Saturday, November 12, 2016


A major element of Trump proposals for US energy policy targets complaints that energy costs, driven by supposedly excessive concerns over climate issues, are disadvantaging US industry, notably in competition with China. As usual there is a complex story to be told, probably too complex for a short comment, but the following observations ought to provoke some thought.

“It’s a lament that rarely holds up under examination of the facts. All too often, these complaints are part of a lobbying campaign that is essentially political. And when that’s not the case, we usually find there’s a lot of money at stake in industries that are reluctant to invest in adjusting to future challenges. And even when corporate leaders know that these investments are necessary, a majority of them still believe the cost should be paid by the taxpayer. That leads them to threaten using their deadliest weapon, the threat of job cuts and the relocation abroad of their factories and production operations.”

Does this sound familiar in a US context? Could it have been written by a US commentator? I suspect it does and could. But, surprising as this may seem, it was written by a former German environment minister in 2014. The context was not the supposedly high costs of US industry, but concerns about the competitiveness of European and especially German industry in relation to a low energy cost USA. He continues the attack.

The complaints by European industry lobbyists, that energy costs are putting them at a “destructive” competitive disadvantage, simply doesn’t stand up to scrutiny. Industry lobbyists will say either that the costs of labour are too high, or that their big problem is the price of energy. America’s historically low gas prices are at present the cause of yet more European moaning.

The facts show how wrong they are. Energy costs account on average for less than 3% of gross production costs in Germany, whereas staffing costs account for about 20%. Even if you look at shares of gross value creation, the energy costs don’t exceed the 10% mark. Yet, industrial lobbies and trade associations continue to prophesy the end of the Western world.

I made similar points in recent evidence to the House of Lords in respect of their questions about loss of industrial capacity in the UK and energy costs as a possible cause.

It is difficult to argue that there is a strong relationship between high energy costs and the loss of industrial capacity in the UK. The following points tend to support this sceptical perspective.

1. The Committee on Climate Change analysis[1] suggests that the proportion of industry and GDP for which energy costs are a significant influence on a firm’s price competitiveness is quite small. [c 2.6% of GDP].  If analysis is confined to goods in extra-EU trade the proportion will be smaller.

2. Exchange rate movements are substantially more significant in their impact on cost competitiveness. The recent depreciation of sterling will have substantially improved the UK position in an international energy price comparison (except to the extent that domestic prices embody international fuel prices). But the same exchange rate depreciation will also have a much bigger and generally more important competitive impact on firms through making their comparative labour costs, and other domestically incurred costs, more favourable (since these are a bigger proportion of total costs even for most energy intensive industry),.

3. The loss of UK industrial capacity in the 1980s and 1990s has been strongly associated with the advent of North Sea oil, sometimes known as the “Dutch disease”, and strongly associated with the exchange rate impacts of North Sea oil as well as of economic policy during that period. It had little to do with energy prices per se.

4. In general the association of energy prices with measures of competitiveness looks weak.  Many of our Asian competitors have faced higher energy costs than the UK or EU. Germany, widely regarded as the most “competitive” of the EU economies, also has among the higher levels of energy costs, in spite of what is sometimes seen as an artificially competitive exchange rate position within the euro[2].

5. There are likely to be some “carbon leakage”[3] issues for particular energy intensive and internationally traded products and industries, especially if competitors are subject to less stringent emissions targets. This should not in principle be a problem in relation to EU competition, assuming the UK were to continue to participate in a reformed EU ETS[4], but may be a problem in relation to other countries, eg Chinese steel.

6. However the appropriate response may be to consider remedies for each of the small number of affected sectors on its merits, rather than to distort the general pattern of UK energy policy.   The political and economic issues are very much akin to those of general trade policy, anti-dumping etc. Anticipation of a changing post-EU trade environment obviously adds to the potential complexity of this particular issue.

From all this we might deduce the probability of a strong read across to the US, ironically with US gas being a main focus of comparison for European “moaning”. The reality for the US is, I suspect, closer to the following.

US coal, and coal communities, will have been hit hard by the fall in US gas prices. Climate policies are a convenient scapegoat in a political environment that includes a strong ideological commitment to rejection of climate science.

There is also a very strong perception that American jobs have been destroyed by competition from “cheap” Chinese labour. Migration of some industry to poorer countries with lower labour costs is an almost inevitable consequence of globalisation. We can and do argue at length in every developed economy about how best to deal with that. It is a serious issue of adjustment to globalisation and free trade. But that is a debate for another day.

The real point though is that energy prices per se seem unlikely to have much connection with concerns over “unfair” Chinese competition, for the reasons given above.  What dominate are first real labour costs, and second exchange rates. Exchange rates are part of the process of adjustment that allows trade to balance in response to differing comparative advantage between countries[5]. Inevitably someone will have a comparative advantage in labour costs and someone else in energy or agricultural production.

Given its resource endowment, the US has always been in a strong position on energy compared to Europe, and it is worth noting that China is pressing ahead hard with an emissions reduction agenda. So using competitiveness concerns as an excuse to avoid ambitious climate targets looks like a particularly specious argument.

There have been other concerns in Europe, mainly on the emissions impact of the unloading of surplus US coal, but that is another and more familiar story.

What is challenging and depressing is the apparent universality of almost entirely phoney claims for the profound significance of energy costs in industrial competitiveness. A good time to ask if the emperor actually has any clothes, or to shout “Cui Bono?”. Who benefits?

[1]Reducing the UK’s carbon footprint and managing competitiveness risks, Committee on Climate Change April 2013.
[2] In the sense that reversion to the DM would make Germany much less competitive. But it should be noted that Germany has also been accused of cross-subsidising parts of its heavy industrial sector.
[3] Carbon leakage occurs if a country exports its own industry emissions to another country solely as a result of having a more stringent policy on CO2 reduction, possibly resulting in the unintended consequence of higher global CO2 emissions.
[4] This point, and that the bulk of this trade is intra-EU, is made in the 2013 Committee on Climate Change report.
[5] In fact the whole concept of industry competitiveness becomes quite questionable in this context. But that again is another question for another day.

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