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STANDING COMMITTEE ON ECONOMICS
23/03/2009
Exposure drafts of the legislation to implement the Carbon Pollution Reduction Scheme

CHAIR —Welcome, Professor Garnaut. Would you like to make an opening statement?

Prof. Garnaut —Thank you, Senators, for inviting me. When I was asked to participate, through my assistant I made it clear that I have not, because of my many day jobs, had the opportunity to carefully go through the legislation, so I am not presenting myself as an expert on the legislation. I was told to come nevertheless. I have three submissions to you. One is my climate change review, copies of which you will all have received, and which is available on the web at www.garnautreview.org.au. The others are my opening addresses to the Australian Agricultural and Resource Economics Society’s annual conference in Cairns last month, and to the CSIRO’s conference in Perth today. I am in your hands to follow your agenda.

CHAIR —Thank you. I will call for questions straight away. Senator Eggleston.

Senator EGGLESTON —Professor, I am just looking at the IPA submission for impact on Australia’s Carbon Pollution Reduction Scheme. They make the comment that the Garnaut report suggested Australia would incur an eight per cent loss in income if no action was taken and went on to comment that this is four times higher than the Stern report’s estimate of global costs. Would you like to explain that difference or comment on it?

Prof. Garnaut —Professor Stern did a very different exercise to me. He was looking at the global costs of climate change and global costs of mitigation. I was looking at the costs of climate change and of mitigation in Australia. Other differences arise from the fact that Professor Stern based his work on middle-of-the-road emissions scenarios that, at the time, were favoured by the IPCC. I undertook analysis of business-as-usual emissions growth in the major developing countries, including China, India and Indonesia, and came to the view that the IPCC scenarios on which Professor Stern based his work greatly underestimated likely business-as-usual growth in emissions from the big developing countries. I thought that the highest of the IPCC scenarios, which carries the name A1FI, should be the basis for the modelling. Of course, those numbers come out of the modelling.

As Professor Stern has acknowledged publicly, my report was the first attempt to thoroughly analyse the costs and benefits from the point of view of one country within a global system, so we were doing different things. So I suppose one should not presume we would come to the same number, because we were measuring different things.

Senator EGGLESTON —That is a valid point. The IPA submission also says that you suggest Indonesia and Papua New Guinea could become vast sinks to offset other countries’ emission levels. They have suggested Australia is geographically more placed to take advantage of such opportunities. Does that imply that an emissions trading scheme of people buying credits would effectively transfer the emissions to Indonesia and Papua New Guinea through the credit purchase and we, in fact, would not mitigate our own emissions?

Prof. Garnaut —Yes, it does imply an element of that. It is much cheaper to reduce emissions in some countries than others, and the objective is to greatly reduce global emissions. So it makes sense, if it is much cheaper to do it in one country than others, to do it there. You can create that result by allocating emissions entitlements across countries and then having trade in permits. The consequence of that is some countries reduce their emissions more than their entitlements might suggest and others by less than their entitlements might suggest. Where would Australia end up in such a scheme? We are looking a long way forward to the middle of the century. That depends a lot on things we do not know about the possible success of biosequestration in Australia.

If that is very successful, that may turn out to be a relatively low cost way of reducing emissions or absorbing emissions, and that might make us an exporter of permits. On the other hand, if that does not become very important and we remain a country with international comparative advantage in energy intensive industries, then we may support proportionately more energy intensive production by buying permits. That is an efficient way for the world to achieve its mitigation objectives.

Senator EGGLESTON —The other question I would like to ask you, Professor, is that when we are talking about an emissions trading scheme, there are those who think a carbon tax would be a simpler, more effective, and less costly avenue to go down. Would you like to comment on that?

Prof. Garnaut —I discuss that in the report. I do not have a strong a priori commitment to either an ETS or a carbon tax. They are different means towards a similar end. On balance I came down in favour of the ETS because you can be more certain of achieving the environmental objective. You give out the number of permits that corresponds to your emissions target, and then the market determines the price. The market price will rise enough to economise on use of permits, so you can be sure of getting to the objective. With a carbon tax, you set a tax rate, and you cannot be sure in advance whether that will get you to your objective. It might get you further or it might get you not as far, depending on the rate you strike. You cannot know in advance. So if you are facing a demanding target, with a carbon tax, to be sure of meeting the target, you have to be ready to change the rate from time to time, and in the political process that is not such an easy matter. So I saw an advantage in the way the ETS goes directly to the objective of keeping emissions to a certain level.

