Handbook of Sustainable Politics and Economics of Natural Resources 1789908760, 9781789908763

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HANDBOOK OF SUSTAINABLE POLITICS AND ECONOMICS OF NATURAL RESOURCES

ELGAR HANDBOOKS IN ENERGY, THE ENVIRONMENT AND CLIMATE CHANGE This series provides a definitive overview of recent research in all matters relating to energy, the environment, and climate change in the social sciences, forming a comprehensive guide to the subject. Covering a broad range of research areas including energy policy, the global socio-political impacts of climate change, and environmental economics, this series aims to produce prestigious, high quality works of lasting significance. Each Handbook will consist of original contributions by leading authors, selected by an editor recognized as an international leader within the field. Taking an international approach, these Handbooks emphasize both the widening of the current debates within the field, and an indication of how research within the field will develop in the future. Titles in the series include: Research Handbook on Communicating Climate Change Edited by David C. Holmes and Lucy M. Richardson Handbook of Security and the Environment Edited by Ashok Swain, Joakim Öjendal and Anders Jägerskog Handbook of Sustainable Politics and Economics of Natural Resources Edited by Stella Tsani and Indra Overland

Handbook of Sustainable Politics and Economics of Natural Resources Edited by

Stella Tsani Assistant Professor, Department of Economics, University of Ioannina, Greece

Indra Overland Research Professor, Norwegian Institute of International Affairs, Norway

ELGAR HANDBOOKS IN ENERGY, THE ENVIRONMENT AND CLIMATE CHANGE

Cheltenham, UK • Northampton, MA, USA

© Stella Tsani and Indra Overland 2021

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2021946152 This book is available electronically in the Political Science and Public Policy subject collection http://dx.doi.org/10.4337/9781789908770

ISBN 978 1 78990 876 3 (cased) ISBN 978 1 78990 877 0 (eBook)

EEP BoX

To my co-travellers Andreas, Melina, and Martha Stella Tsani

Contents

List of contributorsx Prefacexxiii Acknowledgementsxxiv List of abbreviationsxxv 1

In quest of sustainable politics and economics of natural resources: a summary of contributions and future research directions Stella Tsani and Indra Overland

PART I

1

RESOURCE SPECIFICS AND CONSIDERATIONS FOR POLICY MAKING

2

Natural resources and economic development Wee Chian Koh

15

3

Renewable energy transition, demand for metals and resource curse effects André Månberger

30

4

Local and global aspects of coal in the ASEAN countries Haakon Fossum Sagbakken, Aidai Isataeva, Indra Overland, Aloysius Damar Pranadi, Beni Suryadi and Roman Vakulchuk

45

5

Policies and socio-economic tools for sustainable water management Stella Tsani, Stella Apostolaki and Phoebe Koundouri

64

6

Inflated expectations and commodity prices: evidence from Kazakhstan Victoire Girard, Alma Kudebayeva and Gerhard Toews

76

PART II

REGIONAL RESOURCE POLITICS AND IMPLICATIONS FOR GLOBAL POLICIES AND ECONOMIC DEVELOPMENT

7

Energy transition, resources and climate change investment policy in the EU Matthias Busse, Oliver Dreute, Vladimir Isaila and Lúcio Vinhas de Souza

8

Climate change policies and resource abundance: the case of Russia Igor Makarov

107

9

Green policies and sustainable development in Saudi Arabia Stella Tsani and Sarah Najm

123

10

How ambitious can the Israeli Green Deal be? Ruslana Rachel Palatnik, Ayelet Davidovitch, Volker Krey, Nathan Sussman, Keywan Riahi and Matthew Gidden

135

vii

95

viii  Handbook of sustainable politics and economics of natural resources 11

Powering the uplands: controversies of developing hydropower in upstream Central and Mainland Southeast Asia Stefanos Xenarios, Murodbek Laldjebaev, Dietrich Schmidt-Vogt, Joost Buurman and Eduardo Araral

12

Small-scale mining, rural resilience and the Sustainable Development Goals in Sub-Saharan Africa Gavin Hilson, Titus Sauerwein and Matondo Estrela Garcia Cardoso

13

Natural resource policies for future sustainability in the African continent Roula Inglesi-Lotz

152

186 205

PART III INSTITUTIONS AND RESOURCE POLICIES 14

Corruption, resource policies and economic growth Heli Arminen, Tiia-Lotta Pekkanen and Jorma Sappinen

218

15

Local content policies and institutional capacity for sustainable resource management230 Yelena Kalyuzhnova

16

Success and failures of sovereign wealth funds: on the macroeconomic performance, time-varying objectives and first liquidations of sovereign wealth funds Jean-François Carpantier and Wessel N. Vermeulen

242

17

Fiscal policy, macroeconomic volatility and the role of institutions under resource abundance Leonor Coutinho and Stella Tsani

261

18

Legal indicators as tools to assess the effectiveness of international rules related to the sustainable management of natural resources Emmanuella Doussis and Ilaria Espa

291

19

Resource conservation and environmental ethics: a theoretical framework supported by panel data Fabio Zagonari

301

PART IV CHANGE AND UNCERTAINTY IN RESOURCE POLICIES 20

Stranded assets and the financial system Andreas A. Papandreou

21

Energy modeling for sustainable policymaking: state of the art and future challenges Stella Tsani and Mariia Kozlova

22

Ambiguity in financing corporate mitigation policies Elettra Agliardi and Willem Spanjers

320

334 348

Contents  ix 23

Resource abundance and socio-economic shocks: COVID-19 pandemic and the State Oil Fund of Azerbaijan Ingilab Ahmadov

366

24

Hydrocarbons during energy transition: from peak oil supply to peak oil demand and investment? Is energy security at risk? Cyril Widdershoven

376

Index393

Contributors

Elettra Agliardi is Full Professor in the Department of Economics, University of Bologna (Italy). She obtained an MPhil and a PhD in Economics at the University of Cambridge (UK) and a PhD (with special mention and Obiettivo Europa Prize) at the European University Institute (Italy). Before joining the University of Bologna, she was Junior Research Officer, Department of Applied Economics (DAE) and College Lecturer in Economics and Fellow (Title A), Churchill College, University of Cambridge. She was Director of the PhD Program in Economics, University of Bologna, 2001–03, Director of Studies of the International Master’s Degree in Economics and Market Policy, 2008–12, and of the International Master’s Degree in Resource Economics and Sustainable Development, 2017–19. She is currently associate editor of the journals Review of Economic Analysis, International Journal of Financial Studies and e-Journal of Corporate Finance Research. Her recent research deals with real options, corporate finance, the economics of climate change and climate finance, where she developed pioneering models on green bonds. Ingilab Ahmadov obtained a Doctor of Science in Economics from the Saint Petersburg State University of Economics and Finance (Russia). He is Director of the Eurasia Extractive Industries Knowledge Hub. Since 1995 he has acted as Director General of the ‘Trend’ analytical information agency and since 2004 as the Director of the Public Finance Monitoring Center. He is a Professor at the School of Economics and Management, Khazar University, Azerbaijan. His research interests include management of oil revenues and impact of oil revenues on the economy, Caspian energy resources, and economic principles of oil contracts. Stella Apostolaki is an environmental scientist. She is Assistant Professor and Program Coordinator of the BSc/(Hons) in Environmental Studies, Department of Science and Mathematics, DEREE – the American College of Greece (ACG). She is also serving as Chair of the Academic Advisory Board at the Center of Excellence for Sustainability at the American College of Greece. She holds a BSc (Hons) in Environmental Science, MSc in Urban Water and Environmental Management and a PhD on Sustainable Urban Drainage Systems and River Management Options from the Abertay University, Scotland. She has been working as a researcher in collaboration with universities, research institutions and authorities for several years. Her main research interests include climate change, sustainable development, the implementation of the 17 Sustainable Development Goals, integrated water management and innovation, sustainable stormwater management, water scarcity, conservation of biodiversity, protected areas, public awareness like stakeholder engagement methods and public education, as well as on school environmental education, and green urban planning with emphasis on amenity and biodiversity. Eduardo Araral has 30 years of experience from academia and government. For 20 years he has served as an advisor and consultant for governments, donors and executive educational facilities in Asia. He holds a PhD in Public Policy from Indiana University-Bloomington, USA, completed on a Fulbright PhD Scholarship with 2009 Nobel Laureate in Economics, Elinor Ostrom, as his supervisor. He has served on three editorial boards, is co-editor of the x

Contributors  xi Cambridge University Press Elements Series in Public Policy, Associate Editor of the Oxford University Press book series on water governance and peer reviewer for journals. He is currently Co-Director of the Institute of Water Policy at the Lee Kuan Yew School of Public Policy (LKY) at the National University of Singapore, Vice-Chairman of the Asia Pacific Water Forum and principal investigator of the programme on AI, Blockchain, Cloud and Data (ABCD) at the LKY School. Heli Arminen is Professor of Economics at LUT University, Finland. Her main research interests lie currently in the fields of environmental and energy economics and corporate social responsibility. She has published 18 journal articles and three book chapters. Arminen is a quantitative research methods specialist (particularly panel data econometrics) and teaches courses in economics, econometrics and mathematics. She is Academic Director of the Bachelor’s programme in Business Administration at LUT. Matthias Busse is Economic Analyst at the European Fiscal Board Secretariat, which has the mandate to evaluate the implementation of the European fiscal framework and make suggestions for its future evolution. From 2018 to 2020 he worked as an analyst in the Economic Policy Unit of the European Political Strategy Centre (EPSC), which was the European Commission’s in-house think tank under President Juncker. Before joining the EPSC in 2018, he worked as a researcher at the Brussels-based think tank Centre for European Policy Studies (CEPS) for seven years. He has worked and published extensively on the European fiscal framework, Economic and Monetary Union governance, EU and international trade policy, EU–Asia relations and labour market policy. Matthias holds both a Master’s in Economics (KU Leuven) and European Studies (University of Hamburg). Joost Buurman is Senior Research Fellow at the Institute of Water Policy, Lee Kuan Yew School of Public Policy, National University of Singapore. His research revolves around two main topics: adaptation to climate change – in particular, decision-making for climate change adaptation measures – and urban water security. He has carried out numerous research projects and published in several high-impact journals. His extensive consultancy experience covers private and public sector organizations. Joost obtained his Master’s and PhD in Economics from the Vrije Universiteit Amsterdam in the Netherlands and has lived and worked in Southeast Asia since 2003. Matondo Estrela Garcia Cardoso is a PhD candidate at the Department of Business Transformation, Surrey Business School, UK. She holds an MSc in Financial Services Management and MBA, both from the University of Surrey. She carries out research that explores the impact of development minerals in Sub-Saharan Africa, exploring specifically how, if properly harnessed, they can catalyse growth and development in the region. Ms Cardoso is currently investigating how revenue from development minerals assist vulnerable groups in Angola, particularly households headed by women. Jean-François Carpantier is an associated researcher and visiting lecturer at the University of Luxembourg and the Université Catholique de Louvain (Belgium). He has worked as a credit expert for an international law firm and currently works as a financial risk expert for the Luxembourg financial sector supervisor. He holds an MSc in Law and a PhD in Economics and Management from the Université Catholique de Louvain. His current research focuses on financial econometrics, commodity markets and macroprudential supervision.

xii  Handbook of sustainable politics and economics of natural resources Leonor Coutinho is an economic analyst at the European Commission, DG Economics and Finance, working on the surveillance of macroeconomic imbalances. She was previously a senior researcher in economics at Europrism (Cyprus) and Special Scientist at the University of Cyprus, remaining a member of the expert panel of the Euro-Mediterranean Economists Association (EMEA). She holds a PhD from the European University Institute in Florence (Italy). Her research interests include international economics, DSGE modelling, macroeconomic imbalances, fiscal and monetary policy. Leonor has been engaged in several research projects, including projects financed by the EU and by the Cyprus Research Foundation. She has published in renowned journals, including the Open Economies Review, the Review of Economic Surveys and International Finance, as well as in the European Commission’s Quarterly Report on the Euro Area (QREA). She was previously research fellow at the Portuguese Science Foundation, Georgetown University (Washington, DC). She has also been Marie Curie Research Fellow at the Centre for European Policy Studies (Belgium) and worked for the World Bank. Ayelet Davidovitch is a research scholar at the Porter School of Environmental Sciences at Tel Aviv University. She joined the IE Applied Lab for Innovation in Industrial Ecology as a postdoctoral researcher. In 2018–19, she was an IIASA-Israel Program Postdoctoral researcher in the Energy Program at the International Institute for Applied Systems Analysis (IIASA), Austria. Davidovitch holds a PhD in Natural Resources and Environmental Management from the University of Haifa, Israel. She was a senior researcher at the Natural Resources and Environmental Research Center (NRERC) at the university. Davidovitch’s research focuses on integrated assessment of energy economics, energy modelling and climate change. Emmanuella Doussis is a Professor of International Institutions at the National and Kapodistrian University of Athens, director of the Institute of European Integration and Policy and UNESCO chairholder on climate diplomacy. She has studied political science and law at the University of Athens and at the Sorbonne in Paris (Paris I). After a first Master’s in Public International Law, she completed a second one in Environmental Law and a PhD in International Law. She has been visiting professor at the Universities of Bourgogne, Grenoble-Alpes and Aix-Marseille, and visiting fellow at the University of Geneva and the European University Institute in Florence. She is a member of the ILA Committee on the role of international law in sustainable management of natural resources, the IUCN World Environmental Law Committee, and the Greek National Committee for Adaptation on Climate Change. She has published alone or in collaboration with other authors ten books, and many articles in peer-review international journals. Her research interests include international and European environmental policy, the role of international institutions in the promotion of sustainable development, climate diplomacy, including the EU climate diplomacy, international settlement of disputes. Her more recent book concerns the role of international law in effectively managing climate change. Oliver Dreute is Chief of Staff at the European Patent Office. Holding a variety of posts in the European Parliament since 1995, he started his career working on external trade and relations with the World Trade Organization. From 2000 onwards, he focused on internal market legislation, especially intellectual property. In 2007, he became Legal Adviser and in 2009 Head of Unit for Legal and Home Affairs in the Group of the European People’s Party. In 2014, he joined the cabinet of the President of the European Parliament, first as Legal Adviser and

Contributors  xiii Team Leader for relations with the administration, then as Deputy Head of Cabinet. Oliver Dreute joined the European Political Strategy Centre, the European Commission’s in-house think tank in January 2017 as Adviser on the Multiannual Financial Framework (MFF). He participated in preparing the Commission proposal for the MFF 2021–27 based on analyses of the needs for expenditure and investment in the various policy areas, and elaborated ideas for forward-looking funding strategies, fostering investment, research and innovation, for facilitating access to EU funding and reducing administrative burden. In October 2020, Oliver Dreute joined the European Patent Office as Senior Policy Adviser. He studied law at the University of Bonn. Ilaria Espa is Assistant Professor of International Economic Law at Università della Svizzera italiana (USI), Switzerland, Senior Research Fellow at the World Trade Institute (WTI), Switzerland, and Adjunct Professor at the Università Cattolica del Sacro Cuore, Italy. She received a Marie Curie fellowship from the European Commission for her post-doctoral studies, and has been a member of the WTI-based NCCR Trade Regulation Programme until its expiration in 2017. Espa holds a PhD in International Law and Economics from the Department of Legal Studies of Università Commerciale Luigi Bocconi, Italy, and was visiting scholar at Columbia Law School, USA, in 2012. She holds a BA in Political Science and an MA in International Relations from Luiss University, Italy. Ilaria is a member of the International Law Association Committee on the role of international law in sustainable management of natural resources. She has published extensively in leading international peer-reviewed journals and is author of a monograph, Export Restrictions on Critical Minerals and Metals: Testing the Adequacy of WTO Disciplines (Cambridge University Press, 2015). Matthew Gidden is Team Leader for Mitigation Pathway Analysis at Climate Analytics. His work focuses on studying sustainable pathways for meeting societal demand for energy while mitigating changes to the climate and environment. Dr Gidden developed strong expertise in energy and climate change modelling during his tenure as a Research Scholar in the Energy Program at the International Institute of Applied Systems Analysis (IIASA), Austria, where he is a guest scholar. Dr Gidden has authored numerous scientific papers as well as scientific software applications in the field of integrated assessment modelling, notably the pyam analysis library. He is also an author of the IPCC Sixth Assessment Report. Victoire Girard is a researcher at Nova School of Business and Economics (Portugal). She holds a PhD in Economics from Paris 1 Panthéon-Sorbonne University. Her research is in development economics, political economy and environmental and natural resources economics. Gavin Hilson is Professor and Chair of Sustainability in Business at the Surrey Business School, University of Surrey, UK. He is a leading global authority on the environmental and social impacts of artisanal and small-scale mining in Sub-Saharan Africa, publishing over 350 journal articles, book chapters and reports on the subject over the last two decades. He is also founder and editor-in-chief of the international journal The Extractive Industries and Society. Professor Hilson received his Master’s degree from the University of Toronto, Canada, and his PhD from the Imperial College of Science, Technology and Medicine, UK. Roula Inglesi-Lotz is Professor at the Department of Economics at the University of Pretoria, South Africa, since 2021. She completed her undergraduate studies in economics at the

xiv  Handbook of sustainable politics and economics of natural resources University of Macedonia, Greece in 2006, an MCom in Economics from the University of Pretoria (cum Laude, 2008) and a PhD in Economics from the University of Pretoria in 2011. She teaches research methodology and econometrics to honours students and energy economics to Master’s degree students. Her research interests revolve around energy and environmental economics, applied economics and the broader development and growth economics field. She has authored and co-authored numerous publications in peer-reviewed journals. She is one of the two co-chairs of the Global Young Academy (GYA) for 2021/22. She is also the current president of the South African Association for Energy Economics (SAAEE), which was established in 2018 and the incoming Vice President of Membership and Affiliate Relations of the International Association for Energy Economics (IAEE) (2021/22). She is a member of the South African Young Academy of Sciences (SAYAS) where she served as a co-lead in 2020. Professor Inglesi-Lotz was named the Distinguished Young Woman Researcher in the Humanities and Social Sciences category of the 2017 DST Women in Science Awards. Vladimir Isaila is a Junior Professional at the European Commission, working in the Directorate-General for Structural Reform Support. He previously worked at the European Commission’s European Political Strategy Centre as a policy analyst in the Economics Unit working to provide policy advice, briefs and analytics to the Presidential Cabinet. Before joining the European Commission, he worked on various economic and social issues at the Beirut-based United Nations Economic and Social Commission of Western Asia in the Economic Development Division. He holds a Master’s in European Politics from the University of Amsterdam and speaks English, Romanian, French, Greek and Italian. Aidai Isataeva is Visiting Research Fellow in the Research Group for Russia, Asia and International Trade at the Norwegian Institute of International Affairs (NUPI). Isataeva has previously worked for Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) and completed an internship at the OSCE Secretariat in Vienna. She holds a BA in Economics from the American University of Central Asia and an MA in Economic Governance and Development from the OSCE Academy in Bishkek, Kyrgyzstan. Her main research interest is in development economics. Yelena Kalyuzhnova is an expert on oil and gas issues and emerging economies. After working as an Economic Adviser to the President of Kazakhstan, she founded and is the Director of the Centre for Euro-Asian Studies at the University of Reading, UK. Professor Kalyuzhnova authored the first book on the Kazakhstani economy in English, and is also the author of a number of research monographs and academic papers on economic issues. Within the UK government, Kalyuzhnova served as an economic adviser on Caspian issues to the Rt Hon. Lord Fraser of Carmyllie, QC, House of Lords as well as to the All Party Parliamentary Group on Kazakhstan, House of Commons. She is now Vice Dean of Henley Business School, UK. She is also a member of the Council of the British Institute of Energy Economics. Wee Chian Koh is a Researcher at the Centre for Strategic and Policy Studies in Brunei Darussalam. He is also an Economist Consultant at the World Bank and Adjunct Associate Professor at Universiti Brunei Darussalam. His research interests are in international and development economics, focusing on macroeconomic policy in resource-rich countries. His consulting experience covers a broad range of policy issues including economic diversification, fiscal policy, productivity, employment, energy, transport, trade facilitation and SME

Contributors  xv development. He holds a PhD in Economics from the Australian National University and an MSc in Finance and Economics from the London School of Economics and Political Science. Phoebe Koundouri is Professor (Chair) of Sustainable Development (Economics and Econometrics) at the School of Economics, Athens University of Economics and Business (Greece) and the elected President of the European Association of Environmental and Natural Resource Economists (EAERE). She holds a PhD and MPhil in Economics and Econometrics from the University of Cambridge (UK). Koundouri is one of the 1 per cent of most-cited women economists in the world, with 15 published books and more than 250 published scientific papers. In the past, Professor Koundouri held academic positions at the University of Cambridge, University College London, the University of Reading and the London School of Economics (UK). She acts as an advisor to the European Commission, World Bank, EIB, EBRD, OECD, United Nations, NATO, WHO, numerous national and international foundations and organizations, as well as national governments on all five continents. She has a global leadership role in the UN Sustainable Development Solutions Network (SDSN) for European Green Deal (EGD) implementation, Sustainable Shipping and Ports, 4-Seas Blue Growth Initiative and is leader (together with Professor Jeff Sachs) of the Senior Working Group on Transformation Pathways for the implementation of the EGD and the SDGs. Mariia Kozlova is a post-doctoral researcher at LUT University School of Business and Management, Lappeenranta, Finland. Her main research is on renewable energy policy analyses. Her methodological portfolio includes simulation, real options approach and multiple-criteria decision making. Her key publications are ‘Investment timing and capacity choice under rate-of-return regulation for renewable energy support’ (Energy, 2019), ‘Real option valuation in renewable energy literature: research focus, trends and design’ (Renewable and Sustainable Energy Reviews, 2017), and ‘Modeling the effects of the new Russian capacity mechanism on renewable energy investments’ (Energy Policy, 2016). Volker Krey is Research Group Leader of the Integrated Assessment & Climate Change Group as part of the Energy, Climate and Environment Program at the International Institute for Applied Systems Analysis (IIASA), Austria, where he has worked since 2007. He also holds the position of Adjunct Professor at the Norwegian University of Science and Technology (NTNU). Dr Krey’s research focuses on the integrated assessment of climate change and the linkages to a broader suite of sustainable development objectives at different scales – global, national and subnational. As a co-chair of the scientific working group on data protocols and management of the Integrated Assessment Modeling Consortium (IAMC), he has significantly contributed to improving transparency and data sharing in the IAM community. Krey is Lead Author of the IPCC Sixth Assessment Report and previously served as Lead Author of the IPCC Fifth Assessment Report, the Global Energy Assessment and the IPCC Special Report on Renewables. He was acknowledged as a Highly Cited Researcher by Clarivate (2018, 2019, 2020). Alma Kudebayeva is Assistant Professor at the Department of Economics, KIMEP University (Kazakhstan) and CERGE-EI teaching fellow, specializing on issues of poverty, inequality and labour economics. She did a post-doc at the German Institute of Economic Research DIW in 2010 and holds a Doctorate in Mathematics from al-Farabi Kazakh National University (Kazakhstan) and in Development Economics from the University of Manchester (UK).

xvi  Handbook of sustainable politics and economics of natural resources Dr Murodbek Laldjebaev is an Assistant Professor at the Department of Earth and Environmental Sciences at UCA’s School of Arts and Sciences in Khorog, Tajikistan. His scholarship is aimed at better understanding of and identifying ways to address pressing societal challenges emanating from human-environmental relations, where humans impact the environment and are impacted by the environment. The driving question is: How can humans improve their lives, while using the natural resources sustainably? Within the sustainability challenge, his research focus is on energy security, energy poverty, environmental sustainability, water resources management, and local indigenous knowledge systems. His teaching includes human geography, research methods, indigenous knowledge, sustainable energy and environmental governance. Dr Laldjebaev has held fellowships with UCA’s Central Asian Faculty Development Programme (CAFDP) and Central Asia and Afghanistan Research Fellowship (CAARF), and worked as a Research Associate on undergraduate core curriculum development for UCA. Previously, he also headed curriculum development and program evaluation for the Institute for Professional Development of teachers in Khorog, consulted the World Bank on pre-service education, and worked as a Senior Specialist with the Ministry of Economic Development and Trade of Tajikistan. Dr Laldjebaev holds a PhD in Natural Resources from Cornell University (USA), a Master’s in Public Policy degree from the Lee Kuan Yew School of Public Policy, National University of Singapore (Singapore), and a Bachelor’s degree with Distinction in English Language from Khorog State University (Tajikistan). Igor Makarov is Head of the School of World Economy of National Research University Higher School of Economics (HSE) in Moscow. He also directs the Laboratory for Climate Change Economics and the Sector of International Economic Studies at the Centre for Comprehensive European and International Studies at the same university. He has been a visiting scholar at Stanford University (2011) and Harvard University (2016 and 2019) and taught at the University of Tehran (2016) and Autonomous University of Madrid (2017). His research interests cover environmental and climate change economics and international political economy. He is an author of more than 60 academic papers and numerous columns for Russian business newspapers. Makarov holds a PhD in Economics, and his academic papers, reports, columns and interviews have been published in Russia, the United States, Canada, the UK, Austria, Italy, France, Singapore, China, South Korea, India, Iran and South Africa. André Månberger is Associate Senior Lecturer and Director of Doctoral Studies at the Department of Technology and Society, Lund University, Sweden. His research focuses are critical material flows, energy security, interactions between security and sustainability transitions, and methodologies for studying uncertainties. André holds a PhD in Environmental and Energy Systems Studies, an MSc in Industrial Engineering and a BSc in Intelligence Analysis. He participates in the interdisciplinary MISTRA Geopolitics research programme and leads the work package on interactions between decarbonization and geopolitics. Sarah Najm is an Assistant Professor of Economics at King Saud University in Saudi Arabia and a Visiting Postdoctoral Fellow at the University of Reading, UK. She holds a PhD in Economics from the University of Reading and an MSc in Economics from the University of York, UK. Her research interests include interaction of alternative and conventional energy markets, pollution havens, attitudes and inequality. Sarah is interested in the role institutions

Contributors  xvii play in generating unequal and paradoxical outcomes, whether environmental, social or fiscal. Sarah’s work appears in Energy Economics and Energy Policy. Indra Overland is Research Professor and Head of the Centre for Energy Research at the Norwegian Institute of International Affairs (NUPI). His publications include ‘The ASEAN climate and energy paradox’, (2021, Energy and Climate Change), ‘Environmental performance of foreign firms: Chinese and Japanese firms in Myanmar’ (2021, Journal of Cleaner Production), ‘Sharing the spoils: winners and losers in the Belt and Road Initiative in Myanmar’ (2020, Journal of Current Southeast Asian Affairs) and ‘The GeGaLo index: geopolitical gains and losses after energy transition’ (2019, Energy Strategy Reviews). He holds a PhD from the University of Cambridge, UK, and has been cited in the Financial Times, Wall Street Journal, Newsweek, Associated Press, Bloomberg, BBC World Service, The Guardian, The Telegraph, Times Literary Supplement, Hokkaido Shimbun, Toronto Star, Het Financieele Dagblad, Radio Free Europe and Politiken. Ruslana Rachel Palatnik, PhD, is Senior Lecturer in the Department of Economics and Management at the Yezreel Valley College (YVC), Israel; Senior Guest Research Scholar at the Energy, Climate, and Environment (ECE) Program at the International Institute for Applied Systems Analysis (IIASA), Austria; and Senior Research Fellow at the Natural Resources and Environmental Research Center (NRERC), University of Haifa, Israel. Her research interests are climate change economics, environmental policy evaluation, energy and natural resource economics, and water management. In 2015–16 she was Visiting Researcher at the Department of Agricultural and Resource Economics at Berkeley, University of California, where she analysed the economic aspects of biofuels. In 2019, Dr Palatnik was granted IIASA-Israel Program Associate Visiting Professor position where she joined the ECE Program to adopt the energy model MESSAGE to Israel for energy-related policy analysis. Previously, she developed a CGE model of the Israeli economy and has been conducting climate change adaptation and mitigation policy analyses. Andreas A. Papandreou is a Professor in the Economics Department of the National and Kapodistrian University of Athens. He received his BSc in Economics from the University of London, Queen Mary College and his MSc in Economics from London School of Economics. He became a Doctor of Philosophy at Merton College, Oxford University, in 1990. He has 30 years of academic experience in various universities, including University College London and Harvard. His research and published work are mostly in the fields of environmental economics, institutional economics, political economy and welfare economics. Among his publications is Externality and Institutions (1998, Oxford University Press). He is the Director of the Political Economy of Sustainable Development Lab (PESD) at the National and Kapodistrian University of Athens. The lab has also established the Athens Behavioral and Experimental Economics and Social Sciences Unit (ABEESS) to undertake, inter alia, experimental research relating to sustainable development. He is Co-chair of the Sustainable Development Solutions Network Greece (SDSN Greece). Tiia-Lotta Pekkanen is post-doctoral researcher at LUT University, Finland. She has a background in economics, international relations and environmental technology, being a holder of Master’s degrees in each field. Her current research is on institutional economics and sustainability, and her main research interests are in the role of institutions, culture and individual

xviii  Handbook of sustainable politics and economics of natural resources agency in informing economic outcomes. She has worked on research projects related to forest industry and bioeconomy. Previously she has also worked in the energy industry. Aloysius Damar Pranadi is a renewable energy and power planning policy researcher. He has five years of professional experience in various energy development programmes in ASEAN and in Indonesia. At ASEAN level, he was responsible for the USAID Clean Power Asia programme, various capacity-building projects, power studies, and has been collaborating with global institutes such as IEA, IRENA, NUPI, GIZ, KEEI (Korea), WCA, ERIA, CREEI (China), amongst others. His research interests range from power economics, renewable energy planning, renewable energy project development to renewable energy policy analysis and modelling. Since 2020, he has acted as a Policy Associate for the UK–Indonesia Low Carbon Energy Transition Programme, MENTARI. He holds a Master’s degree in Electrical Engineering from Universitas Indonesia. He has been Director of Research and Development for the EnerBI foundation for seven years, supporting renewable energy collaboration in Indonesia. Keywan Riahi is the Director of the Energy, Climate and Environment Program at the International Institute for Applied Systems Analysis, Austria (IIASA). He is lecturing as a Visiting Professor of Energy Systems Analysis at the Graz University of Technology and has recently also joined the Payne Institute of the Colorado School of Mines as a Fellow and serves as an External Faculty Member at the Institute for Advanced Study (IAS) at the University of Amsterdam. In 2021, Mr Riahi was appointed to the 10-Member Group by the United Nations Secretary-General Guterres to advise on Science, Technology and Innovation for the implementation of Agenda 2030. Mr Riahi ranks first in the recent list of 1000 most influential climate scientists by Reuters and has been selected as Highly Cited Researcher worldwide by the Web of Science/Clarivate Analytics (2016–20). In 2015, he also received the Integrated Assessment Modeling Consortium (IAMC) award for extraordinary contributions to the field of integrated assessment modelling. His publications receive more than 10 000 citations per year and cover, inter alia, the following disciplines: mathematics, economics, finance, engineering/energy and environmental sciences. Haakon Fossum Sagbakken is a Junior Research Fellow at the Norwegian Institute of International Affairs (NUPI). He researches mainly climate change and energy policy frameworks in Southeast Asia, and has previous work experience from the Norwegian Ministry of Foreign Affairs and the Mitsubishi Research Institute Inc. He completed his BA in Political Science at Brown University in the United States, has an MPhil from the University of Oxford, UK and was an Aker Scholar. Jorma Sappinen works as Associate Professor at LUT University, Finland. His main research interests have been in the history of economic thought and the methodology of economics. Associate Professor Sappinen teaches courses on microeconomics, organizational economics and philosophy of science. Titus Sauerwein is a PhD candidate at the Department of Business Transformation, Surrey Business School (UK). His research focuses on the interface between large-scale gold mining companies and artisanal and small-scale miners in Côte d’Ivoire. He is particularly interested in the dynamics that develop between these stakeholders at the intersection of formality and

Contributors  xix informality. Mr Sauerwein holds an MSc in International Relations from the University of Amsterdam and a MA in African Studies from Leiden University, the Netherlands. Dietrich Schmidt-Vogt is a geographer and Honorary Professor at the Faculty of Environment and Natural Resources, Freiburg University, Germany. From 2015 to 2017 he was also Director of the Mountain Societies Research Institute, University of Central Asia, in Bishkek, Kyrgyz Republic. Prior positions include Full Professor at the Kunming Institute of Botany, Chinese Academy of Sciences, in Kunming, China, from 2009 to 2015, Associate Professor at the Asian Institute of Technology, Thailand, from 2002 to 2009, and Senior Lecturer at the South Asia Institute of Heidelberg University, Germany, from 1998 to 2002. Dietrich studied geography and English in Germany and Canada and obtained his doctoral and postdoctoral degrees at Heidelberg University, Germany. Spanning more than 30 years of research experience in Asia, his interests include forest–farming interactions, multifunctional landscapes, integrated land use systems, land use change, and natural resources management. Willem Spanjers is a microeconomist, with specializations in behavioural decision models – including models of ambiguity – in financial economics, and in rethinking the social market economy. These interests are reflected in his academic career. After completing his doctorate as a teaching and research assistant at Tilburg University, Willem held positions outside the Netherlands: in Germany at the Institute of Mathematical Economics of the University of Bielefeld, at the University of Saarland, and Chemnitz University of Technology; in the UK at the University of Birmingham and at Kingston University. At Kingston University, Willem was Director of Studies, Deputy Head of School and Acting Head of the School of Economics. Currently, he is Course Director for Kingston University’s undergraduate degrees in Economics. From 2009 to 2011 Willem was seconded to the University of Freiburg in Germany as Acting Full Professor and Interim Director of the Institute for Research in Economic Evolution, on the Chair formerly held by Walter Eucken, a founding father of the Freiburg School of economic thought and of the social market economy. Beni Suryadi is Manager of Power, Fossil Fuel, Alternative Energy and Storage at the ASEAN Centre for Energy (ACE). He leads the work on the 6th ASEAN Energy Outlook (AEO6), the flagship study on ASEAN’s energy future, which was launched at the 38th ASEAN Ministers of Energy Meeting in November 2020, as well as the ASEAN Interconnection Masterplan Study (AIMS) III for the ASEAN Power Grid (APG), a regional blueprint for electricity interconnection and higher penetration of renewable energy in the region; and the ASEAN Climate Change and Energy Project (ACCEPT), the first integrated project on energy and climate change in ASEAN. He holds a Bachelor’s degree in Mechanical Engineering from the Bandung Institute of Technology and a Master’s degree in Chemical Engineering from the University of Indonesia. Nathan Sussman joined the Graduate Institute Geneva as Full Professor of International Economics and Director of the Institute’s Centre for Finance and Development. He was Associate Professor of Economics in the Department of Economics and in the integrated Philosophy, Economics, and Political Science Programme (PEP) at the Hebrew University of Jerusalem. He was the Director of the Research Department at the Bank of Israel and a voting member of the Monetary Policy Committee. His fields of expertise are monetary and financial economic history. He has written numerous articles and co-authored a book on emerging markets and financial globalization. Professor Sussman earned his PhD in Economics from the

xx  Handbook of sustainable politics and economics of natural resources University of California, Berkeley. He was Full Professor and Economics Department Chair at the University of Western Ontario in Canada, and served as Chairman of the Economics Department, Director of the Maurice Falk Institute for Economic Research, and Associate Dean of the Faculty of Social Sciences at the Hebrew University. Gerhard Toews completed his DPhil (PhD) at the Economics Department of the University of Oxford, UK. Before joining the New Economic School in Moscow where he is the RNG Assistant Professor, he did his postdoc at the Oxford Centre for the Analysis of Resource-rich Economies (OxCarre). He is an applied economist with an interest in natural resource economics and economic history. Stella Tsani is Assistant Professor at the Department of Economics, University of Ioannina, Greece. She holds a PhD in Economics and Business from the University of Reading, UK. She has worked with multisectoral networks across the knowledge triangle and has participated in more than 30 research projects funded by national and international bodies (European Commission FP7, Horizon 2020, EU Directorates, National Bank of Greece, World Bank, Ministry of the Environment of Cyprus, etc.). Her research includes work on public policy assessment, sovereign wealth funds (SWFs), natural resources with focus on renewables, hydrocarbons and water, the water–energy–food–ecosystems nexus, sustainable development, institutions, labour markets, technology innovation, economy energy and environmental modelling and scenario analysis. She has published in leading economics peer-reviewed journals (Economics Letters, Environmental Science and Policy, Energy Economics, Economic Systems, Science of the Total Environment, Resources Policy, etc.) in edited volumes and in the media. Roman Vakulchuk is Senior Research Fellow at the Norwegian Institute of International Affairs (NUPI) in Oslo. He holds a PhD in Economics from Jacobs University Bremen in Germany. His main geographical specialization is the countries of Central Asia and Southeast Asia and major research areas are economic transition, trade, natural resource management and investment policy in emerging markets. His publications include ‘Renewable energy and geopolitics: a review’ (Renewable and Sustainable Energy Reviews, 2020) and Kazakhstan’s Emerging Economy: Between State and Market (Peter Lang, 2014). Vakulchuk previously worked for the oil company Shell in Germany. He has also served as project leader in research projects organized by, inter alia, the Asian Development Bank (ADB), the World Bank and Natural Resource Governance Institute (NRGI). In 2018, he worked as governance expert for the OECD mission in Kazakhstan. In 2013, Vakulchuk was awarded the Gabriel Al-Salem International Award for Excellence in Consulting. Wessel N. Vermeulen is Visiting Lecturer (Assistant Professor) in macroeconomics at Newcastle University (UK). He has worked and published on issues related to sovereign wealth funds, natural resources, international trade, environment and regional economics. He holds a PhD in Economics from the University of Luxembourg. Lúcio Vinhas de Souza is an Advisor at the EU’s European External Action Service (EEAS). Before that he was the Head of the Economics Team at the European Political Strategy Centre, the internal think tank of the President of the European Commission in Brussels until 2020. Before that, he was the Chief Sovereign Economist of Moody’s Investor Services. Prior to that position, he coordinated the analysis and forecasting for the ‘High Income Countries’

Contributors  xxi and ‘Europe and Central Asia’ regions at the World Bank’s Development Prospects Group. Dr Vinhas de Souza was responsible for western members of the ‘Community of Independent States’ (a successor framework for the former republics of the Soviet Union) at the Directorate General for Economic and Financial Affairs at the European Commission in Belgium, and before that he was a Coordinator of Research Area at the Kiel Institute for World Economics in Germany. His first work experience as an international economist was at the United Nations Secretariat. He is widely published in noteworthy economic journals in different languages and has organized and participated in numerous international meetings, seminars and workshops. Dr Vinhas de Souza, a Portuguese citizen, holds a PhD in Economics from the Erasmus University Rotterdam in the Netherlands, and Bachelor’s and Master’s in Economics from the Nova University in Lisbon, Portugal. Cyril Widdershoven is a veteran global energy market expert and founder of the consultancy Verocy. He holds several advisory positions at various international think tanks and western energy firms. He has been heavily involved in the oil and gas sectors throughout his career, holding positions at Capgemini Consulting (Principal Consultant, Centre of Excellence Oil and Gas International, Calgary, Canada), Deloitte Financial Advisory Services (Senior Manager, Oil & Gas), and as Senior Financial Analyst Oil & Gas Sector FDA, where he managed and advised the oil and gas department on equity and bond markets. He has led energy publications, including North Africa Oil and Gas Magazine, the Middle East Oil Gas Newsletter and Africa Oil Newsletter at Newsbase. He earned his postgraduate degrees at King’s College, University of London, Department of War Studies, and an MA in Middle East Studies at the University of Nijmegen, Netherlands. Stefanos Xenarios is an environmental economist with a focus on water resources and climate change. He acquired three years of postdoctoral experience in India and Ethiopia as a staff member of the International Water Management Institute (IWMI), and subsequently did research on climate change and agriculture in South Asia, based at the Norwegian Institute of Bioeconomy (NIBIO). He also worked as Head of the Water and Energy Security Unit at the Organization for Security and Cooperation in Europe (OSCE) Office in Tajikistan. Before joining Nazarbayev University, Kazakhstan, as an Associate Professor in the Graduate School of Public Policy, he was Senior Researcher in the University of Central Asia (UCA), Tajikstan, leading activities on the water–energy–food–environment nexus in the region. He is on the Editorial Board of the International Journal of Water Resources Development, Hydrology Research Journal and the Central Asian Journal of Water Research, and on the Management Board of the International Water Association’s Specialist Group on Statistics and Economics. Fabio Zagonari obtained a Laurea in Economics at University of Bologna (Italy) in 1990, an MPhil in Economics of Developing Countries at University of Cambridge (UK) in 1993 and a PhD in Economics at University of Ancona (Italy) in 1995. He has published on many topics, from industrial organization to hospitality management, from decision economics to science metrics, although his main focus is on ethics (e.g., Journal of Happiness Studies, Quality & Quantity), environment (e.g., Applied Mathematical Modelling, Environment and Development Economics, Environmental and Resource Economics, Environmental Management, Environmental Modelling & Software, Journal of Environmental Economics and Management, Journal of Environmental Management, Natural Hazards, Ocean and Coastal Management, Water Resources Management, Science of the Total Environment), and

xxii  Handbook of sustainable politics and economics of natural resources environmental ethics (e.g., Environment, Development and Sustainability, Nature – Palgrave Communications, Nature – Humanities & Social Sciences Communications, Sustainability, Sustainability Science). He has held academic positions at University of Bologna since 1995, with lectures mainly on microeconomics and environmental economics.

Preface

Natural resources are a gift from nature that, if properly managed, can support economic development and human welfare. Experience indicates that the design and implementation of prudent resource policies to realize the full potential of natural resource wealth is a challenging task. It becomes even more challenging in the context of climate change, regional and global climate change mitigation and adaptation actions and international agreements and targets such as the Paris Agreement, the European Green Deal and the United Nations Sustainable Development Goals and Agenda to 2030. This Handbook brings together expert analysis with the aim of understanding the policy challenges and solutions related to resource management in the face of climate change and sustainable development targets. Towards this end, the Handbook offers state-of-the-art interand intra-disciplinary contributions that consider the economic, policy, legal, environmental, social, financial and technology dimensions of resource policies. The studies investigate the particularities and uncertainties that surround specific resources, regions, institutions and related policies. The multidimensional scope and the study of complementary areas of research are reflected in the structure of the Handbook. Part I and Part II cover resource- and regional-specific challenges that shape national and global policies and development. Part III includes investigations on the institutional aspects of resource management and their implications for policy making. Part IV brings together studies on the uncertainties and risks associated with climate change and socio-economic shocks and the need for a forward-looking approach to resource-related economic management and policy design. We believe that this compilation of works makes a fresh start in bringing together consolidated knowledge in the relevant fields and suggestions for future studies in the related disciplines. Stella Tsani and Indra Overland

xxiii

Acknowledgements

We are grateful to all the world-class contributing authors to the Handbook. We thank them for their devotion to this project and their timely addressing of suggestions and comments for revisions. Completing this Handbook during the COVID-19 pandemic would not have been possible without the authors’ commitment. We thank Edward Elgar Publishing for all their support in the preparation and delivery of this Handbook. Special thanks to Daniel Mather, Dee Compson, and Sarah Brown for all their hard work and their excellent and timely assistance. Stella Tsani and Indra Overland My deep gratitude goes to Indra Overland for his trust and approach to novel ideas and co-generation. It has been a true pleasure working with Indra all the way from conceptualization to materialization of this Handbook. My overwhelming appreciation also goes to my colleagues at the University of Ioannina in Greece. Stella Tsani I am deeply indebted to Stella Tsani for taking the lead on this book, being its powerful driving force and bringing it to fruition. It has been a pleasure and a privilege to work with Stella and reap the benefits of her speed and energy. Indra Overland

xxiv

Abbreviations

ASEAN ASM BG BOT CA CAGR CAPEX CAPS CAREC CCS CES CO2 CSP DoC EBRD EC EFSI EGDIP EIB EITI EMH E&P EPI ETF ETS EU EU MS EV FAO FDI FSU GDP

Association of Southeast Asian Nations artisanal and small-scale mining British Gas build-operate-transfer Central Asia compound annual growth rate capital expenditure Central Asia Power System Central Asia Regional Economic Cooperation Program carbon capture and storage constant elasticity of substitution carbon dioxide concentrated solar power declaration of cooperation European Bank for Reconstruction and Development European Commission European Fund for Strategic Investment European Green Deal Investment Plan European Investment Bank Extractive Industries Transparency Initiative efficient market hypothesis exploration and production Environmental Performance Index Exchange-traded fund emissions trading system European Union European member states electric vehicle Food and Agriculture Organization foreign direct investment former Soviet Union gross domestic product xxv

xxvi  Handbook of sustainable politics and economics of natural resources GHG GMS HPP ICE IDP IEA IEEFA IEF IFAS IMF INDC IOC IPCC LC MFF MRC MSEA NDC NG NGO NOC OECD O&G OGCI OPEC PPA PV R&D RE SAP SDG SEIP SWF TAP TEV TFP UNEP

greenhouse gas Greater Mekong Subregion hydropower power plant internal combustion engine internally desplaced person International Energy Agency Institute for Energy Economics and Financial Analysis International Energy Forum International Fund for Saving the Aral Sea International Monetary Fund intended nationally determined contribution international oil company Intergovernmental Panel on Climate Change local content multiannual financial framework Mekong River Commission Mainland Southeast Asia nationally determined contribution natural gas non-governmental organization national oil company Organisation for Economic Co-operation and Development oil and gas Oil & Gas Climate Initiative Organization of the Petroleum Exporting Countries power purchasing agreement photovoltaic research and development renewable energy structural adjustment programme Sustainable Development Goal Sustainable Europe Investment Plan sovereign wealth fund Trans-Adriatic Pipeline total economic value total factor productivity United Nations Environment Programme

Abbreviations  xxvii UNFCCC WFD WTO WTP

United Nations Framework Convention on Climate Change Water Framework Directive World Trade Organization willingness to pay

1. In quest of sustainable politics and economics of natural resources: a summary of contributions and future research directions Stella Tsani and Indra Overland

1 INTRODUCTION Much of the literature and empirical research in the fields of economics and politics shows that natural resources are a gift from nature that, if properly managed, can support economic development, social prosperity and human welfare. While resources may be naturally available, the design of prudent policies and the use of appropriate economic instruments to best manage them are coupled with significant challenges. These are linked to, among other things, resource-specific characteristics, such as the finite nature of minerals and hydrocarbons, the geographical concentration, the weak links between resource policies and the wider fiscal, social and macroeconomic packages, the difficulties in developing and implementing an optimal socio-economic and environmental policy mix, and the significant risk, uncertainty and change that characterize the intertemporal use of natural resources and related decision making. In light of the ongoing processes of socio-economic transition towards a sustainable and resilient mode of development and growth, driven by the understanding that humanity can no longer continue along the same socio-economic path with the same policies and models of production and consumption, resource management deserves a careful review and update. Global commitments, regional actions and common target setting, including the Paris Agreement, the European Green Deal, the United Nations 2030 Sustainable Development Agenda and the 17 Sustainable Development Goals (SDGs), give new impetus to debates on the policy and economic challenges and opportunities related to natural resource management. In these debates, the accumulated experience of resource economics and politics offers a solid base of knowledge about the key concerns and practical issues. Complementing the state-of-the-art research on past experience, forward-looking approaches to natural resource politics and economics lay the groundwork for novel research in this area and provide insights on the core issues that policy makers and practitioners in the field should pay more attention to in the near future. The Handbook of Sustainable Politics and Economics of Natural Resources is a result of precisely this realization – that we need to learn from the past but also to have a clear understanding of the transformative developments ahead, to better prepare a set of policies and economic tools for natural resources that can support sustainable development and resilient growth, economically, socially and environmentally. Driven by this aim, this Handbook brings together state-of-the-art interdisciplinary contributions that consider the economic, environmental, social, financial and technological dimensions of resource policies. This is done with the target and belief that the Handbook advances scientific research in the area, contributes to

1

2  Handbook of sustainable politics and economics of natural resources well-informed policy making and constitutes useful reading for academics, researchers, policy makers, advanced students and practitioners in the field. Contributors to the Handbook examine resource policies to understand the challenges and solutions in a changing environment where the SDGs and climate change form the backdrop for policy making. Towards this end, the authors study the particularities and uncertainty that surround specific resources, regions and institutions and their policies. The Handbook contributions extend into four complementary areas of research and are correspondingly grouped into four parts. Part I and Part II investigate the resource- and region-specific challenges, respectively, that shape national and global policies and developments. Part III focuses on the institutional aspects of resource management and their implications for policy making. Part IV brings together studies on the uncertainties and risks associated with climate change and the requirements of forward-looking resource policies. The complementary focus areas that determine the structure of the Handbook are interlinked, and to some extent overlap. For instance, the study of oil price volatility in Kazakhstan relates to resource-specific challenges (e.g., the volatility of hydrocarbon prices) but also region-specific developments (e.g., the dependence of Kazakhstan/Central Asia on oil and gas, and their vulnerability to oil price fluctuations, macroeconomic and fiscal volatility). This topic could also link to institutional characteristics (i.e., the quality of political institutions, such as transparency in revenue allocation, the rule of law, or the presence of specific sovereign wealth funds that are used to protect the economy from adverse shocks). These overlaps indicate that the subjects addressed in this Handbook are indeed related to multidimensional challenges and should not be studied in isolation. While the structure of the Handbook is based on the thematic focus areas for the ease of the reader, the interlinkages between the thematic areas are also underlined and readers may want to keep them in mind. This chapter provides a comprehensive overview of the contributions included in the Handbook, highlighting the core points of policy interest and the results, with a focus on recommendations and directions for future research. The content of the Handbook is non-exhaustive; it is well understood and acknowledged that the topics of relevance to sustainable politics and economics for natural resource management extend well beyond a single volume. However, this Handbook makes a start in bringing together consolidated knowledge and suggestions for further work in the field. Hopefully, this will provide useful material and an impetus for future similar collective works and updates to this Handbook. In the same way, the insights and recommendations that can be extracted from the contributions to this Handbook are far more than those that are summarized in a single chapter. This chapter therefore provides only a snapshot of the contents, outlining the individual contributions with their most significant insights and recommendations. The snapshot provided in this chapter follows the structure of the Handbook. Section 2 presents the contributions that focus on resource-specific characteristics, policy and economic challenges. Section 3 summarizes the works that have a regional focus. Section 4 presents contributions to the Handbook that investigate the institutional aspects of resource management and their implications for policy making. Section 5 summarizes the chapters that relate to the uncertainties, socio-economic shocks and risks associated with climate change and the forward-looking requirements of resource policies. The last section wraps up the chapter with some concluding remarks.

In quest of sustainable politics and economics of natural resources  3

2

RESOURCE SPECIFICS AND CONSIDERATIONS FOR POLICY MAKING

If properly managed, natural resources can be transformed into surface assets. Nevertheless, this transformation has been proven to be a practical challenge. In Chapter 2 of this Handbook, Koh discusses the role that natural resources play in the economic development of different countries. Failures and difficulties in resource-based economic growth and development are related to the exhaustible nature of resources (e.g., point, finite resources) and to the economic particularities related to volatility, information asymmetry, rent seeking, technical requirements and incentive distortion. The analysis provided by Koh shows that the design of the institutional framework and fiscal regime are crucial elements in maximizing economic returns from natural resources, a point that is highlighted in several other contributions (see also Coutinho and Tsani’s discussion in Chapter 17). Koh’s analysis shows that economic diversification and structural policies are key to sustainable growth and development linked to natural resources. Conclusions relate to the policy aspects and economic tools that can support prudent natural resource management. These include robust regulatory and fiscal regimes applied to all industry actors and essential elements such as licensing, allocation of rights, fiscal terms, health and safety regulations and environmental standards. It is also suggested that countercyclical fiscal policy, pursued through appropriate fiscal tools such as sovereign wealth funds (covered in detail in Chapter 16 by Carpantier and Vermeulen and also in Chapter 17 in the work of Coutinho and Tsani), protects against boom-and-bust cycles. Additional policies to support resource-related economic development, indicating areas for future research and policy emphasis, relate to the identification and implementation of appropriate monetary and exchange-rate policies, economic diversification to increase new market opportunities and diversified foreign direct investment, and careful spatial, human capital, institutional and governance policies. In Chapter 3, Månberger projects an understanding of the challenges related to finite resources into alternative future developments by looking at the interactions between renewable energy penetration, transport electrification and the demand for metals. His work identifies the essential metals for renewable energy technologies. Månberger provides a condensed review of the metal requirements of alternative renewable energy technologies, shedding light on the potential metal demand developments that might result from the transformation of the global energy system, robust climate change mitigation actions and sustainability transitions. The analysis shows that while metals are finite and geographically concentrated, like hydrocarbons, they may generate less revenue and expose owner countries to less resource dependence, with lower fiscal and macroeconomic volatility transmission. While the macroeconomic and fiscal impact of mineral extraction for renewable energy technologies may be deemed less severe as compared to the fiscal impact of hydrocarbon extraction, the local impact of mineral exploration and commercial exploitation may be significant, both in social terms (e.g., conflict) and economic terms (e.g., local economic development, employment and income generation). Impacts are also discussed in terms of the scale of the mining activities (e.g., the impacts of large-scale vs small-scale mining). There are links between Chapter 3 and other chapters. Extensions to the implications of mining scale are also discussed in Chapter 12 on small-scale mining in Sub-Saharan Africa, which Hilson, Sauerwein and Cardoso discuss through the prism of rural resilience and the SDGs. Both the works of Månberger and Hilson et al. highlight the local impact of natural resources and the need to understand them better and design appropriate regional- and

4  Handbook of sustainable politics and economics of natural resources community-level policies. The local impact and policy focus are also examined in Chapter 15 in the work of Kalyuzhnova on the appropriate policies for local development and resilience. All these works show the importance and priority for better understanding of the local impact of certain types of natural resources (metals, minerals and hydrocarbons) that are characterized by small-scale geographical concentration, capital intensity and their finite nature. In Chapter 4, Sagbakken, Isataeva, Overland, Pranadi, Suryadi and Vakulchuk investigate coal, a depletable resource that is characterized by geographical concentration and capital intensity. Most importantly, coal is subject to significant phasing out and global decarbonization efforts. In their analysis, the authors examine the global shift away from coal and the contrasting expansion in coal mining and consumption in Southeast Asia, in an attempt to understand the connections and disconnections between the coal sector in the member countries of the Association of Southeast Asian Nations (ASEAN) and global climate policy. Acknowledging the impact of moving away from coal and targeting the reduction of CO2 emissions, the authors discuss the risks of coal opt-in in the ASEAN region. The analysis shows that these relate to energy insecurity, the undermining of the ASEAN international climate commitments, neglect of significant untapped renewable energy potential, and impaired health and environmental quality. Despite the ease of access and seeming abundance that make coal an attractive resource in the ASEAN region in the short term, the negative impacts across a number of sectors that are crucial for the ASEAN economies, such as tourism and agriculture, indicate that the least attractive option would be to continue the exploitation of coal in the context of decarbonization and sustainability transition. It is this increasing social understanding of the dangers related to coal that has given power to local civil society in resisting efforts to continue along the same coal-dependent path in the ASEAN. This indicates the potential for empowerment and transformation of social understanding of the impact of using conventional energy sources, which are expected to intensify in the future as a result of efforts to implement the SDGs and shape the exploration and exploitation of conventional resources such coal in the immediate future. The analysis of the ASEAN region in Chapter 4 indicates the socio-political areas that deserve special attention to better understand and prepare for future developments in conventional energy sectors. These include minority and local community rights, regional versus global political divides, national and international cooperation and coordination, development of activist networks and international civil society. Some of these points are also highlighted in the work of Inglesi-Lotz (Chapter 13) that focuses on the African continent. The importance of regional and global policy alignment, of national and international cooperation and coordination, is also noted by Tsani, Apostolaki and Koundouri in Chapter 5. The authors consider the case of water resources and the importance of integrating socio-economic, technological and environmental management. The authors discuss regional policies on water management with a focus on the EU Water Framework Directive, a blueprint for sustainable water management. While the Directive shares several characteristics and end targets with the UN SDGs, it still lacks the fully developed tools that allow for the integrated sustainable management of water resources. The authors discuss methodological considerations and potential solutions for integrated water management, with a focus on the economic tools for full water cost recovery – that is, methods that allow for the capture of the total costs and benefits related to water, whether economic, social, technological, financial or environmental. This work provides insights into the ways that these economic tools can be updated to achieve sustainable management of water resources. This chapter also discusses the need to examine regional and

In quest of sustainable politics and economics of natural resources  5 global cooperation pathways to achieve universal implementation of methods that allow for full water cost recovery. Focusing on the policy and economic challenges related to conventional energy sources, Girard, Kudebayeva and Toews study the relationship between oil price booms, income and satisfaction in Chapter 6 with the empirical analysis of data for Kazakhstan. The authors explore time, sectoral and spatial variations to identify the impact of the recent oil boom on an oil-dependent economy. The analysis contributes to our understanding of the impact of resource policies by highlighting the economic and political consequences of information about future point resource wealth and the idea of inflated expectations. In addition, it indicates that the prospect of resource wealth might unleash political forces leading to changes in people’s perceptions, group-level dissatisfaction and potential conflicts. Quickly changing aspirations can easily be exploited by political actors to engage different groups. The results are in line with the news-shock literature and provide insights into the way that private sector information changes people’s aspirations to benefit from a resource price boom. Linking this work to the analyses presented in Chapters 2 and 3, an interesting research path emerges for future work on the implications of price shocks for the nations emerging as core global producers of finite resources that are important for renewable energy technologies and climate change mitigation (e.g., minerals, metals and rare earths).

3

REGIONAL RESOURCE POLITICS AND IMPLICATIONS FOR GLOBAL POLICIES AND ECONOMIC DEVELOPMENT

Part II of the Handbook gathers chapters with a regional focus to their analysis. Global climate change and sustainable development targets are defined by commitments under global climate agreements (e.g., the Paris Agreement) and the United Nations 2030 Sustainable Development Agenda. At the regional level, the European Green Deal constitutes an action paradigm with multiple implications for other countries in the world. As the EU is a significant trading partner of developed and developing regions worldwide, the European Green Deal will directly and/ or indirectly impact other regions and countries. Part II starts with a presentation of the Green Deal and a discussion of the related financing mechanisms from Busse, Dreute, Isaila and Vinhas de Souza in Chapter 7. The European Green Deal is an ambitious policy framework that seeks to ensure continued European global climate leadership and galvanize the private sector to speed up the energy and climate transition, in an effort to live up to the promises of the Paris Agreement and the SDGs. The ramifications of target-setting actions to be taken and outcomes of the Deal are important for EU member states and for the rest of the world. While Europe is moving relatively swiftly forward with climate change and sustainable development policies, major energy producers and consumers worldwide with significant reserves and market power in conventional energy sources are operating with different priorities and speed. This coexistence of different policy priorities and political agendas related to climate change will have a profound impact on global decarbonization, climate change action and the sustainability transition. This is understood not only from the work of Busse et al., but also from the other works that are included in Part II of the Handbook. All these works indicate the need for future research to shed more light on these discrepancies and on their policy and economic ramifications.

6  Handbook of sustainable politics and economics of natural resources In Chapter 8, Makarov recognizes Russia as a case of special interest in global climate change and sustainability transition. Russia remains an important country for global climate change mitigation. Nevertheless, the national policy stance to date has demonstrated weak ambitions to reduce greenhouse gas (GHG) emissions. While international commitments have been made, no real impact of these is seen in policy making. In an attempt to understand this stance, which is similar to that of other large energy producers, factors such as the country’s heavy dependence on fossil fuels, the industrial structure of the economy and reliance on energy-intensive industries, as well as climate scepticism in public discourse, emerge as noteworthy. While these explain developments on the ground, they also indicate the threat that Russia and other resource-dependent emerging economies face. Dangers are related to the outdating of the economic model based on extraction and exports of fossil fuels (this dimension is also discussed in Chapters 4 and 9). At the same time, Makarov identifies new opportunities connected with significant potential for cheap emissions reduction in Russia. Changing the industrial base is also identified as an opportunity for Saudi Arabia in Chapter 9 by Tsani and Najm and for Israel in the work of Palatnik et al. presented in Chapter 10. All studies indicate the need to better understand the underestimated opportunities for meaningful change in energy-intensive industries and countries dependent on conventional energy sources, something that is largely disregarded by national politics due to short-term political goals. This conclusion is also drawn in the work of Tsani and Najm, presented in Chapter 9. The authors conduct a critical assessment of the political economy of energy in Saudi Arabia and the impediments to achieving a national sustainability transition. The analysis shows that while current political will is seeking various diversification plans and environmental initiatives, the pace of change remains largely insufficient and lacking coordination. Tsani and Najm, like Makarov in Chapter 8, document the lack of sufficient action, determined mostly by the oil dependence of the economy and the importance of individual preferences for sustainability transition. (The issue of preferences is further formalized in Chapter 21, where Tsani and Kozlova discuss methodological advances regarding behavioural representation in decision making relating to energy and the environment.) The analysis of Tsani and Najm extends to arguments on the timely action from large oil producers like Saudi Arabia and related advantages coming from long experience with the management of the oil and gas sector, accumulated oil wealth and related labour market policies. The authors point out that the debate on energy transition in oil-rich countries disregards their competitive advantages related to the extensive experience and established capacity to produce at low cost and to optimize their production and sectoral management for many decades. Diversification strategies that seek to deploy strengths related to managerial experience, labour market policies, capital availability and established supply chains could yield significant benefits for large oil producers. In Chapter 10, Palatnik, Davidovitch, Krey, Sussman, Riahi and Gidden provide a comprehensive, economy-wide analysis of the alternative pathways for energy-related carbon emissions reduction in Israel. The modelling results show that ambitious CO2 reduction policies can be implemented with a minor impact on gross domestic product (GDP) growth. Decarbonization of the Israeli economy will necessarily be based on increasing the electrification of transport and industry and on generating power from renewable energy resources (this highlights the timely insight offered by Månberger’s analysis of the demand for metals, presented in Chapter 3). Chapter 10 provides valuable insights for the design of clean energy policies that can enable the achievement of sustainability targets and methodological advancements that can help decision makers to understand the options available to them to accomplish

In quest of sustainable politics and economics of natural resources  7 ambitious decarbonization and sustainability goals. Important conclusions and indications for future research point to the opportunities related to long-term strategic planning that can achieve both emissions reductions and economic growth through the synergy between adopting emissions reduction targets and upgrading infrastructure and technology. Looking at both the increasing demand for renewable energy and the pressure put on natural resources, in Chapter 11, Xenarios, Laldjebaev, Schmidt-Vogt, Buurman and Araral present the case of hydropower generation in Central Asia and mainland Southeast Asia. The analysis highlights the impact of the increasing growth of China and the need to develop the region’s energy sources. While hydropower is a promising alternative for Southeast and Central Asia, emerging as a new bonanza for the two regions, it also gives rise to territorial disputes, uneven access and exploitation of the natural resource at hand, with important economic, social and environmental implications. The analysis indicates emerging conflicts with different sectors (e.g., agriculture and tourism) as the result of water use for energy production. The importance of skewed distribution of economic benefits is also discussed in relation to hydropower, indicating the need to better understand and further investigate the similarities between the management of depletable and renewable energy sources related to institutional capacity and the appropriateness of the policy approaches and economic tools used. In the context of mining, Hilson, Sauerwein and Cardoso discuss in Chapter 12 the potential benefits of co-existence of different economic activities in local communities, as a way of more quickly achieving the SDGs. The authors discuss the case for formalizing and supporting artisanal and small-scale mining (ASM) – low-tech, labour-intensive mineral extraction and processing – in Sub-Saharan Africa, by focusing on how the sector enhances food security and builds resilience in the region’s vulnerable rural communities. While Sub-Saharan Africa is characterized by a long history of ASM and smallholder activity, rarely have the synergies between these activities, food security and resilience been examined in the policy making or in the international aid and development programmes targeting the region. The analysis indicates not only the gaps in current approaches to resource-based economic development, but also future directions in policy making and formal analysis of the synergies between the resource sector and other complementary policy areas that require urgent attention (e.g., food security, social cohesion, community resilience and adaptation to climate change). In Chapter 13, Inglesi-Lotz provides a bird’s-eye view of resource management in the African continent. In line with the analysis of other contributors to this Handbook, Inglesi-Lotz also points to the need to carefully examine and understand local resource-based economic, social and industrial development, with the aim of creating a local and internationally competitive supply chain. Inglesi-Lotz discusses the need to explore policies that will provide synergic benefits in both natural resource exploitation and improving the quality of human capital. The work of Inglesi-Lotz adds to the arguments in favour of a more careful future study of local conditions and characteristics for better addressing sustainability and green transition challenges. This is also a basic stance in the works included in the third part of the Handbook.

4

INSTITUTIONS AND RESOURCE POLICIES

In the first two parts of the Handbook, the focus rests with resource and region-specific insights. While the outcomes offered in this regard are important, the works included in these parts also provide other indirect results and insights. Related insights include the importance

8  Handbook of sustainable politics and economics of natural resources of institutions for prudent resource economics and politics. This is explicitly recognized as an important area of past and future investigation in the third part of the Handbook. The works included in this section refer explicitly to the importance of institutions, whether formal or informal, and provide useful documentation of the status of knowledge and future priority areas of policy making and research. In Chapter 14, Arminen, Pekkanen and Sappinen discuss a prevalent topic in the field of resource economics and politics: institutional quality and the prevalence of corruption. The authors discuss the role of resource policies in alleviating or exacerbating the corruption– resource trap by surveying the existing literature on timber, oil, precious metals and diamonds. Their recommendations point to the importance of grasping the notable differences between natural resources in their susceptibility to the resource curse and related issues. They also indicate the need for further work on understanding the differences in institutional quality and the level of corruption in particular, to better characterize and explain the heterogeneous development paths of resource-abundant countries. In this sense, the focus should be not only on economic development, but also on social and institutional development. At the global level, the analysis shows that universally effective policy recommendations cannot be made because the success of policies is highly context-dependent and varies between resources, regions and countries. In this regard, future research may fill more knowledge gaps through analysis at the community level. In Chapter 15, Kalyuzhnova examines the role of institutional capacity for successful local content policy, an instrument used for maximizing the impact of natural resource development. Sustainable local content policies target the use of domestic sources at different stages throughout the value chain to generate local employment, strengthen cross-sector benefits and create knowledge and skills linkages. Kalyuzhnova discusses the importance of policies targeting domestic producers and the role that appropriate institutional contexts play in this regard. For successful design and implementation of local content policies, institutional capacity in resource-rich countries should be such that it enables open access to international expertise in the areas of technology and management, industrial diversification, innovation-led growth, setting up and encouraging open communication and participation, and more inclusive decision-making processes. Kalyuzhnova points to the importance of decision makers considering local content requirements and negotiations for successful implementation. Moreover, it shows the direction forward for related scientific research, which needs to provide further knowledge on the institutional changes to any aspect of resource development and management for an all-encompassing and overarching management strategy, including all government and non-government functions. Carpantier and Vermeulen shift the institutional focus to the macroeconomic management of resource wealth in Chapter 16. The authors review the experience of commodity-based sovereign wealth funds (SWFs), as part of a larger group of more than 100 SWFs around the world. In the face of headwinds due to the end of the commodity super-cycle and the gradual reduction of the global imbalances, Carpantier and Vermeulen review the alternative institutional design for reaching the objectives of SWFs. Paving the way for future research, the authors identify that the success of SWFs in fulfilling their objectives has so far been under-investigated. They also indicate areas requiring a careful consideration related to macroeconomic stabilization and the understanding of SWFs’ contribution in supporting the non-commodity-related exporting industries. In terms of intergenerational transfers, SWFs need to be examined through the prism of the global evolution of the international net finan-

In quest of sustainable politics and economics of natural resources  9 cial position of the countries that have set up the SWFs. Last, what also appears important is the identification of better governance structures for SWFs in managing trade surpluses and the impact of SWFs in institutional performance and governance in resource-rich countries. Research efforts in this context are critical, as SWF countries might well face greater challenges in the coming decades, as SWFs emerge as important players in the global financing of climate change mitigation and sustainable development actions (Tsani and Overland, 2020; Tsani et al., 2021). Coutinho and Tsani examine the role of SWFs under the topic of fiscal procyclicality and macroeconomic volatility that are evidenced in many resource-rich countries. Chapter 17 presents their detailed review of the work published to date on the links between macroeconomic volatility and fiscal policy in resource-rich countries and on the role of institutions. The literature review shows that fiscal pro-cyclicality in resource-rich countries remains under-investigated. Few recent studies attempt to address this issue by providing evidence that fiscal policy has been pro-cyclical in resource-rich countries. Linking this subject to institutional quality and explicit fiscal tools for macroeconomic management of natural resources, such as SWFs and fiscal rules, analysis shows that countries with stronger institutions have been better able to cope with the challenges of natural resource wealth management. While arguments in the literature point in this direction, the empirical and country evidence on this matter remains inconclusive. Coutinho and Tsani show that a systematic analysis of fiscal policy responses in resource-rich countries and of the fiscal arrangements (i.e., fiscal rules, SWFs) can offer valuable contributions to the understanding of resource economics and politics for sustainable resource management. Beyond national policies and institutions, international actions and institutional capacity also have a significant impact on the sustainability transition and climate change mitigation achieved by countries worldwide. This argument is acknowledged in this Handbook and examined in detail in the work of Doussis and Espa, presented in Chapter 18. Coupled with a legal perspective, this chapter discusses the importance of conceptualizing, assessing and quantifying the effectiveness of international legal institutions and provisions for the sustainable management of natural resources and the implementation of the SDGs. Doussis and Espa discuss the methodological challenges of developing and implementing quantitative measures of the performance of legal systems and the meaningful contributions that such measures could provide to multiple agreements. In support of future work in the field, Doussis and Espa discuss the pros and cons of tailoring the choice of suitable legal indicators for clusters of agreements, either on a natural resource basis (e.g., agreements on the protection of water) and/or on a treaty basis (e.g., the Paris Agreement). The work presented in Chapter 18 prepares the ground for more interdisciplinary research on the methodological framework for the development of legal indicators to be employed in the assessment of SDGs implementation and performance relating to resource protection, conservation and sustainable socio-economic development. In Chapter 19, Zagonari adds in a novel and challenging way to the debate on the links between institutional characterization, resource management and SDGs implementation. His work provides a first empirical assessment within a single analytical framework of the links between different religious and secular ethics frameworks and the conservation of resources (water) and biodiversity. His work provides theoretical evidence that both religious and secular ethics can support resource conservation, by stressing either respect for nature and non-human beings or reciprocity for future generations. The statistical results summarized in

10  Handbook of sustainable politics and economics of natural resources Chapter 19 show that religious ethics have a beneficial impact on resource and biodiversity conservation, while secular ethics have a beneficial impact on biodiversity conservation. In terms of policy reliability, Zagonari finds that neither religious nor secular ethics are reliable policies to achieve resource conservation. The work of Zagonari indicates the need to better understand the relationship between informal institutions, resource management and sustainable development, and to further investigate the differences between informal institutions in different countries and how these explain the divergence in sustainability and climate change action in those countries.

5

CHANGE AND UNCERTAINTY IN RESOURCE POLICIES

Parts I–III of the Handbook provide fresh insights on topics that have long been debated in the economics and politics literature on natural resources. This supports the state-of-the-art provisioning of the Handbook. Nevertheless, any attempt to build a holistic understanding of the current state of resource politics and economics and the challenges lying ahead for policy makers and researchers in the field would be incomplete if emerging trends in the literature and topics gaining momentum in the recent past were disregarded. Part IV of the Handbook takes a forward-looking approach to issues of resource politics and economics by looking at recent and emerging trends in the literature relating to the national and global policy scene, uncertainty, risk and unanticipated socio-economic shocks. In Chapter 20, Papandreou provides an overview of the literature on stranded assets and financial system vulnerability. This follows burgeoning interest in the risks associated with stranded assets. The review of alternative definitions of stranded assets and climate-related risks reveals the plethora of their links to the financial system. Two main channels of climate-related risks are discussed in depth: risks of physical impacts from climate change and risks associated with the transition to a low-carbon economy. The analysis shows that the financial system is not yet prepared to adequately account for the potential links and the low responsiveness with corrective policies so far. The study indicates the special challenges and threats to financial stability associated with the sustainability transition, which need to be thoroughly understood and addressed in the years to come. Tsani and Kozlova discuss methodological approaches to the interaction between the economy, the environment and the energy system in Chapter 21. While traditional models can adequately capture the macroeconomic conditions and drivers of resource use and energy interaction with the rest of the economy–environment system, they may largely disregard agents’ behavioural characteristics. Following landmark global and regional actions to address climate change and the shift to green energy, economies and societies have entered a new era of technological revolution, with green energy technologies developing fast and with ever-decreasing production costs. The development of these technologies will inevitably transform the energy sector at unprecedented levels. Moreover, it will introduce significant uncertainty and several challenging questions for policy making related to energy. The analysis shows that questions related to investors’ attitudes and decision making in conditions of uncertainty and the effects of retroactive policy changes and technology learning emerge as being of primary importance for energy modelling and energy policy making. Such behavioural aspects and changes cannot be captured adequately by the energy–economy models developed so far. Methodological and conceptual developments to address these limitations look at the usefulness of real options

In quest of sustainable politics and economics of natural resources  11 models, indicating directions for future research and areas of policy making where such tools could prove useful. Agliardi and Spanjers discuss ambiguity and risk in the context of financial markets, climate change policies and investor behaviour in Chapter 22. The authors start their analysis with the realization that uncertainty and risk from climate change represent one of the most significant and complex challenges facing the world this century. They also acknowledge that to sustain the transition towards a low-carbon economy, a huge number of financial resources are needed. Nevertheless, investments face ambiguity and risk. Agliardi and Spanjers provide a brief survey of the different approaches to ambiguity in the literature. They examine the effects of ‘deep’ uncertainty on firms’ decisions to issue green bonds in a structural model, where there is ambiguity about the effectiveness of the environmental projects that have been financed and the investors’ ‘green perception’ in portfolio choices. Their analysis shows that ambiguity affects defaults, credit spreads and the so-called ‘greenium’ or green premium, and impacts on investors’ optimal portfolio decisions, potentially impeding the financing of green projects. The results show the need for the design of policy measures and initiatives that can foster transparency through standardized definitions and disclosure requirements, to reduce the ‘deep uncertainty’ experienced by investors. Chapter 23 illustrates the discussion on SWFs with the recent developments in Azerbaijan and its State Oil Fund. Countries sitting on substantial revenues coming from natural resources ought to be in a better position to address unexpected socio-economic shocks like the COVID-19 pandemic. Ahmadov, in his analysis of the experience of Azerbaijan with the pandemic and the use of the State Oil Fund for emergency response, indicates the risks and opportunities and the importance of transparency and accountability. The review indicates that setting policy priorities correctly and aiming for transparency and accountability are very important. These preconditions become imperatives for successful operation and mobilization of resource wealth in times of crisis and unexpected shocks. Widdershoven in his analysis in Chapter 24 argues that COVID-19 may be one of the unexpected bumps in the road to energy transition, adding to the economic and financial constraints. While energy transition is defined as a period where conventional energy supplies will be complemented and replaced by renewables and new energy sources, scenarios and expert analysis show that in the coming decades oil and gas will have an important share in the global energy production mix. At the same time, policy and investor actions intensify for divestment from hydrocarbon assets and no financing of hydrocarbon projects. The analysis discusses the implications of energy transition and underfinancing in the oil and gas sector for future meeting of energy demand and for the socio-economic development of hydrocarbon producers and developing regions, indicating the uncertainties that surround the oil and gas producers but also the end users of conventional energy sources.

6

CONCLUDING REMARKS

This review of the works included in the Handbook of Sustainable Politics and Economics of Natural Resources has revealed the plethora of issues of policy and economic relevance that require careful attention and adequate understanding for sustainable resource management. Following a brief overview of the individual contributions to the Handbook, a collection of broad-brush conclusions and directions for future research is presented in this final section.

12  Handbook of sustainable politics and economics of natural resources First, successful resource management in social, economic, technology and policy terms should address challenges all the way from resource discovery to revenue management. Research in this area should look at the resource specifics and the links between challenges and opportunities at the different stages of resource exploitation. Second, policy and economic solutions to challenges related to natural resources require community-level and local assessment in tandem with the wider macroeconomic analysis. Empirical and theoretical works in this area need to shed more light at the micro level and enrich existing knowledge obtained from a macro perspective. Third, natural resource-specific characteristics matter to the analysis and to the design and achievement of sustainability transition. Point, finite natural resources, such as minerals, metals and hydrocarbons, expose economies to considerable economic challenges, while they may also impact on the transition speed and coordination of policies and targets in resource-dependent economies. The scientific community can look further into what resource dependence means for the transition path and speed of economies worldwide. Fourth, policy choices to continue using the same resources and energy sources (e.g., hydrocarbons) expose economies to the risks of being left behind in technological innovation, and of not achieving socio-economic transformation in a timely and cost-effective manner. Thus, it seems important to understand and better characterize incentive provisioning in times of socio-economic and technological transformation. Fifth, meeting ambitious climate targets may pose an opportunity for structural change and diversification of economies away from dependency on conventional energy sources. These opportunities should be understood, quantified and clearly communicated to policy makers and the wider community. Sixth, prudent management necessitates the development of appropriate tools (e.g., models or fiscal mechanisms) and coordination at the micro level (e.g., at the level of investors or sectors) and at the macro level. To develop future policies and recommendations, it is necessary to look at experience (e.g., experience with fiscal rules, sovereign wealth funds or local content) and extract useful conclusions for actions in times of uncertainty and where greater flexibility is needed. Seventh, risk and uncertainty remain crucial for sustainable development and climate change action, as they affect investors’ decisions and the channelling of adequate capital towards the financing of sustainability transition. A key challenge for policy makers and researchers is to understand their impact and to appropriately capture them in the decision-making process. Future research should target this challenge. Eighth, agendas of countries worldwide, the presence of nationally and/or regionally specific targets, resource abundance, unforeseen developments and socio-economic characteristics play a key role in the way forward. Thus, coherence of national–global actions and target priorities in the policy sphere should be better grasped and analysed to support timely and meaningful alignment of policies. In relation to this, the importance and efficiency of international law and institutions need to be better understood. Ninth, the decline in demand for conventional energy sources and the increase in demand for renewable energy may impact on regional outlooks in the near future and on the economic and political relationships between regions and countries in the world. These changes need to be identified and analysed at country, regional and global levels. Tenth, institutional capacity, cooperation and identification of the formal and informal ‘rules of the game’ that play a part in resource management are crucial to sustainable devel-

In quest of sustainable politics and economics of natural resources  13 opment and call for a thorough understanding from the perspective of both policy making and scientific research. Last, the experience with the COVID-19 pandemic indicates that the related conceptualization and careful economic and policy design are essential not only for the long-term sustainable development, but also for the resilient and efficient resource management in times of unforeseen socio-economic shocks.

REFERENCES Tsani, S. and Overland, I. (2020). ‘Sovereign wealth funds and public financing for climate action’. In W. Leal Filho, A. Azul and L. Brandli et al. (eds), Climate Action (Encyclopedia of the UN Sustainable Development Goals series). Cham, Switzerland: Springer. Tsani, S., Riza, E., Tsiamagka, P. and Nassi, M. (2021). ‘Public policies, one-health and global inequalities under the Covid-19 lens’. In W. Leal Filho, A. Azul and L. Brandli et al. (eds), Reduced Inequalities (Encyclopedia of the UN Sustainable Development Goals series). Cham, Switzerland: Springer.

PART I RESOURCE SPECIFICS AND CONSIDERATIONS FOR POLICY MAKING

2. Natural resources and economic development Wee Chian Koh

1 INTRODUCTION Since the 1960s, resource-rich developing countries have, on average, experienced lower growth and worse development outcomes compared to their resource-poor counterparts (Sachs and Warner, 1995). To many, this ‘resource curse’ may contradict the common-sense view that natural resources are riches. After all, present-day developed countries such as Australia, Canada, the United States and the Scandinavian countries became rich because of their natural resource wealth. It is true that resource wealth can spur economic growth by providing a source of funds for governments to invest in development. However, resource wealth may also create disincentives to develop other areas of the economy that are more important for long-term growth and can lead to corruption or be a source of conflict. In other words, natural resources can be both a blessing and a curse. Norway is a success story of oil-based development, but Nigeria is the opposite. Similarly, diamond-rich Botswana and Sierra Leone have divergent development paths, and so have copper-rich Chile and Zambia. This chapter reviews the challenges of natural resource-based development and discusses the policies that can help developing countries transform their natural resource wealth into sustainable development. Section 2 outlines the impediments to development based on natural resources. Section 3 highlights selected country cases of successful resource-based development and contrasts their experiences with countries that have failed despite similar natural resource endowments. Section 4 presents some stylized facts on resource dependence. Section 5 discusses policies that can help resource-dependent countries build resilience and Section 6 concludes.

2

OBSTACLES TO NATURAL RESOURCE-BASED DEVELOPMENT

Natural resources play an important role in the economy of many countries as they offer vast opportunities for development. In theory, revenues derived from non-renewable subsoil assets such as hydrocarbons and minerals can be transformed into reproducible surface assets by investing in human and physical capital, strengthening social capital and accumulating foreign assets to sustain economic growth and development. However, this transformation has been difficult in practice (Venables, 2016). Some countries have succeeded in using natural resources for development, but many others have failed. Harnessing natural resources involves several phases, each with its own set of challenges. At the initial stage, discovery of resource deposits and their extraction requires substantial investment and technical expertise, which typically involves foreign-owned firms. The host country needs to design an appropriate regulatory and fiscal regime so that the investor can 15

16  Handbook of sustainable politics and economics of natural resources make a normal rate of return and the state can have a fair share of resource revenues. Several complications can arise. First, the awarding of licenses for exploration and development rights can possibly be corrupt, such as the Simandou iron ore project in Guinea and the Petrobras oil scandal in Brazil (Burgis, 2014; Segal, 2015). Second, the host government may have limited technical capacity in valuing their natural resources, designing fiscal regimes, negotiating with extractive companies and monitoring resource revenues. This information asymmetry can result in an exceptionally low take of resource rents. In the case of copper mining in Zambia, the average effective royalty rate (prior to changes in 2008) was 0.6 percent, much lower than the global average range of 2 to 6 percent (Lundstøl, Raballand and Nyirongo, 2013). In Tanzania, the average effective tax rate for mining (prior to new laws passed in 2017) was less than half that of petroleum. The next stage concerns the management of volatile and exhaustible resource revenues – how much to spend on current consumption and how much to save for the future (Collier et al., 2009). According to the permanent income hypothesis, consumption from a resource windfall should be smoothed through time – borrowing during periods in which permanent income exceeds actual income and saving to accumulate assets when actual income exceeds permanent income. However, developing countries are capital-scarce and have pressing needs for infrastructure, health and education investment that could offer higher social returns. Yet, high-return projects are not a given, as resource-rich countries are often plagued by poor public investment management efficiency. There have been numerous white elephant projects, such as grand infrastructure projects in Equatorial Guinea that appeared to have little social value (Appel, 2012). Volatile commodity prices can induce procyclical fiscal policy that causes boom-and-bust cycles. During good times, the government may be pressured to increase spending, sometimes more than proportionately. For instance, public sector employees may demand higher salaries and wages. During bad times, the government is forced to cut spending, possibly because of limited access to international borrowing. Many countries have established stabilization or savings funds to delink government spending from volatile resource revenues. However, in some countries, the effectiveness of their resource funds has been undermined by the absence of sound legal institutions. A particular example is Chad, which set up a sovereign wealth fund with assistance from the World Bank. However, the fund was raided and spent on buying weapons when political tensions erupted, prompting the World Bank to suspend loan disbursements (Zissis, 2006). In addition to volatility, commodity prices are subject to a long-term declining trend (Harvey et al., 2010). The Prebisch-Singer hypothesis argues that the prices of mineral and agricultural products follow a long-term downward trajectory relative to the prices of manufactured goods (Prebisch, 1950; Singer, 1950). The declining terms of trade are due to the lower income elasticity of primary products: for every 1 percent increase in income, the demand for raw materials increases by less than 1 percent. This accords with Engel’s Law that households spend a smaller fraction of their income on food and basic necessities as they become richer. Technological developments that create synthetic substitutes further compress the prices of commodities. Resource wealth can distort incentives of the ruling elite by tilting wealth distribution in their favor to perpetuate their hold on political and economic power. The incumbent government may bribe voters or spend heavily on its favored partisan groups (Robinson, Torvik and Verdier, 2006). The ruling party may also block institutional reforms such as democracy by

Natural resources and economic development  17 using patronage to repress popular movements (Ross, 2001). A resource bonanza also encourages entrepreneurs, who are otherwise productive, to resort to rent-seeking such as lobbying or corruption (Torvik, 2002). Point resources, such as oil, diamonds and minerals, generate greater opportunities for corruption than diffuse resources, such as cropland and livestock, as they are spatially concentrated and hence more easily captured and controlled (Isham et al., 2005). Resource wealth can also increase the incidence of conflict, especially when there is a valuable resource such as oil or diamonds, as exemplified by the civil wars in Angola (Le Billon, 2001). Some unpleasant side-effects may arise from a resource windfall, leading to a shift in the structure of an economy. Factors of production are drawn to the resource sector and also to the non-tradable sector due to increased demand from domestic spending of resource revenues, while displacing other sectors such as manufacturing, possibly leading to deindustrialization (Corden and Neary, 1982). This phenomenon is referred to as the ‘Dutch disease’, coined after the decrease in manufacturing exports in the Netherlands following the discovery of gas in the North Sea in the 1950s. Moreover, as the manufacturing sector demands a comparatively high level of human capital, as opposed to primary production, the government is less likely to invest in a better educational system and will instead devote efforts to the exploitation of the natural resource (Gylfason, 2001). The above catalogue of potential failures, from resource discovery to management of resource revenues, demonstrates the difficulties of natural resource-based development. Even so, some resource-rich countries have made impressive progress in raising the standard of living for their people.

3

SELECTED CASES OF DEVELOPMENT BASED ON NATURAL RESOURCES

Prior to the late 1980s, natural resource wealth was widely viewed as a blessing by enabling developing countries to escape the ‘underdevelopment trap’, just as developed countries such as the United States had done. The United States grew rapidly, not despite its natural resource endowment but because of it (Wright, 1990). However, the disappointing performance of resource-rich developing countries from the 1960s to the 1990s provides a cautionary tale of development based on natural resources. This has been in part due to a decline in real non-energy commodity prices, as bulk transport costs fell and governments abdicated from intervening in commodity markets (Radetzki, 2011). Many countries in Latin America and Sub-Saharan Africa also engaged in excessive borrowing and faced severe difficulty in repaying external debt (Koh et al., 2020). Meanwhile, the resource-poor Asian tigers – Hong Kong, Singapore, South Korea and Taiwan – grew at a rapid rate. Yet, resource abundance or dependence is not all doom and gloom. There have been several high-growth outliers; in particular, Botswana, Chile, Indonesia, Malaysia, Mauritius and Norway (see Figure 2.1). Diamond mining has made Botswana among the most prosperous countries in Sub-Saharan Africa. The Botswana economy has undergone a significant structural transformation since gaining independence in 1966. The share of agriculture in gross domestic product (GDP) declined from 41 percent to 2 percent in 2018, while the mining sector’s contribution is now around 35 percent. Gross secondary school enrolment rose from 8 percent in 1970 to 80 percent in 2008. Life expectancy at birth increased from 54 years in 1970

18  Handbook of sustainable politics and economics of natural resources to 69 years in 2017, after making progress in reducing HIV prevalence in recent years. Poverty rates have declined by more than two-thirds. Botswana’s development success has been attributed to good policies – investment in human and physical capital and prudent fiscal policy – and good governance – a law-abiding government largely free of kleptocracy (Lewin, 2011). This contrasts sharply with Sierra Leone, which is also endowed with rich diamond deposits. Botswana’s kimberlite diamonds, which lie deep in the ground and hence are not very lootable, may have also played a role in its success, whereas Sierra Leone’s alluvial diamonds are easy to mine and easy to loot (Olsson, 2006). Chile has made tremendous progress since the 1980s. Inflation has been brought down from double digits to less than 3 percent, life expectancy at birth is higher than the United States and poverty rates have been reduced by more than three-quarters. Copper mining has been a key driver of Chilean exports after the country opened up to trade. Chile’s prudent management of fiscal policy – through a fiscal rule and a stabilization fund – and the development of an institutional structure around it have helped to contain spending pressures from short-term political interests (Marcel, 2013). By contrast, Zambia has failed to grow despite abundant copper deposits. Its real per capita income in 2018 was only slightly higher than in the 1960s. After independence in 1964, Zambia closed off its economy from the rest of the world by erecting tariffs and currency controls. Copper mines were nationalized, which meant they became a source of patronage and this also led to looting of public funds (Meller and Simpasa, 2011). Despite its vulnerabilities to weather and price shocks, the small island nation of Mauritius has been transformed from a poor sugar economy to the second richest country in Sub-Saharan Africa. It has been successful in reducing reliance on sugarcane production by diversifying into textiles, tourism, business process outsourcing, and financial services. Good policies – open trade, investing in education and improving the business climate – and good institutions – a parliamentary democracy and low levels of corruption – have been the key factors in Mauritius’s success (Frankel, 2016). By contrast, Fiji – also a sugar exporter and a small island nation – has exhibited dismal economic progress, largely attributed to the political instability created by a series of military coups (Prasad, 2014). Malaysia has transformed dramatically from being dependent on primary commodity exports in the 1970s to a diversified economy with strong links to global value chains. In 1970, agricultural raw materials accounted for one-half of total merchandise exports, ores and metals constituted about one-quarter, while manufactured goods made up less than 7 percent. In 2018, the shares were 1 percent, 4 percent and 70 percent, respectively. Malaysia’s impressive growth has been driven by structural reforms that focused on capitalizing its favorable geographic location to promote export-oriented industrialization, which has facilitated the development of the manufacturing sector (Koen et al., 2017). Similarly, Indonesia’s economy has expanded strongly, and its structure has changed considerably. Economic reforms aimed at industrialization and global integration have been successful in diversifying away from oil exports (Elias and Noone, 2011). As a share of merchandise exports, fuel exports declined from 70 percent in 1980 to 20 percent in 2018, while manufactured exports grew from 2 percent to 45 percent. Norway is among the richest countries in the world and sits at the top of the United Nations Human Development Index. Much of its development success has been a result of disciplined oil revenue management, including building strong institutions to avoid the rent-seeking problems that have afflicted most oil-exporting countries (Gylfason, 2011). Earnings from oil are invested offshore in a sovereign wealth fund to save for future generations and to

Natural resources and economic development  19 shield the economy from currency appreciation pressures. In Nigeria, the largest oil producer in Sub-Saharan Africa, real per capita income has stagnated since its independence in 1960. Nearly half of its population lives in poverty. Life expectancy at birth is 54 years, among the lowest in the world. Successive military dictatorships have plundered the country’s oil wealth, resulting in its miserable underdevelopment (Sala-i-Martin and Subramanian, 2003).

Source:

Maddison Project Database; World Development Indicators.

Figure 2.1

Real per capita GDP based on purchasing price parity (2011 international $) in selected countries, 1950–2015

20  Handbook of sustainable politics and economics of natural resources Equatorial Guinea’s exceptional growth after large oil reserves were discovered in 1996 has structurally changed its economy from being dependent on timber and agriculture to one of the most oil-dependent countries in the world. However, its vast oil wealth has underpinned a dictatorship, provided more avenues for political patronage and undermined economic development (Frynas, 2004). In 2006, three-quarters of the population remained in poverty. Oman, on the other hand, has achieved a high standard of living by investing substantially in education, health and public works. However, distribution of oil rents through funding a large public sector with high wages and social benefits has led to a heavy reliance on cheap foreign labor in the private sector. The continued bifurcation of the labor market will have repercussions on both fiscal and political stability (Ennis and al-Jamali, 2014). A combination of depleting oil reserves in Equatorial Guinea and Oman – about 15 years based on proved reserves and production in 2018 – and the plunge in oil prices since 2014 has exposed the vulnerabilities of development based on a single commodity: real per capita incomes have experienced a sharp decline in recent years.

4

STYLIZED FACTS OF RESOURCE DEPENDENCE

Beyond these individual anecdotes or case studies, there is a large empirical literature on whether natural resources are a blessing or a curse (Van der Ploeg, 2011). Although the empirical debate is far from settled, the general consensus is that the quality of political and economic institutions is a fundamental factor that determines whether resource-dependent countries perform well or not. Figure 2.2 shows scatter plots between resource dependence and growth, human development and institutional quality. The fitted regression lines indicate a negative relationship: on average, countries that are more resource dependent experience lower growth and poorer human development outcomes and are associated with lower institutional quality. A country is considered resource dependent if primary exports make up at least 60 percent of total merchandise exports (United Nations Conference on Trade and Development [UNCTAD], 2019). Figure 2.3 shows the distribution of resource-dependent countries by geographical region, income group and special needs. Several facts are evident. First, resource dependence is a common phenomenon. More than half the countries in the world are resource dependent. Second, resource dependence is especially pervasive in Sub-Saharan Africa (83 percent), Latin America and the Caribbean (65 percent) and the Middle East and North Africa (62 percent). Third, resource dependence is heavily concentrated in poor developing countries. Ninety percent of low-income countries and 63 percent of lower-middle income countries depend on resource exports. Fourth, a majority of the countries that are the most vulnerable are resource dependent: 91 percent of countries in fragile, conflict and violence situations; 73 percent of landlocked countries; and 59 percent of small island developing states Some countries have an extremely high dependence on a single primary export group. Table 2.1 shows the top ten resource-dependent countries for agricultural raw materials, food, fuel, and ore and metal exports over the past ten years. All the top ten energy exporters are highly dependent on oil and gas (more than 90 percent of merchandise exports). Among mineral exporters, Zambia is dependent on copper exports and Guinea on aluminum ore and gold. The Maldives and Greenland export mostly fish and seafood. More than three-fifths of exports from the Solomon Islands are timber.

Natural resources and economic development  21

Note: Growth rate is the annual change in real per capita GDP based on purchasing price parity; data based on 195 countries, 1962–2018 average. Human Development Index is the United Nations’ composite measure of life expectancy, education and gross national income per capita; data based on 176 countries, 1990–2018 average; a higher index indicates better human development outcomes. Institutional quality score is the average of the six dimensions of the World Bank’s Worldwide Governance Indicators – voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law and control of corruption; data based on 185 countries, 1996–2018 average; a higher score indicates better quality of institutions. Source: United Nations Development Programme; World Development Indicators; Worldwide Governance Indicators.

Figure 2.2

Resource dependence and growth, human development and institutional quality

22  Handbook of sustainable politics and economics of natural resources

Note: Geographical region, income group and fragility, and situations of conflict and violence are based on World Bank’s classification (FY 2020). Landlocked countries and small island developing states are based on UNCTAD’s classification. Source: World Development Indicators.

Figure 2.3

5

Distribution of countries by resource dependence and geographic region, income group and special needs

POLICIES TO BUILD RESILIENCE IN RESOURCE-DEPENDENT COUNTRIES

The institutional framework and fiscal regime design are crucial elements to maximize economic returns to the state. Macroeconomic stabilization policies can help to reduce the transmission of commodity price volatility to the economy in the short term. Over the medium to long term, economic diversification and structural policies are keys to sustainable growth and development.

Country

11.3

Ethiopia

World Development Indicators.

11.5

New Zealand

Source:

12.7

Kenya Malawi

Tonga

Vanuatu

Seychelles

Cabo Verde

20.8

St. Vincent and the

28.8

38.0

Central African

Faroe Islands

Cameroon

40.4

Mali

89.7

97.8

exports

Share of merchandise

78.9

80.3

80.8

81.2

82.8

84.0

88.0

São Tomé and Príncipe 89.4

Timor-Leste

44.3

Benin

Greenland

Grenadines

44.3

Burkina Faso

Republic

63.0

Solomon Islands

exports Maldives

Food

Share of merchandise

Agricultural Raw Materials

Venezuela, RB

Nigeria

Azerbaijan

Sudan

Kuwait

Brunei Darussalam

Angola

Algeria

Libya

Iraq

Country

Fuel

Top ten resource-dependent countries by primary export group

Country

Table 2.1

90.6

90.6

92.4

92.5

93.3

93.8

95.6

96.1

97.8

99.7

exports

Share of merchandise

Armenia

Mauritania

Niger

Peru

Mongolia

Lao PDR

Papua New Guinea

Chile

Guinea

Zambia

Country

Ores and Metals

43.2

44.2

46.6

50.7

52.7

54.4

55.8

57.3

74.0

78.3

exports

Share of merchandise

Natural resources and economic development  23

24  Handbook of sustainable politics and economics of natural resources 5.1

Regulatory and Fiscal Regime

The legal and regulatory framework governing resource extraction is fundamental in transforming resource wealth into development. Legislation should be consistently applied to all industry actors and include core elements such as licensing, allocation of rights, fiscal terms, health and safety, and environmental standards. Regulatory oversight and effective enforcement of rules are crucial in a strong institutional set-up. The process of awarding contracts and licenses to extractive companies should be transparent to limit corruption. Standardizing contract terms and competitive bidding of licenses can increase the likelihood that the host government and investor will get a good deal. The design of the fiscal regime determines the government’s share of resource revenues. An effective regime should take into account the state’s risk-bearing capacity, revenue horizon, timing preferences and the broader context of development policies. In developing countries, a fiscal regime combining a royalty and a resource rent tax has appeal as it ensures some government revenue inflow at the start of production and revenue rises in line with commodity price increases (International Monetary Fund [IMF], 2012). 5.2

Fiscal Policy

Procyclical fiscal policy exacerbates the impact of volatile commodity prices on the economy. To diversify away from commodity price shocks and to stabilize the economy, the fiscal stance should be countercyclical. This can be achieved by saving surplus revenues in a reserve fund during booms and using the accumulated fiscal space to implement fiscal stimulus during busts (Tsani, 2013). The proliferation in resource funds coincided with the commodity price boom in the late 1990s. A third of developing countries ‘graduated’ from fiscal procyclicality during the period 2000–09 (Frankel, Vegh and Vuletin, 2013). About half of this cohort comprises resource-dependent countries, suggesting that resource funds may have played an important role in reducing the procyclical bias (Coutinho et al., 2013; Koh, 2017). Resource funds are nonetheless not a panacea, as they could be misappropriated if the legal framework is weak, as the Chad experience shows. In this regard, legally imposed fiscal rules to correct distorted incentives and contain overspending pressures can be helpful, as exemplified by Chile’s success. Prudent budget management, such as establishing a medium-term expenditure framework and basing fiscal projections on equilibrium commodity prices, can strengthen fiscal discipline and credibility (World Bank, 2012). Increasing non-resource revenues can reduce the dependence on volatile receipts. There is considerable scope to boost revenues from goods and services, since resource-dependent countries collect only about half that of other countries (Medas, Salins and Danforth, 2016). New revenue sources can include a broad-based value-added tax and excise taxes on tobacco and sugary beverages. Commodity derivate instruments such as forward contracts, futures, options and swaps can make resource revenues more predictable, but the costs become prohibitively expensive beyond a hedging duration of one to two years.

Natural resources and economic development  25 5.3

Monetary and Exchange Rate Policies

Flexible exchange rate regimes allow a smoother output adjustment to commodity price shocks through changes in the nominal exchange rate, if depreciation and inflation risks are well-managed (Koh, 2016). In contrast, fixed exchange rate regimes allow only a limited depreciation and the macroeconomic stabilization burden is thus borne by fiscal policy. Tightening monetary policy or selling international reserves may be required to sustain the currency peg, which can be costly. Following the plunge in oil prices in mid-2014, Russia transitioned to a free-floating regime in November 2014. Kazakhstan abandoned its soft peg to the US dollar in August 2015, followed by Azerbaijan in December 2015 and Nigeria in June 2016. These countries were forced to devalue their currencies after suffering substantial declines in their international reserves to support the exchange rate pegs. Following a resource windfall, foreign exchange intervention by the central bank can soften the negative effects of Dutch disease by reducing exchange rate appreciation pressures and hence preserve the competitiveness of the domestic economy (Faltermeier, Lama and Medina, 2017). Moreover, such interventions can help to build policy space. Many countries in Latin America accumulated large foreign reserves during the commodity price booms in the 2000s. These buffers were deployed to address disorderly conditions in the foreign exchange market during the 2008–09 Global Financial Crisis (Koh and Yu, 2019). 5.4

Economic Diversification

Resource-dependent countries are vulnerable to external shocks, especially those that are small, geographically remote, or with a heavy concentration on a limited range of commodities. Diversification helps to lower volatility by stabilizing export revenues and hence provide a more stable path for growth and development. Globalization and technological change offer multiple pathways to economic diversification. Malaysia sustained growth by diversifying into labor-intensive manufacturing and then shifted toward higher-technology products. Mauritius transitioned from dependence on sugar to textiles to a broad-based services economy. Chile diversified within the copper industry by exporting processed products and developing its domestic ancillary and logistics services. Successful diversification requires a multi-pronged approach that takes into account the country’s endowments, geography, institutions, governance and implementation capacity (World Bank, 2019). Trade and investment policies – openness to foreign investors, new markets and new skills – are vital: no country has experienced sustained growth and development without integrating into the global economy. Tariffs on imports can constrain participation in regional and global value chains and affect trade patterns, as illustrated by the ongoing trade tensions between the United States and China. Non-tariff barriers, such as border procedures, technical regulations and standards, and sanitary and phytosanitary measures, can raise trade costs. Trade agreements that include provisions for harmonization or mutual recognition of standards can help to address arbitrary discriminatory measures. To increase new market opportunities, it may be easier for firms to export to neighboring countries as regulatory requirements are often similar. Liberalization of the service sector aimed at improving efficiency in telecommunications, finance, insurance and logistics can help to facilitate goods exports. Investments in critical transport infrastruc-

26  Handbook of sustainable politics and economics of natural resources ture – roads, railways, seaports and airports – as well as improving trade facilitation at borders can further reduce trade costs. A conducive business environment is integral to incentivizing investment in new activities. Clear and transparent regulations, predictable enforcement of contracts and intellectual property rights, and strong market competition encourage firms to test new products and markets. Non-discriminatory competition policy that guarantees neutrality, especially in markets saddled with entry barriers and a large presence of state-owned enterprises, can foster innovation and help firms expand and diversify based on their own merits. Foreign direct investment (FDI) can also act as an enabler of diversification, particularly those that show greater linkages and positive spillovers to the rest of the economy. The impact of FDI on diversification also depends on host country conduct. Vietnam has become an attractive investment destination largely due to its pro-business attitude. FDI helped Vietnam integrate into global supply chains and diversify its exports – from agricultural raw materials to processed food, and then to manufacturing of textiles, footwear and electronics – as well as diversify its trading partners – from the Soviet Union to Asia, Europe and the United States (Papageorgiou and Spatafora, 2012). Spatial policies to stimulate economic development such as special economic zones (SEZs) can support diversification. SEZs in Dubai, Malaysia, Mauritius and Vietnam have generated new economic activities and a significant number of jobs. However, there are also many failed examples (Lederman and Maloney, 2012). Streamlined ‘doing business’ procedures, sound physical infrastructure and strong government ownership are important to the success of SEZs. Dubai has more than 30 SEZs with low tax regimes and other concessional benefits. Dubai’s very open trade, investment and labor policies provide incentives for multinational companies to invest in state-of-the-art infrastructure, real estate and business services to serve as a transport and logistics hub to exploit agglomeration externalities (Gelb, 2011). 5.5

Structural Policies

A broad-based quality education and skills ecosystem is a key component of economic diversification. Australia and Norway have successfully diversified to a ‘resource-based knowledge economy’ through learning and knowledge creation to facilitate innovation in new resource products and industries (Ville and Wicken, 2013). High enrolment rates in secondary and tertiary education do not automatically translate into good learning outcomes. Aligning education curricula and training needs to labor market demand is critical to address skills mismatches and allow the workforce to thrive in new industries. Financial sector policies can further support diversification. Deepening financial markets allow firms to access diverse sources of long-term capital financing, and a variety of financial instruments can facilitate risk management. Financial market development is particularly important in Africa, given the shallowness of finance in the region. Firms are reliant on a narrow range of risk-averse banks and also face constraints such as high interest rates, complex application procedures and a lack of collateral (Beck and Cull, 2014). Policies to improve institutions and governance quality are central to diversification as they allow proper functioning of the state and economy-wide service delivery. This includes checks and balances on power to avoid the emergence of patronage politics and competition for resource rents, which has hampered development progress in many resource-dependent countries.

Natural resources and economic development  27

6 CONCLUSION Natural resources do not necessarily confer widely shared benefits and economic success. While some countries, such as Botswana, Chile and Norway, have gained enormously from their resource endowments, others, such as Sierra Leone, Zambia and Nigeria, have remained in dire straits, marred by violent conflicts with devastating effects for society. Natural resources can be a blessing if the challenges, from resource discovery to resource revenue management, can be overcome. The experiences of developing countries that have successfully transformed natural resources into sustainable development offer valuable policy lessons. A sound legal and regulatory framework and an effective fiscal regime are crucial to ensure the state receives a fair share of resource rents from granting rights to extractive companies. Macroeconomic stabilization policies can help to minimize fluctuations of volatile resource revenues in the short term. Over the medium to long term, economic diversification and structural change should be pursued to sustain growth and development. Policies aimed at fostering open trade and investment, investing in human capital and building strong institutions are vital.

REFERENCES Appel, H. (2012), ‘Walls and white elephants: oil extraction, responsibility, and infrastructural violence in Equatorial Guinea’, Ethnography, 13 (4), 439–65. Beck, T. and Cull, R. (2014), ‘SME finance in Africa’, World Bank Policy Research Working Paper No. 7018. Burgis, T. (2014, 29 April), ‘Guinea inquiry finds Steinmetz unit won mining rights corruptly’, Financial Times. Collier, P., Van der Ploeg, F., Spence, M. and Venables, A. (2009), ‘Managing resource revenues in developing economies’, IMF Staff Papers, 57 (1), 84–118. Corden, M. and Neary, J. (1982), ‘Booming sector and de-industrialisation in a small open economy’, Economic Journal, 92 (368), 825–48. Coutinho, L., Georgiou, D. and Heracleus, M. et al. (2013), ‘Limiting fiscal procyclicality: evidence from resource-rich countries’, Centre for Economic Policy Research Discussion Paper No. 9672. Elias, S. and Noone, C. (2011), ‘The growth and development of the Indonesian economy’, RBA Bulletin, December Quarter, 33–43. Ennis, C. and al-Jamali, R. (2014), ‘Elusive employment: development planning and labour market trends in Oman’, research paper, Chatham House. Faltermeier, J., Lama, R. and Medina, J. (2017), ‘Foreign exchange intervention and the Dutch disease’, IMF Working Paper No. 17/70, International Monetary Fund. Frankel, J. (2016), ‘Mauritius: African success story’, in S. Edwards, S. Johnson and D. Weil (eds), African Successes, Volume IV: Sustainable Growth, Chicago, IL: University of Chicago Press for the National Bureau of Economic Research, pp. 295–342. Frankel, J., Vegh, C. and Vuletin, G. (2013), ‘On graduation from fiscal procyclicality’, Journal of Development Economics, 100 (1), 32–47. Frynas, J. (2004), ‘The oil boom in Equatorial Guinea’, African Affairs, 103 (413), 527–46. Gelb, A. (2011), ‘Economic diversification in resource-rich countries’, in R. Arezki, T. Gylfason and A. Sy (eds), Beyond the Resource Curse: Policies to Harness the Power of Natural Resources, Washington, DC: International Monetary Fund, pp. 55–80. Gylfason, T. (2001), ‘Natural resources, education, and economic development’, European Economic Review, 45 (4–6), 847–59. Gylfason, T. (2011), ‘Natural resource endowment: a mixed blessing?’, in R. Arezki, T. Gylfason and A. Sy (eds), Beyond the Resource Curse: Policies to Harness the Power of Natural Resources, Washington, DC: International Monetary Fund, pp. 7–34.

28  Handbook of sustainable politics and economics of natural resources Harvey, D., Kellard, N., Madsen, J. and Wohar, M. (2010), ‘The Prebisch-Singer hypothesis: four centuries of evidence’, Review of Economics and Statistics, 92 (2), 367–77. International Monetary Fund (IMF) (2012), Fiscal Regimes for Extractive Industries: Design and Implementation, Washington, DC: IMF. Isham, J., Woolcock, M., Pritchett, L. and Busby, G. (2005), ‘Varieties of resource experience: natural resource export structures and the political economy of economic growth’, World Bank Economic Review, 19 (2), 141–74. Koen, V., Asada, H. and Nixon, S. et al. (2017), ‘Malaysia’s economic success story and challenges’, OECD Economics Department Working Paper No. 1369, Organisation for Economic Co-operation and Development. Koh, W.C. (2016), ‘Oil price shocks and macroeconomic adjustment in oil-exporting countries’, International Economics and Economic Policy, 14 (2), 187–210. Koh, W.C. (2017), ‘Fiscal policy in oil-exporting countries: the roles of oil funds and institutional quality’, Review of Development Economics, 21 (3), 567–90. Koh, W.C., Kose, M.A. and Nagle, P. et al. (2020), ‘Debt and financial crises’, World Bank Policy Research Working Paper No. 9116. Koh, W.C. and Yu, S. (2019), ‘Macroeconomic developments’, in M.A. Kose and F. Ohnsorge (eds), A Decade After the Global Recession: Lessons and Challenges for Emerging and Developing Economies, Washington, DC: World Bank, pp. 119–58. Le Billon, P. (2001), ‘Angola’s political economy of war: the role of oil and diamonds, 1975–2000’, African Affairs, 100 (398), 55–80. Lederman, D. and Maloney, W. (2012), Does What You Export Matter? In Search of Empirical Guidance for Industrial Policies, Washington, DC: World Bank. Lewin, M. (2011), ‘Botswana’s success: good governance, good policies and good luck’, in P. Chuhan-Pole and M. Angwafo (eds), Yes Africa Can: Success Stories from a Dynamic Continent, Washington, DC: World Bank, pp. 81–90. Lundstøl, O., Raballand, G. and Nyirongo, F. (2013), ‘Low government revenue from the mining sector in Zambia and Tanzania: fiscal design, technical capacity or political will?’, ICTD Working Paper No. 9, International Centre for Tax and Development. Marcel, M. (2013), ‘The structural balance rule in Chile: ten years, ten lessons’, IADB Discussion Paper No. 289, Inter-American Development Bank. Medas, P., Salins, V. and Danforth, J. (2016), ‘How to adjust to a large fall in commodity prices’, IMF Fiscal Affairs Department How-to Note No. 16/01, International Monetary Fund. Meller, P. and Simpasa, A. (2011), ‘Role of copper in the Chilean and Zambian economies: main economic and policy issues’, GDN Working Paper No. 43, Global Development Network. Olsson, O. (2006), ‘Diamonds are a rebel’s best friend’, World Economy, 29 (8), 1133–50. Papageorgiou, C. and Spatafora, N. (2012), ‘Economic diversification in LICs: stylized facts and macroeconomic implications’, IMF Staff Discussion Note No. 12/13, International Monetary Fund. Prasad, B. (2014), ‘Why Fiji is not the “Mauritius” of the Pacific? Lessons for small island nations in the Pacific’, International Journal of Social Economics, 41 (6), 467–81. Prebisch, R. (1950), The Economic Development of Latin America and its Principal Problems, New York: United Nations. Radetzki, M. (2011), ‘Primary commodities: historical perspectives and prospects’, in R. Arezki, T. Gylfason and S. Sy (eds), Beyond the Resource Curse: Policies to Harness the Power of Natural Resources, Washington, DC: International Monetary Fund, pp. 35–51. Robinson, J., Torvik, R. and Verdier, T. (2006), ‘Political foundations of the resource curse’, Journal of Development Economics, 79 (2), 447–68. Ross, M. (2001), ‘Does oil hinder democracy?’, World Politics, 53 (3), 325–61. Sachs, J. and Warner, A. (1995), ‘Natural resource abundance and economic growth’, NBER Working Paper No. 6938, National Bureau of Economic Research. Sala-i-Martin, X. and Subramanian, A. (2003), ‘Addressing the natural resource curse: an illustration from Nigeria’, NBER Working Paper No. 9804, National Bureau of Economic Research. Segal, D. (2015, 7 August), ‘Petrobras oil scandal leaves Brazilians lamenting a lost dream’, The New York Times.

Natural resources and economic development  29 Singer, H. (1950), ‘The distribution of gains between investing and borrowing countries’, American Economic Review, 40 (2), 473–85. Torvik, R. (2002), ‘Natural resources, rent seeking and welfare’, Journal of Development Economics, 67 (2), 455–70. Tsani, S. (2013), ‘Natural resources, governance and institutional quality: the role of resource funds’, Resources Policy, 38 (2), 181–95. United Nations Conference on Trade and Development (UNCTAD) (2019), Commodity Dependence: A Twenty-Year Perspective, New York: UNCTAD. Van der Ploeg, F. (2011), ‘Natural resources: curse or blessing?’, Journal of Economic Literature, 49 (2), 366–420. Venables, A. (2016), ‘Using natural resources for development: why has it proven so difficult?’, Journal of Economic Perspectives, 30 (1), 161–84. Ville, S. and Wicken, O. (2013), ‘The dynamics of resource-based economic development: evidence from Australia and Norway’, Industrial and Corporate Change, 22 (5), 1341–71. World Bank (2012), Beyond the Annual Budget: Global Experience with Medium-Term Expenditure Frameworks, Washington, DC: World Bank. World Bank (2019), ‘Economic diversification: lessons from practice’, in OECD/WTO, Aid for Trade at a Glance 2019: Economic Diversification and Empowerment, Paris: OECD Publishing, pp. 135–60. Wright, G. (1990), ‘The origins of American industrial success 1870–1914’, American Economic Review, 80 (4), 651–68. Zissis, C. (2006, 26 April), ‘Chad’s oil troubles’, Council for Foreign Relations.

3. Renewable energy transition, demand for metals and resource curse effects1 André Månberger

1 INTRODUCTION Mitigating climate change will require major changes to energy systems. It is widely acknowledged that fossil fuels can affect local and national development pathways, for better or worse. Low-carbon energy systems use renewable energies instead of fossil fuels. With only a few exceptions, renewable energies use flows that are often diffuse and distributed geographically, and renewables are therefore assumed to reduce the risk of a resource curse (Månsson, 2015). The energy transition is framed by some as ‘geopolitical’, as it creates both relative winners and losers, depending on, for example, how natural resource endowments are distributed (Overland et al., 2019; Vakulchuk, Overland and Scholten, 2020). Compared to fossil energy, low-carbon energy technologies contain both more metals and new ones too. Some of these metals are geographically concentrated and found in countries with fragile institutions and high levels of corruption. Policy responses may therefore be required to avoid some of the drawbacks associated with fossil fuels (Ali et al., 2017; Bazilian, 2018; Lee et al., 2020). The aim of this chapter is to provide an overview of the present state of knowledge of how a renewable energy transition affects metal demand and the risk of a resource curse in mining countries. The chapter starts with an overview of metals that are used in low-carbon energy systems and are perceived as critical. Next, the chapter summarizes insights from the existing literature on the potential metal demand for a renewable energy transition. The final section then turns to the supply side to address from where these resources could come and what impacts this could have for states and local mining communities.

2

LOW-CARBON ENERGY SYSTEMS AND THEIR DEMAND FOR CRITICAL METALS

Renewable energy systems require more materials in total and some different materials than their fossil fuel counterparts. Materials are used in all steps of the supply chain and some metals are used in several steps. To grasp which materials and how much can be required for low-carbon energy transitions, the entire supply chain needs to be analysed. This section there-

1 This is an open access work distributed under the Creative Commons Attribution -NonCommercial-NoDerivatives 4.0 Unported (https://​creativecommons​.org/​licenses/​by​-nc​-nd/​4​.0/​). Users can redistribute the work for non-commercial purposes, as long as it is passed along unchanged and in whole, as detailed in the License. Edward Elgar Publishing Ltd must be clearly credited as the rights holder for publication of the original work. Any translation or adaptation of the original content requires the written authorization of Edward Elgar Publishing Ltd.

