Carbon pricing: a policy tool for sustainable growth (2019)

Cars in Traffic jam
Cars in Traffic jam

Putting a price on carbon in global markets allows for the trade in carbon to be taxed. Carbon taxing is an effective economic tool to drive down countries’ emissions. Developing world countries are far behind the Global North in terms of testing different approaches to carbon taxes and emissions trading. Researchers at EfD centres in Colombia, China, Ethiopia and Costa Rica aim to address this knowledge gap and support policy makers in their countries.

What are the challenges?

The 2015 Paris Agreement that resulted from the United Nations Framework Convention on Climate Change annual meeting recognized the need for a global commitment to address climate change. Every signatory country is required to commit to efforts that will reduce their greenhouse gas emissions through Nationally Determined Contributions (NDCs). These NDCs state each country’s planned emissions reduction goals and strategies. The Paris Agreement also recognized the unique challenges that low-income countries face, particularly relating to the need to eradicate poverty and promote sustainable development. 

Carbon pricing offers an economically efficient approach to emission reductions, and is a promising tool for countries looking to make significant environmental progress without jeopardizing economic development. In the Global South, however, there is relatively little experience with pricing approaches such as carbon taxes and emission trading programs, and there are major knowledge gaps relating to how such programs should be designed to meet the unique challenges of each country.

“In my view, there are important practical differences among countries at different stages of development that need to be respected in crafting portfolios of initiatives for addressing both greenhouse gases (GHG) mitigation and vulnerability to climate change” says  Michael Toman, Lead Economist and Manager of the Development Research Group from the World Bank and member of EfD Research committee.

EfD is addressing the problem

EfD has been working to fill these gaps through research and engagement with policy makers, addressing such topics as program design, appropriate stringency, implementation issues, and evaluation. These efforts are also helping policy makers see that pricing can not only be a tool for reducing the damages and environmental impact but also an opportunity to promote sustainable economic growth that can help poverty alleviation in developing countries.

The cases of Colombia, China, Ethiopia and Costa Rica are clear examples of how EfD’s work is helping developing societies go through this process, sharing the paths and lessons learned from each other.

China’s pilot emissions trade schemes

In 2013 China launched seven emissions trading scheme (ETS) pilot projects in seven provinces (Beijing, Chongqing, Guangdong, Hubei, Shanghai, Shenzhen, Tianjin) to test a cost-effective approach for low carbon development. Later, in 2017, the country built on these pilots and established a nationwide carbon emissions trading market. The stakes for success are high globally, because of the importance of emission reductions from China. But the nation’s continuing need for robust economic growth, to lift millions of citizens into the middle class, also means that the country needs to succeed in this regard.

There has been much debate regarding the actual performance of the program. In response, EfD researchers Xing Chen and Jintao Xu from the Environmental Economics Program in China (EEPC), prepared a policy overview including an analysis of the policy design, the legislative basis and the market performance after four years of pilot testing.

Their results show that the market is not yet liquid enough to work properly, resulting in low trading volume and missed opportunities for efficiencies. The primary recommendations for policy makers are to expand the coverage of the ETSs beyond the energy-intensive sectors, improve market transparency, and allow trading of multiple types of pollutants to improve liquidity.

EfD Colombia’s key input for carbon tax policy

Colombia estimates that, with a carbon tax, the country will reduce its emissions by 45 percent by the middle of this century. This policy is likely to have significant economy-wide impact, with some losses in its gross domestic product (GDP).

To reduce the impact on the economy, the policy recommendations emphasize the important role of electricity in achieving CO2 emission reductions through increased deployment of wind and hydro-power production. Promoting this type of energy was a key element of the tax reforms enacted in 2017.

EfD-Colombia researcher Santiago Arango-Aramburo worked with the country’s National Planning Commission (NPC). He says that the electric power sector plays an important role in achieving CO2 emission reductions in Colombia, through the increase of hydropower, the introduction of wind technologies, and the deployment of biomass coal and natural gas.

EfD Ethiopia: guiding national policy from the get-go

The Government of Ethiopia, the Ethiopian Development Research Institute (EDRI, where the EfD center is based), and the World Bank joined forces on a carbon pricing policies study. The objective was to draw up recommendations on the role and possible forms of carbon pricing, and the potential benefits and costs for Ethiopia to reduce greenhouse gas (GHG) emissions.

Important results of this study are:

  • Imposing a carbon price on fuels has a small impact on the economy. Using the carbon tax revenues to cut sales tax or business income tax leads to a smaller impact on GDP compared to the other scenarios.
  • The country can raise significant revenue through a carbon tax. The policy scenario of this study states that, with the price on carbon rising to $30/ton in 2030, total revenue from the carbon tax can be as high as $800 million in that year, depending on the scenario. As a source of income, this tax can be transferred to lower-income households, or used for other public purposes.
  • In terms of the distributional implications, industry and service sectors are more transport-intensive and therefore more fuel-intensive. Therefore, a carbon tax has a larger proportionate effect on them. Since most urban households receive a large proportion of their income through employment in the service and industrial sectors, a carbon tax tends to affect income and consumption of urban households more than rural households.

A valuable benefit of this study is that its lessons may also be useful for other low-income countries.

Similar and significant efforts in the design stage of ETS are taking place in other centers, including India, Costa Rica, and Vietnam.

“Even in a small country like Costa Rica, there is a very large number of carbon emitters who are very different from one from the other, so in order to successfully reduce emissions we need a systemic policy tool. The best tool is to put a price on carbon and we’d produce an analysis of the impact of the carbon policy on GDP, on the distribution of income and potentially on emissions, for policy makers to understand the options and make a well informed decision” says EfD Central America Researcher and Partnership for Market Readiness specialist, Francisco Alpizar.

Costa Rica officials are in the final policy decision making stage followed by the actual implementation of the carbon tax.

Which SDGs does this work tackle?

SGD 13: Climate action

Carbon pricing is one way of supporting Sustainable Development Goal (SDG) 13. By including the cost of climate change in the price of fuel and other energy-intensive goods and services, a carbon price sends a price signal to industries, households and individuals to encourage a change in behavior.


Calderón, Silvia; Álvarez, Andrés; Lobo, María; Arango, Santiago; Calvin, Katherine; Kober, Tom; Daenzer Kathryn & Fisher-Vandem, Karen. Achieving CO2 reductions in Colombia: Effects of carbon taxes and abatement targets. Energy Economics. 56. 575-586. 10.1016/j.eneco.2015.05.010

Chen, Xing & Xu, Jintao. (2018). Carbon Trading Scheme in the People's Republic of China: Evaluating the Performance of Seven Pilot Projects. Asian Development Review. 35. 131-152. 10.1162/adev_a_00117.

Meckling, Jonas & Sterner, Thomas & Wagner, Gernot. (2017). Policy sequencing toward decarbonization. Nature Energy. 2. 10.1038/s41560-017-0025-8.

Telaye, Andualem; Benitez, Pablo; Tamru, Seneshaw; Medhin, Haileselassie & Toman, Michael. Exploring Carbon Pricing in Developing Countries. A Macroeconomic Analysis in Ethiopia. To be published by World Bank.

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Sustainable Development Goals
Story | 14 May 2019