The other advantage that I saw with the ETS was that it lent itself more readily to international trade in permits. I think international trade in permits is going to be absolutely essential to get the participation of many of the developing countries. In the work on the review I had quite a lot of contact with leaders in some of the developing countries that are very important to Australia. One of those was Indonesia. Ministers in Indonesia made a few points clear. Firstly, they were deeply committed to playing a large role in the global mitigation effort. Secondly, it would be extremely difficult politically, given the political influence of elements of the forestry industry. Thirdly, if there were mechanisms by which the government could point to gains to the country through sale of permits, if they overachieved on targets, it would tip the political weight in favour of strong action.

So the fact that the ETS lends itself more easily to international trade in permits is a big advantage in getting countries like Indonesia fully to participate in a global regime. It is sometimes said that the carbon tax is simpler. I would love it to be so. People say that a lot of the complication of the ETS comes from fights over free permits. If you are not giving any free permits, because you just apply a tax to everyone, there is nothing to fight over. But I think we would have the same political noise about who gets exempted from the carbon tax. So what appears a simpler approach may not be so simple in practice. I see, and economists generally see, some advantages in something nice and simple like a carbon tax without exemptions. But I am not sure whether you would get a carbon tax without exemptions if you set out to apply a carbon tax.

Senator EGGLESTON —In the IPA submission they suggested an ETS would increase the prices of energy more than a carbon tax, I think. They say:

Europe’s ETS and wind energy requirements have brought a doubling of electricity costs and in the US recession has hit hardest in states like California which have taken the lead on penalising fossil fuel use.

They go on to say:

Australia has more to lose than almost any other country from the costs imposed by CO2 emission restraints. Cheap coal based electricity has been the bedrock on which much of our industrial development rests. Smelting industries in particular gravitated to Australia in the wake of the 1970s oil price hikes but low cost electricity has assisted the competitiveness of all our tradable goods industries.

Do you wish to comment on that scenario as an impact of ETS?

Prof. Garnaut —There are a few different points there, but the general point is that Australia has a high proportion of coal based industries including the smelting industries, and they would be affected by an ETS or a carbon tax. The first thing I would tell you is that there would be no difference, in effect, between an ETS and a carbon tax if the price was the same in both cases, and the exemptions were the same in both cases. Let us assume that that is the case. So there is no difference between a carbon tax and ETS in the effects on industry. How would comprehensive carbon pricing affect competitiveness of Australian energy intensive industries? There is quite a lot of that in chapter 20 of the report. That is the chapter on energy in Australia. At the moment some countries have constraints on emissions and others do not. At the moment we do not, and that gives us a competitive advantage in aluminium smelting and some other coal based energy industries.

With carbon pricing, whether through an ETS or a carbon tax, the cost of those industries will rise. If it is a comprehensive global agreement, and that is what we have to work towards, then the carbon price will become embodied to some extent in the global price of smelted metals. Our export industries would be able to recoup some of their costs through the higher price. But to the extent that there are places in the world where you can produce aluminium with low emissions, for example, from stranded hydroelectricity, which does not have other uses, or geothermal, then it may be that our competitors can produce aluminium with far lower emissions. There would be some tendency for at least the growth in smelting capacity to shift towards the low-emissions economies. That is actually how you would want the world to work, if we were facing up to a big global mitigation task, and if the way we produced aluminium was much more emissions intensive than the way the Congo, or Mozambique or Iceland produced aluminium from hydroelectricity or geothermal power.

It is not certain that that would be the outcome. Whether or not we retain a comparative advantage in metal smelting will depend on a lot of factors. We have some advantages in smelting within Australia. Bauxite, for example, is a bulky commodity with high transport costs. International transport costs would rise with comprehensive carbon pricing. That would create greater advantages in processing close to the raw material’s source. If we look a long way ahead, and companies making new aluminium industry investments will be looking a long way ahead, then comparative advantage in energy intensive industries is going to be determined by who produces low-emissions energy most cheaply.