30

Renewable energy transition, demand for metals and resource curse effects  31 fore provides an overview of metals used in the different steps of the supply chain, starting with production, distribution and storage and then ending with final use. Each step of the supply chain utilizes different technologies to meet a certain requirement. Solar panels, solar thermal and wind power plants are all examples of renewable energy production technologies that can be used, but they operate on different principles and can require different materials. Each of these groups of technologies also contains different sub-technologies that use different physical principles to convert energy into electricity, and as a result they have different material demands. The heterogeneity of materials used in different technologies enables substitution, which in turn provides flexibility. Availability of certain elements may therefore not be as critical for specific technologies in the long term as they are in the short term. Also, new technologies may be developed that depend on other physics and material needs. Some of these technologies are known but are currently at the research and development stage, while others are as yet unknown. Markets for technologies and raw materials are dynamic and can incentivize development of new technologies as well as improve the performance of existing ones if some materials become more scarce and costly. 2.1

Renewable Power Production

Renewable low-carbon energy production converts solar inflow or natural flows derived from this, geothermal heat, or potential energy from gravitation such as wave power, into usable forms of energy. Solar photovoltaics (PV) and wind power receive most attention and are often assessed to meet most of the demand in future renewable energy systems (see, e.g., International Energy Agency [IEA]/Organisation for Economic Co-operation and Development [OECD], 2017). This section will therefore focus on the material requirements of these two technology groups. Solar PV The most common solar power technique is the first generation of solar PV, containing crystal silicon wafers and silver on the back (Kavlak et al., 2015). Second-generation cells either contain cadmium and tellurium (CdTe) or copper, indium gallium and selenium (CIGS) (Elshkaki and Graedel, 2015). These cells are also referred to as thin film cells and have a multi-crystal structure. Third-generation solar cells – for example, perovskite solar cells and Grätzel cells – are not yet commercialized, but several options are being researched that use metals that are more abundant than current technologies. Silicon is the most abundant element in the earth’s crust but requires an energy-intensive and costly process to purify it to PV grade standard. Tellurium, indium and gallium are by-products from extraction of copper, zinc and aluminium, respectively (Nassar, Graedel and Harper, 2015). Most of the global silver production is mined as a by-product, mainly from sulphide lead-zinc ores. The host metal restricts the maximum extraction of the by-product, but current recovery rates are far below the theoretical potential which provide flexibility to expand by-product production (Frenzel et al., 2017). Wind power The most common wind power plant designs use non-renewable basic materials such as steel and aluminium in the tower and nacelle, and concrete in the foundations. There are different sub-technologies available for the generator. The two main categories are permanent magnet

32  Handbook of sustainable politics and economics of natural resources (PM) and electrically excited, in terms of material requirements (Viebahn et al., 2015). The PM generator contains a mix of materials including neodymium (a rare earth element with magnetic properties), dysprosium (rare earths that increase the PM’s heat tolerance), iron, boron and sometimes praseodymium and terbium (Pavel, Lacal-Arántegui and Marmier et al., 2017). Generators that are electrically excited have copper coils instead of PMs, which make the configuration heavier, increase the size and reduce efficiency at partial load. A gearbox is sometimes also used, which reduces the PMs’ weight relative to installed power capacity, but also reduces reliability. PM designs are therefore preferred for offshore installations since maintenance is more costly there than onshore. High-temperature super conductors using yttrium may be used in the future, but much more development is required for this technology to be commercialized (Viebahn et al., 2015). Other technologies Concentrated solar power (CSP) uses reflectors to heat up a medium that is then used to propel a turbine connected to a generator. For the generator’s material requirement, these technologies use silver in the collector to increase conversion efficiency and some also use nitrate salts (NaNO3 + KNO3) for thermal storage (Pihl et al., 2012). There are several other technology groups that can be part of a renewable power mix. However, these are likely to partly demand similar materials to wind power plants if generators are used to convert kinetic or potential energy into electricity – for example, wave energy. To what extent these technologies are more or less material intensive than wind power will thus partly depend on their respective capacity factor. 2.2

Distribution and Storage

Electrification and grid storage Some renewable energy production is distributed – for example, solar PV – which limits the need for transmission infrastructure. Other technologies, such as wind power, express economies of scale and require new transmission infrastructure to be constructed so that production can be situated in optimal production localities rather than proximate users. Expanding transmission infrastructure facilitates the integration of variable renewable production, as it helps balance the grid. Investments in such super-grids may require the use of copper in high-voltage direct current (HVDC) cables (Harmsen, Roes and Patel, 2013). Copper is also used in other power electronics, such as fast chargers for EVs. Storage technologies include grid-connected stationary storage and mobile storage used, for example, in vehicles. Redox flow batteries using vanadium are well suited for use as stationary storage, owing to their competitive cost and because discharge power and energy storage can be designed independently (Stantec, 2018). Energy storage in vehicles The two main energy storage technologies expected to be used in electric vehicles are batteries and fuel cells. Lithium-ion batteries are the currently preferred sub-technology as a result of their high energy capacity, power capability and lifetime. A variety of lithium-ion cathode chemistries are in use that contain nickel, manganese and/or cobalt in different proportions (IEA/OECD, 2019). Cathode chemistries are abbreviated according to metals used and their relative proportions. For example, NMC111 contains the same ratio of nickel, manganese

Renewable energy transition, demand for metals and resource curse effects  33 and cobalt. The relatively higher cost of cobalt compared to the other metals has incentivized battery manufactures to reduce its ratio, and newer NMC generations include NMC433, NMC532, NMC622 and the latest NMC811. The main material trade-off is the increased use of nickel to replace cobalt. Lithium batteries that do not contain cobalt (lithium ferrophosphate [LFP] chemistry) have been used in vehicles but their performance (e.g., energy density) has so far been inferior compared to chemistries that contain cobalt. Solid-state batteries that have higher performance than current batteries and do not use cobalt are being researched as well as ion batteries that do not use lithium – for example, sodium-ion batteries (Vaalma et al., 2018). Fuel cells are used to convert hydrogen and air to electricity and water. Platinum is typically used in the fuel cell as a catalyser and assumed to be used in future hydrogen vehicles (see, e.g., Sun, Delucchi and Ogden, 2011). However, some of the platinum can be replaced by other platinum group elements (PGEs), such as palladium (Antolini et al., 2011). Although many (institutional) barriers exist, hydrogen can also be used instead of coal for direct reduction to produce steel with radically lower emissions than today (see, e.g., Kushnir et al., 2020). This sector may add additional demand for platinum and PGEs. 2.3

Final Use

Increased electrification and energy efficiency can increase demand for some metals. Electric vehicles (EVs), including hybrids, have motors that operate on similar principles as generators in wind power plants and therefore use the same materials: copper (coils) or rare earths (PM) (Pavel, Thiel and Degreif et al., 2017). The combination of higher efficiency at partial and variable load and smaller size makes PM motors particularly attractive in hybrids where engine space is restricted, and the motor complements an internal combustion engine. PMs are also preferred in EVs but electrically excited copper coils have lower cost and have therefore been used as the space is not as limited as in hybrids. Replacing incandescent light bulbs with light emitting diodes (LEDs) increases energy efficiency but also demand for scarce materials, in particular indium, but also gallium, germanium and some rare earths (europium, terbium and yttrium) (Pavel et al., 2016). Some of these metals are the same as those used in thin-film solar PVs, owing to similarities in optical and semiconducting requirements. Newer LED generations, and those currently being researched, use less and fewer scarce metals than older technologies. 2.4

Overview of Metals and Criticality Status

Fifteen of the metals identified above are summarized in Table 3.1. As can be seen from the table, the United States Department of the Interior classifies ten of these as critical and the European Union eight (EU, 2017; US DoI, 2018). These classifications are continually updated to include more raw materials. The US and the EU have some similarities in selecting criteria for inclusion on the list, such as import dependence, geographical concentration of supply sources and the extent to which substitutes are available, but the lists still differ slightly. For example, the US list is slightly longer as it includes a total of 35 mineral commodities, while its European equivalent includes 27. Adding a resource to the list has implications for natural resource markets, as businesses, government agencies and research funding can then be prioritized to mitigate the supply risk. In Japan, government and businesses cooperate to secure available supplies and reduce price volatility by coordinating procurement and

34  Handbook of sustainable politics and economics of natural resources stockpiling of some raw materials perceived as critical (Japan Oil, Gas and Metals National Corporation [JOGMEC], 2017). One recent study suggested that policymakers should evaluate and include demand for critical raw materials in their climate change mitigation planning, specifically relating to countries’ nationally determined contributions (NDCs) (Sovacool et al., 2020). How and why some raw materials are assessed as critical is subject to increasing research interest (Graedel and Reck, 2016; Schrijvers et al., 2020). 2.5

Metal Demand in Energy Transition Scenarios

A number of recent studies have estimated metals requirements for transitioning parts of or the whole global energy system (Watari, Nansai and Nakajima, 2020). Different methodologies have been used, but they all involve estimating current material intensities (i.e., the weight of metal per kilowatt [kW] power or kilowatt-hour [kWh] storage), material intensity learning effects (the rate at which metal intensity declines and its shape), future demand for energy technology groups (e.g., installed wind power capacity) and the composition of sub-technologies within those groups. Estimates of material intensities vary greatly, partly because of rapid technological development that makes older estimates invalid. Current values are often, but not always, much higher than the theoretical limit and future improvements are therefore highly likely, but their magnitude and pace remain unknown. The composition of sub-technologies is uncertain and can be dynamic, so that if the supply of certain metals becomes restricted and price increases, the composition will change in response. Scenarios are therefore often used to manage the uncertainty inherent in the large number of assumptions that must be made and assess how this impacts the end results. Each scenario combines a normative end state target and explores plausible pathways to reach that target. Two of the main results derived from these calculations are cumulative material demand for each metal and the respective growth rate. When combined with estimates of material recycling rates, their development and technological lifetimes, this shows how demand for primary metal can change as a result of an energy transition. These estimates can then be compared with current known reserves (i.e., economically recoverable reserves using current technologies and market price), technically recoverable resources and current mining rates. The results indicate whether certain scenarios are unlikely (e.g., when cumulative metal demand is much higher than technically recoverable reserves) and identifies bottlenecks (e.g., if the mining rate must increase rapidly from today’s level). Several conclusions of possible future metal demand and how it relates to reserves, resources and mining growth rates can be drawn, based on previous studies. Not all sub-technologies are scalable, but backstop technologies exist to enable technology groups to scale up (Månberger and Stenqvist, 2018). For example, some thin-film solar PVs use scarce metals, and current metal intensities make it unlikely for these alone to meet future PV demand, but crystalline silicone PVs and third-generation PVs use more abundant materials. Metal scarcity may affect the future market share of different sub-technologies, but it is less likely to constrain the growth of entire technology groups. Primary demand for many critical metals is likely to grow, and low-carbon technologies can dominate demand for many metals. Some critical metals are produced as by-products, which makes supply less responsive and dependent on host metal supply (Elshkaki and Graedel, 2015). There is room to increase by-product recovery without increased extraction of the host

Lithium-ion batteries

Electrification (production, distribution, storage, use)

Motors, generators

Solar PV, LED

Solar PV, LED

Lithium-ion batteries

Motors, generators

Lithium-ion batteries

Fuel cells

Lithium-ion batteries

Solar PV

Solar PV, solar thermal

Solar PV

Solar PV

Redox flow batteries

Copper (Cu)

Dysprosium (Dy)

Gallium (Ga)

Indium (In)

Lithium (Li)

Neodymium (Nd)

Nickel (Ni)

Platinum (Pt)

Manganese (Mn)

Selenium (Se)

Silver (Ag)

Tellurium (Te)

Silicon (Si)

Vanadium (V)

16 000–160 000

15 000–50 000

30 000–450 000

55 000–110 000

22 000–66 000

2000–4000

30 000 000–60 000 000

10 000–30 000

35 000–400 000

20 000–90 000

300 000–600 000

400 000–1 000 000

360 000–28 00 000

5000–10 000

30 000–90 000

Market Price Range ($/ton)a

Yes Yes

Yes

No

No

No

No

Yes

No

Yes

No

Yes

Yes

Yes

No

Yes

Critical According to EUc

No

Yes

No

No

Yes

Yes

No

Yes

Yes

Yes

Yes

Yes

No

Yes

Critical According to USb

Notes and sources: a. Approximate price range is calculated for the element using the market price of the traded grade during the last ten years – for example, vanadium market price is based on vanadium content of vanadium pentoxide (V205). Price data are from Leader, Gaustad and Babbitt (2019), Månberger and Johansson (2019) and US Geological Survey (USGS) (2019). b. US DoI (2018). c. EU (2017).

Application(s)

Cobalt (Co)

Overview of 15 elements used in low-carbon energy technologies, approximate market price range in the last ten years and criticality classification

Element

Table 3.1

Renewable energy transition, demand for metals and resource curse effects  35

36  Handbook of sustainable politics and economics of natural resources (Frenzel et al., 2017). However, by-products have low elasticity of supply even when the host supply is not restricted (Fu, Polli and Olivetti, 2018). By-products represent a low share of the product cost and the metal producer’s revenue (miner and refiner). Price increases can therefore incentivize additional supply without major increases in the cost of the final product. Recycling of critical metals has limited impact on short-term primary metal demand but a considerable impact in the long term (Kushnir and Sandén, 2012). This is because recycling rates are currently often low (e.g., only a few per cent for lithium), critical metal demand is increasing rapidly, technologies have long lifetimes (which delays the time until the material can be recycled) and a limited amount of critical metals are to be found in older technologies (Månberger and Stenqvist, 2018). Recycled material can overtake primary material supply in 2050 for many applications if recycling rates increase as metal intensities decline (Månberger and Johansson, 2019). The impact of other circular economy strategies (remanufacturing, reuse and lifetime extension) has received less research attention (Watari et al., 2020). Demand for several metals is increasing rapidly, according to many studies – for example, dysprosium, neodymium and lithium (ibid.). Two metals used in batteries – lithium and cobalt – are often depicted as the main bottlenecks, both when reserves are compared to cumulative demand and when demand growth rates are compared with current mining rates (Deetman et al., 2018; Giurco et al., 2019; Månberger and Stenqvist, 2018). Cobalt is a short-term bottleneck, as to a large extent it is produced as a by-product (of nickel and copper) and cobalt demand is growing more rapidly than host demand. Some studies show that cobalt reserves are insufficient in the long term, but this should be interpreted with caution, given the available substitutes and the rapidly decreasing cobalt content in newer lithium batteries (Månberger and Stenqvist, 2018). Extractable lithium resources are sufficient to electrify the global road transport system, but current reserves are not. It should be noted that future reserve growth is likely to occur as a result of technological development of extraction techniques, new discoveries and higher prices, but its magnitude is uncertain. Lithium recycling rates are low and must increase for lithium batteries to dominate the road transport sector’s demand for energy storage in the second half of the twenty-first century. There are metal demand trade-offs. Cobalt is increasingly being substituted by nickel in lithium batteries. Nickel resources are an order of magnitude higher than cobalt resources and nickel mining is greater too, which makes supply more flexible, but there are currently not enough refineries to purify nickel to the required battery grade (IEA/OECD, 2019). Demand for non-fuel minerals increases with higher climate ambition – that is, the 1.5°C target has higher metal requirements than 2°C target as a result of more rapid electrification of the transport sector and penetration of renewable power in the supply mix. This holds both for short-term metal demand (IEA/OECD, 2019) and long-term metal demand (Watari et al., 2019). Rapid electrification of the transport sector doubles its demand in 2030 for lithium, cobalt, copper and nickel compared to a baseline scenario, according to the IEA (IEA/OECD, 2019). However, it should be noted that these studies use quantitative demand modelling techniques and the role of behavioural change and other structural changes required to meet more stringent emission reductions may therefore be overlooked. Studies of future demand for critical metals in renewable energy systems seldom estimate if and how demand from other sectors can develop (Watari et al., 2020). Studies therefore tend to underestimate aggregate future metal demand. One exception can be found in Deetman et al. (2018), who analyse demand up to 2050 for five metals (copper, cobalt, lithium, neodymium and tantalum) for vehicles, power production and appliances in several climate-mitigation

Renewable energy transition, demand for metals and resource curse effects  37 scenarios. The study finds that appliance demand for neodymium and tantalum can be similar to demand from the power and vehicle sectors. Growth in lithium and cobalt demand is completely dominated by batteries used in EVs. At least 75 per cent of copper is used for vehicles and power production.

3

IMPACTS ON NON-FUEL MINERAL-RICH COUNTRIES

As noted above, it is widely assumed that a renewable energy transition will increase metal demand, but the literature on how this increased demand can affect non-fuel mineral producers is still scarce. On the other hand, a vast literature exists on how fossil fuel (rents) can be a ‘resource curse’ (see, for example, Månsson, 2014). The resource curse hypothesis has several dimensions. One is that resource wealth can reduce development prospects and instead enable undemocratic governments to remain in power. Another is that affected countries have lower economic growth than comparable countries without resource wealth. Resource conflicts can involve both state and non-state actors that fight for control of and access to resources. Fossil fuel rents from ‘conflict resources’ can be used to finance non-state actors participating in conflicts in poor countries that are rich in resources – that is, countries that have low gross domestic product (GDP) per capita but a high share of their GDP attributed to resource extraction (Basedau and Lay, 2009). A related issue is the infamous ‘Dutch disease’ – that is, the notion that resource extraction can crowd out other sectors of the economy due to currency appreciation, to such an extent that economic diversity is reduced, and the country’s economy becomes sensitive to the produced commodity’s world market price (Corden, 1984). There are several underlying factors that explain how resources can affect states’ development, such as the geographical concentration of resources, the high economic value compared to the size of the economy, and institutional conditions. These parameters are used here to explore whether metals used for renewable energy can cause a resource curse and identify countries at risk. These insights can be used to mitigate the risk, as resource wealth is not deterministic in causing a resource curse, as demonstrated, for example, by Norway’s development and its successful approach in establishing a sovereign wealth fund. 3.1

Geographical Concentration of Reserves

The geographic resource concentration, measured by the Herfindahl-Hirschman Index (HHI) (calculated as the sum of the squares of individual countries’ shares of global reserves), for nine of the metals covered in this chapter is higher than for crude oil (see Table 3.2). The only metals with lower concentration than oil are copper and tellurium. The PGEs have the highest concentration (HHI = 8373 of maximum 10 000) followed by lithium (HHI = 3893), vanadium (HHI = 3298) and cobalt (HHI = 2832). As a reference point, the United States Department of Justice considers HHI value between 1500 and 2500 to be moderately concentrated and above 2500 as highly concentrated (US DoJ, 2010). Six countries (Australia, Chile, DR Congo, China, Brazil and Russia) together hold the majority of reserves of cobalt (70 per cent), lithium (83 per cent), rare earths (65 per cent) and vanadium (83 per cent). This group of countries also holds a large share of copper (39 per cent), nickel (42 per cent) and silver (31 per cent) reserves. DR Congo, Chile, South Africa and China hold close to half or more of the global reserves of four metals (cobalt, lithium, PGE and

38  Handbook of sustainable politics and economics of natural resources vanadium). These countries are thus important for future supply of these resources. Mining policies, fiscal incentives, taxes and environmental regulation in just a handful of countries can thus affect global supply and market prices. Collusion among these producers is possible but it is far from certain that it would be beneficial for the producers in the long term, as substitution (metal-by-metal or using other technologies), recycling and reduced metal intensity enable primary metal demand to respond to higher prices. These options provide a different dynamic for metal markets than has been the case for oil that is combusted when used. In addition to holding reserves and extracting them, China is also a major actor in refining mineral concentrates into metal grades of the purity used in renewable energy technologies. For example, China is home to more than half the global refining capacity for lithium, cobalt and rare earths and has between 30 and 45 per cent of the capacity to refine copper and nickel. China also dominates manufacturing of key components used in renewable energy technologies (e.g., PM) and final products (e.g., solar PV). Other countries’ dependency on China for these downstream stages of supply chains is therefore higher than indicated by proxies of resource concentration (Smith Stegen, 2015). However, supply networks are dynamic over time and can, unlike natural resources, change without redrawing state borders. Long-term assessments of supply and criticality therefore tend to focus on where reserves are located geographically rather than the concentration of refining and manufacturing capabilities. 3.2

Resource Revenues

Månberger and Johansson (2019) analysed how demand for 14 elements (metals and metalloids) could increase as a result of a renewable energy transition and the size of the revenue that this could generate for countries holding reserves of these metals (Table 3.3). The study assumed that countries would extract a share of the global output proportional to their share of the reserve size reported by USGS (2018). Metal prices were assumed to trade in a price spread similar to the previous ten years. A sample of 37 countries was analysed, but the study only identified four countries that had the potential to generate revenues corresponding to more than 5 per cent of their current GDP (Chile, Cuba, DR Congo and Zambia). An alternative baseline is to compare the economic value of extracted metals with countries’ export revenues instead of their GDP. This comparison is better at capturing the magnitude required for mining to provide ‘hard currency’ for countries that have limited exports compared to the size of their present economies. From the same sample of 37 countries, ten countries (DR Congo, Cuba, Madagascar, Chile, Zambia, Indonesia, Australia, South Africa, Guatemala and Argentina) generate export revenues above 5 per cent of their current exports. Seven of these countries (Argentina, Chile, Cuba, DR Congo, Indonesia, Madagascar and Zambia) generate export revenues of around 10 per cent or more. Battery metals (lithium, cobalt and some nickel) explain most of the value for the countries with around 10 per cent or more additional export revenue. It is the combined future primary demand and price that result in high revenues. Prices of these metals, particularly lithium and cobalt, have historically been volatile, more so than oil. It is therefore possible that average revenues are much lower than at the peak. The past price volatility can in part be explained by the small market size, lack of transparency and future price curve, and strong demand increase in recent years due to sales of EVs taking off. It is therefore likely that the volatility will be lower in the future if these conditions change. Countries can in part mitigate the impact of fluctuating resource rents by having sovereign wealth funds. However, estimates of state stability

Chile (57)

Venezuela (19)

China (47) Saudi Arabia (17)

Russia (25)

Peru (12)

Russia (20)

Poland (20)

Brazil (18)

Russia (6)

Australia (21)

Ukraine (18)

Australia (19)

Australia (11)

Canada (11)

South Africa (17)

United States (11)

Peru (13)

Australia (16)

Vietnam (18)

Zimbabwe (2)

Brazil (12)

Brazil (14)

Argentina (14)

Peru (10)

Iran (10)

Australia (10)

Sweden (2)

United States (10)

Russia (8)

Russia (10)

United States (1)

Russia (9)

Australia (13)

China (7)

Russia (7)

Iraq (9)

Brazil (1)

 

Canada (6)

China (7)

India (6)

 

Cuba (6)

Gabon (9)

 

Indonesia (6)

33

0

54

25

29

11

0

28

16

3

45

15

Other Countries (%)

Note: PGE = platinum group elements; REE = rare earth elements and includes neodymium and dysprosium reserves. HHI = Herfindahl-Hirschman Index and is calculated as the sum of the squares of individual countries’ shares of global reserves. A high value corresponds to a high concentration with the maximum value of 10 000. Oil is provided as a point of reference. Sources: Table adapted from Månberger and Johansson (2019) with updated data from USGS (2019).

1119

Oil

China (21)

727

3298

Tellurium

Peru (20)

China (26)

1243

1418

Silver

Selenium

Vanadium

China (37)

2159

REE

Indonesia (24)

South Africa (91)

1346

8373

Nickel

South Africa (30)

PGE

3893

1781

Lithium

Manganese

Chile (21)

814

Canada, Russia and the Philippines (4 each)

Copper

DR Congo (49)

Cuba (7)

2832

Cobalt

Australia (17)

HHI

Resource(s)

Share of Global Reserves (%)

Geographical concentration of major reserves by reserve holder for 2019

Table 3.2

Renewable energy transition, demand for metals and resource curse effects  39

40  Handbook of sustainable politics and economics of natural resources Table 3.3

Nation

Basic data for 18 countries: reserves used in renewable energy systems that the respective countries possess; peak revenues attributable to increased metal demand for renewable energy during an energy transition up to 2060 compared to their GDP and export revenues; and estimates of current state stabilitya GDP/  

Metal Reserves

Capita

Oil Revenue/ GDP 2016 (%)c

2016

Peak Metal

Peak Metal  

Revenue/GDP Revenue/Export (%)d

Current State of Stabilityf

Revenue (%)e

(US$)b Argentina

12 499  

Li

Australia

54 069  

Cu, Co, Li, Nd,

1.8

1.1

9.6  

More stable

0.44

2.0

7.3  

Very sustainable

2.32

0.58

4.6  

Elevated warning

4.66

0.93

3.0  

Very sustainable

Cu, Li, Ag

0.03

10.5

37  

Very stable

Cu, Li, Nd, Dy,

0.57

0.17

 

Dy, Ag, Ni, Si Brazil

8 649  

Li, Nd, Dy, Mn, Ni, Si

Canada

42 154  

Cu, Co, Nd, Dy, Pt, Ni, Te, Se, Si

Chile

13 794  

China

7 993  

Elevated warning

Ag, Mn, Ni, Te, Se, Si Cuba DR Congo Indonesia Madagascar

7 815  

Co, Ni

0.89

14.0

96.0  

512  

Cu, Co

9.9

44.0

124.0  

Warning

3 570  

Cu, Ni

2.9

14.0  

Elevated warning

451  

Co, Ni

0

13

36.0  

High warning

Alert

Peru

6 049  

Cu, Ag, Te, Se

1.1

1.2

4.8  

Warning

The

2 951  

Co, Ni

0.1

1.2

3.8  

High warning

8 655  

Co, Nd, Dy, Pt,

14.0

0.61

2.3  

Elevated warning

0.1

1.5

5.0  

Elevated warning

1.1

0.02

0.1  

Very stable

Warning

Philippines Russia

Ag, Ni, Se, Si South Africa

5 274  

Co, Nd, Dy, Pt, Mn, Ni, Si

US

57 808  

Cu, Co, Li, Nd, Dy, Pt, Ag, Mn, Ni, Te, Se, Si

Vietnam

2 171  

Nd, Dy

2.9

1.6

1.7  

Zambia

1 270  

Cu, Co

0

8.3

24.0  

Li, Pt

0

0.50

2.5  

Zimbabwe

998  

High warning Alert

Notes and sources: a. Table adapted from Månberger and Johansson (2019) with updated data and new estimates. b. United Nations (2018). c. The average oil price in 2016 was the lowest in ten years (US$44/barrel) and these values are therefore lower than usual. d. Highest value identified up to 2060. Note that GDP for 2016 is used in all comparisons. e. Highest value identified up to 2060. Calculated using data from Månberger and Johansson (2019) and World Bank (2019). f. Fund for Peace (FfP) (2019). The fragility of the nations is categorized in 12 groups from most sustainable to very high alert. This can give an indication of current fragilities but its usefulness in long-term analyses can be questioned (see, for instance, a discussion in Johansson, 2010).

Renewable energy transition, demand for metals and resource curse effects  41 (see Table 3.3) indicate that it is far from certain that the identified mineral holders have the institutional capabilities to do so and exchange their mineral wealth for prosperity. It should be noted that all estimates of revenues are compared with current GDP and exports. The share of GDP attributable to increased metal demand for renewable energy would be (much) lower if economies are assumed to grow (or higher if economies contract). Månberger and Johansson (2019) also found that producer revenues will increase up to mid-2030, after which recycling rates affect primary demand, and if recycling increases sufficiently it can cause revenues to reach a plateau or even decline due to peak demand. Assuming a technological disruption, primary cobalt producers are exposed to this situation if cobalt intensity continues to decline rapidly, as demand for primary cobalt can decline by half during a period of less than ten years. 3.3

Subnational Impacts

Church and Crawford (2018) compared the geographical distribution of metal reserves used in renewable energy technologies with estimates of states’ levels of fragility and corruption. By doing so, they identified three hotspot regions: South America, Sub-Saharan Africa and Southeast Asia. The authors caution that local grievances and violence have occurred in the past due to mining, and the risk of such tensions is assumed to increase in the hotspot regions if a renewable energy transition takes place. Conflict resources – that is, when resource rents are used to fund intra-state conflicts – is mainly a concern in poor, weak states. Conflict resources must be accessible and ‘lootable’, and it is therefore primarily minerals that can be mined profitably via small-scale mining by artisanal miners that meet these criteria (Le Billon, 2012; Lujala, 2010). Many metals perceived as critical for renewable energy technologies are extracted in low concentrations and produced as by-products from large-scale mining or metal refining. The scale and complexity make these metals unlikely to be conflict resources. Artisanal and small-scale mining is an important source of income in the Global South with more than 150 million depending on it for their livelihoods, but the targeted minerals are usually not used primarily for energy technologies – for example, tantalum, tin, gold, tungsten, diamonds and gemstones (Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development [IGF], 2018). However, there are examples where local geological conditions differ so that critical energy metals can be profitably extracted at a small scale. A case in point is some of the cobalt deposits situated in DR Congo. Studies of Congolese cobalt mining have documented that on the one hand it provides opportunities for poverty reduction and local development, and on the other hand it can lead to violent conflicts and environmental pollution (Sovacool, 2019). The issue is complex, as the outcome is a result of policies from government (national and local), the mining sector, local communities and industries that purchase the cobalt. Sovacool (2019) cautions against outright banning of cobalt produced by artisanal miners as it provides a source of income in poor regions, and instead suggests a path forward with joint ventures and benefit-sharing agreements involving small- and large-scale miners and government agencies.

42  Handbook of sustainable politics and economics of natural resources

4 CONCLUSIONS Low-carbon energy transitions are material intensive and use metals that are perceived as critical. Markets provide flexibility over longer periods of time and price signals can incentivize reduced metal use, substitution and increased recycling. The total amount of metals required for a global energy transition is therefore uncertain but likely to be lower than current reserve estimates for most metals studied here. Mining rates can be a supply bottleneck as it takes time to scale up mining and critical metals are often produced as by-products that are less responsive to price increases than host resources. Reserves of critical metals used in renewable energy technologies are more geographically concentrated than oil. Previous studies have found that potential new mining revenues are generally low, but five countries have been identified that can obtain significant revenues when compared to the size of their current economies. This study identified a group of ten countries where metal export revenues could be higher than 5 per cent of current export revenues. Metals used in batteries explain most of this value and this observation is therefore sensitive to demand and prices for battery metals. The local impact of mining for supplying metals used in low-carbon transitions has not been the focus of much research. Countries that hold reserves and are characterized by high corruption and fragile institutions are a cause for concern. The future is not pre-determined, but successful policy interventions are complex as they require several actors to be involved in the unlocking of prosperous development pathways for affected local mining communities and countries.

ACKNOWLEDGEMENT This publication is a deliverable of MISTRA GEOPOLITICS, which is funded by the MISTRA – the Swedish Foundation for Strategic Environmental Research.

REFERENCES Ali, S.H., Giurco, D. and Arndt, N. et al. (2017). Mineral supply for sustainable development requires resource governance. Nature 543, 367–72. Antolini, E., Zignani, S.C., Santos, S.F. and Gonzalez, E.R. (2011). Palladium-based electrodes: a way to reduce platinum content in polymer electrolyte membrane fuel cells. Electrochimica Acta 56, 2299–305. Basedau, M. and Lay, J. (2009). Resource curse or rentier peace? The ambiguous effects of oil wealth and oil dependence on violent conflict. Journal of Peace Research 46, 757–76. Bazilian, M.D. (2018). The mineral foundation of the energy transition. The Extractive Industries and Society 5, 93–7. Church, C. and Crawford, A. (2018). Green Conflict Minerals: The Fuels of Conflict in the Transition to a Low-carbon Economy. Winnipeg, MB: International Institute for Sustainable Development. Corden, W.M. (1984). Booming sector and Dutch disease economics: survey and consolidation. Oxford Economic Papers 36, 359–80. Deetman, S., Pauliuk, S. and Van Vuuren, D.P. et al. (2018). Scenarios for demand growth of metals in electricity generation technologies, cars, and electronic appliances. Environmental Science & Technology 52, 4950–9.

Renewable energy transition, demand for metals and resource curse effects  43 Elshkaki, A. and Graedel, T.E. (2015). Solar cell metals and their hosts: a tale of oversupply and undersupply. Applied Energy 158, 167–77. European Union (EU) (2017). COM(2017) 490 Final: The 2017 List of Critical Raw Materials for the EU. European Commission. Frenzel, M., Mikolajczak, C., Reuter, M.A. and Gutzmer, J. (2017). Quantifying the relative availability of high-tech by-product metals – the cases of gallium, germanium and indium. Resources Policy 52, 327–35. Fu, X., Polli, A. and Olivetti, E. (2018). High-resolution insight into materials criticality: quantifying risk for by-product metals from primary production. Journal of Industrial Ecology 23, 452–65. Fund for Peace (FfP) (2019). Fragile States Index 2019. Washington, DC: FfP. Giurco, D., Dominish, E. and Florin, N. et al. (2019). Requirements for minerals and metals for 100% renewable scenarios. In S. Teske (ed.), Achieving the Paris Climate Agreement Goals. Cham, Switzerland: Springer, pp. 437–57. Graedel, T.E. and Reck, B.K. (2016). Six years of criticality assessments: what have we learned so far? Journal of Industrial Ecology 20, 692–9. Harmsen, J.H.M., Roes, A.L. and Patel, M.K. (2013). The impact of copper scarcity on the efficiency of 2050 global renewable energy scenarios. Energy 50, 62–73. Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development (IGF) (2018). Global Trends in Artisanal and Small-Scale Mining (ASM): A Review of Key Numbers and Issues. Winnipeg, MB: IGF. International Energy Agency (IEA)/Organisation for Economic Co-operation and Development (OECD) (2017). Energy Technology Perspectives 2017: Catalysing Energy Technology Perspectives. Paris: OECD Publishing. International Energy Agency (IEA)/Organisation for Economic Co-operation and Development (OECD) (2019). Global EV Outlook 2019: Scaling-up the Transition to Electric Mobility. Paris: OECD Publishing. Japan Oil, Gas and Metals National Corporation (JOGMEC) (2017). Stockpiling: metals. Accessed 28 February 2020 at http://​www​.jogmec​.go​.jp/​english/​stockpiling/​stockpiling​_10​_000001​.html. Johansson, B. (2010). Climate Change, Vulnerability and Security Risks – Methodological Aspects Regarding Identification of Vulnerable Countries and Hotspots. Stockholm: Swedish Defence Research Agency. Kavlak, G., McNerney, J., Jaffe, R.L. and Trancik, J.E. (2015). Metal production requirements for rapid photovoltaics deployment. Energy & Environmental Science 8, 1651–9. Kushnir, D., Hansen, T., Vogl, V. and Åhman, M. (2020). Adopting hydrogen direct reduction for the Swedish steel industry: a technological innovation system (TIS) study. Journal of Cleaner Production 242, Article 118185. Kushnir, D. and Sandén, B.A. (2012). The time dimension and lithium resource constraints for electric vehicles. Resources Policy 37, 93–103. Leader, A., Gaustad, G. and Babbitt, C. (2019). The effect of critical material prices on the competitiveness of clean energy technologies. Materials for Renewable and Sustainable Energy 8, Article 8. Le Billon, P. (2012). Wars of Plunder: Conflicts, Profits and the Politics of Resources. London: C. Hurst & Co. Lee, J., Bazilian, M. and Sovacool, B. et al. (2020). Reviewing the material and metal security of low-carbon transitions. Renewable and Sustainable Energy Reviews 124, Article 109789. Lujala, P. (2010). The spoils of nature: armed civil conflict and rebel access to natural resources. Journal of Peace Research 47, 15–28. Månberger, A. and Johansson, B. (2019). The geopolitics of metals and metalloids used for the renewable energy transition. Energy Strategy Reviews 26, Article 100394. Månberger, A. and Stenqvist, B. (2018). Global metal flows in the renewable energy transition: exploring the effects of substitutes, technological mix and development. Energy Policy 119, 226–41. Månsson, A. (2014). Energy, conflict and war: towards a conceptual framework. Energy Research & Social Science 4, 106–16. Månsson, A. (2015). A resource curse for renewables? Conflict and cooperation in the renewable energy sector. Energy Research & Social Science 10, 1–9.

44  Handbook of sustainable politics and economics of natural resources Nassar, T., Graedel, T.E. and Harper, E.M. (2015). By-product metals are technologically essential but have problematic supply. Science Advances 1, Article e1400180. Overland, I., Bazilian, M. and Ilimbek Uulu, T. et al. (2019). The GeGaLo index: geopolitical gains and losses after energy transition. Energy Strategy Reviews 26, Article 100406. Pavel, C.C., Lacal-Arántegui, R. and Marmier, A. et al. (2017). Substitution strategies for reducing the use of rare earths in wind turbines. Resources Policy 52, 349–57. Pavel, C.C., Marmier, A. and Tzimas, E. et al. (2016). Critical raw materials in lighting applications: substitution opportunities and implication on their demand. physica status solidi (a) 213, 2937–46. Pavel, C.C., Thiel, C. and Degreif, S. et al. (2017). Role of substitution in mitigating the supply pressure of rare earths in electric road transport applications. Sustainable Materials and Technologies 12, 62–72. Pihl, E., Kushnir, D., Sandén, B. and Johnsson, F. (2012). Material constraints for concentrating solar thermal power. Energy 44, 944–54. Schrijvers, D., Hool, A. and Blengini, G.A. et al. (2020). A review of methods and data to determine raw material criticality. Resources, Conservation and Recycling 155, Article 104617. Smith Stegen, K. (2015). Heavy rare earths, permanent magnets, and renewable energies: an imminent crisis. Energy Policy 79, 1–8. Sovacool, B.K. (2019). The precarious political economy of cobalt: balancing prosperity, poverty, and brutality in artisanal and industrial mining in the Democratic Republic of the Congo. The Extractive Industries and Society 6, 915–39. Sovacool, B.K., Ali, S.H. and Bazilian, M. et al. (2020). Sustainable minerals and metals for a low-carbon future. Science 367, 30–33. Stantec (2018). Bitumen Beyond Combustion – Phase 2 Report. Edmonton, AB: Stantec Consulting Ltd. Sun, Y., Delucchi, M. and Ogden, J. (2011). The impact of widespread deployment of fuel cell vehicles on platinum demand and price. International Journal of Hydrogen Energy 36, 11116–27. United Nations (UN) (2018). Statistical Yearbook 2018 Edition. New York: UN. US Department of the Interior (DoI) (2018). 83 FR 23295 – Final List of Critical Minerals 2018. Washington, DC: Office of the Secretary, DoI. US Department of Justice (DoJ) (2010). Horizontal Merger Guidelines. Washington, DC: US Department of Justice & the Federal Trade Commission. US Geological Survey (USGS) (2018). Mineral Commodity Summaries 2018. Washington, DC: US Government Printing Office. US Geological Survey (USGS) (2019). Mineral Commodity Summaries 2019. Washington, DC: US Government Printing Office. Vaalma, C., Buchholz, D., Weil, M. and Passerini, S. (2018). A cost and resource analysis of sodium-ion batteries. Nature Reviews Materials 3, Article 18013. Vakulchuk, R., Overland, I. and Scholten, D. (2020). Renewable energy and geopolitics: a review. Renewable and Sustainable Energy Reviews 122, Article 109547. Viebahn, P., Soukup, O. and Samadi, S. et al. (2015). Assessing the need for critical minerals to shift the German energy system towards a high proportion of renewables. Renewable and Sustainable Energy Reviews 49, 655–71. Watari, T., McLellan, B.C. and Giurco, D. et al. (2019). Total material requirement for the global energy transition to 2050: a focus on transport and electricity. Resources, Conservation and Recycling 148, 91–103. Watari, T., Nansai, K., Nakajima, K. (2020). Review of critical metal dynamics to (2050) for 48 elements. Resources, Conservation and Recycling 155, Article 104669. World Bank (2019). Exports of goods and services (current US$). Accessed 28 February 2020 at http://​ data​.worldbank​.org/​indicator/​NE​.EXP​.GNFS​.CD.

4. Local and global aspects of coal in the ASEAN countries1 Haakon Fossum Sagbakken, Aidai Isataeva, Indra Overland, Aloysius Damar Pranadi, Beni Suryadi and Roman Vakulchuk

1

THE ENVIRONMENTAL, HEALTH AND ECONOMIC IMPACTS OF COAL

The global energy system is currently undergoing a rapid transition, with profound consequences for the fossil fuel industries, perhaps most notably the one with the highest greenhouse gas emissions – coal. Having played a major role in recent decades, especially in rapidly growing emerging economies such as China and India, coal is being phased out across much of the world, as its environmental and health impacts have become prohibitively costly while its supposed economic advantages are rapidly disappearing as its relative affordability is undermined by the falling cost of renewable energy in many parts of the world (Finkelman and Tian, 2018; Gimon et al., 2019; Hendryx, Zullig and Luo, 2020; Kerimray et al., 2017; Rauner et al., 2020; Strasert, Teh and Cohan, 2019). Coal also has disproportionally large negative environmental and economic externalities in that its emissions degrade local agricultural, water and human resources (Bhuiyan et al., 2010; Hota and Behera, 2015). Coal’s water requirements also put pressure on already strained water resources in places such as India, to the extent that water shortages render coal plants themselves unreliable (Wang et al., 2019, p. 3164). However, despite falling in status and despite their commitments under the Paris Agreement, coal is still favoured by many large developing countries and exposes them to significant economic and stranded asset risks as the cost of coal is being rapidly undercut by renewable energy technologies (Clark, Zucker and Urpelainen, 2020; Edenhofer et al., 2018, p. 2). A significant body of research has examined the health, environmental and economic impact of coal use across the developing and developed world in recent years (Amster, 2021; Amster and Lew Levy, 2019; Henneman, Choirat and Zigler, 2019; Johnsen, LaRiviere and Wolff, 2019; Kravchenko and Lyerly, 2018; Munawer, 2018; Wang et al., 2019; Xiao et al., 2020). The negative health and environmental effects of coal are well known, with some concluding that the costs outweigh the short-term economic benefits (Rauner et al., 2020, p. 308). Others have pointed to the direct risks of coal plants becoming stranded assets due to rapidly changing energy markets as well as public pressure to adopt more stringent pollution 1 This is an open access work distributed under the Creative Commons Attribution -NonCommercial-NoDerivatives 4.0 Unported (https://​creativecommons​.org/​licenses/​by​-nc​-nd/​4​.0/​). Users can redistribute the work for non-commercial purposes, as long as it is passed along unchanged and in whole, as detailed in the License. Edward Elgar Publishing Ltd must be clearly credited as the rights holder for publication of the original work. Any translation or adaptation of the original content requires the written authorization of Edward Elgar Publishing Ltd.

45

46  Handbook of sustainable politics and economics of natural resources standards (Caldecott, Dericks and Mitchell, 2015). Environmentally, local emissions and waste from coal plants poison agricultural fields and local water supplies, a problem that is magnified with subcritical plants often built in developing countries due to their lower cost. This can cause not only a loss in livelihoods, but also migration or even forced resettlement. Emissions from coal plants have proven deleterious effects on human health (Buchanan, Burt and Orris, 2014, p. 266; Burt, Orris and Buchanan, 2013, p. 2; Chen et al., 2014, p. 736; Finkelman and Tian, 2018, p. 579; Munawer, 2018, p. 87; Silva and da Boit, 2011, p. 187). In addition, coal consumption entails coal mining, which is a hazardous occupation with not only long-term health impacts on workers but also putting them at high risk of accidents (Hendryx, 2015, p. 823). As coal use grows, so necessarily does mining and the frequency of accidents, as has been observed in the case of China for decades (Dhillon, 2010, p. 68). Mining accidents tend to be more frequent in developing countries due to lower security requirements and more labour-intensive methods of extraction. The international community has developed few tools for pressuring and assisting countries to phase out coal (Ayling and Gunningham, 2017; Green, 2018; Kalkuhl et al., 2019; Richardson, 2017; Trinks et al., 2018). Recent studies point out that intergovernmental initiatives aimed at attaching a stigma to coal suffer from a lack of member states among major coal-consuming countries (Blondeel, Van de Graaf and Haesebrouck, 2020, p. 3). They are mainly developing countries with newer coal plants with longer remaining lifespans (Jewell et al., 2019). No national government has yet put restrictions on coal power as part of its foreign policy towards other states. Nor are there any mechanisms for punishing countries that fail to abide by their commitments under the Paris Agreement because they build new coal power plants, such as by massively expanding coal (Karlsson-Vinkhuyzen et al., 2018; Kemp, 2018; United Nations Framework Convention on Climate Change [UNFCCC], 2015). Thus, for the time being, effective political and social opposition to coal power plants is more likely to play out in national and local arenas than at the global level, as most national governments must in some way take public sentiment into account when making energy policy (Overland, 2018). Local resistance to coal exists in various forms in many countries, from Australia (Higginbotham et al., 2010) to Bangladesh, to Turkey (Arsel, Akbulut and Adaman, 2015). Such dynamics have become particularly apparent in countries seeing rapid expansion of coal power, several of which are members of the Association of Southeast Asian Nations (ASEAN).

2

COAL IN THE ASEAN COUNTRIES

Against this backdrop, the ASEAN member states have been enthusiastically embracing coal in recent years. As much of the world is pivoting away from fossil fuels, many Southeast Asian countries have been rapidly expanding their use of coal to meet the region’s rising energy consumption, chiefly the projected rise in demand for electricity (Clark et al., 2020; Overland et al., 2021). In 2019, coal demand was projected to grow 5 per cent annually in Southeast Asia through 2023, the highest growth rate in the world. Along with Chinese and Indian demand, this has contributed to maintaining a high level of coal consumption globally (Figures 4.1 and 4.2) (International Energy Agency [IEA], 2019a). As regional gas and oil reserves rapidly deplete, the ASEAN countries have made a sharp turn towards coal (ASEAN Centre for Energy [ACE], 2017, p. 2; Cornot-Gandolphe, 2016, p. 3; Shi, 2016, p. 678). Figure 4.1 shows that in 2019 the IEA projected that ASEAN demand

Local and global aspects of coal in the ASEAN countries  47

Note: Mtce = million tonnes of carbon equivalent. China is omitted as its dominant role in global coal consumption would distort the graph. Source: IEA (2019b).

Figure 4.1

Source:

Coal consumption by selected regions/countries, 2017–24

IEA (2019b).

Figure 4.2

Projected compound average annual growth rate (CAAGR) of coal consumption 2017–24

48  Handbook of sustainable politics and economics of natural resources for coal would overtake that of the EU by 2022 (IEA, 2019b). The same year, IEA estimated that, while the rest of the world, on average, is phasing out or limiting new coal plants, ASEAN coal demand will grow by 3 per cent every year until 2040, building on the rapid pace of deployment since the turn of the millennium. In 2018, ASEAN was the only part of the world in which coal’s share in the electricity generation mix increased (IEA, 2019b, p. 20). As shown in Figure 4.2, ASEAN’s coal consumption has been predicted to increase more rapidly than that of any other major region and significantly faster than China from 2018 to 2024 (ibid.). Indonesia and Vietnam are the main drivers of this trend. From 2000 to 2018, the share of coal in the ASEAN electricity generation mix doubled, and currently accounts for 40 per cent, a level that the IEA predicts will be stable until at least 2040 (IEA, 2019c). The net addition of 90 gigawatts (GW) of coal power in ASEAN from 2019 to 2040 contrasts starkly with global energy transition trends (IEA, 2019c). Within the shorter period from 2008 to 2017, a staggering 39 990 megawatts (MW) of coal power capacity were added in the ASEAN countries (ACE, 2019). Paradoxically, and as shown in Figure 4.3, ASEAN’s installed coal power capacity grew rapidly at the same time as the threat of climate change became an increasingly prominent public policy concern and a threat to sustainable development in the years preceding the Paris Agreement. Indonesia and Vietnam were the two main contributors (Figure 4.3). Indonesia alone raised the installed capacity of its coal-fired power plants by 17 920 MW from 2008 to 2017, with Vietnam adding 12 513 MW during the same period. In the decade from 2008 to 2018, the compound annual growth rate (CAGR) of coal consumption in ASEAN was 7.8 per cent, dwarfing any other major consuming region in the world (IEA, 2019b, p. 15).

Note: Coal does not play a significant role in Singapore and Brunei Darussalam, hence their exclusion from Figure 4.3. Source: ACE database 2019.

Figure 4.3

Annual installed capacity of coal power plants in the ASEAN member states, 2005–17

Local and global aspects of coal in the ASEAN countries  49 The IEA predicted in 2019 that coal would replace gas as the main energy source for power generation in Southeast Asia by 2030 (IEA, 2019c, p. 62). As shown in Figure 4.4, demand is driven chiefly by Indonesia, Vietnam and the Philippines, but with Myanmar, Malaysia and Laos also including coal as a key component of their future energy systems (see also International Renewable Energy Agency [IRENA], 2018, p. 34). Myanmar’s Energy Master Plan envisions coal providing 30 per cent of electricity production by 2030 (IEA, 2020a). However, with almost 50 per cent of the population still lacking access to electricity in 2019 (IEA, 2019c), Myanmar also has a unique opportunity to avoid such a coal-centric scenario when undertaking grid planning (Sternagel, 2018). It could utilize its high renewable energy potential instead (Vakulchuk et al., 2017). Even Cambodia, which lacks significant domestic energy resources, signed a power purchasing agreement (PPA) in 2019 for large coal-generated electricity imports from Laos for the coming decades (Vanda, 2019), despite the latter’s established image as a mainly hydropower-exporting country and its aspirations to become the hydropower ‘battery of Southeast Asia’ (Watcharejyothin and Shrestha, 2009; Yu, He and Phousavanh, 2019). Coal is a non-existent part of the energy system of Brunei and is negligible in the electricity production in Singapore (less than 1 per cent), although these countries will also remain dependent on fossil fuels for the foreseeable future (IEA, 2020b, 2020c; Quek et al., 2018). It is also noteworthy that almost all the current and planned new coal plants in the ASEAN countries, with the exception of Malaysia, are the least efficient subcritical type of power plants (Climate Analytics, 2019, p. 42). ASEAN’s coal expansion is a potential lifeline for both the regional and global coal industries. Arguably, regional coal utilization is particularly in the interest of Indonesia, which holds some of the world’s largest reserves and stands to enhance its already dominant position in the global export market. Indonesia was the world’s largest exporter of coal in 2018, having jostled with Australia for the top spot in the preceding years, and accounted for double the volume of that of the third-largest exporter, Russia, in that year (IEA, 2019a). This may be of particular importance to Indonesia since its status as a net oil exporter has waned with the depletion of its reserves and lack of new major discoveries. Demand for coal is projected to exceed domestic reserves in all ASEAN countries except Indonesia. Thus, Southeast Asian demand would also help maintain the global coal industry (World Coal Association [WCA], 2019). Australian coal exporters and Japanese and Korean coal plant construction firms face significantly less stringent environmental standards in ASEAN than in their home markets (Jong, 2019a; Zhao and Alexandroff, 2019, p. 518). The Southeast Asian coal sector is also attractive to Chinese coal plant builders, as they are likely to face more stringent emissions standards and domestic demand is projected to taper off in the coming years (Yuan et al., 2018, p. 443). Hence, Chinese firms already have a major presence in the Indonesian and Vietnamese coal sectors (Shearer, Brown and Buckley, 2019). Thai firms have also become active players in the Greater Mekong Region, seeking to construct power plants in Myanmar for electricity exports back to Thailand (Sternagel, 2018). Due to the unpopularity of coal plants in Thailand, Thai investors have already constructed a coal power plant in Laos which will mainly supply the Thai electricity grid (Deboonme, 2012). Such circuitous transnational plans and preference for frontier markets such as Laos and Myanmar despite the high transmission costs back to Thailand underline the social costs and risks that coal power already faces in Thailand and the multifaceted pressures on the industry in Southeast Asia.

Coal-powered plants by province across ASEAN

Global Energy Monitor (2020).

Figure 4.4

Source:

50  Handbook of sustainable politics and economics of natural resources

Local and global aspects of coal in the ASEAN countries  51

3

THE IMPACT AND RISKS OF BETTING ON COAL IN SOUTHEAST ASIA

Coal-centric policy planning exposes the ASEAN countries to significant economic risks. The current hazards and future risks of coal as an energy source have been examined at both regional and national levels in Southeast Asia (Shi, 2016). The Carbon Tracker Initiative has noted that the combination of steadily lower prices for renewables and higher standards for particle emissions driven by public discontent with coal plant pollution will likely make coal less economic than solar power in Indonesia, the Philippines and Vietnam within less than a decade, despite the fact that these countries are planning the greatest expansions in coal capacity in Southeast Asia (Carbon Tracker, 2018a, 2018b, 2018c). By 2025, rapidly rising domestic demand for electricity in Indonesia might curtail the ability to maintain current export levels as domestic consumption eats up the supply (Cornot-Gandolphe, 2017, p. 2). Another element of uncertainty is foreign investor scepticism about unpredictable and costly royalties (ibid., p. 23). As a consequence of these developments and prospects, other ASEAN countries that are expanding their dependency on coal, and thus increasing their reliance on Indonesian policymaking, face greater energy insecurity. Large importing countries, such as China and India, although not projected to expand coal at the same pace as the ASEAN countries, will by virtue of their size remain major competitors for Australian coal. Southeast Asia has already seen competitive financing for coal plant projects dry up and be hampered by ambitious coal plans in ASEAN in the past two years (IEA, 2019c). In sum, the reliability and affordability of coal appear to hold largely illusory benefits for most ASEAN countries in the long run. Even as the global climate crisis, international pressure to decarbonize and plummeting costs of renewables make coal increasingly unpalatable and uneconomic, ASEAN leaders continue to emphasize promotional campaigns for ‘clean coal’ and the ‘benefits of coal’ to their general publics in joint communiqués from regional energy summits (see, for example, ASEAN, 2019). However, despite the longstanding rhetoric and lack of specifics about the supposed mitigating factors of ‘clean coal technologies’, as of 2020, ASEAN had only a single ultra-supercritical coal power plant, Malaysia’s 100 MW Manjung 4. Thailand is planning to refit an old coal plant with supercritical technology to provide 660 MW capacity, yet this plant is, and will continue to be, powered by lignite, the least efficient and most environmentally harmful form of coal. However, the maintenance of such plants is framed as environmentally sound, as the particle emissions having the most hazardous effects on local public health will be curtailed (Paiwan, 2019). Even in planned capacity additions, subcritical and supercritical plants will account for the bulk of expansion up to 2040 (IEA, 2019c, p. 69). Coal mining, which within ASEAN is concentrated in Indonesia, also poses significant risk of accidents, as many mines lack proper security infrastructure and protective measures for workers (Anggoro and Simorangkir, 2019). The ASEAN member states have received due criticism for their coal expansion as it undermines their international climate commitments (Clark et al., 2020; Overland et al., 2017; Prakash, 2018). International organizations note that the region has significant untapped renewable energy potential that could be exploited instead of coal (IEA, 2019c; IRENA, 2018). A Massachusetts Institute of Technology study from 2018 estimated that ASEAN countries must collectively cut emissions by 11 per cent by 2030, compared with the current trajectory, to meet their nationally determined contributions (NDCs) under the Paris Agreement, which

52  Handbook of sustainable politics and economics of natural resources are in many ASEAN states defined as being against business-as-usual (BAU) scenarios (Fulton et al., 2018). While an 11 per cent cut would be significant, the projected role of coal as providing over half of electricity demand in the Philippines and Vietnam by 2030 (ACE, 2017, p. 15; Philippine Power Statistic, 2018) in this scenario underlines the future high growth of emissions from the region even if the NDCs are met, at a time when much of the world is aiming to reduce emissions in absolute terms. Berlin-based Climate Analytics, in cooperation with the United Nations Environmental Programme (UNEP), estimated in 2019 that coal’s share in electricity generation in ASEAN would have to fall below 8 per cent by 2030 to meet the Paris Agreement’s targets of limiting the temperature rise to 2°C. The IEA projected that the share will be about 40 per cent (IEA, 2019c, p. 65). Coal’s expansion is a deliberate result of governments’ budget priorities, as public spending accounts for the bulk of investments in new plants from 2014 to 2018 (ibid., p. 16). With current policies (as of 2020), ASEAN will emit 2.4 gigatons of CO2 in 2040, overshooting any target in the Paris Agreement by a wide margin, with coal being responsible for nearly 50 per cent of these emissions (ibid., p. 101). However, the climate change impact is only part of the picture, as coal plants and mines have, and will continue to have, an immediate impact on the local population, to which we turn in the next sections. 3.1

Health Impacts of Coal in ASEAN

Coal-fired power plants also pose a more immediate threat to health and local economies across the region. With much of Southeast Asia having little wind and limited space, the abundance of coal-fired power plants in close proximity to population centres has had profound public health implications. Respiratory diseases are a rapidly growing health hazard in Southeast Asia due to forest fires, urban congestion and industrial emissions – with coal plants playing an increasingly prominent role (Koplitz et al., 2016; Ming et al., 2018; Tacconi, 2016; Taghizadeh-Hesary and Taghizadeh-Hesary, 2020). A 2017 study estimated annual excess deaths from coal-induced surface air pollution at 19 880 in the region, projected to rise to 69 660 by 2030 at the current pace of power plant expansion (Koplitz et al., 2016, p. 1467). In one commune in Vietnam, Ky Loi, cancer rates resulting from coal emissions have soared, to the extent that in 2019 its 11 000 residents were scheduled to be resettled, paradoxically to make more space for additional coal plants (Le, 2019). 3.2

Water, Agricultural and Economic Impacts

Coal plants represent a multifaceted threat to the water resources of Southeast Asia, with significant health and agricultural implications. Coal plants require substantial water volumes for cooling (Huang, Ma and Chen, 2017; Qadrdan et al., 2019; Zhang et al., 2017). A recent study noted how many newly built Indian coal plants had to temporarily shut down due to water shortages in recent years, and that the current Southeast Asian plans for coal expansion would put further stress on the region’s already depleted water resources (Wang et al., 2019, p. 3164). Coal plant waste also poses a threat to riverine livelihoods in the region, not only in terms of contaminating drinking water but also undermining fisheries (Runivarajom, 2018). Coal plant fly ash also poses a threat to water quality, impacting drinking water sources and irrigation. More directly, ash from coal plants has already poisoned agricultural fields, triggering local

Local and global aspects of coal in the ASEAN countries  53 protests in Batang in Central Java (Darmawan, 2019), Kalimantan (Funfgeld, 2018, p. 223) and multiple locations in Vietnam (Le, 2019). Although difficult to measure quantitively before it is too late, coal plants may also pose a threat to the tourism sector in Southeast Asia. For years, Thailand had been planning to enhance electricity supplies to its southern provinces by means of new coal-fired power plants, partly to meet demand as the tourism sector expanded. Yet, according to the provincial tourism board, the choice of coal and its emissions may undermine the attractiveness of one of the world’s tourism hotspots (The Nation Thailand, 2018a). Vietnam’s famous Ha Long Bay is already facing ecological problems, with coal plants onshore in Quang Ninh Province and coal shipping through the bay being amongst the major culprits (Tran, Pham Le and Le Thi, 2019). Coal plants similarly risk undermining the tourism sector on Bali, with projects proposed for construction near popular beaches and national parks (Greenpeace, 2018). Coal mining has also had negative effects on local communities and agriculture in other parts of Indonesia (Fatah, 2008). In East Kalimantan, land grabs and pollution have forced local farmers to resettle as mining firms exploit the large reserves (Tondo and Siburian, 2019). This trend is likely to intensify as this area holds a significant portion of Indonesia’s coal reserves, and the Indonesian government plans to move the national capital there from Jakarta in the 2020s (Shani, 2019).

4

EVOLVING RESISTANCE TO COAL POWER IN ASEAN

Faced with such implications and considering the rapid expansion of coal to date, it is not surprising that opposition both to coal-fired power plants and coal mining has been growing across the ASEAN region. Opposition ranges from local groups fearing for their health and livelihoods to emerging nationwide campaigns emphasizing climate implications. The form of resistance and the level of coordination amongst environmental groups and international civil society in each country is shaped by the national socio-political conditions. This section maps the heterogeneous opposition to coal-fired power plants in ASEAN states from 2010 to 2020, including the framing of grievances and the domestic socio-political dynamics that shape both the nature and effectiveness of this resistance. As protests are ongoing and have, to varying extents, already changed policy trajectories, we have scoured newspapers and other news sources covering environmental, coal and mining issues in Southeast Asia in an attempt to answer the following questions: ● Is opposition localized to specific plants or mines (and thus fragmented) or national in nature? ● What is the format of the opposition (on-site protests, marches, online campaigns, etc.)? ● Are grievances local, national or global in essence? ● Which political constituencies and actors comprise the opposition to coal projects? ● Have resistance efforts been successful at the local, provincial or national level? ● Which social, political or economic conditions are prerequisites for successful resistance?

54  Handbook of sustainable politics and economics of natural resources 4.1

Resistance to Coal Mining in Indonesia: A Fragmented Phenomenon

Southeast Asian opposition to coal mining is mainly concentrated in the countries with significant coal reserves. ASEAN holds about 4 per cent of global proven recoverable reserves (IRENA, 2018, p. 32); however, although demand is growing across much of the region, the distribution of coal reserves is highly uneven. Indonesia is amongst the world’s top coal exporters and holds over 80 per cent of ASEAN’s coal reserves, both hard coal and lignite (ibid., p. 32). Coal mines have had a significant negative impact on local communities across Indonesia for many decades, as insufficient legislation and enforcement have led to inadequate safety standards, lax waste containment and lack of protection or compensation for local communities (Ballard, 2001, p. 3). Due to the large size and de facto decentralized governance of much of Indonesia outside Java, some mining projects were approved by local authorities without complying fully with the national legal framework. Even regionally approved legislation to enhance mine safety has often been ineffective (Toumbourou et al., 2020). However, Indonesia also has a rich history of environmental activism, which was treated more leniently than other public expressions of discontent under the Suharto regime (1967–98) (Brown and Spiegel, 2017, p. 108). This, coupled with the massive expansion in coal mining and export in recent years, has prodded local Indonesian activists and the affected communities to partner with international non-governmental organizations (NGOs) to protest against mines in ecologically rich yet vulnerable areas such as Kalimantan (ibid., p. 106). Local opposition to new coal mines in West Papua is also growing, with local activists fearing that their environmental impact could further escalate the longstanding armed conflict in the restive province (Firdaus, 2018). In early 2020, local activists won a legal victory when the Indonesian supreme court ordered a mining permit in Central Kalimantan to be revoked on the grounds that it had not gained the approval of local communities, whose opposition centred on the threats to their livelihoods posed by the mine (Jong, 2020). The dispersed nature of Indonesian anti-mining activism to some extent reflects the country’s vast and diverse geography, rendering coordination amongst impacted local communities difficult. 4.2

Anti-mining Activism in ASEAN

In Vietnam, which has the ASEAN’s second-largest reserves of hard coal after Indonesia, coal mining is a hazardous activity. Yet, strong government control of the industrial sector appears to have prevented systemic protests against coal mines, as shown in Table 4.1. Protests have erupted over specific mining projects in the past, although chiefly due to foreign ownership concerns and growing anti-Chinese sentiment (Lam, 2018). In contrast, Malaysia’s plans to expand coal mining in Sabah encountered stiff opposition in 2018 (Table 4.1). Local NGOs, coordinating with international environmentalist groups and regional political parties in Sarawak and Sabah, argued that states in Malaysia should have greater influence over resource management (Joibi, 2018). Local protests emphasizing regional rights have also taken place in Myanmar, notably in Shan State (Table 4.1), where villagers have held peaceful protests against new coal mines, focusing on local environmental degradation, although, in Myanmar’s case, it also has an ethnic minority rights dimension (Mon, 2019; Sternagel, 2018).

Local and global aspects of coal in the ASEAN countries  55 Table 4.1

Opposition to coal mining in Southeast Asia 2010–20

 

Presence of Protests

Areas of Grievances

Local or National Focus

Policy Effects

Vietnam

None found

n/a

n/a

n/a

Malaysia

At least one (Sabah)

Agriculture, tourism, ecological

Supported by national political

None found

conservation

parties

Degraded fisheries, agriculture,

Protest march in Jakarta

Indonesia

Widespread

livelihoods, tourism, public health Myanmar

4.3

At least two (Shan State)

Agriculture, livelihoods

Suspended one mining licence

Local village-centric activism

None found

Resistance to Coal-fired Power Plants in ASEAN

Protests against coal-fired power plants are also widespread in Indonesia (Table 4.1), and they exhibit increasing signs of national and even international coordination. Importantly, the Indonesian government has curtailed the authority of local government bodies to block new licences for coal plants, preventing local residents from exerting political influence on their local administrations to halt new projects (Jong, 2019b). This prevents the widespread circumvention of national laws at the provincial level, but it also robs local activists of the power to exert successful political pressure on their local authorities to halt new coal projects, since it centralizes decision-making power in Jakarta. Nevertheless, protests in Indonesia have been multifaceted and widespread, although not always massive, strongly emphasizing local environmental and health impacts, even by protestors travelling to Jakarta to make their case (Jong, 2019a). In some more remote provinces, police have brutally cracked down on protestors (Karensa, 2016). In early 2017, over 2000 people from affected communities gathered in Jakarta and marched against coal, highlighting its negative impact on local livelihoods and health across the archipelago (Jatam, 2017). However, the links to climate change were not clearly articulated, and 2000 protestors is not a very large crowd on an Indonesian scale. Opposition to specific plants in Indonesia, Myanmar, the Philippines, Thailand and Vietnam have all been spearheaded by locals concerned about the effects of coal emissions on the immediate environment. Farmers in Batang in Indonesia expressed concerns about emissions from a new nearby plant in 2019 poisoning their agricultural fields (Darmawan, 2019), as did villagers in Karen State in Myanmar in the same year (Thant, 2019). In the latter case, resistance was also triggered by the fact that the plant was intended to sell most of its electricity to the Thai market, with limited benefits or improved supply for the local community. In Myanmar, local communities have formed organizations in recent years to protest specific projects (Sternagel, 2018), which unfortunately has only caused coal plant construction firms to pursue the project in another area. Villagers’ concerns about local waste effects led to suspension of a plant in Karen State in 2018 (Environmental Justice Atlas, 2018). In previous similar projects, local protestations proved unsuccessful (Win and Win, 2016). In Binh Thuan Province, local health-focused protestors rallied in 2015 in a rare display of physical protest in Vietnam and forced the Vietnamese government to impose superficial restrictions on a new plant’s emissions (AP, 2015). However, a similar situation developed in the following years about another planned coal plant in the province, although the small-scale protests by that point were also emphasizing climate change as well as public health (Banktrack, 2020). However, both the existing plant and planned project are still set to continue. Laos, with only a single large coal plant as of 2020, has yet to see major protests, which is likely explained

56  Handbook of sustainable politics and economics of natural resources by the small size of the town close to the plant as well as the Laotian one-party system that restricts almost all organized civic or environmental activism. Interestingly, despite protests in 2010 and 2011 against new plants, Malaysia has not seen major efforts by activists to stop new coal plants in recent years even though coal is an important source of power and will continue to remain so in the coming decades. This is not to say Malaysia does not have its fair share of climate or environmental activism, but this appears thus far to be focused on issues other than coal plants, such as deforestation and the country’s large palm oil industry (Ocharoenchai, 2019). Environmental activism and anti-coal protests have also been growing an online presence. Vietnam, in which the ruling socialist party controls most traditional media outlets and prohibits mass public protests, has seen a stronger presence of online campaigns against coal power, with national pop culture celebrities participating (Mekong Eye, 2016). However, the nature of the Vietnamese political system has limited any mass protests, local or provincial, despite massive environmental damage caused by coal emissions and waste in recent years (Tran et al., 2019). Nevertheless, there have been recent cases of NGOs successfully lobbying the government to limit future expansions, despite environmental activism carrying great risks in Vietnam (Bangkok Post, 2020). There have also been occasional climate protests in Vietnam, yet these have been rare and not focused on coal, but rather more broadly on air pollution (Palatino, 2019). The Philippines has arguably seen the most cohesive environmentalist pushback against coal in the ASEAN region. A key facet of Philippine activism is the emergence of national campaigns that have put pressure on both the central government and local administrations in recent years. Piglas Batangas! Piglas Pilipinas!, a national campaign launched by civil society groups in 2016, has organized demonstrations against various projects across the country, including large protest marches. Importantly, this initiative has ties to broader global climate activist networks. As the Philippine government has rapidly expanded the import and use of coal, local and nationally coordinated opposition has been growing, emphasizing the health, economic and climate change implications. Local churches have played a key role in organizing local communities to stage protests and launch petitions (Bugnot, 2018). The most noteworthy example of a multifaceted opposition effort to coal plants in the region, in terms of complex socio-political coordination as well as the multifaceted nature of grievances, has taken place in two provinces in the Philippines: Negros Oriental and Negros Occidental. These provinces make up the nation’s fourth-largest island, Negros in the Visayas, and effectively forced a phase-out of coal plants and proposed projects in 2018 and 2019, with the governors involved citing both local health concerns and the threat of climate change (Partlow, 2019; San Jose, 2019). The persistence of local youth protest initiatives, coupled with national exposure through national environmental networks, has likely played a significant role in pressing through this policy change. Despite this, coal remains a key priority for the Duterte administration, which touts its properties as ‘clean energy’ necessary to ensure energy security (Thomas, 2019). Ironically, almost all coal consumed in the country is imported, rendering its contribution to energy security questionable (Philippine Power Statistic, 2018). Thailand has also seen an increasingly nationally coordinated anti-coal network of activists emerge in recent years, emphasizing both local health and economic concerns as well as climate change. In September 2019, as part of the Global Climate Strike action, approximately 150 petitioners carried out a ‘die-in’ demonstration representing death from climate change

Local and global aspects of coal in the ASEAN countries  57 Table 4.2  

Opposition to coal-fired power plants in Southeast Asia 2010–20 Local and/or

Grievances

Format of Opposition

National Focus

Centre–Periphery Government Policy Effect/Changes Dynamic

Vietnam

National

Health

Online

None – highly stratified

None

Indonesia

Local

Health

Local protests

Local government

None

Livelihoods

Protest march in

marginalized

Jakarta Philippines

Thailand

Local and

Climate

Local protests

Local governments in two

Successful local policy

national

Health

National

cases instrumental in anti-

moratoriums

Livelihoods

demonstrations

coal policy adoption

Health

Local protests

Local tourism associations

Successful suspension

Tourism

National protests

side with demonstrators

of two new projects

Local protests

Local governments at odds

Successful prevention

with protestors

of at least one plant

Local

Climate change Livelihoods Myanmar

Local

Health Livelihoods

Note:

Cambodia, Laos and Malaysia were omitted because no data were found.

outside the Thai Ministry of Natural Resources and Environment, demanding coal to be phased out in the country (Palatino, 2019). In late 2018, after years of protests and public hearings, the Electricity Generating Authority of Thailand (EGAT) indefinitely postponed the construction of coal power plants in Songkhla and Krabi in the southern part of the country in favour of increased reliance on natural gas (The Nation Thailand, 2018a). The protests included publicized hunger strikes in Bangkok (Bangkok Post, 2018), and were driven by a number of relevant arguments. These ranged from local residents citing public health concerns, threats to fisheries and the area’s tourism sector, to local NGOs framing the issue in terms of climate change (The Nation Thailand, 2018b). In Krabi, the local tourism board was also highly sceptical of the proposed plants, as the region constitutes the heartland of the Thai tourist industry. Resistance to coal power in Southeast Asia is longstanding and multifaceted, shaped by geographic, political, economic, social and technological factors. The level of organized and successful protests correlates with political systems, especially the accountability and policymaking powers of regional and local authorities. While a more open system in the Philippines produced local policy changes and enabled national coordination, the stratified Vietnamese political system has contributed to a more muted activism, yet online campaigns have partly filled the void. Protests in Indonesia have rarely produced policy changes in Jakarta, partly due to coordination difficulties and partly to weak enforcement of existing policies. Fears of losing agricultural, hunting and riverine livelihoods dominate in almost all anti-coal discourses across the region, but the threat coal poses to highly profitable industries such as tourism has also catalysed opposition. Climate-focused activism against coal is a facet of Thai and Philippine politics but is otherwise still nascent in most of Southeast Asia, although it is on the rise (Table 4.2).

58  Handbook of sustainable politics and economics of natural resources

5 CONCLUSIONS By 2020, coal mining and power generation had been growing in Southeast Asia for decades and were projected to rise to new heights of prominence in regional energy systems, weakening the energy security of all states in the region except Indonesia, jeopardizing the NDCs of the ASEAN states under the Paris Agreement and deepening existing domestic political fault lines. Coal utilization has well-known public health, agricultural, water security and economic consequences, many of which are magnified in Southeast Asia, with its high population density and limited wind and arable land. Paradoxically, the short-sighted focus on affordability imposes significant longer-term economic risks on these states as renewable energy prices fall, while ASEAN markets for such energy sources remain underutilized. Encouragingly, and likely partly spurred by sustained public resistance to coal and calls for climate action, EGAT in late 2019 announced that coal would account for only 12 per cent of power generation in 2037 in Thailand (Theepara and Praiwan, 2019). Coal mining, no less hazardous in Southeast Asia than elsewhere, has triggered widespread locally organized protests in Indonesia, although not yet in Vietnam. While protestors have only achieved minor victories in some Indonesian cases, coordination amongst communities across the archipelago is increasing, and a nationally organized campaign in cooperation with international civil society might have a greater impact on Indonesia’s coal-centric energy trajectory. Coal plants and opposition to them are intertwined with existing socio-political fault lines: ethnic minority rights in Indonesia and Myanmar and regional political divides in Malaysia and Thailand. In Vietnam, the top-down one-party system blocks many protest avenues, which has triggered more creative and less overt forms of resistance against new coal-fired power plants. Opposition to coal across the region is heterogeneous, but trending towards greater national coordination and international cooperation amongst activist networks and even local governments. Local concerns continue to drive most protests, with the Philippines representing a more well-articulated pattern that links local and national environmental issues to climate change. International civil society organizations aiming to exert pressure on governments to reform their energy systems would do well to work more closely with activists on the ground in regions similar to Southeast Asia to shed an international spotlight on these issues, provide an international platform for local initiatives, make their case and form networks for collective action. This case shows how international actors as well as regional activists would stand to benefit substantially from closer cooperation, which has significant potential to pressure governments to abandon coal in Indonesia, Malaysia and Thailand. The international community has few direct tools or platforms through which pressure can be exerted on states to reconfigure their energy systems. Thus, the most viable option to effect change is through national and international coordination with global environmentalist NGOs, which can help harness, consolidate and empower the local efforts of Southeast Asian communities by linking local concerns with national policy trajectories to combat climate change.

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5. Policies and socio-economic tools for sustainable water management Stella Tsani, Stella Apostolaki and Phoebe Koundouri

1 INTRODUCTION Water is an indispensable natural resource for human existence and life on earth and remains an important input to many economic sectors of production like agriculture, industry and power generation. In a market-based system, the cost (unit price) of water largely determines the efficient use of the resource. Water price is often estimated based on water demand and water supply costs (infrastructure, collection, treatment and distribution), largely neglecting the environmental and resource costs and benefits related to water use. One of the obstacles in defining an integrated value of water, a price that accounts not only for the financial costs but also for the environmental and resource costs of water use, is related to the fundamental water dimensions (in the provision of environmental goods and services and as a natural resource) that are systematically ignored, mainly due to a lack of information or even understanding. Environmental and ecosystem valuation of water resources that considers water quality, amenity and biodiversity benefits is gaining ground. However, aspects related to water use and long-term impacts of water use, the impact of wastewater generation, changes in runoff patterns and the cultural, aesthetic and ethical dimensions of water (to name a few) are neglected for current and future generations, i.e. they are not well defined and not fully captured in the market price of water. Economists recognize and address the complexity inherent in managing water resources and particularly in defining the value of the non-market characteristics of the water resources (Akinsete et al., 2019; Apostolaki et al., 2019; Booker et al., 2012; Easter and Renwick, 2004). Full cost recovery of water services, i.e., the monetization of the total costs and benefits of water use, whether financial, environmental or resource related, is a cornerstone of any sustainable water management policy. Full cost recovery relates to the welfare economics literature, which argues that for maximum economic efficiency, prices should be set equal to the marginal (opportunity) cost. Allocative efficiency can also be promoted. Allocative efficiency requires that all users face a clear signal regarding the value of water services. This can only be achieved if all costs are recovered through water pricing (Reynaud, 2016). In addition, the financial sustainability of operators is a prerequisite for the sustainable operation of water services. Core issues here are the level of revenues and their predictability. Nevertheless, the implementation of full cost recovery remains challenging, and it can raise social and redistributive concerns. From a methodological perspective, full cost recovery necessitates the identification of cost components of water use not fully incorporated in the market price and the availability of data on the marginal costs of water use by user (e.g., households, industry and agriculture). From a policy perspective, priority should be given to developing an integrated approach to water management, one that incorporates the economic, social and environmental value of water, as well as the impact of the implemented measures. From 64

Policies and socio-economic tools for sustainable water management  65 a development perspective, efforts need to look carefully at the social and economic factors that relate to water management and to the wider regional and global efforts to achieve sustainable economic growth. This chapter discusses the policy and methodological challenges to sustainable water management with a focus on the European Union and the socio-economic tools that can be employed for efficient water management, with the intention of deriving useful policy and methodological insights. Section 2 briefly reviews the European water management policies and introduces links to global initiatives for sustainable development. Section 3 discusses the policy and methodological challenges to full water use cost recovery, while Section 4 discusses the available socio-economic tools that can assist in this direction. The last section offers concluding thoughts.

2

THE EU WATER FRAMEWORK DIRECTIVE THROUGH THE LENS OF THE GLOBAL SUSTAINABLE DEVELOPMENT GOALS

EU policies of the last three decades address the need for sustainable water management with an increasing intensity, and several EU water management directives have put this target into practice. Following the first EU directive of this kind, the 1980 Drinking Water Directive (Directive 80/68EEC) that defines the standards for toxic chemicals and for substances that cause health hazards and occur in drinking water, several subsequent directives on the chemical and ecological status of European waters have followed: the Nitrates Directive (1991), Urban Wastewater Treatment (1991), Plant Protection Products (1991), Integrated Pollution and Prevention Control (1996), Biocides (1998), New Drinking Water (1998) and Groundwater (2006). While these directives made the water regulatory framework robust enough, they did not address adequately and in an integrated manner the presence of multiple stressors on water bodies and the need to identify the integrated value and impact of water use. Multiple pressures were addressed for the first time and in an integrated manner with the introduction of the Water Framework Directive in 2000 (WFD, Directive 2000/60/EC). The WFD covers water quality, water quantity and aquatic habitat. It considers both the chemical and ecological status of water, and it is being developed in three management cycles: the first management cycle ended in 2015, the second runs until 2021 and the third cycle will end in 2027 (Tsani, Koundouri and Akinsete, 2020). Article 5 of the EU WFD, ‘Characteristics of the river basin district, review of environmental impact of human activity and economic analysis of water use’ and Article 9, ‘Recovery of costs for water services’ put at the core of policy implementation the recovery of the total economic cost of water services. This explicitly recognizes for the first time the importance of socio-economic assessment and tools for achieving good environmental and chemical status in water bodies. The EU WFD introduces the fundamental idea that water is both a social and an economic good. This concept imposes the implementation of measures for the recovery of the costs of water services. On a global scale, the importance of water and the need for integrated management are reflected in the Sustainable Development Goals (SDGs) of the United Nations’ 2030 Agenda. SDG 6 (Clean Water and Sanitation) and SDG14 (Life below Water) refer explicitly to water. Reading the targets of the 17 SDGs reveals that other goals also relate to water. Tsani, Koundouri and Akinsete (2020) review the SDGs and identify those that are directly and indirectly linked to water policies and developments in Europe. For instance, the authors note that

66  Handbook of sustainable politics and economics of natural resources core targets of SDG1, SDG2 and SDG8 concern the sustaining of per capita economic growth and achievement of higher levels of economic productivity and global resource efficiency in consumption and production, with parallel decoupling of economic growth from environmental degradation. These targets are linked to the pressures that water bodies in Europe will be faced with as a result of eradication of poverty and hunger worldwide and an increase in living standards and per capita income. These developments will possibly translate into higher demand for EU exports, and therefore greater economic activity in the EU in a set of economic sectors including agriculture, industry, services and energy. This might be linked to greater sectoral pressures on Europe’s water bodies. Similar global developments that are associated with pressures and future developments relating to EU water bodies are identified in the targets underpinning SDG3, SDG6, SDG7, SDG9, SDG12, SDG13 and SDG15. The mapping of the UN SDGs to the EU water policies reveals the complementarities and the missing links between European and global targets for sustainable water management. At the core of the sustainable water management efforts is the need to move beyond the mere financial costs of water use and the urgency of setting the notion of total water use cost estimations and recovery at the forefront of water management policies and economic approaches.

3

METHODOLOGICAL AND POLICY CHALLENGES FOR ACHIEVING TOTAL WATER COST RECOVERY

The EU WFD introduces the fundamental idea that water is both a social and an economic good. This concept imposes the implementation of measures for the recovery of water services costs. The innovative aspect in the EU WFD is that, for the first time in the EU, a legal text proposes economic principles and measures as basic instruments for the achievement of specific environmental objectives. One of the most important features of the EU WFD is that it establishes a common framework for water resources management based on the full water services cost recovery. One core step of this process is the definition of the costs of water services, which distinguishes between three different cost categories: financial, resource and environmental. Financial costs or water supply costs include the costs of investment, operation and maintenance, labour, administrative costs and other direct economic costs. Resource costs represents the loss of profit due to the restriction of available water resources (the opportunity cost of water use). Environmental cost represents the cost of the damage to the environment and aquatic ecosystems (i.e., the cost of environmental externalities like water pollution) caused by water use and services. According to the European Commission Working Group 2.6 (WATECO) Guidance Document No. 1, the environmental costs ‘represent the costs of damage that water uses impose on the environment and ecosystems and those who use the environment’ (WATECO, 2003, p. 69), while the resource cost ‘represents the costs of foregone [sic] opportunities which other uses suffer due to the depletion of the resource beyond its natural rate of recharge or recovery’ (p. 72). As noted by the European Environment Agency (2013a), such definitions are not straightforward and need further clarification. To this end, the European working group (DG ECO 2) was set up in 2003 and has provided more in-depth definitions (DG ECO 2, 2004). To achieve full water cost recovery, all water uses should be identified and linked to the respective economic agents and sectors (e.g., households, industry and agriculture). The environmental costs take into account both use and non-use values, while estimation of resource

Policies and socio-economic tools for sustainable water management  67 costs is not confined to water resource depletion only, but also takes into account the inefficient allocation (in economic terms) of water and/or pollution over time and across different water users. The definition of the different uses and costs of water indicates the complexity of estimating the full water costs. The estimation of financial costs is relatively easier to obtain and is related to parameters such as the duration of investments, discount rates, the value of existing infrastructure and depreciation methods. With regard to the environmental costs, it is important to identify the services affected and to monetize the effect on the environment to obtain a monetized value for the cost estimations. The same difficulties apply in the case of the resource-use cost where information on the marginal costs of water use must be made available. Additional issues that influence estimates of a fair and efficient water price are linked to market characteristics and inefficient government interventions. The availability of high-quality fresh water improves individuals’ welfare and benefits society. This means that water is not just a social but also a common good. Water as a social good can be examined and analysed as a private good as well, where more water consumption from one user means less water consumption from another user of the same water resource. Thus, management of water as an economic good means that water will be allocated to competitive uses in such way so that the net social benefit is maximized. The public good nature of water means that market principles for efficient allocation of the resource might not work. Given the lack of information on supply costs and consumers’ willingness to pay (WTP), it is very difficult to derive a market-efficient price that incorporates the social costs and benefits from the use of the resource (Koundouri, 2009; Koundouri and Papandreou, 2013). Water is also subject to externalities. Consider, for instance, water pollution. Examples include effluent from waste treatment plants and factories and urban and agricultural run-off. In these cases, the social costs of producing the good – for example, farm products or manufactured goods – are ignored, leading to artificially low production costs and hence overproduction of the good that generates the externality. Government failures can also lead to misallocation of resources – for example, subsidies for agricultural production, leading to the overexploitation of water resources for irrigation purposes (Bielsa and Cazcarro, 2015; Koundouri, Roseta-Palma and Englezos, 2017). As a result of these market inefficiencies and externalities the natural resource is not allocated efficiently among alternative resource users. The economic literature discusses several approaches to estimating the environmental and resource costs of water. Nevertheless, the quantitative findings remain sporadic, rendering the estimation of full cost recovery of water a difficult task. In economics, the basis of value is determined by individual preferences. Preferences reflect the welfare (utility) expected to be derived from the consumption of resources. To correctly evaluate a given resource, one needs to consider the total economic value (TEV) of the resource – that is, the whole class of values that have a basis in human preferences (Karousakis and Koundouri, 2006). TEV is composed of direct and indirect use values, as well as non-use values. Current use value derives from the utility gained by an individual from the consumption of a good or service, or from the consumption of others (for example, parents may obtain utility from their children’s consumption). Current use value is composed of direct use value (commercial and recreational) and indirect use value (such as amenity value or general ecosystem support). Option value derives from retaining an option to a good or service for which future demand is uncertain. If we are not certain about either our future preferences or about future availability, we may be willing to pay a premium (the option value) to keep the option of future use open. The option value

68  Handbook of sustainable politics and economics of natural resources is an additional value to any utility that may arise if and when the good is actually consumed. Existence value derives from human preferences for the existence of resources, unrelated to any use to which such resources may be put. Individual preferences may exist for maintaining resources in their present forms even where no actual or future ‘use’ is expected to be made of the resource. Given that many of these components of value are not reflected in market prices of water, economists attempt to estimate the true resource value through user WTP for a given quantity and quality of supply. Valuation techniques are therefore necessary to assign appropriate prices that will enable water to be allocated in the most efficient manner. A variety of these techniques have been developed over the years to address this issue and are generally classified as ‘revealed preference techniques’ or ‘stated preference techniques’. Revealed preference techniques use data about goods or services that are marketed and do have observable prices, in order to value some environmental attribute that is embodied in the marketed goods and services but is not traded itself in any market. In stated preference techniques, individuals are provided with a constructed scenario in which they are asked how much they are willing to pay for changes in environmental quality. Within the category of revealed preference techniques for water resources, one approach is the residual value method that values all inputs for the good produced at market price, except for the water resource itself. The residual value of the good is attributed to the water input. For example, one can value water as an input in the production of different crops. A problem with this methodology is that only part of the use value of water can be captured.

4

SOCIO-ECONOMIC APPROACHES FOR ACHIEVING TOTAL WATER COST RECOVERY

Efficient water pricing comes with the advantage that it provides an incentive to protect water use and quality. Changes in prices can provide signals to consumers and producers alike with regard to real water costs and water scarcity. Through the pricing mechanism, the necessary revenues for infrastructure maintenance and upgrade can also be collected. Efficient pricing can also ensure that all consumers have fair and sustainable access to the resource. On the downside, there is often disagreement about the objectives that water pricing and tariff design should meet. It is also often the case that water prices are not set in a transparent manner or they are based on a complex system. This lack of transparency and high level of complexity often lead to misunderstandings about the real value of water or the aims that are to be met from the revenues collected from water pricing. The water pricing structures more frequently applied in practice depend on single fixed-fee charges, taxes, volumetric assessment, and in relation to certain water services and elements – for example, according to land area or per application. The cost recovery principle for water services aims at improved water resource use in a way that considers societal and environmental aspects. It refers to assessing the costs that should be recovered from water users, a complex and a non-straightforward task due to the difficulties in identifying all services, costs and externalities. This process of cost assessment is also made complex due to the different operators, users and authorities involved in the functions of water supply and demand. Water pricing approaches observed in EU member states include: (1) fixed charges through water bills, irrespective of the volume of water consumed; (2) uniform volumetric tariffs that apply the same charges to water consumption, irrespective of the total amount water con-

Policies and socio-economic tools for sustainable water management  69 sumed; (3) increasing or decreasing step-wise volumetric charges where volumes of water are priced at the same rate in blocks (volumes) in an increasing or decreasing rate (accordingly), irrespective of actual total consumption; and (4) two-part tariffs that have both a fixed and a variable charge component. The pricing of water is coupled with particularities and limitations in efficient setting and application and in addition it requires a wider political-economic approach and agreement (consider, for instance, affordability issues or equal rights to the resource use). Water resources are a sui generis social commodity, with strong elements of natural monopoly, with high environmental and public health protection requirements, well-established perceptions of usage rights and intensely differentiated institutions for their distribution to users. In this regard, each of the economic instruments for achieving full cost recovery discussed next should be viewed through the prism of the existing pricing system and a review of established practices. In the context of conventional markets, private firms set prices with the aim of maximizing profit, with known technological limitations. In the resource markets, such as that of water, price setting should be primarily concerned with full cost recovery, including environmental and resource costs. In achieving full cost recovery, it is important to keep in mind the wider pricing implications that are associated with developmental (e.g., exportability, productivity), social (e.g., employment, securing a basic amount of water, avoiding social conflicts) and environmental objectives (e.g., saving water resources, ensuring good status of water bodies) of water management and supply (Koundouri, 2009; Rusca and Schwartz, 2018). When discussing the alternative socio-economic instruments for achieving full cost recovery, it is important to keep in mind the basic functions that must be met (European Environment Agency, 2013b). These are: (1) monetization (computational and management convenience, affordability); (2) cost allocation (fair and full cost allocation); and (3) provision of incentives (dynamic efficiency, saving of the resource, transparency and accountability). Keeping in mind the latter functions, several pricing models coupled with socio-economic instruments can be proposed for achieving full cost recovery and meeting the criterion of economic efficiency. With regard to the monetization and revenue generation function of water pricing, the theory advocates applying water pricing based on average costs. If each user pays the average cost of the amount of water they consume, then revenues will be equal to the total cost of water supply. Nevertheless, it is usually the case that the largest percentage of the financial costs of the enterprises (services) of water consists of fixed costs – that is, costs that are not related to the amount of water consumed. Such a cost structure coincides with the conditions of ‘natural monopolies’ and is characterized by a declining average cost, which is greater than the marginal cost in the largest segment of the production capacity of the enterprise. In those cases that are specific to natural monopolies (average cost greater than marginal), billing based on marginal cost is unable to cover the total cost of water supply. Two alternatives are usually proposed for addressing this case: decreasing block water tariffs or average cost pricing (Tsur, 2004). The criticism in this case is that pricing based on average costs results in social losses in prosperity and therefore is not effective, as it cannot maximize surpluses for producers and consumers. With regard to social acceptance issues, if high water consumption comes from the richer layers of society, then differentiated pricing based on incremental block rates can work towards social equality. Bar-Shira, Finkelshtain and Simhon (2006) summarize a series of empirical studies that apply block rates pricing and advocate that the increasing block tariffs work in favour of equity and fairness. By contrast, Dahan and Nisan (2007) find that increasing block pricing may work against social equality. This may happen in cases where

70  Handbook of sustainable politics and economics of natural resources Table 5.1

Alternative water pricing approaches: monetization ease, incentives provision, economic efficiency and social acceptance

Water Pricing Approaches

Monetization

Provision of Incentives

Efficiency and

(Computational and

(Dynamic Efficiency

Social Acceptance

Management Ease,

in Water Demand and

(Fair and Full Cost

Affordability)

Supply, Transparency and

Allocation)

Accountability) Fixed charges

High

Low

Low

Uniform volumetric tariffs

High

Low

Low

Increasing or decreasing stepwise volumetric charges

Low

High

Low

Two-part tariffs

Low

High

Low

high water consumption does not come from the richest households but from the largest households, which are often also the households with low incomes. Considering the computational and management ease of the different water pricing mechanisms for achieving full cost recovery, it can be argued that the volumetric measure of the consumed water is the most important factor that determines the computational and management convenience of the pricing methods. Average cost calculation is possible if all that is required is dividing the total cost by the amount of water supplied. Therefore, pricing based on average cost is preferred from a computational and management ease point of view. By contrast, the methods that use marginal cost pricing, non-linear cost pricing and two-part tariffs are more complex, since an estimate of the cost function is required. Table 5.1 summarizes the main pricing approaches to water and ranks their performance (high/low) with regard to computational and management ease, their ability to provide incentives for current and future sustainable water use and their ability to achieve full cost recovery. The valuation of environmental functions and services remains a challenging task. The quantification and monetization of the environmental services and goods provided by water bodies is not a straightforward and easy-to-follow process, as it needs to address the physical characteristics of the resource, social values, ecosystem values and policy requirements. The estimation of the TEV, which includes quantified estimations of the value of environmental goods and services, can be addressed in terms of (1) use value, which refers to the benefits individuals gain from using the resources to cover the fundamental needs of society (e.g., access to clean water and sanitation, water for agriculture and water for recreation), benefits related to sustainable management of the resource (e.g., demand vs supply and seasonality) and minimization of negative impacts, reduction of any sort of nuisance, enhancing good physical and mental health, supporting a strong and healthy economy; and (2) the non-use value that corresponds to the value individuals associate with an environmental resource they do not use (Remoundou et al., 2009). Different valuation processes are used to achieve full cost recovery and also to assess consumers’ WTP for services and water use, as well as for restoring any environmental damage caused. A popular tool towards a more effective methodology to achieve full cost recovery is the implementation of a choice experiment, which comprises the economic valuation of natural areas with non-market features that are either degraded or under degradation (Birol, Karousakis and Koundouri, 2006; Koundouri, Scarpa and Stithou, 2013). Another method for valuation of environmental and resource goods and services, which is increasing in popularity, is the benefit transfer method. This method, instead of depending on gathering ground

Policies and socio-economic tools for sustainable water management  71 data − something that may not always be easy or attainable − makes use of existing economic value estimates from one site to another site (referred to as the policy site), provided the two sites are similar in terms of socio-economic and environmental characteristics. The WTP or other instruments/tools applied in one site are adjusted to the other site. The benefit transfer methodology offers significant potential for achieving full cost recovery and complying with the WFD (Koundouri, Papandreou et al., 2013). Nevertheless, it should be noted that, although the benefit transfer is a supposedly faster and cheaper alternative for valuation of resources, it depends on the quality of the available data in the primary study area (Green and Tunstall, 1991). The literature offers a wide range of studies on the economic tools for fair and efficient allocation of natural resources, with a focus on water (Carolus et al., 2018; Chávez-Jiménez et al., 2013; Koundouri, 2008, 2010; Koundouri and Pashardes, 2003; Kraemer and Banholzer, 1999; Ozdemiroglu et al., 2006, Remoundou et al., 2015; Spash and Vatn, 2006). These form a basis of knowledge and available insights that can serve the purpose of achieving full cost recovery. Next, drawing from Koundouri et al. (2019), we present the main tools, their advantages and shortcomings. 4.1

Water Abstraction and Pollution Taxes

Taxes can be used to restrain water users from excessive use. Pollution taxes represent an efficient method of addressing water quality problems if these are adopted at the optimum level. Pigouvian taxes are statically and dynamically efficient as they trigger innovation. Area pricing is probably the most common form of water pricing, whereby users are charged for the water used. Other less commonly used forms of taxes include output and input pricing. Output pricing methods involve charging a fee for each unit of output produced per user, while input pricing involves charging users for water consumption through a tax on inputs (for example, a charge for each kilogram of fertilizer purchased in agriculture). The effectiveness of water pricing methods is associated with institutional factors and the administrative and monitoring capacity of the setting body. The effectiveness of a tax depends on the correct estimation of the marginal tax level and on how risk-averse users are with respect to damage from reduced water availability (in terms of both quality and quantity). The administrative costs of such an approach can also be high, since a differentiated tax is not easy to control and monitor. The financial impact on affected parties depends on the restitution of revenues, which affects tax acceptability. Finally, there are practical implementation problems, as it may be hard to define a good basis for a tax. 4.2 Subsidies Subsidies can be directly implemented for water-saving measures to induce users to behave in a more environmentally friendly way. Alternatively, indirect subsidy schemes may also be implemented. These include tax concessions and allowances and guaranteed minimum prices. Subsidies, however, may not be economically efficient, as they create distortions and do not provide incentives for the adoption of modern technologies.

72  Handbook of sustainable politics and economics of natural resources 4.3

Tradable Permits

Another instrument prescribed by economists in the face of demand–supply imbalances is the introduction of water markets in which water rights, or permits, can be traded. The rationale behind water allocation through tradable rights is that in a perfectly competitive market, permits will flow to their highest-value use. Different types of tradable permit systems can be established that address different aspects of the water resource problem (Kraemer and Banholzer, 1999). These include tradable water abstraction rights for quantitative water resource management, tradable discharge permits for the protection and management of (surface) water quality, and tradable permits to use or consume water-borne resources. The financial impact on affected parties and related acceptability of tradable permits depends on the initial allocation of rights. These can either be distributed for free (for example, depending on historical use or other criteria) or auctioned off to the highest bidder. If they are auctioned, revenues are created that can be used by the government, thereby generating a fiscal effect. 4.4

Standards and Quotas

Standards and quotas are legally established binding restrictions on natural resource use. A legal water standard or quota can be introduced that places restrictions on the amount of water that can be extracted for use. Such instruments remain effective if users are faced with substantial monetary penalties for lowering the water level below this standard or not adhering to the quota. Water quality standards may also be established. Although easy to set and implement, standards and quotas may not improve economic efficiency to the extent required and may hinder incentives to innovate. The financial impact is not always equally distributed among affected parties, since there are differences in the vulnerability of areas to changes induced by these instruments. Differentiated standards and quotas, however, pose a large burden on the administrative capacity and this is one of the reasons why these instruments are less preferred. 4.5

Voluntary Agreements

Voluntary agreements are agreements between different local users and stakeholders and rely on specialized knowledge of participants about local conditions. When costs and benefits are not equitably distributed among affected parties, both parties can bargain overcompensation payments. The allocation of such payments depends on the assignment of rights. 4.6

Environmental Liability Systems

Environmental liability systems can internalize and recover the costs of environmental damage through legal action, and make polluters pay for the damage their pollution causes. If the penalties are sufficiently high, and enforcement is effective, liability for damage can provide incentives for taking preventative measures. For such systems to be effective, there needs to be one or more identifiable actors (polluters); the damage needs to be concrete and quantifiable; and a causal link needs to be established between the damage and the identified polluter. Theoretical views on the tools to integrate externalities in the market for natural resources and to address market inefficiencies vary in terms of the tools proposed, the practicalities

Policies and socio-economic tools for sustainable water management  73 attached to each alternative and their effectiveness. From a theoretical perspective, all the economic instruments discussed above can be proposed for use in a complementary manner, in order to achieve sustainable water management. Each case, however, requires clear communication of the advantages and the shortcomings attached to each alternative economic instrument, and this needs to be matched to the particularities of each case, to the severity of the problem that needs to be addressed and to the particular social and economic conditions prevalent in each case study (Nauges and Whittington, 2017). Thus, the final selection must be based on stakeholder views and priorities.

5

CONCLUDING REMARKS

Sustainable water management requires that policy making and the implementation of socio-economic tools fully grasp and integrate the need for total water cost recovery. The EU water management policies record a clear move towards the integration of economic tools and instruments to achieve socio-ecological targets related to water resource management. To date, the implementation of economic instruments, irrespective of the related methodological advantages and limitations, has been inadequate in achieving environmental targets. This is explained largely by the lack of a knowledge base for integrating environmental and economic concepts and instruments into wider EU water policy debates, as well as barriers to acceptance and a lack of harmonized methodologies. Additionally, the economic tools for sustainable water management need to consider the integrated value of water (e.g., economic, financial, environmental and resource). The economic and financial values are easier to quantify with the use of market-derived mechanisms (e.g., price of water or investment cost for infrastructure). What remains difficult to monetize are the related environmental and resource changes, such as the physical, chemical, biological or ecological changes due to water use and their impact on ecosystem quality and diversity. For the quantification and monetization of these changes and the related costs and benefit impacts, integration is required to explore water values held by ‘ordinary’ users and citizens. This is important in the context of developing a non-monetary approach to valuation and suggests how these values could and should be integrated into water resource management policies. The economic literature develops several methodologies in this direction. These alternatives and the quantified insights that they offer need to be communicated to policy makers and integrated in the policy regulations and directives to achieve sustainable water management. This can support the achievement of the sustainable development goals in the EU, and also provide a methodological and policy prototype that is applicable and/or adaptable to other regions.

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6. Inflated expectations and commodity prices: evidence from Kazakhstan Victoire Girard, Alma Kudebayeva and Gerhard Toews

1 INTRODUCTION How are individual perceptions of income affected by fluctuations in commodity prices and thus resource wealth? Recent developments in the literature document the consequences of resource wealth at the local level. We now know that resources may foster local economic development (Aragón and Rud, 2013; Bazillier and Girard, 2020; Cust and Poelhekke, 2015) while also attracting corrupt individuals to power (Asher and Novosad, 2018) and triggering local conflicts (Berman et al., 2017; Rigterink, 2020). However, to the best of our knowledge, we know very little about the impact of resource booms on individuals’ perceptions. Since perceptions and behavioural biases end up driving actions, understanding whether and how resources affect perceptions is important to understanding the local impact of natural resources overall (Collier, 2017). We investigate how perceptions react to a distinctive feature of natural resources: the fact that their ownership is contestable. As opposed to goods and services that must be produced, natural resource extraction poses subtle ownership questions. At least three groups may claim ownership of resources and thus potential rents associated with these resources (ibid.). First, those who directly participate in the extraction of the resource: workers and firms in the resource extractive sector. Second, those who consider themselves entitled to claim ownership of the land above the reserves: locals and landowners. Third, people located within the same national borders as the resource: nationals. Since all these actors can in principle make a case for ownership, there is a risk that some actors may end up frustrated if reality does not keep up with their expectations. In this chapter we show how a commodity price boom affects households’ perceptions of their income, depending on whether they belong to the group of workers or the group of locals. To do this, we use the recent resource boom in Kazakhstan as a case study. Our treatment group comprises the private sector workers of the oil-rich districts of Kazakhstan who are closest to the oil sector (by nature of their activity and place of residence). We refer to these workers henceforth as oil-related household heads. The differential evolutions in satisfaction of household heads employed in other sectors, or located in other districts – in other words, households who are more remote from oil and gas extraction than the oil-related households – provide us with plausible counterfactuals. We then exploit plausibly exogenous fluctuations in the price of oil to show how these fluctuations affect satisfaction with household income. Kazakhstan provides an ideal case study for three main reasons. First, the Kazakh government has collected original and spatially disaggregated survey data. The government closely monitored citizens’ satisfaction with income throughout most of the 2000s using a representative household panel survey. In particular, the household head of the surveyed households would be asked to report how satisfied she is with the monetary income of the family within 76

Inflated expectations and commodity prices: evidence from Kazakhstan  77 the last three months. Using this data allows us to link variations in the price of oil to variations in satisfaction with income – conditional on income. We thus capture the changing perceptions of individuals regarding their income. Second, Kazakhstan is a small, open, resource-rich economy, such that we can consider changes in the price of oil as exogenous, providing us with our identifying time variation. Third, the oil and gas resources of the country are clearly concentrated in a few resource-rich districts, whose economic activity almost exclusively depends on the extraction of oil and gas (Pomfret, 2006). This concentration of resources provides us with a sectoral and spatial variation that allows us to consider the group of private sector workers in the oil-rich districts as either directly or indirectly involved in the extraction of oil and gas and thus economically dependent on the activity in the primary sector (Aragón, Rud and Toews, 2018; Toews and Vezina, 2017). Note that a violation of this assumption would lead to an attenuation bias in our results. Relying on a triple-difference specification that exploits the three dimensions of our data (space, time and sector of activity), we show that there is a swift and negative impact of an increase in the price of oil on satisfaction with income for oil-related household heads. In our preferred specification, doubling the price of oil decreases satisfaction by one-tenth of a standard deviation. This result is robust to different definitions of the control group. Moreover, introducing district-time fixed effects allows us to rule out that our results are driven by local inflation (Corden and Neary, 1982; Harding, Stefanski and Toews, 2020), migration (Beine, Coulombe and Vermeulen, 2014; Moretti, 2010) or local public spending (Caselli and Michaels, 2013). Furthermore, allowing for sector-time fixed effects allows us to account for sector-specific transformations, which may be fuelled by Dutch disease mechanisms (Cust, Harding and Vezina, 2019; Stefanski, 2016). Finally, we also show that our results are driven by the contemporaneous price of oil rather than its leads or lags. The instantaneous reaction of satisfaction to oil price fluctuations is important for two reasons. First, from a policy perspective, satisfaction with income is likely to evolve more rapidly than real actions, allowing the policy maker to prepare and potentially avoid the negative consequences of upcoming events. Second, from an empirical perspective, we can disregard alternative confounding factors, such as a recomposition of the workers’ pool through migration or sector and location specific adjustment to the oil price boom, as these adjustments will typically take time to be implemented and should thus show up in the data with a lag. By ruling out alternative explanations, we provide evidence that ‘while a rise in the region’s income may be good, a disproportionate rise in expected incomes may pose problems. People are dissatisfied with their income – no matter how large it is – if it falls short of their aspirations’ (Ross, 2007, p. 245). Moreover, if such a discrepancy between expectations and reality occurs simultaneously in a large group of people, it has the potential to create fertile ground for populist movements and even violent conflicts. In fact, in Kazakhstan, the rising dissatisfaction in the private sector of the oil-rich districts seems to have culminated in the Zhanaozen conflict in 2011, during which more than ten people were killed and more than 100 were injured. Each country is unique and may face different labour dynamics. Unfortunately, the experience of Kazakhstan seems far from atypical. Towards the end of this chapter, we compare a set of conflict data for Kazakhstan to a global dataset on labour conflicts in the extractive industries. We show that the recent increase in commodity prices increased the number of conflicts, not only in Kazakhstan, but also in the rest of the world. This chapter relates to two ideas in the resource curse literature. First, our results add to the literature on the economic and political consequences of information about future resource

78  Handbook of sustainable politics and economics of natural resources wealth. Arezki, Ramey and Sheng (2017) show that giant oil and gas discoveries have real economic consequences long before production starts, because they change people’s expectations and thus their actions. This is in line with our results suggesting that workers’ aspirations change very quickly, potentially before any changes in fundamentals are observed. In line with the idea of inflated expectations, Cust and Mensah (2020) show that the same giant discoveries appear to have a significant positive effect on people’s expectations about the future of their respective countries, which translates into different migration and fertility decisions. Finally, Cust and Mihalyi (2017) show that these giant discoveries have a negative effect on short-term economic performance, measured in gross domestic product (GDP) growth, when compared with counterfactual forecast growth estimates published by the International Monetary Fund (IMF), suggesting that the IMF is also not immune to the expectation-altering effect of giant discoveries. Moreover, these results are important because just the prospect of resource wealth might unleash political forces (Venables, 2016). For instance, new information on the value of a commodity may quickly create fertile ground for conflicts and populist movements (Christensen, 2019; Funke, Schularick and Trebesch, 2016). We add to this discussion by showing that changes in commodity prices may quickly translate into changes in people’s perceptions, group-level dissatisfaction and potentially conflicts (Berman et al., 2017; Collier and Hoeffler, 2004; Rigterink, 2020). Most papers in this literature implicitly assume that conflicting groups are already organized and motivated by greed, grievances or some combination of the two.1 We, on the other hand, suggest that quickly changing aspirations can be easily exploited to draw different groups, here delimited by their work and place of residence, into violent conflicts. In the next section of the chapter, we provide some background information on the specific case of Kazakhstan. In Section 3 we discuss data, identification strategy and the results. In Section 4 we discuss alternative mechanisms for the identified effect, and we provide some concluding thoughts in Section 5.

2 BACKGROUND Kazakhstan’s economy heavily depends on oil (Vakulchuk and Overland, 2018). From the dissolution of the Soviet Union until 1999, Kazakhstan’s economic growth was either negative or close to zero. This was partly driven by low commodity prices that remained low throughout the 1990s and did not allow the country to benefit from its natural resource abundance (Pomfret, 2006). This changed in 1999, when the oil price slowly started increasing from an all-time low of US$12 per barrel to an all-time high of more than US$100 ten years later. Beyond the generation of resource rents due to high commodity prices and small operational costs of extraction in the short run, forward-looking multinational companies expanded investments, made huge discoveries,2 and eventually expanded production. Driven by this oil boom,

1 An exception is Berman, Couttenier and Girard (2020), who document how natural resource wealth ends up triggering a change in a subnational group identity, exacerbating identity fragmentation between the national and ethnic identity. 2 Most notably Kashagan, which is located in the northern part of the Caspian Sea and is considered to be one of the biggest oil fields outside the Middle East.

Inflated expectations and commodity prices: evidence from Kazakhstan  79 GDP per capita increased from US$1130 in 1999 to over US$9136 in 2010 (Statistical Agency of the Republic of Kazakhstan [SARK], 2011). The increase in GDP was directly fuelled by the oil- and gas-rich districts, predominantly those located in the Atyrau and Mangystau regions in the western part of Kazakhstan on the shores of the Caspian Sea. In 2010, value added in the oil and gas sector accounted for 11.5 per cent of Kazakhstan’s GDP. At the same time, more than half (57 per cent) of Kazakhstan’s exports consisted of oil and gas (ibid.).

Note: The names denote the respective regions that are spatially separated by the dark lines. The region of South Kazakhstan was renamed Turkistan in 2018.

Figure 6.1

Kazakhstan

The yearly oil production of Kazakhstan adds up to approximately 2 per cent of global oil production. Thus, while oil is central to the Kazakh economy, the country is at the very bottom of the top 20 global producers and has in that time period not been part of an international organization effectively contributing to the control of the oil price. This allows us to treat Kazakhstan as a small open economy with regard to the price of oil. In other words, Kazakhstan is a price taker on the oil market, and oil price fluctuations can be considered exogenous to what happens within the country. The known offshore reserves located below the Kazakh part of the Caspian Sea and the onshore reserves in the adjacent oil- and gas-rich districts, shaded as treated in Figure 6.1, add up to approximately 40 billion barrels of oil. As presented in column 2 of Table 6.1, the biggest oil and gas projects are dominated by international oil companies (IOCs) (Munayshy Public Foundation, 2005). Most of the biggest IOCs have been involved in the extraction of oil and gas in Kazakhstan, including BG Group, BP, Chevron, ConocoPhilips, ENI-Agip, ExxonMobile, RoyalDutch Shell and Total (Vakulchuk and Overland 2019), and only 25 per cent of the oil and gas sector has been kept under the control of the government. To a considerable extent this is because the extraction of oil and gas in Kazakhstan is particularly difficult due to severe climate conditions and geological challenges. Thus, the Kazakh government has had to rely on the expertise of IOCs (Kaiser and Pulsipher, 2007).3

3 For instance, Kashagan is considered one of the most expensive projects in the world due to the difficult climate conditions.

80  Handbook of sustainable politics and economics of natural resources Due to a combination of geology, climate and an idiosyncratic history, the local labour markets in the oil-rich districts are extremely isolated and highly dependent on the extraction of oil and gas, providing us with an ideal case study for our research question. Worldwide, as the oil sector is highly capital intensive, the share of the population involved directly in the oil and gas sector is typically small across countries (Ross, 2012). Moreover, it is usually difficult to link oil and gas extraction to a specific location and an exact economic activity, because one particular asset may affect different regions simultaneously via different channels. For instance, an onshore asset located in region A at the border of region B may pay taxes to the government of region A but employ mainly individuals from region B. Moreover, the creation of back and forward linkages to the IOCs, especially in the presence of local content requirements regarding the inclusion of small businesses and locals in the production process, usually makes it hard to identify sector-specific spillovers from the place of overall economic activity (Aragón and Rud, 2013; Bazillier and Girard, 2020). For instance, should the construction of a new harbour or the extension of a pipeline for the purpose of oil exports be considered part of the production process? Or similarly, should the construction of roads and railroads connecting the port to the oil well be considered part of the production process? And finally, should the creation of houses, hotels and restaurants, which facilitate the influx of oil workers somehow be considered? These questions are almost impossible to answer in most cases, but we can isolate some of them in Kazakhstan. Several features of the oil-rich districts in Kazakhstan, which are discussed in the next few paragraphs, allow us to define the group of oil-related workers that may be considered strongly associated with the oil sector in terms of the location of the household and the activity of the household head. First, oil and gas basins are only located in the western part of Kazakhstan, such that the rest of the country can easily be considered oil poor. Moreover, and more importantly, this region of Kazakhstan would have remained uninhabited in the absence of oil and gas. This is because of the harsh climate conditions, which make settling difficult, and vegetation that essentially makes agriculture impossible. Historically, this area has been sparsely populated by nomadic tribes, which were neither interested in the creation of settlements nor involved in agriculture. This part of Kazakhstan remained nomads’ land until the nineteenth century. Throughout the nineteenth century, the Russian Empire expanded southward, with the aim of reaching the former silk road towns in contemporary Uzbekistan, and by doing so conquered western Kazakhstan (Hopkirk, 1992). Initially, this area remained free from major settlements until the end of the nineteenth century, when the region received more political attention due to the discovery of oil and the desire to extract, process, transport and eventually export it. In fact, most cities in western Kazakhstan were created or greatly expanded around the late nineteenth century or throughout the twentieth century due to the discovery of oil.4 If the city existed before the nineteenth century, the discovery of fossil fuels significantly transformed and reoriented these economic agglomerations towards the oil and gas sector. Most prominently, Atyrau, the capital of Atyrau Region, was initially created as a Russian fort in 1640 on the European side of the Ural River. The discovery of oil and gas in the region, however, pushed the population of the city from less than 10 000 in 1887 to a population of close to 80 000 in 1959 and moved the centre of the city to the Asian side of the Ural River,



4

For example, Zhanaozen in Mangystau, Kulsary in Atyrau and Karauilkeldy in Aktobe.

Chevron, ExxonMobil,

Tengizchevroil

KazMunayGas, LukOil

PetroKazakhstan (until

Kazakhoil Aktobe

PetroKazakhstan

KasGerMunai

Gommern

Oil AG, Erbdöl-Erdgras

JSC Yuzhneftegas, Feba

Munai

LukOil, Hurricane Kumkol

2005)

CNPC

AktobeMunaiGas

Energy Ltd (until 2006)

BP Group, ENI

Turgai-Petroleum

Manghystauskiy,

8 500

13 000

23 000

3 500

24 000

36 000

10 000

3

5

Kyzylorda

Kyzylorda

Kyzylorda

Aktobe

1 9

Aktobe

West Kazakhstan

Mangystau

9

13

4

www​.mmg​.kz

www​.kmg​.kz

www​.kmg​.kz

www​.tengizchevroil​.com/​

–

Webpage

Syrdarinskiy

Syrdarinskiy

Syrdarinskiy

Baiganinskiy

Temirskiy, Mugalzharskiy,

www​.kgm​.kz/​en/​

www​.turgai​.kz

www​.petro​-kazakhstan​.kz

www​.koa​.kz

.shtml

2020Kazakhstana/​2020Kazakhstan​ Baiganinskiy

www​.kpo​.kz www​.cnpc​.com​.cn/​en/​

Temirskiy, Mugalzharskiy,

Burlinski

Tupkaragansky, Manghystauskiy www​.kbm​.kz

Zhanozen (city), Aktau (city)

Mangystau

9

25 000

Karakhiyanskiy, Zhanozen (city)

Manghystauskiy,

Zhylyoyskiy, Atyrau (city)

Makhambetskiy, Makatskiy,

Kzylkoginsky, Isatayisky,

–

–

District

2009)

Canada’s Nations

Karachaganak

Karazhanbasmunai

Central Asia Petroleum Ltd

Mangystau MunayGas

Mangystau

10

Atyrau

Mangystau

Beyneusky (Mangystau) Atyrau,

Zhylyoyskiy (Atyrau),

Mangystau, West Kazakhstan

Aktobe, Atyrau, Kyzylorda,

Region

27 000

5

25

100

Share (%)

Karakhiyanskiy, Tupkaragansky,

KazMunayGas

UzenMunayGas

13 000

65 500

265 000

Cum. Prod.

(until

KazMunayGas

EmbaMunayGas

KazMunayGas, LukArco

–

Owner

Major

Cumulative production of main oil and gas projects 2001–05 (in 1000 tonnes)

Kazakhstan

Name

Table 6.1

Inflated expectations and commodity prices: evidence from Kazakhstan  81

82  Handbook of sustainable politics and economics of natural resources closer to oil extraction.5 In a nutshell, when the Russian Empire conquered the area, it was previously sparsely populated by nomadic tribes. The population density of the area and its concentration in major settlements have heavily increased following the discovery of oil since the late nineteenth century. Nowadays, the western part of Kazakhstan remains sparsely populated and economically dependent on the extraction of fossil fuels. With a geographical area comparable to contemporary Germany, which has a population of over 80 million people, in 2008 western Kazakhstan officially had a population of one million, of whom a bit less than half, 471 000, were registered employed. The labour market features of – and data available for – the region of Mangystau allow us to illustrate the dependence of western Kazakhstan on fossil fuel extraction by providing some basic statistics. Mangystau is considered the centre of the oil-rich area in Kazakhstan and the only region in which every district is defined as being oil rich, thus the entire region is part of the treatment group in our analysis.6 Based on the official statistics from Mangystau, approximately 20 per cent of the population are directly involved in the extraction of oil and gas, while roughly 50 per cent are occupied in construction, real estate management, hotels, restaurants, trade, transportation and the distribution of energy and water. These are sectors that we typically think of as being closely linked, being fuelled by, and even necessary for, the existence and effective extraction of oil and gas. Finally, roughly 25 per cent of the workers are employed in the public sector (education, health, local administration and other public services). The remaining 5 per cent of the workers are occupied in agriculture, fishing, non-resource manufacturing and finance. To sum up, most of the private sector activities in the settlements of Mangystau are highly specialized in facilitating the extraction, processing and transportation of oil and gas, such that, in principle, individuals may identify with the production process and thus claim some ownership. We therefore think of these cities as ideal typical examples of isolated mining towns, which are economically completely dependent on a single tradable good that they are selling to the rest of the world. As a result, all individuals employed in the private sector in these cities may, in principle, claim some ownership rights due to their involvement in the production process. In flavour, this is similar to remote coal mining towns in which coal is often at the core of a town’s identity, holding the community together (Carley, Evans and Konisky 2018). Before we conclude this section, note that any violation of the above interpretation – that private sector individuals in mining towns all have some sort of link to the mining industry – works against our results. Indeed, in the case that some household heads employed in the private sector of the oil rich districts (which we consider in our treatment group) do not feel related to oil and gas, their satisfaction with income will display the same relation to the oil price as the satisfaction of household heads employed in other sectors and/or districts (which we consider in our control group), implying an attenuation bias in our results.

5 This expansion is all the more noteworthy given that most cities in the Soviet Union shrank at that time due to the World Wars and the Russian Revolution. 6 Unfortunately, we only have access to the aggregate statistics on sectoral decomposition of employment at the region level and not at the district level. Hence, we cannot perform the decomposition for every oil-rich district. Since Mangystau is the only region in which all districts are treated, we assume that the labour market of Mangystau is representative for other oil rich districts.

Inflated expectations and commodity prices: evidence from Kazakhstan  83

3 EMPIRICS 3.1 Data To answer our research question, we combine detailed household survey data with information on the location of oil and gas extraction in Kazakhstan and the price of oil. Oil data We define oil-rich districts as districts hosting at least one of the major oil projects listed in Table 6.1 and as indicated on the map in Figure 6.1.7 The real price of oil comes from the BP Statistical Review. The timing of the last oil price boom, which began around 2004, means that we observe in our sample a before period in 2001–04 with low oil prices and an after period in 2005–09 with high oil prices.8 Household data At the core of our analysis is the information contained in the Kazakhstan Household Budget Survey (KHBS henceforth). The KHBS is a nationally representative annual household survey that collected information on 12 000 households from 2001 to 2009. The sample was selected from a household register based on the 1999 population census. In the first stage of the sampling, within each region (except Almaty and Astana), areas have been divided into four strata: large cities, medium cities, small towns and rural settlements. In the second stage, primary sampling units with at least 150 households have been selected within each stratum. Within each primary sampling unit, households were sampled with a sampling probability proportional to the size of the households, and 30 households were listed.9 The questionnaires contain four modules: (1) daily expenditure on food and necessities of households; (2) quarterly expenditure on clothes, durables, utilities, education, healthcare, transportation, other expenditures and incomes of household members; (3) housing conditions, livestock, equipment and machinery, education and employment; and (4) household composition and size. The surveys were conducted quarterly with a rotating sample between 2001 and 2009, where 25 per cent of households surveyed were replaced randomly in each year.10 In Table 6.2 we present some basic descriptive statistics for the main variables in our analysis. 3.2 Descriptive An original feature of the questionnaire is that it contains a question regarding satisfaction with household income. The household head is asked: ‘Please tell us how satisfied you are with the monetary income of your family within the last three months?’ with answers ranging from 1 to 5. It is important to note that households’ satisfaction with their income tends to be higher in oil-rich districts on average throughout the period and that households’ satisfaction increased

Note that some of the projects span district borders. Our results are not sensitive to the exact division of our sample into periods. 9 Ten additional households were listed as replacements. 10 Between 2006 and 2008, the survey methodology changed, during which time only 3000 households were surveyed every quarter and then annual information for 12 000 households was constructed from the quarterly surveys. Thus, we will not exploit the quarterly variation in our analysis. 7 8

84  Handbook of sustainable politics and economics of natural resources Table 6.2

Descriptive statistics

Variable

Mean

P50

SD

Max

Min

Satisfaction (1–5)

2.65

2.75

0.74

5.00

1.00

ln(income)

11.58

11.63

0.83

15.89

5.99

Private sector (1 = 0)

0.29

0.00

0.45

1.00

0.00

Public sector (1 = 0)

0.33

0.00

0.47

1.00

0.00

Secondary education (1 = 0)

0.68

1.00

0.47

1.00

0.00

Tertiary education (1 = 0)

0.18

0.00

0.38

1.00

0.00

Family members

2.76

2.00

1.35

15.00

0.00

 

 

 

 

Number of observations = 93 739

over time for the oil rich and the oil poor districts. Thus, the results we are documenting in our empirical analysis capture the relative drop in satisfaction conditional on individual and year fixed effects. While all individuals in our sample are Kazakh nationals and thus may claim some share of the rents, we are particularly interested in checking whether individuals active in the private sector of the oil-rich districts end up displaying a differential reaction to the evolution of the oil price. Our interpretation of such a differential evolution is that it is rooted in differential claims to the oil rents. In the event of differential claims, we expect satisfaction with income of oil-related households to be more sensitive to the price of oil and the availability of rents relative to other households. Figure 6.2 shows how an individual’s satisfaction with the same level of income reacts to a change in the oil price, by grouping individuals into eight groups based on three dimensions: private versus non-private sector, oil-rich versus oil-poor districts (see Figure 6.1) and a period of high (2005–09) and low (2001–04) oil prices. The results plotted in Figure 6.2 are conditional on individual and year fixed effects. Individual fixed effects account for variation across individuals – for example, in their baseline perception of their income – and time fixed effects account for any national trend, including possible changes in the interpretation of satisfaction questions across years. First, in all panels of Figure 6.2, the relationship between satisfaction with income and income is upwards sloping. This upward slope has been already documented and is quite intuitive (see, for instance, Frey, 2008): reported satisfaction with household income increases with income. Second, focusing on oil-poor districts, which appear in the bottom panel, we depict the relationship between income and satisfaction for our counterfactual groups. In oil-poor districts, the relation between satisfaction and income is virtually the same across sectors (private sector versus other sectors) as well as across periods of low (years 2001 to 2004) and high (years 2005 to 2009) oil prices, when comparing the left and right of the bottom panel. The conclusion changes if we turn to the top panel of Figure 6.2, which depicts the relationship between income and the price of oil in the oil-rich districts. The relationship between satisfaction with income and income is still upward sloping, but it is only for individuals employed outside the private sector that the relationship remains the same in periods of high and low oil prices. Individuals employed in the private sector appear to be sensitive to the price of oil. Comparing how these oil-related individuals evaluate their satisfaction with income across periods, we see that they tend to appreciate the same level of income more than other workers do during the period of low oil prices (top left panel), but they tend to appreciate the

Figure 6.2

Satisfaction with income

Note: The figures present the relationship between logged household income per family member and the satisfaction with this income reported by the head of the household on a scale from 1 to 5. All results are conditional on individual household fixed effects and year fixed effects. We exclude the top and bottom 1 per cent of the residual values in all the figures for a better representation of the results. The local polynomial smoother is employed using the Epanechnikov kernel with a bandwidth of 0.6 for all figures. Note that the sub-sample of low oil prices stretches between 2001 and 2004, while the period of high oil prices includes the years from 2005 onward.

