefits on vastly different horizons;
– reconcile politicians’ short horizons with longer one that is socially optimal
– facilitate coordinated intervention transcending national borders; and
– make transfers that align globally optimal action with local/national incentives.

13. Policy Considerations—Subsidies
• Upgrade policies toward the EU environmental acquis to reduce
environmental damage and fiscal risks.
• Scrutinize subsidies and cross-subsidies in line with the
IEA, OPEC, OECD, World Bank Joint Report (June 2010) Decision
Tree.
• Pursue regional integration and design National Action Plans to phase
out unjustified fossil fuel subsidies.
• Support energy efficiency upgrade and the use of renewable energy
• Devise operational regional arrangements to use energy infrastructure
• Apply State Aid Laws in line with the EU acquis, and adopt the

14. • Thank You for Your Attention
• Questions, Comments Most Welcome