There are some places in the world that can probably produce low-emissions energy for smelting very cheaply, and they are mostly developing companies. BHP has a big smelter in Mozambique that it has made bigger and indirectly it uses hydro from Mozambique. It goes through a circuitous process through the South African grid before it gets to the smelter. The electrons get mixed up with coal electrons, but there is a sense in which the power comes from the hydro. BHP is doing studies of major hydro developments in the Congo. It is developing countries that have low-cost, low-emissions energy potential that is underutilised. If you have hydro capacity near Sydney, Melbourne or Perth then it is probably already being used.

Over time the relative costs of coal based and renewable energies will change a lot. Because it depends on technological change, we cannot be sure of how it will change. But if the world is running mainly on renewable energy in 40 years time then Australia will have lots of advantages in that world. If solar energy turns out to be the low-cost, low-emissions energy source, then obviously we have advantages over any other developed country in that. If wind energy over time becomes a very efficient source of energy, then we have big advantages in that. There is nowhere in the world much better than the west coast of Tasmania for the blowing of the wind. If biosequestration becomes the low-cost energy source, then both the research base and the natural conditions are highly favourable for it in Australia.

So in a world in which comprehensive carbon pricing is making renewables the main source of energy at some time in the future it is quite likely we will be a low-cost producer. Coupled with having the bauxite already here, we may still have an international comparative advantage, but it will be based on a different source of energy. It is not certain that renewables will be the low-cost form of low-emissions energy. If it were the case that geosequestration of carbon dioxide from fossil fuel combustion through carbon capture and storage turned out to be economically successful, then it may very well be that we will be a low-cost producer of energy and competitive in the production of energy intensive goods. We probably are the best located country on earth in relation to geosequestration opportunities, so if that is the way the world goes we are likely to be very competitive. We cannot be certain now which of all these technologies will turn out to be the successful ones, but we are pretty well placed across quite a wide range of them.

Senator MILNE —It is interesting that you are saying that, effectively, in the future it will be a disadvantage to have favoured coal now against the renewables, if indeed the competitive advantage of the trade exposed and future high-intensity energy is with renewables or some other form. But this is what I want to ask you about in particular. One of the most controversial aspects of the government’s proposed scheme, apart from the lack of ambition of the target, is the compensation provisions, both for trade exposed industries and coal fired generation coalmines. So can you just explain to us the differences between what you proposed in terms of how we deal with compensation for those sectors compared with what the government is proposing. What do you see as the costs—both real and opportunity costs—of going with the types of provisions that accede to special pleading?

Prof. Garnaut —This is covered in chapter 14, section 5 of my report. The essential difference is that what the government is seeking to do is compensate Australian producers because we have carbon pricing. The right approach is to compensate firms for a transitional period because some other countries do not have carbon pricing. It might seem a rather niggardly point, but the difference has very big consequences. One difference is that the approach that I suggest would automatically phase out as other countries introduce carbon pricing.

In the Australian public discussion we underestimate the extent to which other countries are already engaged in mitigation. If you had an objective body—and I suggested using a body like the Productivity Commission that is arm’s length from political government—if you had objective calculations of the effect on the world price of various products, like aluminium, and if you had calculations of the effect of other countries not having comparable carbon pricing, you would take into account the fact that quite a lot of countries already have constraints on emissions. These are not only developed countries.

I mentioned the BHP smelter in Mozambique a moment ago. It draws its electricity through the grid of South Africa. South Africa has introduced a carbon tax. It is a developing country but has a carbon tax. China has a number of special levies on energy intensive and emissions intensive industries like aluminium, steel and cement. And, of course, many states of the United States and provinces of Canada have state and provincial schemes even though they do not yet have national mitigation schemes. If you look objectively at what everyone is doing and then work out what is the actual effect on the world price and therefore the disadvantage to our producers of some other countries not having a carbon tax, the absence of other countries’ carbon pricing would not be as comprehensive as is commonly believed in Australia. So that is one big difference.