Inflated expectations and commodity prices: evidence from Kazakhstan  85

86  Handbook of sustainable politics and economics of natural resources same level of income less during the period of high oil prices (in the top right panel, the level of satisfaction of private sector workers is below the level of satisfaction of the other households for any given level of income). These results are consistent with the existence of a reference point relative to which satisfaction with income is determined (Frey, 2008; Kahneman and Tversky, 1979; Mas, 2006). The exact position of the reference point is determined by a complex interaction of past, current and expectations about future experiences to which the price of the single most important good in the oil rich districts is likely to contribute. 3.3 Identification To evaluate this relationship more formally, we estimate the following specification: yisdt = α ln(Oilpricet) × OilDistrictd × Privates + b'Xit + FEi + FEst + FEdt + FEsd + εisdt(6.1)

where yisdt indicates how satisfied household head i is with his or her income, knowing he or she works in sector s in district d, in period t. We rely on a triple-difference specification to identify α, linking satisfaction with income to the logged price of oil, which is interacted with dummies, indicating a household head’s sector of employment and whether an individual is located in the oil-rich district or not. Doing so allows us to control for any respondent and household time-invariant characteristics through the household fixed effects FEi (including individual biases in perceptions). It also allows us to control for sector-specific variation over time, such as an employment boom in the public sector through sector-year fixed effects FEts. The district-time fixed effects FEdt additionally account for local factors such as local inflation, migration and environmental damage. We can also account for fixed effects at the sector-district level FEsd, which are identified because some household heads switch their sector of employment during the period of observation. This fixed effect allows us to account for the inherently different histories of how these sectors emerged in the different districts and their difference in specialization. In our preferred specification we also control for household income since we are interested in evaluating changes in satisfaction with income conditional on the level of income, as depicted in Figure 6.2. Most other controls on the household level barely matter, due to the large number of fixed effects employed in our model. 3.4 Results Table 6.3 outlines that the change in the oil price decreases satisfaction with income in the group of oil-related households, consistent with the graphical results in Figure 6.2. Conditional on changes in income, a 20 per cent increase in the price of oil decreases satisfaction with income by 0.03 points (column 3 of Panel A in Table 6.3). This result survives a battery of alternative specifications, with respect to the coding of the dependent variable, inclusion of standard controls or the different definitions of the treated and control groups. The negative reaction of oil-related households to the oil boom remains unaffected by the controls. In the first column of every panel, we present the results without any controls. In column 2 we control for household income. By controlling for income, we make sure that households’ satisfaction with their income does not merely reflect variations in their income. Controlling for income between columns 1 and 2 of Table 6.3 leaves the coefficient of interest statistically unchanged. In the third column, our preferred specification, we control addition-

Inflated expectations and commodity prices: evidence from Kazakhstan  87 Table 6.3

Satisfaction with income Satisfaction with Household Income as Reported by Head of Household (Dep. Var.)

 

(1)

(2)

(3)

(4)

(5)

Dep. var. coding

Raw

Raw

Raw

Dummy

Raw

Sample includes

All

All

All

All

Permanent

Panel A: full sample OilPrice × OilDistrict × Private

–0.245***

–0.207*** –0.140*** –0.206***

–0.434***

 

(0.064)

(0.053)

(0.050)

(0.055)

(0.062)

Observations

81 778

81 762

81 761

81 761

40 949

R2

0.707

0.724

0.634

0.725

0.737

Panel B: private sector workers versus public sector workers OilPrice × OilDistrict × Private

–0.335***

–0.196**

–0.620***

 

(0.115)

–0.299*** –0.293*** (0.104)

(0.105)

(0.080)

(0.056)

Observations

38 319

38 315

38 314

38 314

21 686

R2

0.718

0.735

0.736

0.653

0.754  

Panel C: private sector workers versus unemployed –0.130**

–0.299**

 

(0.046)

(0.053)

(0.052)

(0.059)

(0.117)

Observations

40 711

40 705

40 705

40 705

27 348

R2

0.715

0.731

0.732

0.644

0.731

Controls

None

Income

Full

Full

Full

OilPrice × OilDistrict × Private

–0.262***

–0.203*** –0.210***

Note: All columns include household and year × district and year × sector fixed effects. We control for household income in every specification from column 2 onwards. Household-level controls, included from column 3 onwards, include the number of household members, and the household head’s education and employment situation. Robust standard errors are clustered at the district level. *p < 0.1, **p < 0.05, ***p < 0.01.

ally for the number of household members, education and sector of employment of the household head. Again, the coefficient remains unaffected. In column 4 we change the functional form of the dependent variable by transforming reported satisfaction into a dummy, whereby 1 indicates that reported satisfaction is above or equal to 3.11 We also acknowledge that households may change their work status over time. Although 80 per cent of the households do not switch status during the period for which we observe them, the 20 per cent of households that change status may have specific characteristics. They may, for example, be recent migrants who came in while unemployed and then got a job in the oil sector, or historic employees of the oil sector who got laid off to be replaced by a recent migrant. We thus omit households who change work status in column 5, and results increase in magnitude. Thus, if anything, keeping sectoral switchers in our sample reduces our results in magnitude. Finally, our control groups may be imperfect, since they may end up being contaminated. However, we can see that the results are robust to different definitions of the control group, which we present in the three panels of Table 6.3. In our preferred specification, we keep the whole sample, as is shown in panel A. In panel B we compare individuals employed in

11 The dummy takes value 1 if the ordinal satisfaction variable takes value 3 or more; besides making economic sense, this cut-off maximizes the variance, as 51 per cent of the sample answers lie below 3 and 49 per cent answer 3 or more.

88  Handbook of sustainable politics and economics of natural resources the private sector only to public sector workers, while in panel C we compare individuals employed in the private sector to those who are employed by neither the private nor public sector (and whom we refer to as being unemployed, although they may have some informal employment). Our results do not appear to be sensitive to any of these choices.

4 DISCUSSION Beyond identifying a sizeable effect of the oil price on workers’ satisfaction with income in oil-rich districts, what could be the cause of this shift in satisfaction? In what follows, we discuss and rule out some typical channels before presenting the interpretation that appears to be the most consistent with the pattern of results. First, in line with Collier (2017), we might be concerned that nationals may be unsatisfied if they observe that the rents from resources benefit agents abroad rather than nationally. However, as Esanov and Kuralbayeva (2010) point out, since the beginning of the oil boom, the government has successfully undertaken a targeted approach in renegotiating previous arrangements to increase the government’s take of oil revenues and to reduce the outflow of capital. More technically, this channel should impact all nationals of Kazakhstan and is thus accounted for in our identification strategy, since we rely on variation from within the national borders of Kazakhstan. Second, as is documented by Caselli and Michaels (2013), an increase in local government expenditure driven by oil wealth may not necessarily be reflected in an increased quality of healthcare, education and infrastructure and may increase dissatisfaction at the local level. Alternatively, local inflation may be associated with resource booms, as has been famously argued by Corden and Neary (1982) and recently empirically documented (Harding et al., 2020). However, while both are valid concerns, we argue that these channels should be captured by our empirical specification, which exploits within-region variation over time by comparing satisfaction with income of private sector and non-private sector employees. Indeed, these two groups should be equally affected by inefficient public spending and local inflation. Third, unsatisfactory sector-level dynamics such as the deterioration of the manufacturing sector, may affect individuals’ satisfaction with income (Allcott and Keniston, 2017; Cust et al., 2019; Stefanski, 2016). However, as before, our triple-difference specification captures this by allowing us to account for sector-time fixed effects. Finally, we might also be concerned about an influx of migrants, which may be triggered by local resource booms (Allcott and Keniston, 2017; Beine et al., 2014). As long as this migration remains a regional concern it should be captured by the district-time fixed effect. However, there remains a possibility that one of the mentioned concerns might be more likely to affect private sector employees in the oil-rich districts. If oil-related households are more affected by that change, such as a migrant influx within their enterprise, we cannot rule out this mechanism as an alternative explanation for the drop in satisfaction with income. To address such district-sector and time-specific omitted variables concerns, we proceed to an additional exercise in which we exploit the exact timing of oil price changes. In Table 6.4 we present the relation between the timing of oil price changes and satisfaction. The results suggest that the exact timing of oil price changes appears to be quite important. We document that the negative variation in satisfaction is related to the current level of the oil price, while satisfaction with income remains unrelated to the leads and lags of the oil

Inflated expectations and commodity prices: evidence from Kazakhstan  89 Table 6.4

Satisfaction with income (leads and lags)

Dep. Var: Are You Satisfied with Your Income?

(1)

(2)

(3)

Lead OilPrice × OilDistrict × Private

–0.151**

 

0.112

 

(0.072)

 

(0.125)

OilPrice × OilDistrict × Private

 

 

–0.228*** (0.059)

Lagged OilPrice × OilDistrict × Private

 

–0.212***

–0.111

 

 

(0.073)

(0.113)

Observations

81 761

81 761

81 761

R2

0.724

0.725

0.725

Note: All columns include household and year × district and year × sector fixed effects and household-level controls (income, including the number of household members, and the household head’s education and employment sector). Lead OilPrice takes the oil price one year after the survey year (it could be seen as a placebo), Lagged OilPrice takes the oil price one year before the survey year (allowing us to check persistence). Robust standard errors are clustered at the district level. *p < 0.1, **p < 0.05, ***p < 0.01.

price (column 3 of Table 6.4). This suggests that our results can only be discredited if we can think of an omitted variable that changes at the sector-region level as quickly as the price of oil, while simultaneously affecting satisfaction with income. Thus, we argue that migration is unlikely to respond within a year to changes in the price of oil, since individuals, firms and regional governments often need up to a year to respond to changes in the price of oil.12 Thus, we argue that the main interpretation consistent with our results is that commodity price booms inflate expectations about one’s income and triggers frustration if the formed expectations are not met (Collier, 2017; Ross, 2012; Venables, 2016). This interpretation bridges our household-level results and Christensen’s (2019) suggestion, based on aggregated data, that discrepancies in perceptions are a driving force of conflictual responses to mining investments in Africa. This interpretation in terms of unmet expectations appears to us to be the most plausible driver varying at the district-sector level and affecting satisfaction with income in the same period as changes in the oil price, after accounting for the alternative mechanisms discussed in the empirical section.

5

CONCLUDING THOUGHTS

In this chapter, we document how an oil price boom affects satisfaction with household income. To do so, we take advantage of sector, location and time variations. We document that, conditional on individual and time fixed effects, individuals who are located in oil-poor districts and individuals who are employed outside the private sector in the oil-rich districts appear to be unaffected by changes in the price of oil. The picture changes if we turn to oil-related household heads who are employed in the private sector of an oil-rich district. Oil-related households experience a significant drop in satisfaction, which closely follows variations in the price of oil. Thus, we provide robust empirical evidence aligned with the idea that satisfaction with income is reported relative to a reference point: good news can trigger

12 Oil companies, for instance, typically need more than year to respond to changes in the price of oil by increasing drilling activity (Toews and Naumov, 2015).

90  Handbook of sustainable politics and economics of natural resources inflated expectations by shifting the reference point, which under certain circumstances may exceed changes observed in reality and thus lead to a drop in satisfaction. These results are in line with the news-shock literature (Arezki et al., 2017; Cust and Mensah, 2020; Cust and Mihalyi, 2017). Since oil production is fixed in the short run and the marginal cost of production is relatively small, workers in the private sector have close to perfect information about the profitability of the companies they are employed by in the short run. Our interpretation of the results is that observing the change in the oil price increases workers’ aspirations to benefit from the oil boom, and thus instantaneously decreases satisfaction with income. The fact that oil-related household heads are the only ones to express dissatisfaction may help to understand what happened in December 2011 when 17 people were killed during a labour conflict in Zhanaozen, a booming oil town in the west of Kazakhstan’s desert. This would prove to be the climax of a surge in labour conflicts in the 2000s accompanying the increase in the price of oil. From zero labour conflicts between 2002 and 2006, the year 2011 alone witnessed 18 conflicts (Figure 6.3). The intensity of these conflicts has also increased. Besides the 17 killed, 100 people were wounded in Zhanaozen in 2011. This was the most violent labour conflict ever recorded in Kazakhstan. The observation that dissatisfaction and labour conflicts not happen only during busts but also during booms echoes recent development in the labour conflicts literature. The traditional economic theory on labour conflicts suggests that workers go on strike due to asymmetric information (Cahuc, Carcillo and Zylberberg, 2014). Since the oil price is public knowledge, such an interpretation is hard to reconcile with a pattern of increasing conflicts as the oil price rises. Rather, our results offer evidence consistent with the argument made by Brunnschweiler, Jennings and MacKenzie (2014) on fairness concerns in labour conflicts with data from the UK.13 These results are all the more important to keep in mind since Kazakhstan was not the only country hit by labour conflicts in its extraction sector during the 2000s. The global number of labour conflicts in the resource sector actually follows a strikingly similar pattern as the development of conflicts in Kazakhstan. In Figure 6.3 we plot the conflicts in Kazakhstan14 and the number of worldwide conflicts.15 Conflict data is notoriously scarce and, in this specific case, the two datasets heavily differ in the sample they cover and in the method in which the data 13 The authors present a model in which fairness concerns play a role in the setting of wages in a negotiation between an employer and a union. 14 The data on labour conflicts contains information on date, location, sector and type of event. To collect the data, keyword searches have been used in major Kazakh newspapers. The search relies on 11 different media sources, most of which are Kazakhstani: Argumenty i fakty Kazakhstan, Ekspert Kazakhstan, express-k.kz, Ferghana.ru, Interfaks Kazakhstan, ITAR-TASS, Izvestiya Kazakhstan, Kazakhstanskaya Pravda, megapolis.kz, newsline.kz, RFE/RL. The seven keywords used are the Russian equivalent for: strike, lockout, hunger strike, rally, demonstration, trade union and picket. The searches for each keyword were conducted with their truncated versions to obtain all articles dealing with either strike or strikers or strikes, and so on. The coding was conducted with a focus on relations between organized labour and employers. The final data records 52 conflicts, 27 of which took place in an oil-rich district. The initial data was collected by Indra Overland for the period 2006–11. We extended the data to include the period between 2001 and 2005 following the same methodology using the maximum number of available sources. 15 Worldwide labour conflict information comes from the GDELT data from Google algorithms and includes a variety of countries. We plot a subset of conflicts selected according to two criteria from

Inflated expectations and commodity prices: evidence from Kazakhstan  91

Figure 6.3

Labour conflicts evolution

was collected. Acknowledging these caveats, the similarity in the pattern of evolution of both the Kazakh conflict data and the worldwide conflict data is even more striking.

ACKNOWLEDGEMENTS We would like to thank Indra Overland for sharing the data he has collected on labour conflicts in Kazakhstan. We would like to thank Christa Brunnschweiler, Paul Collier, Mathieu Couttenier, Jim Cust, Mikhail Drugov, Yelena Kalyzhnova, Martina Kirchberger, Karlygash Kuralbayeva, Jérémy Laurent-Lucchetti, Alexander Naumov, Peter Neary, Richard Pomfret, Simon Quinn, Dominique Rohner, Michael Ross, Lilia Shevchenko, Petros Sekeris, Rick van der Ploeg, Anthony Venables and Pierre-Louis Vézina as well as participants at AEL Conference 2013, CES workshop on Labour and Development, CSAE 2012, EEA Conference 2012, EUDN PhD Meeting 2012, OxCarre Seminar and Oxford BB seminar for useful comments. Support from the BP-funded Oxford Centre for the Analysis of Resource-Rich Economies (OxCarre) is gratefully acknowledged. This chapter supersedes OxCarre Research Paper 109, ‘Inflated expectations and natural resource booms: evidence from Kazakhstan’.

the GDELT data: (1) these conflicts involve civilians opposing a multinational company; and (2) the multinational company at stake is active in extractives.

92  Handbook of sustainable politics and economics of natural resources

REFERENCES Allcott, H. and D. Keniston (2017). ‘Dutch disease or agglomeration? The local economic effects of natural resource booms in modern America’. The Review of Economic Studies 85(2): 695–731. Aragón, F.M. and J.P. Rud (2013). ‘Natural resources and local communities: evidence from a Peruvian gold mine’. American Economic Journal: Economic Policy 5(2): 1–25. Aragón, F.M., J.P. Rud and G. Toews (2018). ‘Resource shocks, employment, and gender: evidence from the collapse of the UK coal industry’. Labour Economics 52: 54–67. Arezki, R., V.A. Ramey and L. Sheng (2017). ‘News shocks in open economies: evidence from giant oil discoveries’. The Quarterly Journal of Economics 132(1): 103–55. Asher, S. and P. Novosad (2018). ‘Rent-seeking and criminal politicians: evidence from mining booms’. Working paper. Bazillier, R. and V. Girard (2020). ‘The gold digger and the machine. Evidence on the distributive effect of the artisanal and industrial gold rushes in Burkina Faso’. Journal of Development Economics 143: 102411. Beine, M., S. Coulombe and W.N. Vermeulen (2014). ‘Dutch disease and the mitigation effect of migration: evidence from Canadian provinces’. The Economic Journal 125(589): 1574–615. Berman, N., M. Couttenier and V. Girard (2020). ‘Mineral resources and ethnic identity’. Mimeo. Berman, N., M. Couttenier, D. Rohner and M. Thoenig (2017). ‘This mine is mine! How minerals fuel conflicts in Africa’. American Economic Review 107(6): 1564–610. Brunnschweiler, C.N., C. Jennings and I.A. MacKenzie (2014). ‘A study of expressive choice and strikes’. European Journal of Political Economy 34: 111–25. Cahuc, P., S. Carcillo and A. Zylberberg (2014). Labour Economics. Cambridge, MA: MIT Press. Carley, S., T.P. Evans and D.M. Konisky (2018). ‘Adaptation, culture, and the energy transition in American coal country’. Energy Research & Social Science 37: 133–9. Caselli, F. and G. Michaels (2013). ‘Do oil windfalls improve living standards? Evidence from Brazil’. American Economic Journal: Applied Economics 5(1): 208–38. Christensen, D. (2019). ‘Concession stands: how mining investments incite protest in Africa’. International Organization 73(1): 65101. Collier, P. (2017). ‘The institutional and psychological foundations of natural resource policies’. The Journal of Development Studies 53(2): 217–28. Collier, P. and A. Hoeffler (2004). ‘Greed and grievance in civil war’. Oxford Economic Papers 56(4): 563–95. Corden, W.M. and J.P. Neary (1982). ‘Booming sector and de-industrialisation in a small open economy’. The Economic Journal 92(368): 825–48. Cust, J., T. Harding and P.-L. Vezina (2019). ‘Dutch disease resistance: evidence from Indonesian firms’. Journal of the Association of Environmental and Resource Economists 6(6): 1205–37. Cust, J. and J.T. Mensah (2020). ‘Natural resource discoveries, citizen expectations and decisions’. Mimeo. Cust, J. and D. Mihalyi (2017). Evidence for a Resource Curse? Oil Discoveries, Elevated Expectations, and Growth Disappointments. Washington, DC: World Bank. Cust, J. and S. Poelhekke (2015). ‘The local economic impacts of natural resource extraction’. Annual Review of Resource Economic 7(1): 251–68. Esanov, A. and K. Kuralbayeva (2010). Riccardian curse of the resource boom: the case of Kazakhstan 2000–2008. OxCarre Working Papers 043. Centre for the Analysis of Resource-Rich Economies, University of Oxford. Frey, B.S. (2008). Happiness: A Revolution in Economics. Cambridge, MA: MIT Press. Funke, M., M. Schularick and C. Trebesch (2016). ‘Going to extremes: politics after financial crises, 1870–2014’. European Economic Review 88(C): 227–60. Harding, T., R. Stefanski and G. Toews (2020). ‘Boom goes the price: giant resource discoveries and real exchange rate appreciation’. The Economic Journal 130(630): 1715–28. Hopkirk, P. (1992). The Great Game: The Struggle for Empire in Central. New York: Kondasana International. Kahneman, D. and A. Tversky (1979). ‘Prospect theory: an analysis of decision under risk’. Econometrica 47(2): 263–92.

Inflated expectations and commodity prices: evidence from Kazakhstan  93 Kaiser, M.J. and A.G. Pulsipher (2007). ‘A review of the oil and gas sector in Kazakhstan’. Energy Policy 35(2): 1300–314. Mas, A. (2006). ‘Pay, reference points, and police performance’. The Quarterly Journal of Economics 121(3): 783–821. Moretti, E. (2010). ‘Local labour markets’. Working Paper 15947. National Bureau of Economic Research. Munayshy Public Foundation (2005). Petroleum Encyclopedia of Kazakhstan. Pomfret, R. (2006). The Central Asian Economies Since Independence. Princeton, NJ: Princeton University Press. Rigterink, A.S. (2020). ‘Diamonds, rebel’s and farmer’s best friend: impact of variation in the price of a lootable, labour-intensive natural resource on the intensity of violent conflict’. Journal of Conflict Resolution 64(1): 90–126. Ross, M.L. (2007). ‘How mineral-rich states can reduce inequality’. In M. Humphreys, J.D. Sachs and J.E. Stiglitz (eds), Escaping the Resource Curse. New York: Columbia University Press, pp. 227–55. Ross, M.L. (2012). The Oil Curse: How Petroleum Wealth Shapes the Development of Nations. Princeton, NJ: Princeton University Press. Statistical Agency of the Republic of Kazakhstan (SARK) (2011). Website accessed 30 July 2021 at https://​stat​.gov​.kz/​. Stefanski, R.L. (2016). ‘Government size, misallocation and the resource curse’. In R. Caputo and R. Chang (eds), Commodity Prices and Macroeconomic Policy (Central Banking, Analysis, and Economic Policies, Vol. 22). Central Bank of Chile, pp. 197–244. Toews, G. and A. Naumov (2015). ‘The relationship between oil price and costs in the oil industry’. The Energy Journal 36: 237–54. Toews, G. and P.-L. Vezina (2017). ‘Resource discoveries and FDI bonanzas: an illustration from Mozambique’. OxCarre Working Papers 199. Oxford Centre for the Analysis of Resource-Rich Economies, University of Oxford. Vakulchuk, R. and I. Overland (2018). ‘Kazakhstan: civil society and natural resource policy in Kazakhstan’. In I. Overland (ed.), Public Brainpower: Civil Society and Natural Resource Management. Cham, Switzerland: Palgrave Macmillan, pp. 143–62. Vakulchuk, R. and I. Overland (2019). ‘China’s Belt and Road Initiative through the lens of Central Asia’. In F.M. Cheung and Y.-Y. Hong (eds), Regional Connection under the Belt and Road Initiative. The Prospects for Economic and Financial Cooperation. Abingdon, UK: Routledge, pp. 115–33. Venables, A.J. (2016). ‘Using natural resources for development: why has it proven so difficult?’ Journal of Economic Perspectives 30(1): 161–84.

PART II REGIONAL RESOURCE POLITICS AND IMPLICATIONS FOR GLOBAL POLICIES AND ECONOMIC DEVELOPMENT

7. Energy transition, resources and climate change investment policy in the EU1 Matthias Busse, Oliver Dreute, Vladimir Isaila and Lúcio Vinhas de Souza

1

INTRODUCTION: WHY THE GREEN DEAL?

Climate change has been increasingly seen as a threat to global prosperity. There are a number of studies with divergent estimates of the costs of climate change (e.g., Dietz et al., 2018), and they have been summarized by the Intergovernmental Panel on Climate Change (IPCC) Fifth Assessment Report: ‘estimates of the aggregate economic impact of climate change are relatively small but with a large downside risk’ (IPCC, 2014, p. 692). An increasing awareness among EU citizens of perceived climate change effects and costs has pushed policy makers to increasingly adopt measures to combat climate change. Specifically, 93 per cent of EU citizens see climate change as a serious problem and 92 per cent agree that the EU should adopt measures to make the EU economy climate neutral by 2050.2 The new European Commission that took office in November 2019 aimed to address such concerns with the Commission’s ‘Political Guidelines’, among which the European Green Deal features prominently.3 Building on the previous EU’s 2030 climate targets, the Green Deal seeks to make the EU economy climate neutral by 2050 and therefore abide by the Paris Agreement. To meet this global challenge, it is estimated that annual investments of $2.4 trillion are needed, representing 2.5 per cent of annual global gross domestic product (GDP).4 This sum should be compared with the estimated economic costs of climate change. A meta study of estimates concludes that ‘there are many studies of theoretical temperature increases in the 2 to 4°C range, and that they cluster in the range of a loss of 0 to 4 per cent of global output’ (see Nordhaus and Moffat, 2017, p. 13). Naturally, such an ambitious policy programme must be backed by adequate financing to fulfil its aims.

1 The views expressed are solely those of the authors and do not necessarily represent the official views of any organization the authors are linked to. 2 See https://​ec​.europa​.eu/​clima/​citizens/​support​_en, accessed 3 August 2021. 3 See more about the six priorities of the 2019–24 Commission at https://​ec​.europa​.eu/​info/​ sites/​default/​files/​political​-guidelines​-next​-commission​_en​_0​.pdf and more specifically regarding the European Green Deal at https://​eur​-lex​.europa​.eu/​resource​.html​?uri​=​cellar:​b828d165​-1c22​-11ea​-8c1f​ -01aa75ed71a1​.0002​.02/​DOC​_1​&​format​=​PDF, accessed 3 August 2021. 4 See https://​www​.ipcc​.ch/​sr15/​chapter/​spm/​, accessed 3 August 2021.

95

96  Handbook of sustainable politics and economics of natural resources 1.1

Maintaining Europe’s Global Climate Leadership

The EU is currently leading the global climate transition. Still among the largest producers of carbon emissions globally – with 8.7 per cent of the 2017 total, far behind China’s 28.3 per cent and not that dissimilar to India’s 6.6 per cent – the EU27 leads in the decarbonization of its economy among large developed economies, with a reduction of 61 per cent on total CO2 emissions between 1971 and 2017, compared with 53 per cent in the US and 36 per cent in Japan.5 However, at current rates of decarbonization, the US will significantly close the gap with the EU by 2050 mainly due to the adoption of shale gas replacing coal, while increasingly adopting renewable energies. Similarly, China’s recent investments in renewable technologies and move towards a service economy have increasingly decoupled China’s traditionally carbon-based manufacturing base from economic growth (Figure 7.1).

Note: Source:

For data availability reasons, EU figures represent EU28. International Energy Agency.

Figure 7.1 1.2

CO2 emissions (tonnes) per capita (left). CO2 emissions (tonnes) per unit of GDP (right)

Where we stand – the EU’s energy mix and dependency

The EU member states (MS) have already made great efforts to adopt renewables as part of their energy mix. They have boosted their share of renewable energy in gross consumption from 6.4 per cent in 2000 to 15 per cent on average by 2018, due to ambitious energy and climate policies. However, their energy mix and production remain extremely heterogeneous, with many MS maintaining high dependency rates on fossil fuel imports, of which Russia and Norway make up the bulk of source countries (Figure 7.2) (Overland, 2019). While EU MS domestic energy production boasts significant and growing shares of renewable energy production, with an EU average of 31 per cent, the dependency on fossil fuel imports for most MS, especially in the transport sector, pose a challenge in achieving climate neutrality.

5 Between the peak US CO2 emissions in 2000 and the last data available for 2017, the US impressively reduced its CO2 emissions by 30 per cent more than the whole EU27 reduction from its 1979 peak, and by more than the total 2017 combined emissions of Brazil and Saudi Arabia.

Energy transition, resources and climate change investment policy in the EU  97

Source: Eurostat.

Figure 7.2

Energy dependency ratio: total primary domestic production as % of total energy supply

Note: Ordered by rate of import dependency as in Figure 7.2. Source: Eurostat.

Figure 7.3

Primary production and total energy supply, by MS and type of energy source, 2018, % share of total

Figure 7.3 makes clear the difficult situation most MS are in. While domestic primary production of energy has high shares of renewables – albeit with high variability among MS – when looking at total energy supply we can see that EU MS for the most part remain extremely dependent on non-renewable sources of energy, mostly oil and gas.

2

WHAT IS THE GREEN DEAL?

The Green Deal is a comprehensive agenda that aims to make the EU climate neutral by 2050. It sets ambitious targets with policy objectives targeting energy, infrastructure, industry

98  Handbook of sustainable politics and economics of natural resources and mobility, which are to be met under a policy umbrella that encompasses the European industrial strategy, Circular Economy Action Plan and the ‘Farm to Fork’ strategy, and financed through the European Green Deal investment plan and via developing green finance frameworks.6 This, however, will imply additional costs to EU business and regions, and risk eroding the international competitiveness of EU economic operators. Those challenges are to be met with an EU compensatory financial mechanism (the Just Transition Fund’) and by a Carbon Border Adjustment Mechanism.7 2.1

Financing the Green Deal

Europe’s transition to a sustainable economy will require very significant investment efforts across all sectors. Reaching the 2030 climate and energy targets alone will require an estimated additional investment of €260 billion per year until 2030. To deal with that, the European Commission has proposed the European Green Deal Investment Plan. This plan aims at the mobilization of public investment and aims to unlock private funds through EU financial instruments, leading to at least €1 trillion of investments over the next decade.8 While all EU MS, regions and sectors will need to contribute to the Green Deal, the proposals regarding financing the Green Deal recognize that some regions will have to undergo a profound economic and social transformation. A Just Transition Mechanism will provide tailored financial and practical support to generate the necessary investments in those areas by making public and private investments more attractive. This package of financial and practical support comprises €100 billion from 2021 to 2027.

6 The global COVID-19 pandemic that hit the world in early 2020 led to significant changes in the resources available and implementation strategy and tools for the EU Green Deal. The most relevant change is the Next Generation EU (NGEU) €750 billion package, agreed jointly with the 2021–27 multiannual financial framework (MFF) in December 2020: the NGEU is an EU-level set of financial instruments for both supporting the immediate recovery from the pandemic-related economic crisis and for a substantial change in the EU long-term growth model. Its core is the Recovery and Resilience Facility, which will make €672.5 billion available (respectively, €312.5 billion in grants and €360 billion in loans) for MS via the submission of national Recovery and Resilience Plans. These plans are to include a combination of short- and long-term investments and reforms, centred on two main axis – 37 per cent of the funds are to be used for green investments and reforms and 20 per cent for digital investments and reforms. Funds will be disbursed from mid-2021 onwards. See more at https://​ec​.europa​.eu/​commission/​ presscorner/​detail/​en/​ip​_20​_2397, accessed 3 August 2021. 7 There are still several unclarified questions about how such a mechanism would be designed, from its sheer technical and practical aspects to its overall compatibility with the EU’s global legal commitments, notably with World Trade Organization (WTO) rules. See, for example, Kortum and Weisbach (2017) and Rocchi et al. (2018). The Commission will assess pathways forward for the Carbon Border Adjustment Mechanism and propose a design based on ongoing impact assessments, external studies and public consultations throughout 2020. See https://​ec​.europa​.eu/​taxation​_customs/​commission​-priorities​ -2019​-24/​european​-green​-deal​-what​-role​-can​-taxation​-play​_en​#heading​_2, accessed 3 August 2021. 8 Many of the financial frameworks linked to the Green Deal build upon the EU’s experience with the European Fund for Strategic Investments (EFSI), popularly known as the ‘Juncker Fund’. See https://​ec​.europa​.eu/​commission/​priorities/​jobs​-growth​-and​-investment/​investment​-plan​-europe​-juncker​ -plan/​european​-fund​-strategic​-investments​-efsi​_en, accessed 3 August 2021.

Energy transition, resources and climate change investment policy in the EU  99 2.2

European Green Deal Investment Plan

The European Green Deal Investment Plan (EGDIP), also referred to as the Sustainable Europe Investment Plan (SEIP), is the investment pillar of the Green Deal. It consists of three elements: ● Financing: mobilizing at least €1 trillion of sustainable investments over the next decade. A greater share of spending on climate and environmental action from the EU budget than ever before will be used to crowd-in private funding, with a key role to be played by the European Investment Bank (EIB). ● Enabling: providing incentives to unlock and redirect public and private investment. The EU will provide tools for investors by putting sustainable finance at the heart of the financial system. It will also make sustainable investment by public authorities easier by encouraging green budgeting and procurement and look at state aid procedures to make approval easier in ‘just transition’ regions. ● Practical support: the Commission will provide support to public administrations and project promoters in identifying, structuring and executing sustainable projects. 2.3

Just Transition Mechanism

The EU has prepared previous cost–benefit analysis of its climate policies9 and others are under preparation for key pillars of the Green Deal (e.g., the so-called ‘Fit for 55’ package due in July 2021). It is clear from these analyses that some regions and sectors will be disproportionately and negatively affected. The Just Transition Mechanism will be a key tool to provide targeted support to help mobilize at least €100 billion over the period 2021–27 for the most affected regions to alleviate the socio-economic impact of the transition. In particular, the mechanism will finance help for workers and communities, which rely on jobs in the fossil fuel value chain. The mechanism will consist of three main sources of financing: ● A Just Transition Fund, which will receive €17.5 billion of EU funds.10 To tap into their share of the fund, MS will have to identify the eligible territories through dedicated territorial ‘just transition’ plans. They will also have to commit to match each euro from the Just Transition Fund with a minimum of €1.5 and a maximum of €3 from the European Regional Development Fund and the European Social Fund Plus, two lines of EU budget funds directed to the EU MS. This funding from the EU budget will have to be complemented by national co-financing according to the EU’s Cohesion Policy rules. Taken together, the funding is expected to reach between €30 and €50 billion over the period 2021–27. ● A dedicated Just Transition Scheme under InvestEU – a new integrated investment programme in the new EU budget – to mobilize up to €45 billion of investments based on an EU financial guarantee. The scheme will seek to attract private investments, including in sustainable energy and transport, which benefit those regions and help their economies find 9 See, for instance, ‘A Clean Planet for all: A European strategic long-term vision for a prosperous, modern, competitive and climate neutral economy’, COM(2018) 773 final. 10 See https://​ec​.europa​.eu/​commission/​presscorner/​detail/​en/​IP​_20​_2354, accessed 3 August 2021.

100  Handbook of sustainable politics and economics of natural resources new sources of growth. It will operate according to the principles that define InvestEU, whereby a portion of the financing under InvestEU will be focused on the ‘just transition’ objectives. The target of generating up to €45 billion of investments corresponds to a provisioning of around €1.8 billion from the EU budget from the InvestEU programme. ● A public sector loan facility with the EIB backed by the EU budget to mobilize €25–30 billion of investments. This facility will be used for concessional loans to the public sector – for example, for investments in energy and transport infrastructure, district heating networks and renovation or insulation of buildings. The loan facility will rely on a contribution of €1.5 billion from the EU budget and an EIB lending of €10 billion at its own risk. ● Supplementary to the Just Transition Mechanism, a dedicated Just Transition Platform will also provide technical assistance to MS and investors to make sure the affected communities, local authorities, social partners and non-governmental organizations are all involved. 2.4

How It Will Be Financed

The intended €1 trillion funding for the European Green Deal Investment Plan will be partly financed from the EU budget, known as a multiannual financial framework, or MFF. The next long-term EU budget – adopted by the European Council on December 2020 – will run for seven years from 2021 to 2027.11 Already in 2018, the Commission proposed that 25 per cent of the total amount of the MFF would contribute to climate action and spending on the environment across multiple programmes (‘climate mainstreaming’), and the final political agreement in late 2020 increased this overall climate target to 30 per cent of the EU 2021–27 budget and the NGEU.12 Taken together and extrapolated from seven to ten years, as well as assuming that the climate target will be at least maintained after the end of the next MFF in 2027, the EU budget will provide €503 billion to the European Green Deal Investment Plan. This is expected to trigger additional national co-financing of around €114 billion over these ten years on climate and environment projects.13 InvestEU, a programme that was proposed in June 2018 as part of the MFF 2021–27 proposal, is part of, and complementary to, the European Green Deal Investment Plan. InvestEU will dedicate at least 30 per cent of mobilized investments to climate- and environment-related projects. It also contributes to the Just Transition Mechanism with a new dedicated InvestEU scheme to mobilize €45 billion of sustainable investments in the regions most affected by the transition challenges. Thus, InvestEU is expected to leverage around €279 billion of private and public climate- and environment-related investments over the period 2021–30. To achieve that, it will provide an EU budget guarantee to allow the EIB Group and other implementing partners to invest in more and higher-risk projects, crowding in private investors. In combination with the EIB’s intention to double its climate target, this means a total of €1 trillion in EIB investments (under the EU mandate and using EIB’s own funds) over the next decade.

11 See https://​www​.consilium​.europa​.eu/​en/​press/​press​-releases/​2020/​12/​17/​multiannual​-financ ial-framework-for-2021-2027-adopted/, accessed 3 August 2021. 12 The European Council approved the MFF-NGEU agreement on 11 December 2020, after which the European Parliament gave its consent on 17 December 2020. 13 For the source of those figures, please see https://​ec​.europa​.eu/​commission/​presscorner/​detail/​ en/​qanda​_20​_24, accessed 3 August 2021. These figures do not include the NGEU amounts linked to green investment mentioned in footnote 6 above.

Energy transition, resources and climate change investment policy in the EU  101 Additionally, the Just Transition Mechanism aims at mobilizing at least €100 billion of investments over 2021–27 with financing coming from the EU budget, co-financing from MS and contributions from InvestEU and the EIB. Extrapolated over ten years, the Just Transition Mechanism is expected to mobilize around €143 billion. The Just Transition Fund, being part of the Just Transition Mechanism, will be equipped with fresh funds of €7.5 billion from the EU budget. Finally, a proposed Innovation Fund and a Modernization Fund, both of which are not part of the EU budget but are to be financed by a part of the revenues from the auctioning of carbon allowances under the revamped EU Emissions Trading System, is expected to provide some €25 billion between 2020 and 2030 for the EU transition to climate neutrality. 2.5

EU Taxonomy to Verify Sustainability of Investments

Finally, the achievement of the EU’s ambitious climate targets is to be supported by an enhanced robust reporting and monitoring system, building on specific methodologies deployed under relevant existing programmes. An EU taxonomy for sustainable investment will provide the private sector with a common definition of ‘green investment’, setting the basis for establishing an EU-wide classification system for ‘environmentally sustainable’ economic activities. The Taxonomy Regulation was published on 22 June 2020 and entered into force on 12 July 2020, and a first delegated act on sustainable activities for climate change adaptation and mitigation objectives was published on 21 April 2021 (a second delegated act for the remaining objectives is to be published in 2022). The EU taxonomy will feed into the InvestEU climate tracking methodology that will be used by the InvestEU ‘implementing partners’. The European Commission is also to explore how the EU taxonomy can be used in the context of the European Green Deal by the public sector, beyond the investment activities linked to the InvestEU.

3

MEMBER STATES’ EXPERIENCES – HETEROGENEITY OF ENERGY SOLUTIONS

Achieving the targets set out in the European Green Deal will need to rely on a ‘whole of government’ approach with significant buy-in from MS. If not tackled holistically, the EU risks losing further competitiveness globally and posing a greater burden on EU citizens while not meeting the ambitious targets. For example, energy costs in the EU are already some of the highest in the developed world, negatively impacting businesses and household income (Figure 7.4).14 A comprehensive but flexible policy framework must be at the core of the transition, with compensatory mechanisms like the Just Transition Fund for those regions that remain dependent on fossil fuel. Given the heterogeneity of MS energy production, grids, natural endowment, geographical location and economic endowments, flexibility in the application of the framework will be key. As we can see from the country case studies (Boxes 7.1–7.3), there are considerable differences in the energy and climate strategies and goals of MS, making 14 The implementation of additional EU policies would by design likely increase these costs further: see, for instance, Panos and Densing (2019).

102  Handbook of sustainable politics and economics of natural resources

Source:

International Energy Agency.

Figure 7.4

US dollars/kilowatt hour

a one-size-fits-all policy framework unworkable, overly complex and risking lack of MS buy-in.

BOX 7.1 GERMANY Over the past decade, Germany has set a set of ambitious environmental targets and implemented new initiatives to work towards a less carbon-intensive economy. In 2000, the German government introduced new renewable energy legislation to foster its expansion, while at the same time announcing the gradual exit from nuclear energy. In 2018 around one-third of energy production in Germany stemmed from renewable energy sources (Figure 7.5).

Source: Eurostat.

Figure 7.5

Germany’s primary energy production (%)

These efforts towards low-carbon energy production are encapsulated in the so-called

Energy transition, resources and climate change investment policy in the EU  103 ‘Energiewende’, the German term for its energy transition plans. The four main targets for the Energiewende are:15 • Renewable energy to make up 40–45 per cent of German energy consumption by 2025. • Today, 43 per cent of gross energy consumption already stems from renewables. • Deactivation of the remaining nuclear power plants by 2022. • Six power plants are still active as of 2020.16 • A 55 per cent reduction in carbon emissions by 2030 compared to 1990. • A 35 per cent reduction has been achieved so far. • A 50 per cent reduction in primary energy consumption by 2050 compared to 2008. • A 12 per cent reduction has been achieved so far, compared to 1990. These measures are flanked by additional efforts – for example, expansion of rail transport,17 investment in electro mobility, introduction of an emissions trading system (ETS) for the transport and heating sectors,18 and funding for green financing,19 among others. The German government expects the energy transition to entail costs of around €550 billion to be spent by 2050 – foremost on modernizing building insulation, renewable energy production, energy storage capacities and the upgrade of the energy grid.20 However, other studies have come to a higher cost estimate of €520 billion by 2025.21

BOX 7.2 POLAND Poland’s energy strategy, most recently outlined in its ‘Energy Policy of Poland until 2040’ paper highlights the unique and complex situation of Poland. The objectives of the strategy are to achieve energy security (with a strong component on domestic production, diversification and reduction of dependency – especially on Russian sources), ensure competitiveness and energy efficiency and the reduction of the energy sector’s environmental impact. The strategy outlines the following indicators in the 2040 energy strategy:22 • A 60 per cent share of coal in the generation of electricity by 2030. 15 See https://​www​.bmwi​.de/​Redaktion/​DE/​Dossier/​energiewende​.html, accessed 3 August 2021. 16 See https://​www​.bmu​.de/​themen/​atomenergie​-strahlenschutz/​nukleare​-sicherheit/​aufsicht​-ueb er-kernkraftwerke/kernkraftwerke-in-deutschland/, accessed 3 August 2021. 17 See https://​www​.umweltbundesamt​.de/​publikationen/​schienennetz​-2025​-2030, accessed 3 August 2021. 18 See https://​www​.klima​-kreislaufwirtschaft​.de/​fileadmin/​user​_upload/​2019​-09​-20​-klimaschu tzprogramm-data.pdf, accessed 3 August 2021. 19 See https://​www​.bundesregierung​.de/​breg​-de/​aktuelles/​faq​-gruenerklimafonds​-1686006, accessed 3 August 2021. 20 See https://​www​.bundesregierung​.de/​breg​-de/​themen/​energiewende/​was​-bringt​-was​-kostet​ -die​-energiewende​-394146, accessed 3 August 2021. 21 See https://​www​.insm​.de/​insm/​presse/​pressemeldungen/​pressemeldung​-studie​-eeg, accessed 3 August 2021. 22 See https://​www​.gov​.pl/​attachment/​376a6254​-2b6d​-4406​-a3a5​-a0435d18be0f, accessed 3 August 2021.

104  Handbook of sustainable politics and economics of natural resources • • • •

A 21 per cent renewables in gross final energy consumption by 2030. Introduction of nuclear energy by 2033. Improvement in energy efficiency by 23 per cent by 2030 relative to 2007. Reduction of CO2 emissions by 30 per cent relative to 1990 (compared with the 11.5 per cent fall between 1990 and 2017).

Source: Eurostat.

Figure 7.6

Poland’s primary energy production (%)

Poland’s dependency on coal (Figure 7.6) will make it very difficult for the Polish economy to decarbonize and fulfil the EU’s climate agenda. Large investments are required in renewables as well as in upgrading existing grids and diversifying the energy mix further.

BOX 7.3 PORTUGAL The Portuguese National Energy Strategy is fully in line with the goal of achieving climate neutrality by 2050 and abiding by the EU’s climate policy. The main pillars of the Portuguese energy and climate strategy are:23 • Energy transition based on the complete decarbonization of electricity production, focusing on domestic electricity production from renewables. • Considerable focus on energy efficiency in all sectors of activity. • Full decarbonization of the road and rail transport sectors. • The creation and maintenance of carbon sinks, particularly forests.

23 See https://​ec​.europa​.eu/​energy/​sites/​ener/​files/​documents/​ec​_courtesy​_translation​_pt​_necp​ .pdf, accessed 3 August 2021.

Energy transition, resources and climate change investment policy in the EU  105

Source: Eurostat.

Figure 7.7

Portugal’s primary energy production (%)

However, while 98 per cent of Portugal’s domestic primary energy production is from renewables (Figure 7.7), this only accounts for 27 per cent of total energy supply for the country. The remaining energy demands are fulfilled by imports of oil, gas and coal.

4 CONCLUSION The Green Transition file is a key one among EU policies and, as such, experiences constant new developments, from political, policy and institutional points of view (examples of this are the proposal for new targets for 2030,24 the role of the National Energy and Climate Plans,25 in driving changes at national level, and the role of the Next Generation EU and in particular the Recovery and Resilience Plans in steering ‘green’ reforms and investments). This is because tackling the perceived costs of climate change while maintaining Europe’s competitiveness is a key challenge for the future of the EU. Given the heterogeneity of EU MS’ energy strategies and most MS continued dependency on fossil fuel imports, any EU framework will necessitate great flexibility in approaches and will require considerable stakeholder buy-in and investment. Indeed, financing the transition is a key challenge, with very great pressures on investments if the EU and its MS are to meet this challenge. 24 See ‘Stepping up Europe’s 2030 climate ambition: Investing in a climate-neutral future for the benefit of our people’, COM(2020) 562 final. 25 See at https://​ec​.europa​.eu/​energy/​topics/​energy​-strategy/​national​-energy​-climate​-plans​_en, accessed 3 August 2021.

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REFERENCES Dietz, S., Bowen, A. and Doda, B. et al. (2018), ‘The economics of 1.5°C climate change’, Annual Review of Environment and Resources 43, 455–80. Intergovernmental Panel on Climate Change (IPCC) (2014), AR5 Climate Change 2014: Impacts, Adaptation, and Vulnerability, Cambridge UK: Cambridge University Press. Kortum, S. and Weisbach, D. (2017), ‘The design of border adjustments for carbon prices’, National Tax Journal, 70 (2), 421–46. Nordhaus, W. and Moffat, A. (2017), ‘A survey of global impacts of climate change: replication, survey methods, and a statistical analysis’, NBER Working Paper No. 23646, National Bureau of Economic Research. Overland, I. (2019), ‘EU climate and energy policy: new challenges for old energy suppliers’, in J. Godzimirski (ed.), New Political Economy of Energy in Europe Power to Project, Power to Adapt, Cham, Switzerland: Springer/Palgrave Macmillan, pp. 73–102. Panos, E. and Densing, M. (2019), ‘The future developments of the electricity prices in view of the implementation of the Paris Agreements: will the current trends prevail, or a reversal is ahead?’, Energy Economics 84, 104476. Rocchi, P., Serrano, M., Roca, J. and Arto, I. (2018), ‘Border carbon adjustments based on avoided emissions: addressing the challenge of its design’, Ecological Economics 145, 126–36.

8. Climate change policies and resource abundance: the case of Russia Igor Makarov

1 INTRODUCTION Russia’s share in global greenhouse gas (GHG) emissions is less than 5 percent (Climate Watch, 2018), but the scale and the structure of the Russian economy make its role in coping with global climate change more significant than that. It was Russia’s ratification of the Kyoto Protocol that allowed the agreement to enter into force in 2005. Since 1990, Russia has achieved the largest absolute reduction of GHG emissions among all the countries (ibid.), primarily due to the deep post-Soviet crisis. Now Russia has one of the most climate-unfriendly export specializations in the world. It is the world’s largest exporter of fossil fuels and one of the major suppliers of diverse energy-intensive industrial goods. The weakness of the Russian economy is that it is very energy inefficient. But the weakness may turn into opportunity – namely, the correspondingly enormous potential for cheap emissions reduction. Due to its heavy dependence on fossil fuels, Russia looks at GHG emissions reduction from the perspective of risks for its national economy, rather than from the perspective of climate change mitigation. Climate policy in the country has always been, and continues to be, determined by exogenous factors, primarily coming from international developments. Contrary to the other leading economies, where a domestic climate agenda creates the background for international commitments, in Russia it is the participation in international agreements that drives the development of national climate policy. The objective of this chapter is to reveal the major factors that determine the development of Russian climate policy in the past, present and future. The chapter shows that the low level of ambition for emissions reduction cannot be explained by the preferences of specific decision-makers but have structural reasons and should be analyzed in the broader context of Russia’s history, economic specialization and position in the international system. The structure of the chapter is as follows. The next section describes the dynamics of Russian emissions. Section 3 provides an overview of Russia’s participation in international climate agreements. Section 4 summarizes the domestic climate policy of the country. Section 5 reveals major factors that explain the passivity of this policy. Section 6 discusses the potential drivers for making Russian climate policy more ambitious. Section 7 contains final conclusions.

2

DYNAMICS OF GHG EMISSIONS

Among national economies, Russia is the world’s fourth largest emitter after China, the US and India. If considering land use, land-use change and forestry (LULUCF), it is also behind Brazil and Indonesia (Climate Watch, 2018). Since the collapse of the Soviet Union, the 107

108  Handbook of sustainable politics and economics of natural resources development of the Russian economy may be divided into three periods, with corresponding distinctions in the dynamics of emissions, as illustrated in Figure 8.1. The first period refers to the 1990s when Russia experienced a deep transitional crisis, with GDP dropping by 42.6 percent between 1990 and 1998 (World Bank, 2020). GHG emissions fell in line with industrial output – by 41.0 percent (without LULUCF). The second period refers to the recovery that started in 1999. It did not bring a significant rise in emissions as it was accompanied by economic restructuring: the carbon-intensive industries that dominated in the Soviet economy were replaced by the service sector. As a result, by 2012, the volume of emissions (without LULUCF) was 32.6 percent lower than the 1990 level (United Nations Framework Convention on Climate Change [UNFCCC], 2020). The second period ended with the global economic crisis of 2008–09, which led to a painful 8 percent drop in GDP. After a quick recovery, Russia has been facing stagnation, with average rates of economic growth equal to 1.6 percent from 2011 to 2018. For this period, Russian emissions have plateaued. It is the dynamics of GDP that determined the dynamics of Russia’s emissions during the first and the third periods: carbon intensity of the economy was almost constant. In the second period, the restructuring of the economy was the major determinant of the emissions trajectory: it made possible significant decoupling of GDP and emissions trajectories.

Sources: UNFCCC (2020); World Bank (2020).

Figure 8.1

GHG emissions (Mt, left axis) and GDP (2010 US$ billions, right axis) in Russia in 1990–2017

In the case of Russia, it is important to make the distinction between emissions with and without LULUCF. While the latter decreased by 32.3 percent in 1990–2017, the former fell even more dramatically – by 49.3 percent (UNFCCC, 2020). This difference appeared in the 1990s because of the collapse of commercial logging, with a four-fold decrease in the area being logged (Zamolodchikov et al., 2013). Even the rising frequency of forest fires over recent decades could not compensate for this effect. However, the difference between GHG levels with and without LULUCF will narrow and vanish completely in a couple of decades, due to the aging of Russian forests (ibid.).

Climate change policies and resource abundance: the case of Russia  109

3

RUSSIA AND THE INTERNATIONAL CLIMATE CHANGE REGIME

Russia has been a part of the international climate regime since its very beginning. It participated actively in developing both the UNFCCC and the Kyoto Protocol, obtaining status as an Annex I country. After the collapse of the Soviet Union, Russia considered these accords (as well as the set of other environmental treaties) as one of the means towards full-scale integration into the international community and strengthening cooperation with the West (Makarov, 2016). During negotiations, Russia insisted on recognition of its tight economic situation and appealed to the fact that any strict commitments would not let the country restore its pre-crisis level of economic development. As a result, Russia succeeded in achieving highly profitable conditions: its commitment under the Kyoto Protocol is not to exceed the emissions level of 1990 by the year 2012. Given the sharp emissions decline due to the transition crisis, it implied the opportunity not only to increase emissions significantly compared to the existing level when the Kyoto Agreement was signed but also to sell the excessive emissions quotas. Such conditions were attained to a considerable extent with the support of the US, which was planning to fulfill its own commitments either through implementation of emissions reduction projects in Russia or direct purchase of its quotas (Andonova and Alexieva, 2012). The situation changed dramatically in 2001 when the US refused to ratify the Kyoto Protocol. On the one hand, it meant that Russia had lost the opportunity to sell most of its excessive quotas; on the other hand, it gave Russia the key role in the fate of the agreement. The countries that had ratified the Kyoto Protocol accounted for just over 44 percent of all emissions at that time, and it was necessary to reach a level of 55 percent for its entry into force. Without the US, Russia remained the only country that could close this gap (Buchner and Dall’Olio, 2004). Heated debates began in the country on whether it should ratify the Kyoto Protocol. Alongside adherents of the ratification, there were many opponents to this idea – including lobbyists from the energy sector, several high-ranking politicians and even some scientists. First, they insisted on the idea that the anthropogenic character of climate change has not been proved. Second, they assumed that accession to the Protocol would be an obstacle for economic development – specifically, it would undermine plans to double GDP by the year 2010, which had been declared by President Putin in 2004 (Makarov, 2016). At the same time, the status of arbiter of fate of the Protocol gave Russia a strong leverage in relations with foreign partners, especially the EU, which was the main initiator of the agreement. It was a foreign policy argument that had played a key role in the ratification. Vladimir Putin finally tilted in its favor only after Russia had received EU concessions in negotiations on joining the World Trade Organization (WTO); many experts saw these concessions as the price that the EU paid for Russia’s ratification of the Kyoto Protocol (Buchner and Dall’Olio, 2004; Charap and Safonov, 2010; Korppoo and Vatansever, 2012; Makarov, 2016). It is also important to note that this deal was not too effective for Russia: the country finally joined the World Trade Organization eight years later. However, even without the geopolitical benefits, the Kyoto Protocol did not bring Russia any significant opportunities. Due to over-fulfilling its commitments, it received the world’s largest reserve of unused quotas – 6 billion tons of carbon dioxide equivalent (CO2e), which could be sold or used to attract foreign investment through joint implementation projects.

110  Handbook of sustainable politics and economics of natural resources These projects brought Russian companies about $600 million. This sum could have been much larger, had the scheme for registering and selecting Kyoto projects been created earlier and organized in a more effective manner (Makarov and Stepanov, 2019). Though Russia became one of the major beneficiaries of the Kyoto Protocol, it refused to make any commitments to reduce GHG emissions in its second period. The Russian delegation at COP18 in Doha in 2012 explained that Russia was unsatisfied with the current format of international cooperation on climate change – in particular, with the fact that the leading emerging economies were not included in Annex I, while the US had not joined the agreement at all. At the same time, Russia declared its readiness to participate in the new climate agreement that was to be finalized by 2015 (Grigoryev, Makarov and Salmina, 2013). As the dynamic of emissions by that time was completely determined by emerging economies, Russia’s argument seemed rational. What was worse, by that time Russia had lost any consistent position within climate change negotiations. Declared aims have been constantly changing. For example, in 2009, President Dmitri Medvedev said that by 2020 Russia would be emitting 10–15 percent less than in 1990 (which implies emissions growth by 30–35 percent compared to the existing level). Later, this target was revised towards strengthening (at COP15 in Copenhagen in 2009, reductions by 20–25 percent compared to the 1990 level were announced), and afterwards towards easing again (in February 2010, emissions were set to be reduced by 15–25 percent) (Charap and Safonov, 2010; Makarov, 2016). At international negotiations, Russia constantly appealed to an argument that the country had succeeded in reducing emissions dramatically compared to 1990 levels, omitting the fact that this had been achieved primarily due to the economic crisis and not as a result of consistent climate policy. Such a position, along with the targets that could have been reached (in whatever way) without additional effort, show the absence of any ambition to reduce emissions (Kokorin and Korppoo, 2013). A similar lack of consistency marked Russia’s participation in negotiations on the new agreement that was finally adopted in Paris in 2015. On the one hand, Russia demonstrated its readiness to become an active part of the new climate regime. In light of the sharp deterioration of Russia–West relations after the annexation of Crimea, climate change was considered to be one major area where cooperation with the western world was possible and desirable. President Putin unexpectedly raised a climate change issue on the sidelines of the UN General Assembly in 2015. In November 2015, he confirmed Russia’s good intentions once again in his speech at COP21 in Paris (Makarov, 2016). On the other hand, formal targets provided by Russia within the framework of nationally determined contributions (NDCs) were hardly consistent with this positive rhetoric. The intended nationally determined contribution (INDC) submitted in April 2015 set Russia’s emissions target for 2030 at the level of 70–75 percent of the 1990 level ‘subject to the maximum possible account of absorbing capacity of forests’ (INDC, 2015). The statement about forests is vague and may be interpreted in different ways. Even without taking this into consideration, and even at its lower end, Russia’s INDC is lower than the business-as-usual scenario and is highly likely to be fulfilled with no additional effort (Climate Action Tracker, 2020; Makarov, Chen and Paltsev, 2020). It is interesting that Russia’s INDC submission was submitted on 1 April, half a year before the COP. In Paris, Vladimir Putin talked about a level of 70 percent and not 70–75 percent, and final NDC submitted in 2021 also contained the target 70 percent.

Climate change policies and resource abundance: the case of Russia  111 Although fulfilling the Russian NDC even in the current version does not require any additional effort, business and political elites of the country have expressed concerns regarding the potential implications of the Paris Agreement for the Russian economy. As a result, although Russia signed the Agreement in 2016, it decided not to ratify it immediately, preferring to wait for implementation guidelines, which should be elaborated at future COPs, and to estimate first all the potential economic impacts. Russia formally joined the Paris Agreement in September 2019, the last among all the major emitters to do so.

4

DOMESTIC CLIMATE POLICY

Domestic climate policy in Russia has always been considered the continuation of the country’s participation in international negotiations. Russia ratified the Kyoto Protocol in 2004, the first legal document devoted to climate change. Nevertheless, Russia’s Climate Doctrine was passed only in 2009. It recognized the high importance of climate change and its anthropogenic character; it also described the general principles of the Russian climate policy (President of the Russian Federation, 2009). With no details on how climate policy in Russia should be organized, the Doctrine was a very declarative document that could, however, be considered the necessary first step in the development of national climate policy. The plan of implementation of the Doctrine could have been more concrete. However, it consisted primarily of general recommendations to the ministries and state agencies, did not provide any specific targets, and did not suggest any specific funding for implementation (Grigoryev et al., 2013). The Climate Doctrine has not played any significant role in Russian climate policy. It was passed right before COP15 in Copenhagen and became a shining illustration of what Kokorin and Korppoo (2013) call ‘window dressing’ – a policy with the major purpose of demonstrating the country’s efforts to foreign partners, rather than to start any decisive climate actions domestically. The next policy of such a type was the Presidential Decree of 2013 on GHG emissions reduction. It was signed soon after COP18 in Doha, where the Russian delegation refused to make commitments for the second Kyoto period and promised to define Russia’s domestic targets instead. According to the Decree, national GHG emissions should not exceed 75 percent of the 1990 level by 2020 (President of the Russian Federation, 2013). The decree did not specify whether this target referred to emissions with or without LULUCF, but in any case, it suggested the opportunity to increase emissions significantly compared to the existing level. Given that the Russian economy had started to slow down, it was highly likely even in 2013 that the target would be fulfilled without any additional effort (Korppoo and Kokorin, 2017). The next set of domestic climate policies was initiated after COP21 in Paris. The preparation plan for the ratification of the Paris Agreement was passed in 2016. It supposes the adoption of a national plan for adaptation to climate change, a long-term strategy of low-carbon economic development, and a national scheme of GHG emissions regulation (Government of the Russian Federation, 2016). The first document (officially – the National Plan of Measures for the First Stage of Adaptation to Climate Change to 2022) was adopted in December 2019; the second (long-term low-carbon strategy) in October 2021; the third (the Law on the limitation of greenhouse gas emissions) was signed in July 2021. Moreover, in October 2021, the target to achieve carbon-neutrality by 2060 was declared by the President.

112  Handbook of sustainable politics and economics of natural resources Large efforts are still needed to arrange these fragmented documents into some order, synchronize them and integrate to the general strategy of the country’s development. At the moment, part of this legislation seems to continue the window-dressing paradigm. For instance, the National Adaptation Plan to 2022 just stipulates that sectoral and regional adaptation plans should be prepared by responsible ministries and regional administrations by 2022 (Government of the Russian Federation, 2019). The Law on Limitation of GHG Emissions does not suggest any policy instruments directed at emissions reduction by 2025, but focuses only on monitoring and verification of GHG emissions by Russian companies. Despite the increasing number of climate-related normative documents, Russian domestic policy to reduce emissions and to cope with climate change is still fragmentary and often inconsistent. It lacks any intrinsic value and is determined by external factors, primarily by signals from other countries (such as EU’s CBAM) and commitments taken by Russia on the international level.

5

DETERMINANTS OF PASSIVITY

This section describes the major factors that explain the passivity of Russian climate policy. These factors are interlinked, are not related to specific decision-makers, are long-term and structural in nature, and arise from the country’s history, economic specialization and specificity of public discourse. 5.1

Economic Specialization

The most obvious factor for the passivity of climate policy in Russia is the country’s heavy dependence on extraction and export of fossil fuels. In 2018, oil and gas provided 46 percent of federal budget revenues (Ministry of Finance of the Russian Federation, 2020), and the share of fossil fuels in Russian exports reached 63.7 percent (Russian Custom Services, 2020). These numbers are much higher than in any country that has ever implemented carbon pricing. Even in Norway, the most energy-abundant European economy, the share of oil and gas in exports does not exceed 50 percent (Observatory of Economic Complexity [OEC], 2020). In energy-importing European countries, reduction of GHG emissions is embedded in the social, environmental, ethical and security narrative and is strongly associated with economic, technical and social progress. In Russia, the system of incentives for decarbonization is the reverse. Ideologically, the green transformation of the economy is often considered as a menace rather than as an opportunity. For instance, the Strategy of Economic Security of the Russian Federation to 2030 mentions ‘changes in the structure of global demand and consumption of energy resources’, the development of energy-saving technologies and reduction of material intensity, and the development of ‘green technologies’ among the challenges and threats to the economic security of the country (President of the Russian Federation, 2017). Decarbonization may also be considered a challenge for social security. It especially concerns the coal industry: its political influence is very high, as most production is concentrated in a small number of regions with non-diversified economies and a long history of social tensions involving coal miners. Employment and social stability in these regions depend entirely on coal production and this is the reason it is heavily subsidized by the government. The reduction of coal production would require decisive and long-term efforts to restructure

Climate change policies and resource abundance: the case of Russia  113 regional economies, which, as yet, have been neither implemented nor planned (Cherdantsev and Thurner, 2017). Green transformation of the global economy is not only a menace for Russian fossil fuels but also for its industry. Industrial products that lie at the core of Russian non-hydrocarbon specialization are also very carbon intensive: iron and steel, non-ferrous metals, fertilizers, chemicals and agriculture. The launch of carbon regulation would bring the additional competitiveness risks to these sectors. A third of Russia’s emissions originate from the production of goods for export. This makes Russia the second largest net exporter of emissions embodied in international trade, just after China. Russian exports are the most energy and carbon intensive among all the leading economies, primarily due to Russia’s export specialization rather than backward technologies (Makarov and Sokolova, 2017). The Western countries that are the major importers of Russian goods can reduce their emissions partly because they have an opportunity to import carbon-intensive goods from abroad, including from Russia (Makarov, 2019). The resultant emissions are, however, considered to be the responsibility of Russia’s exports and not of the developed-world consumers’ demand. The issues of sharing responsibility for GHG emissions between exporters and importers of carbon-intensive goods are widely discussed in the literature (Fezzigna, Borghesi and Caro, 2019; Liu, Jayanthakumaran and Neri, 2017; Zhu et al., 2018), often refer to ethics, and are beyond the scope of this chapter. However, the clear contrast in interests of exporters and importers of emissions embodied in trade is a fundamental factor explaining the difference in the narratives of Russia and of the developed world with regard to decarbonization that is usually ignored both in academic analysis and public debate. 5.2

Soviet Heritage and High Energy Intensity

The Russian economy inherited a lot from the Soviet Union, including its high energy intensity (Overland, 2010). The Soviet economy was based on traditional industries, including heavy machinery, metals, oil refining, chemical industry and pulp and paper production, and Russia kept the same specialization with only minor changes. Aside from specialization, the command-and-control system played its own negative role. For instance, the high volume of energy per unit of labor (an indicator called energovooruzhennost in Russian) was considered by state planners to be an advantage of the Soviet economy, and the rise of this indicator a sign of technical progress (Charap and Safonov, 2010). Simultaneously, enterprises, sectoral and regional officials had incentives to overstate their energy needs, meaning any incentives for energy saving were lacking. As a result, before the collapse, the volume of emissions of the Soviet Union was very close to that of the US (Marland, Boden and Andres, 2011), with GDP level nearly two times lower. The awareness of environmental problems in the Soviet era was very low; information about them was not provided to the public. The state ideology developed the narrative of ‘man conquering Nature’ that suppressed ecological consciousness and is probably one of the reasons for the widespread skeptical attitude to ecological problems in today’s Russia. Ecological awareness increased significantly in the late 1980s, when perestroika and glasnost showed the people the real scale of environmental problems in the country (including the impacts of the Chernobyl nuclear disaster) and legalized the civil environmental movement. However,

114  Handbook of sustainable politics and economics of natural resources after the collapse of the Soviet Union, the deep economic and social problems overshadowed environmental concerns (Henry and Douhovnikoff, 2008). As for the energy intensity of the Russian economy, it did not decrease significantly in the 1990s, despite the sharp de-industrialization. A new negative factor appeared – dilapidated equipment, which led to energy losses at all stages of industrial processes. Energy infrastructure, most of which was built in the 1960s–70s also became obsolete. As a result, Russia faced increasing losses of energy in the power network and in its power plants. The energy intensity started to decrease in the 2000s, with average annual rates of decline more than 5 percent in 2000–08. Half of the decrease was explained by the industrial restructuring and 30 percent by the modernization of equipment (Bashmakov and Myshak, 2012). Even with this progress, Russia remained behind the rest of the world in terms of energy intensity, apart from a few other countries in transition (like Ukraine) and the oil exporting countries of the Persian Gulf (like Saudi Arabia). Comparison with northern countries like Canada or Scandinavian states is also not favorable to Russia. Recognizing that high energy intensity is an obstacle for sustainable economic growth, in 2009, President Dmitri Medvedev declared a national goal to reduce the energy intensity of GDP by 40 percent from the level of 2007 by 2020. The state program, Energy Saving and Increasing Energy Efficiency to 2020, soon defined the key directions of energy saving policy (Government of the Russian Federation, 2010). However, in 2014, when the Russian economy faced the double shock of falling oil prices and western sanctions, the sequestration of the state budget led to an approximately 50-fold reduction in budget for the Energy Efficiency Program. As a result, since 2008, the energy intensity of Russian GDP has not decreased at all (Bashmakov, 2018). 5.3

Climate Skepticism in Public Discourse

Another important factor for the passivity of Russian climate policy is the low demand for it from society (Poussenkova and Overland, 2018). While in the countries of Western Europe, active climate policy measures are pushed forward by the active support of a large part of the population, there is nearly no such bottom-up pressure on politicians in Russia. Social and economic concerns of the population are much higher. Other environmental problems are also of greater importance for most Russians than climate change. While in the western countries, climate is considered to be a major environmental challenge, Russian people are much more concerned by local environmental problems like air and water pollution or disposal of waste (Grigoryev et al., 2013). One may explain the relatively low level of concern about climate change by the benefits that it brings to Russia. Many integrated assessment models show that Russia is one of the few countries with positive social costs of carbon (Ricke et al., 2018; Roson and Sartori, 2016; Stern, 2006). However, the picture of Russia benefiting from climate change can be questioned, given the limited scope of such models and their focus on the impacts that are representative for the other large economies: those on agriculture, healthcare, tourism, and so on. In Russia, the major negative impacts of climate change consist of melting permafrost, which is usually ignored in such models. The cost of infrastructure and residential buildings that may be damaged by melting permafrost under the RCP8.5 warming scenario may reach $100 billion by 2050 (Streletskiy et al., 2019).

Climate change policies and resource abundance: the case of Russia  115 Another kind of damage concerns the rising frequency and intensity of natural disasters. The number of extreme meteorological events has tripled over the last 20 years (Roshydromet, 2019). Some natural disasters cause significant losses: in particular, the heatwave in the European part of Russia in 2010 resulted in 54 000 deaths (Revich, 2011) and economic damage is estimated in a range from 210 to 450 billion rubles (Makarov, 2014). Damage caused by the flooding in the Far East in 2013 has reached 527 billion rubles – around 0.8 percent of Russian GDP (Porfiriev, 2015). The forest fires of 2019 in Siberia covered an area the size of Belgium and caused damage worth at least $100 million (The Moscow Times, 2019). These events have raised the awareness of the population on climate change but were not enough to undermine completely the positions of climate skeptics. In a recent survey by the Russian Public Opinion Research Center, 52 percent of respondents defined global warming as a serious problem. This is a large number, but at the same time 40 percent of respondents think that global warming is an overblown and far-fetched issue (TASS, 2020). According to the Global Attitude Survey by the Pew Research Center, 43 percent of Russians consider climate change to be a major threat and 33 percent a minor threat. These numbers are much lower than in other middle- and high-income countries: Russia still remains one of the most climate-skeptic countries in the world (Fagan and Huang, 2019). Public skepticism is supported by the media, where the voices of denialists are presented more widely than those of scientists and journalists referring to the mainstream climate science (Tynkkynen and Tynkkynen, 2018). Another important feature of Russian climate change discourse is the presence of denialists among scientists, including in the Russian Academy of Science. For instance, in December 2018, the Academy recommended the government not to ratify the Paris Agreement. Among the arguments was the absence of consensus between the Russian and global academic community on the causes of climate change (Dobrovidova, 2019). Similar arguments were used in 2004 when the Russian Academy of Science stood against the ratification of the Kyoto Protocol (Buchner and Dall’Olio, 2004; Tynkkynen, 2010). The attitude of the Russian political leadership to climate change is not consistent either. Vladimir Putin’s position on the issue changed from the joke that Russia would ‘save on fur coats and other warm things’ (Myers and Revkin, 2003) in 2003 to the recognition that ‘climate change is one of the most serious challenges humanity faces today’ at COP21 in 2015 (Putin, 2015). However, at Russian Energy Week International Forum in 2019, he changed the tone once again: ‘The so-called anthropogenic emissions are most likely not the main cause of this warming. It could be caused by global changes, cosmic changes, some changes in the galaxy that are invisible to us – and that’s that’ (Putin, 2019). Finally, at the same forum in 2021 President Putin underlined once again that Russia recognizes to full extent the urgency of challenges climate change brings and declared the intention to achieve carbon neutrality of the Russian economy by 2060. It is important to note that Russian official documents, including the Climate Doctrine, the National Adaptation Plan, and Law on Limitation of Greenhouse Gas Emissions, recognize the anthropogenic causes of climate change.

6

DRIVERS FOR CHANGE

As coping with climate change has no intrinsic value for Russia and climate policy is driven primarily by the country’s participation in international cooperation, it is the international

116  Handbook of sustainable politics and economics of natural resources environment and global trends that may become the major drivers for emissions reduction in the country. The decarbonization of the global economy affects the Russian economic model and pushes it to change. At the same time, it creates the new opportunities for Russia; the country may embark on a path towards green development in order to seize them. 6.1

‘Green Menace’

Smeets (2018) uses the metaphor of ‘green menace’ in analyzing the public justification of green transition in Russia. This term refers to the situation when green transition globally becomes a challenge to the Russian economic model based on fossil fuel extraction and export. This menace may also be a driving force for gradual diversification of the Russian economy. Makarov et al. (2020) estimate the impacts of climate policies worldwide on Russian energy exports. They considered three scenarios: (1) the business-as-usual (BAU) scenario, in which countries do not change their policies; (2) the INDC scenario, where countries fulfill their targets declared in INDCs within the framework of the Paris Agreement by 2030; and (3) the 2oC scenario, in which countries introduce additional policies after 2030, which would make it possible to keep the rise in the global temperature below 2oC compared to the pre-industrial level. Scenario simulation results show the significant impact of the Paris Agreement on Russian energy exports. In the INDC scenario, by 2030 it would be 20 percent lower, and by 2050, 25 percent lower than in the BAU scenario. While in the BAU scenario exports of all fossil fuels are expected to rise (Figure 8.2a), in the INDC scenario the exports of coal would decrease dramatically – six times compared to BAU (Figure 8.2b). Oil exports would remain stable and natural gas exports would rise significantly (they would be twice as large in 2050 as in 2010), but slower than in the BAU scenario. The 2oC scenario (Figure 8.2c) predicts a significant reduction in Russian exports of all types of fossil fuel. Russian exports of oil and natural gas would decrease correspondingly by 65 percent and 49 percent, respectively, compared to the INDC scenario (ibid.). Lower energy exports mean slower economic growth. Climate policy in correspondence with INDC would lower Russia’s GDP growth rate in the period 2020–30 by 0.2–0.3 percentage points. If the global community increases its ambitions for global GHG emission reductions after 2030 in line with the 2oC trajectory, it will add another half of a percentage point to a negative impact on Russia’s GDP growth rate in 2035–50 (ibid.). Not only Russian exports of fossil fuels are under significant risks, but the industrial exports as well. Metals, fertilizers, chemical and other major products of Russian exports specialization are very carbon-intensive (Makarov and Sokolova, 2017). It makes them vulnerable to barriers appearing at foreign markets. Many companies in developed countries consuming raw materials and intermediate goods from Russia have started paying more attention towards emissions along the value chain. The European Union will introduce a carbon border adjustment mechanism imposing carbon price on goods imported from the countries with no carbon regulation (European Commission, 2021). Russian business is concerned of these developments. The plans of the EU played an important role in the rise of climate ambitions of Russia in 2021 and revitalized the debates about domestic regulation of carbon emissions: Russian government would prefer to collect carbon price from Russian companies itself rather than to let them pay to the EU budget.

Russia’s energy exports in: (a) the BAU scenario; (b) the INDC scenario; (c) the 2oC scenario

Makarov et al. (2020).

Figure 8.2

Source:

Climate change policies and resource abundance: the case of Russia  117

118  Handbook of sustainable politics and economics of natural resources The ‘green menace’ is also a challenge for Russian technological development. Mitrova and Melnikov (2019) frame the major drivers of the energy transition worldwide into the concept of 3D: decarbonization – digitalization – decentralization. For Russia, decarbonization, and partly decentralization, are not relevant, leaving space just for digitalization. The latter is at the core of the country’s technological policy in the energy sector (Proskuryakova and Ermolenko, 2019), aiming to prevent the emergence of a technology gap in relation to other major economies. The same motivation is dominant in the development of renewables – the major objective of the existing state support program is to catch up with global green development through building a strong export-oriented sector of renewables equipment (Kozlova, Collan and Overland, 2020; Smeets, 2018). 6.2

New Opportunities

Though the global trend of decarbonization bring significant risks to the Russian economy, it may bring new benefits and opportunities to some companies and interest groups. It is these agents who may be drivers of more active climate policies in the country. For instance, aluminum producer RUSAL has become one of the first Russian companies to introduce a corporate carbon price. In 2017, RUSAL presented its low-carbon aluminum brand, ALLOW, which it now promotes on international markets. Moreover, RUSAL is among the major advocates of worldwide carbon pricing. The company’s motivation is clear: in the aluminum market, RUSAL’s competitors are the Chinese producers who use impure coal as an energy source. By contrast, more than 90 percent of the energy consumed by RUSAL is generated at carbon-neutral hydropower plants. Carbon pricing would therefore create additional costs for Chinese producers and increase the competitiveness of the Russian company (Makarov, 2016). Another example of a company that may benefit from Russia’s turn to a greener economy is RUSNANO. This state-controlled corporation not only invests in renewables, but has also patented single-walled carbon nanotubes – the universal nanomodifier that improves the mechanical properties of various materials and consequently significantly decreases the material intensity of many goods and constructions (RUSNANO, 2020). The company promoted this expertise at COP21 in Paris and is one of the major proponents of active climate policy in Russia. The Russian energy sector is very diverse in terms of motivations regarding decarbonization. Companies such as RusHydro (the state-controlled operator of hydro-power plants) and Rosatom (the state-controlled operator of nuclear power plants) are among the beneficiaries. Even for the gas giant Gazprom, it brings not only risks but also some opportunities. Pricing carbon would increase the competitiveness of gas-based electricity generation compared to coal-based electricity within the country. Shifts from coal to gas in China and Germany open new niches for natural gas in these two large markets. Gazprom is also beginning experiments with hydrogen that may help maintain the company’s presence in the European market even under conditions of deep decarbonization in Europe (Aksyutin, 2018). To give systemic form to these fragmented opportunities and to foster decarbonization in Russia, it is critically important that both Russia and its foreign partners consider the country’s emissions in the global context. Decarbonization of the western countries would be no more than a formality without Russia, which provides them with carbon-intensive raw materials and intermediate goods. Considering Russian emissions as part of a global problem, rather

Climate change policies and resource abundance: the case of Russia  119 than just its own responsibility, will help to see Russia as part of the solution as well. The high energy and carbon intensity, the initial low level of development of renewables and the huge energy losses as a result of the outdated infrastructure all make Russia a country with significant potential for low-cost emissions reduction. One sector that holds great potential for reductions is forestry, where there are plenty of opportunities for increasing forest cover and reforestation. If it is cheaper to reduce emissions in Russia than in most other countries, then this means that it could benefit from participating in international market mechanisms. This potentially gives Russia opportunities to attract finance in low-carbon projects through carbon markets from global companies that are trying to reduce their carbon footprint. The number of such companies would increase worldwide with the expansion of governmental carbon regulation, increased awareness and the spread of voluntary schemes. Such projects may be given impetus if the corresponding offsets are taken into account within the European emissions trading system. Nevertheless, much work needs to be done in this area. Carbon market infrastructure is only at the initial stage of development in Russia, and it is up to the government to support and expand it. However, if national carbon pricing appears in Russia in the coming decade, the country would benefit significantly from linking it with the EU Emissions Trading System, and so would the EU by involving Russia in joint decarbonization efforts.

7 CONCLUSION Despite a huge emissions reduction from the 1990 level, Russia has always been considered the enfant terrible of the international climate change regime – the free-riding country that would be the last in the movement towards a green future. There have been some strong arguments in favor of such a vision: Russia remains a climate-skeptic country with an energy-inefficient economy and limited political will for the green transition. Partly, this is the heritage of the Soviet era, partly a result of the country’s current economic specialization, and partly the responsibility of policymakers. Still, it is hardly productive to consider Russia as just a part of the problem but not part of the solution. Deep decarbonization of the global economy is impossible without involving Russia in international cooperation. Its emissions are not purely a domestic affair and its own responsibility – about a third of them are generated for production of exported goods that are consumed worldwide. The export specialization of Russia and its focus on fossil fuels and carbon-intensive goods is not just its own choice but also a reflection of the high consumption in the West. The influence of the international environment has always been the major factor defining Russian climate policy. The rapid green transformation that the global economy faces today would make such influence even stronger. Russia has great potential for cheap GHG emission reductions. Linking it with the capital of enthusiastic international companies, financial institutions and countries that are ready to invest in the green transition will open a new window of opportunity for deep decarbonization. Taking into consideration the political confrontation between Russia and the Western countries, it would not be an easy task. However, in the 1960s and 1970s, geopolitical tensions did not impede the Soviet Union and the European countries in building a comprehensive pipeline system linking them to each other for more than 50 years. The climate challenge today requires another type of interconnection – through the flows of

120  Handbook of sustainable politics and economics of natural resources green finance. To build and maintain such an interconnection is an ambitious task for both Russia and the West in the years to come.

ACKNOWLEDGEMENT Support from the Basic Research Program of the National Research University Higher School of Economics is gratefully acknowledged.

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9. Green policies and sustainable development in Saudi Arabia Stella Tsani and Sarah Najm

1 INTRODUCTION Oil producers receive a backlash from the climate change community as the energy sector accounts for a considerable share of the global emissions (BP, 2017, 2020). Despite global calls for action, the role of the oil industry and the hydrocarbon-producing countries in tackling climate change remains limited compared to demand-driven policies (Sinn, 2012). Only recently have large global producers, including Saudi Aramco, Equinor, BP and Shell, formalized joint coordinated action to address climate change – for instance, through actions like the Oil & Gas Climate Initiative (OGCI), a CEO-led initiative that supports the Paris Agreement and collectively invests in low-carbon solutions to lead industry response to climate change.1 While large international companies make some progress, developments with oil-producing countries that are major suppliers in the international markets remain slow. Energy transition and its implications are acknowledged by large producers, despite the lack of concrete targets and actions put in place. Indicative of this is the increasing interest in and reference by the Organization of Petroleum Exporting Countries (OPEC) to ‘inclusive’ and ‘sustainable energy transition’ through various publications and events. Climate change, global mitigation and adaptation actions will have considerable implications for OPEC large suppliers like Saudi Arabia. The transition comes with challenges attached and in contrast with the prevalent industrial policies that still place a considerable weight on the oil and gas sector. At the same time, transition comes with opportunities related to the accumulated experience with energy sector management, capital availability and relevant labour policies. This chapter aims to contribute to the critical assessment of the political economy of energy transition and resource diversification in Saudi Arabia. Being the largest economy in the Arabian peninsula, Saudi Arabia plays a strategic role in global oil markets as a top oil producer with the largest proven oil reserves (BP, 2019). As a result of long-recorded abundant hydrocarbon resources, historical dominance in the international oil markets and the comparative advantage of oil production, its socio-economic structure is heavily dependent on oil. Despite the heavy reliance on oil, Saudi Arabia has considerable socio-economic incentives to take climate and energy diversification actions in the wake of the global and regional sustainability transition. Geographic characteristics (desert landscape, arid weather), dangers of stranded assets, technological lag and global demand diversification from fossil fuels mean that timely action for climate change mitigation, adaptation and energy diversification in the kingdom is crucial. The negative impact of climate change on the desert nature of the kingdom amplifies various environmental concerns such as air pollution, sandstorms, rising sea levels and groundwater depletion (Abubakar and Dano,

1

See https://​www​.ogci​.com/​, accessed 2 August 2021.

123

124  Handbook of sustainable politics and economics of natural resources 2019). The water situation in Saudi Arabia is expected to deteriorate with climate change, leading to forced displacement of populations and to the creation of additional pressures on the global refugee crisis (Sever, Tok and D’Alessandro, 2019). Environmental issues may therefore prove costly for aggregate social welfare and for the political stability in Saudi Arabia and in the wider region. Since oil remains the main source of public revenues in Saudi Arabia, policy making is faced with conflicting objectives and drivers concerning the oil sector and future priority actions. The country is faced with choosing between oil-dependent economic diversification plans and implementing environmental policies away from oil and related products for future welfare gains. Towards this end, the chapter discusses aspects of relevance for the Saudi economy such as energy trends, the ‘green paradox’ and the changing dynamics of global oil players, with implications to the green leap forward. The analysis extends to arguments on the timely action from large oil producers like Saudi Arabia and related advantages coming from the extensive experience with the management of the oil and gas sector, the accumulated oil wealth and the labour market policies. The remainder of the chapter develops as follows. Section 2 discusses the political economy of Saudi Arabia and how energy policies impact the energy transition. Section 3 provides a critical overview of the politics and economics of energy in Saudi Arabia and investigates how they impede decarbonization plans and environmental initiatives. Section 4 discusses some overlooked benefits that large oil producers may gain from the timely climate and industrial diversification. Section 5 concludes.

2

ENERGY DIVERSIFICATION AND POLITICAL ECONOMY OF SAUDI ARABIA

Economic diversification plans of Saudi Arabia have long intended to increase the economic contribution of the non-oil sectors, but the oil sector still represents almost half of economic activity and around 90 per cent of government revenues (Saudi Arabian Monetary Authority [SAMA], 2019). The current political will outlined in the Saudi Vision 2030 calls for deep structural reforms, both social and economic, and diversification of economic rent.2 The implementation mechanism, however, lags behind, especially with respect to the environment and climate change mitigation. Thus, Saudi Arabia’s environmental policy projections can be described as ‘ambitious but reluctant’ (Al-Sarihi, 2019). Saudi Arabia ranks 90th globally in the Environmental Performance Index (EPI, 2020). Various environmental initiatives have failed to deliver, including international collaboration in renewable energy projects. Saudi Arabia has tripled its renewable energy target in the recent past and has successfully tendered for large-scale projects in wind and solar energy. Yet, alongside this, over the past decade, Saudi Arabia has increased its oil production by 2 million barrels a day (Safi, 2019). According to policy announcements, Saudi Arabia plans to invest in huge renewable energy projects and to raise environmental awareness. Saudi Arabia has formed a joint venture to build a ‘green hydrogen’ plant, powered by 4 gigawatts of renewable electricity, with a planned capacity of 650 tonnes per day (Al-Saffar and Van der Beeuren, 2020). In September 2 More information about the Saudi Vision 2030 National Transformation Program can be found at https://​vision2030​.gov​.sa/​en. Accessed 2 August 2021.

Green policies and sustainable development in Saudi Arabia  125 2020, it shipped its very first cargo of ‘blue ammonia’ to Japan. The emissions generated from the formation of the ammonia were captured for use in methanol production and enhanced oil recovery. In January 2021, the Saudi crown prince announced the launch of a zero-carbon city in the NEOM business zone (El Yaakoubi and Rashad, 2021). Yet, paradoxically, policies in the kingdom continue to promote emissions-intensive industries, including petrochemicals, as part of economic diversification plans. In 2018, Saudi Aramco announced the investment of more than $100 billion in petrochemicals over the next decade (Turkes, 2018). A prime concern is that the petrochemical sector is, by definition, heavily reliant on the livelihood of the oil industry. Thus, it remains challenging to implement environmental initiatives and aim for the so-called net-zero targets while simultaneously building thriving emissions-intensive sectors in the economy. While policy announcements call for diversification, actual developments highlight the over-dependence on conventional energy forms. The developments happen in parallel with increasing trends of energy consumption in Saudi Arabia. Per capita energy consumption is rising at 7 per cent per annum (BP, 2017). High levels of per capita energy consumption classify the country among developed economies, partly due to progressive economic development plans, but this is more indicative of wasteful energy usage driven by large subsidies (Alrajhi and Abdullah, 2014). Energy usage is related to rising urbanization and population growth rates. The kingdom experiences high urbanization rates as more than 80 per cent of individuals live in main cities. Belloumi and Alshehry (2016) find that urbanization is associated with greater energy intensity between 1971 and 2012 in Saudi Arabia. Rising energy intensity over time contradicts conventional economic wisdom. Technological progress and efficiency gains are expected to decrease energy intensity. This remains problematic as urbanization requires excess energy usage in congested and in overpopulated cities. High energy consumption is also linked to historically subsidized utility tariffs in the kingdom. The actual cost of utility tariffs is not explicitly declared in annual budgets, but the burden is often passed on to utility companies, refineries and semi-governmental entities who provide cheap energy tariffs for both producers and end-consumers (Althumairi, 2020). However, in 2015 and 2016, the government began to implement gradual removal of energy and water subsidies. Removal of subsidies creates resistance from the public as it requires cultural changes in a country that has been used to cheap utility tariffs. Krane (2019) argues that the changing dynamics of domestic oil demand calling for subsidy removal challenge the conventional wisdom of excess benefits in exchange for limited political rights in rentier states. This may explain why current reforms involve modernization plans on the social well-being front and the increase of leisure and recreational services in the country. Historically, subsidized energy tariffs often provide little incentive to implement efficiency measures in the energy sector (Krarti, Dubey and Howarth, 2017). Energy trends are linked to the political economy of energy in Saudi Arabia in three main ways. First, Saudi Arabia is classified as a developing economy in a state of transition subject to industrialization priorities where this explains weak implementation of environmental initiatives. Alarenan, Gasim and Hunt (2020) examine the demand for industrial energy, accounting for around 30 per cent of energy usage in Saudi Arabia between 1986 and 2016. Using econometric methods and decomposition analysis, the study finds inelastic income and price elasticities for aggregate industrial energy demand. The activity and structural effects have a positive impact compared to the limited impact of energy prices during the period of study. This indicates that energy demand is projected to increase as the economy grows,

126  Handbook of sustainable politics and economics of natural resources particularly with more dependence on manufacturing industries. The study also finds that implementing energy efficiency standards is evidenced to reduce industrial energy demand since 2010. This is a positive outcome, but more is needed to reduce emissions in aggregate and tackle the impact of climate change. Some studies find evidence in favour of the Kuznets curve hypothesis in Saudi Arabia, predicting a bell-shaped relationship between economic development and environmental degradation (Alabdulrazag and Alrajhi, 2016; Apergis and Ozturk, 2015). The analysis indicates that Saudi Arabia would start prioritizing environmental concerns as the country achieves higher levels of economic development. The questions that remain are when this change of pace would occur and the extent to which it is a plausible premise for policy projections. Second, a pressing concern is the excessive reliance on air conditioning in the hot region of Saudi Arabia. The IEA (2018) projects the future air-conditioning industry to fuel global electricity usage, describing it as a ‘blind spot’ in the energy and climate change debate. The building sector, including cooling industries, accounts for 75 per cent of energy electricity demand in Saudi Arabia, calling for robust institutions to implement efficiency standards (Krarti et al., 2017). Howarth et al. (2020) find that the relationship between electricity use for air conditioning and emissions has plateaued since 2016, indicating progressive efficiency measures in Saudi Arabia. Excess use of air conditioning remains a challenge in the desertic environment of Saudi Arabia as the impact of climate change intensifies, especially with a more than 2 per cent annual population growth rate (General Authority for Statistics [GASTAT], 2017). Third, urbanization and expansion of main cities drive greater energy demand for transport in Saudi Arabia. Data suggest that demand for transport accounted for around 20 per cent of energy consumption in 2016, and this is expected to increase by around tenfold in 2030 (Saudi Energy Efficiency Center, 2018). This is a cause of concern with the underdeveloped public transport systems in Saudi Arabia. Saudi Arabia has invested massively in the so-called ‘Saudi Railway Master Plan’ for developing national and regional railway systems for both domestic and freight transport.3 A question remains whether social norms would adjust to similar developments – for instance, when facing the choice to use public versus private transport. The household response is less elastic to price reforms introduced in 2015 than industrial energy demands (Atalla et al., 2018; Howarth et al., 2020). Social norms need to change for households to adapt to price reforms, which may require some time to be reflected in the data.

3

POLICY DILEMMAS AND THE ‘GREEN PARADOX’

Oil-exporting countries often face conflicting policy objectives, whether political or social. Conflicts often stem from three potential constraints in oil-exporting developing economies (Alrajhi and Abdullah, 2014). The first aspect includes oil market-related policies that require regional and international coordination with other oil producers. Second, economic objectives involve fiscal and industrialization objectives, subject to assumptions on the level of oil production. National policy objectives are not necessarily in line with other regional OPEC producers, creating tension among members. Third, foreign policy objectives in oil-producing 3 See Dornier Consulting (2021). Saudi Railway Master Plan up to year 2040. Accessed 2 August 2021 at https://​www​.dornier​-consulting​.com/​en/​reference/​saudi​-railway​-master​-plan​-up​-to​-year​ -2040/​.

Green policies and sustainable development in Saudi Arabia  127 countries, whether dealing with consuming or producing countries, in the developing and in the developed world. Political economy constraints faced by oil producers in developing countries also relate to the nature of their fiscal policy behaviour. Fiscal policy in oil-exporting countries is often procyclical, as governmental spending goes with, instead of against, the economic cycle (Coutinho et al., 2013; Frankel, Vegh and Vuletin, 2013). Conflicting policies expressed in industrial and diversification plans may stand in the way of climate change mitigation in Saudi Arabia. In light of these developments, it is important to understand the impact of such policies in a world struggling to decarbonize, for both energy consumers and the global energy transition. In this quest, it is useful to consider the role of Saudi Arabia in global markets and the changing dynamics of oil players. The role of Saudi Arabia in the global energy markets is assessed here through the lens of the ‘green paradox’. The green paradox (Sinn, 2012) explains how the behaviour of fossil fuel producers obstructs global efforts to tackle climate change by increasing production in anticipation of lower demand in the future. In this sense, producers would prefer to ensure short-term profits instead of uncertain future gains due to the rising support for renewable energy industries. Studies with inconclusive findings on the green paradox include theoretical approaches based on the Hotelling rule, such as Rezai and Van der Ploeg (2016), Smulders, Tsur and Zemel (2012), Van der Ploeg and Withagen (2012) and Gerlagh (2011), along with some empirical findings, including Lemoine (2017), Zhang, Zhang and Liang (2017), Grafton et al. (2014) and Di Maria, Lange and Van der Werf (2014). To what extent, however, would oil-producing countries behave as forward-looking producers, compared to private oil companies? Would the level of economic development play a role? Empirical evidence on the green paradox remains limited in the case of Middle Eastern oil producers. Najm’s (2019) results are in contrast with the ‘green paradox’ theoretical prediction, as excess spending seems to prevent Saudi Arabia from following a profit-maximizing behaviour. It remains important to analyse political economic factors when studying the global energy transition, given the diverse nature of oil producers. Would this outcome implicitly suggest that autocratic political regimes generate fairer oil production strategies in responding to environmental policies? The absence of the green paradox prediction can be environmentally problematic for two reasons. State-owned oil companies may well be preserving oil resources, but the political will to invest in petrochemicals can be equally harmful to the environment. Even if oil producers fail to follow economically rational behaviour in responding to renewable energy policies, diversifying their economies based on the livelihood of oil remains uncertain. A relevant concern is the nature of Saudi Arabia’s oil customers. Oil may become less appealing to developed economies with a strict implementation of carbon-cutting targets, but developing countries and emerging markets may fall behind. Ceteris paribus, the asset value of Saudi Arabian oil is expected to fall if oil consumers decarbonize their economies over time. This is more likely for oil customers from the developed world, but it is less realistic for developing countries subject to economic constraints. Over the past few decades, data suggest that demand for Saudi Arabian oil from developed economies has fallen dramatically but is increasing from developing and emerging markets. Current Saudi Arabian oil consumers are developing countries striving to advance their economies by prioritizing development policy objectives. Asia and the Far East accounted for, on average, 45 per cent of Saudi Arabian crude oil exports between 1970 and 2018 (Althumairi, 2020). Compared to the 1970s, in recent years, Western Europe’s demand for Saudi oil has fallen by more than 70 per cent and North America’s demand has dropped by more than 85

128  Handbook of sustainable politics and economics of natural resources per cent (ibid.). In contrast, during the same period, oil demand from Asia and the Far East has almost tripled. The changing patterns of Saudi Arabian oil customers has important implications, given the economic structure of oil importers. Economic activities in developing countries are often more energy intensive. In addition, weaker institutions may disincentivize decarbonizing their economies. Developing economies often have laxer regulations compared to the developed world. In other words, Saudi Arabia may continue to provide oil to its loyal oil customers, even though we are heading towards an anti-oil world. However, concentrated oil demand from Asia and the Far East makes Saudi Arabian oil exports vulnerable to potential shocks in the region. This creates additional risk factors for Saudi Arabia’s oil industry. Climate agreements are hardly binding, especially if counting on effective burden sharing between countries to tackle climate change. The impact of the rising number of oil producers remains an open question, irrespective of implementing climate change policies. For instance, whether Saudi oil will maintain its global appeal with the rise of non-conventional oil producers. Data show the changing dynamics of global oil players, including the projected rise of oil supply from different countries: Brazil, Canada and Norway (IEA, 2019). It remains to be seen how the 2020 administration change in the USA and Biden election will impact the USA oil supply profile, given the announced shift in energy and climate change priorities. Basic economics suggests that oil markets seem to be headed towards a competitive structure, given the rising number of producers. Excess supply is a concern for Saudi Arabia as a strategic player in the global oil market. This provides another economic incentive to accelerate decarbonization plans away from oil and hydrocarbon-related products and sectors.

4

THE PROSPECTS FOR A SUSTAINABLE ENERGY TRANSITION

Fattouh (2020) argues that expecting oil exporters to diversify away from the oil sector is not only unrealistic but also suboptimal. If oil exporters diversify away from oil, they will limit their risk reduction strategies by not leveraging on their core strengths and their portfolio of assets. He also argues that the oil sector remains very profitable and enjoys higher margins than any new industries/sectors that governments aim to establish. On the other hand, scientific evidence that urges for the need to take action, the United Nations’ 2030 Agenda, and landmark regional initiatives such as the European Green Deal, indicate that business as usual in oil-based economies and oil-centred industrial development may have dire consequences for the large oil producers. The energy transition is associated with peak oil demand and a sharp drop in demand estimated before 2040–50 as per BP (2020), OPEC and IEA scenarios. If energy transition scenarios materialize for developing countries, the implications for large oil producers, like Saudi Arabia, will be even more severe. The experience with the COVID-19 pandemic indicates how a sharp drop in demand would affect the fiscal stance of oil-producing countries. According to the IMF (2021), the economy of Saudi Arabia contracted by 4.2 per cent year-on-year in 2020 Q3 after declining by 7 per cent year-on-year in 2020 Q2. The government’s response to COVID-19 included a range of measures to limit the spread of the virus and to support the economy. Fiscal support included a SAR70 billion ($18.7 billion or 2.8 per cent of GDP) private sector support package, including the suspension of government tax payments, budgetary reallocations, wage benefits, and electricity subsidies to commercial, industrial and

Green policies and sustainable development in Saudi Arabia  129 agricultural sectors. Economic reforms also entailed raising the share of non-oil revenues and rationalization of spending, such as removing cost-of-living allowances for public sector workers, VAT increase to 15 per cent from 5 per cent, increase of custom duties, and wage benefits to Saudis working in the private sector (ibid.). Potential demand-driven shocks for the oil producers, combined with the projected impact of climate change in Middle Eastern countries, provide opportunities to embrace the energy transition. Rising temperatures due to climate change will significantly impact energy demand, creating a prime opportunity for renewable energy sector deployment. According to the IEA, solar photovoltaics (PV) is already competitive, on a levelized cost of electricity basis, with the existing oil-fired generating fleet when oil is priced at US$40/barrel and above (Al-Saffar and Van der Beeuren, 2020). Arguments favouring energy efficiency measures are likewise strong, indicating the importance of accelerating efficiency measures under the projections of increasing energy demand for cooling. Significant benefits are also linked to the indirect effect of the upgrade of the building stock (e.g., retrofitting), indicating employment and domestic supply chain effects, with implications for many non-oil-based industries. Deployment of renewables and efficiency measures may lead to a more efficient allocation of capital and help with diversification strategies of large oil producers like Saudi Arabia. What remains disregarded in the debate about energy transition of large oil producers is that their competitive advantage is related not just to the mere presence of natural resources but also to the established capacity to produce at low cost and to optimize their production and sectoral management for many decades. Diversification strategies that seek to deploy these strengths, ranging from managerial experience to established supply chains, could yield significant benefits for large oil producers (ibid.). Implications of this accumulated knowledge also extend to other economic aspects, including employment. While the time dimension of the effects of energy transition on employment and labour markets is still unknown, energy transition and development of renewable energy technologies should have a positive direct employment effect related to green investments and energy-efficiency improvements. The aggregate impact of energy transition on employment is expected to be favourable. Nevertheless, at disaggregated levels, the effects on skills and employment demand may be significantly different, particularly for energy-intensive sectors and extractive industries such as oil and gas (Tsani, 2020). Adjustment to the new needs and demands and the uptake of the new skills require time and flexibility. Such requirements may retard the transition to a greener economy. If adjustments come as a shock to the labour force and other sectors, it may lead to increased social unrest, supply bottlenecks and market distortions (Matsuo and Schmidt, 2019). This can represent a severe problem for countries heavily dependent on oil by adding to the pressure from permanently lower oil prices due to global decarbonization. Such requirements are well known in countries with significant oil and gas resources. In this group of countries, Saudi Arabia has considerable experience with sectoral employment effects and needs at different project stages (e.g., development, operation). Experience with local content policies used for both employment generation and industrial development, which is in abundance in Saudi Arabia, may prove extremely useful in the quest for sustainable and inclusive energy transition. Recent studies show that supporting and developing technology skills through local content policies can contribute to economic growth through increased productivity, innovation and human capital upgrade (Heim et al., 2019). Views in support of local content requirements highlight the accelerating impact they may have on the political momentum for more

130  Handbook of sustainable politics and economics of natural resources ambitious renewable energy policies (Tsani, 2020). Local content requirements may further support the move of the economic base away from consumption and rent seeking closer to the creation of domestic production and value added (United Nations Conference on Trade and Development [UNCTAD], 2014). At the same time, if not properly managed, local content policies raise issues of timely and proper implementation, as they may work counterfactually by imposing impediments on trade, competitiveness, market efficiency and sustainability (Baker and Sovacool, 2017). Under the prism of labour markets and local content policies, energy transition may pose an opportunity for Saudi Arabia in times where knowledge and technology play a more important role than resource availability. Opportunities are associated to employment stimulation beyond the oil and gas sector, expertise transfer, sectoral and regional development. Saudi Arabia’s experience with local content policies puts it in a favourable position with regard to the timely implementation of appropriate employment, regional, education and industrial policies. This experience can reap significant socio-economic and technology benefits from the development of renewable technologies. Saudi Arabia is also in a favourable position with regard to the much-needed availability of capital for the green leap forward. Sustainability transition creates a prime opportunity to transform the accumulated oil wealth in the Public Investment Fund, Saudi Arabia’s sovereign wealth fund (SWF), one of the largest SWFs globally, into projects with long-lasting socio-economic impact. As discussed in Tsani and Overland (2020), well-managed SWFs can support the implementation of climate policy through investment in high-social-impact green projects, the improvement in public spending and the fostering of international competitiveness. Through the employment and the promotion of commonly accepted investment standards (such as the Santiago Principles or the One Planet Sovereign Wealth Fund framework), SWFs can further promote sustainable development by financing greener and more ethical investments. For countries that operate hydrocarbon-based SWFs, this shift to green investments can have profound implications for their economic diversification and smooth transition to the post-oil era. Investments in clean energy production, renewable energy and the electrification of transport can enable traditional oil and gas producers to close the gap with other economies in the race of new clean technologies and possibly reap first-mover technological advantages. Last, opportunities are not just related to policies that move away from oil and gas but also to policies that promote R&D and industrial policies for a cleaner oil and gas sector. While non-oil-rich countries may have little incentive to invest in the cleaning of oil as an energy input, large oil producers have strong socio-economic and environmental incentives to do so. In the case of Saudi Arabia, this is related not just to the estimated increase in the per capita energy production but also to concerns related to the climate stance that oil-hungry developing states will take. Figures illustrate that the Middle East will need fossil fuels until 2050, with projections of 70 million barrels per day (Murray, 2020). In this case, questions should be related to whether Saudi Arabia could lead the race towards a clean oil sector. A cleaning transformation of the sector requires investments in new technologies that can improve core operations of exploration, production and refining. In recent years, industry venture capital firms have invested in sensors and other ‘Internet of Things’ (IoT) technologies that have improved monitoring, analytics and remote-control capabilities (CBInsights, 2020). Additional opportunities are towards circular economy implementation and R&D. For large oil producers, a transition from a linear to a ‘closed’ model of production links extracting as much value as possible from oil with recovery and regeneration of products and materials at

Green policies and sustainable development in Saudi Arabia  131 the end of their service life (Alnuaim, 2019). Implementation of the circular economy concept can have significant implications for downstream operations through refining, oil logistics and the petrochemical industry. This is acknowledged as part of the OGCI agenda in which Saudi Aramco plays a part. Opportunities also include plastic recycling and waste (e.g., tyres) used to generate heat energy (Johnston, Blakemore and Bell, 2020). All these alternatives breed opportunities for Saudi Arabia. At the same time, Saudi Arabia enjoys the advantage of sitting on large investment capital, part of which can be directed towards projects with high socio-economic return, such as greening of the oil sector and circular production, and of joining forces with large international companies with common interests and priorities.

5

CONCLUDING REMARKS

In the energy and sustainability transition, Saudi Arabia, like other developed and developing economies, stands at a crossroads where it should decide on the speed and on the direction of the transition. Beyond this shared challenge, large oil producers face additional challenges associated with the time dimension of exploiting their natural resources and how this enters the decision-making process. What seems clear from the experience to date in past industrial transformations is that latecomers find themselves in a position of competitive disadvantage. In contrast, first-movers, and those with the capital to implement robust transformative changes, enjoy the benefits of technological and cost comparative advantages. Saudi Arabia is faced with a challenging yet prime opportunity to transform its rent-based economy. Capital availability, resulting from many years of considerable oil revenue accumulation, allows for financing projects with long-term socio-economic impacts that exceed private cost benefits. Such projects can be related to energy-efficiency improvements, renewable energy project deployment, training, and upgrading of human capital to prepare for the new industrial demands. In this transformation, the accumulated experience with human and technology capital management can prove useful in designing and implementing updated sets of policies that can support the national economy and regional stability. Such economic policy priorities can accelerate the response of Saudi Arabia to climate change and bring it closer to a resilient future. Saudi Arabia should carefully consider the time left for hydrocarbons as important inputs to the energy mix. This calls for the need to prioritize policies that can support the local supply chain, employment and innovation ecosystem in a way that extends beyond the hydrocarbon sector. This imminent structural change that the hydrocarbon sector faces is understood by the major international oil companies (Tsani, 2021). Policy should put forward actions that can support education and cooperation in favour of development of skills, technology and expertise that can find applications in activities beyond hydrocarbons, like environmental safety and monitoring, infrastructure development and collocation of activities, IT tools for large data management or remote monitoring, and so on. Priority can be given to actions aligned with OGCI priorities, including support from and cooperation with national research institutions. Additional policy recommendations regard the design and implementation of well-informed and coherent fiscal, employment and industrial policies for the creation of long-term backward and forward links of the energy sector with the domestic economy. Policies should consider specific targets to be met and the present and future capacity of the domestic economy. This

132  Handbook of sustainable politics and economics of natural resources should be an integral part of the larger economic and regional development package to contribute effectively to boosting economic development and employment. COVID-19 has uncovered considerable technological, human capital, gender and economic inequalities and the need to address them (Tsani et al., 2021a). Technology, expertise and skills transfer should be at the core of policies, as this facilitates just energy transition and sustained transformation of labour markets. Collaboration through partnerships and clusters to establish common approaches can leverage just transition in the energy and labour markets alike. The creation of clusters is especially important for the energy sector that is dominated by large companies investing significant time and capital in technological upgrading and innovation (Tsani, 2020). The creation of clusters can be geographically and sectorally distributed within or outside national borders (e.g., formations can be expanded at transnational or regional level to exploit economies of scale). A key challenge for oil-producing regions may be the lack of the respective culture and incentives for cooperatives and exchange of good practices. In this regard, a key recommendation would be the support and the development of industrial and technology clusters across the knowledge triangle (research, education and innovation) in support of business development, access to innovation, better coordination, effective use of public goods and dissemination of best practices. COVID-19 response worldwide and in Saudi Arabia mobilized public funds to maintain current consumption and production, income and employment levels (IMF, 2021). Given the long-lasting implications and the public fund mobilization patterns, COVID-19 response poses a prime opportunity for incentive provision, skills and technology upgrade that are needed for the just transformation in the labour markets (Tsani et al., 2021b). Policy making should consider the importance of digitalization, IT and green infrastructure to speed up the greening of the economy and the production and employment in the emerging sectors. Infrastructure investments may pay off in terms of employment and long-term productivity. Last, fiscal measures should look beyond direct financial support to the most vulnerable. Instead, measures should actively seek a combination of financial, training and education support packages to ensure the resilience of the most vulnerable under the current conditions and readiness for future uncertainties and skill requirements.

REFERENCES Abubakar, I.R. and Dano, U.L. (2019). Sustainable urban planning strategies for mitigating climate change in Saudi Arabia. Environment, Development and Sustainability, 22, 5128–52. Alabdulrazag, B. and Alrajhi, A. (2016). The validity of environmental Kuznets curve hypothesis in the Kingdom of Saudi Arabia: ARDL bounds testing approach to cointegration. International Review of Management and Business Research, 5(4), 1450–64. Alarenan, S., Gasim, A.A. and Hunt, L.C. (2020). Modelling industrial energy demand in Saudi Arabia. Energy Economics, 85, Article 104554. Alnuaim, S. (2019). Circular economy: a sustainability innovation and solution for oil, gas, and petrochemical industries. Journal of Petroleum Technology. Accessed 2 August 2021 at https://​pubs​.spe​ .org/​en/​jpt/​jpt​-article​-detail/​?art​=​5340. Alrajhi, A. and Abdullah, M. (2014). Energy Economics. Riyadh: King Saud University Press. [In Arabic] Al-Saffar, A. and Van der Beeuren, M. (2020, 18 November). The case for energy transitions in major oiland gas-producing countries. International Energy Agency. Accessed 2 August 2021 at https://​www​ .iea​.org/​commentaries/​the​-case​-for​-energy​-transitions​-in​-major​-oil​-and​-gas​-producing​-countries.

Green policies and sustainable development in Saudi Arabia  133 Al-Sarihi, A. (2019, 18 November). Renewable energy in the Gulf Arab states. Center for Contemporary Arab Studies, Georgetown University. Althumairi, I. (2020). Saudi Economy (From Foundation to Vision 2030). Riyadh: King Saud University Press. [In Arabic] Apergis, N. and Ozturk, I. (2015). Testing environmental Kuznets curve hypothesis in Asian countries. Ecological Indicators, 52, 16–22. Atalla, T.N., Gasim, A.A. and Hunt, L.C. (2018). Gasoline demand, pricing policy, and social welfare in Saudi Arabia: a quantitative analysis. Energy Policy, 114, 123–33. Baker, L. and Sovacool, B.K. (2017). The political economy of technological capabilities and global production networks in South Africa’s wind and solar photovoltaic (PV) industries. Political Geography, 60, 1–12. Belloumi, M. and Alshehry, A.S. (2016). The impact of urbanization on energy intensity in Saudi Arabia. Sustainability, 8(4), 375. BP (2017). Energy Outlook – 2017 Edition. BP (2019). Energy Outlook – 2019 Edition. BP (2020). Energy Outlook – 2020 Edition. CBInsights (2020, 12 October). Oil, gas corporates continue to invest in clean tech in 2020. Accessed 2 August 2021 at https://​www​.cbinsights​.com/​research/​oil​-gas​-corporates​-clean​-tech​-sustainability​ -expert​-intelligence/​. Coutinho, L., Georgiou, D. and Heracleous, M. et al. (2013). Limiting fiscal procyclicality: evidence from resource-rich countries. CEPR Discussion Papers 9672. Centre for Economic Policy Research. Di Maria, C., Lange, I. and Van der Werf, E. (2014). Should we be worried about the green paradox? Announcement effects of the Acid Rain Program. European Economic Review, 69, 143–62. El Yaakoubi, A. and Rashad, M. (2021, 10 January). Saudi crown prince launches zero-carbon city www​ .reuters​ .com/​ in NEOM business zone. Reuters.com. Accessed 2 August 2021 at https://​ article/​us​-saudi​-neom​-project/​saudi​-crown​-prince​-launches​-zero​-carbon​-city​-in​-neom​-business​-zone​ -idUSKBN29F0L8. Environmental Performance Index (EPI) (2020). Website accessed 2 August 2021 at https://​epi​.yale. edu/. Fattouh (2020). The energy transition and adaptation strategies for oil exporters. The Oxford Institute for Energy Studies. Accessed 2 August 2021 at https://​www​.oxfordenergy​.org/​publications/​the​-energy​ -transition​-adaptation​-strategies​-for​-oil​-exporters/​. Frankel, J.A., Vegh, C.A. and Vuletin, G. (2013). On graduation from fiscal procyclicality. Journal of Development Economics, 100, 32–47. General Authority for Statistics (GASTAT) (2017). Website accessed 2 August 2021 at https://​www​ .stats​.gov​.sa/​en/​. Gerlagh, R. (2011). Too Much Oil. CESifo Economic Studies, 57, 79–102. Grafton, R.Q., Kompas, T., Long, N.V. and To, H. (2014). US biofuels subsidies and CO2 emissions: an empirical test for a weak and a strong green paradox. Energy Policy, 68, 550–55. Heim, I., Kalyuzhnova, Y., Li, W. and Liu, K. (2019). Value co-creation between foreign firms and indigenous small- and medium-sized enterprises (SMEs) in Kazakhstan’s oil and gas industry: the role of information technology spillovers. Thunderbird International Business Review, 61(6), 911–27. Howarth, N., Odnoletkova, N. and Alshehri, T. et al. (2020). Staying cool in a warming climate: temperature, electricity and air conditioning in Saudi Arabia. Climate, 8(1), 4. International Energy Agency (IEA) (2018). The Future of Cooling. Paris: IEA. Accessed 2 August 2021 at https://​www​.iea​.org/​reports/​the​-future​-of​-cooling. International Energy Agency (IEA) (2019). Oil 2019. Paris: IEA. Accessed 2 August 2021 at https://​ www​.iea​.org/​reports/​market​-report​-series​-oil​-2019. IMF (2021). Policy responses to COVID-19: policy tracker. Accessed 2 August 2021 at https://​www​.imf​ .org/​en/​Topics/​imf​-and​-covid19/​Policy​-Responses​-to​-COVID​-19. Johnston, R., Blakemore, R. and Bell, R. (2020). The Role of Oil and Gas Companies in the Energy Transition. Atlantic Council Global Energy Center. Krane, J. (2019). Too much of a good thing: subsidy reform and tax increases defy academic theory on the rentier Middle East. Center of Energy Studies, Baker Institute for Public Policy, Rice University.

134  Handbook of sustainable politics and economics of natural resources Krarti, M., Dubey, K. and Howarth, N. (2017). Evaluation of building energy efficiency investment options for the Kingdom of Saudi Arabia. Energy, 134, 595–610. Lemoine, D. (2017). Green expectations: current effects of anticipated carbon pricing. The Review of Economics and Statistics, 99, 499–513. Matsuo, T. and Schmidt, T.S. (2019). Managing tradeoffs in green industrial policies: the role of renewable energy policy design. World Development, 122, 11–26. Murray, J. (2020, 4 March). Can the Middle East be a leader in the global energy transition? Nsenergybusiness.com. Accessed 2 August 2021 at https://​www​.nsenergybusiness​.com/​news/​middle​ -east​-energy​-transition/​#. Najm, S. (2019). The green paradox and budgetary institutions. Energy Policy, 133, Article 110846. Rezai, A. and Van der Ploeg, F. (2017). Second-best renewable subsidies to de-carbonize the economy: commitment and the green paradox. Environmental and Resource Economics, 66, 409–34. Safi, M. (2019, 12 October). How real is Saudi Arabia’s interest in renewable energy? The Guardian. Accessed 2 August 2021 at https://​www​.theguardian​.com/​environment/​2019/​oct/​12/​how​-real​-saudi​ -arabia​-interest​-renewable​-energy. Saudi Arabian Monetary Authority (SAMA) (2019). Annual Statistics 2016. Saudi Energy Efficiency Center (2018). Enhancing vehicles energy efficiency in Saudi Arabia. Presentation at the G20 Transport Task Group workshop, Buenos Aires, Argentina, September. Sever, S.D., Tok, M.E. and D’Alessandro, C. (2019). Global environmental governance and the GCC: setting the agenda for climate change and energy security. In L.A. Pal and M.E. Tok (eds), Global Governance and Muslim Organizations. Cham, Switzerland: Springer, pp. 197–227. Sinn, H.-W. (2012). The Green Paradox: A Supply-Side Approach to Global Warming. Cambridge, MA: MIT Press. Smulders, S., Tsur, Y. and Zemel, A. (2012). Announcing climate policy: can a green paradox arise without scarcity? Journal of Environmental Economics and Management, 64, 364–76. Tsani, S. (2020). Public policies for just transition: local content, employment, and human capital. In W. Leal Filho, A. Azul and L. Brandli et al. (eds), Decent Work and Economic Growth (Encyclopedia of the UN Sustainable Development Goals series). Cham, Switzerland: Springer. Tsani, S. (2021). Energy sector developments, local content policies and economic growth. In V. Vlachos, A. Bitzenis and B. Sergi (eds), Modeling Economic Growth in Contemporary Greece: The Role of Changing Economic and Industrial Contexts. Bingley, UK: Emerald Publishing. [Forthcoming] Tsani, S. and Overland, I. (2020). ‘Sovereign wealth funds and public financing for climate action. In W. Leal Filho, A. Azul and L. Brandli et al. (eds), Climate Action (Encyclopedia of the UN Sustainable Development Goals series). Cham, Switzerland: Springer. Tsani, S., Riza, E., Tsiamagka, P. and Nassi, M. (2021a). Public policies, ‘one health’ and global inequalities under the COVID-19 lens. In W. Leal Filho, A. Azul and L. Brandli et al. (eds), Reduced Inequalities (Encyclopedia of the UN Sustainable Development Goals series). Cham, Switzerland: Springer. Tsani, S., Riza, E., Tsiamagka, P. and Nassi, M. (2021b). Public financing and management for a sustainable healthcare sector: some lessons from the COVID-19 pandemic. In W. Leal Filho (ed.), COVID-19: Paving the Way for More Sustainable World. Cham, Switzerland: Springer. Turkes, H. (2018, 27 November). Saudi Aramco to invest over $100B in petrochemicals. Aa.com. Accessed 16 January 2020 at https://​www​.aa​.com​.tr/​en/​energy/​news​-from​-companies/​saudi​-aramco​ -to​-invest​-over​-100b​-in​-petrochemicals/​22473. United Nations Conference on Trade and Development (UNCTAD) (2014). Local Content Requirements and the Green Economy. UNCTAD/DITC/TED/2013/7. Van der Ploeg, F. and Withagen, C. (2012). Is there really a green paradox? Journal of Environmental Economics and Management, 64, 342–63. Zhang, K., Zhang, Z.-Y. and Liang, Q.-M. (2017). An empirical analysis of the green paradox in China: from the perspective of fiscal decentralization. Energy Policy, 103, 203–11.

10. How ambitious can the Israeli Green Deal be? Ruslana Rachel Palatnik, Ayelet Davidovitch, Volker Krey, Nathan Sussman, Keywan Riahi and Matthew Gidden

1 INTRODUCTION The energy sector in Israel is at a crossroads. Coal and oil are in the process of being replaced by natural gas (NG) and renewable energy (RE) in power generation. Industry and transport sectors are also being gasified and electrified. Long a resource-poor country, with significant discoveries over the past decade, Israel now has abundant NG supplies for the next 30 years. As Israel’s energy import bill before the NG discoveries was about $10 billion per year – more than 5 percent of the gross domestic product (GDP) – the supply of domestic NG and its export have been contributing to the country’s trade balance (Palatnik, Tavor and Voldman, 2019). Ultimately, the process is expected to lead to cleaner energy and reduced environmental impacts. However, concerns about energy reliability and security, the intermittency of RE and fear of rising electricity prices, associated with cleaner energy reform, could stir up popular discontent, while uncertainty about the costs of energy transition and the required infrastructure pose a challenge to policy makers in committing to the transition. Globally, smarter technologies and designs that use energy more efficiently could provide the same or better services with far less energy, costs and risk (Gielen et al., 2019). Moreover, fossil fuels that provide most of the energy now generally cost more than the modern renewable sources that have already taken over two-thirds of the world’s power-plant market (International Energy Agency [IEA] and International Renewable Energy Agency [IRENA], 2017). Recent years have seen tremendous turmoil in regional and global energy markets, with volatile oil prices, geopolitical tensions over oil and NG supply, and tightened environmental regulations. Those transformations offer remarkable opportunities for policy makers to build a durable economy and to make energy supplies resilient to catastrophic interruptions of supply. Evidence is now emerging in such major economies as China, India, the USA and the EU that, if based on the lowest-cost available resources, ambitious global climate protection can be profitable rather than costly (Committee on Climate Change [CCC], 2019; Kemfert, 2017; National Development and Reform Commission [NDRC], 2016). The national carbon mitigation goals for 2050 should be declared at the next United Nations Climate Change Conference (COP 26). The EU has recently stated ambitious targets of net zero carbon emissions to be reached by the year 2050 (European Commission, 2019). The Israeli policy makers are skeptical of how far greenhouse gas (GHG) emissions reduction in Israel can go without hampering economic growth. The aim of this chapter is to investigate the economic impacts of alternative paths for GHG emissions reduction in Israel. Gielen et al. (2019) state that well-designed transition policies should consider the characteristics of energy systems and encompass energy supply and demand. This chapter proposes a unique modeling setup that is the best fit to represent the Israeli energy system and 135

136  Handbook of sustainable politics and economics of natural resources economy. It provides a useful tool to inform debate and to facilitate the decision process for energy-related GHG emissions-reduction goals to be set by the future government of Israel. The chapter is structured as follows. Section 2 presents the motivation for the methodology used. Section 3 describes the modeling framework. Section 4 outlines the research structure. Section 5 presents the main assumptions for different scenarios, followed by key results presented in Section 6. Section 7 concludes with discussion and policy recommendations.

2

METHODOLOGY: BACKGROUND

Energy is a crucial economic input within the economy, is widely utilized as a production factor and is consumed in various forms by households. For these reasons, any changes in the energy sector can have a significant impact on the entire economy. The challenge in modeling energy markets and policy is to adequately capture the energy system effects, the sectoral and macroeconomic impacts and the feedback effects (Helgesen and Tomasgard, 2018). The literature provides a variety of approaches to combining economic and energy-system models (Arndt et al., 2016; Bohringer and Rutherford, 2008; Helgesen and Tomasgard, 2018). Bottom-up engineering models include thorough descriptions of technological aspects of the energy system, including future improvements (Hourcade et al., 2006). They include interactions among the numerous individual energy technologies that make up the energy system of an economy, from primary energy sources, via conversion and distribution processes, to final energy use. A solution constitutes a partial equilibrium wherein energy demand is fulfilled in a cost-optimal fashion. Energy modeling frameworks commonly consist of technology-rich, bottom-up representations of the energy sector alone, while policy interventions relating to the energy sector entail the assessment of the economic and environmental impacts of the sector on the whole set of productive sectors within a national economy (Sustainable Development Solutions Network [SDSN] and Fondazione Eni Enrico Mattei [FEEM], 2019). Thus, partial equilibrium modeling of an energy sector is not sufficient to analyze policy questions (Palatnik and Shechter, 2008). Top-down general equilibrium (GE) models, on the other hand, describe the entire economy and emphasize the possibilities of substituting different production factors to maximize the profits of firms (Palatnik, 2019). The substitution possibilities between energy and other production factors are captured in production functions, which describe changes in fuel mixes as a result of price changes under certain substitution elasticities. Prices are determined by market clearance conditions, which equalize supply and demand for all commodities in the economy, both energy and non-energy (Siddig and Grethe, 2014). The constant elasticity of substitution (CES) type production function aggregates economic quantities in a non-linear fashion, conserving value but not physical energy flows (SueWing, 2006). Even if the scope of top-down models is comprehensive, such models are characterized by a high aggregation level; indeed, energy technologies are usually lumped together in one average ‘energy sector’ (SDSN and FEEM, 2019). For such reasons, that approach should be considered complementary to bottom-up models, rather than the opposite, thus encouraging a new methodology to bridge these tools, often called ‘links’, which are increasingly proposed in the recent literature (Brown et al., 2018). Top-down and bottom-up models represent two contrasting and widespread approaches for quantitative assessment of energy policies. Linking them allows for the strengths of one

How ambitious can the Israeli Green Deal be?  137 model to complement those of the other (Bohringer and Rutherford, 2008). Among examples of soft-linking between bottom-up and top-down models are the MESSAGE-MACRO model (Messner and Schrattenholzer, 2000; Orthofer, Huppmann and Krey, 2019) and MARKAL-MACRO (Manne and Wene, 1992). The South African TIMES energy system model (SATIM) has been hard-linked to a detailed dynamic CGE model of South Africa (SAGE) (Arndt et al., 2016). In another example, a soft link between the TIMES_PT energy bottom-up partial equilibrium model and the dynamic general equilibrium model (DGEM) top-down model for the Portuguese economy is created to analyze potential carbon mitigation pledges for Portugal (Seixas et al., 2017). Kober et al. (2016) linked a macroeconomic model to an energy system model by considering the decreases in consumer spending resulting from the introduction of carbon taxes. As part of the current EU policy of modeling and evaluation, the TIMES model has been integrated with GEM-E3 – the CGE model – to assess the economic and environmental consequences of a variety of energy policies (Capros et al., 2013). The top-down analyses of the Israeli economy include the CGE model for Israel, IGEM (Palatnik and Shechter, 2008), which has been developed and employed for more than ten years, to analyze the economy-wide impacts of climate change (Baum et al., 2016; Davidovitch et al., 2015) and climate change mitigation policies in Israel (Palatnik and Shechter, 2008, 2010). Other CGE-based analyses include Luckmann et al. (2014) and Yerushalmi (2018), who demonstrated the economy-wide costs of water scarcity for the Israeli case study. Siddig and Grethe (2014) used a Global Trade Analysis Project (GTAP) based CGE model to analyze the costs of disruptions of the NG supply from Egypt. The bottom-up energy-related models for Israel usually focus on a specific sector within energy – that is, the electricity sector (Solomon, Bogdanov and Breyer, 2018; Tishler et al., 2008), NG or oil (Yu, Pearlmutter and Schwartz, 2018). Those approaches fail to assess major shifts in the energy system and their macroeconomic implications. Due to expected shifts to NG and RE in power generation, as well as to the electrification of transport and industry, a comprehensive representation of the energy sector and the interlinkages with the macro-economy is required. MESSAGEix_IL-MACRO is the first modeling attempt to represent the Israeli energy sector as a whole via MESSAGEix_IL and to link it to a macroeconomic model, MACRO, to retrieve feedback from the energy demand side.

3

DESCRIPTION OF THE MODELING FRAMEWORK

In this work, a novel long-term-horizon, linear, least-cost, integrated-assessment model of the Israeli energy system, MESSAGEix_IL, is utilized. MESSAGEix_IL is a country-level application of the integrated assessment model MESSAGEix1 over the past four decades (Huppmann et al., 2019). MESSAGEix is a dynamic, bottom-up, technology-based optimization model designed for medium- to long-term energy planning and policy analysis that provides a framework to represent energy systems with all their interdependencies and correlations. MESSAGEix can describe the entire energy system, including resource extraction, trade, conversion, transmission and distribution, and the provision of energy end-use services 1 Open model, data and documentation may be found at https://​docs​.messageix​.org. Accessed 26 July 2021.

138  Handbook of sustainable politics and economics of natural resources such as lighting, space conditioning, industrial process heating, and transportation at different scales – for example, national (Orthofer et al., 2019) or global (Fricko et al., 2017). The optimization model is solved to find the least-cost solution for satisfying energy demand under various technical, economic and ecological constraints. To obtain macroeconomic feedback for changes in an energy system, MESSAGEix_IL is linked directly to the MACRO module of the MESSAGE model introduced by Messner and Schrattenholzer (2000). MACRO maximizes the intertemporal utility function of a single representative producer-consumer through optimization (Fricko et al., 2017). The result is a sequence of optimal savings, investment and consumption decisions. The main variables of the model are the capital stock, available labor and energy inputs, which together determine the total output of an economy, according to a nested production function with constant elasticity of substitution. It considers the six commercial energy demand categories in MESSAGE. The combined model calculates, among other variables, the required capacity investment, the optimal energy system configuration and the resulting emissions. In this study, we developed a linked framework of the MESSAGEix_IL bottom-up energy model for Israel with the MACRO model to obtain the feedback of carbon mitigation on energy demands and the overall economic performance.

4

RESEARCH STRUCTURE

The research was conducted in the following steps, as shown in Figure 10.1. First, the global energy model MESSAGEix-GLOBIOM was rescaled to represent the energy sector in a country-level model (Palatnik et al., 2021). In our case, the global energy model was transformed to represent a small open economy with imports of crude and refined oil and coal together with exports of NG and oil products. A series of additional updates to system closure rules was performed. Second, the key parameters that characterize the Israeli energy sector were updated. Those include 900 billion m3 (BCM) of NG reserves discovered offshore Israel, energy taxes, power-generation capacity according to fuel mix, costs of power plants, storage and others (see Table 10A.1 in the Appendix). The rich historical data comprises the technologies in place, capacity, investment, operating and management costs, efficiency factors and more. Close collaboration with the Ministry of Energy resulted in obtaining the most updated data for MESSAGEix_IL. Third, in collaboration with stakeholders, the future development of the energy sector in Israel until the year 2050, following official policy plans, was identified. Accordingly, the ‘baseline’ scenario for the future development of the energy sector in Israel until the year 2050 was generated by MESSAGEix_IL. Fourth, the ‘baseline’ scenario generated by MESSAGEix_IL served for calibration of the aggregated macroeconomic model, MACRO. In the baseline calibration of MACRO, the GDP and population growth of Israel follow the official reports, while the energy development is generated by the baseline scenario in MESSAGEix_IL. Finally, alternative policies, such as a higher share of power generation from RE, complete electrification of the transport sector by the year 2050 and carbon taxes, were imposed as external shocks to the energy system in MESSAGEix_IL. In response to those shocks, the cost-minimization model, MESSAGEix_IL, rearranged the energy mix. The resulting energy

How ambitious can the Israeli Green Deal be?  139

Figure 10.1

Research structure

prices were transferred to MACRO, which generated the response of the final demands and transferred the energy demands back to MESSAGEix_IL. The models were run until the energy quantities converged. The results represent the alternative pathways of energy sector development in Israel that take into account the direct economic costs of energy-related GHG emissions reduction. Although MESSAGEix_IL reflects in detail the energy-related carbon emissions, other sources of GHG, such as agriculture, waste and land use change, are not presented in the current version of the model. Therefore, the analysis below reflects the potential change in about 85 percent of the GHG emissions in Israel. Notably, the estimations below do not include the co-benefits of reduced emissions of local pollutants that are gained in each policy scenario. The decline in emissions of local pollutants is correlated with the reduction of carbon emissions (Bloomberg and Aggarwala, 2008). Therefore, improved air quality, which leads to gains in health and labor productivity, is not covered in the current analyses.

5

ASSUMPTIONS FOR BASELINE AND ALTERNATIVE SCENARIOS

Several scenarios for energy policy are currently being discussed by the Ministry of Energy (MOE) and the government and are not yet concluded. The plan for Energy Economy Objectives for the year 2030 (MOE, 2018) provides a cost–benefit analysis of transformations in three sectors: (1) removing coal from the energy mix for power generation while increasing the share of NG to 70 percent and RE to 17 percent; (2) increasing the NG share for the production of energy and steam in the industrial sector; and (3) shifting to electric vehicles and NG-powered trucks. A positive net economic benefit was observed for the plan. The present study broadens the scope of the policy alternatives and evaluates each of them with the

140  Handbook of sustainable politics and economics of natural resources rigorous tool of applied system analysis, specifically developed to represent the Israeli energy sector and the Israeli economy. We employ a multi-scenario analysis to identify the economic prospects of clean energy pathways for Israel and the associated changes in CO2 emissions under climate mitigation policies. The key assumptions for each scenario are summarized in Table 10.1. To allow for the considerable uncertainty of future economic development, we produced two ‘baseline’ scenarios for population growth that differ according to differing projections of the Central Bureau of Statistics (CBS) (2017) and corresponding GDP growth. In addition, Baseline I scenario assumes 17 percent of RE in power generation by 2030, as per the Israeli commitment to the Paris Agreement (United Nations Framework Convention on Climate Change [UNFCCC], 2015). Baseline II scenario implements the recently discussed goal of the Ministry of Energy to reach 30 percent use of RE by the same year. Baseline II scenario also contains a higher rate of electric transport by the year 2050. Starting from each baseline scenario, two alternative policy scenarios were analyzed. The policy scenarios share the same assumptions for the year 2050 about the share of RE in the energy mix for electricity production (85 percent), the rate of electric transportation (100 percent) and a complete phase-out of coal by 2030. The only difference between the two policy scenarios is the annual rate of carbon tax levied per ton of carbon (Table 10.1). Policy scenario introduces increasing carbon tax that follows the mid-range of EPA (2015) and Ambitious Policy scenario introduces a higher carbon tax that corresponds more closely to recent estimations of the social cost of carbon (Pindyck, 2019).

6 RESULTS According to development assumptions (Argov and Tsur, 2019), GDP is projected to grow by about 140 percent to 230 percent in Baseline I and II scenarios, respectively, in the period 2015 to 2050, while the population almost doubles. The corresponding growth of energy-related GHG emissions, as estimated by MESSAGEix_IL, is 30 percent and 37 percent, respectively, in Baseline I and II scenarios (Figure 10.2). Evidently, the difference in key assumptions in Baseline II vs Baseline I has offsetting impacts on energy-related GHG emissions. On the one hand, the higher population and GDP growth rates increase energy demand. On the other hand, higher rates of RE in power generation and transport electrification diminish carbon emissions. Consequently, GHGs show a similar trend in both baselines. As the GDP growth in the baselines is significantly higher than that of GHG emissions, a partial decoupling between economic growth and carbon emissions in the Israeli economy might be achieved if currently planned policies are indeed implemented (Figure 10.2). Applying Policy scenario and Ambitious Policy scenario to Baseline I and II scenarios show that the Israeli economy can reach a significant reduction in energy-related GHG emissions without compromising economic growth (Table 10.2). Table 10.2 presents the estimated percentage change in energy-related GHG emissions projected for 2050 as compared to those of year 2005, which was the Paris Agreement reference year for Israel (UNFCCC, 2015). Evidently, if Israel follows the currently planned development paths (Baseline I and II scenarios) the energy-related GHGs are projected to rise by half. However, policies that promote reaching 85 percent of RE in the energy mix for

Socio-economic

No carbon tax

60% in 2050

NG export of 25% of reserves by 2050

Carbon tax (average annual in a five-year period, per ton CO2)

Gas

remaining 3400 megawatts (MW) available till 2050

Reduction of the capacity of coal power plants by 2030,

30% from 2030 on

17% from 2030 on

Authority [PUA], 2018)

Coal

2019)

2.5% (Argov and Tsur, 3.5% (Public Electricity

2017)

of Statistics [CBS],

1.7% (Central Bureau

2.0% (CBS, 2017)

Growth, RE and EV

Population Growth, RE and EV

Baseline II: High Population

Baseline I: Low

RE

GDP (average annual growth)

Population (average annual growth)

Scenario assumptions

30% in 2050

Power

Electric transport

generation

Scenarios

Table 10.1

Ambitious Policy Scenario

$0 $23.3 $48 $53 $58 $62 $67 $69

2020 2025 2030 2035 2040 2045 2050 2055+

100% electric transport

$212

$205

$190

$176

$160

$145

$61.8

$0

No limit on NG capacity after 2025

Graduate reduction to 0 by 2030

85% in 2050

Follow baselines

Follow baselines

Policy Scenario

How ambitious can the Israeli Green Deal be?  141

142  Handbook of sustainable politics and economics of natural resources

Figure 10.2

GDP and carbon dioxide equivalent (GHG) emissions in Baseline I and II scenarios

Table 10.2

Summary of key results for baseline and policy analyses

  Baseline I scenario

Emissions in 2050 vs 2005 (%)

GDP vs Projection in 2050 (%)

48

–

Policy scenario

–66

–0.31

Ambitious Policy scenario

–92

–0.62

Baseline II scenario

49

–

Policy scenario

–61

–0.02

Ambitious Policy scenario

–73

–0.32

power generation and full electrification of transport by 2050 and are combined with modest carbon tax rates not only prevent the increase in GHGs, they also reduce emissions by about two-thirds (Policy scenario). A higher carbon tax rate might achieve an even sharper decline of 73 percent to 92 percent (Ambitious Policy scenario), placing Israel in line with the nationally determined contributions (NDCs) for 2050 of most Organisation for Economic Co-operation and Development (OECD) countries (UNFCCC, 2020). The estimated direct economic cost in 2050 is between 0.02 and 0.62 percent of GDP. The year 2015 is the most recent historical period in the model, which runs in five-year steps. Therefore, the first output of the MESSAGEix_IL-MACRO framework is obtained for the year 2020. Figures 10.3 and 10.4 show the estimated GHG emissions and GDP for each baseline and policy scenario, starting from the observed year 2015 and with five-year-step projections until the year 2050.

How ambitious can the Israeli Green Deal be?  143

Figure 10.3

GDP and GHG emissions in Baseline I, Policy and Ambitious Policy scenarios

Figure 10.4

GDP and GHG emissions in Baseline II, Policy and Ambitious Policy scenarios

The government take from the carbon tax (Table 10.3) has an inverse U shape, as the tax per ton of CO2 equivalent increases while GHG emissions are projected to decline over time.

144  Handbook of sustainable politics and economics of natural resources Table 10.3

Income of carbon tax from energy related GHG emissions

Year

Policy

Ambitious Policy

Tax ($ per ton

Emissions (mil.

Tax Income (% of

Tax ($ per ton

Emissions (mil.

Tax Income (% of

CO2eq)

ton CO2 eq.)

GDP) 0

ton CO2 eq.)

GDP)

73.30

CO2 eq.)

72.14

0

2025

23.3

71.62

0.44

61.8

64.81

1.07

2030

48

60.61

0.65

145

45.19

1.48

2035

53

55.47

0.56

160

37.11

1.13

2040

58

43.41

0.40

176

27.90

0.79

2045

62

31.63

0.27

190

20.08

0.52

2050

67

23.69

0.18

205

18.28

0.43

  2020

0

0

Checking the energy mix in power generation closely, we see that coal phases out completely in both the Baseline II and Policy scenarios (Figure 10.5). In Baseline II scenario, NG use in power generation is expected to increase significantly by 2050, while in Policy scenario, the energy mix in 2050 is composed of 15 percent NG and 85 percent solar energy. (The corresponding needs of storage are included.) In total, power generation is projected to rise significantly in the Policy scenarios when compared to the Baseline scenarios. The additional growth is mainly due to storage needs, to compensate for the higher share of solar in power generation.

Figure 10.5

Energy mix in power generation, terawatt-hours (TWh)

How ambitious can the Israeli Green Deal be?  145 MESSAGEix_IL allows us to investigate the segmentation of the reduction and transformation components that the energy sector undergoes in Policy scenario relative to the Baseline scenarios. For example, in Figure 10.6 we compare the total final energy consumption (TFC) between 2020 and 2050 in the Baseline II and Policy scenarios. Evidently, the energy consumption in transport is projected to rise in Baseline II scenario but to decline in Policy scenario, even though the number of vehicles is growing significantly in both. This is mainly because electric transport is much more energy-efficient than transport with internal combustion engines.

Figure 10.6

Total final energy consumption (TFC) in petajoules (PJ) by sector in Baseline II and Policy scenarios

The main transformation of the energy sector in Israel, as projected in the Policy scenario, is summarized in Figure 10.7. The share of RE in power generation sharply increases to reach the goal of 85 percent by 2050. Carbon taxes, enhanced energy efficiency and transport electrification increase the overall electrification of the economy from about 30 percent today to 70 percent in 2050, while the energy intensity declines by 53 percent. While the decline in energy intensity may seem sharp, 40 percent of it is reached in the baseline scenario, and only about 13 percent is driven by policy. This composition of energy intensity reduction indicates that full implementation of all current policy plans and support of the natural efficiency trends are crucial.

146  Handbook of sustainable politics and economics of natural resources

Figure 10.7

7

Energy intensity share of electricity in final energy mix, and share of RE in power generation under the Policy scenario

DISCUSSION AND POLICY RECOMMENDATIONS

Policy makers around the world are in the process of establishing national development plans projected to the year 2050 to combat climate change. This chapter summarizes the simulation results of the adoption of energy-related carbon emissions-reduction targets and their impact on economic growth in Israel by means of an original dynamic integrated energy-macroeconomic framework, MESSAGEix_IL-MACRO. Six scenarios are simulated and reported. Two baseline scenarios served as the starting points for two policy scenarios, Policy scenario and Ambitious Policy scenario, which have a higher carbon tax rate. The results show that, by adopting Policy and Ambitious Policy targets, energy-related GHG emissions could be reduced by about 60 percent and 90 percent, respectively, by 2050 relative to the reference year of 2005 with only a minor impact on GDP growth. The decline in emissions would be achieved by higher energy efficiency, which contributes about 60 percent to the reduction in energy consumption per unit of GDP, compared to 2017. Another important step for decarbonization is diverting energy production from the use of polluting fossil fuels to RE while electrifying the economy, so that the rate of electricity use in total final energy consumption increases from about 30 percent to date to 70 percent in 2050 in the Policy scenario. The improved efficiency and transition to RE are partly due to the exogenous targets for RE in power generation and full electrification of transport and partly due to imposing a carbon tax. Importantly, the analysis so far covers about 85 percent of GHGs in Israel that result from energy-related processes. Other sources of GHGs, such as agriculture, waste, and land use change are not represented in the current version of the model. In addition, the simulation does not consider the health benefits to the economy that result from the reduction of regional air pollutants, which are highly correlated with GHG emissions. Moreover, the economic and

How ambitious can the Israeli Green Deal be?  147 social benefits from climate change mitigation – the avoided climate impacts – are not incorporated in the analysis, as the mitigation results are dependent on the global decarbonization effort. Furthermore, the model does not take into account the effect of structural changes in the economic sectors on the composition of employment. Nevertheless, the analysis allows us to derive several important conclusions. First, adopting targets to reduce GHG emissions by 2050 represents an exceptional opportunity for long-term strategic planning in Israel. Significant reductions in GHG emissions can be achieved by electrification of the economy, while basing power generation on RE sources. Achieving these goals involves investing, which, if implemented optimally, can contribute to achieving both emissions-reduction goals and economic growth. In particular, there is a synergy between adopting emissions-reduction targets and the need for considerable investment in infrastructure to achieve the Israeli economy’s growth targets, given the expected demographic growth. However, considerations of energy security must also be evaluated carefully. On the one hand, increased use of domestic RE reduces the reliance on imported coal and oil. On the other hand, the main source of RE in Israel is solar energy, while wind potential is not yet proven and hydroelectric and nuclear-based power generation are not feasible. Accordingly, to meet the goals of RE in power generation, demand management and storage of electricity, as well as wind and waste-to-energy, should be promoted. The transport sector is responsible for more than two-thirds of Israel’s fossil fuel final energy consumption. In addition, Israel suffers from a decade-long underinvestment in transportation infrastructure. Given the urgency of solving road congestion and the continuing increase of new vehicles on our roads every year, which are driven by demographic and economic growth, we recommend rapid electrification of light-duty vehicles and public transport as the government’s most important budgetary commitment, requiring immediate implementation. Accordingly, we call for investment in electric and efficient public transportation. Infrastructure that allows transmission for electricity storage and supply can also contribute to solving the challenge of a high share of solar energy in power generation. The construction sector also provides an opportunity to achieve decarbonization goals. The high rate of population and economic growth requires construction of about 100 000 new residential units per year. The government-sponsored Buyer’s Price Program (Ministry of Finance, 2020) speeds up housing construction at lower-than-market prices but avoids green building standards and energy efficiency considerations completely. Energy efficiency can be increased, both by designing residential dwellings and commercial, public and industrial centers according to green building standards that reduce energy consumption, and by connecting them with efficient electric public transportation. Those steps might lead to increasing up-front building costs in the short term, but they have been proven to be cost-efficient in the long run (Gabay et al., 2014; Palatnik et al., 2018). The green standard must also be applied to construction, as part of the renovation/evacuation/construction government programs that are planned to replace National Outline Plan (TAMA) 38 for private and public buildings and offices. Another recommendation is to promote the ‘prosumers’ (Mega, 2019) programs, wherein the end users provide their energy needs by solar panels or wind turbines and supply the surplus to the grid. Industry is also responsible for a significant proportion of pollutant emissions. To make the most of Israel’s offshore NG reserves, the government subsidizes investment in NG infrastructure for energy-intensive industries. The utilization of NG is indeed preferable in terms of pollution when compared to other fossil fuels. However, heavy investment in NG

148  Handbook of sustainable politics and economics of natural resources infrastructure might prevent investment in the electrification of industry that is required to meet the goals of decarbonization. In addition, the government is called upon to reconsider the industry development plans of oil refineries. In addition, the manufacturing sector should prepare for the possibility of other countries adopting green regulations that would make it difficult to export products produced in Israel with polluting energy that could be produced elsewhere with RE. The many investments, in Israel and globally, that are needed to adopt energy-efficient and non-polluting technologies in transportation, construction and other sectors also create an opportunity for investment in technological innovation in industry. A major incentive for energy efficiency and the transition to RE among the various economic players is the relative price of polluting energy. The carbon tax internalizes the negative externalities created by GHG emissions and is therefore found to be the best solution to mitigate GHG emissions, both globally and locally. Therefore, we recommend accompanying the policies proposed above with the adoption of a carbon tax, combined with the provision of subsidies for the use of non-polluting capital. Carbon tax levied on a budget-neutral basis does not increase the tax burden and may lead to a double dividend in terms of improved environmental and economic performance (Palatnik and Shechter, 2008).

ACKNOWLEDGEMENTS The study was conducted as a part of the project ‘Sustainable Economic Development’ led by the Ministry of Environmental Protection and the Israel Democracy Institute, Israel. The authors thank Dr. Gil Proector, Mr. Yuval Laster, Mrs. Daphna Aviram-Nitzan, Mr. Ron Kammara, Mr. Elior Bliah, Mrs. Hila Shoef and the Energy Research Program at IIASA for fruitful cooperation and valuable input.

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How ambitious can the Israeli Green Deal be?  149 Davidovitch, A., Palatnik, R.R., Ayalon, O. and Shechter, M. (2015). An assessment of the impact of climate change on the insurance market: global and local analyses. Paper presented at the Annual Conference of the European Association of Environmental and Resource Economist EAERE, 21, Helsinki, Finland. Environmental Protection Agency (EPA) (2015). EPA fact sheet: Social cost of carbon Accessed 26 July 2021 at https://​www​.epa​.gov/​sites/​default/​files/​2016​-12/​documents/​social​_cost​_of​_carbon​_fact​ _sheet​.pdf. European Commission (2019). The European Green Deal. Brussels: European Commission. Fricko, O., Havlik, P. and Rogelj, J. et al. (2017). The marker quantification of the Shared Socioeconomic Pathway 2: a middle-of-the-road scenario for the 21st century. Global Environmental Change, 42, 251–67. Gabay, H., Meir, I.A., Schwartz, M. and Werzberger, E. (2014). Cost–benefit analysis of green buildings: an Israeli office buildings case study. Energy and Buildings, 76, 558–64. Galo, L. (2017). Long term forcast for electricity demand in Israel. Bank of Israel Research Department. Gielen, D., Boshell, F. and Saygin, D. et al. (2019). The role of renewable energy in the global energy transformation. Energy Strategy Reviews, 24, 38–50. Helgesen, P.I. and Tomasgard, A. (2018). From linking to integration of energy system models and computational general equilibrium models effects on equilibria and convergence. Energy, 159, 1218–33. Hourcade, J.C., Jaccard, M., Bataille, C. and Ghersi, F. (2006). Hybrid modeling: new answers to old challenges – introduction to the special issue of the Energy Journal. Energy, 2, 1–11. Huppmann, D., Gidden, M. and Fricko, O. et al. (2019). The MESSAGEix Integrated Assessment Model and the ix modeling platform (ixmp): an open framework for integrated and cross-cutting analysis of energy, climate, the environment, and sustainable development. Environmental Modelling and Software, 112, 143–56. International Energy Agency (IEA) (2019). World Energy Balances: Overview. Paris: IEA. International Energy Agency (IEA) and International Renewable Energy Agency (IRENA) (2017). Perspectives for the Energy Transition: Investment Needs for a Low-carbon Energy System. Paris: IEA. Kemfert, C. (2017). Germany must go back to its low-carbon future. Nature News, 549(7670), 26. Kober, T., Summerton, P. and Pollitt, H. et al. (2016). Macroeconomic impacts of climate change mitigation in Latin America: a cross-model comparison. Energy Economics, 56, 625–36. Luckmann, J., Grethe, H. and McDonald, S. et al. (2014). An integrated economic model of multiple types and uses of water. Water Resources Research, 50(5), 3875–92. Manne, A. and Wene, C.O. (1992). MARKAL-MACRO: a linked model for energy-economy analysis. BNL-47160 Informal Report. Brookhaven National Laboratory. Mega, V.P. (2019). The paths to decarbonisation through cities and seas. In V.P. Mega, Eco-Responsible Cities and the Global Ocean. Cham, Switzerland: Springer, pp. 121–66. Messner, S. and Schrattenholzer, L. (2000). MESSAGE-MACRO: linking an energy supply model with a macroeconomic module and solving it iteratively. Energy, 25(3), 267–82. Ministry of Energy (MOE) (2018). Energy economy objectives for the year 2030. Accessed 26 July 2021 at https://​www​.gov​.il/​BlobFolder/​news/​plan​_2030/​en/​energy​_economy​_objectives​_2030​.pdf. Ministry of Finance (2020). Apply to be eligible to participate in the Buyer’s Price Program (Mechir Lamishtaken) and the Target Price program (Mechir Matara). Accessed 26 July 2021 at https://​www​ .gov​.il/​en/​service/​request​_for​_eligibility​_confirmation. National Development and Reform Commission (NDRC) (2016), The 13th Five-Year Plan for Energy Development. Beijing: NDRC and NEA. Orthofer, C., Huppmann, D. and Krey, V. (2019). South Africa after Paris – fracking its way to the NDCs? Frontiers in Energy Research, 7, Article 20. Palatnik, R.R. (2019). The economic value of seawater desalination – the case of Israel. In G. Wittwer (ed.), Economy-Wide Modeling of Water at Regional and Global Scales: Advances in Applied General Equilibrium Modeling. Singapore: Springer, pp. 193–208. Palatnik, R.R., Davidovitch, A., Ayalon, O. and Trop, T. (2018). Is green profitable? Cost benefit analysis of green schools in Israel. Ecology and Environment, 9(1), 50–57.

150  Handbook of sustainable politics and economics of natural resources Palatnik, R.R., Davidovitch, A. and Krey V. et al. (2021). Is carbon pricing more efficient than policy standards? Insights from a co-production of knowledge process in Israel. Energy Policy. [Submitted for publication] Palatnik, R.R. and Shechter, M. (2008). Assessing the impact of greenhouse gas emission controls within the framework of a general equilibrium model of the Israeli economy. Economic Quarterly, 55(4), 545–73. Palatnik, R.R. and Shechter, M. (2010. The Israeli economy and potential post-Kyoto targets. Israel Economic Review, 8(1), 21–43. Palatnik, R.R., Tavor, T. and Voldman, L. (2019). The symptoms of illness: does Israel suffer from ‘Dutch disease’? Energies, 12(14), 2752. Pindyck, R.S. (2019. The social cost of carbon revisited. Journal of Environmental Economics and Management, 94, 140–60. Public Electricity Authority (PUA) (2018). Report on the State of Electricity Sector 2018. Public Electricity Authority (PUA) (2019). Report on the State of Electricity Sector 2019. Seixas, J., Fortes, P. and Gouveia, J.P. et al. (2017). The Role of Electricity in the Decarbonization of the Portuguese Economy. Munich: MPRA. Siddig, K. and Grethe, H. (2014). No more gas from Egypt? Modeling offshore discoveries and import uncertainty of natural gas in Israel. Applied Energy, 136, 312–24. Solomon, A., Bogdanov, D. and Breyer, C. (2018). Solar driven net zero emission electricity supply with negligible carbon cost: Israel as a case study for Sun Belt countries. Energy, 155, 87–104. SueWing, I. (2006). The synthesis of bottom-up and top-down approaches to climate policy modeling: electric power technologies and the cost of limiting US CO2 emissions. Energy Policy, 34(18), 3847–69. Sustainable Development Solutions Network (SDSN) and Fondazione Eni Enrico Mattei (FEEM) (2019). Roadmap to 2050: A Manual for Nations to Decarbonize by Mid-Century. Accessed 26 July 2021 at https://​roadmap2050​.report/​?mc​_cid​=​85727aa78dandmc​_eid​=​b1ed9d2da0. Tishler, A., Newman, J., Spekterman, I. and Woo, C. (2008). Assessing the options for a competitive electricity market in Israel. Utilities Policy, 16, 21–9. United Nations Framework Convention on Climate Change (UNFCCC) (2015). INDCs as communicated by Parties. Accessed 26 July 2021 at http://​www4​.unfccc​.int/​submissions/​indc/​Submission​ %20Pages/​submissions​.aspx. United Nations Framework Convention on Climate Change (UNFCCC) (2020). Communication of long-term strategies. Accessed 26 July 2021 at https://​unfccc​.int/​process/​the​-paris​-agreement/​long​ -term​-strategies. US Energy Information Administration (EIA) (2019). Annual energy outlook 2021. Accessed 25 July 2021 at https://​www​.eia​.gov/​outlooks/​aeo/​. World Bank (2019, 23 April). World Bank commodities price forecast. Accessed 25 July 2021 at https://​thedocs​.worldbank​.org/​en/​doc/​598821555973008624​-0050022019/​original/​C​MOApril201​ 9Forecasts​.pdf. Yerushalmi, E. (2018). Using water allocation in Israel as a proxy for imputing the value of agricultural amenities. Ecological Economics, 149, 12–20. Yu, H., Pearlmutter, D. and Schwartz, M. (2018). Life cycle assessment of an energy–economy nexus: the case of Israel and South Korea. Environmental Impact Assessment Review, 69, 61–9.

How ambitious can the Israeli Green Deal be?  151

APPENDIX Table 10A.1

Detailed data sources

Data

Source

Population growth

Medium and high scenarios (CBS, 2017)

GDP growth

Medium (Argov and Tsur, 2019); High (PUA, 2018)

Energy prices till 2030

World Bank (2019)

Energy prices 2031–50

US EIA (2019)

Interest rate

Israeli National Economic Council (unpublished)

Energy taxes Israel

Ministry of Energy, Fuel Department (4/2019)

Coal power generation Israel

Ministry of Energy Chief Scientist

Storage costs Israel

Ministry of Energy Chief Scientist

NG capital cost and operations & maintenance (OM) cost

Ministry of Energy Chief Scientist

Coal capital cost and OM cost

Ministry of Energy Chief Scientist

Solar capital cost and OM cost

Ministry of Energy Chief Scientist

Technology efficiency

Ministry of Energy Chief Scientist

Power plants lifetime

Ministry of Energy Chief Scientist

NG reserves

Adiri committee 2018

NG export till 2050

Adiri committee 2018

Historical data on energy balance, Israel

US EIS (2019) and CBS

Elasticities of electricity demand

BOI (Galo, 2017)

Emissions factors

Ministry of Environmental Protection

Carbon tax

Environmental Protection Agency (EPA) (2015)

Electricity transportation

Ministry of Energy (personal communication)

Renewable energy goals

Ministry of Energy Roadmap 2030 and PUA (2019)

11. Powering the uplands: controversies of developing hydropower in upstream Central and Mainland Southeast Asia Stefanos Xenarios, Murodbek Laldjebaev, Dietrich Schmidt-Vogt, Joost Buurman and Eduardo Araral

1 INTRODUCTION The development of hydropower energy has generated mixed responses. Heralded on the one hand as a major driver of economic growth, especially in water-resource-rich developing countries – Jawaharlal Nehru praised dams as the temples of the new India (Amrith, 2018) – hydropower development is, on the other hand, viewed negatively because of its destructive impacts on the environment and livelihoods and because of the uneven distribution of costs and benefits in river basins along an upstream–downstream gradient. A telling example is the Arun III hydropower project in East Nepal, which was stopped in 1995 when the World Bank pulled out in the midst of a controversy over the economic and environmental implications of this project and in an international atmosphere of criticism of large dam projects (Rai and Schmidt-Vogt, 2004). However, the project was revived on a bilateral basis in November 2014, when an Indian hydro firm agreed with the government of Nepal to resume implementation of the project (The Economist, 2014). Despite continuing opposition to the construction of large dams, especially in Europe and the United States, we are currently experiencing a resurgence of hydropower development on a large scale, especially in developing and transition countries with substantial surface water endowments (Eder and Mardell, 2019). Hydropower development is often linked with energy security considerations, while the energy trade with neighbouring countries is foreseen as a major leverage for economic growth. An additional argument for hydropower development is the decoupling of economic growth from environmental pollution through the reduction of emissions from fossil fuels (Berga, 2016). Yet another justification is the capture in reservoirs of meltwater resulting from accelerated snow and ice melting in mountainous areas to ensure its availability for irrigation as well as for hydropower production (Milner et al., 2017). There is a surge of hydropower development in the uplands of Central Asia (CA) and Mainland Southeast Asia (MSEA). In CA, the upstream countries of Afghanistan, Tajikistan and Kyrgyzstan contain the sources of the Syr Darya and Amu Darya rivers, which are the main arteries of the Aral Sea Basin, flowing through the lowlands of Uzbekistan, Kazakhstan and Turkmenistan before they end in what is left of the Aral Sea. The Mekong River and its tributaries cover nearly the entire region of MSEA, flowing through the upstream countries of China, Laos and Myanmar before entering the downstream countries of Thailand, Cambodia and Vietnam and emptying into the South China Sea. In both regions, there are numerous ongoing and planned hydropower sites, mostly constructed and driven by foreign investors and public–private partnership schemes (Hecht et 152

Controversies of developing hydropower in Central and Mainland Southeast Asia  153 al., 2019). Energy trade corridors have been established with the support of development organizations to transfer energy surplus within and between regions to better allocate the electricity load among countries and/or to generate income through electricity exports. The Central Asia-South Asia power project (CASA-1000) in CA is the most emblematic ongoing project connecting Kyrgyzstan, Tajikistan, Afghanistan and Pakistan to improve electricity allocation among the four countries by multiplying energy trade potential (Xenarios et al., 2019). In a similar manner, the Greater Mekong Subregion (GMS) network is the flagship regional network among MSEA countries to better distribute energy volume within the region (Matthews and Motta, 2015). The hydropower plants (HPPs) and energy transmission projects are expected to transform upstream countries into the ‘energy batteries’ of CA and MSEA on a regional scale. However, China, as the most powerful economy in the region with aspirations to project its influence abroad through infrastructure projects, plays a special role that differs between CA and MSEA. While its role is restricted to that of an investor in CA, it emerges in MSEA as both an investor and a competitor with downstream countries for the water resources of the Mekong and its tributaries. The advantages of hydropower expansion in the upland countries of CA and MSEA are extensively discussed in the relevant literature. The economic benefits consist mostly of foreign direct investment (FDI) in the weak and slowly developing economies of the uplands, through operation of HPPs and grid expansion (Li, Gallagher and Mauzerall, 2020; Wall et al., 2019). FDI is frequently presented as a major opportunity to overcome poor economic performance and associated poverty through large infrastructure developments in these countries. Energy security, especially for rural areas where electrification is still deficient in many cases, is another major expectation from hydropower development, although decentralized energy solutions are also recommended (Chala, Ma’Arof and Sharma, 2019). Economic leverage exerted by upland countries through control of water resources and export of surplus energy volume downstream can also affect the geopolitical power relations within these regions (Araral and Wang, 2013; Gopalan and Rajan, 2016; Luo et al., 2020). The literature deals with uplands also as areas that provide environmental goods and services for local people to pursue their livelihoods (Moran et al., 2018; Sovacool and Walter, 2019). In the past, the focus was mainly on the negative externalities of hydropower development, such as the disruption of river flow affecting water availability, particle transport and aquatic life. However, nowadays, hydropower is also seen as an alternative to polluting hydrocarbon sources that can contribute to climate change mitigation. Moreover, reduced dependency on fossil fuels and greater emphasis on clean energy can make uplands, as the main producers of hydropower, less dependent on volatile energy markets (Hussain et al., 2019; Shruti et al., 2020). However, there are also some worrisome implications of the expansion of HPP systems in CA and MSEA. One of them is the economic dependency of upland countries on foreign investors. Although some funding is provided through concessions and soft loans, there are also cases where the investors request to become major shareholders and control management of the assets (ETEnergyWorld, 2020). The potential control of large HPPs through foreign investors may also involve issues of national control over strategic assets of the countries or even issues of national sovereignty. The pronounced dependency on foreign markets and foreign investors could even affect national energy policies and thus overall development at a country level.

154  Handbook of sustainable politics and economics of natural resources Environmental impacts on the hydrology of these river basins can affect aquatic life as well as human activities that are dependent on water resources, such as irrigated agriculture and fisheries. In the case of aquatic life, some of these impacts could be irreversible, especially for endemic and rare species with high dependency on aquatic ecosystems. The impact on commercial fish species is already evident in the decrease of fish harvests in the Lower Mekong Basin (Baumgartner et al., 2021; Ziv et al., 2012). Some studies claim that the income loss from declining fish harvest in the Mekong Basin will be distinctly higher if all the planned HPP projects are completed (Dugan et al., 2010; Friend and Arthur, 2012). The formerly abundant fisheries of the Aral Sea have already been wiped out by poor management of water resources, mostly in the agricultural sector. In another context, the retaining of sediments in the HPP reservoirs of MSEA and CA has caused substrate and soil loss in the Mekong Delta (Anthony et al., 2015) and contributed to soil salinity in the lowlands of the Aral Sea Basin. There are concerns that if planned HPPs are fully developed in MSEA, Tonle Sap Lake in Cambodia, which is the largest freshwater lake in Southeast Asia, may experience water withdrawal symptoms similar to, though not on the same scale as, those of the Aral Sea (Althor et al., 2018). Another repercussion is the displacement of local communities from inundated reservoirs, which has already occurred and will continue to occur in connection with the planned HPPs (Kuenzer et al., 2013). In this chapter, an attempt is made to comparatively assess the opportunities and challenges of ongoing and planned hydropower development in the uplands of CA and MSEA. To start with, the physical and historical background of the two regions is described, including the geopolitical implications of hydropower development in the upland countries. The hydropower potential and installed capacities are also examined by summarizing the findings of previous studies, paying attention to large and small HPPs. Further, the direct and indirect socio-economic and environmental effects emerging from HPP structures are identified in the two regions and the distributional effects and social acceptance in the local communities are investigated. Finally, the most significant challenges and opportunities of hydropower energy in CA and MSEA are synthesized by focusing on the upland areas.

2

PHYSICAL FEATURES, HISTORICAL BACKGROUND AND GEOPOLITICAL SIGNIFICANCE OF THE MEKONG AND ARAL SEA BASINS

The Mekong and Aral Sea Basins, which cover extensive parts of the MSEA and CA regions, are considered to be eminently significant basin areas worldwide in terms of maintaining environmental sustainability, economic development and social cohesion (Grumbine, 2018; Xenarios et al., 2019). The Mekong River originates on the Tibetan Plateau at an altitude of about 5200 m and, with a length of 4900 km, is the seventh longest river in Asia and the 12th longest in the world, with an average annual discharge of 14 500 m3/sec. The Mekong River and its tributaries drain a basin area of 805 604 km2, which is shared by six countries: China, Myanmar, Thailand, Laos, Cambodia and Vietnam (Asian Development Bank [ADB], 2012). The basin can be divided into two parts: the Upper Mekong Basin in China (where the river is called Lancang Jiang) and the Lower Mekong Basin, which comprises parts of Laos, Thailand, Myanmar, Cambodia and Vietnam. There is a distinct difference in physical conditions between the Upper and the Lower Mekong. The Upper Mekong flows through a long narrow

Controversies of developing hydropower in Central and Mainland Southeast Asia  155 valley, cutting through the mountains and plateaus of Southwest China. About 90 per cent of the elevation drop between source and delta area take place in China. The Lancang contributes 14 to 16 per cent of the average total annual flow of the Mekong and thus has a major impact on flow regimes in Northern Thailand and Laos (ibid.). The Lower Mekong, below the point where the Mekong forms the boundary between Myanmar and Laos, flows through a basin and range landscape until it forms a delta in Southern Vietnam (White, Owen and Jacobs, 2019). The hydrology of the Mekong is characterized by extreme seasonal fluctuations driven by the tropical monsoon regime of alternating dry and wet seasons. Almost 80 per cent of the annual precipitation falls during the rainy season from June to September. The flow regime is so extreme that high water from July to October causes the Tonle Sap River, which flows from Tonle Sap Lake into the Mekong during the dry season, to reverse its flow by increasing the lake area fourfold from 2600 to 10 500 km2. The Mekong Basin is predominantly rural, with 85 per cent of the population depending on agriculture, forestry and fisheries. The Lower Mekong Basin has extensive areas of irrigated agriculture and rich freshwater fisheries with an annual catch of about 2.3 million tons (Biba, 2018). In Figure 11.1, the Mekong River Basin is presented with various types of HPP, commissioned, ongoing and planned in the six countries. The Aral Sea Basin in CA is drained by two main rivers, the Amu Darya and the Syr Darya, and their tributaries. The Amu Darya and Syr Darya rivers originate in the Pamir and Tian Shan mountains and discharge into the Aral Sea. The basin covers a total area of 1.76 million km2 and includes parts of Afghanistan, Tajikistan, Kyrgyzstan, Uzbekistan, Turkmenistan and Kazakhstan. It can be divided into two main zones: the Turan Plain to the west and northwest and the mountain zone in the east and southeast. About 80 per cent of water originates in the upstream countries of Afghanistan, Kyrgyzstan and Tajikistan, while 80 per cent of it is consumed in the downstream countries of Uzbekistan, Turkmenistan and Kazakhstan. Under the conditions of a predominantly dry climate with an annual mean rainfall of 170 mm in the Amu Darya Basin, glaciers and snowfields play a very important role in storing water from the 800 to 1600 mm surplus precipitation in the mountains and providing water through glacier and snow melt in the summer season (Hoelzle et al., 2020). Most of the rainfall and snowfall occurs in winter and spring from December to April. Distribution of annual runoff is uneven, with about 80 per cent occurring between April and September, while most of the flow is generated in the mountains (Xenarios et al., 2020). Meltwater contributes 70–80 per cent of the annual flow of Syr Darya and Amu Darya rivers, which compose the larger Aral Sea Basin. The mean annual flow of the two rivers into the Aral Sea was estimated at 115 km2, but nowadays only 10 per cent reaches the deltas due to excessive irrigation in the lowlands (Djumaboev et al., 2020). Agriculture remains an important pillar of the economies of countries in the Aral Sea Basin and 90 per cent of the water is withdrawn for irrigation purposes (Murzakulova et al., 2020). Before the Aral Sea dried out, it supported thriving fisheries with an annual catch of 45 000–50 000 tons and sustained local communities in its surroundings (Peterson, 2019). The hydropower potential in the Aral Sea Basin is great, due to the large snowpack areas and glaciers in the mountainous parts of the basin. Similar to Figure 11.1, the dams under construction in the Aral Sea Basin are presented in Figure 11.2. There are parallels and differences between the Mekong Basin and the Aral Sea Basin with respect to their history of water resource management. In both basins, water resources of the main rivers and their tributaries were used in early times mainly for irrigated agriculture. Local management of water resources by communities preceded large-scale state-led water

156  Handbook of sustainable politics and economics of natural resources

Source:

Greater Mekong Dams Observatory (2020).

Figure 11.1

Dams in Mekong River Basin

management schemes and later co-existed with these. Famous examples of pre-colonial water-dependent civilizations are the empire of the Khmer, centred around Angkor Wat in the Mekong Basin, and cities such as Samarkand and Bukhara in the Aral Sea Basin (Abdullaev, Wegerich and Kazbekov, 2020; Hall, 1981).

Controversies of developing hydropower in Central and Mainland Southeast Asia  157

Source:

Djumaboev et al. (2020).

Figure 11.2

Dams under construction in Aral Sea Basin

The colonial period was dominated in CA by one single power: the Tsarist Russian empire, which conquered CA in 1865 and which was succeeded by the Soviet Union. Throughout this period, most of the Aral Sea Basin was a political entity ruled from one centre. Under Russian/ Soviet rule, irrigated agriculture became a large-scale monoculture focusing on the production of cotton (Peterson, 2019). This development peaked in the Great Hydraulic Mission of 1930 to 1980 that led to the desiccation of the Aral Sea (Abdullaev et al., 2020). The retreat of the Hydraulic Mission coincided with the collapse of the Soviet Union. Former republics became independent nations and transboundary riparian states of the Aral Sea Basin. Formerly common, centrally controlled water resources were now administered on a national scale. The situation in the Mekong Basin has been much more complicated since the colonial period when the Lower Mekong Basin was largely under the control of French Indochina. At that time, some sections were controlled by Thailand’s predecessor, Siam, while the small part of the basin that belongs to present-day Myanmar was then part of British India. The upper course of the Mekong was part of the Chinese Empire. Yunnan province was then considered so remote as to be of no commercial interest to the empire or to the colonial powers who preyed on it. In contrast to Russia in the Aral Sea Basin, neither the colonial powers in the Mekong

158  Handbook of sustainable politics and economics of natural resources Basin nor China had any interest in promoting commercial irrigated agriculture (Biba, 2018). Their main economic interests were in extracting timber and mineral resources and, to some extent, commercial plantations that did not require extensive irrigation infrastructure (e.g., the rubber plantations in French Indochina). The French were interested in the Mekong mainly as a transport and trade route to China. These hopes were dashed, however, by topographical obstacles such as waterfalls and rapids. Early attempts at developing the hydrological potential of the Mekong were soon overshadowed by the struggle for independence and foundered entirely during the Vietnam War. As a result of the Vietnam War and the Cold War, MSEA fragmented into communist China, Vietnam and Laos, and independent Thailand, which was closely allied with the US, while Cambodia and Myanmar became isolated under authoritarian regimes (Osborne, 2013). Development of hydropower in the Mekong Basin started with the ‘pacification’1 of the region after the end of the Vietnam War in 1975, which was paralleled by attempts at regional integration. The need to back up development of the hydrological potential in a transboundary river basin with regional integration was understood early on and entailed the establishment of the Committee for the Coordination of Investigations into the Lower Mekong Basin (Mekong Committee) in 1957. Among its recommendations was the construction of large dams for irrigation and power generation. Its successor was the Mekong River Commission for Sustainable Development (MRC) founded in 1995 (MRC, 2020) with Cambodia, Laos, Thailand and Vietnam as signatories. China and Myanmar became dialogue partners in 1996. As another framework for regional cooperation, the Greater Mekong Subregion Economic Cooperation Program was initiated by the Asian Development Bank (ADB) in 1992. The GMS consists of Cambodia, China (Yunnan Province and Guangxi Zhuang Autonomous Region), Laos, Myanmar, Thailand and Vietnam. Actors in the process of developing the hydrological potential of the Mekong Basin were the governments of the riparian states, but also international organizations like the Canadian International Development Agency, ADB and the World Bank. China has recently emerged as the main actor in developing hydropower on the Mekong. It started by building dams on its own territory along the Lancang – the upper course of the Mekong – from 1984 onwards, without consultation with downstream riparian countries (Williams, 2020). It is for this reason that China has not joined the MRC organization. However, China launched the Lancang-Mekong Cooperation (LMC) in 2015 as its own platform for communicating and coordinating with riparian states in the Mekong Basin (Cheang, 2020). Apart from exploiting its own potential, China has become one of the main investors in hydropower development projects abroad, especially in Cambodia and Laos. The reasons for China’s shifting focus downstream include maintaining the growth of its economy and shifting the environmental and social burden of developing hydropower to neighbouring countries. China is now implementing its strategy to project its economic and political influence into neighbouring countries under the Belt and Road Initiative through the development of economic corridors (Clarke, 2017; Mark, Overland and Vakulchuk, 2020). China is not the only actor to develop a concept of corridors as a means to achieve better regional cooperation. Earlier, the ADB produced its own corridor concept not only in the Mekong Basin through 1 For more information about pacification, please refer to https://​www​.encyclopedia​.com/​social​ -sciences​-and​-law/​political​-science​-and​-government/​military​-affairs​-nonnaval/​pacification. Accessed 3 August 2021.

Controversies of developing hydropower in Central and Mainland Southeast Asia  159 GMS, but also in CA through the Central Asia Regional Economic Cooperation Program (CAREC) that was established in 1997 in an attempt to integrate the wider Eurasia region (Xenarios et al., 2018). Development of hydropower in the Aral Sea Basin started much earlier than in the Mekong Basin and was initiated by the Soviet government. A complex and closely interconnected system of canals and reservoirs was developed in the period 1960–80 to regulate the Syr Darya River and partly regulate the Amu Darya River for irrigated agriculture, flood risk reduction and hydropower generation. Conflicts between upstream and downstream countries, as well as between the agriculture and energy sectors, were regulated by the CA Power System (CAPS) that was established in the 1970s as the main regional energy network during the Soviet period. Within the CAPS, the upstream and hydropower-producing countries of Kyrgyzstan and Tajikistan were compensated for releasing water for irrigation downstream in summer by receiving fossil fuels and surplus electricity from the downstream countries of Uzbekistan, Kazakhstan and Turkmenistan. The upstream countries were also reimbursed by receiving water rights and entitlements of irrigated land use in the downstream republics (Wegerich, 2008). In the post-Soviet era, the newly independent countries faced the challenge of maintaining the infrastructure that they had inherited without the economic, technical or administrative support that was available when they were a single political entity. Regional integration as a basis for sustainable management of water resources, therefore, became a priority as in the case of the Mekong Basin. For this purpose, the Agreement on Cooperation in Joint Management, Use and Protection of Interstate Sources of Water Resources was signed in 1992 and the International Fund for Saving the Aral Sea (IFAS) was set up in 1993 (Kraznai, 2020). A major difference lies in the role of China, which in MSEA is both a national actor and an external investor, while in CA it is mostly an investment entity. However, as in the case of the MSEA, China’s activities in CA are now conducted under the Belt and Road Initiative along economic corridors (Vakulchuk and Overland, 2019). In CA, however, China must take into account the influence of Russia, which is trying to reassert its presence in the region through military bases and economic trade through the establishment of the Eurasian Economic Union (Kraznai, 2020).

3

HYDROPOWER ENERGY AND POTENTIAL IN CENTRAL ASIA AND MAINLAND SOUTHEAST ASIA

3.1

Hydropower Potential in Central Asia

The hydropower potential in the CA and MSEA regions is among the highest in the world, with upland countries possessing the largest endowment. In the case of CA, the current use of hydropower resources is minuscule compared to the estimates of its potential. The upstream countries of Kyrgyzstan and Tajikistan comprise the largest share of hydropower in the region with over 3000 megawatts (MW) and 6000 MW, respectively, in installed capacities. Next in line are Kazakhstan with over 2500 MW, and Uzbekistan with over 1500 MW, followed by Afghanistan with 300 to over 400 MW, and Turkmenistan with only 1 MW installed capacity. This wide range in installed hydropower capacity is due to the different estimations provided

160  Handbook of sustainable politics and economics of natural resources in the literature for each country, as shown in Table 11.1, as well as the geographic suitability and financial wherewithal of each country. Since 2000, the installed and generation capacities have grown in all countries, except for Turkmenistan – however, at a rather slow pace. There are several reasons why hydropower energy cannot reach higher installed capacity in the uplands of CA, such as the lack of financial capital, outdated technologies, absence of trained specialists, and bureaucratic licensing systems that discourage such types of investment. The restraining factors are limited hydropower potential in Turkmenistan, persistent insecurity and instability in Afghanistan, and the fact that some countries are endowed with major stocks of hydrocarbons and economically more affordable sources in their lowlands (e.g., coal, gas and oil in Kazakhstan, Uzbekistan and Turkmenistan). However, as concerns about the limited supply of non-renewable resources, price volatility and climate change are mounting, hydropower is increasingly credited as a potentially clean, economically affordable and renewable resource that could satisfy the growing energy demands in the region. Greater valuation of hydropower provides an additional incentive to reconsider the estimates for hydropower potential in CA as a first step and to explore opportunities for its development in subsequent steps. Table 11.1 presents the current state of hydropower capacity in CA according to different literature sources and statistical agencies of the respective countries. As mentioned above, there is, in quite a few instances, a considerable discrepancy between statements concerning the current installed capacity in each CA country, which raises concerns about the reliability of the published figures and the methodologies applied for obtaining them. The potential for hydropower in CA is immense, ranging from about 3000 MW to over 60 000 MW in gross estimates, even though technical and economic2 estimates vary between literature sources, as shown in Table 11.2. A comparison of countries in terms of their hydropower potential may be possible in broad strokes (e.g., considering river flow/discharge and elevation), while a more precise analysis, however, is hampered by lack of transparency concerning the approaches and tools employed in the studies. Figure 11.3 shows the installed capacity (MW) trends of each CA country for the last 20 years. A more detailed presentation of installed capacity (MW) and generation capacity (GWh) per country3 in CA is shown in Appendix Tables 11A.1 and 11A.2, respectively.

2 ‘Gross theoretical hydropower potential is defined as the annual energy that is potentially available if all-natural runoff at all locations can be harnessed down to sea level (or to the border of a region when calculating regional potential) without any energy losses. Technical potential of hydropower is defined as the annual energy that could be developed under current technology, regardless of economic and other restrictions. Economic potential of hydropower is defined as the annual energy that can be developed at costs competitive with other energy sources’ (Zhou et al., 2015, p. 2624). The World Energy Council (2010, p. 294) shared similar definitions for gross and technical potential and further clarifies economic potential as ‘the amount of the gross theoretical capability that can be exploited within the limits of current technology under present and expected local economic conditions’. 3 According to the US Office of Energy Efficiency & Renewable Energy (2017), installed capacity is ‘maximum output of electricity that a generator can produce under ideal conditions’, while electricity generation ‘refers to the amount of electricity that is produced over a specific period of time. This is usually measured in kilowatt-hours, megawatt-hours, or terawatt-hours.’

100

2551.50

 

 

 

 

 

 

41.5

 

46.5

 

3072

3071

1200

3070

3673

Kyrgyzstan

25

 

12.2

 

4982

5500

 

 

5217

6395

5273

Tajikistan

5

 

1.2

 

5

 

 

 

 

1

1

Turkmenistan

Notes: a. For plants ≤ 35 MW. b. For plants ≤ 10 MW, as defined by respective countries given in the report by UNIDO and ICSHP (2016).

78b

119.3a

 

80

222.2

 

2019

2016

8

 

224.6

2675

2598

461

254

2778

Kazakhstan

333

Afghanistan

Hydropower capacity in CA (MW installed capacity)

2020

Small hydro

2016

2019

All hydro

 

Table 11.1

71

 

20.2

 

1850

 

 

131.6

974

1865

1939

Uzbekistan

UNIDO and ICSHP (2016)

(2020)

Power Market Operator (KOREM)

and Kazakhstan Electricity and

International Development (USAID)

(2020b); United States Agency for

Association of Qazagstan

Nogaev (2020); Solar Power

Eshchanov et al. (2019)

Qazagstan (2020a)

(2020); Solar Power Association of

Ministry of Energy of Kazakhstan

Hydro Power (ICSHP) (2016)

and International Center on Small

Development Organization (UNIDO)

United Nations Industrial

Shadrina (2019)

Dikambaev (2019)

Eshchanov et al. (2019)

Schrader et al. (2020)

Association (IHA) (2020)

International Hydropower

Agency (IRENA) (2020)

International Renewable Energy

Source

Controversies of developing hydropower in Central and Mainland Southeast Asia  161

All hydro

Tajikistan

Small hydro

All hydro

Kyrgyzstan

Small hydro

All hydro

Kazakhstan 175 170

19 406‫٭‬

350‫٭‬ 527 527‫٭‬

40 000

60 160‫٭‬

60 167

8‫٭‬

917‫٭‬ 527

26

3000‫٭‬

60 160‫٭‬

4‫٭‬

1667‫٭‬

245‫٭‬

27 950 2‫٭‬d

270‫٭‬

30 833‫٭‬

409

142

16 210‫٭‬

80

228‫٭‬

9132‫٭‬

163

79‫٭‬

9023‫٭‬

18 607‫٭‬

140‫٭‬

16 000‫٭‬

26 000

65

7420‫٭‬

‫٭‬

20 000

 

199

35‫٭‬

175‫٭‬b

22 671‫٭‬

20 000a

4000‫٭‬

36 100‫٭‬

36 096‫٭‬

24 000‫٭‬

36 187‫٭‬

275‫٭‬

900‫٭‬

500

123‫٭‬

2740‫٭‬

16 770‫٭‬

18 500

9726‫٭‬

15 600‫٭‬

11 301‫٭‬

2707

4800

2397‫٭‬

7078‫٭‬

6000 ‫٭‬

7066‫٭‬

1200

6000‫٭‬c

MW

All hydro

Technical

MW

TWh

Gross

316‫٭‬d

316‫٭‬d

210‫٭‬d

317

2‫٭‬e

8‫٭‬e

4‫٭‬e

1‫٭‬e

24‫٭‬e

147‫٭‬d

162‫٭‬d

85‫٭‬d

137‫٭‬d

99

24‫٭‬e

42‫٭‬e

21

62

53 ‫٭‬e

62

11‫٭‬e

53‫٭‬e

TWh

18 050‫٭‬

18 048‫٭‬

12 000‫٭‬

18 048‫٭‬

92‫٭‬

300‫٭‬

167‫٭‬

41‫٭‬

913‫٭‬

8385‫٭‬

9250‫٭‬

4863‫٭‬

7800‫٭‬

5582‫٭‬

902‫٭‬

1600‫٭‬

856‫٭‬

3082‫٭‬

3000 ‫٭‬

3401‫٭‬

400‫٭‬

3000‫٭‬

MW

Economic

158‫٭‬e

158‫٭‬e

105‫٭‬e

158‫٭‬e

0.8‫٭‬h

3‫٭‬h

1‫٭‬h

0.4‫٭‬h

8‫٭‬h

73‫٭‬e

81‫٭‬e

43‫٭‬e

68‫٭‬e

49‫٭‬e

8‫٭‬h

14‫٭‬h

8

27

26‫٭‬g

30‫٭‬g

4‫٭‬h

26‫٭‬g

TWh

Hydropower potential in CA (terawatt-hours [TWh] to be potentially produced)

Small hydro

Afghanistan

 

Table 11.2

Energy Charter Secretariat (2013a)

ICSHP (2016)

Energy Charter Secretariat (2013a); UNIDO and

Shadrina (2020)

(2016)

Eshchanov et al. (2019); UNIDO and ICSHP

UNIDO and ICSHP (2016) for plants ≤ 10 MW

UNIDO and ICSHP (2016) for plants ≤ 30 MW

UNIDO and ICSHP (2016) for plants ≤ 30 MW

Gassner et al. (2017)

Baybagyshov and Degembaeva (2019)

Baybagyshov and Degembaeva (2019)

Dikambaev (2019); UNIDO and ICSHP (2016)

Commission for Europe (UNECE) (2018)

Dikambaev (2019); United Nations Economic

Shadrina (2020)

Eshchanov et al. (2019)

UNIDO and ICSHP (2016) for plants ≤ 10 MW

UNIDO and ICSHP (2016) for plants ≤ 35 MW

Energy Charter Secretariat (2013b)

Energy Charter Secretariat (2013b)

Shadrina (2020)

Eshchanov et al. (2019)

UNIDO and ICSHP (2016) for plants ≤ 10 MW

Ahmadzai and McKinna (2018)

Source

162  Handbook of sustainable politics and economics of natural resources

15 70‫٭‬

1700

7966‫٭‬ 10‫٭‬ 20‫٭‬

1180

2257‫٭‬

‫٭‬

89

9000‫٭‬

4

677‫٭‬ 

354‫٭‬

2390‫٭‬e 6

3‫٭‬e

21

e‫٭‬

510 ‫٭‬

27‫٭‬

2‫٭‬f

5‫٭‬f

55‫٭‬e

79‫٭‬e

3031‫٭‬e

260‫٭‬

546‫٭‬

6317‫٭‬

TWh

226‫٭‬

118‫٭‬

797‫٭‬

255 ‫٭‬

1515‫٭‬

130‫٭‬

273‫٭‬

2106‫٭‬

3000‫٭‬

MW

Economic

2‫٭‬h

1‫٭‬h

7‫٭‬h

2‫٭‬g

13‫٭‬g

1‫٭‬h

2‫٭‬h

18‫٭‬h

26‫٭‬h

TWh

UNIDO and ICSHP (2016) for plants ≤ 10 MW

UNIDO and ICSHP (2016) for plants ≤ 10 MW

UNIDO and ICSHP (2016)

Shadrina (2020)

Eshchanov et al. (2019)

UNIDO and ICSHP (2016)

Eshchanov et al. (2019)

ICSHP (2016) for plants ≤ 30 MW

Energy Charter Secretariat (2013a); UNIDO and

UNIDO and ICSHP (2016) for plants ≤ 30 MW

Source

Notes: * Denotes authors’ calculation, while unmarked numbers are borrowed directly from the sources; numbers are rounded to the nearest one. a. 20 000 MW is attributed to the Panj-Amu Darya River and its tributaries along the border with Tajikistan and Uzbekistan. b. The potential generation in TWh is calculated according to a formula from Gassner et al. (2017), e.g., 20 000 MW × 365 days × 24 hours × 1 (100%) capacity factor/1e + 6 = 175.2 TWh. c. Reverse calculation, e.g., 198.6 TWh/365days/24hours/1 (100%) capacity factor × 1e + 6 = 22 671 MW. d. 0.6 (60%) capacity factor. e. Assuming 0.3 (30%) capacity factor. f. 0.2 (20%) capacity factor. g. 0.15 (15%) capacity factor. h. 0.1 (10%) capacity factor.

Small hydro

All hydro

11‫٭‬

24

10 103‫٭‬

1300

Uzbekistan

2728‫٭‬

Small hydro

263‫٭‬ 185

30 000

MW

21 057‫٭‬

Technical

MW

TWh

Gross

All hydro

Turkmenistan

Small hydro

 

Controversies of developing hydropower in Central and Mainland Southeast Asia  163

164  Handbook of sustainable politics and economics of natural resources

Source:

IRENA (2020).

Figure 11.3 3.2

Installed capacity (MW) of each CA country for the period 2000–20

Hydropower Potential in Mainland Southeast Asia

The Mekong River, which is the main water artery of the MSEA region, was one of the least regulated large rivers globally, yet over the last decade the number of dams and storage facilities has increased rapidly. The demand for electricity in the fast-growing economies in the basin is increasing steadily, and hydropower is exploited to address shortages by creating a more diversified power mix. In the upstream region, China has deployed the largest share of hydropower in the basin with close to 18 000 MW installed capacity, as presented in Table 11.3, which is, however, only a fraction of China’s overall 356 400 MW installed capacity. In Myanmar, hydropower covers around 70 per cent of the energy mix with an installed capacity of around 3200 MW (Thin et al., 2020), yet only a very small part of this is generated in the Mekong Basin. Laos has a large potential for hydropower and the installed capacity, most of it located in the Mekong Basin, was around 6000–7000 MW in 2009. Only 10 per cent of the electricity production is used domestically in Laos; the remainder is exported, mainly to Thailand and some to Vietnam and Cambodia (UNIDO and ICSHP, 2016). Thailand has an installed capacity of around 3500–4500 MW, of which about 1250 MW is located in the Mekong Basin. Hydropower has not increased much in Thailand during recent years as potential sites are limited and located in protected forest areas where environmental impacts would be high, while the new projects face opposition from non-governmental organizations (NGOs) and civil society (Kraitud, 2017). Cambodia has an installed capacity of 1330 MW, of which 401 MW is in the Mekong Basin. Nearly all dams are developed under a build-operate-transfer

Controversies of developing hydropower in Central and Mainland Southeast Asia  165 (BOT)4 agreement with China. More dams are planned, as Cambodia has an electrification rate of around 60 per cent within the country. Finally, Vietnam has an installed capacity of around 17 000 MW of which around 2700 MW is in the Mekong Basin. These hydropower dams are located on tributaries of the Mekong River, as the Mekong Delta is not suitable for hydropower generation. As in the case of CA, there are discrepancies between the estimates for each country, though to a lesser extent. The Mekong Basin, which constitutes a large part of MSEA, has considerable potential for hydropower. It is assumed that currently only about 10 per cent of the technical hydropower potential in the Lower Mekong Basin countries is developed (Aroonrat and Wongwises, 2015; World Energy Council, 2013). The Mekong River Commission (2020) estimated the hydropower potential of the Lower Mekong Basin to be 30 000 MW, while the potential of the Upper Mekong Basin is estimated at 23 000 MW (Li, 2012). Country-wise estimations of potential are scarce and may not be accurate, as shown in Table 11.4, similar to the situation in the Aral Sea Basin. The HPPs scheduled for development along the main course of the Mekong are controversial due to the potential impact on the rich natural resources and the fragile biodiversity of the river’s floodplains. For instance, in Cambodia, the government decided in early 2020 to postpone building new dams on the main river for a decade (Ratcliffe, 2020). Yet, in Cambodia, about 50 per cent of the hydropower potential is on the Mekong’s mainstream and 30 per cent on the tributaries of the Mekong. Figure 11.4 presents the installed capacity (MW) trends of the MSEA region for the last 20 years by differentiating the Chinese capacity on the left axis and the other MSEA countries on the right axis because of the major scale difference between them. A more detailed presentation of the national installed capacity is shown in Appendix Table 11A.3 and the generation capacity (GWh) in Appendix Table 11A.4.

4

DIRECT AND INDIRECT SOCIO-ECONOMIC AND ENVIRONMENTAL EFFECTS

The identification of the direct and indirect socio-economic and environmental effects from hydropower development in the CA and MSEA regions is a rather complicated and ambiguous undertaking. There are several parameters affected simultaneously by the development of HPPs in CA and MSEA, which makes it very difficult to assess each of them individually. An additional problem is the HPPs that are currently in the planning and construction phase, and which cannot be evaluated ex ante, especially due to the interacting effects between cascading systems. Moreover, the HPPs’ performance in the two regions can be affected by climatic and geophysical factors and dynamics in an unpredictable manner. There are also major institutional aspects that could determine the magnitude of the socio-economic and environmental effects in the CA and MSEA regions. The distribution of the potential benefits from HPP development and cooperative arrangements within and between the riparian countries is a fundamental issue debated in the literature. Within MSEA 4 As per Investopedia source ‘The BOT scheme refers to the initial concession by a public entity such as a local government to a private firm to both build and operate the project in question. After a set timeframe, typically two or three decades, control over the project is returned to the public entity’ (Hayes, 2019).

 

 

 

1.3

 

Small hydro

2017

2016

2015

 

12

 

 

 

3329

 

 

104

 

 

 

7200

5974

 

 

34.2

 

 

 

805

 

 

 

 

 

3151

3331

3304

 

Thailand

110

108

7b

 

3497

3761

 

 

3488

 

1246c

 

4510

3667

 

Vietnam

 

1836

 

 

 

Aroonrat and Wongwises (2015)

UNIDO and ICSHP (2016)e

Kraitud (2017)

 

Aroonrat and Wongwises (2015)

UNIDO and ICSHP (2016)

(2017)

15 703

Vietnam National Mekong River Committee

2700d

Ministry of Mines and Energy (2017)

Kraitud (2017)

Hecht et al. (2019)

Kraitud (2017)

Thin et al. (2020)

IHA (2020)

IRENA (2020)

 

Source

17 000

 

 

 

 

 

16 759

18 069

 

Notes: a. Capacity in entire country unless stated otherwise; in China, the Mekong Basin is 1.7% of the total area, in Myanmar it is 3.6%; in Laos 84.9%; in Thailand 35.9%; in Cambodia 85.6%; and in Vietnam 19.6%. b. Mekong basin only. c. Mekong Basin only, data from 2017, but includes Lamtakong units 3–4, which became operational in 2019 (500 MW) and Chulabhorn (1.25 MW). d. Combined capacity on Sesan and Srepok rivers, which are tributaries to the Mekong River. e. China ≤ 50 MW; Cambodia ≤ 10 MW; Laos ≤ 15 MW; Myanmar ≤ 10 MW; Thailand ≤ 6 MW; Vietnam ≤ 30 MW.

 

73.2

 

 

304 860

929

 

 

 

2013

2016

 

401b

 

1328

 

 

 

 

  17 770b

356 400

1330

 

356 403

1330

2019

2017

 

 

All hydro

Myanmar

China

Cambodia

 

Laos

Hydropower capacity in MSEA (MW installed capacity)a

Table 11.3

166  Handbook of sustainable politics and economics of natural resources

18‫٭‬ 210‫٭‬

24 000‫٭‬

300

2072‫٭‬

300

34 247‫٭‬ 7200

622

20 548‫٭‬

14 041‫٭‬

700

1826‫٭‬

197

63‫٭‬

5‫٭‬

180‫٭‬

123

6‫٭‬

16

2‫٭‬

140

139

18‫٭‬

63

1121‫٭‬

556‫٭‬

3552 ‫٭‬

2474

3‫٭‬d

88‫٭‬bc

34

TWh

Economic

2400‫٭‬

207‫٭‬

10 274‫٭‬

11 416‫٭‬

233‫٭‬

1712‫٭‬

66‫٭‬

7991 ‫٭‬

39 726‫٭‬

667‫٭‬

2660‫٭‬

42 667‫٭‬

21 167‫٭‬

202 470‫٭‬

200 114‫٭‬

100‫٭‬

5000‫٭‬d

571‫٭‬

MW

21‫٭‬

2‫٭‬

90‫٭‬

100

2‫٭‬

15

1‫٭‬

70‫٭‬

35‫٭‬

6‫٭‬

23‫٭‬

374‫٭‬

185*

1776‫٭‬

1753

1‫٭‬e

44‫٭‬

5

TWh

UNIDO and ICSHP (2016) for plants ≤ 30 MW

UNIDO and ICSHP (2016) for plants ≤ 10 MW

World Energy Council (2013)

World Energy Council (2010)

UNIDO and ICSHP (2016) for plants ≤ 6 MW

World Energy Council (2010)

UNIDO and ICSHP (2016) for plants ≤ 10 MW

World Energy Council (2013)

World Energy Council (2010)

UNIDO and ICSHP (2016) for plants ≤ 15 MW

World Energy Council (2010)

UNIDO and ICSHP (2016) for plants ≤ 50 MW

UNIDO and ICSHP (2016) for plants ≤ 10 MW

World Energy Council (2013)

World Energy Council (2010)

UNIDO and ICSHP (2016) for plants ≤ 10 MW

Ministry of Mines and Energy (2017)

World Energy Council (2010)

Source

Notes: ‫ ٭‬ Denotes authors’ calculation, while unmarked numbers are borrowed directly from the sources; numbers are rounded to the nearest one. a. The potential in MW is calculated per formula from Gassner et al. (2017), e.g., 6083 TWh/365days/24hours/1 (100%) capacity factor × 1e + 6 = 695 548 MW. b. Reverse calculation for generation potential, e.g., 3973 MW × 365days × 24hours × 1 (100%) capacity factor/1e + 6 = 35 TWh. c. Assuming 0.6 (60%) capacity factor. d. 0.3 (30%) capacity factor. e. 0.1 (10%) capacity factor.

Small hydro

All hydro

20‫٭‬

18

34 247‫٭‬

2,333‫٭‬

Vietnam

2055‫٭‬

Small hydro

657‫٭‬ 6‫٭‬

15 982

233

26 636 ‫٭‬

15 868‫٭‬ ‫٭‬

348

2 000

7192

‫٭‬

All hydro

Thailand

Small hydro

All hydro

58‫٭‬

233

128 000

39 726‫٭‬

6 667‫٭‬

Myanmar

26 598‫٭‬

3738‫٭‬

426 667‫٭‬

Small hydro

1854‫٭‬

211 667‫٭‬ 63 500

405 479

5920

675 799 ‫٭‬

282 420‫٭‬

6083

‫٭‬

300

10 000

3881‫٭‬

695 548‫٭‬

9‫٭‬

146‫٭‬

16 667‫٭‬

1000‫٭‬

88

10 046‫٭‬a

Technical MW

MW

TWh

Gross

Hydropower potential in MSEA (TWh to be potentially produced)

All hydro

Laos

Small hydro

All hydro

China

Small hydro

All hydro

Cambodia

 

Table 11.4

Controversies of developing hydropower in Central and Mainland Southeast Asia  167

168  Handbook of sustainable politics and economics of natural resources

Source:

IRENA (2020).

Figure 11.4

Installed capacity (MW) of each MSEA country for the period 2000–20

countries, there have already been protests by rural communities concerning the unfair allocation of the economic benefits from the newly built HPPs, such as in Laos, Myanmar and Cambodia (Althor et al., 2018; Chea, Grenouillet and Lek, 2016). There are allegations that rural electrification has not improved much after the HPP construction while the compensation for displacement and loss of agricultural lands is considered inadequate (Chea et al., 2016). In CA, there are concerns about the unjust distribution of the benefits from HPP developments between the riparian states, which has led to major frictions between the upstream and downstream states. The hydropower development in upstream CA countries has also triggered conflicts among transboundary communities, although the establishment of local committees for conflict resolution has recently raised some hopes (Djanibekova, 2019; Xenarios et al., 2018). Moreover, downstream countries and especially Uzbekistan have made attempts to defuse the tensions and even to jointly invest in HPPs in Tajikistan for mutual use by both countries (Azernews, 2020). The unequal distribution of benefits among MSEA countries in the Mekong Basin has also caused major friction especially between China and the other riparian countries (Biba, 2018). This is mainly because China not only possesses the upper part of the basin but also invests heavily in HPPs in other MSEA countries, indirectly controlling and benefiting from the assets’ development and energy transfer to its mainland. In another instance, Thailand has taken the investor role in Laos, financing HPPs and in exchange receiving the largest share of their electricity output (Hensengerth, 2015). Distributional effects are also pertinent to proprietary aspects and ownership of the HPPs and the surrounding facilities (e.g., reservoirs and pumping stations). Ownership status is not always straightforward, and proprietors cannot always be directly identified (Kraznai, 2020). While HPPs are in many instances supervised by a state-owned managing authority, funding

Controversies of developing hydropower in Central and Mainland Southeast Asia  169 agencies involved in HPP development can exert considerable pressure on the operational status of the system (Biba, 2018; Shadrina, 2020). Also, there are bilateral agreements between riparian countries that dictate the amount of energy to be transferred under certain conditions (e.g., season or peak demand) that essentially affect the functioning mode of the HPPs (Hensengerth, 2015; Thomas, 2019). Despite constraints such as these, we have attempted to synopsize the major direct and indirect use effects to derive from the HPP developments in CA and MSEA regions. We consider a 15-year period (2021–36) for the estimation of anticipated effects from HPP development at a national level. The 15-year period has been selected as a medium-term timeframe for the completion of small and mid-sized HPPs. Large-scale constructions will have been advanced within this timeframe. The assessment is conducted at country level. The identification and assessment of the direct and indirect effects is based on indicators. Indicators were selected on the basis of the authors’ familiarity with the literature (Calabria, Camanho and Zanella, 2018; Han et al., 2014; Hecht et al., 2019; McManamay et al., 2020) and their own experience in the two regions. We acknowledge that there can be some overlap between indicators (e.g., economic development and irrigation), but we consider it beneficial to distinguish between major sectors and aspects – represented by indicators – that could be substantially affected by the anticipated HPP development in the two regions. The distinction between the direct and indirect use effects is grounded in environmental economics. We acknowledge that the classification applied in environmental economics is different from the one suggested by us. However, we consider this distinction between direct and indirect effects to be an explanatory format that better categorizes and estimates the future effects within the 15-year period (2021–36) in the two regions. The selected indicators are presented below: ● Direct use effects: ● Economic Development (ED): the negative (–) or positive (+) effects of HPPs on the overall economic development of the country measured through mainstream (e.g., gross domestic product – GDP) and less direct (e.g., Doing Business)5 metrics. ● Energy Security (ES): the negative (–) or positive (+) effects of HPP development on the installed energy capacity of the country and the coverage of national needs. ● Irrigation (IRR): the negative (–) or positive (+) effects of HPPs in terms of volumetric supply in the irrigation networks of the country. ● Fishery (FS): the negative (–) or positive (+) effects of HPPs on commercial and subsistence fisheries. ● Dislocation (DIS): the negative (–) or positive (+) effects of dislocation of local communities and the loss of agricultural lands due to HPP developments. ● Indirect use effects: ● Sediment Deposition (SED): the sediment deposition withheld due to the HPP development and the negative (–) or positive (+) effects in each country. ● Salinity (SAL): the effects that influence the process of salinization increase (–) or mitigation (+) in agricultural lands because of the HPP developments in each country. ● Hazards (HAZ): the effects of the HPPs on hazard increase (–) or mitigation (+)

5 As per the World Bank: ‘A high ease of doing business ranking means the regulatory environment is more conducive to the starting and operation of a local firm’. See https://​www​.doingbusiness​.org/​ en/​rankings. Accessed 3 August 2021.

170  Handbook of sustainable politics and economics of natural resources according to the hazard type in each country. ● Biodiversity (BIO): the effects of the HPPs on the increase (+) or decrease (–) of biodiversity in the sub-basins within the country boundaries. ● Hydrological Balance (HYD): the effects of HPP development on hydrological surplus (+) or deficit (–) of the sub-basins and the overall basin within the country boundaries. ● Social Acceptance (SOL): the high (+) or low (–) level of social acceptance of HPP development at a country level. ● Wealth Distribution (WL): the tendency towards an equal (+) or unequal (–) wealth distribution emerging from the HPP developments at a country level. The values for the qualitative rating approach are assigned according to the authors’ judgement, which is based on literature review findings and personal experience with hydropower energy in both regions. Each author was asked to individually evaluate the anticipated effects of the selected indicators and to validate the ratings. The individual assessments and arguments were then compiled and discussed among the authors to reach a consensus on the final ratings for each indicator and country.

5

ASSESSMENT OF HYDROPOWER ENERGY DEVELOPMENT FOR CA AND MSEA REGIONS

5.1

The Central Asia region

The direct and indirect effects in the CA region seem to be moderate in most countries; however, high and low values are given for some indicators, mostly in upstream countries. As shown in Table 11.5, a substantial improvement in economic development (ED) is expected in Tajikistan and Kyrgyzstan due to the increase of domestic sales and revenue generation through electricity exports to neighbouring countries. Likewise, some improvements from domestic sales are expected for Afghanistan, which in future may also benefit from the energy transit of the CASA-1000 network to Pakistan. Hardly any improvement is expected in Turkmenistan due to the low potential for hydropower development in this country. Also, only a small improvement is anticipated for Kazakhstan and Uzbekistan, on account of their limited potential for hydropower development; nonetheless, hydropower development will generate some income and will decrease the dependence on fossil fuels. In terms of energy security (ES), a sizeable improvement is also expected for Tajikistan and Kyrgyzstan because hydropower generation can cover the demand from various sectors of the economy and also generate surplus. This will relieve the winter shortages in areas connected to the main grid. However, some remote mountain regions will likely not benefit from increased capacity unless hydropower generation is accompanied by grid extension. Some improvement can be expected for Afghanistan depending on hydropower development on the shared Amu Darya River (called Panj in the upper reaches) (potential of 20 000 MW), to which Tajikistan also lays claim. Whether a mutually beneficial arrangement will be reached remains questionable, especially in view of the recent regime change in Afghanistan and depending on whether hydropower plants are constructed. Turkmenistan is expected to remain at the same level, while small improvements may occur in Kazakhstan and Uzbekistan, especially in some rural areas where off-grid HPP developments are planned.

Controversies of developing hydropower in Central and Mainland Southeast Asia  171 Table 11.5

Assessment of HPP developments in CA in 15-year period (2021–36)

 

Direct Use Effects

Countries/Indicators

ED

ES

IRR

FS

DIS

SED

Indirect Use Effects SAL

HAZ

BIO

HYD

SOL

WL

Tajikistan

+++

++

++

+/–

–

+/–

+/–

––

––

++

+++

–

Kyrgyzstan

+++

++

+

+/–

–

+/–

+/–

––

––

++

+

–

Afghanistan

++

++

+

+/–

+/–

+/–

+/–

–

–

+/–

+++

+

Turkmenistan

+/–

+/–

–

+/–

+/–

–

–

+/–

+/–

–

+

+/–

Kazakhstan

+

+

–

+/–

+/–

––

–

–

–

–

+

+/–

Uzbekistan

+

+

–

+/–

+/–

––

–

–

–

–

+

+/–

Notes: ED = Economic Development; ES = Energy Security; IRR = Irrigation; FS = Fishery; DIS = Dislocation; SED = Sediment Deposition; SAL = Salinity; HAZ = Hazard Control; BIO = Biodiversity Loss; HYD = Hydrological Balance; SOL = Social Acceptance; WL = Wealth Distribution. Scale = high improvement: +++; moderate improvement: ++; little improvement: +; indifferent: +/–; little negative impact: –; moderate negative impact: – –; high negative impact:– – –.

In the irrigation field (IRR), some improvement is bound to happen in Tajikistan due to the increased capacity for regulating water flow through new large reservoirs, especially the Rogun dam,6 which one can expect to be completed in 15 years’ time. Kyrgyzstan may also benefit from the increased reservoir capacity upstream of Syr Darya (called Naryn in the upper reaches), though to a lesser extent, also because irrigated agriculture is quite limited compared to other CA countries. Improvement in Afghanistan is expected to be small because the planned HPPs are likely to be run-of-the-river or with rather smaller reservoirs. Also, the potential for irrigation along the Amu Darya River is minimal on the Afghanistan side. In the case of the downstream countries, the impact of water withheld in reservoirs is anticipated to be small in Turkmenistan, mainly due to the lack of arable land. It is expected to be small also in Kazakhstan and Uzbekistan due to bilateral cooperation on HPP developments with Tajikistan after the regime change in Uzbekistan. However, a high level of uncertainty prevails due to ongoing deliberations on water allocation among the CA countries. After the desiccation of the Aral Sea, there is no longer any commercial fishery (FS) in CA except perhaps for recreational and subsistence fishing on a very small scale, thus no effects are anticipated. With respect to displacements (DIS), some estimates foresee the resettlement of about 20 000–40 000 people due to the construction of the Rogun reservoir in Tajikistan and of Kambarata I and II in Kyrgyzstan.7 Some locations have been specified and some people were relocated in Tajikistan, although not all were satisfied with this relocation scheme. There is possibly no impact in other countries, as most of the HPPs are likely to be run-of-the-river systems. Withheld sediments (SED) are anticipated to become an issue of concern in Tajikistan

6 According to Xenarios, Laldjebaev and Shenhav (2021, p. 2), ‘the huge Rogun embankment dam under construction in South Tajikistan will nearly double the country’s installed energy capacity to about 9000 MW when completed. The reservoir is an overall USD 3.9 billion project, with a height of 335m and estimated capacity of 3600 MW. The first turbine, of 600 MW, was commissioned in 2018, and the capacity will be gradually increased as the reservoir is filled’. 7 According to Djumaboev et al. (2020, p. 35), ‘Kyrgyzstan has initiated the construction of the Kambarata 1 and Kambarata 2 dams in the eastern part of the country, close to the source of the Naryn River. Once constructed, the first unit of the Kambarata 2 will allow Kyrgyzstan to produce an additional 500 to 700 million kWh/year, increasing the current production of 14 billion kWh/year and enhancing energy export potential (Dzyubenko, 2010)’.

172  Handbook of sustainable politics and economics of natural resources once the Rogun dam is completed. Other sources claim, however, that much of the sediment is already withheld in the Nurek reservoir, downstream of the anticipated Rogun reservoir (Schrader et al., 2020). The situation is similar in Kyrgyzstan with respect to the cascade dams on the Syr Darya, while no impact is foreseen in Afghanistan due to the run-of-the-river HPP schemes. In the downstream countries, negative effects are expected mainly in the delta areas of the Amu Darya and Syr Darya rivers, which will suffer from the reduction of deposits held by a series of cascading dams. While salinization (SAL) is not a major issue in upstream countries, decrease of sediments can aggravate salinization effects in downstream countries (Yellen et al., 2017). However, the major driver of salinization downstream and especially in Uzbekistan is irrigation with drainage water. With respect to hazards (HAZ), instability of slopes (river banks) can possibly arise as a consequence of the completion of the large reservoirs in Tajikistan and Kyrgyzstan. For Afghanistan, a little disturbance (by blasts, excavations, etc.) of the stability of slopes is expected during the construction of HPPs in mountainous areas. In downstream countries, erosion can be a consequence of the release of large volumes of water once the HPPs are operating, although the hazard will decrease with increasing distance from reservoirs. Also, the effects of droughts can be aggravated in downstream locations if the water volume released during the summer season is insufficient. The biodiversity (BIO) in aquatic life will probably decrease in all countries and especially in Tajikistan and Kyrgyzstan due to the difficulty in creating spillway passages in the scheduled large dams, but also by complicating movement of terrestrial wildlife or by submerging grazing areas. From a hydrological perspective (HYD) there will be increased control over the retention of flow behind the dams, which will enhance the water stocks in Tajikistan and Kyrgyzstan. No impacts on the run-of-the-river HPPs are expected in Afghanistan, while upstream control of water may result in some seasonal deficit in downstream countries during the summer period if water release is reduced for filling the upstream reservoirs. Social acceptance (SOL) is very high in Tajikistan and Kyrgyzstan in response to state propaganda claiming large HPPs as national symbols. However, those to be relocated may have a different perspective; moreover, adversarial politics in Kyrgyzstan may fuel protests, as recently occurred in the country, and obstruct hydropower development (BBC, 2020). Acceptance is rather high even in Afghanistan, due to improved access to energy, and in downstream countries, where some positive impact is expected from access to low-cost and clean energy sources. The wealth distribution (WL) in Tajikistan and Kyrgyzstan is likely to be unequal because it is unclear who will reap the benefits of electricity sales. It is also unlikely that the tariff will be low, which may impact the income of middle- and low-income communities. The distribution may be better in Afghanistan, as remote communities residing close to off-grid HPPs will benefit from the hydropower developments. The distribution in downstream countries is mixed, as the energy portfolio will be enhanced at the national level on the one hand, while on the other hand, policy for higher tariffs is expected due to the subsidization of renewable sources. 5.2

The Mainland Southeast Asia Region

The economic development (ED) is rated positive for all Mekong countries, as all their economies will benefit from a relatively reliable energy source, as shown in Table 11.6. The upstream countries, as the main producers of hydropower energy, will benefit more than

Controversies of developing hydropower in Central and Mainland Southeast Asia  173 Table 11.6

Assessment of HPP developments in MSEA in 15-year period (2021–36)

 

Direct Use Effects

Countries/Indicators

ED

ES

IRR

FS

DIS

SED

Indirect Use Effects SAL

HAZ

BIO

HYD

SOL

WL

China

++

+

+

–

–

–

+/–

–

––

+

+

–

Myanmar

+/–

+

+/–

+/–

–

+/–

+/–

+/–

––

+/–

–

–

Laos

+++

+++

+/–

––

––

––

+/–

+/–

–––

+/–

+

–

Vietnam

+

++

+/–

––

–

–––

––

–

–––

––

+/–

–

Cambodia

+

++

–

–––

––

–––

+/–

+/–

–––

–––

––

–

Thailand

+

++

+/–

––

–

––

–

–

–––

–

+/–

–

Notes: ED = Economic Development; ES = Energy Security; IRR = Irrigation; FS = Fishery; DIS = Dislocation; SED = Sediment Deposition; SAL = Salinity; HAZ = Hazard Control; BIO = Biodiversity Loss; HYD = Hydrological Balance; SOL = Social Acceptance; WL = Wealth Distribution. Scale = high improvement: +++; moderate improvement: ++; little improvement: +; indifferent: +/–; little negative impact: –; moderate negative impact: – –; high negative impact:– – –.

downstream countries, which are also dealing with the environmental impacts of dams built along the upper Mekong. Laos will benefit most, on account of the size of projected operations on the Mekong and its tributaries, and due to the impact of FDI and revenues on a relatively weak economy. The effect on the economies of downstream countries will be less, because of the small size of operations in Vietnam and because in Myanmar there are few options for hydropower development on the Mekong tributaries. The effects will also be less on Thailand, which has discontinued efforts to develop its own potential, and on Cambodia, which has postponed development of its potential on the Mekong (Ratcliffe, 2020). The energy security (ES) of all countries will also improve, though at variable scales. For China, the Mekong produces only a small share of the energy consumed at the national level. There are other sources compared to which improvements along the Mekong will be of minor importance. For Thailand, as the most developed economy in the Lower Mekong Basin, diversifying energy sources is more important than stepping up its already existing energy security. Laos will benefit most, partly because of the low level of electrification in rural areas, partly because of the scale of anticipated hydropower potential. There will be improvement also in Myanmar, Cambodia and Vietnam, though on a smaller scale than in Laos. In most countries, the dams are not important for irrigation (IRR). However, there have been reports of the dams affecting flow regimes with impacts on irrigated agriculture, which can be expected to be exacerbated by further upstream developments. Negative impacts on irrigation are compounded by droughts, such as the severe drought of 2016 in the Lower Mekong Basin, which caused China to release water from its dams at the request of the Mekong River Commission. Ongoing climate change may aggravate these effects in the near future. Negative impact on fisheries (FS) is often given as a major argument against dams in the Mekong basin. Negative effects consist mainly in the reduction of water volume and, hence, in the size and depth of water bodies important for the fishery sector, and in blocking the path of migrating species. While negative effects would be less in upstream sections of the Mekong, they would be more severe in downstream countries, where the population is more dependent on fisheries than in upstream countries. Cambodia especially would be severely affected. Fishery accounts for nearly 12 per cent of Cambodia’s GDP and is a major source of food for the majority of the population. Fisheries are concentrated around Tonle Sap Lake, whose delicate hydrology could be highly impacted by further changes in the flow regime of the Mekong

174  Handbook of sustainable politics and economics of natural resources River. In 2019, fish catches declined by 80–90 per cent in some parts of the country when the Mekong fell to its lowest level since records began (The Economist, 2020). In most dam developments, local communities have to be relocated (DIS), hence this is rated negative for all countries, especially for Laos and Cambodia, where large dams require relocation of villages. In Cambodia, this would be the case if the government decides to go ahead with dam projects that are currently on hold. Withheld sediments (SED) are reported to contribute to soil and substrate loss in the Mekong Delta. The floodplains of Cambodia are also delicate systems in which sediment deposition plays an important role. The problem is compounded by the mining and export of sand for the production of concrete. Again, Cambodia is especially affected by this type of exploitation. The impact of withheld sediments may be less in other countries, but changes in sediments are an important negative impact, wherever this occurs. Salinization (SAL) is an issue in the drier parts of the Mekong basin – for example, in Northeast Thailand – where the problem occurs as a result of inappropriate irrigation and where it has been exacerbated by the extensive droughts of recent years. Salinization has also been reported in the Mekong Delta of Vietnam, where it occurs as a consequence of drought as well as of sea water intrusion due to lower water levels of the Mekong, partly attributed to upstream dams and partly to drought. The problem of sea water intrusion may in future be exacerbated by rising sea levels due to climate change. Evaluating hazards (HAZ) is complex as it has multiple dimensions. Dams are reported to have reduced flood risks in Laos but may also introduce the new hazard of a possible dam failure. Such a case occurred in Laos for a dam under construction in 2018 with major socio-economic and environmental impacts. The Mekong region is one of the richest areas in biodiversity worldwide. Biodiversity (BIO) will be negatively affected in all countries, but especially in the lower Mekong Basin, where the impact on aquatic ecosystems will be strongest. As in the case of fisheries, the Tonle Sap aquatic environment will be significantly affected by changes in the flow regime. As hydropower (HYD) developments withhold water in the upstream countries, downstream countries are negatively affected in terms of the hydrological balance. In the context of current developments, impacts are still moderate but could become more severe when more hydropower is developed in the future. Social acceptance (SOL) is difficult to rate as there are winners and losers in all countries. Social acceptance is quite strong in China, where dams are seen as a symbol of China’s ascendancy and where the voices of the losers are muted by patriotic sentiment. On the other hand, acceptance of dam projects can be compounded by perceptions of Chinese influence, which can be negative in countries with a large presence of Chinese investors, such as Laos, and in countries with a history of conflict with or domination by China, such as Vietnam and Myanmar. Acceptance in Laos is, nevertheless, high because of the general belief in the benefits of dam construction to the economy. Acceptance in Thailand is influenced by the political conflict between Bangkok-based elites, who favour hydropower development, and rural or civil society actors, who generally oppose them. Wealth distribution (WL) of hydropower is likely to always be unequal in all countries, even though the governments may attempt to redistribute the benefits.

Controversies of developing hydropower in Central and Mainland Southeast Asia  175

6

HYDROPOWER IN CENTRAL AND MAINLAND SOUTHEAST ASIA: A MIXED BLESSING?

Hydropower in CA and MSEA is perceived as an economically affordable and clean source of energy that could offer energy security and economic development to both regions. However, the repercussions in terms of direct use and indirect use effects are multiple, interactive (e.g., hazards could possibly affect economic development) and difficult to measure. To sum up anticipated benefits and negative impacts is an arduous task due to the limited comparability and commensurability among the indicators selected for this study. There is further a need to take into consideration the difference between large and small HPPs, as well as the difference in effects between stand-alone and cascading dams. In addition, more light should be shed on HPPs connected to the national grid versus off-grid installations, which mostly serve remote communities to cover their basic needs. Also, our preliminary assessments would have benefitted from more reliable estimates of the hydropower potential in each country. There is considerable discrepancy between statements on the hydropower capacity and potential (Tables 11.1 and 11.2) in CA. Statements for MSEA are also marred by discrepancy (Tables 11.3 and 11.4), though to a lesser extent. Therefore, we are left with a sense of uncertainty concerning the estimated gains and losses for the HPP installations in both regions. More transparency around the methods used to estimate the hydropower potential in each region would have been helpful. The preliminary assessment conducted in this study suggests that the upstream countries of CA seem to have a clear advantage with respect to economic and energy security aspects that are likely to offset environmental and social impacts. This situation does not appear to be similar in the upstream MSEA countries except for China and Laos. In the case of China, there is an inherent difficulty in estimating the HPP effects, as China is both an upstream country with its own hydropower development program and an HPP developer in most of the other MSEA states. Downstream countries in CA and MSEA appear to benefit, at least partly, from HPP developments within their sovereignty, but negative effects are expected from the planned operation of HPPs in the upstream countries. The problems arising in downstream countries from the operation of HPPs upstream could possibly be defused by a regional energy trade in CA and MSEA. The energy trade could cover the seasonal demand and shortages especially for upstream countries by also providing the opportunity for major economic benefits from export activities. Also, the downstream countries could gain access to clean energy sources by gradually abandoning their dependency on fossil fuels. An energy trade existed within the CA region during the Soviet era in the form of the Central Asia Power System (CAPS), as mentioned in Section 2. The dissolution of CAPS after the independence of CA states (1991) led to unilateral energy security actions, the effects of which are still being felt today. However, there has been a partial reactivation of CAPS, which, despite disruptions and limited trade volume, has already improved energy security and economic development in the region. The fully fledged operation of CASA-1000 is expected to amplify the regional cooperation of upstream countries by improving the overall energy trade in CA. In the case of MSEA, the Greater Mekong Subregion Economic Cooperation Program that was established in 1992 through the Asian Development Bank has reinforced energy cooperation within the region to some extent but apparently not on a level comparable to that in CA. A major problem in the Mekong Basin is the institutional disconnect between the

176  Handbook of sustainable politics and economics of natural resources Upper and the Lower Mekong Basins. We encounter here a fundamental difference between the two basins that is grounded in history. In CA, hydropower development along with a regional exchange mechanism was imposed and centrally controlled by the Soviet Union as a hegemonic power. While the Soviet Union no longer exists, there is the historical precedence and there may even be some institutional memory of past collaboration between upstream and downstream countries – a legacy that can be revived and form the basis of future collaboration between independent states. In MSEA, on the other hand, there is no such historical precedence or legacy, and regional cooperation must be developed from scratch. However, this is complicated by the fact that China ‘occupies the high ground’ not only in terms of controlling the upstream water resources, but also because it seems to be gradually slipping into the role of a regional hegemon with increasing economic and also political influence on at least some of the riparian countries. In contrast to CA, collaboration is needed not exactly between upstream and downstream countries, but between one powerful upstream country and several downstream countries. The regionalization of energy demand and supply requires that infrastructural and political deliberations take place in both regions. However, while political deliberations need to take place, especially in MSEA, both regions are in need of technical deliberations. The transmission lines, converters, stations and the overall technology of the energy network in CA date mostly to Soviet times, and the upstream countries in particular are burdened with outdated machinery and other inefficiencies. The energy network in the MSEA region also needs considerable investment in the upgrading of the transmission systems to accept a large energy volume exchange between the neighbouring countries, except for China and Laos, where state-of-the-art systems for the transmission of energy from Laos to China already exist. Further, there is a prevailing mistrust between upstream and downstream countries as well as among upstream countries. In CA, for instance, the upstream Kyrgyzstan and downstream Uzbekistan refrain from activating energy trade between them due to negative experience of similar undertakings in the past (Xenarios et al., 2021). In upstream MSEA, Vietnam prefers to purchase coal from the open market rather than importing HPP energy from upstream Myanmar at a relatively lower cost (National Bureau of Asian Research [NBR], 2017). The fact that major development of hydropower in CA and MSEA has occurred and is occurring mostly in the uplands is due partly to geography, and partly to the agency of powerful actors: the Soviet Union in CA in the past, and China in MSEA at present. While in both regions there is a lack of coordination between upstream and downstream countries, which can lead to anticipated benefits from hydropower development being counterbalanced by negative economic and environmental impacts, the potential for developing regional cooperation seems to be somewhat better in CA than in MSEA. Moreover, the divergence of hydropower potential estimates among the sources frustrates efforts to compare the HPP effects and possibly arrive at a consensus. Rather than taking the estimates for granted, it is prudent for policymakers to commission studies of the hydropower potential in their respective countries to obtain an informed understanding of hydropower energy resources. Bilateral and multilateral platforms need to be strengthened by also providing more transparency on the energy installation assets in order to improve energy potential estimations and minimize faulty assumptions. The comparative analysis of the CA and MSEA regions and, within them, of the Ara Sea Basin and the Mekong Basin, has shown that hydropower development could benefit the upstream countries in both regions without causing much harm downstream, if coordinating

Controversies of developing hydropower in Central and Mainland Southeast Asia  177 actions, transparency and proper impact evaluation analyses are implemented. These need to be supported by appropriate regulatory frameworks that will also cover the regional perspective, while higher infrastructural support must be provided for the economically weaker countries of CA and MSEA. Capacity building of technical providers and awareness raising at the community level could mitigate the opposition to HPP development by incorporating local views and concerns in the planning and operational processes.

ACKNOWLEDGEMENTS We gratefully acknowledge the valuable support of Ms Seint Shwe Zin and Mr Masood Ahmed in the data collection and compilation of relevant sources on hydropower developments in the Aral Sea and Mekong Basins.

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182  Handbook of sustainable politics and economics of natural resources

APPENDIX Table 11A.1

Hydropower installed capacity (MW) in Aral Sea Basin

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Afghanistan 192

192

192

192

192

193

196

196

208

213

241

245

273

277

280

284

329

333

333

333

Kazakhstan 2260 2260 2260 2260 2263 2249 2251 2251 2263 2265 2273 2274 2574 2588 2675 2678 2696 2726 2756 2778 Kyrgyzstan 2943 2943 2943 2943 2943 2943 2943 2944 2944 2944 3064 3072 3072 3572 3671 3677 3677 3689 3673 3673 Tajikistan 4061 4061 4061 4061 4061 4116 4116 4116 4116 4803 4802 4809 4811 4814 5035 5033 5039 5039 5153 5273 Turkmenistan 1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

Uzbekistan 1596 1596 1596 1599 1599 1599 1599 1630 1630 1630 1746 1746 1746 1746 1761 1761 1794 1839 1915 1939

Source:

IRENA (2020).

2001

458

8081

12 430

14 200

3

Source:

5879

6186

3

15 200

10 787

8890

458

2002

7620

3

16 400

13 004

8600

458

2003

9010

3

16 339

14 094

8000

459

2004

8630

3

16 968

13 980

7900

462

2005

9160

3

16 700

13 653

7700

660

2006

6400

3

17 114

14 004

8200

692

2007

11 360

3

15 800

10 759

7400

592

2008

9330

3

15 900

10 098

6800

754

2009

Hydropower generation (GWh) in the Aral Sea Basin

IRENA (2020).

5959

Uzbekistan

3

Turkmenistan

14 060

Tajikistan

13 682

Kyrgyzstan

7531

Kazakhstan

458

Afghanistan

2000

Table 11A.2

8100

3

16 400

11 255

8022

803

2010

8100

3

16 200

14 309

7900

682

2011

8100

3

16 900

14 179

7600

736

2012

8100

3

17 071

13 097

7731

855

2013

8100

3

16 312

13 298

8263

968

2014

8100

3

16 900

11 093

9269

1001

2015

8100

3

16 803

11 498

11 621

1025

2016

8100

3

17 312

14 204

11 210

1049

2017

5897

3

18 573

14 318

10 395

928

2018

Controversies of developing hydropower in Central and Mainland Southeast Asia  183

2001

10

12

2002

12

2003

13

2004 12

2005 12

2006 12

2007 13

2008 13

2009 13

2010

Hydropower installed capacity (MW) in the Mekong Basin

207

2011 225

2012 683

2013 929

2014 929

2015

930

2016

979

2017

1329

2018

1329

2019

642

Source:

3273

Vietnam

2975

Thailand

317

4118

2975

347

643

4170

2975

347

643

IRENA (2020).

3809

2975

317

Myanmar

641

Laos

4212

2975

422

643

4267

2975

702

684

4507

2975

713

684

4910

2975

738

684

5911

2980

768

684

7184

2987

1422

1835

8652

2987

2212

2550

10 080

2999

2539

2555

13 552

3008

2673

2964

14 718

3015

2812

2969

15 069

3048

2984

3253

15 905

3078

3198

4355

17 131

3088

3264

4813

17 809

3088

3304

5005

17 989

3107

3304

5255

18 069

3107

3304

5973

74 352 77 700 81 070 89 896 100 242 111 790 124 090 139 285 162 403 182 590 199 127 214 597 229 137 258 907 282 750 296 500 305 380 314 384 322 271 326 113

China

10

Cambodia

2000

Table 11A.3

184  Handbook of sustainable politics and economics of natural resources

2001

30

29

2002

40

2003

28

2004 43

2005 50

2006 49

2007 46

2008 47

2009

Hydropower generation (GWh) in Mekong Basin

31

2010 51

2011 517

2012

16 016

6303

2012

3640

17 317

7471

2115

3477

17 535

7299

2079

3186

17 711

6040

2412

3355

17 874

5798

3005

3520

8114

3623

3384

18 885 20 580

8125

3329

3606

24 789

7113

4076

3728

30 142

7148

5261

3388

36 314

5537

6193

8457

42 316

8163

7549

12 991

56 113

8640

7771

12 768

1851

2014 2159

2015

2567

2016

2711

2017

4737

2018

58 113

5611

11 315

15 517

61 027

5323

10 297

15 749

56 904

3878

10 639

16 000

64 672

3651

12 126

17 601

88 747

4833

10 830

19 489

85 097

7783

12 413

21 169

909 610 1 051 150 1 114 515 1 162 589 1 161 947 1 199 200

1015

2013

Note: a. The downward trend presented from 2011 onward may be related with the major floods that hit Thailand in 2011/2012. The hydropower dams had some role in aggravating the floods and probably since 2013 flood protection got priority of hydropower production – and then Thailand experienced a drought in 2015. Source: IRENA (2020).

13 766

Vietnam

6026

Thailanda

1896

Myanmar

3687

Laos

219 782 274 802 285 342 281 052 350 912 394 076 432 531 480 558 579 828 608 439 711 370 688 050 862 797

China

40

Cambodia

2000

Table 11A.4

Controversies of developing hydropower in Central and Mainland Southeast Asia  185

12. Small-scale mining, rural resilience and the Sustainable Development Goals in Sub-Saharan Africa Gavin Hilson, Titus Sauerwein and Matondo Estrela Garcia Cardoso

1 INTRODUCTION Could intensified support to artisanal and small-scale mining (ASM) activities – low-tech mineral extraction and processing – help to stabilize the precarious food security situation and local economies more generally in many rural sections of Sub-Saharan Africa? This is a question worth exploring, given the challenging circumstances a large share of the region’s population faces today. Between 1990 and 2015, the number of extremely poor people in Sub-Saharan Africa rose from 278 million to 413 million; the region’s overall poverty rate currently stands at 41 per cent.1 Fresh development strategies are therefore needed if the hardships of rural African families are to be alleviated and their livelihoods improved. The effort must start with smallholder agriculture, a sector in which most people in Sub-Saharan Africa engage. Today, there are approximately 33 million smallholders (those with plots under 2 hectares) in Sub-Saharan Africa; they produce an estimated 80 per cent of the region’s food (African Smallholder Farmers Group [ASFG], 2013; Wiggins and Keats, 2013). Close to 95 per cent of their production, however, is rain-fed (International Water Management Institute [IWMI], 2010), which puts the tens of millions of rural Africans who depend on them as a source of food and for income under constant strain. Not surprisingly, most people in Sub-Saharan Africa who face absolute poverty are found in the smallholder sector (ASGF, 2013; Pretty et al., 2014). Extreme climate-related events have made their situations even more precarious: today, droughts and floods alone account for 80 per cent of loss of life and 70 per cent of economic losses in the region (Shiferaw et al., 2014). There are already 239 million people in Sub-Saharan Africa who are undernourished (Food and Agricultural Organization [FAO], 2019), and if the needs of the region’s struggling, weather-dependent smallholder farm populations are not attended to urgently, this figure will continue to rise. This leads back to the question raised at the beginning. On the one hand, in Sub-Saharan Africa, the region’s smallholders clearly play an important role in achieving food security and alleviating poverty. On the other hand, their farms are on the frontline of climate change and are therefore under constant threat (ASGF, 2013; FAO, 2009; FAO and United Nations Economic Commission for Africa [UNECA], 2020). Could intensified support to ASM, already the most important rural non-farm activity in Sub-Saharan Africa, help the region’s vulnerable smallholder-based communities build resilience and cope with climate-induced 1 World Bank (2018), ‘Year in review: 2018 in charts’, accessed 12 October 2020 at worldbank​ .org/​en/​news/​feature/​2018/​12/​21/​year​-in​-review​-2018​-in​-14​-charts.

186

Small-scale mining, rural resilience and the Sustainable Development Goals  187 shocks and stresses, and in the process stabilize local food security overall? Significantly, there is a sizable body of evidence that points to ASM dovetailing with subsistence farming across Sub-Saharan Africa, from Ghana, through Sierra Leone, to Tanzania (Hilson, 2016; Maconachie and Binns, 2007). In some cases, ASM and farming appear to be carried out seasonally, complementing one another, whilst in other cases the evidence points to groups of people – typically families – carrying out both activities simultaneously. The importance of ASM in the rural livelihood diversification debate in Sub-Saharan Africa, however, continues to be downplayed, and at times ignored outright, in policymaking and donor circles. This is on account of most ASM activities in the region (at least 95 per cent) being rooted in the informal economy and therefore not being recognized by regulators, although the evidence points to a combination of excessive licensing fees, bureaucratic permit procedures and the tendency for African governments to give preferential treatment to foreign large-scale mining and mineral exploration companies, stifling the sector’s formalization (Hentschel, Hruschka and Priester, 2002; Hilson, Hilson and Maconachie, 2018; International Labour Organization [ILO], 1999). Governments in Sub-Saharan Africa have tended to draw attention to what they see as ASM’s ‘illegality’, at the same time dismissing their own complicity in fuelling the sector’s informality through their deliberate policy stances. They have also skilfully used the theme of illegality to draw attention to – in most cases, exaggeratedly – the range of adverse environmental and social impacts associated with this informality. Increasing the visibility of ASM in debates on livelihoods and rural development in Sub-Saharan Africa, therefore, first requires changing the narrative about the sector. Articulating the role ASM plays in improving food security in the region and how supporting its activities builds resilience in rural communities would be an important step in this direction. This chapter further explores the links between ASM and subsistence farming in Sub-Saharan Africa, with the aim of making a case that supporting communities engaged in both activities builds rural resilience. Despite evidence of there being strong – in most cases, inseparable – interconnections between the two economic activities throughout Sub-Saharan Africa, dynamics that have evolved and become more rooted over generations, both have long been, and continue to be, siloed in the region’s economic development and poverty alleviation strategies. Continued separate policy treatment for each is proving to be a missed opportunity to alleviate poverty and build resilience in rural Sub-Saharan Africa in a more effective and coordinated fashion, as well as stimulate development and growth in the region more broadly. With the Sustainable Development Goals (SDGs) becoming more influential in the region, there seems to be a sense of urgency in donor circles about needing to transcend, when designing policies and technical interventions, the general discussions and debates at the heart of the general themes underpinning each. Yet, in Sub-Saharan Africa, there continues to be a lack of urgency to identify more innovative development solutions that can keep pace with an evolving dialogue around the SDGs. The oversight is perhaps most glaring with the planning and policymaking linked to the region’s rural areas, where populations are vulnerable and poverty stricken, and in desperate need of support. A better synchronization of the developmental work being undertaken in rural sections of Sub-Saharan Africa is therefore essential. This must begin with work being undertaken in the areas of ‘agriculture for development’ and ‘formalization of ASM’. Interventions made in these two areas continue to be packaged around basic ideas around poverty, livelihoods and regulation that no longer inspire, and which have failed to evolve in step with the SDGs. These ideas, therefore, no longer have the traction they once did in donor and policymaking

188  Handbook of sustainable politics and economics of natural resources circles, nor do the messages underpinning them resonate as powerfully with a general public now exposed to newer and more nuanced developments. A likely reason, this chapter explains, is that the work being conducted under the banners of ‘agriculture for development’ and ‘formalization of ASM’ is being carried out in isolation, virtually cut-off from complementary undertakings. Significantly, however, when these narratives are juxtaposed, what becomes clear is how bringing them together with the aim of devising more integrated rural development strategies could provide a much-needed renaissance for each within a regional policy architecture underpinned by the SDGs. This chapter argues that mapping each on to an agenda of food security and rural resilience, with emphasis placed on their interconnectedness, would be an important step toward delivering much-needed development in impoverished rural sections of Sub-Saharan Africa.

2

AGRICULTURE AND ASM IN SUB-SAHARAN AFRICA: CONCEPTUALIZING THE LINKS

Given the deeply rooted and inseparable linkages between ASM and smallholder farming across Sub-Saharan Africa, it is surprising how little effort has been made over the years to even consider developing integrated regional rural development strategies that prioritize support for both activities and the families involved. There is a burgeoning body of evidence, gathered over the past two decades, which captures in depth the importance of ASM to millions of farm-dependent households across Sub-Saharan Africa (e.g., Banchirigah and Hilson, 2010; Hilson, 2016; Hilson and Garforth, 2013; Hilson and Van Bockstael, 2011; Kamlongera, 2013; Maconachie, 2011; Maconachie and Binns, 2007; Pijpers, 2014). It offers a glimpse of the role played by the two activities in the livelihoods of these families, and how this diversification helps the communities they are part of buffer against shocks and stresses. What this literature does, very importantly, is paint an accurate picture of these diversified livelihood portfolios. It also weighs in on the changing roles played by each activity in numerous rural communities across Sub-Saharan Africa. For example, agriculture has long been recognized in the donor community (by the World Bank, FAO, International Fund for Agricultural Development [IFAD], United Nations Children’s Fund [UNICEF] and UNECA) as the main source of employment in the region (Maconachie and Hilson, 2018). Projects that its key players have funded to support rural livelihoods in Sub-Saharan Africa reflect this position, making the smallholder the centrepiece of support strategies in recognition of the fact that, of the more than 570 million farms worldwide, more than 90 per cent ‘are run by an individual or a family and rely primarily on family labour’ (FAO, 2014a, p. 89). The strategy has remained largely unchanged since the 1970s, despite evidence that points to the fact that the economic and social dynamics of the region and associated income-earning activities have since changed noticeably. This includes the emergence of ASM as the most important rural non-farm activity in Sub-Saharan Africa and evidence that points to it becoming, in a large proportion of the region’s rural areas, an even more reliable source of income for families than agriculture. A quick glance at the economic timeline for Sub-Saharan Africa explains why. The structural adjustment programmes (SAPs) implemented across the region under the auspices of the World Bank and International Monetary Fund, beginning in the 1970s and 1980s, would have a profound impact on ASM. The neoliberal reforms implemented under

Small-scale mining, rural resilience and the Sustainable Development Goals  189 structural adjustment were designed to liberalize trade and attract foreign direct investment (FDI) through deregulation (e.g., reducing taxes and government intervention), which were seen as cornerstone strategies for bolstering the region’s floundering economies, whilst simultaneously facilitating development and alleviating poverty (Weber-Fahr, 2002). But whilst these changes proved to be an effective recipe for attracting FDI, they would also cause significant unemployment. A growing number of the region’s unemployed have found refuge in ASM because of its low barriers to entry (Banchirigah, 2006; Banchirigah and Hilson, 2010; Spiegel, 2009). These burgeoning masses of people include hundreds of thousands of smallholder farmers who, unable to purchase crucial agricultural inputs such as fertilizers and pesticides that were no longer subsidized by the state, quickly realized they could not survive financially on their diminished and devalued harvests alone. Many of the region’s subsistence farm-dependent people therefore transitioned into ASM, solely to supplement their income. This pattern of diversification, however, was predictable. For generations, hundreds of thousands of the region’s families have routinely moved in and out of ASM and farming – albeit under different circumstances – as well as a range of other income-earning activities. In their assessments, scholars commonly attribute the long-standing connection between the activities to seasonality: how, during the dry season, when riverbeds are low, people tend to engage more in mining and then shift to farming during the rainy season (Banchirigah and Hilson, 2010; Maconachie and Binns, 2007). Traditionally, it is the fluidity of movement between these activities that has enabled communities in rural Sub-Saharan Africa to build resilience over generations, as well as to cope with unanticipated shocks and stresses, the seriousness of which cannot be overstated in a region scarred by poverty. This was very recently on display during the Ebola crisis in West Africa where, as Maconachie and Hilson (2018) reported, drawing on findings from research conducted in Sierra Leone, established linkages between ASM and farming provided pathways to survival. Over the past two decades, in households engaged in both ASM and agriculture in rural Sub-Saharan Africa, the roles of each have changed significantly, with the former increasingly becoming the main source of income and the latter being viewed as a source of food for the families involved (Banchirigah and Hilson, 2010). The importance of ASM as an income-earning activity among the region’s farm households has been captured in considerable depth in several country cases, including Ghana (Hilson and Garforth, 2013), Liberia (Hilson and Van Bockstael, 2011), Mali (Hilson and Garforth, 2012), Malawi (Kamlongera, 2011) and Sierra Leone (Maconachie and Binns, 2007; Pijpers, 2014). Income generated from ASM is likely to become even more important for these households, given the precarious food security situation in Sub-Saharan Africa (Table 12.1). From the data available, the outlook is bleak: the percentage of undernourishment in the region remains the highest in the developing world, due to its rapid population growth (Organisation for Economic Co-operation and Development and Food and Agricultural Organization [OECD/FAO], 2016a). Moreover, the prevalence of hungry people in the region reached 239 million in 2010,2 and today there are approximately 347 million people here who are at least ‘moderately food insecure’ (FAO/UNECA, 2020). The situation is bound to worsen due to climate change, with the World Bank projecting that a 1.5–2°C temperature increase would lead to the region’s farmers losing between 40 and 80 per cent of cropland by the 2030s and 2040s (World Bank, 2013). At the same time, its officials 2 FAO Regional Strategic Framework for AFRICA (2010–2015), accessed 4 October 2020 at www​.fao​.org/​3/​am054e/​am054e00​.pdf.