A second difference is that, if you are calculating the effect on the world price of other countries not having a carbon tax, you would take into account that for some industries—not all, but for some industries—if every country in the world had the same carbon pricing there would not be a comparable disadvantage to producers in some countries because they are producing aluminium or other products through low-emissions means. You would take that into account. So that is an essential difference. It sounds technical and it is, but it has large consequences.

One disadvantage of the way the government has gone about it in the white paper and in the legislation is that there are no clear principles that allow you to draw the line. Someone always just misses out and feels that it is all very unfair. That will be true wherever you draw the line, so you do not end the debate by shifting the line. You just change the participants in the debate. We have seen that progressively since last July with the green paper and then in December with the white paper. There is continual pressure to redraw the line. That is absolutely inevitable unless you have clear principles for compensating trade exposed industries during the transition period. The right principles are the ones I set out in my report.

What we have done is not unique to Australia and I am not saying that the government has done this particularly badly. You could make similar comments about Europe and how they have gone about things in the past. You are getting a similar debate in the United States. In the United States, President Obama’s election policy was, ‘Auction the whole lot.’ But they are talking about a carbon tax on imports from countries that they think are not doing enough on climate change, which would end up having similar distortions to the allocation of free permits.

So there is a general problem. Every country at the moment is looking at doing the compensation in its own way, and without reference to basic economic principles. We are going to create more and more arguments by affected industries that they are being unfairly treated compared with someone else. When you have different arrangements in different countries, everyone will be badly treated compared with someone else. That becomes an argument for more free permits. There is no end to that political road. The formula that I propose deals with that question. It is also a satisfactory basis for an international agreement. All countries could do it. In fact that is the way for all countries to do it until we have an effective global agreement with trade in permits.

I have discussed this matter with the Director-General of the WTO, who came to my office in Canberra to discuss that a couple of weeks ago. You can be assured that leaders of the WTO are as concerned as I am about the distortions of the trading system that will result from what is going on at the moment, not only in Australia, but in every country. We are just talking about transitional arrangements. The problem disappears once all major countries have emissions entitlements and you have trade in permits, because the trade will lead to similar emissions prices in all countries and no-one will be able to complain that they are being affected more than their competitors.

Senator MILNE —I know everybody wants to participate in this. We do not have a lot of time. But just to follow on from what you are saying about those compensation arrangements and the WTO distortions, as it stands, do you think the government’s scheme will be able to be self-funding?

Prof. Garnaut —That depends.

Senator MILNE —Given what we are hearing on all the compensation arrangements as they currently stand—

Prof. Garnaut —It depends on a few things. It depends on how fast the trade-exposed industries grow compared with other industries. Their growth is being affected now by recession. Hopefully, this is short-lived, but it depends on that.

Senator MILNE —Yes.

Prof. Garnaut —It depends on the targets. If you tighten the targets—and the government’s range is five to 15—if you go to 15, it is less likely to be self-funding because you are selling fewer permits. A higher proportion of the permits are going to the trade-exposed industries. A higher proportion of the permits will go to the trade-exposed industries if the trade-exposed industries are growing relatively fast. So there is at least a reasonable possibility that the scheme will not be self-funding.

Senator MILNE —So just to clarify the statement, what you were just saying is if you have an unambitious target and these generous compensation provisions and the science then demands—which I believe it will—that you go to a much more stringent target, the consequence will be, if the architecture is in place as it currently stands, a mega cost to the taxpayer.

Prof. Garnaut —We would need to add another variable and that is how fast the trade-exposed industries grow. But if you add that to the mix of points you made then, it is an accurate statement.

Senator MILNE —Thank you.

CHAIR —Thank you. We will come back too, if we have got time. Senator Furner?

Senator FURNER —Thank you. Welcome, Professor. As you would be aware, there are calls out there for the delay of any scheme as a result of the global financial crisis. Firstly, should the scheme be delayed? Secondly, how important is it to get the framework up and running for next year?