190  Handbook of sustainable politics and economics of natural resources Table 12.1

Food insecurity and undernourishment levels in selected countries in Sub-Saharan Africa

Country

Prevalence of

Prevalence of

Moderate or Severe

Undernourishment

Food Insecurity

(% of Population)

Major Commodities Mined on an Artisanal and Small Scale

(% of Population) Liberia

84.96

38.8

Diamonds, gold

Sierra Leone

83.02

23.0

Diamonds, gold

Malawi

81.88

17.7

Coloured gemstones, development minerals

Guinea

72.75

14.8

Diamonds, gold

Togo

66.94

17.1

Development minerals

Niger

66.42

11.6

Gold

Namibia

65.97

29.7

Gold, development minerals

Angola

64.55

26.4

Diamonds, development minerals

Cameroon

62.25

7.7

United Republic of Tanzania

61.22

31.5

Gold, diamonds, coloured gemstones

Kenya

56.54

25.0

Gold, coloured gemstones, development minerals

Ghana

49.55

6.2

Burkina Faso

40.68

20.0

Nigeria

36.43

9.6

Gold

Gold, diamonds, development minerals Gold Gold, development minerals, coloured gemstones

Note: Data extracted from ‘Indicator 2.1.1 Prevalence of undernourishment’, www​.fao​.org/​sustainable​ -development​-goals/​indicators/​2​.1​.1/​en/​; ‘Indicator 2.1.2 Prevalence of moderate or severe food insecurity in the population, based on the Food Insecurity Experience Scale’, www​.fao​.org/​sustainable​-development​-goals/​indicators/​ 2​.1​.2/​en/​; both accessed 14 October 2020.

see farming as the solution, stemming from the belief that growth originating from agriculture is two to four times more effective at reducing poverty than that in other sectors (World Bank, 2015). In the short term, therefore, innovative solutions and strategies will be needed to support farm-based family-oriented agriculture. Why, then, given this position, do existing linkages between farming and ASM continue to be overlooked or ignored outright in policymaking and donor circles as a foundation for catalysing economic development and alleviating poverty in rural sections of Sub-Saharan Africa? It becomes even more inexplicable when the position of donors is taken into account: how most appear to recognize that ‘rural people in many parts of the world have, over long time scales, adapted to climate variability, or at least learned to cope with it’ and ‘have done so through farming practices and use of wild natural resources (often referred to as indigenous knowledge or by similar terms), as well as through diversification of livelihoods and through informal institutions for risk-sharing and risk management’ (Dasgupta et al., 2014, p. 618). The rhetoric emerging in the donor community close to a decade ago suggested that organizations recognized the importance of livelihood diversification as a strategy for farm-dependent households to buffer against shocks and stresses, particularly in Sub-Saharan Africa. This was especially true of the FAO, which went as far as embedding this idea in policies, plans and strategies. For example, at the 27th Session of the FAO Regional Conference for Africa, 23–27 April 2012, it was explained under the ‘Focused Areas of Priority Action for 2014–15’ that the ‘FAO will focus on increasing agricultural productivity and encouraging diversified production systems, enhancing value addition and food quality, facilitating market access and trade and strengthening public–private cooperation’ (FAO, 2012, p. 10). These complemented the ideas enshrined in the FAO Regional Strategic Framework for Africa (2010–2015), in

Small-scale mining, rural resilience and the Sustainable Development Goals  191 which it is stated: ‘Activities towards the achievement of RAF [Regional Office for Africa] priorities include, among others, strengthening capacity to formulate and implement coherent policies on hunger, food security and malnutrition, developing governance framework for sustainable natural resources management and enhancing market development through greater diversification and creating opportunities to add value to agriculture produce’.3 The ASM sector, however, has yet to feature in donor-led discussions and policy dialogues on livelihood diversification in Sub-Saharan Africa. There is no obvious explanation for why this is the case. It may be the perception that the sector poses a threat to agriculture and, ultimately, food security, due to its environmental impact, a point raised by several scholars (Africa Center for Economic Transformation [ACET], 2017; Maconachie and Binns, 2007; Ofosu et al., 2020). Notable impacts include mass deforestation, soil erosion, acid drainage and chemical contamination. The more likely explanation is the sector’s largely informal nature, a point that will be elaborated on in the next section of the chapter. Host African governments tend to have very little information about ASM on hand because of its widespread informality; this makes monitoring and regulating activities challenging, and in some cases, impossible. In Sub-Saharan Africa, the case for legalizing and supporting ASM, and featuring it more heavily in the region’s rural development policies and strategies, is already built on how the sector supports rural households economically even in its predominantly informal state. The case for ‘formalization of ASM’ in Sub-Saharan Africa would have greater appeal if the narrative were rewritten to underscore how the sector helps to stabilize food security and builds resilience in the region’s rural areas.

3

TWO NARRATIVES, TWO DIRECTIONS AND A LARGE DIVIDE

The donor community’s position on whether better-supported smallholder farming activities can address food insecurity challenges and build resilience in rural Sub-Saharan Africa is unclear. It portrays the region’s smallholder sector as a struggling enterprise, incapable, in its current state, of supporting the individuals directly involved, let alone being able to satisfy the needs of entire communities. As indicated, farms of less than 2 hectares (ha) account for more than 80 per cent of all farms at the global level but combined only account for 12 per cent of total productive agricultural land (FAO, 2014a; Lowder, Skoet and Raney, 2016). The data available paint a precarious picture for most of its countries. In most cases, the national average plot size falls well short of the 2 ha international average (see Table 12.2) and labour productivity linked to the agriculture within these plots could be as much as six times lower than that of non-farm activities. With limited mechanization, the amount of land used for crop cultivation by most households remains small (between 0.3 and 0.51 ha/adult), which does not bode well for a continent where at least 24 countries are suffering from a food crisis (Deininger, Savastano and Xia, 2018; FAO, 2015; Lowder et al., 2016; McCullough, 2017). The concern becomes even more serious when climate change is considered, the persistent drought and flooding that the region’s smallholders routinely face a glimpse of what likely lies ahead (Dasgupta et al., 2014; FAO, 2015; Ringler et al., 2010). 3 FAO Regional Strategic Framework for Africa (2010–2015), accessed 4 October 2020 at www​ .fao​.org/​3/​am054e/​am054e00​.pdf.

192  Handbook of sustainable politics and economics of natural resources Table 12.2 Country and Year

Smallholder farm data from selected countries in Sub-Saharan Africa Number of Smallholder Farms

Average Farm Size (ha)

Ethiopia, 2012

7 309 739

0.78

Ghana, 2013

2 245 165

1.56

Kenya, 2005

3 615 094

0.53

Malawi, 2011

1 825 776

0.47

Niger, 2011

1 569 599

2.91

14 019 622

0.53

Nigeria, 2013 Tanzania, 2013

4 964 306

1.2

Uganda, 2012

3 617 478

0.97

Note: FAO (n.d.), ‘Family farming knowledge platform’, accessed 4 November 2020 at www​.fao​.org/​family​ -farming/​home/​en/​.

Yet, despite the productivity limitations, concerns around climate change, and the very obvious logistical and developmental challenges smallholders face in Sub-Saharan Africa overall, the donor community remains adamant that ‘[f]amily farms are part of the solution for achieving food security and sustainable rural development’ in the region (FAO, 2014a, p. xvi). This stems from the belief that ‘[a]gricultural development is one of the most powerful tools to end extreme poverty, boost shared prosperity and feed a projected 9.7 billion people by 2050’, and, despite evidence at least from the smallholder sector which suggests otherwise, that ‘[g]rowth in the agriculture sector is two to four times more effective in raising incomes among the poorest compared to other sectors’.4 There is little evidence to suggest that smallholder farming will cease being a centrepiece of rural development and poverty alleviation strategies in Sub-Saharan Africa because of donors’ confidence that ‘the world’s food security and environmental sustainability depend on the more than 500 million family farms that form the backbone of agriculture in most countries’ (FAO, 2014a, p. 93). There are grounds for ASM being integrated into this ‘smallholder-first’ strategy through policy interventions that aim to promote livelihood diversification. Several donors have started acknowledging the importance of livelihood diversification in farm-dependent areas of Sub-Saharan Africa, although rarely has ASM featured in these discussions. Nevertheless the view that ‘[n]onfarm enterprises in rural Sub-Saharan Africa are most often operated for economic necessity and survival’ (Nagler and Wim Naudé, 2017, p. 75) maps visibly on to the ‘poverty-driven’ narrative that has long dominated discussions about why the region’s ASM sector continues to proliferate so rapidly. The rhetoric emerging from the FAO suggests that its officials acknowledge that smallholder agriculture is incapable of lifting rural communities out of poverty in Sub-Saharan Africa on its own, and that diversification may have a role to play. Many such farmers supplement both income and nutrition from other parts of the landscape, through forests, pastures and fisheries and from off-farm employment. For these farmers, diversification and risk-spreading through these and other livelihood strategies will be necessary (FAO, 2014a, p. xi). As will be explained, however, bringing together ‘agriculture for development’ and ‘formalization of ASM’ as one integrated strategy to tackle poverty and facilitate economic

4 International Development Association (n.d.), ‘Agriculture’, accessed 3 October 2020 at https://​ida​.worldbank​.org/​results/​agriculture.

Small-scale mining, rural resilience and the Sustainable Development Goals  193 development in rural Sub-Saharan Africa would by no means be straightforward, given how each is handled by specific and specialized institutions. 3.1

Navigating the Institutional Framework

Designing and implementing a coordinated rural development approach that features both ‘agriculture for development’ and ‘formalization of ASM’ as its centrepieces would require securing the participation of key institutions which rarely stray outside of their own, well-defined areas of focus. It would also require involving them in dialogues that their researchers have unlikely ever been a part of. In the case of ‘agriculture for development’, the institutions in question are the World Bank and the FAO: in Sub-Saharan Africa, the ASM sector has never featured in the agriculture-focused work of either. The World Bank has long been the leading financier of agricultural projects in developing countries, supporting an array of interventions in several areas seen as key to supporting farm activity, from extension through to technology transfer. Its approach to lending in this area, however, has remained largely the same over the past five decades. This is in spite of the emergence of a nuanced climate change and development agenda that, in Sub-Saharan Africa, has heavily prioritized and showcased rural resilience and stressed the importance of protecting the welfare of pastoralists and farm families (Cairns et al., 2013; International Union for Conservation of Nature and Natural Resources [IUCN], 2010). Publication of the World Bank’s World Development Report 2008: Agriculture for Development (World Bank, 2007a) was supposed to provide clarity on the organization’s position on agricultural lending, seen hitherto as very tenuous and ambiguous. Significantly, and as conceded by Bank officials themselves, up until this point, ‘[t]he World Bank has not had a separate strategy for agriculture in Africa except as part of its wider rural development strategies, and over time the agriculture strategy was subsumed in a broader rural focus’ (World Bank, 2007b, p. xxv). Despite not having a clear lending strategy in place for agriculture, during the 25 preceding years the Bank provided ‘the countries of the Africa region’ with US$2.8 billion in investment lending in agriculture (or 8 per cent of total Bank investment lending to the region). Much of this lending took the form of farm components of larger rural projects, implemented alongside an additional 77 Development Policy Loans with agricultural components. Little would change, however, following publication of World Development Report 2008. The document does little more than rationalize the Bank’s stance on agriculture hitherto, which was to support and incubate the smallholder. This continues to be the approach taken by the organization today, guided by the belief that ‘[a]gricultural growth has special powers in reducing poverty across all country types’ (World Bank, 2007b, p. 6). Specifically, and as elaborated by Veltmeyer (2009), Bank officials believed that ‘[t]he key to improving the competitiveness of smallholder farming in agriculture-based countries, and so reducing rural poverty…is to make markets work better in the production of traditional staples and non-traditional agricultural (and resource-based commodity) exports, and in higher value crop, livestock and horticultural products, by integrating smallholders into global agri-food commodity chains, deepening and broadening the export orientation of agricultural production’ (p. 404). Officials have tended to focus on the conditions faced by smallholders to justify this approach (World Bank, 2005). By comparison, whilst the FAO’s modus operandi has evolved considerably since its inception in 1945, its objective has remained largely unchanged (FAO, 2015; Phillips, 1981).

194  Handbook of sustainable politics and economics of natural resources At the time of the organization’s inaugural meeting in Quebec, the impacts of World War II were being felt globally, and ‘with Europe in ruins, hunger had become a real threat to many’ (FAO, 2015, p. 17). Since moving its headquarters to Rome in 1951, the FAO has continued to work to protect the interests of smallholders and facilitate the transfer of food surpluses from developed countries to areas in need in developing countries. Much like the World Bank, the FAO, an inter-governmental organization with quasi-universal membership and one of the first specialized agencies (OECD/FAO, 2016b), has made building the capacity of the smallholder a major focus of its operation. This has particularly been the case in Sub-Saharan Africa, where, consistent with the organization’s goals of ‘Eradicating hunger and achieving food security’ and ‘Tackling climate change’ (FAO, 2015), it has worked with the region’s herders and smallholders to build their capacity in a bid to avert local food crises and improve nutrition amongst the poor (FAO, 2014b, 2016). More dynamic actions themed around more contemporary development topics that resonate more powerfully with a more enlightened general public, including livelihoods and resilience, began to take shape following the onset of the financial crisis of 2008. Each aligned closely with regional priorities identified by the FAO’s Regional Office for Africa and the organization’s FAO Regional Strategic Framework for Africa (2010–2015). With projects that fall under the theme ‘agriculture for development’, both the World Bank and FAO work with the ministries in charge of agriculture and/or food production. Policy treatment of the ‘formalization of ASM’ has been equally siloed, typically handled by national ministries of mines and geological surveys or their equivalents. The World Bank is also heavily engaged in support for formalizing ASM but through a separate section focused on ‘extractive industries’. Over the years, numerous multimillion-dollar mining technical support programmes have been financed by the Bank across Sub-Saharan Africa. Each has a devoted section for ASM support and/or formalization; more recently, many standalone ASM formalization projects have been launched. For more than three decades, efforts to formalize ASM in Sub-Saharan Africa have been buoyed by dialogue that draws attention to the sector’s livelihoods dimension, in particular its contribution to employment and ability to create addition downstream and upstream economic activities (Barry, 1996; Hentschel et al., 2002; Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development [IGF], 2017; ILO, 1999). There have also been claims, with a continuous stream of supporting evidence, that ASM is ‘poverty driven’, providing employment to tens of millions of otherwise jobless people (Banchirigah, 2006; Mkodzongi and Spiegel, 2020). The ‘poverty-driven’ narrative has had a profound impact on the rhetoric espoused by the donor agencies, including the World Bank and United Nations, and several bilateral organizations that have sponsored work aimed at formalizing and supporting ASM in recent years, notably the German development agency GIZ, United States Agency for International Development (USAID) and SWISSAID. Yet, despite being managed exclusively by government agencies and divisions of donor agencies that focus on mining issues, ‘formalization of ASM’ has failed to gain much traction in the extractive industries and development agenda in Sub-Saharan Africa. This is unsurprising, given the dearth of knowledge about the informal sector in which its activities are firmly embedded, and the actors who populate it. Without adequate information about the sector’s production, the networks its activities supply and the quantities of minerals and finances that flow through it, the ‘formalization of ASM’ has been viewed and consequently treated as an ‘add-on’ by those driving an extractive industries and development agenda heavily focused on transparency and anti-corruption. This is why, as officials at the ILO observed, more than

Small-scale mining, rural resilience and the Sustainable Development Goals  195 two decades ago, at a time when some of the inaugural efforts were being made to formalize ASM in Sub-Saharan Africa, that ‘once a project has been left to stand on its own, it has often gently wound down due to a lack of continued government support or supervision’ (ILO, 1999, p. 72). 3.2

Synchronizing Two Agendas?

For there to be any realistic chance of alleviating significant poverty, building resilience and facilitating economic development in impoverished farm-dependent stretches of Sub-Saharan Africa, effective solutions and strategies must be formulated quickly. They must be firmly anchored in an SDGs framework that has at its core a specific group of topical themes such as gender equality, youth unemployment and food security. The problem is that the work being carried out under ‘agriculture for development’ and ‘formalization of ASM’ has barely evolved from its original form, overseen almost exclusively by the same institutions. The opportunity to interrogate the ‘agriculture for development’ narrative came and went following publication of the World Development Report 2008 (World Bank, 2007a). Rather than exploring ways in which smallholder activity could be included as part of a more dynamic suite of options for facilitating development, the report simply reiterated the importance of supporting individual farmers on the basis of ‘the large absolute numbers of the poor in rural areas, the strong dependence of non-farm activities in most SSA on demand emanating from the agricultural sector, and consequently the evidence that the income and poverty multipliers are greater for the agricultural sector than the non-agricultural sector’ (Staatz and Dembélé, 2007, p. 4). Significantly, the report underscored how the World Bank’s position on ‘agriculture for development’ in Sub-Saharan Africa remained unchanged: specifically, how officials continued to invest in the idea that bolstering smallholder activity was a key to raising living standards in the region, and that liberalized national markets will remain the primary strategy for facilitating productivity increases and poverty alleviation (Havnevik et al., 2007). This was despite the growing number of people across Sub-Saharan Africa branching out of agriculture, a sign of its reduced economic viability as a source of wages (Banchirigah and Hilson, 2010); little evidence to suggest that smallholder farming was capable of delivering both equity and efficiency in a level-playing field (Oya, 2011); and the region’s agricultural producers or peasants showing little interest in adapting to the requirements of modern farming (Veltmeyer, 2009). The decision to continue championing this strategy has looked even more questionable since FAO officials admitted that ‘[w]hile agriculture and agricultural innovation can improve livelihoods, they are unlikely to be the primary means of lifting this group of farmers out of poverty’ and that ‘[h]elping such farmers escape poverty will require broad-based efforts, including overall rural development policies and effective social protection’ (FAO, 2014a, p. 90). The most likely explanation for the continued acceptance of an ‘agriculture for development’ strategy that lacked nuance was the emergence of a food security and resilience agenda at the time. Over the past decade, this agenda has received significant visibility in debates on climate change. In Sub-Saharan Africa itself, it has been the idea of ‘agriculture for development’ not the outdated, ineffective and siloed strategies pursued repeatedly in this area over the past three decades that has found its way into these debates. ‘Agriculture for development’ has received renewed emphasis and focus simply because of the ‘important role of the agricultural sector in contributing to food security’ (OECD/FAO, 2016a, p. 60), buoyed

196  Handbook of sustainable politics and economics of natural resources by the objectives enshrined in important regional policy initiatives such as the Comprehensive Africa Agriculture Development Programme (CAADP)5 and the Three Regional Initiatives.6 The FAO has matched its rhetoric on livelihood diversification in Sub-Saharan Africa by investing heavily in programmes that aim to build resilience in rural communities, particularly those affected by climate change.7 The organization’s focus, however, has been largely on crop diversification, which explains why ASM has never featured in any of the organization’s resilience programmes in Sub-Saharan Africa, nor in discussions its officials have led on natural hazards, food chain threats and protracted crises. A recent presentation delivered to members of the Resilience Unit FAO Headquarters in Rome confirmed as much: broad consensus among attendees that diversified livelihood portfolios help to buffer against shocks and stresses, but at the same time, confirmation of an audience that, despite appearing to recognize ASM’s potential, was not ready to embrace the sector being a part of the poverty solution in rural Sub-Saharan Africa (Hilson, 2017). On the flip side, whilst donors have long recognized the livelihoods dimension of ASM, rarely has it been used to strengthen the case in support of the sector’s formalization. The idea that ASM is a ‘poverty-driven activity’ was first tabled and debated at an international plenary nearly three decades ago. Research that has since been carried out has confirmed this to be the case, particularly in Sub-Saharan Africa, where entrenched poverty and joblessness has, very visibly, fuelled movement into ASM. Detailed cases studies from a range of countries, including Ghana (Kumah, Hilson and Quaicoe, 2020), Liberia (Hilson and Van Bockstael, 2011), Mali (Hilson and Garforth, 2012), Mozambique (Spiegel, 2009), Madagascar (Cartier, 2009); DR Congo (Geenen, 2012; Geenen and Verweijen, 2017), Malawi (Kamlongera, 2011) and Sierra Leone (Engwicht, 2018), capture this phenomenon in considerable detail. Complementary work has been carried out simultaneously, drawing attention to the adverse social and environmental impacts associated with this largely unregulated, rapidly proliferating informal ASM sector now rooted in the region. Emphasis has been placed on concerns such as the exploitation of women working at sites, child labour and pollution from mercury used to amalgamate gold. The case in support of ‘formalization of ASM’ in Sub-Saharan Africa has tended to emphasize these visible concerns, with special emphasis on how improved regulation and legalization of the sector’s activities would transform the sector into a more manageable and monitorable entity. Moreover, the architects of the Africa Mining Vision8 and the region’s ratifying governments more specifically have made it clear that formalization is a key to stimulating innovation 5 The New Economic Partnership for African Development (NEPAD) is the economic development programme of the African Union, established in 2001. The CAADP is the agricultural programme for NEPAD, established in 2003 to facilitate improved agricultural productivity by at least 6 per cent annually by 2015. It seeks to facilitate increased investment in agriculture by 10 per cent of national budgets annually to ‘eliminate hunger and reduce poverty through agriculture’ (Pretty et al., 2014, p. 5). 6 The FAO’s Three Regional Initiatives for Africa, developed by its FAO Regional Office for Africa, are as follows: (1) accelerate action by countries in the fight against hunger (Africa’s Commitment to End Hunger by 2025); (2) promote inclusive, sustainable, innovative production and post-production practices; and (3) strengthen resilience among vulnerable farming and pastoral communities (FAO, 2019). 7 See FAO (n.d.), ‘Resilience: areas of work’, accessed 3 October 2020 at www​.fao​.org/​ resilience/​areas​-of​-work/​en/​. 8 The Africa Mining Vision is a pathway conceived specifically to facilitate development linked to mineral extraction in the continent. It was adopted by Heads of State at the February 2009 African

Small-scale mining, rural resilience and the Sustainable Development Goals  197 in ASM and transforming it into a more efficiently managed and mechanized sector (African Union, 2009). With the passing of time, however, the poverty-driven dimension of ASM in Sub-Saharan Africa has become rapidly overshadowed by donor dialogues around technological advancement, operational efficiency and production in the sector. Consequently, and like the current outmoded iteration of the ‘agriculture for development’ narrative in Sub-Saharan Africa, the case in support of ‘formalization of ASM’ in the region is also rapidly losing momentum. An infusion of new ideas is desperately needed to reshape this narrative; phrases such as ‘poverty-driven activity’ no longer galvanize the general public, nor do host governments get particularly excited anymore about the potential for technological development and innovation in the sector. Efforts to rebrand ‘formalization of ASM’ in Sub-Saharan Africa must begin with showcasing more effectively the most significant aspect of the sector’s livelihoods dimension that continues to be heavily ignored: its links with agriculture. The SDGs provide a platform for nuancing this dialogue to include a food security angle, as well as for extending the debate on ‘agriculture for development’ in Sub-Saharan Africa to include ASM, again the region’s most important rural non-farm activity. The next section of the chapter weighs in on the rationale for such a move and identifies the areas of Sub-Saharan Africa this work should initially be concentrated.

4

SMALLHOLDER FARMING AND ASM: CORNERSTONES OF A FRAMEWORK FOR RESILIENCE AND FOOD SECURITY IN SUB-SAHARAN AFRICA?

An important source of inspiration for the ideas developed in this section of the chapter was Zhang et al. (2020), who have carried out one of the few studies on food security and ASM in Sub-Saharan Africa. Focusing on the case of Guinea, the study introduces a community resilience angle by examining, specifically, how local food vendors cater to ASM operators at sites. The angle introduced in this chapter, however, provides a far more holistic overview of the linkages between ASM and smallholder activity, specifically how their synergies build resilience and stabilize food security in rural stretches of Sub-Saharan Africa. The chapter seeks to move the discussion beyond the site level and speak to issues at the heart of the SDGs. Framing ‘agriculture for development’ and ‘formalization of ASM’ in the context of food security and rural resilience would give renewed importance to both narratives under the SDGs framework, through which both are mutually reinforced. 4.1

Navigating the Policy Machinery

The African Development Bank projected, a decade ago, that Africa would need, up until at least 2030, US$20–30 billion in assistance to offset costs associated with adaptation to climate change (African Development Bank, 2011). In Sub-Saharan Africa, this begins with safeguarding smallholder production, preservation of which is the key to navigating the region through future food crises. Rises in population are expected to place even more strain Union Summit, following the October 2008 meeting of African Ministers responsible for Mineral Resources Development. See https://​au​.int/​en/​ti/​amv/​about/​, accessed 3 August 2021.

198  Handbook of sustainable politics and economics of natural resources on fragile food production systems in Sub-Saharan Africa in the years ahead: whilst global demand for cereal and meat products is expected to slow after 2025, it is projected to accelerate in the region annually from 2.26 to 2.60 per cent, and 1.42 to 3.65 per cent, respectively (Ringler et al., 2010). The donor community conceded that adaptation will require modifying agricultural management practices to position smallholders to better cope with changes in climate. But for the likes of the World Bank and FAO, as well as host African governments, there seems to be recognition that an integral part of adaptation strategies will entail supporting the development of rural non-farm activities. Importantly, however, this exercise must entail recognizing and supporting existing linkages, foremost the visible connections smallholder production has with ASM. For this linkage to have any chance of being legitimized in policy, ASM will, of course, need to be formalized. An emphasis on food security and resilience, which speaks directly to SDG1 (‘No Poverty), SDG2 (‘Zero Hunger’) and SDG8 (‘Decent Work and Economic Growth’), would go a long way toward redefining ASM’s role in rural development and poverty alleviation strategy in Sub-Saharan Africa, and facilitate a much-needed bolstering of efforts to formalize its operations. The work being undertaken by donors in the areas of ‘agriculture for development’ and ‘formalization of ASM’ continues to be heavily siloed. Perhaps for the first time, however, the policy frameworks now in place in the region offer the opportunity to showcase both as centrepieces of a rural development strategy anchored in the themes of food security and resilience. Any push to do so will likely continue to encounter some resistance – at least initially – because of the newness of this approach and possibly its perceived radicalness. But with the suite of policy frameworks now in place in Sub-Saharan Africa shaped heavily by, or aligned with, the SDGs, designing more comprehensive rural development strategies that feature both activities side-by-side would no longer be unprecedented provided that what is being proposed is being done with priority economic objectives in mind. Officials at the FAO would likely embrace such a change. The series of initiatives and agreements it ushered through in 2015–16 to reset global development agendas and that provide a context for its work in the future fall under the SDGs. Doing so has committed the FAO to fulfilling the interconnected goals and objectives enshrined in the Addis Ababa Action Agenda, the Paris Agreement on Climate Change, the World Humanitarian Summit, the Secretary-General’s Agenda for Humanity, the Second International Conference on Nutrition, the UN Summit for Refugees and Migrants, the XIV World Forestry Congress and the United Nations Forum on Forests Ministerial Declaration (FAO, 2016). Whilst the World Bank, due to its sheer size and additional layers of bureaucracy, may be more challenging to engage at the outset, perhaps initially going through the Global Environmental Facility (GEF),9 for which it serves as the trustee, would be the appropriate starting point. The GEF could, in fact, be a strategic entry point for aligning ‘agriculture for development’ and ‘formalization of ASM’ because it has funded projects in both areas: in the case of the former, the Resilience Food Systems programme, and the latter, planetGOLD.10

9 The GEF was established on the eve of the 1992 Rio Earth Summit to help tackle the planet’s most pressing environmental problems. It has since provided over US$20 billion in grants and mobilized an additional US$112 billion in co-financing for more than 4800 projects in 170 countries. 10 The GEF co-funded the launch of the Resilient Food Systems programme, a five-year initiative (2017–22) committed to fostering sustainability and resilience for food security in Sub-Saharan

Small-scale mining, rural resilience and the Sustainable Development Goals  199 4.2

Starting Point: Targeting Low-hanging Fruit

For each of the countries listed in Table 12.3, a convincing case could be made that more effective food security strategies are needed and that ASM could play an expanded role in safeguarding rural smallholder systems. To build this case, however, results will be needed rather quickly, which is why the region’s countries where subsistence food systems have been most visibly compromised by extreme events and are under constant strain should be targeted initially. This makes Malawi and Mali two of several obvious priority destinations. Malawi: coping with famine Malawi is an intriguing case because it has never been viewed as a strategic destination for investment in mining, nor has its ASM sector received much coverage. The outlook has changed, however, over the past decade. Malawi has finally turned its attention to overhauling its Minerals and Mining Act, implemented in 1981, replacing it with a new Minerals and Mining Act, 2018. It has also, very importantly, drafted and implemented a National Artisanal and Small-Scale Mining Policy, which will be necessary if the pockets of gold rush activity surfacing across the country at present are to be regulated and the hundreds of thousands of people engaged in other types of ASM activities are to be adequately supported (Kamlongera, 2020). Malawi is small and landlocked, with a population expanding rapidly at 3 per cent per year. Most of its population is dependent on agriculture, which has put individual families in precarious positions, exposing them to prolonged dry spells and flash floods. Malawi’s challenges are compounded by a volatile economy, high rates of HIV/AIDS infection (at 9.6 per cent), a low primary school completion rate (at 51 per cent) and a high level of stunting (at 37 per cent for children under five).11 Given these challenges, the United Nations World Food Programme supports the government in attaining a food- and nutrition-secure and resilient future, guided by the SDGs with a particular emphasis on achieving zero hunger (SDG2). The World Food Programme has been present in Malawi since 1965 (World Food Programme, 2020a). For Malawi, however, the implementation of mining legislation has proved timely. Unlike most other countries in Sub-Saharan Africa, the government has the opportunity to think more creatively about the role ASM can play in the country’s development because its regulatory framework for the extractive industries is still evolving. This includes the possibility of integrating ASM into programmes being funded under the World Food Programme. Mali: coping with desertification Landlocked Mali is one of the world’s poorest countries. Approximately 60 per cent of its population is poverty stricken, the majority in the south, where 90 per cent of its people live. Over Africa, particularly areas of the region plagued by low crop and livestock productivity. The planetGOLD programme was launched to improve the production practices and work environments of artisanal and small-scale gold miners, initially in nine countries. See GEF (2020), ‘Food security’ at https://​www​ .thegef​ .org/​ topics/​ food​ -security; and GEF (2019), ‘planetGOLD: making a world of difference in small-scale gold mining’, at www​.thegef​.org/​publications/​planetgold​-making​-world​-difference​-small​ -scale​-gold​-mining; both accessed 3 November 2020. 11 Data obtained from FAO (n.d.), ‘Malawi’, accessed 4 October 2020 at http://​faostat​.fao​.org/​ static/​syb/​syb​_130​.pdf; and FAO (n.d.), ‘Malawi’, accessed 5 October 2020 at http://​www​.fao​.org/​ faostat/​en/​#country/​130.

200  Handbook of sustainable politics and economics of natural resources Table 12.3 Country Name

Rural development indicators in selected ‘ASM countries’ in Sub-Saharan Africa % of Rural

% of Population

% of Vulnerable

% of Population Living

Estimated ASM

Population

Employed in

Employment

Below the National

Population Size

(2019)

Agriculture

(2018)

Poverty Line (2007–18)

(2019) Angola

33.8

50.2

67.1

36.6

900 000

Burkina Faso

70.0

92.0

86.4

40.1

1 000 000

Burundi

86.6

24.7

94.7

64.9

52 000

Central African Rep

58.2

77.1

93.6

62.0

2 400 000

Chad

76.1

76.3

93.1

46.7

600 000

DRC

54.9

65.1

79.7

63.9

1 200 000

Ghana

43.3

28.5

68.9

23.4

4 400 000

Guinea

63.5

61.3

89.9

55.2

1 500 000

Liberia

48.4

43.0

77.7

50.2

600 000

Madagascar

62.1

63.8

85.3

70.7

2 500 000

Malawi

82.8

62.3

59.5

51.5

240 000

Mali

56.9

43.2

89.6

41.1

2 400.000

Mozambique

63.5

69.9

83.1

46.1

1 200 000

Niger

83.5

74.9

89.0

44.5

2 700 000

Nigeria

48.8

34.7

78.4

46.1

2 500 000

South Africa

33.1

4.9

9.7

55.5

1 200 000

Sierra Leone

57.3

54.4

86.3

52.9

1 800 000

Tanzania

65.5

64.9

82.7

28.2

9 000 000

Uganda

75.6

72.4

75.2

21.4

900 000

Zimbabwe

67.8

62.3

65.6

72.3

3 000 000

Note: Additional data taken from World Bank (n.d.), ‘Employment in agriculture’, at https://​data​.worldbank​ .org/​indicator/​SL​.AGR​.EMPL​.ZS; and Globaleconomy.com (n.d.), ‘Rural population, percent in Africa’, at www​ .theglobaleconomy​.com/​rankings/​rural​_population​_percent/​Africa/​; both accessed 1 December 2020. Source: United Nations Development Programme (UNDP) (2019).

80 per cent of Malians depend on agriculture for their livelihoods, but with one growing season and only 7 per cent of the country’s 437 million arable ha of land being currently cultivated and only 14 per cent of 2.2 potentially irrigable ha not being exclusively rain-fed, the future appears uncertain for millions of families (World Food Programme, 2020b).12 Mali has a well-developed artisanal gold panning sector that flourishes alongside subsistence agriculture throughout the south of the country. With the sector being firmly anchored in the traditional economy, largely disconnected from national regulators, there is a rare opportunity here to build grassroots-oriented programmes that continue to foster its linkages with subsistence agriculture (Hilson and Garforth, 2012). Given the high level of participation of women in the country’s gold panning sector, programmes could emphasize gender empowerment, another major focus of the SDGs. Despite facing major cultural barriers, which have stifled their development, women have found innovative ways of obtaining gold washing cards and securing paid work in ASM, generating incomes that they have used to support their families, invest in farming activities and/or purchase food (Brotten and Ba, 2019; Hilson, 2012). 12 Data extracted from World Bank (n.d.), ‘Mali’, at https://​cl​imateknowl​edgeportal​.worldbank​ .org/​country/​mali; and World Bank (n.d.), ‘The World Bank in Mali’, at www​ .worldbank​.org/​ en/​ country/​mali/​overview; both accessed 5 November 2020.

Small-scale mining, rural resilience and the Sustainable Development Goals  201 With the World Bank currently in the midst of implementing its Mali Governance of Mining Sector project, the opportunity to redesign rural development strategies to feature artisanal gold panning more prominently is fast approaching. A major focus of the project is ‘creating economic opportunities (for both men and women through development of links with large-scale mining and through rationalizing small-scale and artisanal mining)’, as well as ‘building resilience (capacity building, local content development, and mining export diversification)’ (World Bank, 2019, p. 19). Could this project be used as a platform to launch programmes that aim to deliver support to both farming and ASM but which, initially, target marginalized rural women? In addition to Malawi and Mali, other prime destinations include Burkina Faso, Niger and Mozambique. Each country has smallholder systems that are under threat from climate change, but also has a sizable ASM sector, the developmental potential of which remains largely untapped.

5

CONCLUDING REMARKS

This chapter has sought to stimulate a critical ‘rethink’ of ASM’s role in development in Sub-Saharan Africa. Efforts made to date to embed the sector in the region’s rural development plans and programmes have been uninspiring and/or ineffective, largely because they have been built on ideas that no longer resonate as powerfully as they once did in donor and policymaking circles and with the general public on the whole. Given the social and economic challenges Sub-Saharan Africa now faces, there has never been a better time for ASM, the region’s most important rural non-farm activity in Sub-Saharan Africa, to be showcased more as a vehicle for delivering change to the lives of millions of rural families. It starts with rewriting the narrative on ‘formalization of ASM’, which, in its current form, no longer commands the attention nor elicits the policy response it once did. One potential route would be to build a case that supporting ASM stabilizes food security, pulling together evidence that points to how, in even the informal economy, the sector’s activities dovetail smallholder agriculture, generating income so crucial to supporting farms. A food security and resilience angle, which maps directly on to the SDGs, would provide efforts to formalize ASM in Sub-Saharan Africa with a much-needed boost. It would also nuance further and likely rejuvenate work being undertaken in the area of ‘agriculture for development’, which has also lost considerable momentum in recent years, due to it being built around unimpactful narratives. In the context of food security and resilience, it remains unclear what path donors will push countries in Sub-Saharan Africa down. Any strategy that fails to include ASM, however, is bound to be ineffective.

REFERENCES Africa Center for Economic Transformation (ACET) (2017). The Impact of Expanding Artisanal and Small-Scale Mining on Small Holder Agriculture in West Africa: A Case Study of Burkina Faso, Ghana and Sierra Leone. Accra: ACET. African Development Bank (2011). The Cost of Adaptation to Climate Change in Africa. Abidjan: African Development Bank.

202  Handbook of sustainable politics and economics of natural resources African Smallholder Farmers Group (ASFG) (2013). Supporting Smallholder Farmers in Africa: A Framework for an Enabling Environment. London: ASFG. African Union (2009). Africa Mining Vision. Addis Ababa: African Union. Banchirigah, S.M. (2006). How have reforms fuelled the expansion of artisanal mining? Evidence from Sub-Saharan Africa. Resources Policy 31(3): 165–71. Banchirigah, S.M. and Hilson, G. (2010). De-agrarianization, re-agrarianization and local economic development: re-orientating livelihoods in African artisanal mining communities. Policy Sciences 43(2): 157–80. Barry, M. (ed.) (1996). Regularizing informal mining: a summary of the Proceedings of the International Roundtable on Artisanal Mining. Industry and Energy Department Occasional Paper No. 6. Brotten, L.V. and Ba, L. (2019). Gendered livelihoods and land tenure: the case of artisanal gold miners in Mali, West Africa. Geoforum 105: 54–62. Cairns, J.E., Hellin, J. and Sonder, K. et al. (2013). Adapting maize production to climate change in Sub-Saharan Africa. Food Security 5: 345–60. Cartier, L.E. (2009). Livelihoods and production cycles in the Malagasy artisanal ruby-sapphire trade: a critical examination. Resources Policy 34(1–2): 80–86. Dasgupta, P., Morton, J.F. and Dodman, D. et al. (2014). Rural areas. In C.B. Field, V.R. Barrow and D.J. Dokken et al. (eds), Climate Change 2014: Impacts, Adaptation, and Vulnerability. Part A: Global and Sectoral Aspects. Contribution of Working Group II to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge, UK: Cambridge University Press, pp. 613–57. Deininger, D., Savastano, S. and Xia, F. (2018). Smallholder land access: a new landscape in Africa? In L. Christiaensen and L. Demery (eds), Agriculture in Africa: Telling Myths from Facts. Washington, DC: World Bank, pp. 21–8. Engwicht, N. (2018). ‘It can lift someone from poverty’: imagined futures in the Sierra Leonean diamond market. The Extractive Industries and Society 5(2): 260–66. Food and Agricultural Organization (FAO) (2009). Climate change in Africa: the threat to agriculture. Brief, December. Rome: FAO. Food and Agricultural Organization (FAO) (2012). FAO Regional Conference for Africa: programme of work and budget in 2012–13 and areas of priority action for Africa in 2014–15. Rome: FAO. Food and Agricultural Organization (FAO) (2014a). The State of Food and Agriculture 2014. Rome: FAO. Food and Agricultural Organization (FAO) (2014b). Strengthening the links between resilience and nutrition in food and agriculture. Brief, October. Rome: FAO. Food and Agricultural Organization (FAO) (2015). 70 Years of FAO (1945–2015). Rome: FAO. Food and Agricultural Organization (FAO) (2016). Strengthening Resilience to Food and Nutrition Insecurity in the Sahel and Western Africa. Rome: FAO. Food and Agricultural Organization (FAO) (2019). Let Us Take a Look At…FAO Africa. Accra: FAO Regional Office for Africa. Food and Agricultural Organization and United Nations Economic Commission for Africa (FAO/ UNECA) (2020). Africa Regional Overview of Food Security and Nutrition 2019. Accra: FAO/ UNECA. Geenen, S. (2012). A dangerous bet: the challenges of formalizing artisanal mining in the Democratic Republic of Congo. Resources Policy 37(3): 322–30. Geenen, S. and Verweijen, J. (2017). Explaining fragmented and fluid mobilization in gold mining concessions in eastern Democratic Republic of the Congo. The Extractive Industries and Society 4(4): 758–65. Havnevik, K., Bryceson, D. and Birgegård, L.E. et al. (2007). African agriculture and the World Bank: development or impoverishment? Uppsala: Nordiska Afrikainstitutet. Hentschel, T., Hruschka, F. and Priester, M. (2002). Global Report on Artisanal & Small-Scale Mining, Minerals Mining and Sustainable Development (MMSD) Project. London: International Institute for Environmental Development (IIED). Hilson, G. (2012). Family hardship and cultural values: child labor in Malian small-scale gold mining communities. World Development 40(8): 1663–74.

Small-scale mining, rural resilience and the Sustainable Development Goals  203 Hilson, G. (2016). Farming, small-scale mining and rural livelihoods in Sub-Saharan Africa: a critical overview. The Extractive Industries and Society 3(2): 547–63. Hilson, G. (2017). Poverty, smallholder farming and the rise of artisanal mining in rural Sub-Saharan Africa. Paper presented at the Food and Agricultural Organization (FAO), Rome, 22 June. Hilson, G. and Garforth, C. (2012). ‘Agricultural poverty’ and the expansion of artisanal mining in Sub-Saharan Africa: experiences from Southwest Mali and Southeast Ghana. Population Research and Policy Review 31(3): 435–64. Hilson, G. and Garforth, C. (2013). ‘Everyone now is concentrating on the mining’: drivers and implications of rural economic transition in the eastern region of Ghana. Journal of Development Studies 49(3): 348–64. Hilson, G., Hilson, A. and Maconachie, R. (2018). Opportunity or necessity? Conceptualizing entrepreneurship at African small-scale mines. Technological Forecasting and Social Change 131: 286–302. Hilson, G. and Van Bockstael, S. (2011). Diamond mining, rice farming and a ‘Maggi cube’: a viable survival strategy in rural Liberia? Journal of International Development 23(8): 1042–53. Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development (IGF) (2017). Global Trends in Artisanal and Small-Scale Mining (ASM): A Review of Key Numbers and Issues. Winnipeg: International Institute for Sustainable Development. International Labour Organization (ILO) (1999). Social and Labour Issues in Small-Scale Mining. Geneva: ILO. International Union for Conservation of Nature and Natural Resources (IUCN) (2010). Building Climate Change Resilience for African livestock in Sub-Saharan Africa. Nairobi: IUCN. International Water Management Institute (IWMI) (2010). Managing water for rainfed agriculture. IWMI Water Issue Brief 10. Kamlongera, P.J. (2011). Making the poor ‘poorer’ or alleviating poverty? Artisanal mining livelihoods in rural Malawi. Journal of International Development 23(8): 1128–39. Kamlongera, P.J. (2013). The mining boom in Malawi: implications for community development. Community Development Journal 48(3): 377–90. Kamlongera, P.J. (2020). Domesticating the Africa Mining Vision in Malawi: approaches and experiences. Canadian Journal of Development Studies 41(3): 467–85. Kumah, C., Hilson, G. and Quaicoe, I. (2020). Poverty, adaptation and vulnerability: an assessment of women’s work in Ghana’s artisanal gold mining sector. Area 52(3): 617–25. Lowder, S.K., Skoet, J. and Raney, T. (2016). The number, size, and distribution of farms, smallholder farms, and family farms worldwide. World Development 87: 16–29. Maconachie, R. (2011). Re-agrarianising livelihoods in post-conflict Sierra Leone? Mineral wealth and rural change in artisanal and small-scale mining communities. Journal of International Development 23(8): 1054–67. Maconachie, R. and Binns, T. (2007). ‘Farming miners’ or ‘mining farmers’? Diamond mining and rural development in post-conflict Sierra Leone. Journal of Rural Studies 23(3): 367–80. Maconachie, R. and Hilson, T. (2018). ‘The war whose bullets you don’t see’: diamond digging, resilience and Ebola in Sierra Leone. Journal of Rural Studies 61: 110–22. McCullough, E.B. (2017). Labor productivity and employment gaps in Sub-Saharan Africa. Food Policy 67: 133–52. Mkodzongi, G. and Spiegel, S.J. (2020). Mobility, temporary migration and changing livelihoods in Zimbabwe’s artisanal mining sector. The Extractive Industries and Society 7: 994–1001. Nagler, P. and Naudé, W. (2017). Non-farm entrepreneurship in rural Sub-Saharan Africa: new empirical evidence. Food Policy 67: 75–91. Ofosu, G., Dittmann, A., Sarpong, D. and Botchie, D. (2020). Socio-economic and environmental implications of artisanal and small-scale mining (ASM) on agriculture and livelihoods. Environmental Science and Policy 106: 210–20. Organisation for Economic Co-operation and Development and Food and Agricultural Organization (OECD/FAO) (2016a). OECD-FAO Agricultural Outlook 2016–2025. Paris/Rome: OECD/FAO. Organisation for Economic Co-operation and Development and Food and Agricultural Organization (OECD/FAO) (2016b). International Regulatory Co-operation and International Organisations: The Case of the Food and Agriculture Organization of the United Nations (FAO). Paris/Rome: OECD/ FAO.

204  Handbook of sustainable politics and economics of natural resources Oya, C. (2011). Agriculture in the World Bank: blighted harvest persists. In K. Bayliss (eds), The Political Economy of Development: The World Bank, Neoliberalism and Development Research. London: Pluto Press, pp. 146–87. Phillips, R. (1981). FAO: Its Origins, Formation and Evolution 1945–1981. Rome: FAO. Pijpers, R. (2014). Crops and carats: exploring the interconnectedness of mining and agriculture in Sub-Saharan Africa. Futures 62: 32–9. Pretty, J., Bharucha, Z.P. and Garba, M.H. et al. (2014). Foresight and African Agriculture: Innovations and Policy Opportunities. London: Government Office for Science. Ringler, C., Zhu, T. and Cai, X. et al. (2010). Climate change impacts on food security in Sub-Saharan Africa: insights from comprehensive climate change scenarios. IFPRI Discussion Paper 01042. International Food Policy Research Institute. Shiferaw, B.M., Tesfaye, K. and Kassie, M. et al. (2014). Managing vulnerability to drought and enhancing livelihood resilience in Sub-Saharan Africa: technological, institutional and policy options. Weather and Climate Extremes 3: 67–79. Spiegel, S.J. (2009). Socioeconomic dimensions of mercury pollution abatement: engaging artisanal mining communities in Sub-Saharan Africa. Ecological Economics 68 (12): 3072–83. Staatz, J.M. and Dembélé, N.N. (2007). Background paper for the World Development Report 2008: agriculture for development in Sub-Saharan Africa. World Bank. United Nations Development Programme (UNDP). (2019). Human Development Report 2019. New York: UNDP. Veltmeyer, H. (2009). The World Bank on ‘agriculture for development’: a failure of imagination or the power of ideology? The Journal of Peasant Studies 36(2): 393–410. Weber-Fahr, M. (2002). Treasure or Trouble? Mining in Developing Countries. Washington, DC: World Bank. Wiggins, S. and Keats, S. (2013). Smallholder Agriculture’s Contribution to Better Nutrition. London: Overseas Development Institute. World Bank (2005). Agricultural Growth for the Poor: An Agenda for Development. Washington, DC: World Bank. World Bank (2007a). World Development Report 2008: Agriculture for Development. Washington, DC: World Bank. World Bank (2007b). World Bank Assistance to Agriculture in Sub-Saharan Africa: An IEG Review. Washington, DC: World Bank. World Bank (2013). Turn Down the Heat: Climate Extremes, Regional Impacts, and the Case for Resilience. Washington, DC: World Bank. World Bank (2015). Ending Poverty and Hunger by 2030: An Agenda for the Global Food System. Washington, DC: World Bank. World Bank (2019). Mali Governance of Mining Sector. Project Appraisal Document. Washington, DC: World Bank. World Food Programme (2020a). WFP Malawi country brief. New York: United Nations World Food Programme. World Food Programme (2020b). WFP Mali country brief. New York: United Nations World Food Programme. Zhang, L.X., Koroma, F. and Fofana, M.L. et al. (2020). Food security in artisanal mining communities: an exploration of rural markets in northern Guinea. Foods 9(4): 479.

13. Natural resource policies for future sustainability in the African continent Roula Inglesi-Lotz

1 INTRODUCTION The future socio-economic development of the African continent depends on eradicating poverty, creating equal opportunities for all and environmental sustainability. The majority of Sub-Saharan African economies depend on their primary sectors, either agriculture or mineral sectors, with a tendency to leapfrog to the tertiary/services sector over time. At the same time, Libya, Nigeria, Algeria and Angola featured in the top 20 countries with proven oil reserves in 2017 (Dillinger, 2019). Chauvin (2018) discusses a report by the Monitor Group, which states that the continent accounts for one-third of the planet’s mineral reserves, as the African countries are leading producers of chrome, manganese, platinum, diamonds and uranium, not underestimating the deposits of gas, gold, iron ore, copper coal and other metals. Regardless of the vast reserves of minerals in the region, minerals account for not more than 38 per cent of the continent’s gross domestic product (GDP). Primary commodities, minerals and resource-based products dominated the exports of the region from the mid-1980s to mid-2000s, in contrast to the Asian countries, for example, that diversified their trade with manufacturing goods. The continent’s employment structure is analogous to the economic production and trade structure, with the agricultural sector employing the majority of the population. All these facts provide evidence of the unexploited source of economic opportunity that could promote sustainable economic growth paths for the continent (ibid.). The strong dependence on agricultural production makes the region dependent on arable land and natural resource usage. To achieve sustainable development, natural resources, such as land, soil and water, should be managed in an optimal manner to ensure substantial improvement of the African population’s living conditions. Although the African continent does not only have a narrative of natural resources, its growth will continue to be linked with oil, natural gas and arable land, as their demand will keep rising internationally. ‘China, for example, has bid for access to ten million tons of copper and two million tons of cobalt in the Democratic Republic of the Congo in exchange for a $6 billion package of infrastructure investments, including mine improvements, roads, rail, hospitals, and schools’ (Leke et al., 2010, para. 4). Due to increasing interest in new avenues for commodities and mineral reserves, the African countries also have the potential to play a more important role in international markets and politics. Furthermore, studies have concluded that the appropriate management of resources has the potential to contribute positively to the improvement of the African population’s well-being and alleviate poverty, reducing diseases and child mortality and improving education for all (Ochola et al., 2010). On the other hand, non-sustainable management can contribute to conflicts, such as the unrest in the Zambian copper belt or the larger conflicts in the oil-rich Niger Delta in Nigeria (Tralac, 2017), as well as threats to households in all spheres of the economy. For example, Ochola et al. (2010) argue that in Sub-Saharan 205

206  Handbook of sustainable politics and economics of natural resources Africa, more than one-third of the deaths of the population can be attributed to environmental degradation. In such a vulnerable position, the continent needs to realize that its development is tightly bound with natural resources that have been continuously degrading in both quantity and quality due to a range of factors (Figure 13.1).

Source:

Ochola et al. (2010).

Figure 13.1

The linkages between climate change and biodiversity loss

Advancing economic growth to improve the living conditions of the population is a challenging task when combined with aspirations to minimize the impact to the environment as well as create resilient socio-ecosystems. However, doing so might be the decisive factor in achieving sustainable development on the African continent (Ochola et al., 2010). The complex challenge of balancing economic growth and development with environmental sustainability needs holistic approaches with the involvement of various stakeholders: policymakers, researchers, industry and local communities. The design and implementation of appropriate policies is critical to achieving the desired results. With natural resource management policies, the main participants to be engaged during the design and implementation phases include national and local governments, civil society, private sector and non-governmental organizations that have the potential to play particular strong roles at different stages. African policymakers should design and implement policies based on sustainable development principles, taking into consideration the specific characteristics and needs of the region for human capital development, technological innovation and environmental protection and sustainability (Chauvin, 2018).

Natural resource policies for future sustainability in the African continent  207

2

NATURAL RESOURCES AND SUSTAINABILITY

2.1

The Concept of Sustainable Development

Ochola et al. (2010, p. 12) define natural resource management as a ‘scientific and technical principle that forms a basis for sustainable management (conservation and use) and governance of natural resources such as land, water, soil, plants and animals, with a particular focus on how management affects the quality of life for both present and future generations’. The literature examining the dynamic relationship between environmental and climate changes and the welfare of the citizens that depend on natural resources is vast, and has been categorized into certain schools of thought, with a popular choice in the literature recently being the ‘sustainable development approach’. The reason for this is the commitment of the African governments to the initiatives and agreements of the United Nations such as the Sustainable Development Goals (SDGs) and the African Union Commission (2015) agreement. There are numerous definitions of sustainable development in the literature, such as the one by Pezzey (1989), a development path is sustainable if total welfare does not decline along the path, or the one by the Brundtland Report, ‘one that meets the needs of the present without compromising the ability of future generations to meet their own needs’. However, specifically for the case of the African continent, a sustainable development path must be aligned with the exploitation of its natural resource endowments. To do so, the definition needs to ensure a combination of natural resources with human activity: the welfare of humans is inseparably tied with the natural resources and hence the latter must be used at a rate that ensures they can be replenished naturally. The three essential dimensions of sustainable development are (Ochola et al., 2010): 1. Economic: an economically sustainable system must be able to produce goods and services on a continuing basis, to maintain manageable levels of government and external debt, and avoid extreme sectoral imbalances that damage agricultural and or/industrial production. 2. Environmental: an environmentally sustainable system must maintain a stable resource base and avoid overexploitation of non-renewable resource systems, including maintenance of biodiversity, atmospheric availability and ecosystem services not always looked upon as economic resources. 3. Social: a socially sustainable system must achieve fairness in distribution and opportunity among all persons with adequate provision of such social services as health, education and gender equity. The social dimension focuses on reconciliation of environment and development, and governance related to provision of social services. The human development aspect should not be understated at this point, as it emerges as the result of all three dimensions, particularly the environmental one (Tiba and Frikha, 2019). The heart of the economic problem lies in the efficient allocation of limited resources to meet unlimited and ever-changing human needs. Natural resources are used while pollution is generated and the human race is developed. Thus, managing the human race separately from the natural resource availability and ecological stability will create unsustainable development systems (Togtokh and Gaffney, 2010). The well-being of not only current but also future generations will be negatively affected due to the lack of sufficient appropriate resources. Indeed, Chauvin (2018) stresses that environmental and social aspects and their interlinkages are bypassed even though mutually beneficial situations are possible at the global and regional

208  Handbook of sustainable politics and economics of natural resources level, while negative impacts can also take place (for example, worse income disparities and negative impacts on local communities). This study also makes the point that economic and environmental development go hand in hand with sustainability of natural resources. 2.2

Economic Growth and Development

Natural resources have the potential to act as contributors to economic development in a variety of ways – for instance, as an economic activity and providing employment or through environmental services (Ochola et al., 2010). Although some types of resource use have direct impacts, from efficient natural resource use to promotion of economic growth, the quality of institutions and human capital are crucial in understanding the relationship between natural resources and economic growth (Figure 13.2).

Source:

Zallé (2019).

Figure 13.2

Direct and indirect effects of natural resources on economic growth: the institutional and human capital channel

With weak institutions and low-quality human capital, natural resources might become a ‘curse’ for the host country. Revenues from the exploitation of natural resources can potentially contribute to economic growth and assist countries to meet their citizens’ needs and investment expenditures through government spending. Zallé (2019, p. 618) also adds that ‘natural resource rents are an important source of domestic resources for resource-rich countries. The mobilization of domestic resources through natural resources frees the state from the burden of debt. It also provides the state with greater flexibility in allocating resources in line with its development objectives.’

Natural resource policies for future sustainability in the African continent  209

3

AFRICA’S DEPENDENCE ON NATURAL RESOURCES

3.1

Resource Curse

Recently, it was empirically observed that countries and regions with abundant natural resource endowments, such as Africa, Latin America and the Middle East, present lower economic growth rates than those with fewer reserves. This phenomenon is referred to as the ‘resource curse’ in the literature, a term coined first by Auty (2002). IDEA (2017) also characterizes the phenomenon as the ‘paradox of plenty’: abundant endowments of natural resources do not lead to equivalent levels of prosperity, broad-based development and resource-based industrialization. Zallé (2019) argues that African countries rich in natural resources, such as Nigeria, the Ivory Coast and Sierra Leone, are examples where the abundance of natural resources has not served as an enabler of economic growth and development, but rather as a hindrance to it. Thus, the relationship between natural resources and economic development is more complex and not as simplistic as natural resources promoting economic growth as an input to production. The negative relationship between natural resources and economic growth is considered to be based on two groups of factors: (1) economic factors linked to volatility of commodity prices, flawed policies and neglect of education; and (2) political factors linked to poor institutions, corruption and mismanagement (Badeeb, Lean and Clark, 2017). Djeflat and Lundvall (2016) and Frankel (2010) summarize six more specific mechanisms through which natural resources inhibit economic growth and development: 1. Prices of such commodities could be subject to secular decline on world markets. 2. Natural resources could be dead-end sectors in another sense: they may crowd out manufacturing, and the latter sector might be the one to offer dynamic benefits and spillovers that promote growth. 3. The volatility of world prices of energy and other mineral and agricultural commodities give rise to economic instability. 4. Countries where physical command of oil deposits or other resources by the government or a hereditary elite automatically confers wealth on the holders may be less likely to develop the institutions, such as rule of law and decentralization of decision-making. 5. Such countries could have a proclivity for armed conflict, which is inimical to economic growth. 6. Swings in commodity prices could engender excessive macroeconomic instability, via the real exchange rate and government spending, imposing unnecessary costs. The literature (Badeeb et al., 2017; Henri, 2019) that examined the hypothesis of the resource curse has reached a consensus on two important findings: (1) the hypothesis does not refer to a country’s or region’s overall abundance of natural resources but to an overwhelming dependence on one or two of them (Karl, 2005); and (2) the impact of the resource curse is negligible when countries experience high rates of economic growth, as well as when their policies are stable and operating within strong institutions (Badeeb et al., 2017) (an example that made researchers curious is that of Botswana; see Corrigan, 2014). Zallé (2019) stresses that a prerequisite for countries to enable a positive relationship between natural resources and economic growth is the efficient management of the profits and revenues from the exploitation of natural resources. Such a task is enabled by good-quality institutions and human capital.

210  Handbook of sustainable politics and economics of natural resources Although potential and opportunities can be created by the good management of natural resources, there are challenges and hurdles that prevent them from materializing. Desertification and improper use and ownership of land, displacement of communities, policy and political uncertainty and poor institutions might sound as though they are easily surmountable obstacles; however, they are persistent and can only be overcome with political and societal will (African Natural Resources Center, 2016). The African continent has shown its aspiration to make optimal and sustainable use of its natural resources collectively through the Agenda 2063 framework (African Union Commission, 2015). In this framework document, adopted in 2015 by the African Union Summit, African countries agree to make efforts towards ensuring that ‘Africa’s collective GDP will be proportionate to her share of the world’s population and natural resource endowments’ (p. 3), as well as intensifying the efforts to optimally exploit its own natural resources in a sustainable way until 2063. 3.2

Natural Resources and Agriculture

Chauvin (2018) repeats that an efficient, well-managed and productive agricultural sector can be the engine to initiate a process of economic growth and development in the world, as well as a strong tool for poverty alleviation and structural economic change. In the African continent, productivity in the agricultural sector is traditionally low and its connections with the industrial sector are at a primitive stage. Such conditions in the agricultural sector have aggravated the already difficult situation with food insecurity in the continent, coupled with dependence on food imports to meet the demands of the growing population. This challenge in the region needs to be decisively addressed without ignoring the scarcity of natural resources and the conflict over land in the affected areas in the continent. The effective use of natural resources for development is a multi-stage economic and political problem that requires a balance of several factors: investment to extract the resource, fiscal regimes to capture revenues, domestic linkages to leverage project economics, sensible investment and spending decisions, and policies to manage volatility and mitigate adverse effects on the rest of the economy (Venables, 2016).

4

AFRICA’S NATURAL RESOURCES AND POLICIES: PAST, PRESENT AND FUTURE

Without doubt, the African continent has been among the richest in the world in terms of natural resource endowments, although the poorest in terms of economic development. More than half the planet’s rare minerals can be found in African countries, while geographically it covers the largest area of arable land in the world and has the second largest and longest rivers. African countries also have 8 per cent of the world’s oil stock and 7 per cent of the world’s natural gas reserves (IDEA, 2017). Minerals are mostly exported to the rest of the world, providing revenue to African countries but at the same time resulting in forgone opportunities for growth and development, and significant environmental degradation. Another consequence of the dependence is that commodity market fluctuations and volatility can have significant impacts on regional economies. To release the full potential of the natural resources in African countries, local resource-based industries should be promoted, with their main purpose being to create a local supply market that can be internationally competitive. Baffes et al. (2015)

Natural resource policies for future sustainability in the African continent  211 discuss the example of the downward spiral of international oil prices in the beginning of 2010s that had negative consequences on many resource-dependent countries. On the path to economic prosperity, structural transformation of the African economies is considered more than a necessary condition. Modernization and diversification are required to be able to compete in the global arena. It is also essential for economies to base their production on a variety of economic sectors to minimize the risk that occurs with one-dimensional economic structures and reduce economic volatility (Chauvin, 2018). For many policymakers, such a future direction translates into a shift away from the agricultural and natural resources sectors. On the contrary, the region should exploit its abundance of resources that constitute a comparative advantage to the rest of the world. The challenge, however, is how to do so while avoiding the resource curse and exploit the available factors of production (ibid.). Here, this chapter argues that the road passes through appropriate, well-designed and efficient policy implementation. The abundance of natural resources in the continent has certainly been a restricting factor to its development. Ross (2004) argues that there is a strong relationship between natural resource endowments and conflict, although he explains that the type of natural resource (for example, diamonds versus oil versus agricultural products) plays a role in the strength of the relationship and the level of violence of the conflict. Behrends (2008) adds that natural resources do not have to be extracted to generate conflict – just the discovery of mineral resources might initiate it. The continent’s natural resource sector has been harmed through the years by conflicts of different dimensions and severity over access and ownership of land (Tralac, 2017). The African Union recognizes the centrality of land in many documents by also stressing the fact that the African continent has underutilized this important resource. The Declaration on Land Issues and Challenges in Africa was adopted in 2009 and stressed the importance of land to promote sustainable socio-economic growth and development and improve livelihoods. To monitor and evaluate progress on the continent, the African Union Commission, Economic Commission for Africa and the African Development Bank launched a project in 2017 at the national and regional level. Although the concept of natural resources is traditionally associated with extractive industries in Africa, resources such as inland water and marine resources that are non-extractive have been traditionally undervalued and less exploited through the decades. For example, the marine environment was used only as a transport avenue. In the past, only regional or one-sided efforts from a policy perspective were promoted in the African region. In 1999, the Nile Basin Initiative created a partnership between ten countries to ‘provide a forum for consultation and coordination among the Basin States for the sustainable management and development of the shared Nile Basin water and related resources’ (Nile Basin Initiative, 2021). Another example is provided from the West African region by the Niger Basin Authority in 1964, which aimed at the holistic management of all resources in the area and not only water-related resources. Recently, however, the African Union has shown interest in developing a comprehensive maritime strategy to manage the marine resources of the region. The AU Assembly adopted the 2050 Africa’s Integrated Maritime Strategy (AIM Strategy) in 2014, which recognized that the continent’s marine resources are at risk due to historic maritime activities, such as shipping and fishing or new offshore renewable energy. The marine environment degraded even more recently due to various forms of illegal trafficking and impacts of climate change. The overarching vision of the 2050 AIM Strategy is to foster increased wealth creation from

212  Handbook of sustainable politics and economics of natural resources Africa’s oceans and seas by developing a sustainable thriving blue economy in a secure and environmentally sustainable manner. Denton et al. (2016) recognize that the African continent is primarily organized at a regional level and that regional institutions are critical in identifying solutions for transboundary challenges, such as natural resource management and climate change and its consequences (Price, 2018). However, the African Union Commission, appreciating the need for a united front against these issues, established the Climate Change and Desertification Unit, followed by a regional development plan, the Agenda 2063, focusing on transforming economic development for the future of the continent. The African Union Commission (2015, p. 15) aims to: transform, grow and industrialise our economies through beneficiation and value addition of natural resources by: • implementing the African Industrial Development Action Plan, the African Mining Vision at country, regional and continental level, in particular fast-tracking the establishment of the Centre for African Mineral Development; • implementing joint cross-border investments to exploit shared natural resources; • promoting social dialogue, sectoral and productivity plans and regional and commodity value chains to support the implementation of industrial policies at all levels, with focus on SMMEs and Agribusinesses; • establishing Commodity Exchanges for strategic African products; • developing strategies to grow the African Blue/ocean and green economies; • developing the African private sector through engagement and a conducive climate, fostering Pan-African businesses through the growth of regional manufacturing hubs and scaled up intra-Africa trade; • enhancing the Productivity Agenda for Africa, as an essential engine for industrialization, progressively enhancing the competitiveness of the continent in the global economy; and • promoting macro-economic policies that facilitate growth, employment creation, investments and industrialisation.

Africa’s Agenda 2063 stresses the plethora of implications of its aspirations for natural resource governance on the continent, particularly that of Aspiration 1 for prosperity via inclusive growth and sustainable development (Tralac, 2017, p. 28): ● Goals: ● modern agriculture for increased productivity and production; ● blue/ocean economy for accelerated economic growth; ● environmentally sustainable and climate-resilient economies and communities. ● Priority areas: ● agricultural productivity and production; ● marine resources and energy/port operations and marine transport; ● sustainable natural resource management; ● biodiversity conservation, genetic resources and ecosystems; ● sustainable consumption and production patterns; ● water security; ● climate resilience and natural disasters; ● preparedness and prevention; ● renewable energy. IDEA (2017) stresses that, regardless of all the developments and efforts from a policy perspective, the abundance of natural resources has not provided a vehicle for sustainable

Natural resource policies for future sustainability in the African continent  213 economic development on the African continent. On the contrary, central African countries in particular have still suffered from violent conflicts in recent decades as a result of unstable political conditions that hamper the region’s development. Democracy is not panacea and a self-sufficient condition but a fundamental condition to build developmental states that are responsive to citizens’ needs and ensure access to services and public security (IDEA, 2017). However, the instability in the political environment is conducive to conflicts, and on the African continent the focus of most conflicts is land related. These conflicts have had negative consequences on the economic performance of African countries as well as the societal unity of the continent and have posed a risk for the future of African society. These facts are evidence for two lessons: (1) the natural resources of the region are not only a factor for agricultural production; and (2) ‘it is time to refocus attention from the extractive industry to recognize the essence of other natural resources both in the ways they can contribute to development but also as they are conflict drivers to enable the development of an effective natural resource governance structure for Africa’ (Tralac, 2017, p. 32). The natural resource sector has the potential to alleviate economic poverty on the African continent, but instead it creates and intensifies conflicts that have only a negative impact on the region’s development. Such resource-related conflicts are responsible for further expanding income inequalities. ‘While the State and elite, in alliance with foreign corporations, enjoy the benefits of the exploited resource, host communities face the debilitating negative environmental impacts’ (ibid., p. 33). The situation, of course, is not helped by the poor institutions and absence of rule of law on the continent. Any framework, policy, strategy or document will have no chance of impact if operating in an environment of corruption, misappropriation and embezzlement. Such policies need to take into consideration the perspectives of opposing views and interests of groups that will benefit or be negatively impacted. Furthermore, the issue of natural resource management is not one-dimensional, as policies will need to address stages from exploration to production through the cycle of management. Transparent and honest management is therefore even more necessary. ‘[A]s Africa seeks to develop a new vision that governs natural resources, it is important that this new vision promotes the development of strong institutions that can democratically address the grievances associated with the management of natural resources’ (ibid., p. 36). Tiba and Frikha (2019) conclude from their empirical modelling exercise for 26 African countries that the quality of institutions is the most important positive contributing factor for the region to reverse the negative relationship between natural resources and economic development. They follow the thought processes of Askari and Jaber (1999) and Segal (2012), who suggest that for proper allocation of resources and the revenues from their extraction and utilization in the African continent, there is only one way forward: the development of a well-designed, transparent and comprehensive framework as a priority for the continent’s policymakers. Tiba and Frikha (2019, p. 449) add: ‘the growth-oriented policies in African abundant economies should be given more attention to the liberalization of markets that can greatly help to palliate market rigidities and high levels of unemployment which seem to be true especially for our sample’. In their dual challenge to raise revenues to support service delivery and exploit the potential of their natural resource reserves, the African countries depend on financial transparency and improved governance in their extractive industries. Decreasing corruption and improving transparency will have a positive influence on business confidence, investment and quality of governance. One such example of effort in this sphere is the Extractive Industries

214  Handbook of sustainable politics and economics of natural resources Transparency Initiative (EITI) (Mawejje, 2019). Henri (2019), however, criticizes the EITI, stressing that corruption has not been reduced since it launched, because corruption is associated with expenditures rather than revenues (where EITI focuses). Within the Sub-Saharan African region, Ghana is often mentioned as an example of the country’s system of managing its mineral resources; however, the policy does not reach its full potential, due to the conflicting interests of local authorities and traditional leaders (Henri, 2019; Standing, 2014). Adams et al. (2019) examined a number of Ghana’s petroleum stakeholders after they joined the EITI, only to find the expected: the EITI membership and the revenue management policy on their own could not address the resource curse consequences if they were not complemented with public administration effectiveness, rule of law, regulatory quality, accountability, corruption controls, and effective accounting practices. Improved governance, in combination with the boom in commodity prices in the first decade of the 2000s, has promoted exploration and led to new resource discoveries, notably in Africa. New players have entered resource extraction and trade – in particular, China. Accompanying these changes has been the increased use of ‘resources for infrastructure’ deals, some of which are barter deals and others part of wider trade and investment agreements (Beardsworth et al., 2014). Bräutigam and Gallagher (2014) estimate that between 2000 and 2011, China committed $80 billion of resource-backed loans to Latin America and $53 billion to Africa, of which $13 billion is to Angola alone. The loans to Angola principally finance infrastructure, but also include school and hospital projects. Much of the construction work is done using Chinese workers, and inputs and repayments are made in oil, specified in quantity not value terms (Cassel, Candia and Liberatore, 2010). Such deals have potential benefits. They are a commitment to transform subsoil assets into investment capital rather than into current consumption, and to do so in a manner that is relatively rapid. However, the devil is in the detail. The terms and conditions of these contracts are generally not transparent, and some appear, on close investigation, to have offered poor terms to the host economy. The quality, design and appropriateness of projects are sometimes questionable. A 2008 agreement between the Democratic Republic of the Congo, China’s Exim Bank and two Chinese construction companies worth up to $6 billion and based on giving copper and cobalt in return for infrastructure has been criticized for lack of transparency and scrutiny, questionable project selection and no process for assessing value for money (Global Witness, 2011). ‘To deliver their potential benefits, resources-for-infrastructure deals need to develop scrutiny procedures that ensure value is being derived’ (Venables, 2016, p. 179). To conclude, African countries need to explore policies that will provide synergic benefits in both natural resource exploitation and improving the quality of human capital. To achieve sustainability for current and future generations, the natural resources will indeed play a fundamental role in socioeconomic development, due to their increasing global demand, but there are risks associated with the degrading of the resource base, historic mismanagement of resources and lack of coherent policies. Climate-related and natural resource policies, plans and actions are in place in the majority of the African countries. Curran et al. (2018) recognize that the mere existence of a policy will not have the desired impact, but policy coherence is necessary – or in other words, as defined in Curran et al.’s study, ‘logical consistency across all dimensions of policy development and implementation’ (p. 2). Policy action can be effective if it provides opportunities for coherent and mutually supportive action at the level of regional, national and sectoral policies (Nachmany and Setzer, 2018; Price, 2018; Runhaar et al., 2018).

Natural resource policies for future sustainability in the African continent  215

REFERENCES Adams, D., S. Ullah and P. Akhtar et al. (2019). ‘The role of country-level institutional factors in escaping the natural resource curse: insights from Ghana’. Resources Policy 61(C): 433–40. African Natural Resources Center (2016). ‘Catalyzing growth and development through effective natural resources management’. African Development Bank Group. Accessed 3 August 2021 at https://​www​ .afdb​.org/​fileadmin/​uploads/​afdb/​Documents/​Publications/​anrc/​AfDB​_ANRC​_BROCHURE​_en​.pdf. African Union Commission (2015). Agenda 2063 Framework: The Africa We Want. Accessed 28 July 2021 at https://​au​.int/​sites/​default/​files/​documents/​36204​-doc​-agenda2063​_popular​_version​_en​.pdf. Askari, H. and M. Jaber (1999). ‘Oil-exporting countries of the Persian Gulf: what happened to all that money?’, Journal of Energy Finance & Development 4: 185–218. Auty, R. (2002). Sustaining Development in Mineral Economies: The Resource Curse Thesis. Abingdon, UK: Routledge. Badeeb, R.A., H.H. Lean and J. Clark (2017). ‘The evolution of the natural resource curse thesis: a critical literature survey’. Resources Policy 51: 123–34. Baffes, J., M.A. Kose, F. Ohnsorge and M. Stocker (2015). ‘The great plunge in oil prices: causes, consequences, and policy responses’. Policy Research Note 15/01. World Bank Group. Beardsworth, J., H. Halland, B.C. Land and J. Schmidt (2014). World Bank Study 88485: Resource Financed Infrastructure: A Discussion on a New Form of Infrastructure Financing. Accessed 3 August 2021 at http://​documents​.worldbank​.org/​curated/​en/​394371468154490931/​Resource​-financed​ -infrastructure​-a​-discussion​-on​-a​-new​-form​-of​-infrastructure​-financing. Behrends, A. (2008). ‘Fighting for oil when there is no oil yet: the Darfur-Chad border’. Focaal No. 52: 39–56. Bräutigam, D. and K.P. Gallagher (2014). ‘Bartering globalization: China’s commodity-backed finance in Africa and Latin America’. Global Policy 5(3): 346–52. Cassel, C., G. de Candia and A. Liberatore (2010). ‘Building African infrastructure with Chinese money’. Accessed 3 August 2021 at https://​pdfs​.semanticscholar​.org/​79f1/​10f16f​87d895480c​7cd7b2e24f​ 9453a5d208​.pdf. Chauvin, N.D. (2018). ‘Economic transformation, natural resources and sustainability in Africa’. RedSur Working Document 9. Corrigan, C.C. (2014). ‘Breaking the resource curse: transparency in the natural resource sector and the extractive industries transparency initiative’. Resources Policy, 40: 17–30. Curran, P., A. Dougill, J. Pardoe and K. Vincent (2018). ‘Policy coherence for sustainable development in Sub-Saharan Africa’. Policy brief. Grantham Research Institute on Climate Change and the Environment and London School of Economics. Accessed 3 August 2021 at http://​www​.lse​.ac​.uk/​ GranthamInstitute/​wp​-content/​uploads/​2018/​07/​Policy​-coherence​-for​-sustainable​-development​-in​ -sub​-saharan​-Africa​_Curran​-et​-al​.pdf. Denton, F., E. Kituyi, H. Lo and H. Wouapi (2016). ‘Regional economic communities and climate change adaptation in Africa: background paper on lessons learned from CCAA’. CARIAA Working Paper #4. Accessed https://​idl​-bnc​-idrc​.dspacedirect​.org/​handle/​10625/​55663. Dillinger, J. (2019). ‘The world’s largest oil reserves by country’. Worldatlas.com. Accessed 3 August 2021 at https://​www​.worldatlas​.com/​articles/​the​-world​-s​-largest​-oil​-reserves​-by​-country​.html. Djeflat, A. and B.Å. Lundvall (2016). ‘The resource curse and the limited transformative capacity of natural resource-based economies in Africa: evidence from the oil and gas sector in Algeria and Implications for innovation policy’. Innovation and Development 6(1): 67–85. Frankel, J.A. (2010). ‘The natural resource curse: a survey’. Working Paper 15836. National Bureau of Economic Research. Global Witness (2011). China and Congo: Friends in Need. Accessed 3 August 2021 at https://​cdn​ .globalwitness​.org/​archive/​files/​library/​friends​_in​_need​_en​_lr​.pdf. Henri, P.A.O. (2019). ‘Natural resources curse: a reality in Africa’. Resources Policy 63: Article 101406. Institute for Democracy and Electoral Assistance (IDEA) (2017). ‘Enhancing natural resource governance in Africa’. Information Brief Africa and West Asia Programme. Accessed 3 August 2021 at https://​www​.idea​.int/​publications/​catalogue/​enhancing​-natural​-resource​-governance​-africa. Karl, T. (2005). ‘Understanding the resource curse’. In S. Tsalik and A. Schiffrin (eds), Covering Oil: A Reporter’s Guide to Energy and Development. New York: Open Society Institute, pp. 21–7.

216  Handbook of sustainable politics and economics of natural resources Accessed 3 August 2021 at https://​www​.op​ensocietyf​oundations​.org/​uploads/​8a632647​-ad24​-43ac​ -a4b8​-892b97b62119/​osicoveringoil​_20050803​.pdf. Keblusek, M.E. (2010). ‘Is EITI really helping improve global good governance?’ Accessed 3 August 2021 at http://​nidprodev​.org/​EITI​_Nigeria Analysis.pdf. Leke, A., S. Lund, C. Roxburgh and A. van Wamelen (2010, 1 June). ‘What’s driving Africa’s growth’. McKinsey & Company. Accessed 3 August 2021 at https://​www​.mckinsey​.com/​featured​-insights/​ middle​-east​-and​-africa/​whats​-driving​-africas​-growth. Mawejje, J. (2019). ‘Natural resources governance and tax revenue mobilization in Sub Saharan Africa: the role of EITI’. Resources Policy 62: 176–83. Nachmany, M. and J. Setzer (2018). ‘Global trends in climate change legislation and litigation: 2018 snapshot’. Grantham Research Institute on Climate Change and the Environment and London School of Economics. Accessed 3 August 2021 at http://​www​.lse​.ac​.uk/​GranthamInstitute/​publication/​global​ -trends​-in​-climate​-change​-legislation​-and​-litigation​-2018​-snapshot/​. Nile Basin Initiative (2021). Website accessed 28 July 2021 at https://​nilebasin​.org/​85​-who​-we​-are. Ochola, W.O., P.C. Sanginga and I. Bekalo (eds) (2010). Managing Natural Resources for Development in Africa: A Resource Book. Nairobi: University of Nairobi Press. Pezzey, J. (1989). ‘Economic analysis of sustainable growth and sustainable development’. Environment Working Paper ENV15. World Bank. Accessed 3 August 2021 at http://​ documents​ .worldbank​ .org/​curated/​en/​234121493257444727/​Economic​-analysis​-of​-sustainable​-growth​-and​-sustainable​ -development. Price, R. (2018). ‘Shared governance of climate change and natural resources issues in East Africa’. K4D Helpdesk Report. Institute of Development Studies. Ross, M. (2004). ‘What do we know about natural resources and civil war?’, Journal of Peace Research 41(3): 337–56. Runhaar, H., B. Wilk and Å. Persson et al. (2018). ‘Mainstreaming climate adaptation: taking stock about “what works” from empirical research worldwide’. Regional Environmental Change 18(4): 1201–10. Segal, P. (2012). ‘How to spend it: resource wealth and the distribution of resource rents’. Energy Policy 51: 340–48. Standing, A. (2014). ‘Ghana’s extractive industries and community benefit sharing: the case for cash transfers’. Resources Policy 40(C): 74–82. Tiba, S. and M. Frikha (2019). ‘The controversy of the resource curse and the environment in the SDGs background: the African context’. Resources Policy 62: 437–52. Togtokh, C. and O. Gaffney (2010, 11 May). ‘2010 Human Sustainable Development Index’. Our World. Accessed 3 August 2021 at https://​ourworld​.unu​.edu/​en/​the​-2010​-human​-sustainable​-development​ -index. Tralac (2017). ‘Background paper on natural resource governance in Africa: conflict, politics and power’. Accessed 3 August 2021 at https://​www​.tralac​.org/​images/​docs/​11546/​tana​-2017​-background​-paper​ -on​-natural​-resource​-governance​-in​-africa​-conflict​-politics​-and​-power​.pdf. Venables, A.J. (2016). ‘Using natural resources for development: why has it proven so difficult?’, Journal of Economic Perspectives 30(1): 161–84. Zallé, O. (2019). ‘Natural resources and economic growth in Africa: the role of institutional quality and human capital’. Resources Policy 62: 616–24.

PART III INSTITUTIONS AND RESOURCE POLICIES

14. Corruption, resource policies and economic growth Heli Arminen, Tiia-Lotta Pekkanen and Jorma Sappinen

1

THE RESOURCE CURSE AND CORRUPTION

There is ample empirical evidence for the so-called resource curse – that is, the negative correlation between natural resource abundance and economic growth (Auty, 2001; Sachs and Warner, 1995, 2001; Van der Ploeg, 2011), although contrasting evidence has also been presented (e.g., Brunnschweiler, 2008; Brunnschweiler and Bulte, 2008; Smith, 2015). Havranek, Horvath and Zeynalov (2016) provide a meta-analysis on the impact of natural resources on economic growth and find that approximately 40 per cent of empirical papers support a negative impact and 20 per cent a positive impact while the rest do not find any impact. However, it is possible that the empirical relationship observed in some studies has been caused by various econometric issues such as endogeneity, omitted variable bias and selection bias (Brunnschweiler and Bulte, 2008; Dauvin and Guerreiro, 2017; Havranek et al., 2016; Van der Ploeg, 2011; Van der Ploeg and Poelhekke, 2010). In addition to slower economic growth, the resource curse may manifest itself as a decrease in the investment rate, non-resource exports, foreign direct investment (FDI) and education, as well as a lower genuine savings rate, slower financial development, higher macroeconomic volatility and weaker institutional quality (Van der Ploeg, 2011). The prominence of corruption, that is ‘the use of public office for private gain’ (Bardhan, 1997, p. 1321), has also been associated with natural resources. For example, Leite and Weidmann (1999) state that natural resource abundance induces rent-seeking behaviour and is an important determinant of the level of corruption in a country.1 The empirical evidence on this relationship is, however, mixed (see, e.g., Knutsen et al., 2017 and Mehlum, Moene and Torvik, 2006b for discussion). Van der Ploeg (2011) surveys the literature on the consequences of natural resource abundance. An economic, or market-based, explanation often given for the resource curse relates to the so-called Dutch disease associated with inter-sectoral resource allocation: if windfall gains from natural resources have a crowding-out effect on the more productive non-resource sectors of the economy, such as manufacturing, being rich in natural resources harms economic devel1 Bardhan (1997) and Treisman (2000) discuss the other determinants of corruption. In general, corrupt practices result when expected benefits outweigh the expected costs. The benefits of corruption are usually associated with the economic rents present in a society, while its expected costs are a combination of the probability of detection and the severity of punishment when caught. Lack of transparency makes corruption more attractive (Kolstad and Wiig, 2009). The voluminous literature on the relationship between corruption and economic growth has found ample evidence for strong two-way causality between the two concepts. On the one hand, the prevalent view is that corruption hampers growth by causing distortions (e.g., Shleifer and Vishny, 1993). On the other hand, higher gross domestic product (GDP) per capita appears to decrease the level of corruption, probably because fighting corruption is costly (e.g., Treisman, 2000).

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Corruption, resource policies and economic growth  219 opment (e.g., Boschini, Pettersson and Roine, 2007; Van der Ploeg, 2011). However, several recent studies approach the issue from the point of view of political economy and highlight the role of national institutions in the consequences of resource abundance (Dauvin and Guerreiro, 2017; Havranek et al., 2016). The literature supports the assertion that the effect of being resource-rich depends on the properties of the resource (Dauvin and Guerreiro, 2017; Havranek et al., 2016). The resource curse appears to be most severe in the case of point-source resources that are extracted from a narrow geographical or economic base and are relatively easy to monitor and control, such as oil and other minerals, while diffuse resources, such as agricultural products, appear to be less prone to the negative consequences of resource abundance (Dauvin and Guerreiro, 2017; Frankel, 2010; Havranek et al., 2016; Kolstad and Søreide, 2009; Van der Ploeg, 2011). The properties of the resource are also important: resources that are easy to transport, trade or smuggle, need little processing and have a high value-to-mass ratio present high technical appropriability, which can induce rent-seeking behaviour (Boschini et al., 2007). High appropriability of a resource is likely to hamper economic growth, while low appropriability can boost growth. The conclusion to be drawn from this, as Kolstad and Søreide (2009) also highlight, is that it is important to consider different resources separately. As Boschini et al. (2007) point out, however, there are plenty of examples showing that the growth paths of countries rich in similar resources can diverge greatly. Many studies seek the explanation for this in institutional quality (e.g., Mehlum, Moene and Torvik, 2006a, 2006b; Robinson, Torvik and Verdier, 2006). According to Kolstad and Wiig (2009) and Kolstad and Søreide (2009), corruption is the most critical aspect of institutional quality in this context. Kolstad and Søreide (2009) classify rent-seeking and patronage as the two main forms of corruption in resource-rich countries. Mehlum et al. (2006a, 2006b) find resource abundance a blessing in the presence of good-quality institutions and a curse in the presence of bad-quality institutions. The key to their result is whether resource abundance attracts entrepreneurs into production, thus supporting economic growth, or diverts them from production into rent-seeking activities, thus hampering growth. In general, the availability of large resource rents increases the attractiveness of rent-seeking in comparison to more productive activities (Kolstad and Søreide, 2009). In a closely related study, Boschini et al. (2007) emphasize that the quality of institutions plays a role through what they term ‘institutional appropriability’: good-quality institutions can offset high technical appropriability of a resource and help to boost economic growth, even when the resource is associated with a high propensity for rent-seeking, while the resource curse manifests itself when appropriable resources are coupled with weak institutions. Resource revenues also induce patronage. Robinson et al. (2006) model the political foundations of the resource curse. They find that the political institutions of accountability and state competence determine whether natural resource abundance is a curse: high-quality institutions rectify harmful political incentives associated with resource booms, thus supporting economic growth, while low-quality institutions do not ameliorate the incentives and make the resource curse more likely. The effect is associated with patronage, which aims at securing political power through the use of public resources (ibid.). If governments pay off supporters to stay in power, allocation of public funds is impacted and accountability reduced (Kolstad and Søreide, 2009). Although the model of Robinson et al. (2006) does not account for different resources, it indicates that publicly owned resources are most likely to have a negative growth impact, which is in line with the results of Boschini et al. (2007).

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2

RESOURCE CURSE AND CORRUPTION: A COMPARISON OF THREE NATURAL RESOURCES

As discussed above, the properties of the natural resources possessed by a country and the quality of institutions – the level of corruption in particular – in that country determine whether natural resource abundance is a curse or a blessing. Below, we discuss three different natural resources. 2.1 Oil Oil is a point-source non-renewable resource (Kolstad and Søreide, 2009) and, as such, more prone to the resource curse than diffuse resources (e.g., Dauvin and Guerreiro, 2017): due to their dense spatial concentration, oil resources can be protected and controlled at a reasonable cost by a relatively small interest group within a society. As discussed above, the rents that such resources generate are relatively easily appropriable (Boschini et al., 2007; Bulte, Damania and Deacon, 2005; Sala-i-Martin and Subramanian, 2013). Although many previous resource-curse studies focus on oil (e.g., Alexeev and Conrad, 2009; Ross, 2015; Sala-i-Martin and Subramanian, 2013), empirical evidence continues to be mixed. Many studies have supported the resource-curse hypothesis, but there exist some divergent results as well. For example, Alexeev and Conrad (2009) find that oil wealth supports long-term economic growth and question the claims of a negative impact of oil on institutional quality. Alexeev and Conrad (2011) examine the impact of oil output on various socioeconomic indicators, finding no significant adverse effects, and conclude that the resource curse does not exist. In a similar vein, Kennedy and Tiede (2013) argue that oil does not weaken governance. In a comprehensive review of empirical literature, Havranek et al. (2016) point out that oil is less prone to the resource curse than some other point-source resources, such as diamonds and precious metals (discussed in the next subsection), and that new oil discoveries have led to long-lasting higher economic growth in many countries. Almost all research on the resource curse is based on observational data, which makes it difficult to settle disputes (Ross, 2015). Experimental evidence could be helpful, but only natural experiments are available. Vicente (2010) utilizes such a natural experiment and finds that an oil discovery is likely to deteriorate the quality of institutions. Moreover, although early resource-curse studies were mainly interested in the average treatment effect of oil wealth in a population of countries, the more recent literature has shifted the focus to how and why outcomes differ in different countries (Ross, 2015). An even more recent trend in the literature is supplementing traditional national-level cross-country analyses with case studies of local political characteristics of oil-dependent countries, and, for example, political elections and corruption processes are studied from the political ecology perspective (Williams and Le Billon, 2017). The evidence supporting the detrimental effects of oil wealth on the quality of institutions comes mainly from subnational studies (Ross, 2015). Furthermore, in a meta-analysis, Dauvin and Guerreiro (2017) find oil wealth to be negatively associated with institutional quality. Problems mentioned in this context include ineffective bureaucracies, weak rule of law, lack of government capacity to promote economic development (Ross, 2015), corruption (Arezki and Bruckner, 2011), rent-seeking (Bhattacharyya and Hodler, 2010; Collier and Goderis, 2008; Kolstad, 2009; Van der Ploeg 2011), patronage or rent sharing (Caselli and Michaels, 2013;

Corruption, resource policies and economic growth  221 Collier and Goderis, 2008; Sala-i-Martin and Subramanian, 2013), embezzlement (Caselli and Michaels, 2013) and weakening of political rights (Arezki and Bruckner, 2011). The relationship between oil wealth and the form of government has also been studied extensively, and it is well confirmed that higher levels of oil wealth enable authoritarian governments and leaders to ward off democratic pressures (Ross, 2015). Moreover, economic dependence on oil has been found to be correlated with the onset and duration of civil war, especially in Africa (Frankel, 2010; Ross, 2015; Van der Ploeg, 2011). An important finding is the relevance of location: oil is more likely to ignite conflict when it is found in relatively poor regions populated by marginalized groups, or when it is located in a region populated by a highly concentrated ethnic group, and when the oil wealth is used as a tool to promote resistance against the central government (Ross, 2015). 2.2

Precious Metals and Diamonds

Like oil, diamonds2 and precious metals are point-source non-renewable resources, but they differ from oil and bulk minerals because their technical appropriability is so high (Boschini et al., 2007) and because they are high-value minerals (Petermann, Guzmán and Tilton, 2007), making them more prone to rent-seeking. The meta-analysis of Havranek et al. (2016) supports this notion. Despite this, the evidence on the relationship between economic growth and precious-metal abundance is mixed (e.g., Dauvin and Guerreiro, 2017), suggesting even that the relationship can vary from a blessing to a curse over time in a given country (Wilson, 2013). Mining for diamonds and precious metals has also been associated with community-level negative consequences such as environmental degradation and negative health effects, loss of agricultural livelihood, increased inequality, increased use of child labour resulting in lower educational attainment, and human rights violations (Ahlerup, Baskaran and Bigsten, 2020; Pokorny et al., 2019; Zabsonré, Agbo and Somé, 2018). Hilson and Laing (2017) discuss how the countries that have prioritized export-led large-scale extraction and processing of gold tend to underperform socioeconomically. In particular, large-scale mining enclaves have a tendency to remain isolated from the rest of society. As a result, foreign investments made in mining do not necessarily benefit society more widely. In support of the Dutch disease hypothesis, Hilson and Laing list several examples in which resource allocation and spending effects have boosted the booming gold mining sector while hampering growth of manufacturing and agriculture sectors. Hilson and Laing (2017) conclude that institutions discouraging rent-seeking appear to be a prerequisite for reaping the benefits of gold abundance, even if policies helping local instead of multinational mining companies are in place. This is in line with the results of Boschini et al. (2007), who state that natural resources are a curse only to the countries with low‐quality institutions, while they are a blessing if the quality of institutions is high enough. In particular, Boschini et al. find that being rich in diamonds and precious metals amplifies both positive and negative effects. As to corruption, mineral discoveries result in high-rent activities, making it possible to pay higher bribes while still operating profitably, and therefore incentivizing bureaucrats to 2 Maconachie and Binns (2007) and Wilson (2013) differentiate alluvial diamonds from kimberlite diamonds. The former can be considered diffuse resources while the latter are point resources. Thus, the discussion in this section applies to kimberlite diamonds.

222  Handbook of sustainable politics and economics of natural resources demand bribes. Furthermore, capital investments in mining appear not that sensitive to prices (including possible bribes), lowering the economic costs of corruption to government and weakening the incentives to invest in the control of corruption. As government actors, moreover, benefit from mining-related bribes, natural resource abundance and dependence are likely to be associated with higher levels of corruption. A factor making mining particularly prone to corruption is that concealing revenue has often been relatively easy in the industry (Knutsen et al., 2017). For example, Wilson (2013) finds that rampant corruption was one of the main reasons why diamonds turned into a resource curse in Sierra Leone in 1968–92. Mining is also associated with local corruption through at least two mechanisms discussed by Knutsen et al. (2017). First, mine openings tend to support local growth, at least in the short term, thus increasing local income both in mining and non-mining activities (see also Aragón and Rud, 2013; Zabsonré et al., 2018). This, in turn, allows the already-present corrupt officials to request more bribes. Second, mine openings can tempt more corrupt officials, such as tax collectors and police officers, into the region, thus resulting in higher levels of local corruption. The geographically fixed nature of mining exacerbates this problem. Although some of the previous results on the macro-level relationship between mining and corruption might not depict causal effects correctly, the recent results of Knutsen et al. (2017) and Dong, Zhang and Song (2019) appear to confirm that mining increases corruption at least at the local level. 2.3 Forests Forests are diffuse and renewable resources, in contrast to point-source, non-renewable oil and precious metals. Cross-country evidence remains inconclusive about the impact of diffuse resources on economic growth (Dauvin and Guerreiro, 2017; Leite and Weidmann, 1999). However, a growing body of literature, often case study based, argues for the existence of a green (or ecosystem) resource curse (Broad, 1995; Cavanagh, 2017; Kronenberg and Hubacek, 2013; Laurence et al., 2012). Forest resource endowments may result in undesired economic development for a variety of reasons –for example, overharvesting for raw wood exports (Laurence et al., 2012), Dutch disease (Družinin, 2001) and the underdevelopment of domestic industries due to raw wood exports (Tykkyläinen and Lehtonen, 2008). In addition, corruption may play its part in hampering the potential for economic growth from forest resources (Søreide, 2007). Corruption in forestry is widespread, and it takes forms both similar to and different from those prominent in oil and precious metals industries (Kishor and Damania, 2007; Kolstad and Søreide, 2009; Søreide, 2007). Key factors explaining the differences include smaller contract size in forestry and less complex technology required to obtain forest resources (Kolstad and Søreide, 2009; Søreide, 2007). Concessions are an issue with both the oil industry and forestry. Administrative allocation of forest concessions may invite bribery and patronage in a very similar way to point-source resources (Kolstad and Søreide, 2009). Instead of revenue management, however, rent-seeking in forestry is often related to local elite capture and petty corruption practices (Cavanagh, 2017; Kolstad and Søreide, 2009; Mrema, 2017). As opposed to grand corruption, petty corruption refers to small payments at lower administrative levels (Søreide, 2007). Corruption in forestry is often directly linked to illegal logging, which may take various forms, from harvesting over the allowable volume to the violation of sustainable logging method requirements and harvesting of protected land area (Amacher, Ollikainen and Koskela,

Corruption, resource policies and economic growth  223 2012; Cavanagh, 2017; Kishor and Damania, 2007). Industrial harvesting is concession based, conducted commonly by private firms under forest management plans. Thus, the concession system within a country embraces various actors from the government to landowners, forest management organizations and logging companies. Accordingly, corruption may involve actors at different levels of the concession system, from the design and allocation of concessions to logging practices (Søreide, 2007). The enforcement and monitoring stage of the concession process in particular embeds petty corruption practices (Kolstad and Søreide, 2009). For example, forest guards may accept bribes for not addressing illegal logging or be directly involved in looting forest resources (Cavanagh, 2017). Local elite capture, in turn, may result from systems of decentralized, participatory forest management (Lund and Saito-Jensen, 2013). The phenomenon refers to local individuals gaining positions of power and privilege that enable them to seize local decision-making processes or forest resources for their own benefit (Mrema, 2017). Forests are not only a source of economic activity, but also provide a broad range of ecosystem services beyond monetary valuation (Agrawal et al., 2013; Kronenberg and Hubacek, 2013). Forests are crucial in maintaining traditional ways of living for forest-dwelling communities (Cavanagh, 2017). Illegal logging links to environmental degradation, including land erosion, diminished biodiversity, water quality and carbon sinks (Pachelo et al., 2016). Thus, illegal logging – and the intertwined corruption – pose a threat to global environmental sustainability and environmental justice. Resource policies to combat corruption in forestry thus connect to these broader contexts and stakeholders. Addressing corruption – and illegal logging – has proved difficult, and the evidence of different resource policy measures remain contradictory (Cavanagh, 2017; Mrema, 2017; Palmer and Bulkan, 2010). The approaches to tackling corruption range from individual to systems level. For example, Miller (2011) argues for better pay for the regulators. Active involvement of marginalized groups (such as indigenous communities or women) in decision making could address local elite capture problems (Saito-Jensen, Nathan and Treue, 2010). Community-based forest management has given promising results; however, the evidence may not always stand up to longitudinal evaluation (Mrema, 2017). At a state level, Palmer and Bulkan (2010) advocate transparency in taxation. Amacher et al. (2012) suggest the approach of designing concession policies under the condition that corruption is an inherent systemic feature.

3

(RESOURCE) POLICY IMPLICATIONS

In addition to institutional quality, policies play a crucial role in determining whether natural resources turn into a curse. In the words of Van der Ploeg (2011, pp. 369–70): ‘Many resource rich economies may have performed badly, not because they relied too much on resources, but because they failed in developing their mineral potential through appropriate policies.’ Furthermore, it is important to differentiate resource abundance from resource dependence in this context because resource abundance is more likely to support economic growth, while resource dependence is more likely to have the opposite effect (Dauvin and Guerreiro, 2017; Havranek et al., 2016; see also Brunnschweiler and Bulte, 2008). Therefore, policies also play an important role in determining whether resource abundance turns into too high dependence (Dauvin and Guerreiro, 2017).

224  Handbook of sustainable politics and economics of natural resources As to resource policies, it appears particularly important to pay attention to how resource revenue is used. According to Van der Ploeg (2011), the normative perspective suggests that resource-rich countries should invest the rents in reproducible assets such as physical and human capital and infrastructure. For example, investing in human capital and the diversification of economic activities helps in absorbing the diffusion of knowledge brought by foreign extractive-industry companies, thereby reducing natural resource dependence and increasing employment (Sisso and Beaumais, 2018; Zallé, 2019). If, on the other hand, capital scarcity is an issue for a country, it could be more beneficial to use the resource revenue to pay off debt, in order to lower interest rates to support capital accumulation and, through that, economic development (Van der Ploeg, 2011; see also Frankel, 2010). Another option that has been recommended is saving at least a share of resource revenue in a sovereign wealth fund or a commodity fund (Coutinho et al., 2015; Frankel, 2010; Tsani, 2013; Van der Ploeg, 2011). To prevent the inappropriate use of such funds, they should be transparently and professionally run and separated from daily politics (Frankel, 2010; Sala-i-Martin and Subramanian, 2013). If the institutional quality is very low in the resource-rich country in question, it might even be necessary to mandate an external agent, such as the financial institution housing the fund, to freeze the account if its rules are violated or in the event of a coup (Frankel, 2010). Making it more difficult for political rivals to raid the fund might also make it more likely that resource revenue is actually put into the fund (Van der Ploeg, 2011). Sala-i-Martin and Subramanian (2013) suggest that resources could be distributed to the citizens to prevent government officials from appropriating the resource rents. In such a case, government would get its revenue from taxes instead of resource rents. A related idea discussed by Frankel (2010) is the lump-sum distribution of (a share of) investment earnings to citizens on an equal per capita basis based on the idea ‘that the citizens know how to spend their money better than does their government’ (p. 33). It is also possible to distribute current resource revenues through community development funds to the communities affected by resource extraction. Such a fund can offset some of the social costs of natural resource extraction within the affected communities – in particular, if the management of the fund is given to local citizens, as investing in infrastructure and social services can help to turn resource revenue into socioeconomic development (Dupuy, 2017; Maconachie and Binns, 2007). However, as Dupuy (2017), Maconachie and Binns (2007) and Wilson (2013) discuss, corruption among the local, often unaccountable, authorities responsible for distributing resource revenues undermines the appropriate use of these funds. Thus, transparency, accountability and broad-based community representation and participation are crucial in making locally managed community development funds work. Yet another policy deemed beneficial is requiring extractive-industry companies to invest in local infrastructure or otherwise engage them in host-community development, with local citizens involved in designing, implementing and monitoring the development programmes (Wilson, 2013). Zabsonré et al. (2018) discuss how such investments may improve access to social and other infrastructure and services in the mining community, thus having a positive effect on local socioeconomic development. In a related study, Bunte et al. (2018) find that if foreign companies are required to build and maintain public infrastructure in or near the location of their investments, FDI in mining can support economic growth. Interestingly, the same impact is not observed for forestry-related FDI, indicating that there are also differences between the resources in which policies are effective.

Corruption, resource policies and economic growth  225 Paying attention to the policies affecting the ownership structure of extractive industries is also important, because domestically owned industry offers more potential for promoting local economic development than multinational (Hilson and Laing, 2017). Hilson and Laing highlight, however, that institutional quality is a prerequisite for reaping the benefits of resource abundance, even if policies helping local instead of multinational mining companies are in place. As to the policies aimed at improving institutional quality, Kolstad and Søreide (2009) conclude that priority should be given to lowering corruption (see, also, Zallé, 2019). Improving institutional quality is particularly important in the countries that are rich in resources with high technical appropriability, since those countries will gain most from higher institutional quality (Boschini et al., 2007). Since rent-seeking is associated with private-sector institutions and patronage with public-sector institutions, the remedies differ (Kolstad, 2009). If rent-seeking is prevalent, private-sector institutions like the rule of law are important. If, on the other hand, patronage prevails, the role of improving public-sector accountability is highlighted. Although Kolstad (2009) finds private-sector institutions more important in his analysis, the question warrants more research. Kolstad and Søreide (2009) discuss in detail how the risk of corruption can be alleviated in the different stages of natural resource exploitation. Since being able to easily conceal resource revenue is associated with the severity of the resource curse and the impact of resources on corruption (Corrigan, 2017; Knutsen et al., 2017), increasing transparency has been suggested as a means to ameliorate the curse (Kolstad and Wiig, 2009; Palmer and Bulkan, 2010; Sala-i-Martin and Subramanian, 2013). For example, the Extractive Industries Transparency Initiative (EITI – https://​eiti​.org/​) standard (e.g., Corrigan, 2014, 2017; Kolstad and Wiig, 2009) shows how curbing corruption in particular and strengthening governance in general are important targets in natural-resource extraction. Corrigan’s (2014, 2017) results indicate that the EITI has indeed supported economic development in its member states although it has not yet curbed corruption. Kolstad and Wiig (2009) argue, however, that focusing on transparency needs to be complemented with other policies, such as fostering education and increasing the accountability of governments: ‘In addition to access to information, you need an ability to process the information, and the ability and incentives to act on the processed information’ (p. 524). Kolstad and Wiig also suggest that since patronage is associated with the allocation of public expenditure, not revenues, the EITI’s focus on revenues should be reconsidered. To summarize, the success of policies in thwarting the resource curse is highly context-dependent and varies between resources and countries. In particular, resource policies and institutional quality are intertwined in the sense that many policies only support socioeconomic development if the level of corruption is low enough.

4 CONCLUSIONS This chapter surveyed the previous literature on the resource curse, corruption and resource policies. The conclusions and recommendations can be summarized as follows. (1) There are notable differences between natural resources in their susceptibility to the curse and the related issues that are essential. (2) Differences in institutional quality – the level of corruption, in particular – are an important factor behind the heterogeneous development paths of resource-rich countries. (3) Focus should be on socioeconomic, not only economic, development. (4) To

226  Handbook of sustainable politics and economics of natural resources be effective at supporting socioeconomic development in resource-rich countries, resource policies should be combined with policies aimed at improving institutional quality. In fact, institutional policies are more important than resource policies in this sense. (5) Universally effective policy recommendations cannot be given because the success of policies is highly context dependent and varies between resources and countries. (6) As to future research, we see community-level studies as being more fruitful than macro-level analysis. We made some delimitations in this chapter. First, the discussion on how natural resource abundance should be measured in empirical literature is beyond the scope of this chapter (see, e.g., Brunnschweiler, 2008; Brunnschweiler and Bulte, 2008; Van der Ploeg and Poelhekke, 2010). Second, natural resource prices and their volatility have also been associated with the natural resource curse (see, e.g., Frankel, 2010; Sisso and Beaumais, 2018). Frankel (2010) discusses policies that have been used to try to limit the negative impacts of price volatility, as well as those for limiting the adverse effects of volatility. These, and monetary policy remedies in general, are not covered in this chapter. Moreover, our overview does not reach into the political economy literature that discusses the impact of political institutions on, for example, stabilizing resource markets and supporting the development of democracy and financial markets (Bhattacharyya and Hodler, 2014).

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15. Local content policies and institutional capacity for sustainable resource management Yelena Kalyuzhnova

1 INTRODUCTION Maximizing the impact of natural resources has always been high on the agenda of resource-rich countries, with local content (LC) policy being one of the instruments to achieve this goal. Governments have introduced requirements for LC through regulatory frameworks. As Kalyuzhnova et al. (2016) have pointed out, ‘the definition of LC varies from country to country and even between periods of policy implementation’ (p. 1). As a consequence, the types of LC policies vary as well. Nevertheless, one common feature of such policies is always present – namely, enabling domestic producers to expand their activities, although in some cases the given project could be completed only partially with domestic inputs. Another aspect of LC policy is to enable access to international expertise in the areas of technology and management. Together, these factors can improve economies of scale and, in principle, have positive domestic effects, resulting in enhanced competitiveness on the international market. In this chapter, we analyse LC policies as part of governments’ efforts to ‘catch up’ at the sectoral level or wider economic and institutional levels. LC policy is situated within a wider framework of sustainability and is focused on industrial diversification and innovation-led growth. It is usually expressed through legally binding requirements relating to procurement and employment of labour at the domestic level, as well as technology transfers. Practice has demonstrated that countries that adopt LC as a developmental strategy for their resource-rich sectors initially develop LC institutional frameworks, allowing the policies to be managed and the outcomes to be observed (Oyewole, 2018). There is no doubt that a well-defined LC framework is an essential basis for the implementation of LC policy. Other factors – legal, institutional and regulatory frameworks – are also imperative for achieving desirable LC outcomes. The problems associated with institutional capacity could become a real obstacle in implementing LC policy. If the institutional capacity is not at the right level, then there is a situation of asymmetric information between companies and government that creates a gap between the expectations and the outcomes of the LC policy. Therefore, country-specific institutional matrices, together with their macro-economic drivers and social development objectives, in conjunction with the role of host governments and the articulation of LC policies, are mitigating factors in enabling LC policies to facilitate an effective ‘catching up’ at the economic and institutional levels. Kalyuzhnova et al. (2016) have demonstrated that the experiences of different countries offer different outcomes. In this chapter, we attempt to identify the factors of successful LC policy implementation, linking them with the required institutional capacity and depicting the broader sustainability implications of resource management in the resource-rich countries where such policies are set up. We focus on factors that play a crucial role in the facilitation 230

Local content policies and institutional capacity  231 of comprehensive management and economic behaviour. LC policies may remedy market and government failures. We identify incentives to provide the populations of resource-rich countries with better services, together with the technologies that enable increased efficiency in the use of resources. Integrated resource management is based on the view that mineral resources are an integral part of sustainable development.

2

LOCAL CONTENT POLICY: CONCEPTS AND PERSPECTIVES

Many authors consider LC policy to be an element of industrial policy (Bianchi, 2008; Bora, Lloyd and Pengestu, 2000; Rodrik, 2010, among others), although the governments of resource-rich countries have viewed it as a tool of diversification policy. It is implemented by many resource-rich countries and considered as a possible vehicle for improvements across a range of areas: new economic activity, technological catch-up, human capital accumulation and supporting demand for local goods, work and services. LC policy could be multidimensional or concentrate on only one of these areas – for example, labour, capital or technology (broader conceptualization). In some cases, LC policies focus only on ownership structure and the transfer of property rights to domestic industrial actors (narrow conceptualization). Striking similarities can be observed in relation to the maximization of the depth and breadth of local contribution (e.g., labour, control and ownership) to capture additional rent from oil resource-rich sectors and increase local value-added production. In this chapter, we concentrate on a broad perspective of LC – namely, the increase of value and rent through labour, procurement and infrastructure at the local level, as well as through diversification and local technology transfer. A narrow focus on ownership might not provide enough of a basis to achieve sectoral or wider catch-up. There are different stakeholders involved in the formation and implementation of LC policy in any resource-rich country. On the one hand, the government is the driver and initiator of LC policy, usually defining the procedures, timelines and, in many cases, the quantitative indicators of LC policy implementation. On the other hand, the companies required to meet the LC targets in their operations often view such LC requirements and pressure from governments as a cost of doing business. They often attempt to influence governments in order to alter quantitative requirements and timing. Although an effective LC policy has the capacity to provide benefits for all stakeholders in the long run, companies frequently focus on the limited duration of specific projects, which is not long enough to implement the required LC policy. For example, it takes around 15 years to train a person to take a managerial position in engineering – however, few contracts are long-term contracts. Therefore, when designing LC policy, governments have to write in a certain level of flexibility to adjust to the particular conditions and circumstances. In addition to the imperative of realism in designing a particular LC requirement, governments need to have a clear understanding of the relation between LC development and World Trade Organization (WTO) membership. It is not a secret that LC requirements are perceived by the WTO as protectionist and trade distorting and are therefore mostly prohibited under WTO rules (Ramdoo, 2015). Some developing countries have asked for modifications to these WTO restrictions to LC requirements. Their arguments include infant industry and diversification, positive externalities and scale economies. The literature highlights some welfare

232  Handbook of sustainable politics and economics of natural resources gains from infant industry/economy protection (Greenwald and Stiglitz, 2006) and the positive role of competition/policy design in promoting desirable outcomes (Aghion et al., 2012). The rationale for LC requirements is twofold, both political and economic. However, some authors have found that protectionist policies can also exhibit negative effects (Belderbos and Sleuwaegen, 1997; Ray, 1998). To date, there are several examples of WTO members pursuing LC policy against the WTO regulations. Kalyuzhnova et al. (2016) have noted that there are weaknesses in the WTO’s dispute settlement system. The main problem is in the interpretation of LC requirements by different countries. In addition to employment and procurement, facilitation of technology and knowledge transfer to the host country could represent another dimension of LC policy. Both developed and developing countries have used an LC instrument at some stage in the development of their resources. For example, to create the basis for new product development following strengthened additional employment and export, Brazil, Kazakhstan, Russia and Norway aimed to create domestic technology leaders in their LC policies. Taking into account the present reality (e.g., existing oil and gas [O&G] clusters and global production networks), it is very unlikely that resource-rich emerging countries could sustain new market development without some form of industrial policy. In this respect, LC policies can be an instrument of industrial diversification and innovation-led growth, as they are in dialogue with the existing innovation system of the country. Norway and the UK are the best examples of this. Both countries were O&G latecomers; nevertheless, they developed internationally competitive goods, work and services, based on existing technological and industrial clusters. Many companies have created and implemented their own LC policies, with mixed results. ‘While some have been effective at developing local businesses and capacity, others have created new channels of corruption or failed in their objectives’ (Esteves, Coyne and Moreno, 2013, p. 1). Practical challenges often become strong impediments to successful implementation – namely, a lack of industrial/human capacities and legislation that does not consider local realities. All this creates opportunities for corrupt practices and leads to economic inefficiency. The long-term vision needs to be embedded into the design of skills and supply upgrade programmes, which will be the basis for sustainable LC policy in the long run. The relations of private firms with public institutions and policy makers are as instrumental for the effectiveness of LC policy outcomes as their links with other entities, whether public or private. This effectiveness needs to be understood through successful strategic intervention in facilitating technological innovation, knowledge transfer, accumulation and economies of scale. The outcome of an effective LC policy is the creation of a favourable environment for spin-offs and for positive externalities to arise. To escape resource dependency, resource-rich economies clearly need to move towards greater diversification, as this promotes quality growth, economic transformation and employment. Many countries, such as Kazakhstan, Trinidad and Tobago and others, considered LC policy to be an engine of diversification, adopting the perspectives of both the market and the state. Local procurement and services in a resource-rich country can be enabled through the creation of backward linkages, with the development of chains facilitating higher value-added processing and manufacturing activities. These linkages could stimulate economic development through the promotion of local industries, creating economic linkages that result in an increase in local capacity, capabilities and technologies, and enable the workforce to develop relevant skills. Therefore, LC and more extensive backward linkages could potentially allow resource-rich nations to avoid the resource curse (Ovadia, 2014).

Local content policies and institutional capacity  233

3

INSTITUTIONAL CAPACITY BUILDING FOR SUSTAINABLE RESOURCE MANAGEMENT

Institutional capacity is related to a country’s capabilities at six core levels: human, scientific, technological, organizational, institutional and resources. The key constraints to sustainable development in many resource-rich countries can be related to the limited capacity of their institutions to absorb financial resources and translate them into tangible actions and projects. The building process of institutional capacity is crucially important for the governments of these resource-rich countries. It enables them to evaluate and address the issues arising from policy choices and from the implementation modes of different development options, based on an understanding of the country’s specific potential and limits. Institutional capacity building includes acquiring knowledge at technical, managerial and institutional levels and developing insights into the socio-economic structure, cultural standards and values of the society concerned. The flexibility of institutions and the ability of the society to adapt to changing circumstances could be considered a successful outcome of institutional capacity building. There are three elements of capacity building that are fundamental for this success – the creation of an enabling environment with optimal (appropriate) frameworks, both policy and legal; the development and strengthening of human resources and managerial systems; and finally, the development of institutions, including community participation. The time factor should not be underestimated. It takes a long time to develop the whole spectrum of capabilities; it is a continuing process involving many stakeholders. The role of people, communities and institutions is vital and should not be underestimated in sustainable institutional capacity building. Many failures in resources management may be attributed to weak institutions and insufficient numbers of trained staff. Capacity building has thus been identified as a missing link in some resource-rich countries in Africa (Collier, Venables and Venables, 2011). Resource management remains a crucially important challenge for the governments of resource-rich countries. The way they manage their resources will determine how successful they are in passing on their mineral wealth to future generations. Failure of governments to manage their mineral resources is often attributed to the management practices of LC policy implementation. Such governmental mismanagement of mineral resources causes serious misallocation, waste and financial loss. The resource-rich countries are faced with specific problems, arising from a number of core failures: resource management is often fragmented among institutional actors with different objectives, with little regard to ensuing conflicts or complementarities. This leads to conflictual relations, confusion, disparities and damaging tactics. A deep analysis of the failures of government in the sphere of resource management shows clearly that some resource-rich nations have been unable to identify problems when attempting to formulate and implement suitable policies and strategies. In addition, weak governmental agencies and institutions, as well as staff training deficiencies, contribute greatly to such failures. The inefficiency of a number of national or local institutions responsible for resource management can be traced back to a lack of clarity in institutional mandates, insufficient funding, the lack of required human resources and inadequate education, compounded by low levels of participation and commitment from communities. Inadequately designed and inefficient LC policies are further aggravated by weak institutional capacity building. New circumstances and challenges demand that countries make a constant effort to adapt their policies and strategies accordingly.

234  Handbook of sustainable politics and economics of natural resources There is a two-pronged aspect to resource management: first, direct measures to control resource use (e.g., regulation or technology); and second, direct measures affecting voluntary behaviour (e.g., market mechanisms, financial incentives or education). Lessons from the past two decades have shown that resource management needs to be based on sounder policies, including greater economic incentives for increasing efficiencies and more rigorous institutional arrangements than those currently in place (Adams et al., 2019; Mohaddes, Nugent and Selim, 2019). The formulation of LC policies needs to address the interdependencies among sectors of the economy, within the context of a comprehensive analytical framework. To implement such an approach demands greater integration and would have significant consequences for businesses, institutional arrangements and capacity building. Moreover, it is essential that regulation and coordination among agencies responsible for resource management should be established to ensure coherent LC policy and consistent rules. The lessons learned from LC policy experience (Kalyuzhnova et al., 2016; Kolstad and Kinyondo, 2017) demonstrate the need for governments to take decisive action to break from past policies to adopt a new approach in LC policy formation. This new approach should be comprehensive, market oriented, participatory and sustainable, and would require difficult decisions from the governments wishing to implement such a strategy. However, the approach is founded on the principle that the LC policy should foreground various aspects of the institutional and human resources framework, whilst tackling the issue of building and enhancing the country’s medium- to long-term institutional capacity. The inclusion of different stakeholders (experts, representative businesses and national governments) in the formulation of LC policy guarantees that their various views will be incorporated into the final version of the policy. The institutional arrangements for the development and ensuing management of LC policy are the transmission mechanisms between LC policy objectives and field-level performance. To make these policies sustainable, the institutional analysis needs to raise the fundamental questions of who is expected to do something, what resources are available and how the institutional building blocks should interact. In this chapter, we define the term ‘institutions’ as the set of rules governing LC policy. The term encompasses the specific organizational arrangements involved in the formulation and implementation of LC laws, strategies and programmes. Together, the rules create the environment enabling sustainable LC policy implementation. It may be necessary to make changes to the rules and organizational arrangements, including with regard to human resources, in order to translate policies into an effective action programme. Such changes should be accompanied by incentives for improved performance at the level of resource planning, allocation and operation management. It tends to be the case that governments generally organize and administer resource sector activities separately rather than in conjunction with each other. Bureaucratic fragmentation results in poor coordination. Individual agency mandates take decisions independently of each other: this often results in waste and duplication, as different agencies may make excessive and unproductive investments by developing the same source for different uses. This piecemeal approach, where the focus is on isolated projects, departments and regions without any effective overview, fails to address present-day resource issues and causes unnecessary difficulties for governments in the management of their resources. In many countries, institutions have evolved at a significantly slower pace than the changing impositions on their resources and have often been driven by reactions to narrow concerns rather than a coherent strategy.

Local content policies and institutional capacity  235 Recently, a new collaborative approach for resource management was advocated, built on clear, transparent and attractive policy, with adequate institutional support (Devenin, 2021; Dietsche, 2014; Fraser, 2018; Heim et al., 2019; Morris, Kaplinsky and Kaplan, 2011; Olawuyi, 2017). This approach to policy formulation is well known in other areas of public policy – for example, in urban planning (Healey, 1998) or wind energy policies (Breukers and Wolsink, 2007). Healey (1998) suggests that collaborative approaches increase awareness of the importance of building new policy discourses and encourage stakeholders to work together in policy development and delivery. Opening out stakeholder involvement beyond traditional power elites results in the recognition of different forms of local knowledge, while the enriched social networks can become a resource of institutional capital that facilitates the speed at which new initiatives can be taken and validated. The collaborative approach to policy design is linked to the concept of institutional capacity building (Healey, 1998; Healey et al., 2003), defined as the capacity to facilitate open-policy processes providing access to relevant stakeholders and making room for various types of knowledge resources (Healey, 1998). Healey (1998) identifies three analytical dimensions to institutional capacity: relational resources, knowledge resources and capacity for mobilization (Healey et al., 2003). Recent research has further examined the relation between the concept of institutional capacity and the ability of organizations to deliver industrial symbiosis, with special attention to how this ability can develop over time (Wang, Deutz and Chen, 2017). Boons and Spekkink (2012), who use the concept of institutional capacity in their analysis of the factors of industrial capacity, identify three sorts of institutional capacity: ● relational capacity: a network of relationships that serves to reduce transaction costs among firms through increased trust and mutual understanding; ● knowledge capacity: the ability to acquire and use information that enables firms and other actors to shape their exchanges in such a way as to reduce ecological impact; and ● mobilization capacity: the ability of actors within the industrial park to activate relevant firms and other parties to develop symbiotic linkages. According to Boons and Spekkink (2012), the interplay between these three dimensions is central to the analysis of institutional capacity. Far more than a mere stock of assets, institutional capacity ‘represents a force which is continually emergent, produced in the interactive context of its use’ (Healey et al., 2003, p. 64). Elaborating on the work of Healey et al. (2003), we suggest applying the concept of institutional capacity building to the design of policy in the resource sector. This idea has been previously discussed by Karl (2007), who advocated that oil rents have a detrimental impact on the quality of administrative institutions, especially in less developed countries, because oil states do not need to rely on their populations for most of their resources and therefore have little incentive to build the institutional capacity required for producing output in more balanced economies. Therefore, in resource-rich states, the institutional capacity is underdeveloped in comparison to the economies of resource-poor states with high income per capita. The concentration of wealth results in the impoverishment of the state, while the dispersion of wealth leads to the enrichment of the state. Three interrelated issues arise in this context: (1) the ownership structure of mineral resources; (2) the fact that institutional capacity in mineral-rich states is shaped, not by mineral wealth per se, but rather by the structure of ownership each country adopts over its mineral resources; and (3) the relative influence of domestic factors versus international factors (Luong and Weinthal, 2006). With regard to this research

236  Handbook of sustainable politics and economics of natural resources agenda, institutional capacity in resource-rich countries includes the ability to formulate and implement LC policy that allows the country to support domestic factors of production and solve the problem of diversification and sustainable development. Institutional capacity – which includes the collection of laws, organizations and behaviours that define the way policy is determined, managed and governed (Ossowski et al., 2008) – may positively correlate with the levels of development of specific countries.

4

LOCAL CONTENT POLICIES AND INSTITUTIONAL CAPACITY – INNOVATION AND CHANGE

The key dimension of institutional capacity is knowledge capacity, which may be subdivided into the three categories of absorptive, knowledge-creating and knowledge-diffusing capacity. The knowledge creation and diffusion capacity of innovation systems rests on the interaction of firms with each other and the knowledge infrastructures. Some economies have substantial absorptive capacity, yet still face a challenge when trying to overcome state autonomy and economic, political and social barriers in their efforts to incentivize economic actors to invest in value-added production or increase labour productivity. In this respect, knowledge institutions, such as schools, technical colleges, universities and research and development (R&D) institutes, together with educational policies, are all components of a system that enables LC policy to function as a catch-up vehicle at the sectoral or economy-wide levels. In their book, Kalyuzhnova et al. (2016) compare current practice in Brazil, Kazakhstan and Russia with historic practice in Norway and the UK. They conclude that in all cases, LC policies were embedded in a wider framework of macro- and micro-economic management, which depends on institutional capacity. The importance for LC policy of the initial conditions, institutional settings and desire for national control of the LC development process cannot be underestimated. The analysis of the experience of Norway and the UK in the 1970s and 1980s shows clearly that the economic and institutional conditions of these two countries were much more robust than those of the countries attempting to implement the same policies nowadays in resource-rich emerging markets. The motivation behind LC policy is to stimulate economic growth and industrial development, as well as deriving non-fiscal benefits of a broader nature from O&G development. Its implementation and success are linked to a range of macro- and micro-economic conditions. ‘The variation in these conditions structure trade-offs between state control over downstream development/supply-chain operations and international oil companies’ access to rent and operational autonomy. From a public perspective LC policy is also about ensuring that the micro-economic behaviour of O&G companies conforms to wider economic and social considerations’ (Kalyuzhnova et al., 2016, p. 7). In developing and emerging resource-rich countries, the challenges in the implementation of LC policies are often associated with a lack of technological, managerial, institutional and civil service capacities. The greater future returns from the LC policy implementation are more or less attractive depending on the specific business environment and current security of property rights and the institutional framework. This is where building institutional capacity has a fundamental role to play. As a rule, institutional frameworks are established by legislation, with the intention of providing operative norms. However, informal institutions always supplement formal institutions established by law, either complementing the functions of institutions or competing with them.

Local content policies and institutional capacity  237 The fundamental questions regarding institutional integration include, on the one hand, how well institutions function internally to carry out the function set by LC policy, and on the other hand, how efficiently they interact with other institutions to fulfil this task. Among the key aspects of institutional structure and operation that need to be considered, most noteworthy are the issue of centralization/decentralization, the role of the private sector, and local-level management. Human resources represent an important aspect of capacity building, which requires adequately trained professionals that are able to function in the multi-sectoral environment of resource management. The resource manager must understand the scientific and technical disciplines related to mineral resources, whilst being knowledgeable in the fields of economics and ecology, and familiar with legal and social analysis. The logic here is quite simple: capacity building depends on appropriate institutions, which in turn depend on human resources, with a workforce paid appropriate salaries. It is obvious that even an ideal institutional structure, if it is held back by poorly skilled personnel, will not have the potential of an ungainly structure that has the benefit of highly competent people. A country’s capacity to achieve its energy sector objectives is directly linked to sound institutions, together with the availability of high-quality human resource staffing. One of the LC policy dimensions is the development, at all levels of the different organizations, of a qualified and motivated staff. To do so, it is necessary to invest in training and education, ensure suitable career and salary development pathways and create a stimulating personnel environment. These are essential instruments without which long-term capacity building is unlikely to be successful. However, they serve different purposes and function on different time scales. For example, training addresses the specific problem of skills shortage and offers directly applicable know-how, but it implies shorter contact times than education as a whole. Education has a broader remit, covering factual knowledge, insight, applicable methodologies and professional attitude, and aims to answer the need for competent professionals with technical and managerial skills who will be able to strengthen the conceptual and strategic capabilities of their resource-rich countries. To sustain competitiveness, the local firms need to engage rapidly with an increase in technical and multi-disciplinary complexity. In turn, professionals need to be better prepared for these challenges, with inspiring vocational and tertiary-level facilities. The curricula of education establishments need to be adapted to the key problems and requirements of the sector, and teaching methodologies need to be reviewed for greater effectiveness. The experience of resource-rich countries shows that a greater emphasis should be placed on developing inter-disciplinary skills and team spirit, so that graduates are comfortable and ready to work in increasingly integrated environments (Kalyuzhnova, 2008). Although training and staff development is often a high priority for LC policy implementation, for its potential effectiveness to be fully realized it needs to be associated with incentives for staff to improve performance. If such incentives are inadequate, the firms and organizations will fail to attract high-calibre staff, making any resolution of the complex existing resource management problems unlikely. The building up and improving of the capacity of states and private businesses in supply chain management, technology development and financial capacity provide a bargaining relationship between host country and international company. Nevertheless, to ensure technological and institutional competition and continued evolution, the role of international expertise and entrepreneurial capital remains an important one. We are dealing with a long-term process

238  Handbook of sustainable politics and economics of natural resources that requires a rational strategy from governments as well as the will to tackle geological and technological challenges. The latter is one of the key determinants of LC potential, which can alter the bargaining relationship between states and companies and make an impact on resource management. ‘An element of LC policy in some of the case study countries is thus facilitating the emergence within the host country of a technology base, or transfer of such by international companies to host countries. Depending on the political and investment context, this aspect of LC policy has the potential to benefit both states and companies’ (Kalyuzhnova et al., 2016, pp. 172–3). So, ‘LC policy provides a vehicle for generating synergies between companies and institutions of state that enable both parties to achieve their ends’ (ibid., p. 175). However, the experiences of different countries demonstrate that the policies that were successful in one country could prove disastrous in another (Tordo et al., 2013). National oil companies (NOCs) can be instrumental in promoting government objectives in the form of domestic procurement, through the support of domestic technological innovation and the development of context-specific technology. Examples of this can be found in the activities of both Statoil (Norway) and Petrobras (Brazil). Overall, to understand the link between innovation systems and industrial policy, it is important to spell out the place of natural resources in the innovation process. A very sensitive issue here is the extent to which authorities have both the ability and the autonomy to define and select which industries should be supported. As natural resources are non-randomly distributed, regulators in resource-rich countries are at an advantage when identifying the extent of investment potential for technological and industrial development. Moreover, LC policies become even more important in cases where the development of O&G fields is technologically complex. In such cases, well-designed LC policies can create synergies between the business objectives of the company and the socio-economic objectives of the country, an essential precondition for this being the state’s ability to maximize the potential spin-off and growth effects in the long term through its national or regional innovation system and effective control of the speed of development. A serious challenge for many resource-rich countries is to embed an exit strategy within their LC policy. To foster innovation, long-term growth LC policies must create incentives for firms and institutions benefiting from LC requirements to become internationally competitive within a short time frame. The sustainability of LC is a real issue, as one of its most important aims is the establishment of firms that will eventually compete in the international market.

5 CONCLUSION Sustainable development has been defined as development that meets the needs of the present, without compromising the ability of future generations to meet their own needs (United Nations, n.d.). Sustainable LC policies aim to ensure the use of domestic sources at different stages throughout the value chain to generate local employment, strengthen cross-sector benefits and create knowledge and skills linkages. LC policies may include many areas: procurement of goods and services, local employment, fostering local technological expertise and small and medium enterprise (SME) activities. In this respect, capacity building is crucially important.

Local content policies and institutional capacity  239 The following policy recommendations are of the utmost importance for decision makers trying to create favourable conditions to stimulate the capacity building of the various institutions and interested agencies participating in LC policy implementation. First, negotiations are crucial; they should be open-minded, respectful of any difference of opinion, and confidential. The enabling and encouragement of open communication and participation allows the decision-making process to be more inclusive, thereby securing essential support for decisions relating to LC requirements. Practice demonstrates that development of long-term vision, particularly at an institutional level, would assist LC policy implementation (Noreng, 1980). This vision should be supported by a clear administrative and legal structure. Both the formal and informal networks within administrative and legal systems need to be considered. Institutional changes to any aspect of resource development and management should be all-encompassing and made within the context of an overarching management strategy of the entire economy, including all government and non-government functions. Partial measures of deficiencies can be connected to inconsistences: in legislation, within the organizational structure, rules and procedures, and generally in the exercise of public and governmental responsibilities. All reform proposals should therefore be guided by an overall framework that explicitly articulates such items to achieve consistency in actions. When designing policy, it is important to bear in mind that legislation with a precisely defined scope and goals can (in theory at least) be a more effective tool for enforcement, but it also carries the risk of being too rigid at a time of rapidly changing competitive circumstances. When legislation ceases to reflect local realities, it can be counterproductive, potentially resulting in economic inefficiency and a rise in corruption. The closer a nation approaches the limit of its available resources, the more pressing the incentive to confront fundamental and far-reaching problems to satisfy its long-term needs in a sustainable manner. Major regions of the world are moving away from a phase dominated by resource development in the mineral sectors, towards a more sophisticated form of resource management.

REFERENCES Adams, D., Ullah, S. and Akhtar, P. et al. (2019). The role of country-level institutional factors in escaping the natural resource curse: insights from Ghana. Resources Policy, 61, 433–40. Aghion, P., Dewatripont, M. and Du, L. et al. (2012). Industrial policy and competition. NBER Working Paper 18048. National Bureau of Economic Research. Belderbos, R. and Sleuwaegen, L. (1997). Local content requirements and vertical market structure. European Journal of Political Economy, 13(1), 101–19. Bianchi, P. (2008). International Handbook on Industrial Policy. Cheltenham, UK and Northampton, MA, USA: Edward Elgar Publishing. Boons, F. and Spekkink, W. (2012). Levels of institutional capacity and actor expectations about industrial symbiosis: evidence from the Dutch stimulation program 1999–2004. Journal of Industrial Ecology, 16(1), 61–9. Bora, B., Lloyd, P.J. and Pengestu, M. (2000). Industrial policy and the WTO. World Economy, 23(4), 543–59. Breukers, S. and Wolsink, M. (2007). Wind energy policies in the Netherlands: institutional capacity-building for ecological modernisation. Environmental Politics, 16(1), 92–112. Collier, P., Venables, A.J. and Venables, T. (eds) (2011). Plundered Nations: Successes and Failures in Natural Resource Extraction. Basingstoke, UK: Palgrave Macmillan.

240  Handbook of sustainable politics and economics of natural resources Devenin, V. (2021). Collaborative community development in mining regions: the Calama Plus and Creo Antofagasta programs in Chile. Resources Policy, 70(C), Article 101284. Dietsche, E. (2014). Diversifying mineral economies: conceptualizing the debate on building linkages. Mineral Economics, 27(2–3), 89–102. Esteves, A.M., Coyne, B. and Moreno, A. (2013). Local content initiatives: enhancing the subnational benefits of the oil, gas and mining sectors. Briefing. Natural Resource Governance Institute. Fraser, J. (2018). Mining companies and communities: collaborative approaches to reduce social risk and advance sustainable development. Resources Policy. Ahead-of-print, https://​doi​.org/​10​.1016/​j​ .resourpol​.2018​.02​.003. Greenwald, B. and Stiglitz, J. (2006). Helping infant economies grow: foundations of trade policies for developing countries. AEA Papers and Proceedings, 96(2), 141–6. Healey, P. (1998). Building institutional capacity through collaborative approaches to urban planning. Environment and Planning A, 30(9), 1531–46. Healey, P., de Magalhaes, C., Madanipour, A. and Pendlebury, J. (2003). Place, identity and local politics: analysing partnership initiatives. In M. Hajer and H. Wagenaar (eds), Cambridge, UK: Cambridge University Press, pp. 60–87. Heim, I., Kalyuzhnova, E., Li, W. and Liu, K. (2019). Value co-creation between foreign firms and indigenous SMEs in Kazakhstan’s oil and gas industry: the role of information technology spillovers. Thunderbird International Business Review, 61(6), 911–27. Kalyuzhnova, Y. (2008). Economics of the Caspian Oil and Gas Wealth: Companies, Governments, Policies. New York: Springer. Kalyuzhnova, Y., Nygaard, C.A., Omarov, Y. and Saparbayev, A. (2016). Local Content Policies in Resource-Rich Countries. Basingstoke, UK: Palgrave Macmillan. Karl, T.L. (2007). Oil-led development: social, political, and economic consequences. Encyclopedia of Energy, 4(8), 661–72. Kolstad, I. and Kinyondo, A. (2017). Alternatives to local content requirements in resource-rich countries. Oxford Development Studies, 45(4), 409–23. Luong, P.J. and Weinthal, E. (2006). Rethinking the resource curse: ownership structure, institutional capacity, and domestic constraints. Annual Review of Political Science, 9, 241–63. Mohaddes, K., Nugent, J.B. and Selim, H. (eds) (2019). Institutions and Macroeconomic Policies in Resource-rich Arab Economies. Oxford: Oxford University Press. Morris, M., Kaplinsky, R. and Kaplan, D. (2011). One thing leads to another – commodities linkages and industrial development: a conceptual overview. MMCP Discussion Paper No. 12. Noreng, O. (1980). The Oil Industry and Government Strategy in the North Sea. London: Croom Helm. Olawuyi, D.S. (2017). Local content and procurement requirements in oil and gas contracts: regional trends in the Middle East and North Africa. OIES Paper: MEP 18. Oxford Institute for Energy Studies. Ossowski, R., Villafuerte, M., Medas, P.A. and Thomas, T. (2008). Managing the Oil Revenue Boom: The Role of Fiscal Institutions. Washington, DC: International Monetary Fund. Ovadia, J. (2014). ‘Local content and natural resource governance: the cases of Angola and Nigeria’. The Extractives Industries and Society, 1(2), 137–46. Oyewole, B. (2018). Overview of local content regulatory frameworks in selected ECCAS countries. ‘Strengthening Development Linkages from the Mineral Resources Sector in Central Africa 1415P Project’ funded by the United Nations Development Account 2015–2017. United Nations Conference on Trade and Development (UNCTAD). Ramdoo, I. (2015). Unpacking local content requirements in the extractive sector: what implications for the global trade and investment frameworks? International Centre for Trade and Sustainable Development (ICTSD). Ray, D. (1998). Development Economics. Princeton, NJ: Princeton University Press. Rodrik, D. (2010, 12 April). The return of industrial policy. Project Syndicate. Tordo, S., Warner, M. Manzano, O.E. and Anouti, Y. (2013). Local Content in the Oil and Gas Sector. Washington, DC: World Bank. Wang, Q., Deutz, P. and Chen, Y. (2017). Building institutional capacity for industrial symbiosis development: a case study of an industrial symbiosis coordination network in China. Journal of Cleaner Production, 142, 1571–82.

Local content policies and institutional capacity  241 United Nations (n.d.). What is sustainable development? Accessed 9 August 2021 at https://​www​.un​.org/​ sus​tainablede​velopment/​blog/​2015/​09/​what​-is​-sustainable​-development/​. [Video]

16. Success and failures of sovereign wealth funds: on the macroeconomic performance, time-varying objectives and first liquidations of sovereign wealth funds Jean-François Carpantier and Wessel N. Vermeulen

1 INTRODUCTION Sovereign wealth funds (SWFs) have existed for more than 50 years. According to the Sovereign Wealth Fund Institute (SWFI), around 100 SWFs have been established during recent decades across the world, from high-income to low-income countries, and from those rich in natural resources or export surpluses to those without, and from democracies to autocracies (Carpantier and Vermeulen, 2018). However, SWFs, especially those funded by commodity exports, face headwinds due to the ending of the commodity super-cycle and the progressive reduction of global imbalances. In this context, we propose a new perspective by focusing on four specific topics, all representing future challenges for their home countries. We first take a fresh look at the defining criteria and discuss the growing difficulty in finding a general definition applicable to all SWFs. There is still considerable heterogeneity among definitions. We then come back to the theoretical foundations of the SWF concept and its various objectives (saving, stabilization and development) and discuss some key institutional specificities. As a third topic, we review the recent empirical assessments of SWFs’ macroeconomic performance. Such studies mainly focus on the effectiveness of economic stabilization, but only a few address their effectiveness in terms of net savings or economic development. We finally shed some light on illustrative failures by summarizing the recent SWF liquidations and by discussing the potential overconfidence in the resilience of current institutions. Concluding, we identify what are, in our view, the most promising research questions that remain to be answered. By design, this review is limited to four topics and can be read as a complement to recent overviews (Bernstein, Lerner and Schoar, 2013; Bortolotti, Fotak and Megginson, 2015; Fotak, Gao and Megginson, 2017; Megginson and Gao, 2020).

2

SWF HETEROGENEITY

There is no definition strictly applicable to all SWFs. Various authors have defined SWFs differently, perhaps depending on their research objectives, while a research institute dedicated to the topic has even changed its definition over time.1 Nevertheless, a general consensus 1 Various articles refer to the description given by the Sovereign Wealth Fund Institute (SWFI), https://​www​.swfinstitute​.org/​, an industry body and consultancy. Its description and criteria have also expanded over time (e.g., compare the current description, https://​ web​ .archive​ .org/​ web/​

242

Success and failures of sovereign wealth funds  243 emerges on some criteria that are relevant to understand the emergence and behaviour of SWFs. We describe the main defining aspects of an SWF through: (1) the ownership of the assets; (2) their operational management; and (3) their liabilities (Amar, Lecourt and Kinon, 2018; Megginson and Gao, 2020). The objectives, and resulting investment strategies, are presented separately in Section 3. 2.1 Ownership Most analysts agree that SWFs are state owned. This is the sole part of the definition that has no exception so far. The origin of this ownership is due to the funding source. First, several SWFs started out as an organizational vehicle to manage state-owned enterprises at an arm’s-length from daily government business, for instance, Singapore’s Temasek (Adeakin, 2018). The second source of funding is linked to the accumulation of foreign exchange reserves due to current account surpluses. Korea, and later China, are the exemplary cases of SWFs funded by the desire to optimize the benefits from their central banks’ accumulation of foreign exchange reserves. However, not all foreign exchange reserves are equal. Current account surpluses are not always due to general trade surpluses but may be due to specific exports or to capital inflows. When the excess reserves are primarily due to the export of extracted mineral commodities, such as fossil fuels or valuable metals and minerals, we sometimes speak of ‘commodity SWFs’. Oil- and gas-rich countries in the Middle East are specifically associated with such funds, and the first SWF to be established was Kuwait’s in 1951 when Kuwait was still under the control of the British empire. Several commodity SWFs have been established in recent times, specifically in low-income countries in Africa and Southeast Asia, following high oil prices in the early 2000s and new large discoveries, which resulted in large economic rents that had to be managed appropriately. When excess reserves are due to capital inflows, the rationale for establishing an SWF is weaker. While India has large foreign exchange reserves, it has not established an SWF to date. Rather than goods exports, for India these reserves are due to portfolio investments and other international investment flows, which have proven prone to rapid capital flight under adverse circumstances. This provides an argument that India should not transfer its reserves to an SWF for long-term, potentially illiquid, investments for fear of a balance of payments crisis later (Sarkar, 2010). 2.2

Operational Management

The way SWFs are integrated in the state institutional framework is another key characteristic. The difficulty lies in the need to give the SWF some autonomy, but not at the cost of losing sight of the general welfare objective. Independently of the source of funding, and despite state ownership, SWFs typically benefit from a relative independence from fiscal and monetary authorities. For instance, a fund within the central bank that manages foreign exchange reserves through buying and holding a portfolio of safe international bonds is not considered 20210519023021/​https://​www​.swfinstitute​.org/​research/​sovereign​-wealth​-fund, with those of an early version, https://​web​.archive​.org/​web/​20080213123234/​https://​www​.swfinstitute​.org/​swf​.php; see also Ang (2012). All websites accessed 4 August 2021.

244  Handbook of sustainable politics and economics of natural resources to be an SWF; neither would a similar fund managed by the ministry of finance. However, when a portion of such funds is transferred to a distinct organizational entity and given a set of criteria for managing the funds for financial and social objectives, we would usually define it as an SWF. This autonomy can sometimes raise some concerns, typically for SWFs that have the explicit mandate to contribute to the development of the domestic economy through the financing of public infrastructure, such as roads, railways, electricity and Internet networks. The issue here is that such development projects would typically be the responsibility of the finance and relevant infrastructure ministries. If such SWFs can decide on what to invest in independently from government development plans, there is clear potential for mismatch with wider government policy and potential for wasteful spending. SWFs also have a nominal duty to make profitable investments, which should, at least partly, be to the benefit of the government budget. In some exemplary cases, this is designated in law – for instance, the Chile Structural Balance Rule (where the fiscal revenue derived from the copper price is based on a forward-looking ten-year average price), or the Norwegian so-called ‘spending rule’ (the non-oil budget deficit should be on average three per cent of the Norwegian SWF over time). Building on this, the IMF has developed an analytical framework designed to manage inflows and outflows under an authority with clear rules and objectives (Al-Hassan et al., 2013). 2.3 Liabilities SWFs tend to have very limited or no liabilities. Funds are granted by the government and, until recently, would not be used to attract additional funding for leveraging investments. True to the idea that an SWF is a savings fund, it consists only of assets fully owned by the government. The criterion of liabilities is often used to differentiate SWFs from pension funds. Like the source of funding coming from individual contributors, a pension fund also has the nominal obligation to pay its contributors their pension benefits. An SWF does not have such an obligation. More recently, some SWFs have experimented with opening their funding base to outside investors (Lugo and Bertoni, 2017). This may be an effective way to target funds at domestic investments, such that the government invests alongside multilateral and private investors to increase the size and number of projects. SWFs that invest alongside other investors or take on additional debt finance are said to be leveraged, since the invested capital is a multiple of the publicly owned capital. While the social benefits of such investments will be larger than if the fund were not leveraged, the financial returns are split between all investors. We discuss this issue further in Section 3.5.

3

HOW AND WHERE TO INVEST: THE OBJECTIVES OF COMMODITY SWFS

The economic theory of saving natural resource revenues is now well established in the literature (e.g., Cherif and Hasanov, 2013; Hartwick, 1977; Van der Bremer and Van der Ploeg, 2013; Van der Ploeg and Venables, 2011; Wills, 2018). In what follows, we draw on this litera-

Success and failures of sovereign wealth funds  245 ture to provide a basic sense of the objectives underlying the creation of commodity SWFs. We concentrate on the objectives since such funds tend to have the largest potential to be used beneficially for economic development and are the most numerous among SWFs. Nonetheless, while most theory on national saving funds focuses on the rationale of commodity exporters, their implications can be generalized to general surplus exporters. As non-renewable natural resources tend to be physically finite, current account surpluses may be finite in terms of time duration. A country, through an SWF, can transform a finite stream of income into a potentially infinite stream of income through a well-diversified portfolio of international investments. The interest and dividends that this portfolio generates can be added to a government budget or reinvested. This common-sense rationale is formalized in economics under the ‘permanent income hypothesis’. This hypothesis can be derived with three pieces of information. First, we have a finite stream of income, such as exhaustible natural resources. Second, we observe that people care a little more about today than tomorrow – that is, the rate of discounting future values. Third, something invested today will, on average, give a positive return tomorrow. Using this, it is said to be optimal to consume only a portion of the income while investing the remainder, such that the investment returns in the future are allowed to remain at a higher level of consumption indefinitely. This result is not affected much by reasonable changes in the rate of return of investments or different preferences on future consumption that affect the discount rate. However, the trade-off between consumption today or tomorrow is changed when reconsidering some crucially important underlying assumptions that are especially relevant for developing economies. First, what if a country’s income is expected to grow significantly over time, for instance when low-income and emerging economies catch up over subsequent decades? Second, what is the consequence if world capital markets are not fully open, such that the rate of expected return in the domestic country may be different from the world average? And third, what is the optimal strategy if the commodity returns are volatile and uncertain – for instance, due to world commodity price fluctuation or uncertain volume of resource recovery, thereby transmitting revenue volatility into the government budget or the overall economy? We address these questions in the next three subsections and then summarise what these three aspects imply for the character and functioning of SWFs. 3.1

SWFs in Low-income Countries

Rather than a ‘permanent level of income’, we may believe that low-income countries will demonstrate convergence in their income levels, independent of their resource wealth. This implies that future generations will be better off than current generations due to relatively faster economic growth. Under this hopeful setting, the argument can be made that current consumption of commodity revenues can be higher, benefiting current generations, and tapering off towards the future, where future generations will be at least as well off due to general economic progress (Van der Ploeg and Venables, 2011). This argument is especially appropriate when some of the countries with the lowest average income and highest poverty rates would otherwise be advised to keep billions of US dollars’ worth of savings from natural resource exports in foreign investments. The counter-argument, touching on political economy, is that distributing money to the poorest in society may not be straightforward if not everyone is fully identified with a known

246  Handbook of sustainable politics and economics of natural resources bank account, or if increased income just raises the prices of all goods to the same amount, or replaces incentives for education and work, or is captured by government institutions through graft and corruption. Therefore, the successful implementation of a policy to distribute revenues more towards current low-income generations relies on socio-economic and political factors that are often confounded with other institutional causes of low incomes. For SWFs, the consequence of early consumption of resource revenue is that there is relatively little saving in early stages of resource exploitation, as the wealth of natural resources will be mostly consumed (e.g., through imports of consumer goods), or invested in the domestic economy, which we describe next. In summary, there is some economic rationale for a resource-rich low-income country not to establish an SWF or to keep it relatively small. 3.2

Domestic vs International Returns

The second question asks what the consequence is if the country that earns the revenues is not fully integrated into the world economy through fully open capital markets. Generally, it can be assumed that when an economy does not allow international capital flows to enter, a divergence emerges between the average rate of return of investments domestically relative to the rest of the world. Moreover, if capital is scarce domestically, rates of return on capital would on average be higher relative to the rest of the world, and specifically relative to developed economies, such as the US and Western Europe. (In open capital markets, such divergence due to capital scarcity would disappear.) Hence, savings from export earnings, such as from natural resources, could potentially be more profitably invested in domestic investment projects than in internationally low-yielding debt. This argument could be used against policy proposals to establish an SWF, in favour of a proposal for the national government to use the funds beneficially through investment projects in the domestic economy. Alternatively, this argument can be used to allow an SWF to invest in domestic projects, not just internationally. Again, some considerations on the political economy side are appropriate. The choice of investable projects in the domestic economy may give rise to opportunities for corruption or political issues relating to regional or demographic distribution of the funds (e.g., by religion, ethnicity, or any other political grouping). 3.3

Volatility of Revenue and Economy

The question of how to manage volatility of revenue is especially relevant for government budgets that rely strongly on that revenue. Revenue volatility can affect an economy in multiple ways. First, the government may create annual budgets using a specific level of the resource price with a projected volume of extraction. Unexpected drops in the price or extraction volumes can potentially lead to large budget deficits that need to be covered by foreign borrowing. Alternatively, to avoid a deficit, the government may cut spending, which will directly affect the rest of the economy. Second, boom-and-bust cycles of the resource sector can also spill over to the wider economy through backward and forward linkages with other industries. Over the longer term, a resource sector may become dominant in an economy, which could become problematic once the resource runs out (Corden and Neary, 1982; Krugman, 1987). Therefore, an SWF can be a useful policy option to mitigate against the so-called ‘Dutch disease’ phenomenon.

Success and failures of sovereign wealth funds  247 In the short to medium term, people and businesses generally prefer a less cyclical and more balanced economy, which creates a level of predictability that allows for planning and facilitates saving and investment decisions. Theory on savings suggests increasing the level of savings in the presence of unpredictable variability relative to the case where future revenue is perfectly known and certain. These additional ‘precautionary savings’ allow future income to be topped up in case of severe unexpected shortfalls of revenue. A major statistical issue is that many commodities, and in particular oil prices, have close to unpredictable price movements, implying that the price level is hard to predict, and periods of stable prices may be followed by periods of high volatility. Therefore, there is some difficulty in deciding on the level of precautionary savings, as well as the right moment when governments should draw on these savings, especially since calls from the public are likely to encourage an earlier drawing than might be prudent. 3.4

Three Objectives of SWFs

The main savings argument combined with these three economic contexts (income level of an economy, domestic investments and revenue volatility) give rise to three distinct objectives for a potential SWF (Venables and Wills, 2016). First, a savings fund for future generations with a diversified portfolio mostly in foreign assets. These investments could very well be in riskier and less liquid asset classes, such as equities, and direct stakes in companies not listed on a stock exchange, since in the long term, these are likely to offer a higher rate of return. Such a fund could easily be run at arm’s length by a national government since its day-to-day operations do not interact with those of the government. Some broad guidance on the style of investment and appropriate companies could be set, but a finance ministry would not be expected to actively manage and approve each investment. Second, a fund dedicated to domestic investments to spur domestic economic growth. Investments are likely to be focused on infrastructure, education and healthcare provision, which will all carry strong socio-economic returns and facilitate future economic growth (Amoako-Tuffour, 2016; Tsani and Overland, 2020). Such public goods tend not to be supplied through private parties, but public investment will be beneficial to the economy in the long run. For such investment, coordination with the national government would be more critical, and the role of the finance ministry and other political bodies would be much greater. An SWF can hardly decide its own infrastructure projects without eyeing other infrastructure projects planned by the government. On the other hand, if the finance ministry uses the SWF as a piggy bank for its favoured projects, then it is unclear why the funds should be held in an organization that is nominally separate from the government budget. Third, the volatility of revenue could be addressed through a so-called volatility, stabilization or liquidity fund. This fund could be used to compensate for shortfalls in the government budget or wider cyclical effects due to exogenous commodity price movements. In this case, the use of the fund is a political decision, although some metrics may be used. Wills (2018) argues that a volatility fund must be left alone and only its returns used, but this does not seem to be the way that a stabilization fund is implemented. For instance, in Chile, the finance ministry, while prudent in their timing, drew on the stabilization fund to finance additional public spending during a recession. In practice, various countries or regions apply different combinations of these three functions. For instance, Bassey et al. (2014) and Oshionebo (2017) discuss the case of Nigeria’s

248  Handbook of sustainable politics and economics of natural resources Excess Crude Account (for short-term gains and shortfalls) and SWF (for longer-term investments). Van de Bremer and Van der Ploeg (2016) present the case for the oil-rich Canadian province of Alberta. In a speech, the central bank governor of Trinidad and Tobago lucidly sets out the same case for a stabilization function of the economy, in case of long depression in oil revenues and a heritage function for the benefit of future generations (Williams, 2007). 3.5 Discussion From a politician’s point of view, a fund for domestic strategic or structural investments for long-term economic development is thought to be the most attractive of the three functions. Tangible investment may have immediate political pay-off, in contrast to funds for the benefit of future generations. Perhaps unsurprisingly, a substantial number of proposals have recently been made by international organizations and national governments to set up strategic development funds with the purpose of investing in infrastructure or ‘critical’ industries (where ‘critical’ is determined by the government).2 The key difference between strategic development funds and SWFs, apart from the exclusive focus on domestic investment, is their funding. These funds are (often) not financed by resource revenues or profits from state-owned enterprises, but with taxes, and leveraged with funds from outside investors, often institutional investors looking for long-term investments. The basic premise can be sound and successful (Clark and Monk, 2015), perhaps especially if the capital constraints of states can be circumvented with the inclusion of outside investors (Arezki and Sy, 2016; Schena, 2017; Schena, Braunstein and Ali, 2018). Halland et al. (2006) and Gelb et al. (2014) emphasize that unless the institutional structure, accountability and objectives are well clarified, such funds run the risk of clashing with the usual state activities of public goods provision. As was hinted earlier, all the above may sound quite reasonable, but also rely heavily on an often-implicit assumption: good quality of government, rule-based public management and absence of special interest or divided constituencies (Amoako-Tuffour, 2016; Van der Ploeg, 2011). In short, the underlying assumption is that a country is not subject to the (political) resource curse, which finds that resource rents undermine the rule of law, democracy and responsible government (Robinson, Torvik and Verdier, 2006; Ross, 2015; Venables, 2016). One implicit reason for the advocacy of SWFs in the past may have been that saving funds with investments held in foreign assets could improve transparency in the use of resource revenues, in contrast to the disappearance of funds through graft and wasteful spending by governments or state-owned resource companies. Now the attention of policy discussions is shifting again to domestic investment funds, but it is not immediately clear that the underlying issues have been resolved. Cases of political interference, or outright malpractice, fraud and stealing from such funds abound, including from Nigeria (Adeakin, 2018; Dixon and Monk,

2 Some examples include the Netherlands (NRC Handelsblad, 20 September 2019, https://​www​ .nrc​.nl/​nieuws/​2019/​09/​20/​ineens​-strooit​-mister​-nein​-met​-miljarden​-a3974163; Financial Times, 17 September 2019, https://​www​.ft​.com/​content/​d45d8378​-d962​-11e9​-8f9b​-77216ebe1f17); South Africa (Reuters, 14 August 2018, https://​uk​.reuters​.com/​article/​uk​-safrica​-swf​-idUKKBN1KZ17E); Germany (Gros and Mayer, 2012); and Europe (Financial Times, 23 August 2019, https://​www​.ft​.com/​content/​ 033057a2​-c504​-11e9​-a8e9​-296ca66511c9), while the EU also uses the European Investment Bank and Fund (EIB/EIF) to funnel funds to specific sectors. All websites accessed 4 August 2021.

Success and failures of sovereign wealth funds  249 2011) and Malaysia (Gabriel, 2018; Hope and Wright, 2018; Lai, 2012), as well as cases of unwise investment choices made for political reasons (e.g., the Alberta Heritage Fund, as argued by Morton and McDonald, 2015).

4

MACROECONOMIC PERFORMANCE

Recent surveys on SWFs typically cover topics such as the definition of SWF, their institutional arrangements (especially the influence of politicians in the decision-making process, but also their investment strategies, including portfolio diversification, interdependence with national macroeconomic profile and level of ownership), and their impact on the targets, including on the valuation and corporate governance of the targets (Bernstein et al., 2013; Fotak et al., 2017; Fotak and Megginson, 2015; Megginson and Gao, 2020). There is, however, a critical topic that has so far been surprisingly underweighted in most surveys: are SWFs successful in fulfilling their objectives of long-term development, macroeconomic stabilization and intergenerational wealth sharing? A first wave of pioneering global empirical studies has been carried out. The time has come to take a first critical view on the genuine SWF benefits, as well as their defects/deficiencies. So far, we find two categories of empirical study. The first category covers those focusing on the impact of SWFs on public expenditure (level, volatility, procyclicality). The second category includes those designed to measure the impact of SWFs on the real exchange rate (size of misalignments or degree of isolation from terms of trade shocks). The studies discussed below are synthesized and reported in Table 16.1. 4.1

Public Expenditures

The research papers that aim quantitatively to assess the role of SWFs on economic volatility – that is, their ability to smooth public expenditure by attenuating the effects of revenue fluctuations – rely on a different set of countries (natural resource countries, oil-exporting countries, regional subsets), on different time windows and different methodologies (see Table 16.1). The simplest approach consists of comparing the volatility of fiscal revenues with that of fiscal expenditures. Le Borgne and Medas (2007) focused on a homogeneous sub-group, the Pacific Island countries (Kiribati, Timor-Leste, Papua New Guinea, Nauru, Tonga, Tuvalu, the Marshall Islands, Micronesia and Palau) and concluded, based on comparative statistics, that accumulating revenues in a fund (thus removing it from the budget) does not necessarily decrease the size or volatility of public spending. The issue with these results is that is hard to disentangle the effect of the SWF from other characteristics of these economies. Another approach was then considered, based on comparing the level of public expenditure before and after the establishment of an SWF to control for country-specific factors (fixed effects). Bagattini (2011) implemented this empirical analysis on a set of 12 countries with SWFs over the period 1992–2007 and came to the conclusion that the existence of stabilization funds is correlated with a lower level of public spending and with high fiscal sustainability (as measured by an original indicator variable summarizing stabilization and saving virtues). Other variables, potentially correlated with the existence of the SWF, could have an effect on the volatility of public spending. To account for a potential omitted variables bias, a more

250  Handbook of sustainable politics and economics of natural resources formal econometric set-up has been considered in other studies such as Sugawara (2014), Koh (2017) and Mohaddes and Raissi (2017). Sugawara (2014) considered, for a panel of 68 resource-rich countries over the period 1988–2012, a fixed-effect estimation set-up incorporating political, financial and economic control variables, while Koh (2017) focused on a panel of 42 oil-exporting countries over the period 1960–2014, by using vector autoregression techniques. Both found that the volatility of public spending is smaller in countries that establish an SWF (13 per cent lower, according to Sugawara, 2014) and particularly in countries with high institutional quality (Koh, 2017). Instead of focusing on public spending, we can also assess the stabilization effect of SWFs by considering alternative macroeconomic variables such as the level of investment, gross domestic product (GDP) growth or the real exchange rate. Contrary to the papers above discussed, Mohaddes and Raissi (2017) interacted an SWF dummy with the commodity terms of trade volatility. Based on a panel of 69 commodity-dependent countries over the period 1981–2014 and using a cross-section augmented autoregressive distributive lag model, they found that the negative impact of commodity terms of trade is lower in countries with an SWF, the dampening effect operating through lower accumulation of physical capital and lower total factor productivity (TFP). Their results supported the effectiveness of SWF in smoothing the effects of commodity price volatility. In brief, most of these studies correlate the establishment of an SWF and more stable macroeconomic indicators. Importantly, this correlation was documented to be stronger in contexts of high institutional quality (Koh, 2017; Mohaddes and Raissi, 2017). 4.2

Real Exchange Rates

The real (effective) exchange rate (REER) of commodity-exporting countries is often found to be influenced by the commodity terms of trade (see the commodity currency literature, such as Cashin, Cespedes and Sahay, 2004 and Bodart, Candelon and Carpantier, 2012). Different empirical approaches can be considered for assessing the role of SWFs. First, we can study the impact of SWFs on the volatility of the REER, or second, the impact of SWFs on the transmission of commodity terms of trade shocks to the real exchange rate, or third, assess the role of SWFs on the degree of misalignment of the real exchange rate. For the first approach, focusing on the volatility of the real exchange rate, we find conflicting results in Shabsigh and Ilahi (2007) and Koh (2017). The latter used, as discussed above, panel vector autoregression techniques on a sample of 42 oil-exporting countries from 1960 to 2014 and found that oil funds are associated with reduced volatility of the real exchange rate in countries with low institutional quality. The former examined whether ‘oil funds bring macroeconomic stability’ from a 30-year panel dataset of 15 countries and found that the negative association between the presence of an oil fund and volatility of the real exchange rate is ‘statistically weak’. More in line with the commodity currency literature perspective, Aizenman, Edwards and Riera-Crichton (2012) studied the buffer role of international reserves in the transmission of shocks from terms of trade to real exchange rates in Latin American countries over the period 1970–2007. They found that active reserve management not only lowers the short-run impact of commodity terms of trade shocks significantly, but also affects the long-run adjustment of REER, effectively lowering its volatility. Since international reserves traditionally do not include assets held by (semi-) independent SWFs, they looked more closely at the specific case

Shabsigh and Ilahi (2007)

Raymond et al. (2017)

Mohaddes and Raissi (2017)

Le Borgne and Medas (2007)

Koh (2017)

Bagattini (2011)

Aizenman and Riera-Crichton (2014)

commodity-dependent countries

CToTb volatility exerts a negative impact on economic growth operating through lower accumulation of physical capital and lower TFP. On average, having an

countries

misalignment and find evidence that establishing an SWF is associated with

countries

fund and inflation and the volatility of broad money and prices in oil exporting countries but a weaker relationship with the volatility of the real exchange rate

15 oil-exporting

The results indicated a robust negative relationship between the presence of an oil

a reduction in the volatility of REER misalignments

24 energy-exporting

Relying on panel cointegration tools, they determine a measure for REER

higher-quality institutions

SWF can mitigate such negative growth effects, especially in countries that enjoy

69

Based on a CS-ARDLa approach to account for endogeneity, they found was that

spending

(removing it from the budget) does not necessarily constrain the size or volatility of countries

Based on comparative statistics they found that that accumulating revenues in a fund Nine Pacific Island

consumption and the real exchange rate in countries with low institutional quality

quality. Nevertheless, oil funds are associated with reduced volatility of government

1973–2003

1980–2010

1981–2014

1990–2005

Volatility of REER

REER misalignments

growth

Real GDP per capita

spending

Volatility of public

REER

spending and of

Volatility of public

countries

effective in reducing fiscal procyclicality in countries with high institutional

1960–2014

42 oil-exporting

Using panel vector autoregression techniques, Koh showed that oil funds are

Fiscal sustainability

Volatility of REER

indicator

1992–2007

Focus Volatility of REER

stabilization funds

The adoption of a stabilization fund is associated with improved fiscal performance 12 countries with

(p. 4)

and the real GDP during the Great Recession and the post-Great Recession period’

between reserves and SWFs, where SWFs take over the buffering role of the REER

1980–2007

Time 1970–2007

Sample Latin America

Looking more closely at SWFs in the same sample, they documented a ‘substitution Latin America

trade shocks and REER in 1985

showed a clear break in the transmission mechanism between commodity terms of

at the specific case of Chile where a copper fund was established in 1985 and

adjustment of REER, effectively lowering its volatility. They also look more closely

of commodity terms of trade shocks significantly, but also affects the long-run

Comment They found that active reserve management not only lowers the short-run impact

Authors

Macroeconomic effectiveness of SWFs

Aizenman et al. (2012)

Table 16.1

Success and failures of sovereign wealth funds  251

countries

resource funds, governance and institutional quality by indicating that resource funds may positively affect the latter

27 resource-rich

The estimation results provided an initial assessment of the relationship between

Notes: a. Cross-sectionally augmented autoregressive distributed lag. b. Commodity terms of trade.

Tsani (2013, 2015)

1996–2007

countries

to be 13% lower in the main estimation. They showed that political institutions and fiscal rules are significant factors in reducing the expenditure volatility

Time 1988–2012

Sample 68 resource-rich

Comment Spending volatility in countries that have established stabilization funds is found

Authors

Sugawara (2014)

Focus

institutional quality

Governance and

spending

Volatility of public

252  Handbook of sustainable politics and economics of natural resources

Success and failures of sovereign wealth funds  253 of Chile, where a copper fund was established in 1985. They showed a break in the transmission mechanism between commodity terms of trade shocks and the REER, starting in 1985. Looking more closely at the SWFs in the same sample, Aizenman and Riera-Crichton (2014) documented ‘a substitution between reserves and SWFs, where SWFs take over the buffering role of the REER and the real GDP during the Great Recession and the post-Great Recession period’ (p. 4). Finally, and originally, a third approach assesses whether commodity funds related to energy (i.e., oil and gas specifically) help in reducing the volatility of real exchange rate misalignments by dampening the domestic transmission of international energy prices. Raymond, Coulibaly and Omgba (2017) focused on 24 energy-exporting countries over the period 1980–2010. Relying on panel cointegration tools, they determined a measure for REER misalignment and found evidence that establishing an SWF is associated with a reduction in the volatility of REER misalignments. Unfortunately, estimation of misalignments relies on strong assumptions about what the fundamental real exchange rate should be. Raymond et al. (2017) based their fundamental values on a long-run proxy of the commodity terms of trade, a choice that can be questioned.

5

SWF FAILURES

Although nothing is definitive, some SWFs are clear successes. The Norwegian Government Pension Fund Global is the largest in the world in absolute value, the Timor-Leste Petroleum Fund is the largest in terms of domestic GDP. Both clearly contribute to a smoother government consumption and to intergenerational equity. Chile’s SWF, together with strict fiscal rules, has been documented to act countercyclically and contribute to macroeconomic stabilization. Singapore, Malaysian and Chinese SWFs have aimed to reduce the social cost of excess foreign reserves by opening the doors to higher-yield investments. Still, these nice-to-share experiences should not hide the less convincing ones. SWFs are not all success stories. They have sometimes not been justified economically or not supported by an appropriate institutional setting (governance, fiscal rules). In this section, we document some anecdotal developments that illustrate that SWFs are not all here to last. These examples also give the opportunity to shed an original light on issues that might become more common in the future. Indeed, SWF countries might well have to face headwinds in the coming decade. First, the commodity super-cycle has ended, and second, global imbalances, which were the main factor behind the establishment of SWFs, are expected to decline in a context of trade wars and potentially rising protectionism. If SWF incomes decline, we might see progressive transfers of their assets to government budgets and progressive depletion of their balance sheets. In Table 16.2, we list the sources of difficulties faced by SWFs. For some of them, these difficulties even resulted in their liquidation. We can identify problems related to two sources: mismanagement and adverse economic circumstances. 5.1 Mismanagement Mismanagement is ultimately rooted in corporate governance problems. Rules on deposits and withdrawals are changed over time due to budgetary pressures. As a first example, Papua

254  Handbook of sustainable politics and economics of natural resources New Guinea’s former Mineral Resource Stabilization Fund (MRSF) was established in 1974. Poor integration with budget and fiscal policy led to large fiscal deficits and public debt. Rules on deposits and withdrawals were changed over time in the face of budgetary pressures. Moreover, the assets were used as collateral for new borrowing and to repay debt. The MRSF subsequently closed in 2001 (International Monetary Fund [IMF], 2010; Le Borgne and Medas, 2007). Similarly, in Ecuador, the Stabilization Fund for Investment and Debt Reduction was founded in 2002. Several sub-funds with extremely complex revenue earmarking rules limited the margin for budget flexibility and led to fragmented cash management. The fund was abolished in 2005. In Chad, the Fund for Future Generations, established in 1999, was abolished in 2006 to streamline the fiscal policy framework and to increase flexibility in the government’s liquidity management. Mismanagement also affected some Pacific Island funds. As noted by Le Borgne and Medas (2007, p. 17), ‘the Nauru and Tonga funds have been almost depleted due to risky investment decisions and mismanagement, as well as the financing needs of the budget’. The portfolio of the Tonga Trust Fund, which was established in 1988, consisted mainly of investments in three US companies active in life insurance, energy and Internet businesses, respectively. As for Nauru, after its independence in 1968, an SWF, the Nauru Phosphate Royalties Trust, was established to manage the revenues from the phosphate industry. The size of the SWF, at its peak of US$1billion in 1991, was modest compared to others internationally, but huge in relative terms, given its 14 000 inhabitants. Once the phosphate mines were depleted, the SWF progressively shrank. Because of mismanagement and depredation of capital (high government expenses, bad investments in real estate, shipping and air services), the island finally went bankrupt. The country, which was once nicknamed the Kuwait of the Pacific, now has a GDP per capita of around US$8500 (Ang, 2012; Cox, 2009). In 2011, Nigeria established a set of three new SWFs with stabilization, future generation and infrastructure objectives, respectively. These funds were designed to increase transparency and make sure that the nation’s resource wealth would not be misappropriated (Bortolotti et al., 2015). Despite the new institutional setting, in 2014 the fund was found to be depleted by US$700 million and remains subject to heavy controversies relating to its compatibility with the national Fiscal Responsibility Act guaranteeing a balance between federal and regional interests (Venables, 2016). We finally note that Cameroon decided, at the start of oil production in 1977, to create an extra-budgetary account (‘Compte Hors-Budget’) to manage oil revenues. The objectives of this structure were in line with those of SWFs but were also associated with lack of transparency and corruption (Gauthier and Zeufack, 2010). If prudent management of resource windfalls could imply the establishment of an SWF, SWFs themselves are only effective if well managed with appropriate corporate governance standards. As documented above, the macroeconomic performance of SWFs depends on institutional quality and corporate governance. 5.2

Adverse Economic Circumstances

Mismanagement is not the only difficulty faced by SWFs. We note that some SWFs were depleted or substantially affected by factors leading to a change of objectives. As a first example, the National Pensions Reserve Fund was created in Ireland in 2001 and lost its investment mandate in 2014. Initially designed to support the funding of pension liabilities, which are expected to increase substantially from 2025 onwards, the fund ultimately served

Success and failures of sovereign wealth funds  255 mainly to bail out the Irish banks during the 2008–10 banking crisis. Of the US$23 billion, US$20 billion was transferred for recapitalizing Allied Irish Banks and the Bank of Ireland. The remains of the fund were transferred in 2014 to the newly established Ireland Strategic Investment Fund.3 Brazil set up an SWF, Fundo Soberano do Brasil, in 2008, initially infused with US$6 billion. At the end of 2017, it only marginally increased, reaching US$7 billion. Given the large public foreign debt (close to US$1 trillion), the government decided to shut it down in 2018 and transferred the money toward repayment of foreign debt. Assets of SWFs were also partially diverted from their initial objective in emergency situations related to international sanctions – for instance, in the case of Iran and Russia. As a third category, we illustrate this source of difficulty with the specific case of Alberta where the investment strategy raises questions. The Alberta Heritage Savings Trust Fund was established in 1976 and was designed to receive 30 per cent of the province’s non-renewable resource revenues. Of the total assets, 65 per cent was designated for its Alberta Investment Division, whose mandate was to ‘strengthen and diversify the economy of Alberta’. This SWF still exists, with US$17 billion in March 2019, but this also illustrates the difficulties faced by SWFs with a domestic development mandate. Morton and McDonald (2015) show that diversification attempts failed globally, noting that the government had lost an estimated US$2.3 billion on various initiatives, and they list what they call the ‘dirty dozen’ of the costliest diversification projects. This experience reminds us that little research sheds light on the diversification effectiveness of SWF development strategies (see Fortescue, 2010 on Russia). Finally, we consider the case where liquidation results from a countercyclical spending policy. The Russian Reserve Fund was created in 2008, when the Russian Stabilization Fund was split into a Reserve Fund, designed to smooth government energy revenues, and a National Wealth Fund, mainly designed to support the pension system. This fund was closed on 1 January 2018. This closure might be seen as the natural consequence of a long-standing countercyclical stance in the context of depressed commodity prices. Determining whether the speed of depletion is appropriate is a complex issue that is far from settled. The various examples discussed so far show that SWFs are not exempt from difficulties and are not immune to liquidation, without exception. The largest SWF in the world has not failed at the time we write this chapter (and hopefully at the time you read it). Still, is the size of the SWF a guarantee that Norway will be economically safe for decades? We probably overvalue the resilience of the fund. So far, SWFs have not been publicly submitted to stress tests as banks are now used to. In the case of a market crash, it is difficult to know what losses such funds would suffer. Norway’s SWF did the exercise in 2018 and ‘said that it could lose more than 40 per cent of its value in a single year because of a combination of a plunge in stock markets as well as a potential strengthening in the Norwegian krone’.4 In addition, the share of the government budget funded by SWF proceeds was around 18 per cent in 2018. Assuming standard countercyclical government spending and a loss of competitiveness due to the strengthening of the krone, it would not be irrational to consider that the fund would be absorbed within a decade. 3 2015. 4 2018.

‘Ireland’s sovereign wealth fund relaunches with €1bn investment’, Financial Times, 4 May ‘Fears over future market crash stalk Norway’s $1tn oil fund’, Financial Times, 11 March

256  Handbook of sustainable politics and economics of natural resources Table 16.2

SWF illustrative problems

Country

SWF

End

Problems

References

Alberta (CA)

Alberta Heritage Savings Trust Fund 1976

Start

–

Bad performance of investments

Morton and McDonald

Brazil

Fundo Soberano do Brasil

2018

Transfers toward repayment of

aimed at economic diversification (2015) 2008

SWFI (2018)

foreign debt Cameroon

Compte Hors-Budget

1977

–

Governance failures

Gauthier and Zeufack

Chad

Fund for Future Generations

1999

2006

Governance failures

IMF (2010)

Stabilization Fund for Investment

2002

2005

Governance failures

IMF (2010)

2001

2014

Emergency (banking sector

Financial Times, 4

recapitalization)

May 2015*

Governance failures

Cox (2009); IMF

(2010) Ecuador

and Debt Reduction Ireland Nauru

National Pensions Reserve Fund Nauru Phosphate Royalties Trust

1968

2005

(2010); Le Borgne and Medas (2007) Nigeria

Nigerian Sovereign Wealth Fund

2011

Papua New

Mineral Resource Stabilization Fund 1974

–

Governance failures

Venables (2016)

2001

Governance failures

IMF (2010); Le

Guinea

Borgne and Medas (2007)

Russia

Russian Reserve Fund

2008

2018

Transfers to cover budget deficit

Reuters, 10 January

(countercyclical); emergency

2018

(international sanctions) Tonga

Tonga Trust Fund

1988

–

Governance failures

IMF (2010), Le Borgne and Medas (2007)

Note: * See footnote 3.

Similarly, at the end of 2018, the Petroleum Fund of Timor-Leste stood at US$15.8 billion (506 per cent of total GDP and 848 per cent of total non-oil GDP), covering more than 166 months of goods and services imports. Although the oil potential is substantial, as stated in IMF (2019), active oil/gas fields are expected to be depleted in 2022. The sad story of Nauru should remind us that success ultimately relies on good institutions and governance.

6

RESEARCH PERSPECTIVES

The success of SWFs in fulfilling their objectives has been so far under-investigated. A few studies, mainly related to the macroeconomic stabilization objective, have assessed the impact of SWFs on the country’s real exchange rates and on the smoothing of public expenditure, but a lot remains to be done. We especially need to further investigate the contribution of SWFs to macroeconomic stabilization and intergenerational wealth transfers. First, in terms of macroeconomic stabilization, we still need to better understand their contribution in tackling Dutch disease – in other words in supporting the non-commodity-related exporting industries. As was illustrated by Morton and McDonald (2015) for Alberta, SWFs’ contribution to domestic development through diversification efforts still needs to be assessed on a wider basis as well. Second, in terms of intergenerational transfers, looking at the size of an SWF balance sheet is not enough. Foreign exchange reserves should also be considered, along with the level of

Success and failures of sovereign wealth funds  257 private and public indebtedness, and more globally the evolution of the international net financial position of SWF countries. Finally, SWFs are accessorily expected to contribute to better governance in managing trade surpluses. For instance, Gabriel (2018) noted a poorer level of governance standards for the Malaysian 1MDB fund compared to the previously established national SWF Khazanah. Few papers address the potentially positive effects of SWFs on corruption/governance in their home country (Tsani, 2013 concluded that SWFs have a positive effect, while Ayadi et al., 2018 found no effect in Nigeria). We might wonder whether the paucity of papers evaluating the macroeconomic success of SWFs is due to insufficient data, to the lack of a satisfactory counterfactual scenario or to the failure to find any effect of SWFs. Research efforts in this context are critical, as SWF countries might well have to face headwinds in the coming decade. Indeed, we are in the down phase of the commodity super-cycle and global imbalances, which were the main factor behind the establishment of SWFs and are expected to decline in the context of trade wars and rising protectionism. If SWF incomes decline, we might expect to see progressive transfer of their assets to government budgets, as was illustrated above for Russia and announced by Norway. As noted by Fotak et al. (2017, p. 26), ‘it is also important to look at the channels that parent-country governments use to explicitly/implicitly force SWFs to support their domestic financial budgets, and to study how political pressure from domestic governments will affect SWF investment strategies’. Le Borgne and Medas (2007, p. 3) noted 13 years ago that ‘from a domestic policymaker’s viewpoint, a…fundamental question is whether SWFs can be a useful instrument to achieve domestic policy goals’. Despite some successes documented in Chile, more than a decade later, the question remains a valid one that still needs to be convincingly and globally addressed.

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Success and failures of sovereign wealth funds  259 Krugman, P. (1987), ‘The narrow moving band, the Dutch disease, and the competitive consequences of Mrs. Thatcher’, Journal of Development Economics, 27, 41–55. Lai, J. (2012), ‘Khazanah Nasional: Malaysia’s treasure trove’, Journal of the Asia Pacific Economy, 17(2), 236–52, Le Borgne, E. and Medas, P.A. (2007), ‘Sovereign wealth funds in the Pacific Island countries; macro-fiscal linkages’, IMF Working Papers 07/297, International Monetary Fund. Lugo, S. and Bertoni, F. (2017), ‘The use of debt by sovereign wealth funds’, in D. Cumming, G. Wood, I. Filatotchev and J. Reinecke (eds), Oxford Handbook of Sovereign Wealth Funds, Oxford: Oxford University Press, pp. 274–97. Megginson, W.L. and Gao, X. (2020), ‘The state of research on sovereign wealth funds’, Global Finance Journal, 44(C), Article 100466. Mohaddes, K. and Raissi, M. (2017), ‘Do sovereign wealth funds dampen the negative effects of commodity price volatility?’, Journal of Commodity Markets, 8, 18–27. Morton, T. and McDonald, M. (2015), ‘The siren song of economic diversification: Alberta’s legacy of loss’, SPP Research Paper No. 8-13, School of Public Policy, University of Calgary. Oshionebo, E. (2017), ‘Mismanagement of Nigeria’s oil revenues: is the Nigeria Sovereign Investment Authority the panacea?’, Journal of World Energy Law and Business, 10, 329–47. Raymond, H., Coulibaly, D. and Omgba, L.D. (2017), ‘Exchange rate misalignments in energy-exporting countries: do sovereign wealth funds matter?’, International Economics, 152(C), 124–44. Robinson, J.A., Torvik, R. and Verdier, T. (2006), ‘Political foundations of the resource curse’, Journal of Development Economics, 79, 447–68. Ross, M.L. (2015), ‘What have we learned about the resource curse?’, Annual Review of Political Science, 18, 239–59. Reuters (2018, 10 January), ‘Russia’s finance ministry fully spend its reserve fund in 2017’, accessed 4 August 2021 at https://​www​.reuters​.com/​article/​us​-russia​-funds​-idUSKBN1EZ13R. Sarkar, R. (2010), ‘Sovereign wealth funds as development tool for ASEAN nations: from social wealth to social responsibility’, Georgetown Journal of International Law, 41(3), 621–46. Schena, P.J. (2017), ‘When states invest at home: the development role of sovereign wealth funds in public finance’, Wake Forest Law Review, 52(4), 917–48. Schena, P.J., Braunstein, J. and Ali, A. (2018), ‘The case for economic development through sovereign investment: a paradox of scarcity?’, Global Policy, 9(3), 365–76. Shabsigh, G. and Ilahi, N. (2007), ‘Looking beyond the fiscal: do oil funds bring macroeconomic stability?’, IMF Working Papers 07/96, International Monetary Fund. Sovereign Wealth Fund Institute (SWFI) (2018, 23 May), ‘Brazilian President Michel Temer orders liquidation of sovereign wealth fund’, accessed 4 August 2021 at https://​www​.swfinstitute​.org/​news/​ 66599/​brazilian​-president​-michel​-temer​-orders​-liquidation​-of​-sovereign​-wealth​-fund. Sugawara, N. (2014), ‘From volatility to stability in expenditure: stabilization funds in resource-rich countries’, IMF Working Papers 14/43, International Monetary Fund. Tsani, S. (2013), ‘Natural resources, governance and institutional quality: the role of resource funds’, Resources Policy, 38(2), 181–95. Tsani, S. (2015), ‘On the relationship between resource funds, governance and institutions: evidence from quantile regression analysis’, Resources Policy, 44, 94–111. Tsani, S. and Overland, I. (2020), ‘Sovereign wealth funds and public financing for climate action’, in W. Leal Filho, A. Azul and L. Brandli et al. (eds), Climate Action (Encyclopedia of the UN Sustainable Development Goals series), Cham, Switzerland: Springer. Van der Bremer, T.S. and Van der Ploeg, F. (2013), ‘Managing and harnessing volatile oil windfalls’, IMF Economic Review, 61(1), 130–67. Van der Bremer, T.S. and Van der Ploeg, F. (2016), ‘Saving Alberta’s resource revenues: role of intergenerational and liquidity funds’, Energy Policy, 99, 132–46. Van der Ploeg, F. (2011), ‘Rapacious resource depletion, excessive investment and insecure property rights: a puzzle’, Environmental and Resource Economics, 48, 105–28. Van der Ploeg, F. and Venables, A.J. (2011), ‘Harnessing windfall revenues: optimal policies for resource-rich developing economics’, The Economic Journal, 121, 1–30. Venables, A.J. (2016), ‘Using natural resources for development: why has it proven so difficult?’, Journal of Economic Perspectives, 30(1), 161–84.

260  Handbook of sustainable politics and economics of natural resources Venables, A.J. and Wills, S. (2016), ‘Resource funds: stabilising, parking, and inter-generational transfer’, Journal of African Economies, 25(Supplement 2), ii20–ii40. Williams, E.S. (2007, 20 September), ‘Understanding the Heritage and Stabilisation Fund’ [speech], accessed 29 July 2021 at https://​www​.bis​.org/​review/​r071004d​.pdf. Wills, S. (2018), ‘Leave the volatility fund alone: principles for managing oil wealth’, Journal of Macroeconomics, 55, 332–52.

17. Fiscal policy, macroeconomic volatility and the role of institutions under resource abundance Leonor Coutinho and Stella Tsani1

1 INTRODUCTION Several studies show that countries endowed with natural resources have failed to grow more rapidly than less endowed countries. This so-called ‘resource curse’ has been particularly evident in countries rich in depletable resources such as hydrocarbons, minerals and metals. This phenomenon has received considerable interest, with extensive research trying to identify the reasons behind it. Early explanations for the resource curse focused on the limited interaction between resource-based sectors and the rest of the economy (Prebisch, 1950). Later empirical work questioned the explanatory power of these earlier structural approaches, emphasizing instead the economic ramifications of natural resource endowments, such as the declining terms of trade, exchange rate pressures and income inequality (see, among others, Corden, 1984; Engerman and Sokoloff, 1997). The literature on these alternative explanatory channels is extensive. Nevertheless, the results remain rather inconclusive regarding the generalization of their applicability and on the net effects of natural resources on growth. More recent explanatory approaches to the resource curse include macroeconomic policies and institutions. The effect of resources on growth through the weakening of governance and institutions and the emergence of illicit practices in the management of natural resource wealth offers a convincing theoretical explanation to the ‘curse’ of national resources (‘the voracity effect’ according to Lane and Tornell, 1997). In addition, extensive empirical work suggests that natural resources are associated with poor government effectiveness, a weakening in the rule of law and increasing corruption (see, for instance, Karl, 2008 and Kolstad and Soreide, 2009). This governance and institutional quality deterioration induced by the presence of vast natural resources seems to account for a substantial part of the poor economic growth and development records of many resource-endowed countries. Research looking beyond the case of resource-rich countries has linked poor economic growth to macroeconomic volatility and fiscal policy procyclicality. Volatility complicates the saving and investment decisions of economic agents and thus affects long-term economic performance. A negative link between volatility and growth can also occur if volatility is associated with worsening financial constraints. In this case, volatility can lead to less human capital development, lower productivity-enhancing expenditure and, consequently, lower growth rates. Aversion to economic downturns can also prompt governments to adopt policies

1 The views expressed in this paper are those of the authors and should not be attributed to the European Commission.

261

262  Handbook of sustainable politics and economics of natural resources such as labor-market restrictions that make firms less flexible and willing to innovate, thus deepening the negative link between volatility and long-run growth. The links between macroeconomic volatility, fiscal policy procyclicality and economic growth have received limited attention in the resource curse literature. This chapter aims to bridge the literature on these topics. The analysis is based on a systematic survey of the literature on the resource curse and focuses on the links between macroeconomic volatility and growth, and the role of fiscal policy procyclicality in explaining growth performance. The aim is to complement existing research on the macroeconomic performance of resource-rich countries by linking these studies to works on macroeconomic volatility, fiscal policy and institutions, which have not necessarily focused on resource wealth, but from which lessons for future research can be drawn. To the best of our knowledge, this is the first time that such an attempt has been made to systematically link the studies carried out to date in these areas with research on resource-rich countries’ economic performance. The discussion is useful for researchers in the field as well as for policy makers, as it systematically brings together studies and findings on the resource curse, macroeconomic volatility, institutions and growth in resource-rich countries, and it further highlights paths for future research. The remainder of this chapter develops as follows. Section 2 introduces the concept of the resource curse and describes recent streams of literature on this issue, with a focus on its causes. Several benchmarks and definitions are employed in the literature with regard to the measurement of resource wealth and the classification of countries into resource rich and poor, and these are detailed in this section. Section 3 offers a detailed survey of the literature on macroeconomic volatility and fiscal policy procyclicality and the implications for growth in resource-rich countries. Section 4 surveys the literature on the role of institutions in fiscal policy outcomes, with a particular focus on resource-rich countries. The last section offers some concluding thoughts.

2

THE ‘RESOURCE CURSE’ LITERATURE

On a theoretical level, the discovery of natural capital should, like other sources of increased wealth, increase national welfare and enable nations to consume more goods and services (Mideksa, 2013). In the standard growth models (Aghion and Howitt, 1992; Romer, 1990; Solow, 1956), new discoveries of natural resource endowments shift the aggregate production possibilities outward by expanding natural capital, thereby increasing growth for a short period and income for a longer period. Sachs (2007) argues that revenues from resources like oil can promote economic development. Indeed, the sustainability literature treats natural resources as wealth in comprehensive national income accounting. In green national income accounting (see Weitzman, 2003), the discovery of natural resource endowments is interpreted as an increase in the nation’s wealth, while activities such as extraction and use, which decrease the stock of this endowment, are interpreted as depreciation of natural capital. There is some empirical evidence supporting the view that natural resource endowments are economic blessings. Using indirect valuations based on World Bank data, Weitzman (1999) concludes that the exhaustion of all non-renewable resources (hydrocarbons, minerals, metals and ores) would reduce world gross domestic product (GDP) by about 1 percent (on the assumption that historical prices correctly reflect scarcity). In a cross-country study, Sala-i-Martin, Doppelhofer and Miller (2004) find that the fraction of GDP attributable to

Fiscal policy, macroeconomic volatility and the role of institutions  263 mining has a robust positive association with economic growth. This result is confirmed in the empirical works of Brunnschweiler and Bulte (2008) and Alexeev and Conrad (2009). The success of industrialized countries like the USA, Canada or Norway, which have been rich in natural resources and continue to be net resource exporters today, suggests that natural resource abundance may be a ‘blessing’. Nevertheless, such successful cases appear to be the exception rather than the rule. In contrast, the evidence from many resource-endowed countries suggests that they have failed to grow more rapidly than resource-poor countries. Many resource-rich countries, such as Angola, Nigeria, Venezuela or Sudan, continue to record low per capita income and low quality of life. A significant number of analytical and empirical studies have emerged that have concluded that instead of raising wealth, natural resource endowments are an economic curse that traps an economy in a lower wealth equilibrium relative to the equilibrium without natural resource endowments. This notion of the ‘paradox of plenty’ has been borne out in econometric tests of the determinants of economic performance across a comprehensive sample of countries and suggests that natural resource abundance can harm growth and economic development. Considerable amounts of empirical work following the seminal work of Sachs and Warner (1995) confirm the resource curse. Indicative is the work of Auty (2001a), Hausmann and Rigobon (2002), Sala-i-Martin and Subramanian (2003), Papyrakis and Gerlagh (2007) and James and Adland (2011). While a significant amount of work confirms the resource curse, some empirical researchers challenge its evidence (see Alexeev and Conrad, 2009; Boyce and Emery, 2011; Davis, 1995; Delacroix, 1977; Herb, 2005); others find evidence for resource wealth as an economic blessing, conditional on other determinants of economic growth (Mehlum, Moene and Torvik, 2006). Others argue, however, that it is the indirect effect of debt overhang, worsening institutions and the hampered learning process in resource-endowed countries that may explain why resource-abundant countries perform worse in terms of economic growth and development (Brunnschweiler, 2008; Manzano and Rigobon, 2001). Institutional economics has brought institutional development to the forefront of economic growth and development analysis (North, 1990). Following this trend, a growing amount of relatively recent literature has shifted the research focus from investment rates, human capital accumulation and financial constraints, for instance, to the role of governance and institutions as determinants of economic growth and development in resource-rich countries (see, for instance, Acemoglu, Johnson and Robinson, 2001). In this respect, the deterioration of governance and institutions in the presence of natural resources is the growth and development problem in resource-abundant countries (Kolstad and Soreide, 2009). Mehlum et al. (2006) suggest that when institutions are ‘grabber friendly’, resources push aggregate income down, while resources under ‘producer-friendly’ institutions raise income. Boschini, Pettersson and Roine (2007) propose that the extent to which natural resources are good or bad for growth depends on their ‘appropriability’ in two dimensions. The authors suggest that natural resource riches do not, by themselves, harm growth, but become a problem in the absence of good institutions (institutional appropriability), also depending on the type of resource (technical appropriability). Both these studies find empirical support for the basic idea that resources can have positive effects on growth if institutions are good enough, emphasizing the interaction effect between these variables. The literature to date provides a rich discussion on the causes of the resource curse, suggesting different channels through which resources ultimately affect economic growth. Prominent

264  Handbook of sustainable politics and economics of natural resources Table 17.1

Explaining the ‘resource curse’: prominent approaches

Approach

Hypothesis

Structuralist explanations

Declining terms of trade of primary commodities and poor Prebisch (1950); Hirschman (1958)

Indicative Literature

communication channels between resource extraction enclaves and the rest of the economy impede economic growth The ‘Dutch disease’

Manufacturing sector is the engine of growth. The boom

Corden (1984); Neary and Van

in the resource sector diverts resources away from the

Wijnbergen (1986); Sachs and Warner

manufacturing sector. Pressures on the exchange rate

(1999)

damage competitiveness and economic growth Income inequality

The nature of the resource-extractive sectors and public

Engerman and Sokoloff (1997);

spending fueled by resource windfalls lead to skewed

Gylfason and Zoega (2003)

income distribution and distorted economic growth The importance of institutions The nature of the resources shapes the form of government Acemoglu et al. (2001); Easterly and and its subsequent policies. Distorted institutions in the

Levine (2003); Bulte, Damania and

presence of finite resource rents are the resource curse

Deacon (2005); Mehlum et al. (2006); Robinson, Torvik and Verdier (2006); Kolstad and Soreide (2009)

The rent-seeking effect

Resource rents can easily be appropriated, encouraging

Lane and Tornell (1997); Torvik

distorted public polices and diversion towards rent-seeking (2002); Papyrakis and Gerlagh (2004); Stevens and Dietsche (2008); Vicente (2010) Corruption and misuse of

Natural resource endowments trigger corruption and

Robinson and Torvik (2005); Collier

resource funds

misuse of resource wealth from political elites. Natural

and Hoeffler (2005); Harford and Klein

endowments reduce the incentives to reform and to be held (2005) accountable Price volatility

Price and revenue fluctuations expose public finances and

Van der Ploeg and Poelhekke (2008)

macroeconomic stability to booms and busts

explanations are summarized in Table 17.1. These include structuralist explanations, which focus on the declining terms of trade of primary commodities (Prebisch, 1950) and on the poor interaction between resource extraction enclaves and the rest of the economy (Hirschman, 1958). Empirical investigation from Behraman (1987), Dawe (1996) and Papyrakis and Gerlagh (2007) have questioned the explanatory power of these approaches. Theoretical developments in the sphere of economic and political economy analysis offer some converging new theories. Under broad categorization these fall under economic explanations of ‘Dutch disease’, income inequality, price and macroeconomic volatility and political economy explanations of rent-seeking and institutional development models. The term ‘Dutch disease’ is used to describe the hypothesis that a boom in the resource sector will divert resources away from the country’s activities that are conducive to long-term growth. The term is borrowed from the experience of the Netherlands after the discovery and exploitation of domestic reserves of natural gas (Kremers, 1986). The term is used to describe the exchange rate appreciation triggered by commodity booms, which results in the contraction of manufacturing exports, drawing labor and capital away from manufacturing, leading to rising costs (Corden, 1984; Neary and Van Wijnbergen, 1986). This can induce lower economic growth on the assumption that the manufacturing sector is the main engine of growth,

Fiscal policy, macroeconomic volatility and the role of institutions  265 either by generating positive externalities or through increasing returns to scale at a sectoral level (Sachs and Warner, 1999; Torvik, 2002).2 Dutch disease and the resource curse are two different issues. Nevertheless, they are often thought to be synonymous. The term Dutch disease is employed to denote the simultaneous existence of booming and lagging sectors in the economy resulting from the unsustained increase in export earnings from one sector. The term describes the causes and the structural effects of the boom-induced growth (Davis, 1995), the problems arising from the point of view of the losing factor of production (Corden, 1984) and the ensuing political pressure for government intervention (Roemer, 1985). The empirical findings on the validity of Dutch disease remain inconclusive. Arguments that weaken the explanatory power of Dutch disease are supported by the diverse and complex experience of resource-rich countries. The literature offers practical examples of countries that have used their resources to build strong economies while others have failed to grow (Barro, 1991; Leite and Weidmann, 1999; Pegg, 2010; Sala-i-Martin and Subramanian, 2003; Stevens, 2006; Wright and Czelusta, 2007). Symptoms of the resource curse have been further related to entrenched income inequality (Engerman and Sokoloff, 1997; Gylfason and Zoega, 2003). Income effects have been attributed to the nature of the resource extractive sectors and to the income differentials generated by public spending. Oil, gas and mining industries are characterized by their ‘enclave’ nature, with limited forward and backward linkages with the rest of the economy. Resource extractive operations employ a small number of highly skilled and well-paid workers. Where domestic supply of highly skilled workers remains limited, they may be imported. Technological capital employed in resource extraction, which is usually sophisticated, is often imported. In addition to the limited creation of linkages with the rest of the economy, public spending can further exacerbate income inequality, hence distorting economic growth. This is the case where public expenditure may focus on a specific sector, on areas where resource extraction takes place, or on specific interest groups. This skews income distribution against rural areas or disadvantaged ethnic or regional groups. Two prominent contributions to the resource curse literature, Mehlum et al. (2006) and Robinson et al. (2006), establish the decisive role of governance and institutional quality for economic growth and development. Knack and Keefer (1995), Bulte et al. (2005) and Stevens and Dietsche (2008) suggest that institutional quality plays an important part in explaining the effect of natural resources on growth. In a growing strand of the literature, the resource curse has been identified as a problem of natural resource endowments that lead to distorted behavior by economic agents and to weaker governance and institutions (Bulte et al., 2005; Mehlum et al., 2006; Sala-i-Martin and Subramanian, 2003). In this respect, the curse is regarded as the impact of resource endowments upon institutions and governance, where resources induce distorted behaviors of rent-seeking, corruption and patronage. The latter can lead to distorted economic outcomes and lower rates of growth in resource-abundant countries. 2 Dutch disease operates through two distinct channels: the resource movement effect and the spending effect (Corden and Neary, 1982). The first occurs when the booming extractive sector draws capital and labor away from other sectors. Domestic wage rates rise as the booming sector is forced to offer workers higher salaries to attract the labor it needs (Davis and Tilton, 2005). This produces other adjustments in the economy, including rising real exchange rates and increased wages and prices in the non-tradable sector, which then draws additional labor from the lagging tradable sectors (Blomström and Lundahl, 1993). The spending effect occurs when the extra income derived from booming resource rents is spent on domestic goods and services.

266  Handbook of sustainable politics and economics of natural resources Lane and Tornell (1997) and Robinson and Torvik (2005) argue that windfall gains may cause a ‘feeding frenzy’, in which competing groups fight for the rents derived from the natural resource, hence exhausting the public good inefficiently. The latter effect is further exacerbated by the direct accrual to the government of a significant portion of the rents. This can possibly delay the implementation of structural reforms. This can further distract public officials from investments in growth-supporting public goods (Collier and Hoeffler, 2005). Sachs and Warner (1995) suggest that countries rich in resources tend to choose a more protective trade policy, liberalizing later than resource-poor economies. This directly affects institutional development. Harford and Klein (2005) argue that natural resource abundance reduces the incentives to reform, or to establish a strong and well-functioning tax system. Lower domestic tax effort reduces incentives for public scrutiny of the government. Rent-seeking models assume that resource rents can be easily appropriated, hence encouraging bribes, distorted public policies and diversion of public funds towards favor-seeking and corruption (Papyrakis and Gerlagh, 2004; Torvik, 2002; Vicente, 2010). For governments managing significant resource rents, rent appropriation may be preferable when compared to the promotion of policies aimed at wealth creation. Rent appropriation may dominate over wealth generation as it offers immediate economic and political gains. In many cases, these gains appear quite appealing as they can be highly personal, favoring specific members of the ruling elite. In the presence of significant natural resource revenues, rent-seeking and patronage may further make government responsive to public pressure to spend more. Such pressures may trigger rushed and ill-coordinated decisions (Stevens and Dietsche, 2008). These decisions can induce distortions in the economy (Auty, 2001a) merely leading to grandiose investments and ‘white elephants’ (Robinson and Torvik, 2005). Furthermore, governments may neglect (even deliberately) the development of human capital by devoting inadequate attention to education (Ascher, 1999; Gylfason, 2001). In resource-driven economies, governments may have no incentives to pay for training in skills that can be employed in other sectors of the economy (Stijins, 2006). The resource curse has been further attributed to the association of resource rents with the emergence of conflict and civil wars (Collier, 2007; Collier and Hoeffler, 2005), as well as with specific types of political regime (Collier and Hoeffler, 2005; Friedman, 2006). However, the conclusion is not unanimous. Brunnschweiler and Bulte (2008) argue that the conventional measure of resource dependence is endogenous with respect to conflict, and that instrumenting for dependence eliminates its significance in conflict regressions. They find conflict increases dependence on resource extraction, rather than the other way around. Price volatility models highlight the cyclical behavior of commodity prices. Uncertainties in discoveries, geopolitical developments and global demand trends have led to notorious and often violent swings in the market prices of natural resources. Price volatility makes economic management and macroeconomic stability very difficult (Van der Ploeg and Poelhekke, 2008). Resource price volatility renders resource exporting countries vulnerable to significant swings in fiscal revenues. Dependence upon natural resources exposes public finances to unpredictable booms and busts. Price shifts induce significant macroeconomic costs. These include reallocation of resources following price changes, real exchange rate volatility and investment distortions in the rest of the tradable sectors of the economy. Swift changes in public expenditure following price shocks can affect private investments and, consequently, the long-term growth of the non-resource-based sectors. An inability to sustainably manage resource windfalls allows the transmission of resource-revenue volatility to the rest of the

Fiscal policy, macroeconomic volatility and the role of institutions  267 economy. An inability to finance large expenditure programs in times of price downturns may force governments to implement abrupt fiscal contractions. 2.1

Definitions and Benchmarks Employed in the Resource Curse Literature

The empirical investigation of the resource curse has employed various alternatives to defining and measuring resource dependence, grouping resource-rich countries and classifying them according to the type of resources in abundance. Several definitions have been employed in the literature to date relating to resource ‘dependence’, ‘intensity’ or ‘abundance’, and ‘resource-rich’ countries. De Renzio, Gomez and Sheppard (2009) define resource dependence as the ratio of resource revenues to total fiscal revenues. Wehner and de Renzio (2013) define the resource dependence of hydrocarbon-producing countries as the value of oil and gas production per capita. Kalyuzhnova (2008), International Monetary Fund (IMF) (2012a) and Tsani (2013) define resource dependence as the share of commodity exports in total exports. The most widely used proxy for resource dependence is defined as the ratio of resource exports to GDP (see, among others, Boschini, 2013; Boschini et al., 2007; Sachs and Warner, 1995). Bruckner (2010) argues that while this share is probably the best measure to capture the economic importance of the natural resource exporting sector (the measure intends to capture the economic importance of the exporting sector relative to other production activities in the economy), using the measure for cross-country analysis requires paying special attention to the role of non-tradables. In this respect, the measure is criticized on the grounds of overstating the economic importance of the natural resource exporting sector in poor countries and understating it in rich countries. As an improvement to this measure, Bruckner (2010) proposes the use of a real measure of natural resource dependence – that is, a purchasing power parity-adjusted resource dependence ratio. Alexeev and Conrad (2009) argue that measuring resources as a share of GDP magnifies the resource curse effect. Brunnschweiler and Bulte (2008) argue that the export to GDP ratio is more appropriate as a measure of dependence or intensity than as a measure of abundance. The denominator explicitly measures the magnitude of other activities in the economy. Consequently, the scaling exercise (i.e., dividing by the size of the economy) implies that the ratio variable is not independent of economic policies and the institutions that produce them. Moreover, not only the scale of economic activity but also the comparative advantage in non-resource sectors are to a large extent determined by government choices. Such a measure of resource dependence may thus potentially suffer from endogeneity problems and perhaps should not be treated as an exogenous explanatory variable in growth regressions (Wright and Czelusta, 2004). Brunnschweiler and Bulte (2008) propose the employment of a measure of resource abundance that would reflect resource stocks, as opposed to current economic flows derived from them. The authors define resource abundance as the per capita natural capital and mineral resource assets based on World Bank measures of national wealth (see World Bank, 1997, 2006). The measure for total natural capital aggregates the estimates for subsoil assets, cropland, pastureland, timber and non-timber forest resources, and protected areas. The subsoil wealth measure values the principal fuel and non-fuel mineral stocks present in a country. All estimates are based on valuations of the net present value of benefits over a time horizon of 20–25 years.

268  Handbook of sustainable politics and economics of natural resources This approach has not been immune to criticism. Torvik (2009) notes that measures of reserves are not necessarily exogenous. Countries with longer periods of being industrialized and better institutions are likely to have explored more and hence found more of their actual reserves. Van der Ploeg and Poelhekke (2010) argue that a careful examination of the World Bank data of subsoil assets employed by Brunnschweiler and Bulte (2008) reveals that data are proportional to resource rents. World Bank data are based on the strong assumption that natural resource reserves last 20 years. This may make sense to obtain a one-off cross-country estimate of natural capital and net adjusted saving but not to obtain a cross-country or panel dataset of subsoil wealth. Boschini et al. (2007) point out that measures of production to GDP may be even more appropriate, since this comes closer to measuring what is ‘there to grab’ at any given point in time. However, this measure would have to deal with the challenge of obtaining such data for all types of resources. For some resources, notably oil, production costs vary a lot across countries (see Tsui, 2011). Taxation also varies across countries, with the latter being important when, for example, measuring the size of government income from resources (see Haber and Menaldo, 2011 and references therein). Boschini et al. (2007) argue that there are a number of theoretical and practical settings for focusing on the share of primary exports in GDP. In models where a politician faces some trade-off between grabbing resources today or developing other parts of the economy in expectation of future gains, or where individuals, for example, choose to work in the (existing and dominant) resource sector rather than educating themselves, or where individuals can become ‘producers’ or ‘grabbers’ (see Mehlum et al., 2006), it is the share of the economy that resources comprise at the point of deciding that matters. In this case, measures of resource reserves, which may arguably be more exogenous, would not be appropriate from this perspective. In cases where it is necessary to have a homogeneous measure over time for as many countries as possible, export shares in GDP and resource rents are the best available measures. Several benchmarks have been proposed and used to date to classify countries into resource rich and resource poor (see Table 17.2). Auty (2001b) defines resource-rich countries as those with per capita cropland in excess of 0.35 ha and/or 40 percent or more of their exports from fuel and minerals. Mehlum et al. (2006) define as resource rich the countries for which resource exports account for more than 10 percent of their GDP. Collier and Hoeffler (2009) define as high-rent those countries where resource rents account for 10 percent or more of GDP. De Renzio et al. (2009), IMF (2010) and Haglund (2011) define resource-rich countries as those recording shares of resource revenues in total fiscal revenues or shares of resource export proceeds in total export proceeds of at least 25 percent. Kalyuzhnova (2008) and Tsani (2013) define as resource rich the countries where the share of resource exports (fuels, ores, minerals, metals) to total merchandise exports is equal to or more than 40 percent. IMF (2012a) defines as resource-rich developing countries the low- and lower-middle-income countries whose exhaustible natural resources (e.g., oil, gas and minerals) comprise at least 20 percent of total exports or 20 percent of natural resource revenues (based on a 2006–10 average). Coutinho et al. (2013) combine some of the above criteria and define resource-rich countries as those with a ratio of commodity exports to GDP equal to or above 8 percent, along with revenues from commodity exports to total exports equal to or above 60 percent, provided that the revenues from their two main commodity exports as a share of total exports are equal to or greater than 40 percent. This last condition ensures that countries that are relatively diversified in their commodity trade are not included in the sample, as such countries might

Fiscal policy, macroeconomic volatility and the role of institutions  269 Table 17.2

Terms and definitions used in the resource curse literature

Term

Alternative Definitions

Indicative Literature

Resource

The ratio of resource revenues to total fiscal revenues

de Renzio et al. (2009);

dependence

The value of oil and gas production per capita (for hydrocarbon-producing Wehner and de Renzio (2013) countries) The share of commodity exports over total merchandise exports

Kalyuzhnova (2008); IMF (2012a); Tsani (2013)

The ratio of resource exports to GDP

Sachs and Warner (1995); Boschini et al. (2007); Boschini (2013)

Resource-rich

Countries with per capita cropland in excess of 0.35 ha and/or 40% or

countries

more of their exports from fuels and minerals Countries with resource exports that account for more than 10% of their

Auty (2001b) Mehlum et al. (2006)

GDP Countries where resource rents account for 10% or more of GDP (also

Collier and Hoeffler (2009)

referred to as high-rent countries) Countries where resource revenues in total fiscal revenues or shares of

de Renzio et al. (2009); IMF

resource export proceeds in total export proceeds are equal to or higher

(2010); Haglund (2011)

than 25% Countries with share of resource exports (fuels, ores, minerals, metals) to

Kalyuzhnova (2008); Tsani (2013)

total merchandise exports are equal to or more than 40% Low- and lower-middle-income countries whose exhaustible natural

IMF (2012a)

resources (e.g., oil, gas and minerals) comprise at least 20% of total exports or 20% of natural resource revenues (based on a 2006–10 average) Countries with ratio of commodity exports to GDP equal to or above 8%,

Coutinho et al. (2013)

with revenues from commodity exports to total exports equal to or above 60%, provided that the revenues from two main commodity exports as a share of total exports are equal to or greater than 40% Point resources

Resources that are extracted from a limited geographic or economic area

Bulte et al. (2005)

(e.g., oil, gas, minerals) Diffuse resources

Resources that are spread across space (e.g., agricultural products,

Brunnschweiler and Bulte (2008)

livestock and fisheries) Finite or depletable Resources that, once extracted, cannot be replenished

Tsani (2013, 2015)

resources

not be considered dependent on a major revenue source and therefore might be significantly less affected by fluctuations in a particular commodity price. Authors have also distinguished between ‘point’, ‘diffuse’, ‘depletable’ and ‘non-depletable’ resources. Point resources are defined as the resources that are extracted from a limited geographic or economic area (Bulte et al., 2005), while diffuse resources are those that are spread across space (Brunnschweiler and Bulte, 2008). Finite or depletable resources are defined as resources that, once extracted, cannot be replenished. Typical point finite resources are hydrocarbons, ores, minerals and metals. Diffuse resources include agricultural products, livestock and fisheries. Engerman and Sokoloff (1997) suggest that with diffuse resources, in the absence of scale economies to exploit (in contrast to point resources), the prevailing class is that of smallholder or family farms. This development makes the population more racially and economically homogeneous. This supports governance and institutional structures that make provisions for a voice for all, in contrast to developments in the presence of point finite resources. Brunnschweiler and Bulte (2008) suggest that the diffuse nature of the resource

270  Handbook of sustainable politics and economics of natural resources makes it harder for agents (i.e., farmers) to organize themselves into a lobby group and successfully appeal for special favors. Point finite resources are usually associated with highly concentrated ownership (Boschini et al., 2007; Sala-i-Martin and Subramanian, 2003). The theory suggests that this renders the state heavily dependent on a small number of rentier capitalists for generating its income. Given this heavy dependence, rentier capitalists can enjoy tax breaks, subsidies and/or levels of import protection. Under this net of relationships, resource rents can be easily appropriated by the ruling elite (Karl, 1997; Stevens, 2008; Wiig and Kolstad, 2010). Point finite resources tend to be more capital intensive than labor intensive. Hence, they tend to polarize society between the haves and have nots. Point finite resources have been associated with civil conflicts and wars, and with the weakening of the state through the financing of rebel groups (Collier and Hoeffler, 2005). Ross (2001) finds that economic dependence on oil and minerals is correlated with authoritarian governments, as do Wantchekon (2002), Jensen and Wantchekon (2004) and Ross (2006). Smith (2004, 2007), Ulfelder (2007) and others generally find that authoritarian regimes have lasted longer in countries with oil wealth. A different approach to the impact that point finite resources can have upon economic growth and institutions has been looking into aspects of market configuration. Extraction of resources like fuels, ores and minerals has traditionally been under the control of a few major international companies (usually from western countries) or under state control (Karl, 2008). In many countries, rulers have been able to use long contracts with multinational corporations and resource rents as a central mechanism for concentrating their power (Wiig and Kolstad, 2010). The presence of a few international players and their dominating power has often triggered conflicts and social unrest under the wide perception that foreign companies and the ruling elite are appropriating the largest part of the natural wealth. State-owned companies in the resource extractive sector can become too powerful in political terms, supporting the creation of industrial oligarchies requesting preferential treatment (Stevens, 2008). Point finite resources have been associated with the emergence of ‘extractive’ political states (Moore, 2004; Ross, 2001). Rent appropriation might be utilized by the respective governments for patronage and consolidation of power. The trade-offs between the employment of an economic model that could favor economic development and rent appropriation that favors specific interest groups and maintains the ruling elite in power, may be immense. Thus, resource revenues may prevent power redistribution towards the middle classes and the adoption of growth-promoting policies (Birdsall and Subramanian, 2004).

3

VOLATILITY AND ECONOMIC GROWTH: THE ROLE OF FISCAL POLICY CYCLICALITY

The importance of macroeconomic volatility to economic growth has received considerable attention in both the theoretical and the empirical economic literature (see Figure 17.1 for a summary). Recent theories have challenged the traditional approaches that have studied long-run growth and volatility separately (indicative is the work of Aghion and Saint-Paul, 1998 and Caballero and Hammour, 1994). Growing empirical evidence has established a strong connection between volatility and long-run performance (see, among others, Deaton and Miller, 1996; Ramey and Ramey, 1995). Empirical evidence on the direction of the relationship between volatility and growth has varied, but it can be argued that comprehen-

Fiscal policy, macroeconomic volatility and the role of institutions  271 sive empirical evidence has been found for the hypothesis that cyclical fluctuations reduce long-term growth (see Priesmeier and Stähler, 2011 for a recent survey). There is an important challenge, however, in estimating the effect of volatility on growth, due to the possibility of reverse causality. Recent studies that address this issue in a more systematic way confirm the significant negative effects of volatility on growth (see Aghion et al., 2010; Fatás and Mihov, 2006; Loayza et al., 2007).3 With regard to commodity exporters, there appears to be growing acceptance that resource intensity may be associated with higher macroeconomic volatility, which in turn tends to be closely chronologically coincident with slower growth. Chen and Rogoff (2003) show that over the twentieth century, resource price movements were associated with real exchange rate shocks even among wealthy resource-intensive economies such as Australia and New Zealand. A detailed examination of the growth performance of 35 countries over the period 1870–1939, conducted by Blattman, Hwang and Williamson (2007), concluded that countries that specialize in commodities with substantial price volatility have more volatility in their terms of trade, enjoy less foreign direct investment and experience lower growth rates than countries that specialize in commodities with more stable prices or countries that are industrial leaders. The authors conclude that specialization in resource-intensive activities exacerbates the terms of trade shocks because resource specialization is often associated with a lack of industrial diversification and because commodity prices are inherently more volatile than the prices of other goods and services that have more price-sensitive supply responses. In the specific case of resource-rich countries, studies highlight the importance of the relationship between volatility and economic growth in explaining the resource curse. Van der Ploeg and Poelhekke (2008) find evidence that natural resources adversely affect economic growth through the indirect negative impact of volatility on the latter. This argument is further confirmed in the work of Leong and Mohaddes (2012), who argue that the source of the resource curse is the volatility of rents as opposed to resource abundance. A stable level of resource revenues eases liquidity constraints and thus may boost innovations and economic growth. However, for a given expected level of natural resource revenues, volatility in commodity prices and resource revenues can harm innovation and growth, especially if financial development is weak. These arguments, in combination with the evidence presented by Lederman and Maloney (2007) showing that particularly high levels of export concentration among late twentieth-century resource-intensive economies is strongly negatively related to growth performance, suggest that there is a robust correlation connecting resource

3 The negative relationship between volatility and economic growth can be justified with theoretical underpinnings going back to Keynes (1936). Volatility complicates saving and investment decisions by governments, firms and households, and in turn affects long-term economic performance. Volatility increases the perceived riskiness of investment projects and thus lowers the demand for investment, which in turn reduces output growth. Ramey and Ramey (1991) argue that if firms must commit to their technology in advance, volatility could lead to lower mean output because they find themselves producing at suboptimal levels ex post. If lower current output affects the accumulation of resources, then growth is adversely affected. A negative link between volatility and growth could occur if downturns are tied to a worsening of financial and fiscal constraints (Hnatkovska and Loayza, 2004). In this case, volatility can lead to less human capital development, lower productivity-enhancing expenditures and, consequently, lower growth rates (see Talvi and Vegh, 2000). Aversion to economic downturns could prompt governments to adopt policies such as labor market restrictions that make firms less flexible and willing to innovate, thus deepening the negative link between volatility and long-run growth.

272  Handbook of sustainable politics and economics of natural resources specialization and commodity price shocks to terms of trade and real exchange rate shocks, macroeconomic volatility, and eventually slower growth. Haussman and Rigobon (2002) explain the volatility curse in resource-rich countries by looking at the interaction between the specialization of the domestic economy in the production of non-tradables and financial market imperfections. As resource-dependent economies become more specialized in the production of non-tradables, the real exchange rate becomes more volatile, as shocks to the demand for non-tradables (associated, for instance, with the fiscal expenditure of shocks to resource income) will not be followed by movements in the allocation of capital and labor but will be accompanied by expenditure switching. This requires much larger relative price movements. Financial frictions (i.e., risk aversion or costly bankruptcy) imply that the interest rate will be a function of the volatility. An increase in volatility can push sector-specific interest rates upwards, causing a decline in output, particularly for the non-resource tradable sector. Through a multiplier process, an initial rise in interest rates causes the tradable sector to contract. This leads to volatility, and interest rates increase. At this stage, the economy records even higher interest rates and a lower level of capital and output in the non-tradable sector. Thus, resource specialization is inefficient and is characterized by high volatility and interest rates, weak real exchange rates, low wages and low levels of investment. Resource price booms can lead to real appreciation and decline of non-commodities exports. The problem arises when the decline in net exports is due to a boom that is short-lived. When the revenues from natural resources fall, the real exchange rate becomes overvalued. But it may not be possible to recover lost non-commodity-based exports or the relevant sectors, notably agriculture and manufacturing, even if the real overvaluation is corrected by a subsequent depreciation. Moreover, adjustments to the real exchange rate are unlikely to be smooth. Instability is very costly, as economies and budgets adjust asymmetrically. Rapid growth in public spending, which often follows resource windfalls, may reduce the quality of public spending and introduce entitlements, including recurrent cost commitments, which are often not sustainable in the long run. Efficiency may further suffer from a high proportion of unfinished projects or ‘white elephants’ (Robinson and Torvik, 2005). Frankel (2010) identifies fiscal procyclicality as a possible additional source of volatility in resource-rich countries. A fiscal policy that is expansionary in booms and contractionary in recessions is likely to exacerbate the magnitude of income swings. The question of fiscal procyclicality has not been exclusively directed applied to resource-rich countries and there are a number of studies trying to identify the responses of fiscal policy to the cycle across a large number of countries. Although the evidence is mixed, there is more support for fiscal procyclicality among developing than among industrial countries, with only a few studies focusing on the specific case of resource-rich countries. It is important to note, however, that the question of whether fiscal policy ought to be countercyclical does not have a clear-cut theoretical answer. Since the seminal work by Barro (1979), a general result in theoretical models is that optimal tax rates should be constant over the business cycle, implying therefore that fiscal revenues should essentially move up and down with the cycle. In the absence of discretionary fiscal policy on the expenditure side, the budget balance would improve in good times and deteriorate in bad times, a pattern that had been characterized by economists as a countercyclical fiscal stance. But what is the optimal expenditure policy? Answering this question with a Keynesian model, in which price rigidity prevents the economy from adjusting rapidly to full employment, would reinforce countercy-

Fiscal policy, macroeconomic volatility and the role of institutions  273 clicality, since in the Keynesian model, the government should increase fiscal spending in bad times and reduce it in good times to stabilize the economy. A neoclassical model, however, may not yield the same answer. In neoclassical models, the answer to the procyclicality of government expenditures is less clear-cut, since the optimal expenditure policy depends on how these expenditures enter into the model, and the appropriate choice is usually dependent on the type of fiscal expenditure considered (Lane, 2003). If government consumption and transfers are assumed to enter the utility of consumers in a separable way and preferences are concave, the optimal policy would be to maintain their level constant over time (‘consumption smoothing’). The result is different, however, if these government expenditures are assumed to be either a substitute or a complement to private consumption. If public and private components are substitutes, government consumption and transfers should move countercyclically, but if they are complements, these government expenditures should move procyclically. There may be stronger arguments for government transfers (e.g., child benefits) to be substitutes to private consumption than for government consumption, which on average can probably be assumed to be neutral and therefore acyclical.4 Government investment, on the other hand, typically enters the model as increasing the stock of public capital, which again can be seen either as a complement to or a substitute for other factors of production. Only if public capital is a substitute for other factors of production will the optimal government investment policy be countercyclical. There could, however, be other factors rendering public investment countercyclical, even in a neoclassical model, such as the presence of multi-period investment plans (ibid.). Finally, the cyclical behavior of debt payments depends on the cyclical behavior of interest rates. In new Keynesian macro models, optimal monetary policy would imply procyclical real interest rates. Overall, there is some consensus in economic theory that government consumption should be countercyclical in most countries (see also Ilzetzki and Vegh, 2008). Alesina, Tabellini and Campante (2008) further argue that fiscal policy could only be procyclical when the government would like to borrow but is prevented from issuing more debt, but this would happen only in a recession. To explain procyclicality in both recessions and booms, Alesina et al. (2008) show that it is necessary to introduce political economy elements in the model. This hypothesis explains procyclical fiscal policy as the result of a political procyclicality arising both in booms and recessions, which can occur, for instance, where political corruption is widespread. Empirically, evidence about the cyclical behavior of fiscal policy is mixed. There is evidence of many countries following procyclical fiscal policies, especially developing countries. Evidence of procyclicality among Latin American countries has been more robust and can be found in studies such as Gavin and Perotti (1997), Stein, Talvi and Grisanti (1999), Catão and Sutton (2002), Manasse (2005) and Talvi and Vegh (2005). There is growing evidence, however, that this phenomenon is not peculiar to Latin America, but is more widespread among developing countries, as documented in Kaminsky et al. (2004), Alesina et al. (2008) and Ilzetzki and Vegh (2008). Some studies, however, have also pointed out that fiscal procyclicality can also be found among industrial countries, although it may be less widespread. Studies identifying fiscal procyclicality for at least a sub-set of industrial countries include 4 Karras (1994) finds that the substitutability of government consumption is positively related to the size of the government. Larger governments expand public services beyond those like national defense that are complementary of private spending.

274  Handbook of sustainable politics and economics of natural resources Arreaza, Sorensen and Yosha (1999), Lane (2003), Talvi and Vegh (2005), Ilzetzki and Vegh (2008) and Beetsma and Giuliodori (2010).

Figure 17.1

Volatility and growth: theory and evidence

It is important to notice that empirical estimates of the cyclical behavior of fiscal policy have a number of important caveats. The first refers to the problem of data limitations. For a significant number of countries, fiscal data are available only in annual terms, and using annual data restricts the content of the cyclical information that can be extracted. Ilzetzki and Vegh (2008) also use quarterly data in their study, but this option has the limitation of significantly restricting the number of countries analyzed, with possible selection bias. A second complication relates to the problem of endogeneity. If the true model follows a standard neo-Keynesian model, in which fiscal policy affects income, a simple OLS regression of fiscal policy on the output gap, or on output growth, would produce a biased estimate, capturing the government multiplier rather than fiscal procyclicality alone. One solution to the endogeneity problem is to instrument the country’s output gap or GDP growth with an instrument correlated with the country’s cyclical conditions but not directly related to the country’s fiscal policy. The problem associated with the instrumental variables approach, however, is to find the appropriate instruments. Gali and Perotti (2003) analyze European countries and the US and suggest using the US output gap to instrument the output gap of EU countries, and EU GDP as an instrument for the US output gap. Jaimovich and Panizza (2007) instead suggest using as the instrument the trade-weighted average of the GDP of the rest-of-the-world. Alesina et al. (2008) use a simplified version of this methodology and instrument the output gap of each country with the output gap of its neighbors (regional output gap excluding the country). Ilzetzki and Vegh (2008) also propose as an instrument for GDP a measure of international financial conditions, given by the real return on six-month Treasury bills weighted for each country, based on the Chinn and Ito (2007) measure of capital account openness, rescaled to range between 0 and 1 and averaged over the relevant sample for each

Fiscal policy, macroeconomic volatility and the role of institutions  275 country (giving one index of financial openness per country). In several cases, lagged GDP growth (or the lagged output gap) is also used as an additional instrument, but, as pointed out by Ilzetzki and Vegh (2008), the strong serial correlation of GDP may make lagged GDP an imperfect instrument, as GDP at time t – 1 may still be correlated with the error term at time t. The other important empirical issue is the choice of control variables to be included in the analysis. Alesina et al. (2008) include in all regressions a measure of terms-of-trade shocks. They define terms-of-trade shocks as the logarithmic deviation from a Hodrick-Prescott-filtered series of the terms of trade, weighted with the degree of openness of the country, measured by exports plus imports over GDP. The inclusion of the terms of trade allows for the capture of an additional source of fiscal volatility. Financial variables have also been singled out in the literature as potential determinants of fiscal variability. Eschenbach and Schuknecht (2004), for instance, highlight the links between asset price cycles and fiscal outcomes. Other studies, including Dobrescu and Salman (2011) and Lendvai, Moulin and Turrini (2011), have identified links between the current account balance and fiscal cycles: a current account deficit should improve revenues from indirect taxes, since net capital inflows finance a higher level of domestic absorption. Benetrix and Lane (2010) argue in addition that domestic financial variables may also influence fiscal outcomes. To account for the influence of financial variables on fiscal volatility, Benetrix and Lane (2010) include as control variables in their fiscal output regressions current account balance and the growth in private credit, both scaled by GDP. Several studies also include the lagged level of the public debt, since a positive relation between the stock of public debt and the primary fiscal balance is typically required to support non-explosive debt dynamics (see Benetrix and Lane, 2010; Lane and Perotti, 2003). Finally, it is also common to include the lag of the fiscal variable, since this class of variables typically exhibits considerable persistence. Some studies have also attempted to understand the sources of fiscal procyclicality by testing the effects of interactions between the economic cycle and alternative variables. Alesina et al. (2008) use this strategy to test for the effect of institutional variables on procyclicality. They construct interactions between the output gap and a measure of democracy constructed from the Polity2 Index, between the output gap and a measure of control of corruption from Kaufmann, Kraay and Mastruzzi (2006), and among these three variables. They find that control of corruption does reduce procyclicality, and more so in democracies. These authors point to the fact that financial constraints may be another determinant of procyclicality, but it is hard to disentangle the effects of financial constraints and the effects of corruption because measures of financial constraints such as credit ratings or interest rate spreads are highly correlated with measures of corruption. Instead of using interactions to test for this effect, the authors split the sample between pre-Mexican currency crisis and post-Mexican currency crisis, arguing that borrowing constraints should be more binding for the second period, but they find no evidence that procyclicality has increased in that period. Benetrix and Lane (2010) test for the effects of the Maastricht Treaty and the Economic and Monetary Union (EMU) on fiscal procyclicality using interactions and find that the Maastricht Treaty seems to have rendered the budget balance to GDP ratios more positively correlated to output, but the effect of the Economic and Monetary Union is only significant in OLS regressions. An additional challenge with studies on the procyclicality of fiscal policy is the choice of the dependent variable. Tax rates are usually not available, and procyclical variations in the tax base render tax revenues less informative for policy analysis. Real government expenditures and real government consumption have been the preferred candidates to define the cyclicality

276  Handbook of sustainable politics and economics of natural resources of fiscal policy. The results using these variables have clear-cut conclusions: a positive correlation with the cycle implies that the government is increasing expenditure/consumption in good times and reducing it in bad times. Looking only at expenditures, however, gives no information about the fiscal stance, which is arguably what matters most for the impact of fiscal policy. Hence, several studies also look at the budget balance. The econometric analysis of the fiscal balance, however, is complicated by the fact that the budget balance can take both positive and negative values, precluding the use of percentage changes. A related issue is whether to scale fiscal variables using GDP. Looking at the ratio between total revenues and GDP can tell us whether total revenues have increased by more or less than GDP, and the same for the ratio of total expenditures to GDP, from which one can infer whether expenditures have increased by more or less than GDP. It is more difficult to interpret the correlations between the budget balance to GDP ratio and the cycle (a positive correlation can tell us that revenues as a ratio to GDP tend to increase more than expenditures as a ratio to GDP in good times, and the reverse in bad times). In the recent literature, Kaminsky et al. (2004) and Ilzetski and Vegh (2008) argue that little can be inferred by looking at ratios to GDP, while Gavin and Perotti (1997), Alesina et al. (2008) and Benetrix and Lane (2010), more in the spirit of the European tradition of monitoring ratios to GDP, have also looked at scaled variables. Some studies have also emphasized the importance of using real-time data to evaluate the procyclicality of fiscal policy. Real-time data is, however, not easily available for use in empirical studies, hence there have been only limited attempts to test its importance. Beetsma and Giuliodiri (2010) use real-time data based on economic forecasts to analyze how fiscal policy responds to new information on the business cycle. Their results show marked differences in the procyclicality of fiscal policy between the planning and implementation stages, as well as between the fiscal policy of EU countries and other Organisation for Economic Co-operation and Development (OECD) countries. Planned fiscal policy is found to be acyclical for EU countries and countercyclical for the other countries. However, implemented fiscal policy in the EU is procyclical relative to unexpected changes in the output gap, while in other OECD countries this is found to be acyclical. One common result that tends to be identified in the empirical literature is that fiscal procyclicality tends to be more frequently identified among developing countries. Researchers have pointed to the fact that this may be due to the larger proportion of commodity exporters within this country grouping. Commodity exporters are subject to large swings in commodity prices and revenues, and therefore face fiscal challenges that may lead them to a more procyclical behavior. Frankel (2010) argues that fiscal procyclicality would exacerbate output volatility in resource rich countries, compounding the problem of resource price swings. For this reason, some studies have focused on the study of fiscal procyclicality in resource-rich countries. On the expenditure side, Cuddington (1989) analyzes the correlation between commodity booms and spending booms and finds that price booms in resource-rich countries are often accompanied by increases in public sector spending. On the revenue side, Vladkova-Hollar and Zettelmeyer (2008) assess the sensitivity of fiscal revenues in Latin America to resource price booms. They find that commodity-related revenues played a substantial role in the 2006–08 revenue boom of commodity exporting countries. In a related study, Bornhorst, Gupta and Thornton (2008) investigate whether countries that receive large revenues from hydrocarbons raise less revenue from other domestic taxation, using a panel of 30 hydrocarbon-producing countries covering the period 1992–2005.

Fiscal policy, macroeconomic volatility and the role of institutions  277 They find a statistically significant negative relationship between hydrocarbon revenues and non-hydrocarbon revenues, which corroborates the hypothesis that higher hydrocarbon revenues may dampen the non-commodity tax effort of the government, increasing dependency on commodity revenues and the vulnerability of the fiscal position to downturns. There are also country case studies documenting fiscal procyclicality in resource-rich countries. Gelb (1989) describes the fiscal responses to the oil shocks of the 1970s in Trinidad and Tobago, Venezuela and Ecuador, and Tornell and Lane (1999) document a large increase in government consumption and transfers in response to the oil booms of 1974 and 1980–82 in Venezuela and Mexico. Sinnott (2009) studies fiscal procyclicality in resource-rich Latin America and the Caribbean countries in a more comprehensive way. The author analyzes the co-movement between fiscal expenditures and revenues and commodity prices using a panel of 19 countries in the region over the period 1964–2008. His results suggest that there has been a positive fiscal revenue response to commodity price changes in recent years and that the revenue response to commodity price changes increased from the late 1990s onwards, but he does not find any significant fiscal spending response. Nevertheless, country-by-country results indicate that this may be due to a large divergence in the response of individual countries to commodity price changes between 2000 and 2008. To avoid the endogeneity problem, Sinnott (2009) uses as a measure of the business cycle the change in the log of the world price of country i’s commodity exports in year t (without instrumenting), assuming that individual countries are price-takers in the world market. As a control variable, the author includes a measure of international interest rate costs as a proxy for global liquidity conditions (as in Ilzetski and Vegh, 2008). Anshasy and Bradley (2012) also look directly at the relationship between fiscal policy and resource prices, focusing on oil-producing countries. Using panel cointegration, they find the ratio of total government expenditure to GDP to be positively related to oil prices in the long run, but find that in the short run the ratio of total expenditures to GDP adjusts downwards in response to an increase in oil prices (this may simply mean that GDP increases more than expenditures when oil prices increase). They also find that an increase in the volatility of oil prices reduces the government expenditure to GDP ratio in countries with fixed exchange rates. Finally, they find that in the short run the government expenditure to GDP ratio increases with positive skewness in oil price changes (i.e., government spending relative to the size of the economy increases as the government expects more positive than negative oil price changes). Cespedes and Velasco (2014) investigate the behavior of fiscal policy during commodity price booms. They construct resource price indexes relevant for each commodity-rich country and, using that index, identify commodity boom episodes. They define a commodity boom episode as a period in which the domestic production-weighted commodity price index surpasses its historical trend by a certain threshold margin. For virtually all countries under study they identify two boom episodes: one taking place in the 1970s and early 1980s, and another in the years immediately prior to 2008. They then analyze the behavior of real government expenditures, real government revenues, and the fiscal balance over the identified commodity price cycles by regressing these variables on the cyclical component of resource prices during the boom periods. The results suggest that fiscal policy in many resource-rich countries was significantly procyclical in the earlier boom episode: in several cases they identify a negative relationship between the fiscal balance (as a percentage of GDP) and the behavior of commodity prices. The evidence for the second boom episode shows a different pattern. Hardly any of the coefficients showing the response of the fiscal balance are negative, suggesting a more

278  Handbook of sustainable politics and economics of natural resources countercyclical stance in this period. The estimates could be biased, however, due to the small sample and to a possible selection bias. Coutinho et al. (2013) follow a different approach by explicitly instrumenting GDP growth in resource-rich countries with commodity price growth, an instrument shown to be very strong. Given that commodity prices are determined in international markets, this empirical result provides a strong confirmation of the intuitive idea that commodity prices can provide plausible exogenous variation in GDP growth for these countries. The large commodity price volatility in the data (as also pointed out by Mendoza, 1995) also means that this exogenous variation is quantitatively large and can therefore provide substantial benefits in identifying plausible causal coefficients. This study also uses a larger panel data set that can result in more efficient estimation, and finds economically significant evidence that fiscal policy is strongly procyclical in resource-rich countries. The results indicate that a 1 percent exogenous rise in GDP growth leads to a 2–3 percent rise in real government consumption growth. This illustrates quite a large procyclical response of fiscal policy to GDP changes and is consistent with the emphasis on understanding commodity price booms and busts in the literature.

4

INSTITUTIONS AND FISCAL POLICY IN RESOURCE-RICH COUNTRIES

Recent contributions focus on the importance of institutions to the conduct and outcomes of fiscal policy (see, for instance, Afonso, Agnello and Furceri, 2010; Fatás and Mihov 2003, 2006, 2011 and references therein). Theoretical approaches rest with the ‘common pool’ phenomenon that arises when the various decision makers compete for public resources and fail to internalize the current and future costs of their choices (see Velasco, Poterba and von Hagen, 1999) and to the ‘agency phenomenon’, which is associated with information asymmetry and incentive incompatibilities that impact the size, allocation and use of public resources (Dixit, 1998). The literature suggests that strong institutions can ensure that fiscal consequences of policy decisions are appropriately considered, and that the agency problem is minimized. Poterba (1996) and Alesina et al. (1999), among others, provide evidence in favor of the argument that institutions are not merely veils, but they can have real effects upon fiscal policy. Institutions in the form of explicit constraints upon fiscal actors, political settings, and regimes are found to impact on fiscal policy outcomes. Several authors have studied the role of institutional constraints in determining fiscal policy outcomes. Recent empirical studies show that they may have a significant impact on fiscal outcomes in different contexts. Indicative is the work of Hallerberg, Strauch and von Hagen (2009) for European countries; Perotti and Kontopolous (2002) for OECD countries; Fabrizio and Mody (2006) and Mulas-Granados, Onrubia and Salinas-Jeménez (2009) for Central and Eastern Europe; Filc and Scartascini (2005) for Latin America; and Prakash and Cabezón (2008) for heavily indebted Sub-Saharan African countries. Recent attempts have focused on the role of fiscal rules and numeric targets. Some studies have questioned their effectiveness, arguing that governments may find ways to circumvent such constraints (see Milesi-Ferretti, 2004; von Hagen and Wolff, 2004). Critics argue that the effectiveness of numerical targets depends on the enforcement of penalties for violating them (Bohn and Inman, 1996). In contrast, an increasing number of studies show that fiscal rules and numerical targets can positively impact fiscal policy outcomes.