Prof. Garnaut —There are costs and risks to the scheme being delayed and I think it is important to get it running for next year. It is a big institutional development putting in place an ETS. There is a lot of learning from a lot of firms, from a lot of regulators, and we will not get this exactly right in five minutes. And the sooner we get everything in place, the sooner the learning begins. In my report, I suggested we begin with a fixed price for a period, the Kyoto period, which would be an opportunity for learning about the system, making sure that we have got the compliance system in place, that firms are geared up in personnel and in training to make sure that emissions are accompanied by a permit.

There are advantages in doing that while you have got a fixed price in the early stage. Starting next year would give us a better chance of the ETS being able to carry the heavier load it will have to carry after 2012. Up to 2012 there is not such a heavy load of emissions reduction, maybe none. But it is likely there will be a big load after 2012. Getting the place working, ironing out the bugs, having it in top shape for 2013 is important.

Getting things moving early is also important for the international discussion. Let us remember that we do not solve the problem unless we have a comprehensive global agreement. At Rio de Janeiro in 1992 and in Kyoto in 97, confirmed in Bali last year, developed countries said they were going to take the lead and a number of developing countries have said, ‘Well, we will do things once the developed countries have done what they said they would do.’ Unfortunately, there is not much evidence of some countries doing what they said they would do and it is a long time since 1992, and a long time since 1997. Putting in place this ETS is one of the things we said we would do. For this to be defeated comprehensively, for Australia not to go ahead with an ETS now, would be one more source of cynicism in the developing countries about whether developed countries ever were going to do what they had promised to do.

Do not forget that we promised to do our part in mitigation at Rio and at Kyoto. We did not ratify the Kyoto agreement for a long time, but we were there in 97 and were part of the formation of that original agreement. It would be a setback for the global negotiation if we pulled right away from it, as distinct from improving it. It is clear from things I have said that I think it can be improved. There is currently an important debate going on in the United States about an ETS. President Obama came to office committed to an ETS. He has asked the congress to come up with an ETS that will reduce emissions by 80 per cent by 2050.

It is controversial there as it is here, and it is hard there as it is here. For those who do not want to take any step in the United States, to be able to point to an Australian government that had come to power committed to introduction of an ETS on this timetable and have it fail, would be influential in the American debate. We sometimes underestimate the extent to which we are noticed, especially on these issues, because we are one of the three developed countries, with the United States and Canada, that have got extraordinarily high emissions per capita and so Americans think a bit of us when they think of what they can do themselves.

Senator FURNER —Just one last question and I am mindful that other people have got questions as well. In referencing your recent comment about breathing space in the current economic crisis, what do you think is going to happen to Australia’s emissions since the economic downturn and, also, where do you think emissions might likely head in the next year or two?

Prof. Garnaut —When I made those comments in the opening address to the annual conference of the Australian Agricultural and Resource Economics Society in Cairns a few weeks ago, I was referring to the global, rather than specifically to the Australian, situation. I addressed those issues again this morning in the opening address to the CSIRO’s annual climate change conference. Clearly, the deep global recession is pulling emissions well below what they otherwise would have been. Emissions may actually have fallen in the September quarter and since. It was some time before we get the numbers, so I do not assert that on the basis of any certainty. But in the September quarter and December quarter last year Chinese electricity demand actually fell, steel production fell and cement production fell. There were big declines in manufacturing output and electricity use in a lot of developed countries, so it would not be surprising if, since the September quarter, we have had a fall in emissions.

What matters for global emissions growth is how quick recovery is, how strong, and what the character of that recovery is. Will it be more of the same or will it be with a focus on lower emissions energy? They are all hard questions. My best guess is that if the world was not doing anything about mitigation this would put back the level of emissions of the world by two or three years. That is equivalent to a pause in emissions growth for two or three years. That is what I referred to as ‘breathing space’. What emissions would have been in 2030 will be the level in 2032 or 2033. That is not much of a comfort, because even if emissions have fallen in the last six or nine months they are still at a level where concentrations of carbon dioxide equivalent in the atmosphere are still growing quite strongly. We are very close to 450 parts per million now, which is sometimes characterised as a point where—

Senator FURNER —That is no excuse, I submit.