Fiscal policy, macroeconomic volatility and the role of institutions  279 Alt and Lowry (1994), Bayoumi and Eichengreen (1995) and Poterba (1994), employing different samples and methodologies, find that fiscal and budget rules have a significant impact on fiscal outcomes and affect fiscal positions and their reaction to fiscal shocks. Bohn and Inman (1996) and Alesina and Bayoumi (1996) conclude that explicit restrictions on fiscal policy reduce the likelihood of deficits. A recent European Commission report finds that numerical fiscal rules can increase fiscal discipline (see European Commission, 2006). Fatás and Mihov (2006) study the relationship between fiscal rules and fiscal policy volatility and cyclicality in the US states. They conclude that fiscal rules (explicit balanced budget and spending constraints) decrease fiscal policy volatility. Canova and Pappa (2006), however, find no relationship between fiscal restrictions and the volatilities and correlations of macrovariables, and the probability of excessive debt, using a panel of 48 US states. Brzozowski and Siwinska-Gorzelak (2010) find that fiscal rules have a significant impact on fiscal policy volatility but depending on the target of the rules – public debt or fiscal balance –they will increase or decrease policy volatility. Finally, Beetsma and Giuliodiri (2010) find that fiscal rules, although imposing some discipline on planned budgets, do not impose any discipline ex post on the implemented budget. An alternative stream of the literature on institutions and fiscal policy has been looking at the importance of political institutions and regimes to fiscal policy outcomes. For instance, Persson and Tabellini (2003) and Tsebelis (2002) study the way that veto points and constitutional rules shape fiscal policy outcomes, concluding that governments in which power is more concentrated and which face fewer veto points are less constrained in the implementation of fiscal policy. Talvi and Vegh (2000) and Persson and Tabellini (2001) show that electoral rules and political regimes systematically influence fiscal policy outcomes. The same authors find that in presidential regimes, the size of the government is smaller and less responsive compared to parliamentary regimes (Persson and Tabellini, 2001). They also show that under majoritarian elections, social transfers are smaller and aggregate spending less responsive to income shocks compared to proportional elections. Albuquerque (2011) provides evidence that a high concentration of parliamentary seats in a few parties would increase public spending volatility. Mierau, Jong-A-Pin and de Haan (2007) show that political institutions affect the decision to implement fiscal adjustments. Diallo (2009) finds a positive association between democratic institutions and countercyclical fiscal policies in a panel of African countries, as opposed to autocracies. The author concludes that formal institutions that impose restraints on the executive branch are the key factor that explains why democracies can smooth business cycles better than autocracies. The literature has also stressed the importance of qualitative aspects of institutions to fiscal policy outcomes. Transparency in government operations is widely regarded as an important precondition for fiscal sustainability and overall fiscal rectitude (see, among others, Milesi-Ferretti, 2004; Shi and Svensson, 2002). Transparency may determine the scope for creative accounting as opposed to ‘true’ fiscal adjustment, or may affect the voters’ trust in government and thus the size of government. Alesina and Tabellini (2005) relate procyclical fiscal policy to corruption. The corruption argument rests on the premise that constituents do not trust corrupt governments to manage additional resources. Public belief rests with the idea that government revenues will be siphoned off by distributing favors to special groups or ‘friends’. Thus, the constituents demand increases in public spending, transfers or public investment, whenever the economy experiences positive shocks, to hold governments accountable. In a more recent study, Alesina et al. (2008) find that control of corruption is

280  Handbook of sustainable politics and economics of natural resources more related to countercyclicality in democracies. Democratic institutions carry transparency and accountability values, and they are likely to restrain any fierce competition for public resources during good times and open a venue for a more relaxed fiscal policy during bad times. Distributional conflicts can also be mitigated by ‘institutions of conflict management’, such as an independent and effective judiciary, and an honest and non-corrupt bureaucracy (Rodrik, 2000). The literature specific to resource-rich countries includes several attempts to identify the relationship between institutions and fiscal policy (Table 17.3). Gylfason (2012) argues that resource-rich countries that have been blessed by successful natural resource economies, such as Botswana, Chile, Malaysia, Mauritius and Norway, are those that have put in place strong fiscal institutions. Regarding constraints and explicit fiscal rules, arguments in favor indicate that binding fiscal rules can be used to limit the use of windfall revenues and guarantee an optimal level of savings (for a detailed discussion, see Barnet and Ossowski, 2003). Several studies have found that Chile’s structural balance budget rule and the resulting countercyclical fiscal policy has led to improved macroeconomic outcomes, including mitigating the impact of copper price shocks on output volatility, sovereign risk premiums, growth and employment (Medina and Soto, 2007). Results from a model calibrated to an average Latin American commodity exporter also indicate the countercyclical structural balanced budget rule as the most successful policy mix in isolating output from commodity price swings, such as the 2007–09 commodity price cycle (IMF, 2012). In contrast, Arezki, Gylfason and Sy (2011) argue that fiscal rules have not had any significant effects on the degree of procyclicality of fiscal policy in resource-rich countries. Nevertheless, the authors acknowledge the fact that the experience with fiscal rules in resource-rich countries is relatively recent and it might be too early to assess the real effects. Recent literature has also paid special attention to the effectiveness of explicit fiscal institutions such as resource funds (also studied within the larger group of SWFs) to fiscal policy outcomes in resource-rich countries. Fasano (2000) provides an analysis of the operational modalities and of the experience with resource funds in Norway, Chile, Venezuela, Kuwait, Oman and the State of Alaska, looking into the variety of objectives attached to the funds and comparing the soundness of overall fiscal discipline in each country. The review concludes that the funds of Norway, Kuwait, Chile and the State of Alaska have contributed to effective fiscal policy. However, this has not been the case for the funds of Venezuela or Oman. These findings have been confirmed in a series of studies suggesting that the funds of Norway, Kuwait, Botswana or Chile can be cited as successful examples of imposing fiscal discipline that has reduced the correlation between resource windfalls and government expenditures (see Hjort, 2006; Tsalik, 2003; Usui, 2007). Davis et al. (2003) argue that resource funds that are integrated with the budget process in a coherent way have been able to maintain a unified control of the fiscal policy and expenditure coordination. In the more recent examples of funds being established – in Azerbaijan and Kazakhstan – Wakeman-Linn et al. (2003) find that establishing the fund allowed the authorities to disentangle tax-related decisions from the easily available oil revenues. Using a panel data set of 68 resource rich countries over 1988–2012, Sugawara (2014) finds that the existence of resource funds contributes to smoothing government expenditure. The analysis shows that political institutions and fiscal rules can be significant factors in reducing expenditure volatility.

Fiscal policy, macroeconomic volatility and the role of institutions  281 Table 17.3

Institutions and the conduct of fiscal policy

Argument

Indicative Literature

Fiscal rules and numerical targets have no or limited effects

Bohn and Inman (1996); Milesi-Ferretti (2004); von Hagen and

on the conduct of fiscal policy. Governments may find ways

Wolff (2004); Canova and Pappa (2006); Beetsma and Giuliodiri

to circumvent constraints. The effectiveness of fiscal rules and

(2010); Coutinho et al. (2013)

numerical targets depends on the enforcement of penalties for violating them Fiscal rules and numerical targets can have a significant impact

Alt and Lowry (1994); Poterba (1994); Bayoumi and Eichengreen

on fiscal outcomes and in response to fiscal shocks

(1995); Alesina and Bayoumi (1996); Alesina et al. (1999); Perotti and Kontopolous (2002); Filc and Scartascini (2005); European Commission (2006); Fabrizio and Mody (2006); Fatás and Mihov (2006); Hallerberg et al. (2009); Mulas-Granados et al. (2009); Prakash and Cabezón (2008)

Political institutions and regimes also matter to fiscal outcomes

Talvi and Vegh (2000); Persson and Tabellini (2001, 2003); Tsebelis (2002)

Qualitative aspects of institutions matter to fiscal policy

Shi and Svensson (2002); Milesi-Ferretti (2004); Alesina and

outcomes. Transparency in government operations and

Tabellini (2005); Alesina et al. (2008); Coutinho et al. (2013)

constraint of corruption can be associated with prudent conduct of fiscal policy Quality of institutions is an important factor for successful fiscal Barnett and Ossowski (2003); Gylfason (2012) policy in resource-rich countries Resource funds can support the conduct of prudent fiscal policy Fasano (2000); Davis, Ossowski and Fedelino (2003); Tsalik in resource-rich countries

(2003); Hjort (2006); Usui (2007); Coutinho et al. (2013)

Resource-rich countries that operate resource funds show no

Davis et al. (2003); Bacon and Tordo (2006); Ossowski et al.

significant differences in the stance of fiscal policy compared to (2008); Villafuerte, López-Murphy and Ossowski (2010) those countries that have not established resource funds

The literature to date also includes both case studies and econometric analysis that find no significant differences in the stance of fiscal policy of countries with funds relative to others (Bacon and Tordo, 2006; Davis et al., 2003; Ossowski et al., 2008; Villafuerte et al., 2010). Econometric estimations by Ossowski et al. (2008) suggest that the existence of special fiscal institutions (resource funds and rules) does not significantly affect the levels of the non-oil budget balance and government expenditure. Further econometric evidence by Crain and Devlin (2003) suggests that funds have a limited impact on government spending. Daniel (2003) and Devlin and Titman (2004) argue that resource funds may either accumulate or exhaust revenues endlessly. Based on the analysis of a number of countries and resource funds, further arguments indicate the problem of fungibility of the accumulated fund assets and the ability of the funds to be integrated with the budget and be protected from corrupt use (Andersen and Faris, 2002; Eifert, Gelb and Tallroth, 2002). When resource funds serve a saving role, they receive a constant share of resource revenues for future generations. In the case of successful resource fund management, they must lead to higher government savings in aggregate. Nevertheless, if the respective government does not reduce its expenditure and borrows to finance spending, then government savings are not affected: the assets of the savings funds are offset by the government debt. This, in addition to the poor integration of the funds with the budget, can lead to a loss of overall fiscal control, to duplication of expenditures or capital spending, or to decision taking that may disregard the implications on future recurrent spending (Ahmad and Singh, 2003; IMF, 2007). Authors have also argued that fund

282  Handbook of sustainable politics and economics of natural resources spending programs can lead to confusion regarding spending priorities and which of them is going to be financed by the fund (Davis et al., 2003). Coutinho et al. (2013) investigate whether there are particular country characteristics that can affect the degree of fiscal procyclicality in resource-rich countries by analyzing first the effects of standard institutional variables used in the literature, such as democracy and corruption. In addition, the study also analyses whether the presence of fiscal rules (expenditure, revenue, debt and/or budget deficit rules) or SWFs are successful in limiting fiscal policy procyclicality. Their results indicate that fiscal policy rules may not be very effective in limiting fiscal policy procyclicality but operating an SWF seems to better achieve this goal. These results are consistent with the idea that resource-rich countries with more democratic institutions and more well-developed checks and balances in their executive bodies can better control fiscal policy procyclicality.

5 CONCLUSIONS This survey of the literature on the ‘resource curse’ reveals that a growing number of studies conclude that natural resource endowments can hamper economic growth. This ‘paradox of plenty’ has been explained on the grounds of ‘Dutch disease‘ and on the implications of the presence of a booming high-rent resource-based sector on institutional developments and macroeconomic volatility. Macroeconomic volatility in resource-rich countries has been associated with commodity price volatility and poor macroeconomic management. In developing countries in general, macroeconomic volatility has also been associated with procyclical fiscal policies, which tend to be expansionary in booms and contractionary in recessions, further exacerbating the economic cycle. The review of the literature on fiscal policy in resource-rich countries shows that procyclicality has not been extensively studied. Relatively few studies attempt to address this issue, providing evidence that fiscal policy has been procyclical in resource-rich countries. Recent literature on fiscal procyclicality has been looking at the role of institutions in determining fiscal outcomes. Several studies have suggested that countries that have been able to address the fiscal policy challenges associated with natural resource endowments have been those that have put in place strong fiscal institutions. Nevertheless, empirical and country evidence on the effectiveness of specific fiscal arrangements like resource funds or fiscal rules remains scarce. Some studies find that the latter may support the conduct of prudent and countercyclical fiscal policy, but more recent research challenges this stance, arguing that resource funds may work as better disciplinary tools.

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Fiscal policy, macroeconomic volatility and the role of institutions  289 Stevens, P. (2008), ‘National oil companies and international oil companies in the Middle East: under the shadow of government and the resource nationalism cycle’, Journal of World Energy Law and Business 1(1), 5–30. Stevens, P. and Dietsche, E. (2008), ‘Resource curse: an analysis of causes, experiences and possible ways forward’, Energy Policy 36, 56–65. Stijins, J.P. (2006), ‘Natural resource abundance and human capital accumulation’, World Development 34(6), 1060–83. Sugawara, N. (2014), ‘From volatility to stability in expenditure: stabilization funds in resource-rich countries’, IMF Working Paper 14/43, International Monetary Fund. Talvi, E. and Vegh, C.A. (2000), ‘Tax base variability and procyclical fiscal policy’, NBER Working Paper 7499, National Bureau of Economic Research. Talvi, E. and Vegh, C.A. (2005), ‘Tax base variability and procyclical fiscal policy in developing countries’, Journal of Development Economics 78, 156–90. Tornell, A. and Lane, P.R. (1999), ‘The voracity effect’, American Economic Review 89(1), 22–46. Torvik, R. (2002), ‘Natural resources, rent seeking and welfare’, Journal of Development Economics 67, 455–70. Torvik, R. (2009), ‘Why do some resource-abundant countries succeed while others do not?’, Oxford Review of Economic Policy 25, 241–56. Tsalik, S. (2003), Caspian Oil Windfalls: Who will Benefit?, New York: Open Society Institute. Tsani, S. (2013), ‘Natural resources, governance and institutional quality: the role of resource funds’, Resources Policy 38(2), 181–95. Tsani, S. (2015), ‘On the relationship between resource funds, governance and institutions: evidence from quantile regression analysis’, Resources Policy, 44, 94–111. Tsebelis, G. (2002), Veto Players, Princeton, NJ: Princeton University Press. Tsui, K. (2011), ‘More oil, less democracy: evidence from worldwide crude oil discoveries’, Economic Journal 121(551), 89–115. Ulfelder, J. (2007), ‘Natural resource wealth and the survival of autocracies’, Comparative Political Studies 40(8), 995–1018. Usui, N. (2007), ‘How effective are oil funds? Managing resource windfalls in Azerbaijan and Kazakhstan’, Asian Development Bank Policy Brief 50. Van der Ploeg, F. and Poelhekke, S. (2008), ‘Volatility and the natural resource curse’, OxCarre Research Paper No. 2008-03, Oxford Centre for the Analysis of Resource-rich Economics, University of Oxford. Van der Ploeg, F. and Poelhekke, S. (2010), ‘The pungent smell of “red herrings”: subsoil assets, rents, volatility and the resource curse’, Journal of Environmental Economics and Management 60(1), 44–55. Velasco, A., Poterba, J.M. and von Hagen, J. (1999), ‘A model of endogenous fiscal deficits and delayed fiscal reforms’, in J.M. Poterba and J. von Hagen (eds), Fiscal Institutions and Fiscal Performance, Chicago, IL: University of Chicago Press. Vicente, P. (2010), ‘Does oil corrupt? Evidence from a natural experiment in West Africa’, Journal of Development Economics 92, 28–38. Villafuerte, M., López-Murphy, P. and Ossowski, R. (2010), ‘Riding the roller coaster: fiscal policies of nonrenewable resource exporters in Latin America and the Caribbean’, IMF Working Paper 10/251, International Monetary Fund. Vladkova-Hollar, I. and Zettelmeyer, J. (2008), ‘Fiscal positions in Latin America: have they really improved?’, IMF Working Papers 08(137), International Monetary Fund. von Hagen, J. and Wolff, G.B. (2004), ‘What do deficits tell us about debt? Empirical evidence on creative accounting with fiscal rules in the EU’, Deutsche Bundesbank Discussion Paper Series 1: Studies of the Economic Research Centre No. 38/2004. Wakeman-Linn, J., Mathieu, P. and Van Selm, B. (eds) (2003), ‘Oil funds in transition economies: Azerbaijan and Kazakhstan’, in J.M. Davis, R. Ossowski and A. Fedelino (eds), Fiscal Policy Formulation and Implementation in Oil-Producing Countries, Washington, DC: International Monetary Fund. Wantchekon, L. (2002), ‘Why do resource dependent countries have authoritarian governments?’, Journal of African Finance and Economic Development 5(2), 57–77.

290  Handbook of sustainable politics and economics of natural resources Wehner, J. and de Renzio, P. (2013), ‘Citizens, legislators, and executive disclosure: the political determinants of fiscal transparency’, World Development, 41(C), 96–108. Weitzman, M.L. (1999), ‘Pricing the limits to growth from minerals depletion’, Quarterly Journal of Economics 114(2), 691–706. Weitzman, M.L. (2003), Income, Wealth, and the Maximum Principle, Cambridge, MA: Harvard University Press. Wiig, A. and Kolstad, I. (2010), ‘Multinational corporations and host country institutions: a case study of CSR activities in Angola’, International Business Review 19, 178–90. World Bank (1997), ‘Expanding the measure of wealth: indicators of environmentally sustainable development’, Environmentally Sustainable Development Studies and Monographs Series 17. World Bank (2006), Where is the Wealth of Nations? Measuring Capital for the 21st Century, Washington, DC: World Bank. Wright, G. and Czelusta, J. (2004), ‘Why economies slow: the myth of the resource curse’, Challenge 47, 6–38. Wright, G. and Czelusta, J. (2007), ‘Resource based growth: past and present’, in D. Lederman and W.F. Maloney (eds), Natural Resources: Neither Curse nor Destiny, Washington, DC/Palo Alto, CA: World Bank/Stanford University Press, pp. 183–212.

18. Legal indicators as tools to assess the effectiveness of international rules related to the sustainable management of natural resources Emmanuella Doussis and Ilaria Espa

1 INTRODUCTION In recent decades, international treaties directly or indirectly concerning the sustainable management of natural resources have proliferated extensively. These treaties set new standards and innovations in their topic fields, which range from more environmentally targeted domains comprising the international law of natural resources (e.g., forestry, wildlife, freshwater and ocean protection instruments) to areas that are at first glance peripheral to the development of natural resources and thus have direct implications for natural resource management and its economic, social and environmental impacts (e.g., trade and investment agreements). Despite the growing number of international legal instruments related to sustainable natural resource management, we still know very little of their actual contribution to sustainable development governance (Doussis, 2017). While a plethora of reports and academic studies highlight remarkable progress and improvement in sustainable development governance achieved by some countries, the quality of the environment has steadily declined and some problems, such as climate change, have become even worse. For instance, in 2019, global carbon dioxide emissions were much higher than in the early 1990s, when negotiations towards an international climate agreement began. As has been noted, ‘effectiveness has been a long-neglected issue’ (Maljean-Dubois, 2017, 1). For some authors it represents ‘the holy grail of modern international lawyers’ (Wälde, 1999, 164), a never-ending and unsatisfactory process. For others, it is a very complex phenomenon, ‘that is difficult, if not impossible, to comprehend and explain’ (Prieur, 2017). Although, environmental lawyers ‘are the species of lawyers most interested in empirical research on the effectiveness of legal and policy instruments’ (Faure, 2012, 294), relatively few published works evaluate the effectiveness of domestic environmental legal systems. It is true that effectiveness issues have only occasionally attracted the attention of international lawyers. In fact, the limited literature to date on the assessment of international law concerning sustainable development has focused mainly on conceptual concerns (Louka, 2006; Mehling, 2002; Seelarbokuks, 2014), specific case studies concerning difficulties in the implementation process (Brown Weiss and Jacobson, 2002; Martin, Boer and Slobodian, 2016; McGrath, 2010; Sand, 2016) or specific decisions of international courts and tribunals (Cordonier Segger and Weeramantry, 2017). Some studies offer useful insights on the real effects that sustainable development principles can have by imposing self-constraints on political and economic actors. However, these experiences come with several limitations. First, most of the existing studies focus on a few 291

292  Handbook of sustainable politics and economics of natural resources principles or specific aspects/case studies and do not allow for comparability across countries or legal instruments. The role of international law in sustainable management of natural resources has not yet been systematically investigated or measured and there is no common methodological framework to this end. Second, most are qualitative studies that describe different aspects of effectiveness without always clarifying the meaning of the term, and they may have multiple meanings, from compliance to the imperatives of a treaty to solve the problem it was designed to address. Much depends on the criteria used for the evaluations. In sum, existing literature provides little evidence of the true value of legal instruments as tools for international sustainable development governance and sustainability overall. For instance, little is known about whether sustainable development principles and rules can address governance inefficiency, alter behavior and practices, or influence the quality of institutions. Attempts to evaluate the effectiveness of international environmental and sustainable development systems and their performance towards achieving sustainability have mostly been undertaken by political scientists and analysts with a background in economics (Hovi, Sprinz and Underdal, 2003). However, these empirical studies (both qualitative and quantitative) do not capture all of the legal steps involved in the implementation process. It is not enough to mention that legal instruments exist. In the same way, it is not enough to argue that an international agreement related to sustainable development is good or bad, legitimate and so on; we need to assess what defines good, bad or legitimate. The same is true for the environment and/or sustainable development scorecards published regularly by states and international organizations, which report almost exclusively on scientific, economic and social data. A prominent example is the Sustainable Development Indicator Framework, adopted in 2017 by UN General Assembly Resolution 71/313 to review the progress of the Sustainable Development Goals (SDGs) (United Nations General Assembly, 2017). This framework consists of 231 indicators to monitor progress towards achieving the 17 SDGs and their 169 targets, many of which involve calculable or scientifically quantifiable benchmarks, while paying minor attention to international law agreements related to sustainable development. Indicators concerning the monitoring of progress of the SDGs with the most environmental linkages and with the highest demand for legal implementation (namely, SDGs 2, 3, 6, 7 and 11–15) refer only to instruments related to climate change and ocean protection. Even the most relevant SDG for legal issues (SDG 16), which concerns access to justice, governance and institutions, does not make any reference to specific indicators related to international environmental agreements and their implementation. Rather, it only mentions the rule of law and international human rights instruments. However, even when international law is taken into consideration in formal state-of-the-environment reports, such as the Organisation for Economic Co-operation and Development (OECD) Environmental Performance Reviews (OECD, various years), it is not the subject of in-depth evaluation. These reviews consider legal frameworks as essential components to address environmental protection and sustainability challenges. Nevertheless, it is not enough to simply tick the box concerning the ratification of an agreement and the existence of institutions to draw conclusions for the effectiveness of international legal instruments. Rather, it is necessary to go beyond the existence of legal instruments, principles and rules and explore if they actually work in practice. In this context, a significant question arises: what does effectiveness mean? As a corollary, it must be asked what makes international sustainable development law effective. And if it is not effective, or not significantly effective, what can make it more so? Finally, it is essential to

Legal indicators as tools to assess the effectiveness of international rules  293 ask whether international law has made a difference in sustainable development governance, including solving, or at least ameliorating, important problems. This chapter clarifies the meaning of effectiveness and the difficulties involved in assessing the effectiveness of international law related to sustainable development. It explains why it is important to integrate the true value of international law in assessing sustainable development governance and how this could eventually be achieved, while highlighting the methodological challenges and their limitations. Finally, it concludes with some general remarks on future research paths.

2

WHAT DOES EFFECTIVENESS MEAN?

According to the literature, three ‘meanings’ (Bodansky, 2011) or ‘levels’ (Maljean-Dubois, 2017) of the term effectiveness exist: ● legal effectiveness, which ‘focuses on the issue of compliance (that is, whether outcomes conform to what a legal rule requires)’ (Bodansky, 2011, 63), and hence is related more to the process of implementing a legal rule; ● behavioral effectiveness, which focuses on the role of international law in influencing, and even changing, actors’ behavior ‘in the “right” direction, that is, towards achieving the treaty’s objectives’ (Bodansky, 2011, 64); ● problem-solving effectiveness, which focuses on the ability of the legal rule to solve or mitigate the problem it was designed to address. Lawyers usually tend to concentrate on legal effectiveness. This aspect is rather easier to assess than behavioral or problem-solving effectiveness that require evidence of a causal connection between the rule and the outcome. Indeed, evaluating legal effectiveness requires ‘compar[ing] what a norm requires with what actually takes place’ (Bodansky, 2011, 64). For example, if a treaty sets forth obligations of conduct, it is legally effective to the degree that states respect this requirement. If the treaty sets forth obligations of result (for instance, the duty to reduce carbon dioxide emissions by a certain percentage), then it is legally effective if emissions decline by the required amount. However, compliance by itself is a poor indicator of a rule’s value (Sand, 2016). A treaty may be legally effective without solving or mitigating the problem it was designed to address or changing the behavior of actors involved. This is because it may not be well designed or it may provide low ambition provisions. Similarly, compliance may also be incidental and not related to the implementation of a specific commitment (Maljean-Dubois, 2017). Consequently, the true value of a legal rule cannot be fully assessed without considering behavioral or problem-solving effectiveness. Nevertheless, the task of evaluating these levels of effectiveness poses many challenges, as they require comparing what takes place with what would have occurred in the absence of the legal rule. This involves counterfactual situations that need expertise from other disciplines and interdisciplinary tools that can match legal aspects with political and socio-economic aspects, as well as environmental and scientific assessment. Lawyers are not so familiar with this sort of exercise and, thus, such tools are still missing. Therefore, the weight and usefulness of international legal instruments in sustainable development governance seems to be underestimated. So far, the effectiveness of these instruments has not been methodically investigated and measured because of the lack of specific

294  Handbook of sustainable politics and economics of natural resources legal evaluation tools. It thus remains an unexplored amount of data. It is evident that there is a methodological gap that needs to be addressed, and that international lawyers should participate in this process, as they are the best placed to identify advantages as well as difficulties inherent in all legal steps relating to the implementation of legal rules and principles, and to explore with, and even propose solutions to, policy makers. In other words, they may help to identify the ‘right’ tools in assessing the true value of a legal rule.

3

LEGAL INDICATORS AS OPERATIONAL TOOLS TO MEASURE EFFECTIVENESS

How can effectiveness be measured in this context? The outcome document of the Rio+20 Conference on Sustainable Development highlighted that indicators are ‘valuable in measuring and accelerating progress’ (United Nations General Assembly, 2012). While the importance of indicators for assessing sustainable development is widely recognized, their use in evaluating legal systems has not yet become systematic. The journey from law-making to effective implementation depends on, among other things, the availability of appropriate tools for evaluation. Legal indicators could be such an essential tool. 3.1

What Is a Legal Indicator?

A legal indicator is a tool, expressed through qualitative or quantitative language, for describing a particular phenomenon (such as the perception of corruption in a certain state or the level of compliance with human rights or the rule of law in another). Davis and Kingsbury define a legal indicator as ‘a named collection of rank-ordered data that purports to represent the past or projected performance of different units. The data are generated through a process that simplifies raw data about a complex social phenomenon. The data, in this simplified and processed form, are capable of being used to compare particular units of analysis (such as countries, institutions, or corporations), synchronically or over time, and to evaluate their performance by reference to one or more standards’ (Davis and Kingsbury, 2012, 73–4). In line with the above-mentioned definition, legal indicators measure ‘the performance of some component of one or more legal system along a particular dimension’ (Davis, 2014, 74). Such components may include principles, rules (i.e., treaties and domestic legislation), practices (i.e., licensing systems, reporting systems and the use of sanctions) and institutions (i.e., control bodies, administrative procedures and courts). For example, a legal indicator might focus on a specific sustainable development principle (that is, public participation), relevant international treaties and agreements to which a state is a party, the measures taken by states to implement this principle in the domestic context, including institutions and enforcement policies (i.e., regulations, administrative action, decision-making processes, penalties, control bodies and available remedies), as well as changes in the behavior of concerned entities, including government actors and others involved in governance (i.e., evidence of their actions) (Doussis, 2017).

Legal indicators as tools to assess the effectiveness of international rules  295 3.2

The Use of Legal Indicators to Assess Other Legal Systems

Legal indicators have already been used by international organizations as governance tools – in particular, to monitor the performance of international policies. The United Nations Office of the High Commissioner for Human Rights (OHCHR) has endorsed a list of quantitative and qualitative indicators to measure the progress of international human rights norms and principles (OHCHR, 2012). The World Bank has produced the Doing Business indicators and the Worldwide Governance Indicators to assess the economic burden of law and governance, respectively. Further, the UN Rule of Law Indicators were created by the Department of Peacekeeping Operations (UNDPKO) and the OHCHR to monitor changes in the performance of criminal justice institutions in conflict and post-conflict situations (UNDPKO and OHCHR, 2011). The idea of using legal indicators in assessing international law related to sustainable development is not new. Legal indicators, such as the European Union’s climate change and energy indicators (European Environment Agency [EEA], 2018) and the Mediterranean Sea indicators (United Nations Environment Programme [UNEP], 2019), have been integrated to assess regional policies. At the universal level, a long-standing initiative is the National Legislation Project established by the Conference of the Parties to the Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES, 2010), which ranks the laws of state parties and may give rise to trade sanctions for inadequate domestic laws. These examples have revealed the multiple roles that indicators might play in assessing the performance of legal systems (Uruena, 2015). For instance, indicators may: ● Influence behavior and align expectations of state and non-state actors in the same way as formal international norms do. ● Embarrass poorly ranked states and force them to take action to achieve a better ranking (ibid.). ● Provide an alternative way for international organizations to communicate a lack of compliance, thus ‘naming and shaming’ states into compliance (ibid.). ● Provide an alternative monitoring mechanism, which allows international institutions to review the implementation of legal instruments, even if they lack the formal mandate or the institutional capacity to engage in formal adjudication (from this perspective indicators are part of the process of enforcing law). ● Influence the incorporation of international law rules into domestic systems and provide a tool for domestic courts to interpret and apply international law (ibid.). Human rights practice provides a useful example of this: the adoption by the Colombian Constitutional Court in 2011 of a set of guidelines for indicators of social and economic rights (endorsed earlier by the Inter-American Commission on Human Rights) (ibid.). In this way, international legal standards whose international binding status remains doubtful have been enforced domestically through the domestic deployment of indicators. ● Help state parties to international treaties to record precise and relevant information for the treaty bodies and help assess progress in implementing treaty obligations. ● Have broader impacts on global governance (ibid.), as they can create horizontal or vertical spaces of interaction and political debate, where all actors (state and non-state) can interact. Horizontal spaces may serve as lingua franca for interaction among different systems. Vertical spaces open new areas of engagement between international institutions

296  Handbook of sustainable politics and economics of natural resources and domestic political processes. This aspect is of particular importance for the sustainable development legal framework, which is highly fragmented. Indicators do, however, contain some limitations, Perhaps the most important being that they should be seen as tools to support qualitative assessments and should in no way be considered a substitute for them. 3.3

Methodological Challenges

There are numerous methodological challenges, as well as conceptual and empirical challenges, in constructing legal indicators to measure the effectiveness of international law related to sustainable development. What to measure, how to collect information and convert data into indicators, while at the same time avoiding the danger of misusing data, are only some initial concerns. A first challenge relates to creation of legal indicators that are meaningful for multiple multilateral environmental agreements (MEAs) dealing with natural resource governance. This is because these agreements have proliferated in number and also vary widely with respect to both the spatial attributes (i.e., nature and location) of the governed natural resources (global resources such as the climate vs regionally located resources like forests) and the regulatory approach that is intended to ensure the sustainable management of the regulated resource (Committee on the Role of International Law in Sustainable Natural Resources Management for Development International Law Association, 2020). Further, the two elements do not always go hand in hand, resulting in competing, or even conflicting, governance and regulatory systems for similar issues. For example, the Montreal Protocol on Substances that Deplete the Ozone Layer and the Paris Agreement on Climate Change espouse two different regulatory approaches – that is, quantified limitation targets on production and consumption of covered substances vs bottom-up nationally determined contributions (NDCs) – but the former resembles the Basel Convention approach, which governs transboundary movements of hazardous waste (Dupuy and Viñuales 2018). Because of this diversity of potential systems, a treaty-based approach is likely the best starting point, keeping in mind any potential for clustering agreements with a resource-based approach to be checked against regulatory approaches. A second challenge relates to the identification of the type of information that legal indicators could/should convey. This is inherently linked to another question: what definition of effectiveness could/should be captured through legal indicators? Here, one could think of two main approaches. The more ‘classical’ approach consists of identifying indicators for measuring the degree to which international environmental law (IEL) is ‘domesticated’. Under this approach, the focus should not be on the principles and rules per se, but rather on the consequences arising from the way they are implemented and enforced in practice. In other words, indicators should take into consideration all the legal steps involved in the implementation process: (1) integration of the rule in the domestic system (the legislative, executive/ administrative and judicial steps taken to implement international commitments); (2) measures taken by states to implement this principle in the domestic context, including institutions and enforcement policies (i.e., regulations, administrative action, decision-making processes, penalties, control bodies and available remedies); (3) administrative and judicial control (i.e., whether courts apply international law directly or use it to interpret national law); and (4) the

Legal indicators as tools to assess the effectiveness of international rules  297 eventual changes in the behavior of concerned entities, serving as evidence of state actions (Prieur, 2017). To the extent that this process requires an extensive analysis of the domestic legal frameworks of all the states that are parties to an MEA, this would be quite burdensome. What is more, such an approach would only convey information on legal effectiveness and would ignore, to a large extent, information on the behavioral and problem-solving connotations of effectiveness, which are ultimately the goal of natural resource governance. A more pragmatic approach could consist of replicating the commitment–effort–result framework that is already common for other legal indicators so as to conceive structural– process–outcome indicators (see Box 18.1) for MEAs that are focused on natural resource governance (OHCHR, 2012). This could cover all three connotations of effectiveness: (1) legal effectiveness could be checked against structural indicators aimed at assessing whether domestic systems accommodate for sufficient incorporation and enforcement of international legal obligations; (2) behavioral effectiveness could be addressed by process indicators aimed at evaluating the adequacy of policy responses towards the MEA goal; and (3) problem-solving effectiveness could be evaluated in light of outcome indicators informing all stakeholders of how the overall international system is solving the problem regulated through the MEA. Within such a framework, structural indicators would be the closest alternative to ‘classical’ legal indicators for the purposes of measuring legal effectiveness, with one fundamental difference: they could be formulated without necessarily inquiring into the specifics of domestic legal frameworks in a comprehensive way. These structural indicators could in fact just focus on aspects of domestic implementation that could be directly inferred by examining whether the international legal obligations directly descending from MEAs are being fulfilled by states. As a concrete example, using the Paris Agreement, under the first scenario, classical legal indicators would require a fully-fledged analysis of the legislative, administrative and judicial developments occurring in each of the state parties. Under the second scenario, one may focus on one or two measures that synthesize the extent to which state parties are in compliance with obligations directly arising out of the Paris Agreement, which would be already indicative in themselves of whether states are actually aligning their domestic legal frameworks. Corresponding process and outcome indicators would complement the picture by measuring the extent to which approximation of the adequacy of domestic responses, as captured by structural indicators, allows state parties to meet the goal/s of the Agreement over time.

BOX 18.1 EXAMPLES OF THE TYPE OF INFORMATION THAT COULD BE INCLUDED IN PARIS AGREEMENT-SPECIFIC LEGAL INDICATORS • Structural indicators: • proportion of ratifying state parties submitting their NDCs in the requisite timeframe; • proportion of ratifying state parties submitting revised NDCs on time. • Process indicators: • proportion of state parties on track to meet the targets announced in their NDCs and revised NDCs; • proportion of state parties submitting a longer-term strategy to the United Nations Framework Convention on Climate Change;

298  Handbook of sustainable politics and economics of natural resources • proportion of state parties on track to contribute to global emissions peaking by 2030 and proportion of global greenhouse gas (GHG) emissions covered; • number of state parties committing to carbon neutrality by 2050 in their NDCs and proportion of global GHG emissions covered. • Outcome indicators: • cumulative trajectory of global GHG emissions (peaking, carbon neutrality); • cumulative increase in global temperature trajectory. Such a framework would have the advantage of translating already available (scientifically rooted and quantitatively determined) data into legally relevant information that could be presented in the form of indicators. As has been established, the availability of relevant and reliable data has in fact been a major problem for the formulation of legal indicators, and especially so for IEL treaties. What is needed here is specific information on the way that IEL is actually implemented. While there will always be some constraints in finding such data, diverse information from different types of sources could be combined to develop indicators. For example, most of the international environmental treaties rely on self-reporting (Dupuy and Viñuales, 2018). Parties periodically report on measures, regulations and policies adopted to implement their commitments. This practice raises some issues, such as the reliability of the data, or even the failure to report so as to avoid being subject to ‘shaming’, for failing to comply with international commitments or simply because parties have limited capacity to collect data. However, over recent years, many treaty body secretariats have developed monitoring practices that gather data concerning implementation. Moreover, independent sources of authoritative information have proliferated (Committee on the Role of International Law in Sustainable Natural Resources Management for Development International Law Association, 2020). These sources could facilitate the compilation of legally relevant information that could be conveyed through structural–process–outcome indicators. A last challenge is to identify well-articulated indicators that are meaningful for multiple agreements or for clusters of agreements, either on a natural resource basis (e.g., agreements on the protection of watercourses) and/or a treaty basis (e.g., the Paris Agreement). The importance of each indicator should then be debated, as well as its relevance to environmental and sustainable development governance outcomes. The designing of such indicators – from conceptualization, to data collection, to testing and implementation – is an interdisciplinary task and therefore requires the involvement of other disciplines (economists and statisticians) that should work together with international lawyers. This process could help refine indicators that otherwise may focus on relatively narrowly or too broadly defined components of the legal system being assessed. In fact, one important step of the process would be to ensure that, once designed, the indicator actually reflects reality.

4

FUTURE RESEARCH PATHS

There are a number of potential, and often complementary, future research paths relating to the development and implementation of legal indicators for the sustainable use of natural resources. One such path is the identification of a suitable structural–process–outcome framework through which to assess and promote the implementation of legal instruments that are either directly or indirectly related to sustainable management of natural resources.

Legal indicators as tools to assess the effectiveness of international rules  299 Another path is to identify what legally relevant data and other information that is currently or potentially available could be translated into a list of illustrative legal indicators and initiate a validation process (involving discussion with experts from treaty bodies, international organizations and civil society and discussion with national stakeholders responsible for reporting) to generate feedback.

ACKNOWLEDGMENTS The authors are grateful to Cairo Robb, Arie Trouwborst and Alexandra Harrington for the comments they provided during the elaboration of the first draft of this chapter.

REFERENCES Bodansky, D. (2011). Implementation of international environmental law. Japanese Yearbook of International Law 54, 62–96. Brown Weiss, E. and Jacobson, H.K. (eds) (2002). Engaging Countries: Strengthening Compliance with International Environmental Accords. Cambridge MA: MIT Press. Committee on the Role of International Law in Sustainable Natural Resources Management for Development International Law Association, ‘The role of international law in sustainable natural resources management for development’ in International Law Association Final Report of the 79th Biennial Conference (Kyoto 2020). (International Law Association Kyoto 2020), Resolution No. 4/2020. Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES) (2010). National laws for implementation of the Convention. Resolution Conf. 8.4 (Rev. CoP15, 1992/2010). Cordonier Segger, M.-C. and Weeramantry, J.C.G. (eds) (2017). Sustainable Development Principles in the Decisions of International Court and Tribunals. Abingdon, UK: Routledge. Davis, K.E. (2014). Legal indicators: the power of quantitative measures of law. Annual Review of Law and Social Science 10, 37–52. Davis, K.E. and Kingsbury, B. (eds) (2012). Indicators as Interventions: Pitfalls and Prospects in Supporting Development Initiatives. New York: Rockefeller Foundation. Doussis, E. (2017). Does international law matter in sustainable development? Yearbook of International Environmental Law 28, 1–12. Dupuy, P.-M. and Viñuales, J.A. (2018). International Environmental Law. Cambridge, UK: Cambridge University Press. European Environment Agency (EEA) (2018). Environmental Indicator Report 2018. Accessed 5/11/2019 on https://​www​.eea​.europa​.eu//​publications/​environmental​-indicator​-report​-2018. Faure, M. (2012). The effectiveness of environmental law: what does the evidence tell us? William and Mary Environmental and Policy Review 36, 294–336. Hovi, J., Sprinz, D.F. and Underdal, A. (2003). The Oslo-Potsdam solution to measuring regime effectiveness: critique, response and the road ahead. Global Environmental Politics 2, 74–96. Louka, E. (2006). International Environmental Law: Fairness, Effectiveness, and World Order. Cambridge, UK: Cambridge University Press. Maljean-Dubois, S. (2017). The effectiveness of environmental law: a key topic. In S. Maljean-Dubois (ed.), Effectiveness of Environmental Law. Cambridge, UK: Intersentia, pp. 1–12. Martin, M., Boer, B. and Slobodian, L. (eds) (2016). Framework for Assessing and Improving Law for Sustainability. Gland, Switzerland: International Union for the Conservation of Nature. McGrath, C. (2010). Does Environmental Law Work? Saarbrücken: Lambert Academic Publishing. Mehling, M.A. (2002). Betwixt Scylla and Charybdis: the concept of effectiveness in international environmental law. Finnish Yearbook of International Law 13, 129–82.

300  Handbook of sustainable politics and economics of natural resources Organisation for Economic Co-operation and Development (OECD) (various years). OECD Environmental Performance Reviews. Accessed 5/11/2019 on https://​www​.oecd​-ilibrary​.org/​ environment/​oecd​-environmental​-performance​-reviews​_19900090. Prieur, M. (2017). Les Indicateurs Juridiques. Study for the Institut de la Francophone pour le Développement Durable (IFDD). Sand, P.H. (2016). The effectiveness of multilateral environmental agreements: theory and practice. Paper presented at the 13th Training Course on International Environmental Law-making and Diplomacy, Joensuu, Finland. Seelarbokuks, C.B. (2014). International environmental agreements (IEAs): an integrated perspective on the concept of effectiveness. International Journal of Environmental Protection and Policy 2, 76–95. United Nations Department of Peacekeeping Operations (UNDPKO) and United Nations Office of the High Commissioner for Human Rights (OHCHR) (2011). The UN Rule of Law Indicators, Implementation Guide and Project Tools. Accessed 5/11/2019 on https://​www​.un​.org/​ruleoflaw/​files/​ un​_rule​_of​_law​_indicators​.pdf. United Nations Environment Programme (UNEP) (2019). Mediterranean Sustainability Dashboard: updated list of indicators, proposals and recommendation. Accessed 5/11/2019 on https://​wedocs​ .unep​.org/​bitstream/​handle/​20​.500​.11822/​28195/​19wg469​_04​_eng​.pdf​?sequence​=​1andisAllowed​=​y. United Nations General Assembly (2012). The Future We Want. Resolution A/Res/66/288. Accessed https://​www​.un​.org/​en/​development/​desa/​population/​migration/​generalassembly/​docs/​ globalcompact/​A​_RES​_66​_288​.pdf. United Nations General Assembly (2017). Work of the Statistical Commission pertaining to the 2030 Agenda for Sustainable Development. Resolution A/RES/71/313. Accessed 1/9/2021 on http://​ggim​ .un​.org/​documents/​a​_res​_71​_313​.pdf. United Nations Office of the High Commissioner for Human Rights (OHCHR) (2012). Human Rights Indicators: A Guide to Measurement and Implementation. Accessed 5/11/2019 on https://​www​.ohchr​ .org/​Documents/​Publications/​Human​_rights​_indicators​_en​.pdf. Uruena, R. (2015). Indicators as political spaces: law, international organizations, and the quantitative challenges in global governance. International Organizations Law Review 12, 1–18. Wälde, T.W. (1999). Non-conventional views on ‘effectiveness’: the holy grail of modern international lawyers? The new paradigm? A chimera? Or a brave new world in the global economy? Austrian Review of International and Comparative Law 4, 164–203.

19. Resource conservation and environmental ethics: a theoretical framework supported by panel data Fabio Zagonari

1 INTRODUCTION Zagonari (2020a) showed that sustainability is an ethical issue. The literature has recently begun to emphasize the role of ethics in achieving environmental sustainability (e.g., Batavia, Bruskotter and Nelson, 2020; Lenzi, 2017; Menning, 2016; Spahn, 2018; Whiting and Konstantakos, 2019). Two main groups of environmental ethics can be identified: secular ethics (SEC) and religious ethics (REL) (Zagonari, 2019a). SEC focus on our responsibility to nature, responsibility to future generations, perceptions of the rights of humans and non-humans, and beliefs in inter- and intra-generational equity (Zagonari, 2019b). REL have a different focus in each religion. For example, Buddhism focuses on maintaining equilibrium, Christianity on love of neighbors, Hinduism on equal dignity of humans and non-humans, Islam on trusteeship and parsimony and Judaism on stewardship (ibid.). However, the observed failures of international agreements on climate change suggest that the unsustainability of global society is a practical problem (i.e., one related to actual practice rather than beliefs) (see Sustainable Development Report 2021 at www​.sdgindex​.org). In other words, it is not enough for an ethical principle or precept to be consistent and to be intended to move the world away from unsustainable practices: the principle or precept must also provide feasible (i.e., effective and practical) and reliable (i.e., unfailing and trustworthy) incentives to achieve sustainability through the application of consistent ethical concepts to achieve realistic equilibrium conditions. This can potentially be achieved using empirical models that predict the consequences of applying these ethical concepts and incentives. The empirical literature on the role of ethics in achieving environmental sustainability – based on actual behavior (instead of self-stated behavior, intentions, attitudes and concerns) – is still in its infancy. For example, studies based on REL ethics include Peifer, Khalsa and Ecklund (2016), Arli and Tjiptono (2017) and Yang and Huang (2018), while studies based on SEC ethics include Yuan et al. (2017), Sorkun (2018) and Khan, Ahmed and Najmi (2019). There is a limited literature based on multiple-country analyses instead of single-culture analyses, such as studies of Christian or Muslim communities, and a limited literature based on the overall population instead of sub-populations, such as students or rural households. For example, Zagonari (2020a) found that the world’s five main majority religions can have beneficial impacts on the feasibility and reliability of efforts to achieve global sustainability. Note that in that study, global sustainability was measured in terms of the ecological footprint. Zagonari (2019a) found that three main SEC principles (intra-generational equity, responsibility to nature and responsibility to future generations) can have beneficial impacts on the feasibility and reliability of global sustainability. Note that in that study, SEC principles were 301

302  Handbook of sustainable politics and economics of natural resources measured in terms of (in)equality and based on percentages of gross domestic product (GDP) spent on environmental conservation and green research and development (R&D). Zagonari (2021) found that the five main majority religions and three main SEC principles can have beneficial impacts on the feasibility and reliability of local sustainability. Note that in that study, local sustainability was measured by household waste management, purchases of organic food and household energy conservation. However, the focus of this book is on natural resources. This chapter seeks to obtain empirical insights into which environmental ethics support resource conservation, based on a theoretical framework that depicts REL and SEC for environmental sustainability. Towards this end, the main REL and SEC for environmental sustainability are summarized in Section 2. Section 3 will present the dataset with the focus on water conservation (WC) as an example of a short-run decision for a resource flow and biodiversity conservation as an example of a long-run decision for a resource stock. The statistical results from random- and between-effects regressions, based on an original panel dataset that comprised 23 religions and three SEC groups in 217 countries, are presented in Section 4. Section 5 discusses the policy implications. Section 6 concludes.

2

THE THEORETICAL FRAMEWORK FOR SUSTAINABILITY ETHICS

The purpose of this chapter is to provide a theoretical framework, sustained by empirical evidence, to support the use of REL or SEC in fostering resource conservation for environmental sustainability. Note that the focus on resource conservation suggests reference to environmental sustainability rather than sustainable development, where the latter includes the former, although to different degrees, according to which sustainability paradigm is adopted. Sustainability ethics requires a focus on ethics relating to nature in general and to non-humans, as well as ethics relating to future generations. Table 19.1 provides a brief account of ethics relating to nature, where each cell tries to answer the following question: could I meet the duty to non-humans specified in this column by implementing the ethical rule specified in this row? Table 19.1 can be combined with Table 19.2 for a summary of environmental ethics for global and local sustainability. See Zagonari (2020b) for a recent review of religious environmental ethics and Zagonari (2019b) for a recent review of secular environmental ethics. As illustrated in the table, responsibility to nature and NH can be direct (intrinsic views in Keitsch, 2018) (column I: teleological speciesism to zoocentrism based on consequences rather than actions if NH are believed to have desires and hopes; column II: deontological biocentrism to ecocentrism based on actions rather than consequences if nature has an intrinsic value) (Coyne, 2017; Diehm, 2014). Relational values (i.e., pertaining to non-substitutable relationships between people and nature), within the Life Framework by O’Connor and Kenter, 2019, are associated with living in and as, while intrinsic and instrumental values are associated with living from and with, respectively. Responsibility to nature and NH can be anthropocentric and indirect (extrinsic views in Keitsch, 2018) (column III: teleological based on utilitarian or eudemonic approaches; column IV: deontological based on freedom or virtue) (Gansmo Jakobsen, 2017; Taylor, 1986). Intrinsic value of nature or NH could come from God (but then God will cope with nature) or from the biotic community (i.e., the interdependence of humans and nature, and mutual causality) up to biospherical egalitarianism (i.e., all organisms

 

 

 

 

HB

HB and NH below

HB and NH

Resources (HB and

 

 

 

(I) Max welfare

(II)

(III)

(IV) Min inequality

 

 

 

 

 

Biomimetic

Equilibrium

Stewardship

Trusteeship

Parsimony  

 

 

 

 

Nozick (1974) (Sci)

X

X

(Zoo)

Dawkins (1988)

Singer (1975) (Sci)

Cohen (1986) (Spe),

X

NH desires or hopes

Teleo

(I)

Direct

Duty to NH

 

 

 

(Bio)

Buddhism, Hinduism

Benyus (1997) (Eco)

Rolston (1979) (Spe)

Callicott (1988) (Eco),

–

–

Leopold (1949) (Eco)

X

X

NH intrinsic value

Deonto

(II)

injuries

 

 

 

 

 

Norton (1991) (Eco)

X

X

O

et al. (2017)

Islam

Islam

Judaism

 

 

O

O

SS

O

 

 

 

 

 

Regan (1983) (Sci)

X

X

Naess (1973) (Bio)

O

X

virtue

negative

 

 

 

 

 

Webster (2003) (Zoo)

–

Wilson (2016) (Eco)

Palmer (2010) (Sci)

X

X

freedom vs no obstacles

NH property or

NH positive vs CG

negative NH welfare vs no

O

Actions (VI)

NH positive vs CG

(V)

Interests

Rights of NH

FG freedom vs CG

Deonto

(IV)

Psychology, Arias-Arévalo O

(1962)

WS, AG, DG, Carson

Utilitarian vs eudemonic

Teleo

(III)

Indirect

Note: Duties and rights (columns) can refer to individual (anthropocentric, scientism [Sci], zoocentric [Zoo], biocentric [Bio]) or social entities (speciesism, ecocentric [Eco]). Indirect duties are anthropocentric; teleological duties refer to consequences; deontological duties refer to actions; Zoo includes both wild and domestic animals; Bio is based on evolutionary theory. Ethical principles and approaches (rows) can refer to single individuals (bold type) or social groups (regular type); italics is used to characterize items in columns, by linking some items to some options in column subtitles. The utilitarian or hedonic approach focuses on welfare or pleasure; the eudemonic approach focuses on prosperity and flourishing, based on wisdom or virtue. Shaded columns might overlap with ethics relating to future generations (FG), as summarized in Table 19.2. CG = current generation; FG = future generation; HB = human beings; WS = weak sustainability; AG = a-growth; DG = de-growth; SS = strong sustainability; X = logically impossible; O = practically unfeasible; – = practically unreliable.

Actions

Outcomes

(V)

(VI)

NH)

Reasons

 

Ethics relating to nature in general and non-humans (NH) in particular

 

Table 19.1

Resource conservation and environmental ethics  303

304  Handbook of sustainable politics and economics of natural resources have the same rights to live and flourish). Rights of nature or NH enforce direct duties to nature or NH (column V: teleological protection of interests, by introducing positive rights of NH or negative rights of CG; column VI: deontological protection of actions, by introducing positive rights of NH or negative rights of CG). NH have no rights (i.e., no columns V and VI), since a formal justice with egalitarian perspectives (i.e., the same respect to each NH individual) and non-perfectionist perspectives (i.e., there is not a better NH individual deserving a higher level of moral regard) should be applied not only to animals characterized by consciousness, intentionality and sentience as subjects-of-a-life, but also to all organisms, with HB having a duty to help NH victims of injustice and never to harm NH individuals, and NH rights overriding HB benefits. Maximization of welfare (Rows I–III) and minimization of outcome inequality (Row VI) refer to humans and NH as individual entities (Sci, Zoo). Minimization of resource inequality (Row IV) refers to humans and NH as social entities (Eco), while minimization of action inequality (Row V) refers to humans and NH as individual entities (Sci, Zoo). Individual ethical rules come from religions (e.g., respect, compassion, not harming, non-violence, not stealing, non-possession) and biology (e.g., nature recycles everything, runs on sunlight, uses only the energy it needs). Descartes is not mentioned, since NH are things to be used. Kant is not included, since only NH characterized by moral agency (i.e., an autonomous agent with the ability to control decisions through free will) should not be treated as a means to an end. WS resembles Judaism; AG is close to Islam; DG evokes the approach in Christianity; and SS resembles the precepts of Hinduism or Buddhism (Zagonari, 2020b). People born as a result of CG actions and policies would not have been born at all in the absence of those policies, so they are not harmed by those actions or policies (contingency of FG upon decisions of CG: Parfit, 1984) (i.e., no Table 19.2). All moments are actual (time in intergenerational relations should be regarded as cosmic, rather than simply historical or psychological: Griffith, 2017) (i.e., no future). All pains are actual (non-identity: Perret, 2003) (i.e., no generations). The date and place of one’s birth is a matter of chance (but then I am not responsible for others’ misfortune) or chosen by God (but then God will cope with FG). Intrinsic value of FG could come from God or from reciprocity (but then efforts towards human continuity might conflict with efforts to reduce human pain) (Jonas, 1979). FG is an abstraction, since there is a continuous overlapping of the next generations (i.e., columns III and IV only). FG cannot have rights or even claims in the present (i.e., no columns V or VI), since they do not exist (non-existence: Maklin, 1981); but compare this with the concessional view (Elliot, 1989) (i.e., rights can exist presently without a holder because they correlate with duties). FG cannot have a right to resources that do not exist at the time of their existence (i.e., no column V), because such a right cannot be satisfied (no satisfaction: De George, 1981); but compare this with the constitutive view (Sterba, 1980) (i.e., a present action that may be a cause for a legitimate complaint represents a future right). Subjects of rights could be social roles or status functions rather than actual persons (e.g., human collectives or human beings). Within comparative standards, apart from the egalitarian standard represented by the eight philosophers (column I) and the commutative standard represented by SS (column II), one could mention an aggregative standard based on total or average basket maximization in a transgenerational community (the most disadvantaged generations make the greatest sacrifices, so justice equates to effectiveness), while within non-comparative standards one could quote the sufficientarian standard (enough resources to pursue the aims and aspirations people affirm) (Frankfurt, 1987) and the communitarian standard (preservation of the cultural identity of communities) (Thompson, 2009). The correct application of a discount factor to

Resources (CG and FG)

Actions (opportunities or

capabilities)

(III) Min inequality

 

 

 

Sher (1979)

Barry (1977),

Dworkin (1981)

Rawls (1971),

Parfit (1984)

Harsanyi (1977),

WS, AG, DG

X

eudemonic

Utilitarian vs

Teleo

(I) Teleo

(III)

Islam

Judaism

O

–

SS

O

X

X

value

 

 

Norton (1991) (Eco)

–

–

X

(2017)

Biology, Thompson

X

eudemonic

Reciprocity vs intrinsic Utilitarian vs

Deonto

(II)

Indirect NEXT

Interests

 

 

O

–

Kant, Aristotle

O

X

X

virtue

Actions (VI)

negative

 

 

O

–

Nozick (1974)

Lomasky (1987),

–

BPP, PPP, ESP

X

damages

 

 

O

–

(2002)

UDHR (1948), DRD

PP, PR

X

X

obstacles

freedom vs no

FG property or

negative

FG Positive vs CG FG Positive vs CG

(V)

FG freedom vs CG FG welfare vs no

Deonto

(IV)

Rights of FG

Note: Ethical principles and approaches can refer to single individuals (bold type) or social groups (regular type); italics used to characterize items in columns, by linking some items to some options in column subtitles. The utilitarian or hedonic approach focuses on welfare or pleasure; the eudemonic approach focuses on prosperity and flourishing based on wisdom or virtue. Shaded rows might overlap with ethics about NH, as summarized in Table 19.1. CG = current generation; FG = future generation; HB = human beings; WS = weak sustainability; AG = a-growth; DG = de-growth; SS = strong sustainability; X = logically impossible; O = practically unfeasible; – = practically unreliable. UDHR = Universal Declaration of Human Rights; DRD = Declaration of Rights to Development; BPP = beneficiary pays; PPP = polluter pays; ESP = equal sacrifice; PP = precautionary; RP = reversibility principles.

 

CG and FG

(II)

 

CG and FG below

 

Stewardship

CG

(I) Max welfare

Trusteeship

Sen (1999)

 

 

Outcomes

 

 

 

Arneson (1989),

 

 

Duty to FG

 

Direct ALL

Reasons

 

Ethics relating to future generations (FG)

Ethical Rules

Table 19.2

Resource conservation and environmental ethics  305

306  Handbook of sustainable politics and economics of natural resources market evaluation of FG welfare, as a surplus within a welfare maximization framework (Row II) means attaching a smaller value to it (i.e., Hardin, 1974: social justice is more important than intergenerational equity in lifeboat ethics). The incorrect application of a discount factor to resources could lead to a debt towards the environment and towards FG if it is inconsistent with natural dynamics (i.e., Azar and Holmberg, 1995: social values of ecosystems are underestimated by marginal market evaluations). The precautionary and reversibility principles (Row III) assume CG risk aversion and amount to MaxMin applied to FG benefits arising from current (technological) risk. Individual ethical rules about the next generation come from religions (e.g., the Golden Rule, love, respect, honor and cherish attitudes) and philosophy (e.g., sensitivity and humility; rationality, consistency and universality). WS resembles Judaism; AG is close to Islam; DG evokes the approach in Christianity; and SS resembles the precepts of Hinduism or Buddhism (Zagonari, 2020b). Note that Table 19.1 is based on the assumption that the measure of environmental sustainability cannot be provided by human beings, although alternative natural indicators can be applied (i.e., natural measures such as ecosystem resilience and ecological footprint cannot be replaced by human measures, such as equal capabilities and genuine investments, in case the former measures come into conflict with the latter measures) (Dicks, 2017). Table 19.2 provides a brief account of ethics about future generations, where each cell tries to answer the following question: could I meet the duty to future generations specified in this column by implementing the ethical rule specified in this row? Note that beauty ethics (i.e., an aesthetic or sublimity judgment producing an outflowing of moral forces) is disregarded as space (culture) and time (history) dependent (Jaffe, 2015), while virtue ethics (i.e., what a virtuous – just, moderate, compassionate, truthful, hopeful – person, with an overall benevolent disposition, would do) is disregarded as context dependent (Abbate, 2014). Moreover, Vinnari and Vinnari (2021), by focusing on farmed and wild animals, present utilitarianism as the main consequentialist ethical theory, but they distinguish egalitarianism from the main deontologist ethical theory, since they do not jointly consider both humans and non-humans. Finally, ethical pragmatism (i.e., the focus on what to do, irrespective of theoretical foundations) is disregarded as inadequate whenever principles come into conflict (Lowe, 2019), while ethical psychologism (i.e., emotional responses to nature) is disregarded since it is based on subjective relational values (Kasperbauer, 2015). In summary, both religious precepts and secular principles can support resource conservation, by stressing either respect for nature and non-human beings or reciprocity for future generations. Note that the former ethics relating to nature in general and to non-humans in particular are likely to prevail if the focus is on flows of resources in the short-run (e.g., WC), while the latter ethics about future generations are likely to prevail if the focus is on stocks of resources in the long run (e.g., biodiversity conservation).

3

THE PANEL DATA

This section focuses on water and biodiversity conservation, based on empirically observed values at a national level to depict the influences of environmental ethics from the theoretical perspective defined in the previous section. To do so, REL are linked to the characteristics of majority and minority religions (Zagonari, 2020a). Also considered are SEC, in terms of reciprocity and concerns for current and future environments (Zagonari, 2019a). Here, the world’s

Resource conservation and environmental ethics  307 majority and minority religions are defined as religions that are based on one or more canonical texts shared by all sects of that religion and which function as the majority religion (i.e., more than 50 percent of the citizens) in at least one country and in no countries, respectively. In particular, the determinants of local environmental behaviors (e.g., waste recycling, purchases of organic food, energy conservation) suggest a need for the following data at a national level: income, education, concern for the environment, age and occupation (Zagonari, 2021). Note that the use of data at a country level rather than at a household level can avoid the gap between belief and action that results from a reliance on self-reported values and behaviors; it also elicits persistent rather than situational influences on behavior and avoids the gap between reality and simulation that results from contexts that differ from daily life (Zagonari, 2020a). Moreover, the use of panel data allows us to test for endogeneity issues (i.e., the direction of influences can be predicted) and spurious correlations (i.e., historical, geopolitical or geographical factors can be eliminated). Finally, the use of a ‘representative individual’ at a country level can be supported theoretically (Zagonari, 2019b). Data from the Food and Agriculture Organization (FAO, 2020) and Protected Planet (2020) were used for the dependent variables (i.e., the levels and dynamics of water consumption per capita in cubic meters and of protected land and sea in percentage of territorial area) relating to six years (1990, 1995, 2000, 2005, 2010, 2015). For the independent variables, REL at a national and individual level were based on the majority religions (i.e., a dummy variable set to 1 if a religion was followed by more than 50 percent of the citizens) and minority religion (i.e., the percentage of the citizens following a specified religion if a religion was followed by less than 50 percent of the citizens). For both majority and minority religions, the World Religion Database (2020) is used. SEC are represented using the Gini coefficient as a measure of trust and reciprocity in terms of income inequality (ine, hereafter) (Barone and Mocetti, 2016). The proportions of GDP spent on environmental protection (cur, hereafter) and environmental R&D (fut, hereafter) depict the concern for current and future environments, respectively, in terms of the present generation’s willingness to pay. Indeed, since data were unavailable for most countries on the proportions of GDP accounted for by private and public debt, which can be used to represent levels of concern for future generations, it is preferred to omit this variable and focus on levels of concern for the future environment. Note that no distinction is made between developed and developing countries (i.e., Organisation for Economic Co-operation and Development [OECD] and non-OECD countries), since the focus remains on environmental ethics. However, it is tested for possible interactions between pro-environmental behaviors and economic or social development by using income (inc), education (edu), unemployment (une) and the proportions of citizens older than 65 years (old) as independent variables. Moreover, SEC is measured at a national level ex post (i.e., as outcomes), but REL is measured ex ante with respect to behavior. This was based on the assumption that in a democratic country where the majority of the population is unsatisfied with a given situation (e.g., environmental protection, social inequality, environmental R&D), new political parties with a different platform will be elected to achieve the desired situation. Finally, WC (i.e., the percentage reduction in water consumption per capita in five years) is an individual decision, based on individual feelings and social pressures, while biodiversity conservation (i.e., increase in protected areas in five years) is a political decision based on social sensitivity and political institutions. In summary, a panel dataset for 217 countries (i.e., the main nations in the World Development Indicators database) is used, where the dependent variables for water and biodi-

308  Handbook of sustainable politics and economics of natural resources versity conservation represent changes in percentages over a five-year period, and coefficients of independent variables for REL and SEC measure their impacts on changes in water and biodiversity conservation. Note that using changes in percentages eliminates the potential consequences of geo-political differences between countries.

4 RESULTS This section, provides some insights into the impacts of REL and SEC on water and biodiversity conservation (BC). With regard to religious precepts, applying the environmental ethics summarized in Section 2 to data on water consumption and protected areas discussed in Section 3 suggests the following hypotheses: chr ~ mus > bud > hin > jew for WC jew > mus > chr > hin ~ bud for BC bud for WC > bud for BC, chr for WC > chr for BC, hin for WC > hin for BC, jew for WC mus for BC Indeed, WC is likely to be affected by social pressures from religious communities (e.g., chr > mus) and individual feelings from religious precepts (e.g., mus > chr), for instance frugality in Christianity and parsimony in Islam. Moreover, BC is likely to depend on religious precepts such as stewardship (e.g., jew) and trusteeship (e.g., mus). Finally, religions based on maintaining equilibrium are likely to stress WC in the short run (e.g., bud > hin) to a greater extent than BC in the long run (e.g., bud ~ hin). Examples might include the Hindu respect for animals derived from animals having been human in a previous life or humans becoming animals in a subsequent life, and the Buddhist respect for animals based on the belief that animal suffering is equivalent to human suffering. Regarding secular principles, applying the environmental ethics summarized in Section 2 to data on water consumption and protected areas discussed in Section 3 suggests the following hypotheses: cur ~ ine > fut for WC fut ~ ine > cur for BC cur for WC > cur for BC, fut for BC > fur for WC, ine for WC > ine for BC Indeed, WC is likely to depend on concern for the current environment as individual feelings and on reciprocity as social pressure, while BC is likely to depend on concern for the future environment as individual feelings and on reciprocity as social pressure. Table 19.3 provides the random-effect regressions for WC as an overall better fit than between-effect regressions, while Table 19.4 represents the between-effect regressions for BC as an overall better fit than random-effect regressions. This confirms that WC is an individual decision, while BC is a political decision. Regarding religious precepts, all religions and two out of five religions have the expected negative sign for WC and the expected positive sign for BC, respectively, where the estimation results can be summarized as follows (i.e., rankings are based on coefficient sign first, on significance level second and on coefficient size third):

Resource conservation and environmental ethics  309 Table 19.3

Determinants of water consumption dynamics (wcd) under five religions’ majority, based on a random-effect regression

wcd

Coef.

Std. Err.

z

P>z

inct

–0.119

0.093

–1.27

0.203

–0.302

0.064

edut

0.147

0.069

2.14

0.032

0.012

0.283

budmaj

–6.866

8.221

–0.84

0.404

–22.981

9.247

chrmaj

–8.359

4.740

–1.76

0.078

–17.651

0.932

hinmaj

–5.269

14.576

–0.36

0.718

–33.839

23.299

jewmaj

–13.716

21.556

–0.64

0.525

–55.965

28.533

musmaj

–3.262

5.632

–0.58

0.562

–14.301

7.776

ine

0.388

0.244

1.59

0.113

–0.091

0.867

cur

–1.940

2.252

–0.86

0.389

–6.355

2.473

fut

–0.583

2.405

–0.24

0.808

–5.297

4.131

0.046

0.110

0.42

0.676

–0.170

0.2625

–0.137

0.220

–0.62

0.533

–0.570

0.295

–14.113

12.237

–1.15

0.249

–38.098

9.871

unet oldt _cons

[95% Conf. Interval]

Note: wcd = ΔWCt; inct = Incomet; edut = Educationt; budmaj = Buddhists; chrmaj = Christians; hinmaj = Hindus; jewmaj = Jews; musmaj = Muslims; ine = Inequity; cur = concern for the current environment; fut = concern for the future environment; unet = Unemployedt; oldt = Elderly; cons = constant. Number of observations = 1085, number of countries = 217. Overall fit goodness (P > χ2) = 0.372.

chr > bud > jew > mus > hin for WC jew > chr > mus > hin > bud for BC Apart from bud for WC (note that Buddhism recommends individual and social punishment as a consequence of actions detrimental to nature preservation), these results are consistent with that hypothesis. The high ranking of chr (i.e., a significant 8 percent reduction in water consumption every five years in countries where Christians make up 50 percent or more of the population) could be accounted for by the new attitude to nature observed in the Catholic Church (the most popular of Christian religions): see, for example, Pope John Paul II in Redemptor mominis (1979), Pope Benedict XVI in Caritas in veritate (2009) and Pope Francis in Laudato si’ (2015). As for SEC, all principles and two out of three principles have the expected negative sign for WC and the expected positive sign for BC, respectively, where the estimation results can be summarized as follows (i.e., rankings are based on coefficient sign first, on significance level second and on coefficient size third): ine > cur > fut for WC ine > cur > fut for BC Apart from fut for BC (note that the concern for the future environment translated into technological innovation might not be turned into biodiversity conservation), these results are consistent with those hypotheses. Note that the high ranking of ine (i.e., a 10 percent increase in equality reduces significantly at 90 percent water consumption by 3.8 percent every five years) supports the considerable importance of social pressure in pro-environmental behaviors. In summary, REL show a greater beneficial impact on WC than on BC. Note that the five main religions represent the environmental ethics that could affect water and biodiversity conservation. Indeed, regressions with more detailed religious traditions produce less signifi-

310  Handbook of sustainable politics and economics of natural resources Table 19.4

Determinants of protected area dynamics (pad) under five religions’ majority, based on a between-effect regression

pad

Coef.

Std. Err.

t

P>t

inct

0.164

0.627

0.26

0.794

–1.072

edut

0.168

0.516

0.33

0.745

–0.849

1.186

–28.433

48.404

–0.59

0.558

–123.871

67.004

chrmaj

3.632

28.033

0.13

0.897

–51.64

58.905

hinmaj

–13.528

85.856

–0.16

0.875

–182.807

155.750

jewmaj

36.449

127.186

0.29

0.775

–214.319

287.218

musmaj

–9.471

33.451

–0.28

0.777

–75.426

56.484

ine

–1.527

1.473

–1.04

0.301

–4.433

1.378

cur

10.870

13.319

0.82

0.415

–15.391

37.132

fut

budmaj

[95% Conf. Interval] 1.401

–19.730

14.506

–1.36

0.175

–48.331

8.871

unet

–0.483

0.712

–0.68

0.498

–1.887

0.921

oldt

3.025

1.396

2.17

0.031

0.272

5.778

44.175

76.453

0.58

0.564

–106.564

194.915

_cons

Note: pad = ΔPAt; inct = Incomet; edut = Educationt; budmaj = Buddhists; chrmaj = Christians; hinmaj = Hindus; jewmaj = Jews; musmaj = Muslims; ine = Inequity; cur = concern for the current environment; fut = concern for the future environment; unet = Unemployedt; oldt = Elderly; cons = constant. Number of observations = 1085, number of years = five (1995, 2000, 2005, 2010, 2015), number of countries = 217. Overall fit goodness (P > χ2) = 0.047.

cant estimations (see the Appendix). Moreover, as expected, the unemployment level reduces WC and BC. Finally, SEC show a greater beneficial impact on BC than on WC. Note that the percentage of elderly (old) seems to better depict the concern for future environment than the percentage of green R&D on GDP (fut) in BC.

5 DISCUSSION This study is the first attempt to compare REL and SEC as feasible and reliable policies to achieve resource conservation in the short and long run, by combining theoretical discussion and statistical results, where individual and social determinants of pro-environmental behaviors are taken into account. Thus, it is not possible to compare the results with previous results and look for confirmation or contradiction of these results in previous research. The main weaknesses of this study are the small number of SEC (i.e., three in all contexts). However, additional national data (e.g., percentages of GDP accounted for by public and private debt to represent concern for future generations) are not consistent at a global level. The main strength of this study is twofold. First, it assumed a representative individual at a country level to use data on actual pro-environmental behaviors for up to 23 religions. Indeed, to achieve the same level of detail, it would have been necessary to perform at least 23 sufficiently large surveys in 23 different countries characterized by different religious traditions. Second, actual pro-environmental behaviors for resource conservation are analyzed in the short run (i.e., WC) and in the long run (i.e., BC). Note that Zagonari (2021) showed that other pro-environmental behaviors, such as energy conservation, do not depend on REL and SEC. The main results achieved in this chapter can be summarized as follows: REL is more likely to affect individual decisions on water conservation in the short run, while SEC is more likely

Resource conservation and environmental ethics  311 to affect political decisions on biodiversity conservation in the long run. In terms of policy suggestions, this implies that SEC should be fostered by environmental education and information campaigns for the whole society to increase resource conservation in the long-run (think of public perceptions of the status of ecosystems), while REL should be fostered by theological changes and environmental sermons for communities of all sizes to increase resource conservation in the short-run (think of frugality in Christianity and parsimony in Islam). The main direction for future development of the present study could come from considering additional SEC (e.g., concern for future generations, attitudes towards consumption goods) and introducing more control variables (e.g., gender, although this is a sensitive issue in comparing both REL and SEC).

6 CONCLUSIONS Tackling environmental sustainability as a practical problem entails an empirical approach. Statistical estimations based on a theoretical framework suggest that REL and SEC are not reliable policies to increase resource conservation. Note that both types of ethics show a greater impact on pro-environmental behaviors to reduce pollution (Zagonari, 2021). In contrast, efficiency in water use and environment as luxury goods depicted by income levels have the expected impacts on WC and BC. Moreover, social pressure represented by equality has a beneficial effect on both WC and BC. Finally, current lifestyle and concern for the future environment depicted by education levels have the expected impacts on WC and BC.

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314  Handbook of sustainable politics and economics of natural resources

APPENDIX Table 19A.1

Determinants of water consumption dynamics under nine religions’ majority with specific traditions based on a random-effect regression

wcd

Coef.

Std. Err.

z

P>z

inct

–0.122

0.094

–1.31

0.192

–0.306

edut

0.147

0.071

2.08

0.038

0.008

0.285

–3.603

14.185

–0.25

0.8

–31.405

24.199

budmahmaj

3.909

20.665

0.19

0.85

–36.593

44.412

budthemaj

–0.683

9.250

–0.07

0.941

–18.812

17.446

chrcatmaj

–1.571

3.589

–0.44

0.662

–8.605

5.463

chrortmaj

–4.488

6.685

–0.67

0.502

–17.591

8.614

chrpromaj

–1.296

4.955

–0.26

0.794

–11.008

8.416

jewmaj

–6.317

21.411

–0.3

0.768

–48.282

35.648

musshimaj

–8.071

9.510

–0.85

0.396

–26.710

10.568

mussunmaj

4.739

4.498

1.05

0.292

–4.077

13.555

ine

0.326

0.253

1.29

0.197

–0.170

0.822

cur

–1.832

2.272

–0.81

0.42

–6.284

2.621

fut

–0.931

2.544

–0.37

0.714

–5.917

4.054

unet

0.042

0.112

0.37

0.708

–0.177

0.261

oldt

–0.108

0.232

–0.46

0.643

–0.563

0.348

–17.976

12.186

–1.48

0.14

–41.860

5.909

budlammaj

_cons

[95% Conf. Interval] 0.061

Note: wcd = ΔWCt; inct = Incomet; edut = Educationt; budmaj = Buddhists (Lamaists, Mahayanists, Theravadins); chrmaj = Christians (Catholics, Orthodox, Protestants); jewmaj = Jews; musmaj = Muslims (Shias, Sunnis); ine = Inequity; cur = concern for the current environment, fut = concern for the future environment; unet = Unemployedt, oldt = Elderly, cons = constant. Number of observations = 1085, number of years = five (1995, 2000, 2005, 2010, 2015), number of countries = 217. Overall fit goodness (P > χ2). = 0.697.

Table 19A.2

Determinants of water consumption dynamics under 14 religions’ majority or minority based on a random-effect regression

wcd

Coef.

Std. Err.

z

P>z

inct

–0.113

0.098

–1.16

0.246

–0.305

[95% Conf. Interval]

edut

0.203

0.073

2.79

0.005

0.060

0.347

bah

14.004

177.153

0.08

0.937

–333.209

361.217

bud

–3.043

10.251

–0.3

0.767

–23.135

17.049

chr

–0.857

3.602

–0.24

0.812

–7.918

6.203

con

–3.350

197.038

–0.02

0.986

–389.537

382.838

dao

780.779

5853.912

0.13

0.894

–10692.680

12254.240

eth

48.612

17.980

2.7

0.007

13.372

83.852

hin

9.199

16.929

0.54

0.587

–23.981

42.379

jai

–1155.476

4578.108

–0.25

0.801

–10128.400

7817.451

jew

–12.574

29.972

–0.42

0.675

–71.318

46.170

mus

10.146

5.116

1.98

0.047

0.119

20.172

shi

364.369

1104.012

0.33

0.741

–1799.456

2528.193

sik

–336.636

1000.829

–0.34

0.737

–2298.224

1624.952

spi

20.427

79.075

0.26

0.796

–134.557

175.411

zor

–17267.250

20259.930

–0.85

0.394

–56975.970

22441.480

ine

0.370

0.254

1.46

0.145

–0.127

0.867

0.078

Resource conservation and environmental ethics  315 wcd

Coef.

Std. Err.

z

P>z

cur

–1.933

2.283

–0.85

0.397

–6.407

2.541

fut

–0.771

2.841

–0.27

0.786

–6.338

4.797

unet

0.004

0.113

0.04

0.971

–0.217

0.225

oldt

–0.035

0.239

–0.15

0.883

–0.504

0.434

–28.018

11.977

–2.34

0.019

–51.493

–4.543

_cons

[95% Conf. Interval]

Note: wcd = ΔWCt; inct = Incomet; edut = Educationt;, bah = Baháʹis; bud = Buddhists; chr = Christians; con = Confucianists; dao = Daoists; eth = Ethnic religionists; hin = Hindus; jai = Jains; jew = Jews; mus = Muslims; shi = Shintoists; sik = Sikhs; spi = Spiritists; zor = Zoroastrians; ine = Inequity; cur = concern for the current environment; fut = concern for the future environment; unet = Unemployedt; oldt = Elderly; cons = constant. Number of observations = 1085, number of years = five (1995, 2000, 2005, 2010, 2015), number of countries = 217. Overall fit goodness (P > χ2). = 0.440.

Table 19A.3

Determinants of water consumption dynamics under 23 religions’ majority or minority with specific traditions based on a random-effect regression

wcd

Coef.

Std. Err.

z

P>z

inct

–0.103

0.100

–1.03

0.301

–0.299

edut

0.217

0.074

2.94

0.003

0.073

0.362

bah

40.329

186.056

0.22

0.828

–324.333

404.991

budlam

–4.266

22.386

–0.19

0.849

–48.142

39.610

budmah

0.155

40.950

0

0.997

–80.106

80.415

budthe

–1.289

15.406

–0.08

0.933

–31.485

28.906

chrcat

3.413

9.017

0.38

0.705

–14.261

21.086

chrind

–12.471

18.235

–0.68

0.494

–48.210

23.268

chrort

–1.664

11.236

–0.15

0.882

–23.686

20.359

chrpro

1.714

10.877

0.16

0.875

–19.605

23.033

con

45.000

213.096

0.21

0.833

–372.660

462.660

dao

852.527

5517.032

0.15

0.877

–9960.657

11665.710

eth

50.757

20.174

2.52

0.012

11.217

90.298

–20.991

124.698

–0.17

0.866

–265.394

223.412

hinsha

3.299

238.538

0.01

0.989

–464.226

470.825

hinvai

14.496

264.435

0.05

0.956

–503.787

532.779

–641.260

5018.192

–0.13

0.898

–10476.740

9194.216

hinsak

jai

[95% Conf. Interval] 0.093

–7.826

30.708

–0.25

0.799

–68.012

52.361

mussch

–10.599

56.540

–0.19

0.851

–121.415

100.218

musshi

–14.788

17.930

–0.82

0.41

–49.931

20.355

mussun

14.156

9.510

1.49

0.137

–4.483

32.794

shi

430.621

1387.129

0.31

0.756

–2288.102

3149.344

sik

–158.339

1053.377

–0.15

0.881

–2222.920

1906.242

spi

19.929

81.893

0.24

0.808

–140.579

180.436

zor

652.760

23172.710

0.03

0.978

–44764.920

46070.440

ine

0.329

0.266

1.24

0.215

–0.191

0.850

cur

–1.934

2.319

–0.83

0.405

–6.480

2.613

fut

–1.600

2.871

–0.56

0.577

–7.227

4.027

unet

0.032

0.116

0.28

0.78

–0.194

0.259

oldt

–0.070

0.246

–0.29

0.775

–0.553

0.412

–28.762

14.622

–1.97

0.049

–57.420

–0.104

jew

_cons

Note: wcd = ΔWCt; inct = Incomet; edut = Educationt; bah = Baháʹis; bud = Buddhists (Lamaists, Mahayanists, Theravadins); chr = Christians (Catholics, Independents, Orthodox, Protestants); con = Confucianists; dao = Daoists; eth = Ethnic religionists; hin = Hindus (Saktists, Shaivites, Vaishnavites); jai = Jains; jew = Jews; mus = Muslims (Schismatics, Shias, Sunnis); shi = Shintoists; sik = Sikhs; spi = Spiritists; zor = Zoroastrians; ine =

316  Handbook of sustainable politics and economics of natural resources Inequity, cur = concern for the current environment; fut = concern for the future environment; unet = Unemployedt; oldt = Elderly, cons = constant. Number of observations = 1085, number of years = five (1995, 2000, 2005, 2010, 2015), number of countries = 217. Overall fit goodness (P > χ2). = 0.722.

Table 19A.4

Determinants of protected area dynamics under nine religions’ majority with specific traditions based on a between-effect regression

pad

Coef.

Std. Err.

t

P>t

inct

0.161

0.630

0.26

0.799

–1.082

[95% Conf. Interval] 1.404

edut

0.130

0.540

0.24

0.811

–0.935

1.194

budlammaj

–14.881

83.654

–0.18

0.859

–179.837

150.075

budmahmaj

–64.241

122.197

–0.53

0.6

–305.201

176.719

budthemaj

–20.351

54.617

–0.37

0.71

–128.050

87.347

chrcatmaj

26.465

21.888

1.21

0.228

–16.696

69.626

chrortmaj

–11.888

39.688

–0.3

0.765

–90.148

66.371

chrpromaj

–12.033

30.810

–0.39

0.697

–72.787

48.721

jewmaj

37.526

126.369

0.3

0.767

–211.661

286.713

musshimaj

–9.345

56.362

–0.17

0.868

–120.485

101.795

mussunmaj

–4.550

26.965

–0.17

0.866

–57.722

48.622

ine

–1.852

1.520

–1.22

0.224

–4.849

1.145

cur

9.861

13.454

0.73

0.464

–16.670

36.391

fut

11.786

–18.514

15.365

–1.2

0.23

–48.813

unet

–0.435

0.722

–0.6

0.547

–1.858

0.987

oldt

3.038

1.476

2.06

0.041

0.128

5.948

53.494

75.878

0.71

0.482

–96.129

203.117

_cons

Note: pad = ΔPAt; inct = Incomet; edut = Educationt; budmaj = Buddhists (Lamaists, Mahayanists, Theravadins); chrmaj = Christians (Catholics, Orthodox, Protestants); jewmaj = Jews; musmaj = Muslims (Shias, Sunnis); ine = Inequity; cur = concern for the current environment; fut = concern for the future environment; unet = Unemployedt; oldt = Elderly; cons = constant. Number of observations = 1085, number of years = five (1995, 2000, 2005, 2010, 2015), number of countries = 217. Overall fit goodness (P > χ2). = 0.079.

Table 19A.5

Determinants of protected area dynamics under 14 religions’ majority or minority based on a between-effect regression

pad

Coef.

Std. Err.

t

P>t

inct

0.034

0.670

0.05

0.96

–1.289

[95% Conf. Interval] 1.356

edut

0.229

0.578

0.4

0.692

–0.910

1.368 1613.324

bah

–492.290

1067.645

–0.46

0.645

–2597.904

bud

–33.447

61.596

–0.54

0.588

–154.926

88.033

chr

–14.686

21.736

–0.68

0.5

–57.554

28.181

con

15.937

1183.980

0.01

0.989

–2319.113

2350.988

dao

21426.700

35305.870

0.61

0.545

–48203.690

91057.080

eth

14.990

110.899

0.14

0.893

–203.726

233.706

hin

–34.934

101.817

–0.34

0.732

–235.738

165.870

jai

–7978.864

27599.830

–0.29

0.773

–62411.360

46453.630

jew

30.279

180.307

0.17

0.867

–325.324

385.882

mus

–21.122

31.706

–0.67

0.506

–83.653

41.410

–2147.401

6653.795

–0.32

0.747

–15270.040

10975.240 14816.350

shi sik

2729.820

6128.435

0.45

0.656

–9356.705

spi

–244.837

476.397

–0.51

0.608

–1184.388

694.715

zor

–4089.349

122372.200

–0.03

0.973

–245432.300

237253.600

ine

–1.066

1.552

–0.69

0.493

–4.128

1.996

Resource conservation and environmental ethics  317 pad

Coef.

Std. Err.

t

P>t

cur

10.048

13.759

0.73

0.466

–17.088

[95% Conf. Interval] 37.185

fut

–19.396

17.490

–1.11

0.269

–53.891

15.098

unet

–0.460

0.745

–0.62

0.537

–1.929

1.008

oldt

3.301

1.556

2.12

0.035

0.232

6.371

31.783

78.149

0.41

0.685

–122.342

185.908

_cons

Note: pad = ΔPAt; inct = Incomet; edut = Educationt; bah = Baháʹis; bud = Buddhists; chr = Christians; con = Confucianists; dao = Daoists; eth = Ethnic religionists; hin = Hindus; jai = Jains; jew = Jews; mus = Muslims; shi = Shintoists; sik = Sikhs; spi = Spiritists; zor = Zoroastrians; ine = Inequity; cur = concern for the current environment; fut = concern for the future environment; unet = Unemployedt; oldt = Elderly; cons = constant. Number of observations = 1085, number of years = five (1995, 2000, 2005, 2010, 2015), number of countries = 217. Overall fit goodness (P > χ2). = 0.367.

Table 19A.6

Determinants of protected area dynamics under 23 religions’ majority or minority with specific traditions based on a between-effect regression

pad

Coef.

Std. Err.

t

P>t

inct

0.050

0.696

0.07

0.943

–1.322

[95% Conf. Interval] 1.422

edut

0.302

0.593

0.51

0.611

–0.868

1.472

bah

2108.602

–118.542

1128.925

–0.11

0.916

–2345.685

budlam

–17.398

135.848

–0.13

0.898

–285.399

250.602

budmah

–124.255

248.284

–0.5

0.617

–614.070

365.561

budthe

–28.447

93.669

–0.3

0.762

–213.237

156.344

chrcat

50.922

55.143

0.92

0.357

–57.864

159.708

chrind

0.718

111.580

0.01

0.995

–219.407

220.842

chrort

–17.927

68.676

–0.26

0.794

–153.411

117.557

chrpro

–23.787

66.574

–0.36

0.721

–155.124

107.549

con

560.772

1292.732

0.43

0.665

–1989.529

3111.074

dao

25302.240

33606.740

0.75

0.452

–40997.140

91601.620

eth

57.183

125.054

0.46

0.648

–189.524

303.890

–122.389

755.639

–0.16

0.872

–1613.113

1368.335

hinsak hinsha

–8.354

1446.962

–0.01

0.995

–2862.921

2846.212

hinvai

–35.624

1605.432

–0.02

0.982

–3202.821

3131.573

–4751.766

30488.280

–0.16

0.876

–64899.040

55395.510

79.182

186.903

0.42

0.672

–289.541

447.905

mussch

–87.783

343.174

–0.26

0.798

–764.797

589.231

musshi

–13.644

109.194

–0.12

0.901

–229.062

201.774

mussun

1.234

58.693

0.02

0.983

–114.555

117.024

jai jew

shi

1305.210

8415.713

0.16

0.877

–15297.310

17907.730

sik

3837.711

6503.903

0.59

0.556

–8993.188

16668.610

spi

–190.133

497.853

–0.38

0.703

–1172.297

792.031

zor

1465.826

141351.700

0.01

0.992

–277392.800

280324.400

ine

–2.057

1.638

–1.26

0.211

–5.289

1.175

cur

8.775

14.099

0.62

0.534

–19.039

36.590

fut

10.469

–24.697

17.826

–1.39

0.168

–59.864

unet

–0.438

0.774

–0.57

0.572

–1.966

1.089

oldt

3.071

1.622

1.89

0.06

–0.129

6.271

46.318

94.432

0.49

0.624

–139.979

232.614

_cons

Note: pad = ΔPAt; inct = Incomet; edut = Educationt; bah = Baháʹis; bud = Buddhists (Lamaists, Mahayanists, Theravadins); chr = Christians (Catholics, Independents, Orthodox, Protestants); con = Confucianists; dao = Daoists; eth = Ethnic religionists; hin = Hindus (Saktists, Shaivites, Vaishnavites); jai = Jains; jew = Jews; mus = Muslims (Schismatics, Shias, Sunnis); shi = Shintoists; sik = Sikhs; spi = Spiritists; zor = Zoroastrians; ine =

318  Handbook of sustainable politics and economics of natural resources Inequity; cur = concern for the current environment; fut = concern for the future environment; unet = Unemployedt; oldt = Elderly; cons = constant. Number of observations = 1085, number of years = five (1995, 2000, 2005, 2010, 2015), number of countries = 217. Overall fit goodness (P > χ2) = 0.619.

PART IV CHANGE AND UNCERTAINTY IN RESOURCE POLICIES

20. Stranded assets and the financial system Andreas A. Papandreou

1 INTRODUCTION The idea of stranded assets is not new but its association with potentially unburnable fossil fuel reserves, given our need to limit CO2 emissions, causes concern that potential sudden devaluations of these assets could cause a shock to the financial system. In this sense, ‘stranded assets’ became a rallying cry that large parts of the business community and the financial world (investors, companies, asset managers and banks) need to wake up to the stark contrast between global political commitments to protect our planet from climate change and their apparent ‘business as usual’ attitude. Many in the financial community have responded to this concern and along with international organizations, non-governmental organizations (NGOs) and the academic community have shed light on many aspects of this issue area, but also broadened the scope of issues that need to be addressed under the rubric of stranded assets. The fast-expanding literature is still young and fairly limited in terms of peer-reviewed academic publications. This chapter presents an overview of this literature with a focus on the risks to the financial system associated with stranded assets and why it needs to be a concern to central banks. It begins with a discussion of the various definitions of stranded assets. Next it looks at potential reasons why the financial system may be unable to adequately account for these risks, which provides the rationale for why specific actions and policies may be required to address these failures both on the part of investors as well as on that of central banks. The chapter continues with taking a step back and looking at the big picture in terms of major technological transitions and the potential threats they raise to the financial system and concludes with some points of policy and business consideration.

2

STRANDED ASSETS: DEFINITIONS AND TRANSMISSION CHANNELS

There are several definitions of stranded assets used in the literature depending largely on context. Accountants have used the term to refer to assets that become obsolete or non-performing but must be recorded as a loss of profit on the balance sheet (Deloitte, 2016). Regulators have used ‘stranded costs’ or ‘stranded investments’ to capture the decline in value of electricity-generating assets resulting from the restructuring of industry. The power market liberalization of the 1990s made this a major issue (Caldecott, 2017). The International Energy Agency (IEA, 2013) provides a definition from an energy economist’s perspective: ‘those investments which have already been made but which, at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn an economic return’ (p. 98). The Carbon Tracker Initiative (2017) uses this definition and links the economic losses to those that are ‘a result of changes associated with the transition to 320

Stranded assets and the financial system  321 a low-carbon economy’. The Generation Foundation (2013) additionally specified the potential changes that could strand assets: ‘legislation, regulation, market forces, disruptive innovation, societal norms, or environmental shocks’ (p. 21). Caldecott, Howarth and McSharry (2013) use a ‘meta’ definition to encompass all the different definitions and contexts: ‘stranded assets…suffer from unanticipated or premature write-offs, downward revaluation or are converted to liabilities’ (p. 7). To the extent that the literature has focused on climate-related risks of stranding assets rather than the more expansive environment-related risks (physical and societal), the standard classification has been between the essentially parallel concepts of climate-related physical risks and transition risks. Accordingly, the literature identifies two broad areas of climate-related financial risks. One is associated with the potential damages resulting from human-induced environmental changes that can adversely impact the economy (physical risk). The other broad area is associated with potential disruption resulting from the transition to a low-carbon economy and the policies implemented to support it (transition risk). Large financial losses can result from direct and indirect physical impacts related to climate change like sea level rise, increased temperatures and catastrophic weather events. Uninsured households and corporations may shoulder the burden, with asset values and the value of investments held by financial institutions being impaired. To the extent that losses are insured, insurance firms will face the brunt of the impact through higher claims. Potential economic disruption, lower productivity and increasing sovereign default risk can also have wider systemic impacts (Scott, Van Huizen and Jung, 2017). When it comes to disruption related to the low-carbon transition, there are several layers of complexity (Campiglio et al., 2017). A large portion of existing reserves of oil, gas and coal will have to remain in the ground and thus become ‘stranded’ if the international community’s commitment to keep global temperatures below 2°C (United Nations Framework Convention on Climate Change [UNFCCC], 2015) is realized. A second layer of complexity relates to the fact that a large part of the economic system is deeply tied to the use of fossil fuels. A third aspect of the implications of a low-carbon transition relates to the stranding of physical assets (natural resources and productive capital) that could in turn lead to sharp reductions in the valuation of companies owning them along with the financial assets they have issued. Unburnable fossil reserves have the potential to become stranded assets, thus raising the risk of investing in fossil fuels and also spurring the fossil fuel divestment campaign (Ansar, Caldecott and Tilbury, 2013). To the extent that upstream fossil fuel assets are significantly overvalued, there is a danger of a financial bubble (or ‘carbon bubble’) that could have systematic implications for the global economy (Caldecott, 2017).

3

MARKET FAILURE AND THE RISK OF STRANDED ASSETS

An important question is the extent to which the financial industry acknowledges the existence of climate financial risks. In perfectly efficient asset markets, as envisaged by the efficient market hypothesis (EMH) (Fama, 1970), asset prices would fully reflect the information available to rational profit-maximizing financial actors. Stock prices of many companies operating in fossil fuel industries have been declining in recent years, but this has been attributed to the large drop in fossil fuel prices in 2014, which in itself is nothing historically unusual and has been driven by a number of factors: demand stagnation, abundant supply (especially in

322  Handbook of sustainable politics and economics of natural resources view of the surprising success of fracking technologies in the US) and geopolitical reasons (Baumeister and Kilian, 2016). While the drop in stock prices may also be related to the growth in renewables, especially in Germany and its effect on utilities, there is not a sense that asset markets have actually priced in the dramatic implications of the low-carbon transition needed to attain the 2°C target. One explanation that would be in line with the EMH is that financial actors do not believe that policy makers will follow through with their commitments. Many reasons have been offered in the literature for why the EMH may not be an accurate model of the real-world financial markets, and perhaps especially so when it comes to the nature of potential financial risks associated with climate change. Two recent articles consider some of the reasons why individuals operating in the financial industry may overlook or under-price low-carbon transition risks (Silver, 2017; Weber, 2017). Low-carbon investment may appear to be a relatively unprofitable niche market given prevailing and widespread convictions and social norms in the financial industry. Due to their educational background, they may have limited knowledge of energy- and climate-related issues so that they can only partially understand or even overlook the related news and empirical evidence. The structure of incentives faced by investment professionals may prevent them from investing in low-carbon assets. Asset managers’ performance is evaluated based on their short-term risk-adjusted returns as compared to that of their peers, which makes them stick close to an established index. A decision to drop potentially stranded assets that are relevant in indices and have been relatively risk free in terms of historical volatility, could be perceived as excessively risky and with possibly lower short-term returns. Accordingly, asset managers may tend to prefer aligning with behavioural norms of their social group and shift the longer-term transition risks to asset owners. Thomä and Chenet (2017) provide a theoretical account of potential reasons (market failures) that transition risks may be mispriced. They do not consider mispricing from other climate-related risks like physical risks or litigation risks. They start by discussing the EMH that if empirically accurate would eliminate any concerns about mispricing by the financial market and consider reasons why the EMH can in theory break down. Bounded rationality (Simon, 1959) provides a strong criticism of utility-maximizing models where agents are seen to use heuristics rather than optimize, and, as such, price formation may not reflect all information and potentially become skewed. When it comes to transition risks, lack of historical data and the form of transition scenario lead to a breakdown of the normal distribution. Agents use simplified assumptions to reduce the complexity. Transition risks are particularly prone to complexity. Asset prices may not fully reflect risks in a world of bounded rationality, limited information and deep uncertainty, which is especially the case when it comes to climate change and a low-carbon transition. The ‘blindness’ of financial experts and economists to the 2008 financial crisis has been attributed to biases such as ‘irrational exuberance’ that lead to an overvaluation of financial assets (Shiller, 2015). Critchlow (2016) has suggested that we may be facing ‘irrational apathy’ in the case of climate change. Accordingly, a number of behavioural biases lead the financial system to disregard transition risks and overprice financial assets related to fossil or fossil-dependent industries. To the extent that the financial community does not price in the risk of transition in the presence of a real low-carbon transition, there will likely come a time where the ‘carbon bubble’ will burst and the macroeconomic and financial implications may be grave.

Stranded assets and the financial system  323 Prospect theory developed by Kahneman and Tversky (1979) suggests that investors appear risk averse for small losses but are less impacted by large losses so that the level of risk aversion is partly dependent on the size of the loss. Similarly, Taleb (2007) discusses how the tail end of distributions are underweighted by the financial market models. To the extent that transition risks have fat tails (low but not insignificant probability of great damages) these may not be accounted for by the financial markets. The 2°C or lower, while being the official target, remains ‘on the lower end of the spectrum of climate roadmaps and far removed from the current business as usual’ (Thomä and Chenet, 2017, p. 7). In addition to problems arising from the design of risk models in financial markets, Thomä and Chenet (2017) also consider the role of time-inconsistent preferences and the role of institutions that can lead to departures from efficient pricing of risk. To the extent that agents’ discounting resembles hyperbolic discount functions (Thaler, 1981) where agents have a ‘present bias’, the immediate future is discounted highly while the long-term future is discounted at a progressively lower rate. As transition risks are likely to be long term, they are likely to be heavily discounted over the short term and, thus, even if investors believe the risks are real, their financial impact will be discounted. Two additional potential sources of financial market failure are presented by Thomä and Chenet (2017). One has to do with principal–agent problems where short-term asset managers externalize long-term costs associated with their investments to asset owners. The other relates to a potential herding behaviour where market participants prefer to move with the crowd than being right on their own. Such behaviour has been used to partly explain booms and busts (Bikhchandani and Sharma, 2000). In one attempt to empirically gauge the extent to which investors are sensitive to climate risks, Batten, Sowerbutts and Tanaka (2016) use standard event study methodology to estimate the market reaction to news stories in major newspapers or energy-specific investment press mentioning the words ‘carbon bubble’, ‘unburnable carbon’, and ‘fossil fuel divestment’ and data from climate organizations tracking divestment announcements. Specifically, they look at the changes in the market valuation of the firm’s equity measures by abnormal returns following the event. They found that these events had a negative but statistically insignificant effect on abnormal returns for oil and gas companies but a positive and significant effect for renewable energy companies. The insignificant impact on market values of fossil fuel companies may be because investors remain uncertain about future climate policies or that they may choose to divest over several years rather than liquidate their portfolios as an immediate reaction to specific news. The results suggest tentatively that some investors may be beginning to incorporate expected changes in energy policy into assessment of firms (Batten et al., 2016). Another recent effort to measure the extent to which investors may be pricing in climate policy risk looks at loan rates charged to fossil fuel firms relative to non-fossil firms. Delis et al. (2019) find no evidence that banks are charging significantly higher loan spreads to fossil firms with higher exposure to climate policies when looking at their entire sample from 2007–16, but do find evidence of banks increasing their loan spreads after 2015. This suggests that the Paris Agreement had an impact on perceived climate policy risk.

324  Handbook of sustainable politics and economics of natural resources

4

ADDRESSING CLIMATE-RELATED RISKS TO ASSETS

Two reports (Institutional Investors Group on Climate Change [IIGCC], 2015; United Nations Environment Programme Financial Initiative [UNEP FI], 2014) explore options for buying into low-carbon opportunities without expecting lower returns or the different climate strategies available to institutional investors to measure and manage stranded asset risk. A consortium of the 2 Degrees Investing Initiative (2DII), UNEP FI and the World Resources Institute have highlighted two approaches and their related metrics and strategies entitled ‘Carbon risk’ and ‘Climate friendliness’. The first focuses on the potential financial risks and opportunities for portfolios of a low-carbon economy, while the second relates to investors seeking to contribute to GHG reductions (Dupre et al., 2015). A popular technique for assessing stranded asset risk within portfolios is the process of footprinting investments and portfolios. Another way to manage exposure is to use carbon intensity of capital as a proxy for a range of climate-related risks. There is also a growing movement to encourage managers to disclose portfolio-level exposure. Many of the major indices that are used in passively managed funds are underweight in renewable energy and overweight in fossil fuels, and this has prompted some investors to use low-carbon indices to reduce their exposure to carbon-related risks. New ‘low-carbon’ or ‘fossil-free’ indices are among such indices that underpin the exchange-traded funds (ETFs). Other indexes for passive investors with exposure to environmentally driven companies include the FTSE Environmental Markets Index series, The S&P Global Eco Index and the MSCI Global Climate Index, MSCI Global Low Carbon Leader Indexes and MSCI ACWI Low Carbon Target Index. While there are numerous opportunities to invest through a range of indices focused on reducing carbon exposure, many investors do not consider them comparable to mainstream indices (Caldecott et al., 2016). Engagement of investors and shareholder voting can play an important role in reducing the carbon intensity of large multinational companies. Such engagement with invested companies has increased in recent years (PRI, 2013). In addition, encouraging low-carbon practices and investment engagement can enhance transparency and disclosure. Shareholder resolutions were filed against oil and gas giants Shell and BP in 2015, demanding greater disclosure and monitoring of exposure to stranded assets risks (Clark, 2015). Investors have filed a record number of shareholder resolutions, mostly focusing on major US energy companies in the wake of the Paris Accord. The market for green bonds grew from US$11 billion in 2013 to US$41.8 billion in 2015 (Kidney, 2016). Outstanding green bonds amounted to US$168 billion in 2019 (International Finance Corporation [IFC], 2020). Green bonds are mostly ‘use of proceeds’ (proceeds earmarked for green projects) or asset linked. In addition, there are green revenue bonds, green project bonds and green securitized bonds. The Climate Bonds Initiative is an international investor-focused NGO focused solely on mobilising US$100 billion labelled green bonds. Country sovereign credit ratings could be influenced by asset stranding both through direct, indirect and systemic effects. Sovereign bonds are one of the most important asset classes held by investors and represent nearly 50 percent of the global bond market (ICMA, 2020). Pressures from increasing global natural resource scarcity, environmental degradation, and vulnerability to climate change impacts are inadequately reflected in traditional sovereign credit risk analysis (ibid.). This has led to a growing literature on how to design methodologies and tools to better understand, map and reduce sovereign credit risks related to climate change.

Stranded assets and the financial system  325 Global Footprint Network and UNEP FI developed an environmental risk and sovereign credit methodology that aims to quantify natural resource and environmental risks for incorporation into country risk assessment (ibid.). The report applied the methodology to five countries and explored the resource balance, trade-related risk, degradation risk and financial resilience of each economy. The increased volatility from rising resource scarcity and climate change was found to particularly expose exporters of natural resources (fossil fuels, timber, fish and crops). Future climate change and the associated ecosystem degradation and water scarcity was also found to lead to higher and more volatile food prices, with potentially significant impact on countries’ credit risk and risk exposure of sovereign bond holders (ibid.). The same report provides examples of banks and asset managers adopting metrics for environmental, social and governance (ESG) risks including labour rights and environmental damage to supplement sovereign credit risk. The European Systemic Risk Board (ESRB, 2016) suggested that to manage climate-related risks, the ESRB could perform dedicated climate stress tests in the medium term. It suggests four potential policy options: (1) building systemic capital buffers to protect against adverse climate shocks with macroeconomic implications; (2) regulatory loss absorbency requirements; (3) capital surcharges based on carbon intensity of individual exposures; (4) large exposure limits to assets likely to be at risk from low-carbon transitions. UNEP (2015) suggests several ways that central banks can promote resilience in the financial system. These include conducting environmental stress tests to evaluate the impacts of environmental scenarios on portfolios, institutions and finical markets. Other tools include refinancing like establishing dedicated credit lines for green investments, liquidity operations like adapting the requirements for collateral in repurchase agreements to include low-carbon assets, interest rates, balances sheet management like incorporating ESG into asset allocation process, quantitative easing like giving greater weight to green assets in special asset purchase programmes, and transparency and reporting. Stress testing against climate-related risks would be one way to examine the resilience of the financial system to adverse scenarios. However, identifying the relative scenario that would likely lead to substantial loss in the financial sector is a key challenge. One would need to formulate a plausible scenario that would lead to large economic losses whether these result from direct physical damages in the domestic economy or to other economies that could impact banks and insurers. Information arising from stress tests of this nature could help financial market participants in their assessment of climate-related risk exposure of particular institutions (Batten et al., 2016). Developing scenarios for stress testing against transition risk may be more straightforward. Looking at different paths of carbon price would be one way to test the exposure of the financial system to fossil fuel-related industries. There are data gaps, however, in undertaking such an exercise. Most of the data about exposures through bonds and loans are not available even to regulators (Battiston et al., 2017). Climate-related disclosures at a company level would help inform stress test exercises. The financial sector can influence physical risks in several ways. It can contribute to climate change by funding activities that are intensive in CO2 emissions, or it can play a role in mitigation by funding technologies that reduce emissions. The standard way to deal with such externalities is to ensure that markets adequately price emissions through an instrument like taxes or emission permits. Given the existence of a possible threat to financial stability from climate change, there has been some discussion about incorporating environmental

326  Handbook of sustainable politics and economics of natural resources considerations into macro prudential regulation. This could both protect the financial system from climate-related risks as well as help low-carbon investments, which are ultimately key to a smooth transition. Rozenberg et al. (2013) have suggested the use of differential reserve ratio requirements so that they favour green sectors. Accordingly, the reserve ratio for banks that direct loans to low-carbon sectors should be lower. This should give banks an incentive to direct large amounts of lending toward green investment. However, according to Batten et al. (2016), prudential regulations are fairly blunt instruments for dealing with climate-related externalities. For instance, capital requirements are designed to mitigate prudential risks, so adapting these to reflect externalities could undermine their primary purpose. Relaxing regulations to encourage climate-friendly activities like reducing risk weights used for calculating regulatory capital ratios could jeopardize the safety and soundness of financial institutions. Alternatively, tightening regulations on financial exposures to carbon-intensive firms could increase the cost of finance for those borrowers and thus reduce their ability to invest in emission-reducing technologies (carbon capture and storage [CCS] or renewables) (ibid.). Another option to protect against climate-related risks to financial stability would be to incorporate ESG criteria into asset risk assessment for risk-weighted capital requirements. This would mean that low-carbon infrastructure projects would appear less risky on banks’ balance sheets. Nonetheless, caution should be used in implementing such tools to avoid the formation of a ‘green bubble’ (Campiglio et al., 2017). Disclosure helps remove asymmetric information between a firm’s management and investors. Depending on their objectives, investors may be interested in different types of climate-related disclosures. Some may be interested in their exposure to financial risks associated with climate change, mitigation policy or divestment campaigns, and others for ethical reasons may be concerned about the potential damage caused by firms. Effective disclosure could facilitate a low-carbon transition by encouraging firms and investors to adopt strategies that lower their exposure to risks of tighter policy on carbon emissions. It could also help institutions and government by better informing them about ways they can influence transition risks. For disclosure to ensure efficient outcomes, there are several considerations that need to be considered. If there are multiple frictions or market failure, then removing one friction may not lead to the best outcome. For instance, having firms disclose the current emissions could make them focus on technologies with immediate short-term emission reductions rather than ensuring more substantial long-term emission reductions. ‘The existing literature suggests that climate-related disclosures are more likely to benefit a wider range of investors, and hence be more effective, if they are based on forward looking information that is simple to interpret, and relevant for assessing financial risks and returns’ (Batten et al., 2016, p. 22). The Financial Stability Board (FSB) proposed the establishment of an industry-wide disclosure, and this led to the formation of the Task Force on Climate-Related Financial Disclosures (TCFD) in December 2015, chaired by Michael Bloomberg. Its final report was published in June 2017 (TCFD, 2017) and the four core elements of recommended climate-related financial disclosures related to governance, strategy, risk management and metrics and targets (TCFD, 2017, p. 28, Figure 8). ‘Through widespread adoption, financial risks and opportunities related to climate change will become a natural part of organizations’ risk management and strategic planning processes. As this occurs, organizations’ and investors’ understanding of the potential financial implications associated with transitioning to a lower-carbon economy and physical risks will grow, information will become more

Stranded assets and the financial system  327 decision-useful, and risks and opportunities will be more accurately priced, allowing for the more efficient allocation of capital’ (TCFD, 2017, pp. 41–2). Beyond protecting against stranded asset risks, there is a growing literature on ways that central banks can help the low-carbon transition. In addition to some of the measures already discussed like green macroprudential regulation, climate-related stress testing, disclosure requirements, green differentiated reserve and capital requirements, there are also policies like accepting carbon certificates as part of commercial banks’ legal reserves, green quantitative easing and reserve management, green finance guidelines and frameworks and soft power (UNEP, 2017). One can think of many ways that such strategies can help avoid the climate risks associated with the financial system. Clearly, the more that the low-carbon transition is assisted, the more the potential damages associated with climate change will be reduced. These policies will also better prepare the financial system against the risks of a low-carbon transition either by directly diminishing banks’ reliance on stranded assets relative to low-carbon assets through climate-aligned financial regulation, or by making the financial risks associated with stranded assets more apparent while also altering the incentive structure in favour of the transition.

5

SUSTAINABILITY TRANSITION

A particular challenge for sustainability transitions is the presence of strong path dependencies and lock-ins in existing sectors (e.g., IEA, 2011; Safarzyńska, 2013). ‘Established technologies are highly intertwined with user practices and lifestyles, complementary technologies, business models, value chains, organizational structures, regulations, institutional structures, and even political structures’ (Markard, Raven and Truffer, 2012, p. 955). For this reason, established socio-technical systems undergo incremental rather than radical changes. The sustainability challenges we currently confront cannot be addressed with incremental changes. The issue of how to promote more fundamental transformations in the modes of production and consumption (as well as in the energy systems) has been receiving increasing attention in the policy (Organisation for Economic Co-operation and Development [OECD], 2011; UNEP, 2011) and social science research arenas. There is a broad range of theoretical approaches that have focused on many aspects relating to transitions. Four theoretical frameworks (transition management, strategic niche management, multi-level perspective socio-technical transition, technological innovation systems) that focus explicitly on transition studies from a perspective of systemic far-reaching transformation processes of socio-technical systems have recently achieved some prominence (Markard et al., 2012). Socio-technical systems consist ‘of (networks of) actors (individuals, firms, and other organizations, collective actors) and institutions (societal and technical norms, regulations, standards of good practice), as well as material artefacts and knowledge (Markard et al., 2012, p. 956). This systems approach highlights the tight interrelationship and interdependence among the broad array of elements and has critical implications for the dynamics of system transformations. A socio-technical transition involves a fundamental shift in socio-technical systems ‘through far-reaching changes along different dimensions: technological, material, organizational, institutional, political, economic and socio-cultural. Transitions involve a broad range of actors and typically unfold over considerable time-spans (e.g., 50 years and more)… The emergence of a transportation system with the automobile technology at its

328  Handbook of sustainable politics and economics of natural resources core, for example, required a complementary development of road infrastructure, fuel supply systems, traffic rules, services (e.g., maintenance, insurance), user practices, etc. In fact, socio-technical transitions do not just change the very structure of existing systems…but they also affect related societal domains, such as living, housing and working, production and trade, and planning and policymaking’ (ibid.). Sustainability transitions then are socio-technical transitions that involve shifts toward more sustainable modes of production and consumption. In principle, these transitions could take place at different scales (in time and space) as more or less guided responses to pressures or environmental bottlenecks and attain different levels of sustainability. History certainly provides many examples of socio-economic transitions emanating from environmental pressures (human-made or not). The sustainability challenges we face today are many and involve several domains. The energy sector is challenged by greenhouse gas emissions and air pollution, nuclear risks, security of supply, rapid resource depletion and energy poverty (IEA, 2011). The water sector confronts challenges of insufficient access in low-income countries, extreme events and scarcity. Similarly, critical challenges are confronted in the transportation sector (congestion, local air pollution, CO2 emissions), the agricultural sector, and so on. All these challenges require multi-dimensional responses and governance of sustainability transition. The climate change challenge is special in that it pervades nearly all sectors in terms of potentially devastating impacts and requires fundamental non-incremental changes (mitigation of emissions and adaptation) in most sectors, many of which have been fundamentally moulded by the fossil fuel energy system of the twentieth century. It is also special in that only a global and comprehensive response within a very short time frame can adequately protect us from taking unfathomable risks. So, while the energy system confronts numerous challenges, the climate change challenge dominates all others in terms of the extent and speed of required transition. The demands on globally coordinated comprehensive action are unprecedented. In terms of a transition to sustainable energy systems, it is important to note that historical regime transitions were rarely if ever explicitly guided by long-term, socially deliberated goals like sustainability (Smith, Voß and Grin, 2010). The nature of transformation required to achieve a low-carbon energy system means that great institutional, economic and political commitments are needed against the incumbent regime.

6 CONCLUSION Despite the growing interest in the risks to the financial system associated with stranded assets, the fast-expanding literature is still young and quite limited in terms of peer-reviewed academic publications. This chapter attempts to provide an overview of this literature with a focus on climate-related risks associated with the financial system and why it needs to be a concern for central banks. It is useful to note that stranded assets can be defined very broadly, allowing us to draw lessons from historical transitions and important parallels with the dynamic nature of economic development, or what Schumpeter (1942) called ‘creative destruction’. Within this very broad context, the recent discussion has focused on the potential stranding of assets from environment-related risks and more narrowly on climate-related risks and how these affect the financial system. Two main channels of climate-related risks have been discussed: risks of physical impacts from climate change and risks associated with society’s response to

Stranded assets and the financial system  329 climate change (transition risks). Risks of physical impacts from climate change encompass the many ways that disruptive phenomena such as coastal flooding, heatwaves, droughts and extreme weather events will impact the assets of households and businesses as well as the balance sheets of insurance companies and commercial banks. Transition risks encompass the many ways that society responds to climate change through mitigation and adaptation and how the form and pace of these responses will affect the risk of stranding assets. An important aspect of the stranded literature discussion involves efforts to quantify the potential physical and transition risks. Dietz et al. (2016) have used an integrated assessment model to provide some measure of global physical and transition risk, while Dafermos, Nikolaidi and Galanis (2017) develop an alternative approach using an ecological macroeconomic model that sheds light on the physical effects of climate change on financial stability. There have also been efforts to quantify transition risks if society is likely to achieve the target set by the Paris Agreement both at the global level but also at the level of sectors and firms. This literature is also recent and very limited but the issue of developing better measures of these various risks will form a critical part of society’s capacity to better understand and respond to the risks of stranded assets. We already know that markets are inherently incapable of addressing the climate change challenge on their own. Indeed, climate change represents the biggest market and institutional failure that humanity has faced. In focusing on the problem of stranded assets the question turns to the narrower issue of whether the financial industry is adequately aware of the nature of climate risks. There are many reasons why the financial industry may misprice both physical risks of climate change and society’s response to climate change. Some of the literature looks at why individuals operating in the financial industry may fail to account for these risks while there is a much broader theoretical and empirical literature related to behavioural and experimental economics that provides explanations for how humans may deviate from the assumptions of rationality commonly assumed in economic models. The literature that attempts to measure the potential extent of mispricing of climate risks by the financial market is still very limited. There are a number of ways that the financial industry can respond to climate risks and there is also a growing discussion about what central banks and financial regulators can do to improve the financial industry’s response or to address its failure to respond adequately. As mainstream investors are awakening to issues of climate change and carbon risk, several new stock indexes, funds, bond ratings and investment tools are being designed. Central banks and financial regulators are increasingly looking at the financial risks associated with climate change, and they are discussing numerous means of enhancing the resilience of the financial systems to climate-related shocks. These include conducting environmental stress tests, dedicated credit lines for green investments, setting rules for transparency and reporting and even quantitative easing like giving greater weight to green assets in special asset purchase programmes. As Campiglio et al. (2018) point out, much work still needs to be done to develop methodologies and collect data for evaluating climate-related risks that companies and investors are exposed to. Models that enable a forward-looking assessment of climate-related risks and their social impacts must also be developed. Central banks can play an important role in facilitating the exchange of practices across modelling communities (ibid.). The final part of the chapter tries to put the stranded asset debate in the historical context of major socio-technical transitions that have taken place in the past. There are common features in past transitions that can guide us to what we might expect in the future but there are also

330  Handbook of sustainable politics and economics of natural resources critical differences that we must be aware of. While most of the focus has been on the worry that the sustainability transition will not be fast enough to address the challenge of climate change or that the policy response will be too slow, leading to a rude awakening at some point, others have suggested that we may be surprised by the speed of technological developments. While the latter is a hoped-for surprise, both can lead to stranding of assets with damaging implications for the financial system. The challenges of a sustainability transition suggest that while it would be hoped that first, climate change policy could give clear and consistent signals about where it is headed, second, the technological and societal transition will be smooth and fast enough to address the climate change challenge but also to accommodate the energy demands of the economy and third, the financial community will find means of handling the several novel risks associated with the sustainability transition, there are very good reasons to expect that some of these conditions will not be met. The nature of deep uncertainty inherent in the sustainability transition and in climate change itself will heighten the need for vigilance against physical and transition risks and for better understanding these as well as finding the means of response at various levels of governance.

ACKNOWLEDGEMENTS I would like to acknowledge the financial support from the Bank of Greece. I would like to thank the Research Department of the Bank of Greece for discussions and comments on earlier versions of this chapter. Any errors are my responsibility.

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332  Handbook of sustainable politics and economics of natural resources Pompian, M.M. (2011). Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor Biases. Hoboken, NJ: John Wiley & Sons. PRI (2013). Building the capacity of investment actors to use environmental, social and governance (ESG) information. UNEP Finance Initiative and UN Global Compact. Accessed 2017-12-26 https://​www​.google​.gr/​url​?sa​=​t​&​rct​=​j​&​q​=​&​esrc​=​s​&​source​=​web​&​cd​=​4​&​cad​=​rja​&​uact​=​8​&​ved​=​ 0ahUKEwjMo​OTh5LnYAhX​JKOwKHZugA​PMQFgg4MAM​&​url​=​https​%3A​%2F​%2Fwww​.unpri​ .org​%2Fdownload​_report​%2F6385​&​usg​=​AOvVaw0pZNWsBajIC4P​_y2pkXgbU. Rozenberg, J., Hallegatte, S., Perrissin-Fabert, B. and Hourcade, J.-C. (2013). Funding low-carbon investments in the absence of a carbon tax. Climate Policy, 13(1), 134–41. Safarzyńska, K. (2013). Evolutionary-economic policies for sustainable consumption. Ecological Economics, 90(C), 187–95. Samuelson, W. and Zeckhauser, R. (1988). Status quo bias in decision making. Journal of Risk and Uncertainty, 1, 7–59. Schumpeter, J.A. (1942). Capitalism, Socialism, and Democracy. New York: Harper & Brothers. Scott, M., Van Huizen, J. and Jung, C. (2017). The Bank’s response to climate change. Bank of England Quarterly Bulletin, 57(2), 98–109. Shiller, R.J. (2015). Irrational Exuberance. New Jersey: Princeton University Press. Silver, N. (2017). Blindness to risk: why institutional investors ignore the risk of stranded assets. Journal of Sustainable Finance and Investment, 7(1), 99–113. Simon, H.A. (1959). Theories of decision-making in economics and behavioral science. The American Economic Review, 49(3), 253–83. Smith, A., Voß, J.-P. and Grin, J. (2010). Innovation studies and sustainability transitions: the allure of the multi-level perspective and its challenges. Research Policy, 39(4), 435–48. Taleb, N.N. (2007). The Black Swan: The Impact of the Highly Improbable. London: Allen Lane. TCFD (2017). Recommendations of the Task Force on Climate-related Financial Disclosures. Accessed 2017-12-26 https://​www​.fsb​-tcfd​.org/​wp​-content/​uploads/​2017/​06/​FINAL​-TCFD​-Report​-062817​ .pdf. Thaler, R. (1981). Some empirical evidence on dynamic inconsistency. Economics Letters, 8(3), 201–7. doi:​10​.1016/​0165​-1765(81)90067​-7. http://​www​.lawcom​.gov​.uk/​app/​uploads/​2015/​03/​lc350​ _fiduciary​_duties​.pdf. Thomä, J. and Chenet, H. (2017). Transition risks and market failure: a theoretical discourse on why financial models and economic agents may misprice risk related to the transition to a low-carbon economy. Journal of Sustainable Finance and Investment, 7(1), 82–98. Tversky, A. and Kahneman, D. (1974). Judgment under uncertainty: heuristics and biases. Science, 185(4157), 1124–31. UNEP (2015). Aligning the financial system with sustainable development. Inquiry: Design of a Sustainable Financial System. Accessed 2017-12-31 http://​apps​.unep​.org/​redirect​.php​?file​=/​ publications/​pmtdocuments/​-Aligning​_the​_financial​_system​.pdf. UNEP (2017). On the role of central banks in enhancing green finance. Inquiry Working Paper 17/01, 17(01), 53. Accessed 2017-12-31 http://​unepinquiry​.org/​wp​-content/​uploads/​2017/​02/​On​_the​_Role​ _of​_Central​_Banks​_in​_Enhancing​_Green​_Finance​.pdf. UNEP FI and Global Footprinting Network (2012). A New Angle on Sovereign Credit Risk E-RISC: Environmental Risk Integration in Sovereign Credit Analysis Phase 1 Report. Accessed 2017-11-06 https://​www​.google​.gr/​url​?sa​=​t​&​rct​=​j​&​q​=​&​esrc​=​s​&​source​=​web​&​cd​=​1​&​cad​=​rja​&​ uact​=​8​&​ved​=​0ahUKEwjo4​cm54LnYAhV​G16QKHcF2A​NUQFggqMAA​&​url​=​https​%3A​%2F​ %2Fwww​.footprintnetwork​.org​%2Fcontent​%2Fimages​%2Farticle​_uploads​%2FERISC​.pdf​&​usg​=​ AOvVaw0xHQb9ogq​-ofQ​-mB8kCyFy. United Nations Environment Programme (UNEP) (2011). Towards a Green Economy: Pathways to Sustainable Development and Poverty Eradication. Nairobi: UNEP. Accessed 2017-12-26 https://​su​ stainabled​evelopment​.un​.org/​content/​documents/​126GER​_synthesis​_en​.pdf. United Nations Environment Programme Financial Initiative (UNEP FI) (2014). Financial Institutions Taking Action on Climate Change. Accessed http://​www​.unepfi​.org/​publications/​climate​-change​ -publications/​technical​-advice​-for​-policy​-makers​-publications/​financial​-institutions​-taking​-action​-on​ -climate​-change/​.