Prof. Garnaut —It is not a reason for delay. It is a small breathing space.

Senator FURNER —Thank you

Senator MILNE —Can I just clarify that, Professor Garnaut. Whilst you talk about the slowdown in emissions, and I accept that, isn’t it true that the science has now shown that global warming is accelerating at a far faster rate than the IPCC and that, whilst you are talking about emissions, they are saying that 450 parts per million is no longer the safe level and we should be down to 350 or 300? In fact, when you take the science into account with what might be seen as a slowing in emissions, we still have a greater target than we had before.

Prof. Garnaut —Yes. I am a little bit careful about use of the term ‘the science.’ Certainly there has been a lot of important scientific work that points in that direction since the IPCC’s last report. The settled process for incorporating that into a global scientific view has been the IPCC. There are quite a few important papers that make the point that you are just making. I never pretended to be an authority on the climate science. I would not like to judge the importance of those developments. It is a reasonable assessment that the recent scientific developments have tended to expand emphasis on the risks. There were several papers at the recent Copenhagen science conference to that effect.

Senator BUSHBY —Basically, as I understand your position—which has been repeated today—in the paper you gave to the CSIRO conference, you believe that there should be a low fixed price for carbon in the Kyoto period before then ramping up. Has the global financial situation increased the need for such a transitionary measure?

Prof. Garnaut —I thought it was the right thing when I did the report. I know that was not favoured by the government, but I thought there were good reasons for it as a way of providing additional certainty during that early period—take some of the pressure away from some of the wilder claims for compensation. If there is uncertainty about the carbon price, then people get anxious and it can exaggerate expectations of the price. So I thought introducing a fixed price during a period when we were not under pressure to greatly reduce emissions had advantages independently of the crisis. The main effect that the crisis has had relevant to this point, I think, is to increase the financial fragility of a lot of enterprises in Australia. That is a temporary thing—or hopefully it is a temporary thing.

Senator BUSHBY —Hopefully, yes.

Prof. Garnaut —And short. If you ask me, as an economist, to give my best guess, I would say that this issue would no longer be a critical one and that we will be expanding again as an economy by the middle of next year. But the fixed price is helpful in circumstances in which there are doubts about that.

Senator BUSHBY —In your review you spoke about a principled approach to assistance to industry.

Prof. Garnaut —Yes.

Senator BUSHBY —And you mentioned today that it has already become clear that the ad hoc approach favoured by the white paper is not plain sailing. I think you might have touched on it in one of your earlier answers.

Prof. Garnaut —Yes.

Senator BUSHBY —Can you, for the committee’s benefit, outline what is the principled approach that you are advocating and why you think that that would be a better way to go?

Prof. Garnaut —Yes. What we are seeking to do in this is play our part in a global scheme. What we are working towards is a scheme in which, at least in all significant countries, you have comparable mitigation effort reflected in a comparable carbon price or emissions price. In such a world these issues of compensation do not arise, because our competitors face the same conditions. It is a world we want to move towards as quickly as possible.

There is a problem in a transition period before you have comprehensive pricing. If we implemented the policies of the white paper in this period we would have some countries with higher carbon prices than us, some with none and some with lower prices. So the question is: what compensation is rational, is economically efficient, in those circumstances? The right level of compensation can be determined by looking at the price in international markets of the product of Australian firms now and what it would be if all countries had comparable carbon pricing. Take cement, because it is simple. There are no low-emissions ways of producing cement from the current technology. If we were to have an ETS with a substantial carbon price and China did not—in fact it has some impositions on cement—if Korea did not and if the Philippines did not, then our producers could not only validly argue that they were more economically and, possibly, environmentally efficient than their competitors but that they were not competitive because we had carbon pricing and they did not.

So you would have an independent body—and in Australia an example is the Productivity Commission—that would work out what the cement price would be if all countries had comparable emissions pricing, and then the basis of compensation would be the difference between the price that our producers are getting and what they would get if all countries were getting it. So that gap would be filled. For ease of administration, I suggested that there be some threshold. For very small effects you do not get compensation, but for everything above that threshold you would get fully compensated. So that is the principle, and, as I said in my answer to Senator Milne, this is capable of international application. This could solve the problem for us alone, but it could also solve the problem for the world trading system. If we had a few years to work on it—if we are focused on making sure it was in place at the end of the Kyoto period—then there would be time for an international understanding if there was the political will to move in that direction.

Senator FURNER —If that had been adopted as part of the CPRS, would that have impacted on the ability to meet reasonable targets?

Prof. Garnaut —No. Under such a scheme, the government would auction all permits and use part of the revenue for this sort of compensation. There would be adequate revenue with plenty left over, I am sure, for research, development and commercialisation of the low emissions technologies, and it would be consistent with our reaching our targets.

Senator CAMERON —Professor Garnaut, a Sydney Morning Herald article has been drawn to my attention. You talk about oiling the squeaks in the system. I must say that we need an oil tanker with ear muffs in this committee. We have had plenty of squeaks coming here over the last couple of hearings.

Prof. Garnaut —I do not think I have ever used that description of what was going on. Someone might have attributed it to me, but it does not seriously misrepresent my views.

Senator CAMERON —We have had the coal industry come here this morning and basically say that they should get more support, that the Western Australian coal industry has not been well looked after, basically, within the $3.9 billion that has been allocated. I am just wondering what your views would be on more assistance to the coal industry?

Prof. Garnaut —The problem is the one I articulated earlier. There is nowhere to draw the line. You do not have clear principles, so it just becomes a political push. As you satisfy another group, then you make really unhappy the people who just miss out, so you give it to another group. There is no principal place to end the process. I think we have to go back to some principles, and I think the one that I have articulated is the right one.

Senator CAMERON —We heard evidence last week from James Cameron. I am not sure if you know of him. Apparently he is an export in Europe who has provided advice to governments and the EU in relation to climate change. I will paraphrase because I do not have the transcript of what he said. It was basically, ‘Australia can play a leading role in demonstrating leadership and even if the scheme that you put in place doesn’t meet everybody’s requirements and it is flawed, you had better put a scheme in place because that is the right thing to do.’ Have you got a view on that?

Prof. Garnaut —I think we can still put in place a good scheme. I do not think it is a compromise of principle to have a fixed price in the beginning, get it all working right and then remove the training wheels after 2012. I think the free permits, or the way they are being worked out in the white paper, are poor public policy. They are a problem for the public financers. That is a big problem. There are questions about whether the funding within the system can provide what is needed for public support for research, development and commercialisation of the new technologies. But you do get the scheme working.

If you were very clear that the current ‘distortionary’ arrangements for trade-exposed industries was very temporary while we put in place a post-2013 arrangement based on principle, I would say it is better to have it than not. For the reasons I said at the beginning, I think there are big consequences in our not going ahead now. It would be a setback for the international discussions. As a country with a poor history on these things, we will be seen by developing countries as not going forward with what we had proposed. I would suggest making some adjustments and going ahead. The risks to the international discussions and the risk to Australia not being well placed in 2013 will be large if it was comprehensively defeated.

Senator CAMERON —You have given us quite a deal of your views on the carbon tax approach. Could you also comment on the baseline and credit scheme and why you opted not to go baseline and credit?

Prof. Garnaut —There are plusses and minuses of the carbon tax and the ETS. On balance, I favour the ETS. I think the baseline and credit is a long way behind. The most important problem with it is it leads to big and arbitrary changes in the distribution of income. The government does not collect revenue out of it to make up for those changes in the distribution of income. Take the energy sector. This was the big problem in Europe. If you have a baseline and credit system, you are in fact giving free permits to everyone who is emitting now. You restrict the number of permits and the price of permits goes up, so anyone who received one of those permits free and is still generating electricity can sell electricity at a higher price because new competitors will have to buy a permit at that higher price. But they have got all these free permits, so they can sell them. They are just a capital gain to those companies at the same time as the users of electricity have to pay much more. This is why the question of energy poverty, which was a big issue in Britain in the eighties and was dealt with and ceased to be an issue, has come back as an issue. The energy producers have passed on the costs. That will happen with an ETS giving out free permits to the energy sector, or it will happen with the baseline and credit, only it happens comprehensively with the baseline and credit. It is more of a problem than it is with the sort of ETS that we are contemplating.

Senator PRATT —I want to pursue the economic question. Professor Garnaut, you talked about how failing to act would disadvantage us in relation to international negotiations. Clearly, you are familiar with, and have detailed knowledge of, economic modelling as it pertains to the question of an ETS. We have just experienced an economic downturn. I am interested in your analysis of how a failure to act would impact on us in terms of coming out of an economic downturn in terms of investment uncertainty. Clearly, we have a contracted economy. Is it better to impose some kinds of modest cost constraints on export industries when the exchange rate is depreciating versus when the exchange rate is appreciating, and looking at those cost imposts when you have a profit sheet that is at an all-time high versus when it is at a low point, as we seem to be experiencing now?

Prof. Garnaut —There are a lot of important issues there and you raised one important point that is not commonly discussed. That is the relationship between the exchange rate and the permit price system. The joint modelling that I did with the Australian Treasury is reported in summary in my review. There is a paper on the technical issues behind that work on the website of the Garnaut review, www.garnautreview.org.au. The Australian economy as a whole is not affected very much by whether we compensate trade-exposed industries. One of the things that happens if we do not compensate trade exposed industries is that we end up with a lower exchange rate. That encourages some other export industries. Those general equilibrium effects are complicated, but the exchange rate ends up becoming important in the overall adjustment of the Australian economy.

Is it a good or a bad time in a recession to introduce mitigation measures? It is a very good time to introduce support for new low-emissions technologies because the opportunity cost of labour and capital is low. It is a time when it makes sense for government to take stimulatory steps in the economy. If you can use the money in ways that help set the economy up for efficient operation in the post-recession world, you get a double dividend for it. So now is a very good time for a big emphasis on public support for research, development and commercialisation of the new technologies.

On carbon pricing, there is a reason to be somewhat cautious about putting an extra cost on some firms while the recession continues because of financial fragility during recession. As I mentioned before, my judgment would be that, by the time an ETS was introduced in the middle of next year, we would be beyond a recession; we would be in an expansionary phase. We do not know that for sure, but if this were the case then that is actually a good time for structural change.

Senator FISHER —I want to turn to the objectives of an emissions trading scheme. Earlier on in your answers you talked about the overall aim is to reduce global emissions. In your view, does the legislation currently before parliament achieve that? What should be the objective of the legislation before parliament? What guarantees are there in that legislation that it will achieve those objectives?

Prof. Garnaut —There are two aspects to my response. First, I have seen questions about how you should interpret what is in the legislation and about the targets. But if the legislation means the target will be somewhere between five and 15, depending on what the rest of the world does, then a 15 per cent target would allow us to play our full proportionate part in a firm but not a very ambitious global agreement. In a global agreement that had the objective of 550, then a 10 per cent reduction would equate to that. Five to 15 would equate to somewhere lower than 550 parts per million.

The white paper, consistent with the recommendations of my review, said that it is in Australia’s national interest to aim for 450 or lower. The targets do not allow Australia to be part of such an agreement. I note that the Prime Minister said at the National Press Club when the white paper was released that he could seek more ambitious long-term mitigation objectives. It would be helpful to our place in these international discussions if we kept on the table the chance of a 25 per cent reduction by 2020, conditional on others doing comparably stringent things.

Senator FISHER —Professor, in answering the question about what is the objective of the ETS, you have gone straight to the issue of targets. What guarantee is there that the debate about the emissions trading scheme does not become a debate simply about targets? What guarantees are there, in your view, in the legislation that will be considered by parliament that ensure the targets do not essentially become the end unto themselves rather than what should be the higher level objective of an emissions trading scheme?

Prof. Garnaut —Senator, I cannot guarantee you anything about what is discussed in the parliament.

Senator FISHER —Then perhaps a question on notice—

CHAIR —Senator Fisher, I think it is a bit much to ask Professor Garnaut a question on notice. He has not got a secretariat. Thank you, Professor Garnaut, for coming along today.

Proceedings suspended from 12.44 pm to 1.06 pm