Stranded assets and the financial system  333 United Nations Framework Convention on Climate Change (UNFCCC) (2015). Report of the Conference of the Parties on its Twenty-first Session, Held in Paris from 30 November to 13 December 2015 Addendum. Part Two: Action Taken by the Conference of the Parties at its Twenty-first Session. Weber, E.U. (2017). Breaking cognitive barriers to a sustainable future. Nature Human Behaviour, 1, Article 0013.

21. Energy modeling for sustainable policymaking: state of the art and future challenges Stella Tsani and Mariia Kozlova

1 INTRODUCTION Energy remains important for all modern economic activities, for socioeconomic development and for human well-being. Access to energy sources, energy markets and transit routes has shaped economies and societies for many decades. Abundance of energy sources has been an input to growth for countries like the USA, Canada and Norway. For other countries, security of energy supply has been a constant issue of concern in policy agendas and a major driver of socioeconomic and technological change (see, for instance, developments in the European Union, including European attempts to diversify away from current energy suppliers – that is, Russia and the Middle East – and the role of the European green energy agenda in stimulating European research and development). Technological progress in the energy system has enabled front-runners to benefit from first-mover advantages and dominant market positions for conventional and/or renewable energy alike. Energy markets, both in terms of demand and supply developments, are subject to high volatility and unpredictability. Sources of uncertain developments are related to the availability of inputs to energy production, technological progress, socioeconomic developments and geopolitical tensions. In the presence of such uncertainties and given the importance of uninterrupted and affordable access to energy, energy policy has always been faced with the need to grasp the trends and the developments lying ahead and to have valid visions of alternative energy futures. This need has driven the development of a diverse set of energy modeling methods and tools since the second half of the twentieth century. The development of energy models and design alternatives allows scientists and, through expert analysis, policymakers to assess current and future developments, to examine alternative technology, policy and socioeconomic development paths of the future, and to lay the ground for optimal policy decisions for current and future energy systems and markets. The development of energy models in the scientific domain has been driven by the main policy challenges and questions to be addressed at different periods in time. The progress and abundance of works in energy modeling have also been supported by advancements in other scientific fields (e.g., IT, economics, finance), which have supported the deployment of alternative modeling approaches (e.g., computational modeling) and scope (e.g., micro, fuel, technology level and/or macro level). In the era of the first and the second oil price shocks, policy questions were related mainly to the security of supply, price developments of oil and their impact on the sectoral and economic outlook of the countries and regions in the world (Rath-Nagel and Voss, 1981). In times of high price volatility in the energy markets, policy concerns were mainly focused on the impact of price changes in the macro- and the micro-economy and the potential of energy supply diversification of sources. As the environmental impact of energy production and the use of conventional sources has been identified, and the calls for shifts to more environmentally 334

Energy modeling for sustainable policymaking  335 friendly energy sources are intensifying, policymaking and the energy sector are concerned with questions of the optimal share of renewables in the input mix to energy production, socioeconomic cost–benefit analysis of alternative energy production technologies and fuels, and the sectoral, macroeconomic and environmental effects of shifts to new energy technologies. Both policymaking and scientific analysis have come to realize that the energy sector cannot be studied in isolation. The interconnections between the energy sector and the rest of the economy have been identified and mapped since the very early energy modeling exercises. As energy modeling evolves over time, the explicit reference to the energy–economy– environment relationships becomes even more prominent and accepted as a standard practice. Approaches in modeling the energy–economy interaction have been developed with the utilization of two distinct approaches. The first consists of a bottom-up approach, where rich technological characterization of the energy system plays a key role. At the other end are top-down approaches that focus on the macroeconomic represesntation of the energy system interactions with the rest of the economy. In these distinct approaches, energy–economy interactions with the environment have been introduced through environmental analysis and use of appropriate environmental variables to account for the links between human activity and the environment. Following landmark global and regional actions to address climate change, such as the Kyoto Protocol, Paris Agreement and European Green Deal, the energy transition and the shift to green energy have accelerated (particularly in Europe) and are being embraced even in countries and regions that have been resistant to agreeing on actions at various scales, whether global and/or regional (see, for instance, China’s pledge in 2020 to be carbon neutral by 2060 and oil-rich Gulf countries like Saudi Arabia investing in renewable energy projects domestically and abroad). Economies and societies have entered a new era of technological revolution, with green energy technologies developing fast with ever-decreasing production costs. The development of these technologies will inevitably transform the energy sector at an unprecedented level. At the same time, such development introduces significant uncertainty and poses several challenging energy-related questions for policymakers. The questions are related to the optimal renewable energy mix for energy production, the socioeconomic and employment effects of alternative energy forms (at sectoral, regional and global levels), the competitiveness impacts of the green energy transition (i.e., the optimal timing for phasing out traditional energy sources and introducing new energy forms in the energy mix). As economies enter this new technological and energy systems race, consumer attitudes and investors’ preferences and decisions will play a crucial role in future developments. Questions related to investors’ attitudes and decision making in conditions of uncertainty, the effects of retroactive policy changes, and technology learning emerge as being of primary importance for energy modeling and energy policymaking in the present and in the near future. Such behavioral aspects and changes cannot be captured adequately by the energy–economy models developed so far, as no possibility like that is inbuilt in their design. Methodological and conceptual developments to address these limitations look at the usefulness of real option models. Real option models, developed first in the financial domain, are often criticized on the grounds of being limited to a single investor’s perspective and failing to capture market-level phenomena. These symmetrical drawbacks of energy–economy models, which have so far failed to capture micro-behavioral characteristics, and real option analysis that is limited to the microeconomic perspective, indicate potential benefits from merging the two modeling approaches and their comparative advantages. This can lead to the delivery of

336  Handbook of sustainable politics and economics of natural resources integrated energy–economy–environment models that adequately represent the macro- and micro-economic aspects of relevance to energy systems and policymaking. Hourcade et al. (2006) define an ideal energy–economy model as one that addresses three key dimensions: technological explicitness, macroeconomic completeness and microeconomic realism. Keeping this definition in mind, this chapter discusses recent developments in energy modeling and the demand for new methodological approaches to addressing pressing current issues of policy relevance. Some popular models that have provided useful insights for policy design and future directions of interest are examined. This is undertaken while keeping in mind historic perspectives of energy modeling that indicate the omnipresent influence of policy needs on methodological developments in energy modeling. Current policy needs and methods indicate the potential usefulness, possibility and relevance of bridging microeconomic/behavioral effects and sector/energy–economy models. The remainder of this chapter develops as follows. Section 2 reviews from a historical perspective the impact of policy needs on energy modeling developments. Section 3 discusses the theoretical background of conventional modeling frameworks and the possibility of merging a real options behavioral framework with the full range of energy–economy models in the context of renewable energy policy analysis. The last section concludes with useful insights on the priority questions for policy that methodological merging should address.

2

POLICY DRIVERS IN ENERGY MODELING

Energy modeling dates to the 1970s and the first oil crisis. While until then the need for an integrated assessment of the energy future was understood, it was only after the first energy and economic shock that this necessity became an urgency (Rath-Nagel and Voss, 1981). While a proactive policy stance regarding future developments has been a major concern and impetus for developing energy models, several other policy-relevant factors have also affect the development of energy models over time. Energy models of the 1960s and 1970s focused mainly on the single fuel markets and sectors (e.g., demand and supply for oil or electricity) and were mainly addressing policy issues of optimal allocation and transport alternatives (Deam et al., 1973). At the same time, models have also been developed looking at the supply side focusing mainly on optimal supply planning to address demand needs, which has been largely treated as an exogenous variable to the models. These models have been developed with a focus mainly on single sectors and fuels. It was understood early on that these single-sided models were not able to capture the complex relationships between the single sector or fuel source and the rest of the economy. Isolation from the energy and economic systems largely ignored the interaction playing a role in the macroeconomic environment but also the ability to substitute fuels or optimize the energy supply with the utilization of alternative energy technologies and sources. Also, it became apparent that any single sector or fuel approach largely neglects the substitution that may result from price, technology and preference changes. These are particularly important if current energy developments related to environmental considerations are taken into account. From a historical perspective, this recognition of the need to look for wider macroeconomic and inter- and intra-sectoral links led to the development of energy system models that introduced for the first time multi-sector and multi-fuel simultaneous demand and supply analysis (e.g., Agnew, Schrattenholzer and Voss, 1979; Hoffman, 1973). In terms of assistance to

Energy modeling for sustainable policymaking  337 policymaking, the systems approach to the energy sector was important, as for the first time it allowed for consideration of the integrated relationships between the energy sector and the rest of the economy, and also to account for the dynamic changes taking place over time. In an energy system approach the dynamic changes are taken into consideration and policymaking can be based on evidence coming from ‘closer-to-reality’ simplified energy–economy models (Rath-Nagel and Voss, 1981). The integrated approach to energy systems introduced for the first time in the energy modeling work the need to focus on the technological features of the different fuels and energy production options. The issue of technological state and progress, and how this relates to policymaking, has been critical for the development of the energy models. Moving beyond linking the energy sector to the economy, technological modeling is important, both in methodological and empirical terms. In terms of methodology and climate change study, modeling of technological change remains important for policy analysis (Gillingham, Newell and Pizer, 2007). While early approaches have treated technological change as exogenous, recent approaches have aimed for the endogenous representation of technological change (Karkatsoulis et al., 2016). Endogenous technological change implies the incorporation of a feedback mechanism that captures the policy impact on the direction and potentially the level of technological change. As Karkatsoulis et al. (2016) note, studies mostly use R&D-induced and learning-induced technological change. In the first case, innovation is treated as the result of explicit investment in R&D, where pathways include a stock of knowledge and a flow of R&D investment into that stock of knowledge. The stock of knowledge directly and/or indirectly affects technological change, and knowledge is treated as a rival or non-rival and appropriable or non-excludable good. Endogenous technological change induced by R&D builds on the work of Kamien and Schwartz (1968), Binswanger and Ruttan (1978), Aghion and Howitt (1998) and Romer (1990). Knowledge generates free spillovers to other firms that are the primary driver of economic growth (Clarke and Weyant, 2002; Jaffe, Newell and Stavins, 2005). Following the endogenous growth theory, common approaches to endogenous technological change include a knowledge stock directly in the economy-wide production function. The recent waves of energy–economy–environment modeling have been facilitated by improvements and innovations in other related fields of research, such as economics and econometrics, statistics, IT and operations research. Nevertheless, the improvement of energy models and the development of new integrated tools is not an end goal per se. It is the challenging policy and sectoral development decisions that need to be taken for sectoral and macroeconomic development that the construction and development of the model should address. Societies, economies and policymakers have long been concerned with energy security, the cost of energy production, and sectoral forecasts, as energy inputs are core to social well-being and economic activities. While the development of energy models to date has looked mainly at the interaction between sectors and the economy, recent global initiatives in support of green energy deployment and sustainability transition, and scientific calls that urge action to transform the energy system (see, for instance, the International Panel on Climate Change [IPCC] 2018 report on limiting global warming to 1.5°Celsius), call for new directions in energy modeling. These new directions should go beyond single fuel, single sector or merely energy–economy interactions. New modeling developments need to consider the environmental dimension of energy, uncertainty around alternative energy inputs, technology innovation, and investment returns, and socioeconomic and environmental sustainability. Of particular importance for

338  Handbook of sustainable politics and economics of natural resources policymaking remains the adequate modeling of behavioral aspects of green energy. This include investors’ attitudes to green technologies, uncertainty around decarbonization efforts and targets, consumers’ acceptance of new energy forms, transport routes and energy communities, the rise of prosumers and related economic analysis and responses to different policy tools that are used for green energy deployment (e.g., subsidies, taxation).

3

STATE OF THE ART IN ENERGY MODELING

The literature on energy modeling offers a plethora of reviews and classification approaches (for recent comprehensive reviews, see Herbst et al., 2012; Müller, Gardumi and Hülk, 2018). A non-exhaustive summary of reviews of energy–economy models is presented in Table 21.1. In general terms, classification looks at the sectoral level of detail, and technology representation and distinction is made between: (1) technology-rich bottom-up models, where the level of detail of the energy sector and the different energy forms and technologies plays a key part; and (2) models with an economy-wide, macroeconomic view of the energy–economy interactions. In each of these two broad categories of modeling and simulation, different methodological approaches have been developed over time, addressing different end-point goals. These range from optimization and simulation to input–output analysis and general equilibrium. A graphic representation of the different approaches and the general categorization of energy models is summarized in Figure 21.1. In addition to the methodological differences, models vary according to spatial scale and resolution, policymaking reference point (e.g., global CO2 abatement vs national renewable energy policy), policy timeframe (Hourcade et al., 2006) and the ways that models can assist policymaking (Capros et al., 2014). An increasing number of researchers make selective reviews of energy models and propose improvements in different directions. Berglund and Söderholm (2006) examine bottom-up energy models concerning the inclusion of technological development or the so-called learning-by-doing effect. They outline the importance of incorporating the learning curves of new technologies into energy models to reflect reality better and properly assist policymaking. However, because of the computational problems caused by the non-convexity of the learning curve, its introduction to the models is hindered, and only a few models include endogenous (adoption-driven) technology development, such as MESSAGE, MARKAL, POLES and ERIS. Capros et al. (2014) review and compare the set of models used for European decarbonization pathways analysis. The PRIMES model is highlighted for its microeconomic details. PRIMES incorporates different policy instruments – for example, tradable certificates – that affect agents’ behavior and, consequently, the market equilibrium of energy supply and demand. The GEM-E3 model is a computable general equilibrium model that can capture the effects of different environmental and energy policy instruments, including auctioning and taxes. The NEMESIS model is an econometric model that, inter alia, can be used to analyze the impact of different policies on research and innovation. The TIMES-PanEU model is technologically oriented and characterized by a thorough industrial subdivision and a great degree of detail, and therefore it is used for emission-reduction potential analysis across individual sectors and subsectors. Another technology-oriented model is GAINS, which is a bottom-up integrated assessment model that has been used for, among other things, policy design and planning processes. The Green-X model specifically focuses on the analysis of

Focus/Highlights

Technology learning curve

European decarbonization pathways

Open science

Nexus concept

Choice of spatial clustering

Inclusion of socio-technical perspective

Berglund and Söderholm (2006)

Capros et al. (2014)

Hilpert et al. (2018)

Brouwer et al. (2018)

Siala and Mahfouz (2019)

Bolwig et al. (2019)

Parameters of Review

(3) Microeconomic element

(1) Open science (free of charge; open license)

(6) Emissions analysis extent

(5) Technology variety

(3) Functionality (economic dispatch, investment planning, power

OSeMOSYS

System dynamics modeling

urbs

(2) Main topics

OSeMOSYS, MAgPIE-LPJmL

–

–

(6) Key gaps in addressing the Nexus

(5) Nexus components

(4) Energy dimension

(3) Geographic coverage

(1) Model type

E3ME-FIT, MAGNET, CAPRI, IMAGE,

flow, unit commitment, sector coupling)

of accuracy, multi-purpose toolbox)

v0.7, calliope v0.5.3, PyPSA v0.12 and

TIMES, MESSAGE-III, oemof v0.2, urbs (2) Concept (high-level language, generic data model, flexible level

WASP IV, EnergyPlan v12, MARKAL/

(2) Model type

GAINS (4) Policy instruments

(1) Application

NEMESIS, WorldScan, Green-X, and

(3) Main findings and implications

exogenous)

(2) Details of learning curve modeling (factors, endogenous/

PRIMES, GEM-E3, TIMES-PanEu,

ERIS

MESSAGE, GENIE, MARKAL, POLES, (1) Model features

Models Reviewed/Used

Summary of selected review studies of energy–economy models

Study Authors

Table 21.1

Energy modeling for sustainable policymaking  339

340  Handbook of sustainable politics and economics of natural resources

Figure 21.1

Methodological classification of energy–economy models

renewable energy diffusion and its costs. The effect of different policy support instruments can be evaluated with this model. Finally, the WorldScan computable general equilibrium model is designed to evaluate the economic impacts of climate policy. Hilpert et al. (2018) discuss energy system modeling practices in the context of open science. A review of selected models showed that some of them are free of charge and only a handful have an open license, while a single modeling framework, suggested by the authors themselves, allows public collaborative development of the model. Brouwer et al. (2018) call for the embedding of the Nexus concept into energy modeling. This concept considers, in addition to energy, the flows of natural resources such as water and food, allowing for their interrelations to be accounted for, and ensuring a better fit with paradigms such as circular economy and sustainable development. The models that to some extent include the Nexus concept are: (1) E3ME-FIT model used for EU policy assessment; (2) the MAGNET model that assesses the impact of climate change on agriculture across the globe (it also serves as a part of IMAGE, an integrated model of the long-term interactions of economy, society and the biosphere); (3) CAPRI, an agricultural–economic model used for EU policy assessment; (4) OSeMOSYS, an open-source model that combines the assessment of energy, climate, land use and water resources; and (5) the MAgPIE-LPJmL model that optimizes land use. Siala and Mahfouz (2019) demonstrate that the choice of spatial clustering in energy modeling – for example, administrative divisions vs clustering based on resource availability – affects the share of renewable energy technology in the future electricity mix, as well as the geographical distribution of power plants. Since many energy models are designed to work with country-level input data, their results may be distorted for policymaking. Bolwig et al. (2019) call for the inclusion of socio-technical perspectives into energy transition modeling by enriching it with such system dynamics elements as reinforcement feedback loops, learning processes and inertia. In their complex interlinked model, technological development is affected not only by R&D and the policy regime, but also by the environmental awareness in society. Hourcade et al. (2006) argue that an ideal energy–economy model should have technological explicitness, complete representation of the macroeconomy and simultaneous realistic representation of the microeconomy. Under these preconditions, both conventional bottom-up and top-down models are found to fall short. Several hybrid approaches attempt to address

Energy modeling for sustainable policymaking  341 the issue of complete energy models, proposing alternative methodological advancements that aim mainly at the better representation of behavioral effects under uncertainty (microeconomic realism). With the energy transition posing new policy and modeling challenges, recent developments have been looking at inputs from other disciplines, like finance, that could enrich the behavioral representation in energy models. Pfenninger, Hawkes and Keirstead (2014) outline the importance of including behavioral aspects in energy models. Indeed, many energy–economy models are built under the assumption of perfect foresight and no uncertainty concerning policy, technological change, or market conditions (Berglund and Söderholm, 2006). In contrast, developments in other disciplines, like finance, offer promising methodological alternatives. A prominent example is the real options framework. Real options analysis originates from finance, from the corporate finance domain, with its practice of investment valuation. The traditional net present value (NPV) investment analysis has proven to be too simplistic and limited, not being able to capture the uncertainty surrounding large and complex investment projects. Addressing this shortfall, a more sophisticated real options analysis has started to spread into academia (Amram and Kulatilaka, 1998; Trigeorgis, 1995) and the corporate world (Block, 2007; Graham and Harvey, 2001; Ryan and Ryan, 2002). In contrast to the traditional NPV analysis, the real options approach incorporates uncertainty and recognizes the value of managerial flexibility or, in other words, the ability to steer a project in the stream of unfolding uncertainty. These flexibilities could generally apply to any investment project, being used for instance to postpone, stage or abandon investment, or it could be, for example, technology specific, such as switching inputs in flex-fuel cars (Trigeorgis, 1995). Although some hybrid models claim to be improved in terms of microeconomic realism (Hourcade et al., 2006; Pfenninger et al., 2014), the effects observed in real options modeling are typically overlooked in energy–economy models. A summary of the existing reviews of real options studies applied to the energy field is presented in Table 21.2. There are a variety of methods in real options valuation, the choice of which depends on the aim of the analysis, the real options available (Kozlova, 2017) and the type of uncertainty faced by the problem (Collan, Haahtela and Kyläheiko, 2016). Inherited from the financial options valuation, real options are often modeled by systems of partial differential equations (Dixit and Pindyck, 1994). Such an analysis, when it allows for an analytical solution, reveals all the system’s interdependencies and enables generalized conclusions to be made on investors’ behavior – for instance, whether there is an incentive to postpone the investment and how it depends on different parameters (see, e.g., Bøckman et al., 2008; Boomsma and Linnerud, 2015; Kozlova, Fleten and Hagspiel, 2019). However, such models must be kept fairly simple to enable an analytical solution. Therefore, they are limited by a rather simplified representation of reality that includes a single or a few uncertainty sources and real options. These limitations are overcome in simulation-based modeling that can include techniques such as Monte Carlo simulation (Mathews, Datar and Johnson, 2007), optimization (Bashiri, Davison and Lawryshyn, 2018), and system dynamics (Jeon, Lee and Shin, 2015). Other methodological approaches exist in real options analysis; however, they are outside the scope of this chapter (see, for example, Kozlova, 2017). Most of the real options studies, due to the nature of the method (investment valuation), take a single investor perspective. Although conclusions from such studies can be generalized, such models cannot reflect the development of an entire market or sector. Nevertheless, some real options studies opt for game-theoretic approaches to study investment behavior in a multi-agent setting (Trigeorgis and Tsekrekos, 2018). However, Trigeorgis and Tsekrekos’s

Technology-specific custom real

options

Empirical studies confirming that

real-world investors’ behavior

Martínez Ceseña, Mutale and

Rivas-Dávalos (2013)

Fleten et al. (2016); Linnerud,

Andersson and Fleten (2014)

Operations research, all application 164 areas

real options approach

design

101

22

–

41

Reviewed

Number of Studies

Coverage and theory expansion of

and policy

Flexibility in project and policy

Kozlova (2017)

Trigeorgis and Tsekrekos (2018)

Renewable energy power projects

Emerging economies

Renewable energy

Norway

Small hydro-power plants in

Electricity generation projects

Scope

Kim, Park and Kim (2017)

follows the real options logic

Focus/Highlights

Summary of selected real options papers

Study

Table 21.2

(6) Information (complete, incomplete)

(5) Empirical or applied

(4) theory advancement

energy etc.)

(3) Application area (generic, R&D, manufacturing, logistics,

(2) Journal

(1) Model context (single firm, game-theoretic setting)

(7) Uncertainty modeling approach

(6) Sources of uncertainty

(5) Mathematical tool

(4) Real option type

(3) Technology type

(2) Analysis focus (project, policy)

(1) Case country

(3) Uncertainty type

(2) Technology type

(1) Case country

–

(4) Mathematical tool

(3) Sources of uncertainty

(planning, operation)

(2) Stage of project at which real option is recognized

(1) Technology type

Parameters of Review

342  Handbook of sustainable politics and economics of natural resources

Energy modeling for sustainable policymaking  343 review (2018) identified only six studies in the category ‘Energy, Natural Resources and Environment’ that approached the problem with a multi-agent game-theoretical modeling concept. The ‘multi-agent’ term in these works is exhaustively limited to two-firm setting or duopoly and is employed to study the effects of the competitive environment. The review of operations research literature that utilizes the real options approach (Trigeorgis and Tsekrekos, 2018) outlines ongoing intensive work on expanding the theoretical framework, invites researchers to develop further and use more extensively numerical tools such as Monte Carlo simulations for more realistic applications, and encourages more empirical work. Concerning the latter, a series of empirical studies has been done in the energy field (Fleten et al., 2016; Linnerud et al., 2014) that demonstrate that the real options framework reflects the observed investment behavior. Martínez Ceseña et al. (2013), in their review of the real options approach applied to electricity generation projects, urge business experts to collaborate with engineers to create technology-specific custom real options to enable flexibility in the very design of projects. Kim et al. (2017) focus on emerging economies, emphasizing the high volatility and risk of energy investments, which makes these projects perfect candidates for the real options framework. Kozlova (2017), in her review of renewable energy studies that used real options as the methodological framework, highlights that this approach, being able to shed light on investment behavior, is often used to analyze and optimize renewable energy support policies. The tradeoff between policy effectiveness (in terms of technology promotion) and cost efficiency (a burden to rate payers) is commonly discussed in such studies. The feed-in tariff scheme has been shown to be more effective, while auctions and renewable energy certificate trading perform better in terms of cost efficiency. Comprehensive development in the renewable energy support policy domain goes beyond its analysis into its design. It is the introduction of real options in the design of the support policy that allows investors to gain extra flexibility and, consequently, value for their projects (Balibrea-Iniesta, Sánchez-Soliño and Lara-Galera, 2015; Yu et al., 2006). Rios, Blanco and Olsina (2019) attempt to integrate real options logic into energy–economy models. Their research focuses on the phenomenon of construction cycles in generation capacity after power market liberalization. Such a cyclical behavior of power markets, despite proven empirically, has not been captured by energy–economy models. The authors build a system dynamics model, where investors have the freedom to delay the investment. The timing of the decision is based on the comparison of the investment value if exercised now and the continuation value if it is postponed. The simulation starts at market equilibrium in zero-profit conditions. Such a situation proclaims that the continuation value is greater than the exercise value, so the investors choose to wait. Several years later, the reserve margin (available capacity minus peak demand) drops, prices spike, the inequality of values flips and immediate investment becomes more attractive than waiting. Growth in the generating capacity increases the reserve margin; this leads to a drop in the electricity price, and the continuation value is again exceeding the exercise value, putting the wave of new investment on hold. Thus, the market cycles arise as a natural model output when the real options theory is imbedded into the investment behavior of an energy–economy model. The model of Rios et al. (2019) is only a start in this important direction and has many limitations. Nevertheless, it is of crucial importance in the energy systems modeling realm, and it can provide a basis for delivering new insights in renewable energy policy analysis as well.

344  Handbook of sustainable politics and economics of natural resources As discussed above, in the Green-X model, investment decisions are influenced by external factors only through the discount rate. For instance, investment timing is defined solely by when a particular technology becomes profitable, considering a risk premium entering through the discount rate. In this model, investors are not able to wait if a project is profitable now, even though it might be expected to be more profitable in the future. The real option element of the hybrid model by Rios et al. (2019) would be of use in Green-X to simulate proper investment behavior and reactions to policy. The Green-X model also incorporates the possibility of changing a policy type along the simulation run by a user. However, again the regulatory risk enters investment behavior through the discount rate premium. If the real options-based behavior is implemented, it might lead to a more realistic investor reaction with major delays to get better information and gain confidence in a new regulatory regime. A technological development phenomenon in the renewable energy context deserves separate attention. Berglund and Söderholm (2006) conduct a comprehensive review in that respect and highlight the importance of modeling technology change as an endogenous process. The authors also emphasize that neither top-down nor bottom-up models can adequately and fully capture technology diffusion processes. The models that undergo detailed scrutiny from these authors include MESSAGE, GENIE, MARKAL, POLES and ERIS. Another model that incorporates technology learning and specifically focuses on renewable energy is Green-X (Capros et al., 2014). Nevertheless, all these models lack the effect that is further induced by technological development. All real options studies that incorporate technology learning into their models unanimously conclude that the anticipation of the future cost drop creates an incentive to postpone investment (Fuss and Szolgayová, 2010; Kumbaroğlu, Madlener and Demirel, 2008; Torani, Rausser and Zilberman, 2016; Welling, 2016). Indeed, from a single investor point of view, why would one buy solar panels today if tomorrow their price is expected to drop? This postponing effect has not been studied systematically to enable a full understanding of how different renewable energy support mechanisms shape it (Kozlova, 2017). However, it is reasonable to speculate that, for example, fixed feed-in tariffs would intensify this effect, providing the same absolute revenues to projects built in different years and so at different capital costs, thereby creating an incentive for investors to wait and thus jeopardizing the efficiency of the policy. Since bottom-up energy models are often used to assess the effects of different public policies (Berglund and Söderholm, 2006), missing this effect out would generate overestimated policy effectiveness results in terms of new investments and technology diffusion.

4

CONCLUDING REMARKS

The overview of the developments in energy modeling shows the richness in methodology and scope of relevant policy questions addressed. Models have been able to assist policymaking with regard to long-lasting issues of concern, such as security of energy supply, energy demand and production, transport, distribution, end-user technology and macroeconomic and environmental effects. Considering sustainability and the green energy transition, these policy issues remain relevant. Traditionally, the issue of security of energy supply was linked with oil and gas import dependence, depletion of conventional sources (hydrocarbons) and geopolitical factors that could impact on the transition of fuels. With increasing climate change concerns, socio-demographic shocks (like migration or climate change refugees) and green investment

Energy modeling for sustainable policymaking  345 shifts, energy supply assessment through modeling exercises needs to be updated with a focus on the uncertainty surrounding these developments. With regard to energy production, transport, distribution and end-user technology there is a range of features and updates that should be included in the energy models to be developed. These relate to inclusion in the mix of diverse and new energy forms (offshore wind, ocean wave, etc.), development of new energy grids and communities (e.g., energy communities, small independent interconnections) and technologies (smart metering, batteries and storage options). The introduction and large-scale commercialization deployment of these new technologies, their costs and technical parameters and characteristics can also be introduced in the modeling exercise. Yet, this introduction is related to considerable uncertainty streaming from microeconomic and behavioral characteristics. The price determinants, reflecting the marginal cost for producers and marginal benefit for the consumer, of these technologies may be complex and yet not understood well enough to fully capture them in the modeling process. This is another challenge that requires appropriate updating of the energy models with detailed microeconomic and behavioral parameters. In the presence of scientific calls for urgent climate action and regional and global policy initiatives for green energy deployment and sustainability transition, the development of appropriate modeling approaches that can address the particularities and uncertainties related to renewable energy forms and new technologies should become a methodological priority. In this push forward to energy–economy–environment modeling, core traditional energy policy concerns, such as security of supply, employment and macroeconomic effects, remain relevant even under the scope of the green transition. Surely for renewable energy policymaking assistance, a model should incorporate details in renewable energy technologies and different support mechanisms, as well as investors’ behavior, to appropriately capture policy effects. What appears as a demanding development in this regard is the introduction of behavioral analysis that better characterizes risk and uncertainty in people’s attitudes towards new technologies. If the modeling developments can provide a better characterization and representation of these matters, this will significantly address policy needs related to the acceptance and time-deployment/fulfillment of the energy transition and sustainable operations at sectoral (energy), economy (micro- and macroeconomy) and environmental level. Ongoing work in energy–economy–environment modeling is considering these extensions. What this review indicates as still missing in the field is the introduction of the sustainability parameters and alternative financing options – that is, extensions in the representation of the financial sector and the novel financing tools that can be used for sustainability and the green energy transition. Future work in energy modeling could also consider questions on the definition and measures of welfare, economic growth and development. Moving beyond gross domestic product and economic growth, other social and environmental parameters may need to enter the models. These can include, for instance, biodiversity or health indices. Considerable uncertainty exists with the future impact of energy efficiency and green energy production to such measures and indices, and future work in the field could enrich scientific knowledge and the insights offered by modeling.

ACKNOWLEDGMENTS This research was supported in part by grant number 16-8940 from the Foundation of Economic Education, Finland.

346  Handbook of sustainable politics and economics of natural resources

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Energy modeling for sustainable policymaking  347 Hoffman, K.C. (1973). A unified framework for energy system planning. In M. Searl (ed.), Energy Modeling: Art Science Practice. Washington, DC: Resources for the Future Press, pp. 150–62. Hourcade, J., Jaccard, M., Bataille, C. and Ghersi, F. (2006). Hybrid modeling: new answers to old challenges – introduction to the special issue of The Energy Journal. The Energy Journal, 27, 1–11. International Panel on Climate Change (IPCC) (2018). Special Report: Global Warming of 1.5°C. Accessed 5 August 2021 at https://​www​.ipcc​.ch/​sr15/​. Jaffe, A., Newell, R. and Stavins, R. (2005). A tale of two market failures: technology and environmental policy. Ecological Economics 54(2–3), 167–74. Jeon, C., Lee, J. and Shin, J. (2015). Optimal subsidy estimation method using system dynamics and the real option model: photovoltaic technology case. Applied Energy, 142, 33–43. Kamien, M.I. and N.L. Schwartz (1968). Optimal induced technical change. Econometrica, 36, 1–17. Karkatsoulis, P., Capros, P. and Fragkos, P. et al. (2016). First-mover advantages of the European Union’s climate change mitigation strategy. International Journal of Energy Research, 40(6), 814–30. Kim, K., Park, H. and Kim, H. (2017). Real options analysis for renewable energy investment decisions in developing countries. Renewable and Sustainable Energy Reviews, 75, 918–26. Kozlova, M. (2017). Real option valuation in renewable energy literature: research focus, trends and design. Renewable and Sustainable Energy Reviews, 80, 180–96. Kozlova, M., Fleten, S. and Hagspiel, V. (2019). Investment timing and capacity choice under rate-of-return regulation for renewable energy support. Energy, 174(C), 591–601. Kumbaroğlu, G., Madlener, R. and Demirel, M. (2008). A real options evaluation model for the diffusion prospects of new renewable power generation technologies. Energy Economics, 30(4), 1882–908. Linnerud, K., Andersson, A.M. and Fleten, S. (2014). Investment timing under uncertain renewable energy policy: an empirical study of small hydropower projects. Energy, 78, 154–64. Martínez Ceseña, E.A., Mutale, J. and Rivas-Dávalos, F. (2013). Real options theory applied to electricity generation projects: a review. Renewable and Sustainable Energy Reviews, 19, 573–81. Mathews, S., Datar, V. and Johnson, B. (2007). A practical method for valuing real options: the Boeing approach. Journal of Applied Corporate Finance, 19(2), 95–104. Müller, B., Gardumi, F. and Hülk, L. (2018). Comprehensive representation of models for energy system analyses: insights from the Energy Modelling Platform for Europe (EMP-E) 2017. Energy Strategy Reviews, 21, 82–7. Pfenninger, S., Hawkes, A. and Keirstead, J. (2014). Energy systems modeling for twenty-first century energy challenges. Renewable and Sustainable Energy Reviews, 33, 74–86. Rath-Nagel, S. and Voss, A. (1981). Energy models for planning and policy assessment. European Journal of Operational Research, 8(2), 99–114. Rios, D., Blanco, G. and Olsina, F. (2019). Integrating real options analysis with long-term electricity market models. Energy Economics, 80(C), 188–201. Romer, P. (1990). Endogenous technological change. Journal of Political Economy, 98(5), S71–S102. Ryan, P.A. and Ryan, G.P. (2002). Capital budgeting practices of the Fortune 1000: how have things changed. Journal of Business and Management, 8(4), 355–64. Siala, K. and Mahfouz, M.Y. (2019). Impact of the choice of regions on energy system models. Energy Strategy Reviews, 25, 75–85. Torani, K., Rausser, G. and Zilberman, D. (2016). Innovation subsidies versus consumer subsidies: a real options analysis of solar energy. Energy Policy, 92, 255–69. Trigeorgis, L. (1995). Real Options: An Overview. Westport, CT: Praeger. Trigeorgis, L. and Tsekrekos, A.E. (2018). Real options in operations research: a review. European Journal of Operational Research, 270(1), 1–24. Welling, A. (2016). The paradox effects of uncertainty and flexibility on investment in renewables under governmental support. European Journal of Operational Research, 250(3), 1016–28. Yu, W., Sheblé, G.B., Lopes, J.A.P. and Matos, M.A. (2006). Valuation of switchable tariff for wind energy. Electric Power Systems Research, 76(5), 382–8.

22. Ambiguity in financing corporate mitigation policies Elettra Agliardi and Willem Spanjers

1 INTRODUCTION Climate change is one of the most significant and complex challenges facing the world this century. The Intergovernmental Panel on Climate Change (IPCC) released the 2018 Special Report, Global Warming of 1.5°C, warning that urgent decarbonization actions are needed to limit temperature change to a maximum of 1.5°C relative to the pre-industrial period to avoid detrimental impacts on the economy and the natural environment (IPCC, 2018). Significant financial resources will be needed to sustain the transition towards a low-carbon economy. In the above-mentioned 2018 Special Report, the IPCC provides an estimate of the additional annual amount of investment in the energy sector needed to avoid the severe consequences of climate change. In broad terms, limiting warming to 1.5°C requires an annual investment of $1.46–3.51 trillion (US$2010) in energy supply and $640–910 billion in energy demand between 2016 and 2050. The United Nations Framework Convention on Climate Change (UNFCCC) estimates that $90 trillion in investments are needed in the next 15 years to build up sustainable infrastructure in all sectors, from energy to public transportation, buildings, water supply and sanitation. This implies that substantial capital flows must be redirected to ‘green’ activities, to guarantee the means for implementing the options and strategies to mitigate climate change. If policymakers implement policies and provide incentives for the transition to a low-carbon economy, the financial system can play a complementary role and help achieve these goals by mobilizing the resources needed for investment in climate mitigation and adaptation. The past decade has shown signs of increasing awareness in many areas of the financial system and effective mobilization of capital in green activities.1 While sustainable investment started with equities, investor demand and policy support spurred the issuance of green bonds. Banks started adjusting their lending policies – for example, by giving discounts on loans for sustainable projects. Various areas in sustainable finance are expanding, such as complex collateralized loan obligations (Agliardi, 2021), loan and local currency guarantees and subordinated debt. However, this new sustainable financial system does not seem to be developing fast enough for the world ‘to stop runaway climate change’ (Carney, 2019, p. 12). 1 In December 2017, the Central Banks and Supervisors Network for Greening the Financial System (NGFS, 2019) was created to develop climate risk management in the financial sector and mobilize funds supporting the transition toward a sustainable economy. In 2018, the EU Action Plan ‘Financing Sustainable Growth’ was developed to reorient capital flows, make the financial sector more climate resilient, and facilitate transparency, including the creation of a taxonomy, enforcing mandatory disclosure and developing prudential requirements. Recently, a Regulation of the European Parliament and of the Council was proposed on the establishment of a framework to facilitate sustainable investment. A Member States Expert Group on Sustainable Finance has also been formed.

348

Ambiguity in financing corporate mitigation policies  349 First, there are concerns over a clear definition of ‘greenness’, the environmental integrity of green instruments and the risks of ‘greenwashing’.2 This may occur in the context of green advertising and communication whenever some claims are either deceptive or ambiguous,3 promoting products by falsely overstating the green attributes of the related financed projects (Amel-Zadeh, 2018). Second, uncertainty may result from unclear regulatory frameworks, insufficiently informed reporting and generic monitoring and deep or radical uncertainty regarding the policies that will be implemented, their timing and their impact. The lack of a harmonized regulatory framework and the plethora of concurrent taxonomies of activities and assets that are defined as ‘green’ may affect the propensity of firms to invest in environmentally friendly projects. Third, the unpredictable emergence of new low-carbon technologies or changes in preferences and lifestyles contributes to the uncertainty that characterizes climate change. In some cases, a precise assessment of the beneficial effects of ‘greenness’ is difficult to establish, because green projects tend to require new technologies, often with long construction and operation periods, so reliable data on their effectiveness may be unavailable. When projects of doubtful environmental value are financed, this may shake market confidence in these financial instruments. Thus, ambiguity may make investors sceptical about green claims. Scenario analyses may be a useful tool to represent plausible future pathways under uncertainty (Bolton et al., 2020). However, ‘scenarios are not associated with probabilities, nor do they represent an exhaustive set of potential outcomes or actual forecasts’ (Trucost ESG Analysis, 2019, p. 39), and their results are subject to a high degree of uncertainty. Although the financial market has the potential to play a crucial role in the low-carbon transition by unlocking new – and redirecting existing – investment flows toward green projects, reducing the ambiguity of environmental integrity and mitigating the risk of the perception of ineffective sustainability labelling remain a challenge (EU, 2019). To the best of our knowledge, the effects of deep uncertainty on issuers’ and investors’ green mandates have not been studied yet. Our model, although stylized, is the first to introduce uncertainty about the cash flows of a firm in the form of ambiguity regarding the effectiveness of the environmental projects that are financed, and regarding the investors’ green perception in portfolio choices. Regulatory policies and appropriate supervisory assessments may help to reduce ambiguity. A number of initiatives have been put forth to set standards and provide a taxonomy of green assets. The Loan Market Association launched the Green Loan Principles (GLP), which build upon the Green Bond Principles (GBP) of the International Capital Market Association (ICMA), setting voluntary guidelines to promote transparency and disclosure, along with reviewers’ opinions. The Climate Bond Initiative (CBI) also provides an extensive taxonomy and certification for green bonds. While certification can create extra costs, it may help to assess bonds’ use of proceeds and therefore boost engagement from investors who are willing to incorporate green goals and sustainability criteria into their strategies. Currently, a few EU 2 Greenwashing refers to the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly, when in fact it does not meet basic environmental standards (EU, 2019). 3 An example of a recent case is ENI, the biggest Italian multi-utility in the energy sector, which was fined EUR5 billion by Italy’s Competition and Market Authority because of ‘misleading commercial practice’ in relation to ‘ENIdiesel+’, which was advertised from 2016 to 2019. The decision refers to their advertisement of a new product, ‘diesel bio, green, renewable and reducing 40% GHGs’, which turned out to be a fraudulent message.

350  Handbook of sustainable politics and economics of natural resources member states have labelling schemes in place. But these schemes build on different taxonomies for classifying environmentally sustainable economic activities. The absence of uniform criteria increases uncertainty and may create a significant disincentive for economic operators in the financial markets for sustainable investment. The objective of this chapter is to focus on green bonds,4 which are the most widespread instruments in green finance and are by now recognized as an important tool to raise finance for climate change solutions and speed up the brown-to-green transition. The CBI stated that from 2008 (the year when green bonds were first launched) to 2018, dozens of institutions and several governments issued more than $521 billion in green bonds. In 2019, new certified green bond issues topped $250 billion globally, and more than 5000 green bond issues are estimated to have come to market (CBI, 2019). The green bond label can be applied to any debt format, including private placement, securitization and covered bond, as well as labelled green loans that comply with the GBP or GLP. Green bonds could eventually raise trillions of US dollars in climate-related projects, including renewable energy, energy efficiency and ecosystem protection and restoration. We study the determinants of credit spreads and the optimal allocation of bonds – green vs brown – from the point of view both of the issuer and of the investor. We use a simple setting with ambiguity, in a way that has not been studied in the literature before. In particular, in Section 3 we analyse how ambiguity affects the default decisions of the issuer (Outcomes I, II and IV), the so-called ‘greenium’ (defined as the difference between the yield on a green bond and the yield on a similar conventional bond) (Outcomes III and V) and, in Section 4, its impact on investors’ optimal portfolio decisions (Outcome VI). Before the basic model is introduced, Section 2 provides a brief survey of the different approaches to ambiguity in the literature. We consider these approaches more appropriate than conventional risk for understanding the problems of uncertainty in the context of climate change. Finally, Section 5 concludes.

2

MODELLING AMBIGUITY

Uncertainty comes in many different shapes and forms, ranging from the familiar form of risk on the one extreme to the potential for unimaginable outcomes to occur on the other. The different shades of uncertainty require different ways of modelling, as do the different ways in which the uncertainty feeds into decision processes and affects decisions and outcomes. For a discussion on the ways in which different forms of uncertainty relate to various aspects of climate change see, for example, Heal and Millner (2014). Facing uncertainty, modelling choices need to be made regarding its (mathematical) representation, and how this affects decision making. Objective risk is represented by a random

4 Green bonds are ‘any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible Green Projects’ (ICMA, 2021, p. 3). Their proceeds must be used to fund environmental or climate-friendly projects, accomplishing, for example, the objectives specified in the recent EU taxonomy: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems (EU, 2019).

Ambiguity in financing corporate mitigation policies  351 variable, specifying a probability distribution over potential outcomes. If the decision making now follows a small number of axioms, evaluations allow for an expected utility representation (Von Neumann and Morgenstern, 1947). The problem remains that reasonable people may evaluate uncertain outcomes differently. The more general the description of uncertainty, the wider the range of potential disagreements. For example, when allowing for subjective probability estimates, rather than restricting probabilities to being ‘objective’, disagreement may arise about which probabilities to apply, over and above how to evaluate outcomes if and when they are received (Anscombe and Aumann, 1963; Savage, 1954). There are a number of sources that provide surveys of the different approaches to modelling uncertainty, their more or less subtle differences, how they affect decision making, and the conditions in which their mathematical representations are equivalent. For a broader context for the discussion of uncertainty below see, for example, Etner, Jeleve and Tallon (2009) and Machina and Siniscalchi (2014). A key conceptual difference in modelling uncertainty is between aspects that can be represented by objective or subjective probabilities and aspects for which this is not possible. The latter is the case when scenarios can be described clearly, but the information on which to base probability estimates is less than solid. This is reflected in the Ellsberg paradox (Ellsberg, 1961); in the same paper a plausible ad hoc solution to the problem is provided. It is suggested that uncertain situations are evaluated on the basis of a convex combination of the expected utility values of the probability estimate and of the ‘worst case’ probability distribution that may plausibly apply. Similarly, there may be a number of probability distributions that the decision maker considers plausible, with no reason to favour some probability distributions over others. This can be described by a set of ‘plausible’ probability distributions, rather than a single one. In line with Ellsberg’s model, the ‘prudent’ or ‘pessimistic’ decision maker evaluates specific situations according to the expected utility of their respective ‘worst-case’ plausible probability distribution – for example, the distribution that yields the lowest expected utility. This is the multiple-priors (or maxmin) expected utility approach, as presented in Gilboa and Schmeidler (1989). The logic of the multiple-priors approach raises the possibility that a decision maker considers some of the plausible probability distributions to be more relevant than others. In the approach of second-order beliefs, the decision maker has pre-specified beliefs about the relevance of the distributions in the set of priors, as well as a separate utility index with respect to these second-order beliefs. The ‘risk attitude’ regarding the second-order beliefs is now interpreted as the ambiguity attitude. Depending on the shape of the second-order beliefs over the set of priors and the second-order utility index, different types of evaluation of uncertain situations arise (the ‘smooth preferences’ model; Klibanoff, Marinacci and Mukerji, 2005). Maxmin expected utility is obtained as a limit case. A different version of uncertainty occurs when solid information only imperfectly maps into the aspects of the problem that the decision maker is interested in (Mukerji, 1997). In line theories of ‘fuzziness’, these situations may be represented by means of ‘minimum probabilities’ or their generalization capacities. Since they may fail to be additive, these capacities are also referred to as ‘non-additive probabilities’. The mismatch between the available and required knowledge creates gaps in the decision maker’s information. It provides room for the emotions of hope and fear, leaving the decision maker caught between hoping for the best and

352  Handbook of sustainable politics and economics of natural resources fearing the worst. This is captured in the Choquet expected utility approach, which restricts expected utility’s independence axiom to uncertain outcomes that have their anchors for hope and fear in the same states of nature (Chateauneuf, Eichberger and Grant, 2007; Gilboa, 1987; Schmeidler, 1989). Ghirardato, Maccheroni and Marinacci (2004) introduce combinations of optimism and pessimism to the multiple-priors model. In line with the intuition of the α -criterion of Arrow and Hurwicz, they extend maxmin expected utility by α -maxmin expected utility, where an action is valued as α times the lowest expected utility plus (1 – α ) times the highest expected utility value over the set of priors. Sometimes scientific evidence is inconclusive as to which theory or theories to focus on and which to disregard. In the robust control approach, a particular theory is taken as the point of departure, but competing theories are taken into account (Hansen and Sargent, 2001, 2008). Decisions are evaluated on the basis of the preferred theory, adding a ‘cost’ reflecting the differences with competing theories. This approach is in line with ‘κ-ignorance’ as in Chen and Epstein (2002) and a special case of ‘variational preferences’ as in Maccheroni, Marinacci and Rustichini (2006). When comparing a status quo and an alternative for multiple priors, a cautious or prudent approach abandons the status quo for the alternative only if the latter is at least as good for each of the priors. This inertia criterion may result in two alternatives being deemed incomparable, as one may be better for some of the priors, while the alternative may be better for others. Such incompleteness of preferences, referred to as ‘Bewley incompleteness’ is introduced in Bewley (1986). The interpretation of this procedure as a unanimity rule regarding potentially conflicting expert opinions is provided in Gilboa et al. (2010). Faro (2015) weakens the unanimity rule to a weighted unanimity rule for which dissent below a threshold value is disregarded. Although the perspectives and details of the above-mentioned approaches to uncertainty are different, each of the approaches can be benchmarked against the multiple priors. The connection between Choquet expected utility and multiple priors is discussed in Schmeidler (1989); the connection between Bewley incompleteness and multiple priors in Gilboa et al. (2010). For smooth preferences, the multiple-priors representation is obtained as a limit case, as shown in Klibanoff et al. (2005). Variational preferences, as discussed in Maccheroni et al. (2006), provide a framework that encompasses robust control and multiple priors. The concept of variational Bewley preferences, as introduced in Faro (2015), encompasses Bewley incompleteness as well as different forms of model uncertainty, including those represented by variational preferences. For equivalent representations, their conceptual differences do not affect the core mathematical analysis. Rather, their impact is restricted to the interpretation of the results. By and large, the same holds for similar representations. This will also apply to the analysis in this chapter.

Ambiguity in financing corporate mitigation policies  353

3

THE MODEL

Let us consider a firm with assets in place that generate uncertain earnings before interest and taxes (EBIT) described by a stochastic process of the form: dVt  Vt dt   Vt dWt ,(22.1) where Wt is a standard Wiener process with respect to an assigned filtration I t 0 , µ is the growth rate, and σ is volatility. The current technology is ‘brown’ – that is, it generates environmental damage. We suppose that the environmental damage is internalized and eventually results in a penalty, reducing firm earnings proportionally by p. Here p ∈ [0,1], where p < 1 means that not all damage is internalized by the firm, either because it cannot be entirely recognized or because the social impact is underweighted. Let D0 denote the damage per unit of production. We build on the setting of Agliardi and Agliardi (2019) to model the firm’s fundamentals. We suppose that the firm may decide to invest in mitigation policies, and thus exercise an investment option to develop a low-carbon or ‘green’ technology. The exercise of this green option is irreversible, but the firm has the flexibility to exercise it at any time. This mitigation policy investment will result in a smaller amount of environmental damage and thus in a substantial reduction of the above-mentioned penalty on earnings. We denote the smaller amount of damage by Dg < D0 . With the brown technology, EBIT is penalized by an amount pVt D0 , while upon exercising the green investment option, the reduction is only pVt Dg . The main assumption in this model is that the firm will finance its green project by issuing a perpetual green bond with a continuous coupon. For simplicity, the firm is managed by equity holders, and they have the option to stop operations and trigger default in an optimal way – that is, maximizing the market value of equity. Let VI denote the level of the fundamental variable V at which it is optimal to issue a green bond, and let V* denote the default threshold – that is, default is triggered whenever V falls below V*. In the case that V falls below V*, then the firm goes bankrupt and the original debt holders take over and obtain the firm’s unlevered assets net of proportional bankruptcy costs. To characterize a green bond, the following features are necessary: (1) all the proceeds from the bond issuance must be used in the pre-specified green project; (2) special reporting, monitoring and accounting procedures are needed to guarantee accomplishment of a Green Standard, as required for certification by the GBP. Both requirements are considered in our model. In fact, we assume that the investment amount equals the bond value at the investment threshold, and that a specific fixed cost, K, must be incurred, representing the total amount of extra costs for certification. Models that involve uncertainty typically characterize parameters with the familiar form of risk. In our setting, this type of uncertainty is described by the dynamics of the risky variable EBIT, following a stochastic process such as a geometric Brownian motion (GBM). However, when dealing with climate change consequences and actions to mitigate them, the nature of uncertainty is not fully characterized by standard risk parameters. As illustrated in Section 2, alternative ways of characterizing uncertainty are more appropriate since uncertainty seems to

354  Handbook of sustainable politics and economics of natural resources be ‘deeper’ than risk. Anderson et al. (2014) discuss three forms of uncertainty: (1) risk, which is the traditional case mentioned above; (2) ambiguity, which is the case where the decision maker is facing incalculable risk and is uncertain about the alternative probability distributions; and (3) misspecification, which is associated with the way in which we use models that are imperfect approximations of the true model. We include both ambiguity and misspecification while preserving the simple framework of a GBM, which is widely used to describe the dynamics of cash flows in real investments and allows us to derive a tool that is tractable enough in various applications. In particular, in Section 3.2. we model ambiguity by means of a Choquet-Brownian motion in continuous time, while in Section 3.4 we model misspecification, with reference to the effectiveness of the environmental damage. 3.1

Ambiguity Frameworks

As we have seen in Section 2, there are different ways to model situations of uncertainty. Although different, these models are closely related and tend to have clear overlaps. In this chapter, it is our aim to emphasize the kind of conclusions that apply to models of uncertainty, rather than to differentiate between them. We use a model where a single parameter combines the level of ambiguity and the decision maker’s attitude towards it. In this setting, the different approaches towards uncertainty reduce to different interpretations of the ambiguity parameter. We model ambiguity using a Choquet-Brownian motion (Kast and Lapied, 2010a; Kast, Lapied and Roubaud, 2014). Like the Brownian motion, this differential stochastic process is obtained as the limit of a discounted discrete stochastic process, which at each point in time displays either an ‘up’ or a ‘down’ movement. But while at each point in time a Brownian motion is based on a probability distribution, the Choquet-Brownian motion is based on capacity, which also represents the ambiguity as perceived by the decision maker in combination with their ambiguity attitude. The decision maker now does not discount the expected values with respect to probabilities at each point of time, but rather the Choquet expected values with respect to the capacity. The resulting process is dynamically consistent and therefore can be represented by a standard Brownian motion, just like the weights assigned to co-monotonic acts can be represented by a probability distribution. That is to say, the Choquet-Brownian motion can be represented as a re-parametrization of a Brownian motion with an additional parameter c relating to the ambiguity perceived by the decision maker. The comparative static analysis with respect to this parameter c compares the outcomes of the associated re-parametrized standard Brownian motions. The value of this parameter c is between 0 and 1, and the value c = 1/2 represents the situation where there is no distortion due to ambiguity, because of the absence of ambiguity and/ or the ambiguity having no impact because the decision maker is indifferent to its presence. Values of c between 0 and 1/2 characterize situations of ambiguity aversion. These are situations in which the decision maker has a pessimistic outlook and acts cautiously in situations with ambiguity, putting additional weight on the worst-case outcome. For values of c between 1/2 and 1, the opposite holds. For these values, the decision maker has an optimistic outlook and behaves exuberantly, putting additional weight on the best-case outcome. The ambiguity parameter c can now be interpreted in line with the different main modelling approaches as follows. First, the c can be interpreted as a combination of the instantaneous

Ambiguity in financing corporate mitigation policies  355 level of ambiguity and ambiguity attitude similar to that found in the Choquet expected utility approach in Chateauneuf et al. (2007), and as in the α -maxmin expected utility in Ghirardato et al. (2004). Alternatively, the parameter c can be interpreted to reflect misspecification concerns – for example, as an α -maxmin expected utility combination of the level of ambiguity and ambiguity attitude over a ‘multiple-priors’ set of relevant Brownian motions. For values of c less than 1/2, this allows for the interpretation of model uncertainty in combination with a ‘prudent’ or ‘pessimistic’ valuation, as in robust control, as in the context of Bewley incompleteness, and as in variational (Bewley) preferences, as in Faro (2015). It would seem intuitively reasonable to interpret values of c exceeding 1/2 as model uncertainty in combination with ‘exuberant’ or ‘optimistic’ valuation in these contexts, even though the formal models are based on ambiguity aversion and do not cover such interpretation. 3.2

Choquet Ambiguity

Suppose that the firm’s management – that is, the issuer (I) – is ambiguous about the effectiveness of the ‘green’ project – that is, the value, Vt – follows a Choquet-Brownian process. It is defined on the basis of a binomial lattice, where for each st at time t, such that 0 ≤ t ≤ T, st + 1u and st + 1d denote the possible successors at time t + 1 for an ‘up’ and a ‘down’ movement, respectively. If ‘up’ and ‘down’ movements have the same capacity weight – that is, have the same non-additive probability – then υ(stu|st) = υ(std|st) = c, where c, 0 < c < 1, is a constant that represents I’s ambiguity about the likelihood of the states to come. If I is ambiguity averse, the capacity is sub-linear, so that c < 1/2. If the perceived ambiguity increases, the value of the parameter c moves further away from the anchor 1/2. Thus, the capacity becomes more convex (for an ambiguity-averse I) or more concave (for an ambiguity-loving I). The symmetric discrete process outlined above can be shown to converge to a continuous time-generalized Wiener process with mean m = 2c – 1 and variance s2 = 4c(1 – c). The absence of an ambiguity bias is obtained as a special case for c = 1/2. Thus, the firm’s earnings are given by:5 dVt     m  dt  s dBt , (22.2) Vt where Bt is a Wiener process. For fully ambiguity-averse Is we have –1 < m < 0 and 0 < s < 1, so       m   and 0  s   . Both drift and volatility are smaller than in the probabilistic model. That is, with ambiguity aversion (c < 1/2) mass is shifted to the ‘worst-state’ outcome, by applying the Choquet integral, so that the drift falls and the perceived variance of the process is reduced. Ambiguity aversion is an aversion to not precisely known probability distributions, which leads to a narrower confidence interval for the variance around the lower mean, resulting in an underestimation of the volatility of the associated random events. On the contrary, for ambiguity lovers we have       m and 0  s   , implying optimism 5 Expression (22.2) is obtained from dVt / Vt   dt   dWt , where Wt  mt  sBt and Bt is a Wiener process. Thus, a Choquet-Brownian process is a distorted Brownian process, where the distortion derives from the nature and intensity of preferences toward ambiguity (Kast and Lapied, 2010a, 2010b).

356  Handbook of sustainable politics and economics of natural resources (positive m) and over (under)-weighting of good (bad) outcome probabilities. In what follows, let us write M    m and Ξ = sσ. 3.3

Green Bond Pricing

In this section we compute the price of a green bond, where we suppose that the firm’s management is ambiguous about the effectiveness of the ‘green’ project. Therefore, the relevant stochastic process for green bond pricing is expression (22.2). It captures the uncertainty about the environmental performance of the green project, which may be due to uncertainties related to the effectiveness of the green technology or to the unclear benefits from the regulatory framework. Let G denote the current value of the green bond. The bond is issued at the time of the investment, and the contractual continuous coupon, g, is tax deductible. Let τ denote the corporate tax rate that the firm faces on its income after servicing possible interest payments on its debt. If the value of the fundamental variable V is above the default threshold V*, then G(V) satisfies the following equation: 2 2 2 V V G  MV V G  rG  g  0, (22.3) 2 g , r which represents the value of a default-free bond. A general solution of the homogeneous equation related to (22.3) will have the form V β , where β solves the following equation: where r is the risk-free interest rate. A trivial solution for expression (22.3) is G V  

2     1  M   r  0 , 2 that is: 1 M  1 M  2r     2  2 . 2 2 2    2

 

Upon default, bond holders receive the value of the firm (evaluated at V*) minus bankruptcy costs, which are a fraction α g ( 0   g  1 ) of the firm’s value. Combining the default value of G with the limit (or no-bubble) condition: G(∞) = g/r, which allows us to get the risk-free bond value g/r for large values of V, we get the following expression for the bond value: G V  

g  g  V    1   g  PgV *    *  ,(22.4) r  r V 

Ambiguity in financing corporate mitigation policies  357 1    pDg

. Note that    0 , while    1 and the shape of (22.4) is obtained rM under the no-bubble condition mentioned above, as is usual in the literature on corporate bonds. Default is triggered by equity holders; therefore, we compute the default threshold as the level of V maximizing the post-investment equity value, E(V). The post-investment equity value solves the following equation: where Pg 

2 2 2 V V E  MV V E  rE  V  g  1     pDgV  0, (22.5) 2 together with the boundary conditions: E(V*) = 0, Eʹ(V*) = 0,

implying that the equity value equals zero at bankruptcy, due to limited liability, and that equity holders choose the bankruptcy threshold optimally. If the no-bubble condition limV  E V  / V   holds, then E(V) has the following expression: E V   PgV 

g 1     g 1     V     PgV *   *  , (22.6) r  r V 

where: V* 

  g 1    .(22.7)    1 rPg

Outcome I Under ambiguity aversion (c < 1/2), we get the outcome that V* increases if ambiguity averV * sion increases (  0 ), implying earlier default than in the case of no ambiguity. On the c contrary, under an ambiguity-seeking attitude (c > 1/2) we get the opposite – that is, default is delayed the more of an ambiguity lover I is. Notice the prediction that default is anticipated as perceived ambiguity aversion increases. This occurs because the value of the ‘green’ option decreases with a higher ambiguity aversion bias, which reduces the variance in the Choquet-Brownian motion. Thus, ambiguity-averse Is default sooner because they undervalue the option value given by the continuation value of equity. Outcome II If c = 1/2, expression (22.4) can be used to describe the green bond when there is no ambiguity. We can compare green bond and brown bond prices for the same level of ambiguity, and

358  Handbook of sustainable politics and economics of natural resources 

in particular for c = 1/2. Let  denote the value of   computed for c = 1/2. The brown bond price B(V) can be written as:

b  b V  * B V    1   b  PV  , (22.8) b b   r  r   Vb*  

where V * 

 b 1    , b is the coupon, α b denotes bankruptcy costs for the brown bond  rP b  1

1    pD0 . As Dg < D0 expression (22.7) predicts a lower r default threshold for a green bond than for a brown bond with otherwise equal indentures and bankruptcy costs – that is, default is delayed with green bonds. Combining (22.4) and (22.7) one gets a higher green bond value for equal parameter values. and Pb is a short notation for

Outcome III Under ambiguity aversion (c < 1/2), numerical computations show that the yield on the green bond (g/G) increases as ambiguity aversion increases (c decreases). On the contrary, under an ambiguity-seeking attitude (c >1/2), we get a lower credit spread than in the case of no ambiguity (c = 1/2). Since the ‘greenium’ is defined as the difference between the yield on a green bond and the yield on a similar conventional bond, an increase in the ambiguity-seeking attitude amplifies the greenium effect, while an increase in ambiguity aversion reduces it. This may lead to a suggested interpretation of the controversial results of the empirical literature on the so-called ‘greenium puzzle’ (Agliardi and Agliardi, 2019, 2021). It is well known that empirical works have not provided clear evidence of the green premium (e.g., Karpf and Mandel, 2018; Larcker and Watts, 2019; Zerbib, 2019). A negative premium is mostly expected, which would make green bonds less expensive for issuers because of lower funding costs, and yet less appealing to investors than other bonds from the same issuers. Our results suggest that in the presence of ambiguity, a negative greenium is more likely under an ambiguity-seeking attitude, while if ambiguity aversion increases, then a larger yield on green bonds is requested as compensation for deeper uncertainty. Summing up (22.4) and (22.6), we get the total firm value after investment, which is: T V   PgV 



 g  g  V     g PgV *   *  .(22.9) r  r V 

Equity holders choose the investment threshold VI to maximize the ex-ante equity value – that 

is, PV  AV  , where the latter represents the investment option. By matching the ex-ante 0 and ex-post values, net of the cost K, and their derivatives at the point VI , the investment ∧

threshold, and the arbitrary constant A can be determined. The extra cost K embodies the additional expenditure related to a green bond issuance, including separate accounting and

Ambiguity in financing corporate mitigation policies  359 additional monitoring and reporting, as requested by the GBP. The two matching equations ∧

can be solved numerically for A and VI . 3.4

Misspecification Concerns

In this section we model uncertainty in the form of misspecification concerns, related to the way in which we use models that are imperfect approximations of the true model. We assume that the GBM reflects a benchmark case for the firm’s earnings, as in expression (22.1). The firm, however, is concerned about possible misspecification of the damage function. These concerns can be introduced by allowing additive distortions in damage, which, for simplicity, we assume add to pDgV linearly, and accumulate like e σ₀(ηt+zt), where σ₀ is volatility, e is a small noise parameter, z is i.i.d and η is the distortion. The distortion reflects possible misspecifications relative to the benchmark model that corresponds to η = 0. If we consider a multiplier robust control problem (Hansen et al., 2006), the ‘entropy penalization’ associated with the distortion relatively to the benchmark model can be expressed as η2/2 ϑ (e), where ϑ (e) is the robustness parameter. It has been shown (Campi and James, 1996) that if θ(e)= ϑ ₀e, then as e → 0 the stochastic robust control problem is reduced to a simpler ‘deterministic robust control problem’, and therefore, in our case, the distorted damage function can be written as: p  DgV   0  , such that the post-investment equity value solves the following equation:

2 2 2 2  0. (22.10) V V E  V V E  rE  V  g  1     p  DgV   0   2 2 Deviation from the benchmark model is penalized since the regulator does not choose the ‘best estimate’ model. The size of the penalty is equal to η²/2 ϑ , which represents the distance between an alternative model and the reference model. In the multiplier robust control setting, we get a zero-sum, two player game, in which the maximizing player (the firm’s manager I) chooses a best response to a malevolent player (‘Nature’), who can alter the stochastic process within a prescribed limit by choosing a distortion η that will ‘harm’ the firm’s objective. We can solve the optimal choices made by both the maximizing agent and the minimizing agent. The minimizing agent (‘Nature’) chooses η at date 0, committing to it until the end, and the maximizing agent (I) will maximize the post-investment equity value, choosing the default threshold V*. Thus, we get  *  p 0 and: 

V* 

2  g 1     p  0 / 2 ,(22.11)  r  g  1

360  Handbook of sustainable politics and economics of natural resources where g 

1    pDg r

.

Outcome IV Misspecification implies a ‘worst-case’ scenario only, and thus preferences for aversion. The higher ϑ, the more I is concerned about misspecification regarding the damage. From (22.11) we get the outcome that the default threshold V* increases if misspecification increases, that is, default occurs earlier. Outcome V We can get the expression for the bond value under misspecification in analogy to (22.4). Numerical computations show that the yield on the green bond (g/G) increases as ϑ increases, implying that misspecification reduces the ‘greenium’. These results confirm what we got in Outcomes I and III, with a different characterization of ambiguity.

4

OPTIMAL PORTFOLIO ALLOCATION BETWEEN GREEN AND BROWN BONDS

In this section, we model the demand side of a green bond by solving the optimal portfolio allocation problem of a representative consumer-investor who can invest both in a green bond and in a brown bond issued by the same company. Let us specify ambiguity as in Section 3.2 and suppose that ambiguity refers to the green bond only, so that the relevant expressions for bond values are (22.4) and (22.8) for green and brown bonds, respectively. Here, because of deep uncertainty phenomena and ambiguity over the effectiveness of sustainability labelling, investors may become sceptical about the green claims and this will have an impact on the optimal portfolio allocation. Let N g denote the number of green bonds and N b the number of brown bonds in the investor’s portfolio. Let R(t) denote the total wealth at time t and y(t) is consumption. Then the consumer-investor’s budget equation is: dR  N g dG  t   N b dB  t   y  t  dt ,(22.12) where G (respectively, B) is the green (respectively, brown) bond value. Let x = the share of wealth in the green bond and thus 1 x 

NgG R

denote

Nb B is the share of wealth invested in R

Ambiguity in financing corporate mitigation policies  361 the conventional bond. In view of the expression (22.4) for the green bond value, G, and expression (22.8) for B, the budget equation can be rewritten as:   dR     r 

g  dV   r  G  Rx V   



1 c   2

r

dV 1  c  b   2  r  B  R 1  x  V    1 c   2

∧

    ydt .(22.13)   ∧

∧

∧

For notational convenience let us denote b/B by b and g/G by g that is, b and g are the yields on the two bonds. In what follows, the yields will be evaluated at the issuance, although a more general case can be handled within this framework. We get the following budget equation:     1  c         2  R r  g  RxM  r  b  R 1  x   y  dt    r     r         1   c        2    r  g  Rx  r  r  b  R 1  x   dW (22.14) r     The consumer-investor’s problem is:  max x , y E   e  rtU  yt  dt  , (22.15)  0 

such that the state variable R follows (22.13) and R(0) is given. Denote the current value of the value function by J(R). Then, from the usual Hamilton-Jacobi-Bellman equations and assuming, for example, a quadratic utility function: U  y 

y1 , 1 

where γ embodies risk aversion, we get the optimal share of green bonds in the portfolio:      r  g  M    1   r  b 

c  



r  2 x  ,(22.16)  2          g  r     1   b  r            r  g    1   r  b      c  2      c  

  2 

 

   r  b   

1 c   2

362  Handbook of sustainable politics and economics of natural resources where the wealth R is normalized to 1. Expression (22.16) specifies the optimal allocation between green bonds (x) and brown bonds (1 – x). Outcome VI In the absence of ambiguity (c = 1/2), the proportion of green bonds (x) increases if the following parameters increase: volatility σ ; the penalty on earnings p; the tax rate τ; and the risk aversion parameter γ. This is intuitive, because in the absence of ambiguity, changes in the parameters σ , τ and γ affect both green and brown bonds, but green bonds are less exposed to the penalty on earnings, due to a smaller amount of environmental damage. Outcome VII Numerical computations show that x slightly increases and then decreases as ambiguity aversion increases (as c decreases below 1/2). Thus, unless the degree of ambiguity aversion is very small, in which case investors increase their relative investment in green bonds, overall ambiguity aversion discourages investors, who decrease their quota of green bonds, hence slowing down this form of financing of green projects. A final remark is in order. In our analysis of optimal portfolio allocation, there are important aspects of dynamic decision making under uncertainty that are not adequately covered using a Choquet-Brownian motion. One relates to dynamic inconsistency in dynamic decision making under uncertainty when updating beliefs in the light of new information. A decision maker may plan a course of action contingent on the information they hold before the new information arrives. When the information arrives and their beliefs are updated, however, they may prefer a course of action that differs from their ex-ante contingent plan. Under Bayesian updating for probability distributions, this cannot happen, and decisions are dynamically consistent (see, amongst others, Faro and Lefort, 2019). Recently, Bleichrodt et al. (2018) found experimental evidence of ‘naive’ intertemporal choice behaviour. Such behaviour focusses on the present decision, disregarding past and future decisions, and fails to be dynamically consistent.

5 CONCLUSIONS In this chapter, we have studied the effects of ‘deep’ uncertainty on firms’ decisions to issue green bonds, employing a structural model, where there is ambiguity about the effectiveness of the environmental projects being financed and the investors’ green perception in portfolio choices. In particular, we focused on some forms of ambiguity – that is, Choquet ambiguity and misspecification/robust control – but the core mathematical analysis of our work applies to a range of special cases of different conceptual models of uncertainty and its evaluation. In the context of our model, the conceptual differences only come to bear in the interpretation of the comparative statics regarding the results of the core mathematical analysis. We find that ambiguity affects the default decisions of the firm, the credit spreads and the so-called ‘greenium’, and has an impact on investors’ optimal portfolio decisions. In particular, under ambiguity aversion, the value of the ‘green’ option decreases, implying an earlier

Ambiguity in financing corporate mitigation policies  363 default and a lower negative premium, making green bonds relatively more expensive because of relatively higher funding costs than in the absence of ambiguity. Policy measures that provide transparency through standardized definitions and disclosure requirements reduce the ‘deep uncertainty’ experienced by investors. This may affect the ‘greenium’ and thus increase the attractiveness of green bonds, increasing their contribution towards combating climate change. The same holds for clear and effective long-term climate and energy policies (see also Spanjers and Agliardi, 2016). We believe that the logic of our model carries over to the financing of government climate change policies.

ACKNOWLEDGEMENT Elettra Agliardi acknowledges the financial support of the AlmaIdea-Unibo Project ‘Circular Economies and Climate Change’.

REFERENCES Agliardi, R. (2021), Green securitization, Journal of Sustainable Finance and Investment. Ahead-of-print, https://​doi​.org/​10​.1080/​20430795​.2021​.1874214. Agliardi, E. and R. Agliardi (2019). Financing environmentally-sustainable projects with green bonds. Environment and Development Economics, 24, 608–23. Agliardi, E. and R. Agliardi (2021). Pricing climate-related risks in the bond market. Journal of Financial Stability, 54, Article 100868. Amel-Zadeh, A. (2018). Social responsibility in capital markets: a review and framework of theory and empirical evidence. Working paper. Anderson, E.W., W. Brock, L.P. Hansen and A.H. Sanstad (2014). Robust analytical and computational explorations of coupled economic-climate models with carbon-climate response. RDCEP Working Paper 13Ð05. Center for Robust Decision Making on Climate & energy Policy. Anscombe, F.J. and R. Aumann (1963). A definition of subjective probability. Annals of Mathematical Statistics, 34, 199–205. Bewley, T. (1986). Knightian decision theory: part I. Cowles Foundation Discussion Paper No. 807. Cowles Foundation for Research in Economics, Yale University. Bleichrodt, H., J. Eichberger and S. Grant et al. (2018). A test of dynamic consistency and consequentialism in the presence of ambiguity. Working paper. Department of Economics, University of Exeter. Bolton, P., M. Despres and L.A. Pereira da Silva et al. (2020). The Green Swan: Central Banking and Financial Stability in the Age of Climate Change. BIS and Banque de France. Campi, M.C. and R.M. James (1996). Nonlinear discrete-time risk-sensitive optimal control. International Journal of Robust and Nonlinear Control, 6(1), 1–19. Carney, M. (2019). Fifty shades of green. Finance and Development, 56(4), December. Chateauneuf, A., J. Eichberger and S. Grant (2007). Choice under uncertainty with the best and the worst in mind: neo-additive capacities. Journal of Economic Theory, 137(1), 538–67. Chen, Z. and L. Epstein (2002). Ambiguity, risk and asset returns in continuous-time. Econometrica, 70, 1403–43. Climate Bond Initiative (CBI) (2019). Green Bonds Global State of the Market 2019. Accessed 6 August 2021 at https://​www​.climatebonds​.net/​resources/​reports/​green​-bonds​-global​-state​-market​-2019. Ellsberg, D. (1961). Risk, ambiguity, and the savage axioms. Quarterly Journal of Economics, 75, 643–69. Etner, J., M. Jeleve and J.-M. Tallon (2009). Decision theory under uncertainty. Mimeo. EU (2019). Financing a Sustainable European Economy: Final Report 2018 by the High-Level Expert Group on Sustainable Finance. Accessed 6 August 2021 at https://​ec​.europa​.eu/​info/​sites/​info/​files/​ 180131​-sustainable​-finance​-final​-report​_en​.pdf.

364  Handbook of sustainable politics and economics of natural resources Faro, J. (2015). Variational Bewley preferences. Journal of Economic Theory, 157, 699–729. Faro, J. and J.-P. Lefort (2019). Dynamic objective and subjective rationality. Theoretical Economics, 14, 1–14. Ghirardato, P., F. Maccheroni and M. Marinacci (2004). Differentiating ambiguity and ambiguity attitude. Journal of Economic Theory, 118(2), 133–73. Gilboa, I. (1987). Expected utility with purely subjective non-additive probabilities. Journal of Mathematical Economics, 16(1), 65–88. Gilboa, I., F. Maccheroni, M. Marinacci and D. Schmeidler (2010). Objective and subjective rationality in a multiple prior model. Econometrica, 78, 755–70. Gilboa, I. and D. Schmeidler (1989). Maxmin expected utility with non-unique prior. Journal of Mathematical Economics, 18, 141–53. Hansen, L.P. and T.J. Sargent (2001). Robust control and model uncertainty. The American Economic Review, 91, 60–66. Hansen, L.P. and T.J. Sargent (2008). Robustness. Princeton, NJ: Princeton University Press. Hansen, L.P., T.J. Sargent, G. Turmuhambetova and N. Williams (2006). Robust control and model misspecification. Journal of Economic Theory, 128, 45–90. Heal, G. and A. Millner (2014). Uncertainty and decision-making in climate change economics. Review of Environmental Economics and Policy, 8(1), 120–37. Intergovernmental Panel on Climate Change (IPCC) (2018). Special Report: Global Warming of 1.5°C. Accessed 6 August 2021 at https://​www​.ipcc​.ch/​report/​sr15/​. International Capital Market Association (ICMA) (2021). The Green Bond Principles: Voluntary Process Guidelines for Issuing Green Bonds. Accessed 7 August 2021 at https://​www​.icmagroup​.org/​ sustainable​-finance/​the​-principles​-guidelines​-and​-handbooks/​green​-bond​-principles​-gbp/​. Karpf, A. and A. Mandel (2018). The changing value of the ‘green’ label on the US municipal bond market. Nature Climate Change, 8, 161–5. Kast, R. and A. Lapied (2010a). Valuing cash flows with non-separable discount factors and non-additive subjective measures: conditional Choquet capacities on time and on uncertainty. Theory and Decision, 69, 27–53. Kast, R. and A. Lapied (2010b). Dynamically consistent Choquet random walk and real investments. Document de Recherche No. 2010Ð21. Laboratoire Montpelliérain d’Economic Théorique et Appliquée (LAMETA). Kast, R., A. Lapied and D. Roubaud (2014). Modelling under ambiguity with dynamically consistent Choquet random walks and Choquet-Brownian motions. Economic Modelling, 38, 495–503. Klibanoff, P., M. Marinacci and S. Mukerji (2005). A smooth model of decision making under ambiguity. Econometrica, 73(6), 1849–92. Larcker, D. and E. Watts (2019). Where’s the Greenium? Working paper. Stanford University. Maccheroni, F., M. Marinacci and A. Rustichini (2006). Ambiguity aversion, robustness, and the variational representation of preferences. Econometrica, 74, 1447–98. Machina, M. and M. Siniscalchi (2014). Ambiguity and ambiguity aversion. In M. Machina and K. Viscusi (eds), Handbook of the Economics of Risk and Uncertainty (Vol. 1). Amsterdam: North-Holland, pp. 729–807. Mukerji, S. (1997). Understanding the non-additive decision model. Economic Theory, 9, 23–46. Network for Greening the Financial System (NGFS) (2019). First Comprehensive Report. A Call for Action – Climate Change as a Source of Financial Risk. Accessed 6 August 2021 at https://​www​.ngfs​ .net/​en/​first​-comprehensive​-report​-call​-action. Savage, L. (1954). The Foundations of Statistics. New York: John Wiley & Sons. Schmeidler, D. (1989). Subjective probability and expected utility without additivity. Econometrica, 57(3), 571–87. Spanjers, W. and Agliardi, E. (2016). Rethinking the social market economy: a basic outline. RCEA Professional Reports PR 16Ð01. Rimini Centre for Economic Analysis. Trucost ESG Analysis (2019). Connecting the Dots: Energy Transition Scenarios and Credit Quality. Accessed 6 August 2021 at http://​et​-risk​.eu/​wp​-content/​uploads/​2019/​01/​Trucost​-Connecting​-the​ -Dots​-08​.pdf. Von Neumann, J. and O. Morgenstern (1947). Theory of Games and Economic Behaviour (2nd edition). Princeton, NJ: Princeton University Press.

Ambiguity in financing corporate mitigation policies  365 Zerbib, O.D. (2019). The effect of pro-environmental preferences on bond prices: evidence from green bonds. Journal of Banking and Finance, 98, 39–60.

23. Resource abundance and socio-economic shocks: COVID-19 pandemic and the State Oil Fund of Azerbaijan Ingilab Ahmadov

1 INTRODUCTION Countries with sovereign wealth funds (SWFs) differ from others in the context of measuring the socio-economic impact of COVID-19, maintaining and restoring the relative stability of the economy. First, the presence of an ‘airbag’ is of great psychological importance here. Since the scale and duration of the current pandemic are difficult to predict, unlike a normal cyclical downturn, governments are cautious and anxious to prepare for the worst-case scenario. From this standpoint, the existence of an SWF is an important confidence factor for the weakest economies, a great advantage to ensuring liquidity. On the other hand, natural resource funds play a role in depreciation during the crisis and can insure the state budget, at least in part, by absorbing negative effects. And finally, in the worst-case scenario, the fund could be used as a special stimulus tool by the government to overcome the crisis. The State Oil Fund of Azerbaijan (SOFAZ) has all these capabilities and is thus subject to great expectations. In addition, it should be taken into account that the Azerbaijani economy, based on the model of state capitalism (Anti-Corruption and Governance Center, 2020), does not have a strong and sustainable private sector, so the government secures macroeconomic balance and regulation through SOFAZ. Thus, the Fund carries the investment burden in the economy, it does not allow excessive growth of foreign borrowing, and consequently acts as exceptional instrument of intervention for maintaining the exchange rate of the national currency. This means that the SOFAZ is not an ordinary welfare fund, but a basic pillar of government economic regulation. This chapter reviews recent developments in the SOFAZ, including reactions and investment and management changes in view of the COVID-19 pandemic. The following section provides an overview of the history of the Fund and changes induced by the pandemic. The next section focuses on the asset management and governance shifts in the Fund. This is followed by transparency- and accountability-focused analysis. The last section concludes with some policy recommendations.

2

THE STATE OIL FUND OF AZERBAIJAN: PAST, PRESENT AND FUTURE UNDER THE COVID-19 CRISIS

SOFAZ is an SWF established in 1999 to effectively manage Azerbaijan’s oil and gas revenues. From the sale of oil and gas resources in 2001–19, the Fund received a total of about $160 billion, of which $119 billion has been spent. More than $100 billion of this expenditure 366

Resource abundance and socio-economic shocks  367 are transfers to the budget. The fund currently has $43 billion in assets. By the end of 2019, the Fund’s assets amounted to 90.2 percent of gross domestic product (GDP) (SOFAZ, 2020a). The Fund manages its assets on the world market in accordance with its charter and rules, and for this purpose invests in securities as well as property and gold. Strategic projects are annually financed from the approved budget of the Fund. However, since 2019, the Fund has minimized its activities in this direction, financing only its traditional activities to improve the socio-economic conditions of internally displaced persons (IDPs). At the same time, since 2003, the Fund has been annually transferring much of its revenues to the state budget. The total revenues of the ratified budget of SOFAZ for 2020 were approved at 12 384 088.2 thousand manats ($7284.8 million) and expenditures at 11 589 910.3 thousand manats ($6818 million). The state’s share of profit oil (net income from the sale of hydrocarbons) made up 85.3 percent of revenues, and transfers to the state budget made up 98 percent of expenditures (Azerbaijan Republic, Ministry of Finance, 2020a). For 2020, the oil price was calculated at $55 per barrel, in both the state’s and SOFAZ’s budgets. However, changes in the budget in early August that year set the oil price at $35 per barrel in both budgets. As a result of the changes, the Fund’s revenues were set at 5041.5 million manats (40.7 percent) or 7342.6 million manats compared to the approved forecast, and expenses increased by 850 million manats (7.4 percent) to 12 410 million manats (ibid.). The largest reduction in the revenue structure was on the sale of oil and gas – 39 percent! In the new budget, this main source of income has been reduced from 10.6 billion manats to 6.5 billion manats. Thus, against the background of an increase in the Fund’s expenses, its new budget deficit is 5 billion manats, which is 68.5 percent of revenues (Azerbaijan Republic, Ministry of Finance, 2020b). The Fund in the pandemic period is being hit by a triple blow. On the one hand, a steep plunge in oil prices has led to a decrease in expected revenues. On the other hand, it is necessary to use more resources of the Fund to compensate the deficit of public finances. And finally, to maintain the rate of manats, more dollars must be put up for sale. Here, despite the decline in economic activity, the pandemic plays an important role. To estimate the expected losses of the Fund for 2020 and beyond, it is necessary to consider the following three elements: (1) how would the oil prices behave in the world market and in what range; (2) what will be the total damage caused by the pandemic to the country’s economy and when will the government suspend the quarantine measures and return the country to normal socio-economic life; (3) depending on 1 and 2, will the government be forced to use the Fund’s additional resources in the event of an emergency, and will it change the legislation and existing practice? The behavior of oil prices depends on several factors. Prices, which have plummeted since February 2020, have been gradually recovering since June 2020 and are at the time of writing (September 2020) hovering around $40 per barrel, contrary to most experts’ forecasts. Undoubtedly, the situation is unstable, it can change at any moment, and against the background of a possible second wave of a pandemic, the change may be more downward. The average oil price for 2020 was predicted to be around $37 per barrel (Energy Information Administration [EIA], 2020). At the same time, it should be considered that the country’s crude oil production is lower than in the past, as Azerbaijan supported the decision on production quotas by OPEC+. Thus, in May 2020, production decreased by 18 percent compared to April and amounted to 557.2 thousand barrels per day. In April, this figure was 679.8 thousand barrels per day (Turan, 2020).

368  Handbook of sustainable politics and economics of natural resources To correctly assess the impact of the pandemic and the sharp drop in oil prices on the Fund, the pre-crisis situation in the Fund is of great importance. At the beginning of the year, the Fund showed good results. Thus, in 2019 the Fund’s budget revenues amounted to 19 030.6 million manats, and budget expenditures 11 588.6 million manats. During 2019, the Fund’s revenues from the implementation of oil and gas agreements amounted to 15 404.7 manats, including 14 614.7 million manats from the sale of profitable oil and gas, bonus payments of 766.4 million manats, per acreage payments of 4.7 million manats, and revenues from transit of oil and gas through Azerbaijan of 18.9 million manats. Income from the Fund’s asset management last year amounted to 3625.9 million manats, which is 19.1 percent of total income (SOFAZ, 2020b). At the same time, it should be considered that, leaving aside the peak period, the Azeri-Chirag-Guneshli (ACG) oil field project is experiencing a steady decline in production from year to year. Thus, if in 2018 the volume of profit oil received by the Fund at ACG was 213.51 million barrels, in 2019 this figure was projected at 195 million barrels, and in 2020 at 186.7 million barrels (Azertag, 2020; Hesablama Palatsi, 2020). Revenues from oil and gas agreements in January–June 2020 amounted to 4914.7 million manats. Profit from the sale of oil and gas in the structure of these revenues amounted to 4130.1 million manats. The average net profit from the sale of crude oil for these months was $38.7 per barrel. In the first half of 2020, the Fund’s costs amounted to 5.8 million manats against 4.9 billion manats in revenues. As costs exceed the revenues, assets have declined. On the other hand, the Fund sold $4 billion (6.8 billion manats) in the domestic market in six months. If $2.9 billion of this amount was Fund’s income, $1.1 billion came from foreign assets (SOFAZ, 2020a). Profits from individual projects for this year are reflected in the review of the Audit Chamber on oil revenues, so that the projected profit oil price for 2020 from ACG, the largest source of income of the Fund, should have been $5.382 billion. In May 2020, the profit from ACG, the Fund’s largest source of income, decreased 5.5 times compared to March 2020 and amounted to only $115 million Of course, it would be wrong to project these losses for the entire year. However, if the current situation continues and the average market price of oil on the world market is expected to be around $37 per barrel by the end of the year, the amount of loss by the Fund from oil prices alone may reach more than 3.5–4 billion manats or $2 billion at best. This means a decrease of about 35 percent for the year compared to the forecast. The forecast for oil prices in the world market for 2020 and 2021 varies greatly. S&P Global Ratings predicts that in 2021 the price of Brent crude oil will rise to more than $50. Other experts are more careful. According to the EIA, the world oil price will hit $45 per barrel at best. However, the reality shows a more optimistic situation – to August 2021 the Brent crude has been traded at $70 per barrel. Forecasts for the rate of decline in GDP in 2020 through post-Soviet countries are also different. S&P Global Ratings estimates the largest decline in Azerbaijan – 6.6 percent. The World Bank (2021) estimates the lowest decline in the region in Azerbaijan – 2.6 percent. All this is a manifestation of the unique nature and uncertainty of the pandemic crisis. Another problem related to forecasting oil revenues in Azerbaijan and managing the risks in this area is that revenues come mainly from one project. Thus, in 2019, 92.1 percent of the Fund’s revenues fell to ACG (SOFAZ, 2020a). However, the Fund received revenues from 11 other projects besides ACG. The small share of other projects in the Fund’s revenues and the unrealistic development of new projects during the pandemic means that the Fund cannot rely

Resource abundance and socio-economic shocks  369 on the growth of revenues from other projects. Dependence on a large project increases the volatility of revenues. It should be noted that the structure of the Fund’s revenues includes annual bonuses totaling $3.6 billion, calculated for eight years ($450 million annually) under the updated ACG project in 2017, which in a sense contributes to the guaranteed income of the Fund. Thus, COVID-19 complicates further diversification of the Fund’s profitability. The proposed new agreements are unlikely to be signed under such conditions. Investors would avoid uncertainty and delay implementation for several years, as most oil countries do.

3

ASSET MANAGEMENT AND GOVERNANCE

The structure of the Fund’s investment portfolio for the first six months of 2020 was as follows: bonds and money market instruments, 66.8 percent; shares, 13.7 percent; real estate, 5.9 percent; gold, 13.6 percent. Interestingly, in the first quarter of 2020 – that is, at the beginning of the pandemic, the Fund’s portfolio was different: bonds and money market instruments, 68.7 percent; equities, 12.4 percent; real estate, 6.1 percent; gold, 12.8 percent (SOFAZ, 2020b). In the second quarter of 2020, the Fund preferred to invest more in equities, as well as gold, and instead reduced investment in real estate and bonds. The performance for the first six months of 2020, primarily suggest that the negative impact of the pandemic on the Fund’s profitability was not as strong as expected. There was no steep decline in revenues as oil prices fell sharply in a short period of time. As for the structure of assets, according to the Fund’s management, the Fund prefers a conservative approach to the risk–profit dilemma. However, an increase in the share of equities in the portfolio instead of bonds suggests otherwise. But in the near future, as noted by the Fund’s management, preference will be given to government bonds that promise high-quality, reliable and stable income. The increase in the share of gold is understandable. Against the background of increasing volatility in the world market over the past three to four months, the price of gold demonstrates stable positive dynamics. It is worth remembering that after the amendments to the ‘Rules on storage, placement and management of foreign exchange assets of the Fund of the Republic of Azerbaijan’ by Decree of the President of the Azerbaijan Republic No. 519 dated 27 October 2011, 10 percent of the total investment portfolio can be invested in gold and real estate, respectively. It should be noted that as of 1 January 2020, the Fund’s assets increased by 12.48 percent compared to the same period in 2019 ($38.515 billion) and amounted to $43.323 billion. The increase in assets in 2019 was due to Fund’s budget revenues, including revenues from asset management. During the relevant period, the highest return was observed on the stock sub-portfolio and a positive return was recorded for each component of the investment portfolio. Thus, despite the negative return on the stock sub-portfolio last year (–6.6 percent), the corresponding figure for 2019 was 21.5 percent (including private shares). In 2020, revenues from the management of the Fund’s assets are projected at 1.45 percent, which is significantly lower than in 2019 (5.29 percent). According to the Fund’s management, given the current situation on the world market, the Fund does not make any new investments in any of the shares listed on the stock exchange, as in previous years, and tries not to incur large losses by choosing a conservative position. Instead, it intends to increase investment in

370  Handbook of sustainable politics and economics of natural resources secured bonds.1 So, the behavior of the Fund’s management is aimed at protecting the Fund’s assets with minimal profitability, without resorting to any risky investments until stability in the world market in the near future is maintained. The Fund’s six-month report confirms this trend, and the Fund is still able to maintain its assets in this regard. Thus, at the beginning of 2020, assets equal to 43.233 million manats fell to 41.349 million manats at the end of the first quarter of the year, but the six-month volume was 43.223 million manats. Undoubtedly, these effects are still at an early stage; thus, the increase in the scale and duration of the pandemic will further increase the adverse effects. The negative impact of the pandemic on the stock market can effectively reduce the Fund’s earnings per share. This will also happen due to the depreciation of assets. This will be reflected in investments in the real estate market. Since, after the global tourism and transport sectors, the real estate market is the most affected by the pandemic, the Fund’s investments in this area will also be accompanied by losses. It should be noted that the property owned by the Fund in Paris, London, Milan, Seoul, Tokyo and Moscow brought dividends from mainly office buildings. At the end of 2019, the share of real estate in the Fund’s portfolio was 5.8 percent, at the end of the first semester of 2020 it was 6.1 percent, and at the end of the first six months of 2020 it was 5.9 percent. Of course, these changes are not associated with the volatility of real estate investments, but with changes in the value of these assets in the new valuation and an increase or decrease in the share of other instruments. The incomes from the real estate are normally symbolic, and in this case the Fund makes these investments to insure part of its assets in the medium and long term. A sharp plunge in demand for office space during and after the pandemic in exchange for companies choosing to operate online would devalue those assets. The Fund’s investment in gold can be considered relatively successful compared to other instruments. At the end of 2019, 11.4 percent of the Fund’s assets was invested in gold, at the end of the first three months of 2020 this figure increased to 12.8 percent, and at the end of the first six months of 2020 it was 13.6 percent (SOFAZ, 2020b). Note that since the beginning of 2020, gold has risen from $1517 to $1881 per ounce (23 July 2020) (more than 21 percent). With regard to government bonds, which are the main investment tool of the Fund, no such drastic change is expected, although developed countries (the Fund has invested in government bonds of those countries) are trying to minimize the price of government bonds to compensate for the losses in the current situation. Hence, the new situation will force the Fund to review its investment portfolio and make some changes in its structure. The share of long-term assets in the Fund’s total assets fell to its lowest level in six years in 2020 – 4.97 percent. This means that the Fund can convert 95 percent of its assets into liquid assets within a year. Long-term assets, which in 2012 took the lowest share (3.3 percent), even rose to 15.2 percent in 2016. The increase in the share of short-term assets last year was due to the growth of gold bullion and securities. On the other hand, ‘The Fund’s investment policy has several important mechanisms to reduce the risks mentioned above. Thus, up to 70 percent of the Fund’s investment portfolio consists of highly liquid investments, including debt obligations and money market instruments. In addition, more than 80 percent of the investment portfolio consists of fixed-yield securities and gold, which are characterized by high liquidity and less price volatility, which are generally considered more reliable instruments in times of



1

Source: Trend News Agency, accessed 8 August 2021 at https://​en​.trend​.az.

Resource abundance and socio-economic shocks  371 market volatility and uncertainty’ (SOFAZ, 2019, p. 56). The modification in the structure of the investment portfolio in the second quarter of 2020 suggests that, in contrast to previous practice, the decision-making mechanism in the management of the Fund has become more flexible, and this is a good thing. It is very likely that the Fund will not make new investments in this area in the medium and long term, but will instead prefer to invest in gold and the stock market. The Fund’s revenue from asset management will fall sharply compared to 2019 and is expected to be around 0 percent at best by the end of 2020. Generally, by the end of the year, the Fund’s assets are expected to fall by 5–8 percent, which will be mainly due to lower oil prices than calculated in the budget, as well as the devaluation of shares and property. In this regard, Fitch Rating takes a tougher position. According to the agency, Azerbaijan’s foreign assets (Fund and central bank) will be reduced to $38.8 billion by the end of 2020. At the end of 2019, this figure was $49.5 billion, and in the first half of 2020, $49.7 billion. The Fund’s assets must be reduced by at least $7–8 billion for Azerbaijan’s foreign reserves to fall to $38.3 billion (Fitch Ratings, 2020). With regard to state transfers, the practice of transferring from the Fund to the budget dates to 2003. The Fund, which was established in late 1999 and has been operating since 2001–02, had no direct relationship with the state budget during that period. The beginning of transfers to the budget is explained by the steep increase in oil revenues and the government’s preference for spending in the domestic market, as well as large-scale public investment along with consumption. The highest share of the Fund in the state budget through transfers was in 2013 – 58.2 percent. The amount of the transfer planned for 2020 was 11 350 million manats. After the amendments to the budget, this amount increased by 850 million manats to 12 200 million manats, which is 98.3 percent of the total costs of SOFAZ. During the first six months of 2020, the Fund transferred 5675 million manats to the budget, which is half of the plan. The amount of transfers varied from month to month, and the Fund was forced to make higher-than-average transfers during periods of turmoil to maintain the stability of the manat. At present, any possible changes related to the transfer of the Fund to the state budget depend on the fiscal situation of the country as a whole and the government’s response to the pandemic. The behavior observed so far suggests that the government prefers not to overspend, saving as much as possible of the planned expenditure for the COVID-19 pandemic. With this approach, the subsequent course of events may be not aligned. Thus, the prolongation of the quarantine period and the decline in economic activity may force the government to change this behavior at the last moment. The practice of large-scale transfers of the Fund to the state budget performs at least two macroeconomic functions simultaneously: (1) by covering about half of budget costs, the transfer effectively mitigates the volatility of oil prices for the budget, ensuring actual fiscal stability by taking on negative shocks; (2) by offering a stable currency to the market, it balances the surplus demand that arises from time to time during the year with the relevant supply, thereby preventing a soft devaluation of the manat. These seemingly positive features carry very serious long-term negative risks. This opportunity to use the Fund correctly assesses the macroeconomic risks and, instead of taking appropriate countermeasures, spurs the government to take administrative steps to further distance the economy from market principles. In both the fiscal and monetary spheres, the balance of supply and demand, which is considered the superpower of the market economy, is realized by the state itself, not between the state

372  Handbook of sustainable politics and economics of natural resources and market ‘players’. If the sole currency seller in the market is the Fund, it is very convenient to manage the macroeconomic balance through administrative ways. On the one hand, the Fund ensures the sale of currency; on the other, the central bank selectively regulates and controls the demand of commercial banks participating in the auction. There is no doubt that such management of the manat exchange rate minimizes exchange rate risks in the short term, making it much easier to manage. But this practice is very different from the usual intervention, because all the levers to control the exchange rate are concentrated in the hands of the government. So, if market signals are not taken into account gradually, the economy will look in a distorted mirror, and the longer this practice lasts, the more difficult the transition to effective macroeconomic regulation will be. Unfortunately, the previously adopted fiscal rule does not break this circle. According to Fitch Ratings, the Fund’s recent sale of currency at the auction is disproportionate to its annual plan. In general, out of the $6.7 billion planned for 2020, $4.1 billion were sold and transferred to the state budget in manats. And $2.5 billion of this amount was sold in March–April. There is a great risk that this pace will continue until the end of 2020, and thus the Fund will sell more currency and transfer to the budget than was planned in the annual forecast (Fitch Ratings, 2020). Practice shows that the demand for currency seriously increases during periods of shocks that usually take place in the market for one reason or another. The Fund addresses this problem by increasing the amount of currency to be auctioned during this period. The peculiarity of the pandemic is that, unlike other crises, both demand and supply are declining, as is the case throughout the world. The demand for foreign exchange is also declining as the restrictive measures minimize economic activity, especially that of the services. However, the sharp plunge in oil prices raised fears among market participants of a possible devaluation, which increased the demand for foreign currency. The government, which has not yet fully recovered from the negative effects of the 2015 double devaluation, is still abandoning a new devaluation. If the government ignores the gradual devaluation, it will soon have to decide to devalue the manat. This will depend on the level of oil prices during the year, the balance of payments and the socio-economic situation. From 2019, the Fund will not directly finance any other projects, except for the resettlement of IDPs. Funding for any project in 2020 is not reflected in the Fund’s budget. It should be noted that the Fund has allocated a total of $20 billion for projects funded since 2002. Most likely, the Fund will not allocate funds for direct financing of such strategic projects in the near future. Exceptionally, if necessary, the financing of the State Oil Company of Azerbaijan Republic (SOCAR) and the state’s share in oil and gas sector development projects may be considered. As for the costs of socio-economic development of IDPs, the Fund will continue to develop as its main mission. The suspension of the Fund’s direct funding of strategic projects may be due to several reasons. The main reasons are the slowdown in the growth of oil revenues since 2015, the prevention of a steep decline in the Fund’s assets and the preservation of a certain amount of funds for future generations (about 90 percent of GDP). In the 20 years since its establishment, there several significant changes have taken place in the regulation of the Fund’s activities: ● 2001: rules on storage, placement and management of foreign currency funds were approved.

Resource abundance and socio-economic shocks  373 ● 2003: the first transfer to the state budget was made. ● 2011: Decree No. 519 was signed on amendments to the ‘Rules on storage, placement and management of foreign exchange assets of the State Oil Fund of the Azerbaijan Republic’. This marked the beginning of the placement of assets in stocks, gold, real estate, and other, softer currencies. Apparently, the government is conservative in its approach to changing the Fund’s activities and investment policy. Most likely, the Fund will continue this approach during the pandemic, and no changes are expected in its activities and management in the near future.

4

ACCOUNTABILITY AND TRANSPARENCY POLICY AND PROSPECTS DURING THE PANDEMIC

The government of Azerbaijan, which joined the Extractives Industries Transparency Initiative (EITI) in 2003, was one of the first countries to prepare semi-annual and annual reports since 2004, became a full member for the first time in EITI history, and in 2017 was forced to abandon this initiative. After leaving the EITI, an Extractive Industries Transparency Commission was established by the Decree of the President of the Azerbaijan Republic on 5 April 2017 and was chaired by the Executive Director of SOFAZ (Chairman of the Government Commission and Multi-Stakeholder Group during EITI membership). The Commission also included officials from five relevant government agencies at the level of deputy ministers. Azerbaijan prepared three reports after it left EITI. Changes in the Fund’s leadership at the end of 2019, as well as the resignation of some members of the Commission, have delayed the preparation of transparency reports. By the Presidential Decree of 28 July 2020 on measures to implement transparency in the extractive industry, the State Statistics Committee was entrusted with ensuring accountability to EITI (President of the Republic of Azerbaijan, 2020). The government attributes this change to the fact that EITI has entered a phase of new systematic information openness (EITI mainstreaming) globally. At this stage, accountability will continue with the systematic updating of online data on one portal, which is supposed to be mainly technical. For more than 17 years, the government of Azerbaijan has been implementing transparency in the extractive industry through the Fund, which was in a sense symbolic. The Fund, in turn, was a worthy organization in comparison with other relevant institutions. The Fund, which has prioritized transparency as a new institution since its inception, has also established a tradition. As the only government agency, it was perhaps the only one operating in a dialogue with the public. The big question is whether the Statistics Committee will be able to continue this mission at the same pace. Setting priorities correctly in times of crisis is more important than in the normal times. Globally, this is one of the most frequently discussed issues of late, as transparency and accountability have become more important for the public during the pandemic. The Fund has been a model for government agencies operating in this direction since the very beginning. Its extensive and accessible information policy on its activities, as well as its multi-stakeholder decision-making practice with civil society organizations, is one of the limited successes of the recent past in this area. The threat of a gradual dissolution of this tradition should be of a primary concern to the government itself.

374  Handbook of sustainable politics and economics of natural resources As for the public oversight over the Fund’s activities, this issue becomes even more relevant during the pandemic. The need for public representation on the Fund’s supervisory board has always been a major challenge for civil society. Taking real steps in this direction now, ensuring the representation of the public on Fund’s supervisory board, would serve to increase the credibility of the Fund’s management, as well as the socio-economic reforms initiated by the government several years ago.

5

CONCLUDING REMARKS AND RECOMMENDATIONS

SOFAZ still has a convincing effect against the background of expected losses. The relative stabilization of oil prices on the world market since June 2020 has strengthened this confidence. In the COVID-19 pandemic period, the Fund’s stewardship focuses on a conservative approach, abandoning risky operations in its investment activities. Most likely, no changes will be made to the rules governing the Fund’s activities and its investment policy in 2020 and 2021. This assumption is based on the observation of the behavior of the government during the pandemic. The government does not consider any form of budget transfers, changes in investment instruments, support for external borrowing or additional stimulus in the domestic economy, as well as a review of the fiscal regulations. Adjustments made to the state budget in August do not promise any direct changes for the Fund, except for an increase in transfers to the budget. The Fund’s assets are not intended to be used in any form other than liquidity in the economy to cover the balance of payments deficit or in accordance with existing rules and practices in economic stimulation. If there is no change in this approach in 2020, the Fund’s assets are expected to decrease by about 8–10 percent by the end of 2020 due to falling oil prices, in the worse-case scenario. The government’s recent behavior also shows that if it is faced with a dilemma, it will prefer foreign borrowing to protect the assets of the Fund. Observations during the pandemic in 2020 reveal that the main issues are related to the governance. Moves towards flexible and inclusive governance emerge as very important in the COVID-19 pandemic. In this regard the following recommendations can be made. The extraordinary role of the Fund in ensuring macroeconomic balance may be reconsidered. In this respect, it is expected that changes will be made to the practice of large-scale transfers to the state budget and its implementation as the sole currency seller at auctions. As the scale of the pandemic is not yet clear, the Fund’s monitoring practice of the process as an outside observer should be changed in the near future. In such emergency situations, it makes more sense to revitalize the economy by making relevant changes to the existing activities of the Fund and using part of its assets. It makes sense for the government to consider appropriate steps in this direction. Although the Fund’s investment policy is generally considered to be satisfactory in the current situation, it is possible to show a more aggressive approach by considering the situation on the world stock market. To do this, the Fund should think about investing in the stock market, rather than government bonds with minimal risk. Investing in relatively low-value stocks will pay dividends in the medium term. The Fund’s policy of transparency and accountability needs to be reconsidered. This seems especially necessary in the context of the transfer of activities of EITI to the State Statistics Committee. The issue of ensuring public representation in the Supervisory Board may be considered.

Resource abundance and socio-economic shocks  375

REFERENCES Anti-Corruption and Governance Center (2020, 16 June). ‘COVID-19 is straining Azerbaijan’s oil-dependent economy’. Accessed 8 August 2021 at https://​acgc​.cipe​.org/​business​-of​-integrity​-blog/​ covid​-19​-is​-straining​-azerbaijans​-oil​-dependent​-economy/​. Azerbaijan Republic, Ministry of Finance (2020a). ‘Narrative on the Draft Law of the Republic of Azerbaijan on Amendments to the Law of the Republic of Azerbaijan on State Budget of the Republic of Azerbaijan for 2020’. Accessed 8 August 2021 at http://​www​.maliyye​.gov​.az/​scripts/​pdfjs/​web/​ viewer​.html​?file​=/​uploads/​news​_files/​5f2486962c071​.pdf. [In Azerbaijani] Azerbaijan Republic, Ministry of Finance (2020b). ‘Draft of the revised budget of the State Oil Fund for 2020’. Accessed 8 August 2021 at http://​www​.maliyye​.gov​.az/​scripts/​pdfjs/​web/​viewer​.html​?file​=/​ uploads/​static​-pages/​files/​5f279f63cb507​.pdf. [In Azerbaijani] Azertag (2020, 2 June). ‘Last year, “Azeri-Chirag-Guneshli” production exceeded 195 million barrels’. Accessed 8 August 2021 at https://​azertag​.az/​xeber/​Oten​_il​_Azeri​_CHiraq​_Guneslide​_hasilat​_195​ _milyon​_barrelden​_chox​_olub​-1406435. [In Azerbaijani] Energy Information Administration (EIA) (2020). ‘Short-term energy outlook’. Accessed 8 August 2021 at https://​www​.eia​.gov/​outlooks/​steo/​report/​prices​.php. Fitch Ratings (2020, 17 July). ‘Fitch affirms Azerbaijan at “BB+”; outlook negative’. Accessed 8 August 2021 at https://​www​.fitchratings​.com/​research/​sovereigns/​fitch​-affirms​-azerbaijan​-at​-bb​-outlook​ -negative​-17​-07​-2020. Hesablama Palatsi (2020). The Opinion of the Chamber of Accounts of the Republic of Azerbaijan on the State Oil Fund of the Republic of Azerbaijan 2020 draft budget. Accessed 8 August 2021 at https://​sai​ .gov​.az/​files/​Rey​_ARDNF​_​%202020​.pdf. [In Azerbaijani] President of the Republic of Azerbaijan (2020, 28 July). Decree of the President of the Republic of Azerbaijan on Implementation of Transparency Reporting in the Extractive Industry. Accessed 8 August 2021 at https://​president​.az/​articles/​40124. State Oil Fund of Azerbaijan (SOFAZ) (2019). International Financial Reporting Standards Consolidated Finance Reports and Independent Auditor’s Report, as of December 31, 2019. Accessed 8 August 2021 at https://​www​.oilfund​.az/​report​-and​-statistics/​get​-download​-file/​8​_2019​.pdf. State Oil Fund of Azerbaijan (SOFAZ) (2020a). Information on revenues and expenditures of the State Oil Fund of the Republic of Azerbaijan for January–June, 2020. Accessed 8 August 2021 at https://​ www​.oilfund​.az/​report​-and​-statistics/​get​-download​-file/​6​_2020​_2​.pdf. [In Azerbaijani] State Oil Fund of Azerbaijan (SOFAZ) (2020b). Annual Report 2019. Accessed 8 August 2021 at https://​ www​.oilfund​.az/​report​-and​-statistics/​get​-download​-file/​7​_2019​_tam​.pdf. Turan (2020, 10 June). ‘Azerbaijan has reduced crude oil production by 18%, and exports by almost a third’. Accessed 8 August 2021 at https://​www​.turan​.az/​ext/​news/​2020/​6/​subsc/​energy​%20news/​ru/​ 124752​.htm. [In Azerbaijani] World Bank (2021). Global Economic Prospects 2020: June 2021. Accessed 8 August 2021 at https://​ openknowledge​.worldbank​.org/​bitstream/​handle/​10986/​35647/​9781464816659​.pdf.

24. Hydrocarbons during energy transition: from peak oil supply to peak oil demand and investment? Is energy security at risk? Cyril Widdershoven

1 INTRODUCTION The future role of hydrocarbons is under pressure, not only due to increased investment in renewables and climate-related transitions, but also as a result of the immense COVID-19 demand destruction and the global economic crisis. At present, oil and gas companies, investors and service companies are re-assessing their future, as it looks rather bleak. Reports of the International Energy Agency (IEA), the energy watchdog of the Organisation for Economic Co-operation (OECD), Organization of the Petroleum Exporting Countries (OPEC) and others indicate a dramatic shift in hydrocarbon demand, especially as fuel in transport or power generation. At the same time, international oil companies (IOCs), such as British oil major BP, Dutch Royal Dutch Shell (Shell) and Norway’s Equinor (formerly Statoil), are being hit by an avalanche of new regulations, financial pressures, low oil and gas prices and revenues, shareholder activism and the withdrawal of institutional investors and pension funds from their sector. The drive to a more renewable future is clear and the energy transition is speeding up, but could hold an immense array of hidden dangers currently not yet being considered. The drive to increase all efforts to get to a net-zero future or a renewable energy future is not without risks. One major indicator that tends to be overlooked is that hydrocarbon demand is not only for fuel. Even though total fuel consumption makes up a very high volume of oil and gas produced, the impact of substituting hydrocarbons with renewables or zero-emission fuels is going to be a very long play. International strategies aimed at speeding up the energy transition mostly overlook the total impact of oil and gas in the economy and the role it still plays in emerging markets. By removing much-needed investment to keep oil and gas production at least at the same levels, instability or volatile markets are created, with a detrimental effect not only on global energy but also vast parts of the economy. Some are even warning that the current OECD energy-transition and end-to-hydrocarbon strategies will lead to severe instability in emerging markets and other regions. Without doubt, hydrocarbons will be playing an important role much longer than is currently expected. This chapter assesses the future of hydrocarbons in general, considering the possible societal and economical changes. It also explores the argument that oil and gas will stay at least until 2040 as a major part of the global fuel mix and products mix.

376

Hydrocarbons during energy transition  377

2

FUTURE SCENARIOS, PEAK OIL, COVID-19 AND THE POST-PANDEMIC STATE OF HYDROCARBON MARKETS

Based on OPEC’s World Oil Outlook (WOO, 2020), which forecasts global oil markets until 2045, the market has been transformed by the unprecedented scale and reach of the COVID-19 pandemic. The outlook states that the market has been taken by surprise by the overall impact of what started at the beginning of 2020 as apparently another SARS-like epidemic, as in 2003 to 2004, but soon became a major pandemic, affecting countries around the globe and leading to the most severe economic downturn since the Great Depression in the 1930s. In a reaction to the unprecedented global oil demand destruction, OPEC+ decided to stabilize oil prices and to rebalance oil markets. All participants in OPEC+ via the Declaration of Cooperation (DoC) decided in April 2020 to collectively adjust down production over a two-year period, starting with almost 10 million barrels per day (bpd), or around 10 per cent of global supply, which has helped put oil markets on a path to rebalance. As indicated by OPEC, and latterly by others such as the IEA, the general feeling in the market is that COVID-19-induced recession and extension of the forecast period to 2045 have brought average long-term global gross domestic product (GDP) growth down to 2.9 per cent per annum. Even though the average growth rate of global GDP has been lowered, most agencies also agree on the fact that the global economy in 2045 will be more than double the size it was in 2019. Overall GDP is expected to hit the $258 trillion mark in 2045, compared with $121 trillion in 2019. China and India alone will account for 40 per cent of global GDP in 2045. The share of OECD countries will decline to 31 per cent in 2045 compared with around 43 per cent in 2019. At the same time, global population is expected to reach 9.5 billion by 2045. In their forecasts, OPEC, IEA and OECD all expect that governmental and international policies relating to energy demand and supply issues will be more stringent up to 2045. The Paris Agreement policies will drive mainstream policies to reach a full energy transition and reduction in greenhouse gas emissions. In addition to policies, technological developments and advancements will also drive a reshaping of the global energy mix. Still, in almost all scenarios published by OPEC, IEA, EU and energy companies such as Shell, BP and others, it has become clear that global primary energy demand is forecast to continue growing in the medium and long term, increasing by 72 million barrels of oil equivalent per day (mboe/d) up to 2045. This means that global energy demand is set to increase from 289 mboe in 2019 to 361 mboe in 2045. The main growth will be outside of the OECD, as predictions show a demand decline of 4.4 mboe/d in OECD countries, but an increase of 76.5 mboe/d in non-OECD countries. In almost all scenarios, oil is the main fuel in the global energy mix up to 2045, even with the ongoing exponential growth of renewables worldwide. OPEC reports that healthy growth rates are expected especially over the medium-term horizon, resulting in oil demand reaching the level of 94.4 mboe/d in 2025 and further progressing to 99.5 mboe/d in 2045. When looking at the total energy mix, OPEC indicates that oil will have a share of 27 per cent in 2045 (2019: 31 per cent), while gas will be 25 per cent and coal still 20 per cent (WOO, 2020). In contrast to most reports in the media, OPEC and others expect natural gas to be the fastest-growing fossil fuel in the 2019–45 period, mainly due to rising levels of urbanization, growth in industrial demand and greater competitiveness over coal in the power generation mix (ibid.). The main driver for the continuing growth of hydrocarbon-based energy sources is that in the period 2019–45, growth in electricity generation is set to continue at rates much higher

378  Handbook of sustainable politics and economics of natural resources than overall primary energy demand. The main drivers are economic development, population growth and expanding use of electric vehicles (EVs), as well as digitalization. Primary energy demand is expected to increase at an average rate of 0.9 per cent per annum between 2019 and 2045, while, at the same time, electricity generation is expected to increase by 2.2 per cent per annum on average. Most of the growth in power generation will come from developing countries. 2.1

Post-pandemic Recovery in the Hydrocarbon Markets

The IEA and OPEC both report that they expect global oil demand to continue growing after the turbulent events of 2020. OPEC even states that this will be at relatively high annual rates to reach a level of 103.7 million bpd by 2025. OPEC’s analysis is the most optimistic, as it indicates that annual increments will be relatively high, especially in 2022 and 2023, at 2.1 million bpd and 1.5 million bpd, respectively (WOO, 2020). Two main drivers for this are a return to pre-COVID-19 economic growth rates and a catching-up function for sectors hit. These two factors are mainly of importance in the developing countries. After the initial 2020–25 period, OPEC and the IEA see a more moderate growth scenario, which could be negatively impacted by outside factors such as growth in renewables, greening of the economy or major programmes such as the EU’s Green Deal. For the post-2025 period, even the most optimistic oil reports of OPEC indicate a more moderate level of annual incremental increase in demand of slightly above 1 million bpd. By 2045, global oil demand would hit a level of 109.1 million bpd. Even though the new figures are lower than presented in the pre-COVID-19 period, OPEC’s and the IEA’s scenarios still show a major growth, which will have to be met by national and international parties in the coming years. While OECD markets were ruling for decades, the post-COVID-19 period will depend on non-OECD countries, with their own national economic-financial and social strategies and their implications for oil and gas demand and investment policies. OPEC reports that OECD demand is expected to plateau at around 47 million bpd between 2022 and 2025 before it starts a longer-term decline towards 35 million bpd by 2045. For non-OECD regions, oil demand is going to grow, driven by an expanding middle class, high population growth rates and stronger economic growth potential. Total non-OECD oil demand is projected to increase by 22.5 million bpd between 2019 and 2045, reaching 74.3 million bpd in 2045 (ibid.). The largest contributor to this incremental demand is anticipated to be India, adding some 6.3 million bpd between 2019 and 2045. The IEA scenarios (Figure 24.1) are a bit more cautious, but in general not very different from OPEC assumptions (IEA, 2020a). 2.2

Plateau in Global Oil Demand

In the coming years, oil demand in road transportation will remain the main source of demand, but growth will come mainly from petrochemicals. OPEC and IEA both report that demand for oil (and products) was mainly coming from road transportation, making up 45 per cent of global demand in 2019. Even though COVID-19 removed around 4 million bpd of demand by transportation sectors, medium and long-term demand will still grow to 47 million bpd in 2045, in comparison to 44.4 million bpd in 2019. The main COVID-19 casualty has been aviation, declining by almost 50 per cent in 2020. It will take several years to reach the 2019

Global oil demand by scenario 2010–40

Values for 2020 are estimates. The pre-crisis trajectory is represented by the World Energy Outlook 2019 Stated Policies Scenario projection. IEA (2020a).

Figure 24.1

Note: Source:

Hydrocarbons during energy transition  379

380  Handbook of sustainable politics and economics of natural resources levels again, but it is expected that aviation demand is going to grow by another 3.7 million bpd during the period 2019–45. Transportation demand will be a major topic of discussion in the coming decades. Most energy-transition and hydrocarbon fuel divestment schemes are targeting vehicles, planes and maritime vessels to counter global warming. With all current programmes taken into account, OPEC, which is considered to be more conservative in its assessments, predicts that of a total of 2.6 billion vehicles on the road by 2045, around 430 million will be EVs, clearly constituting the second-largest group after internal combustion engine (ICE) vehicles. The EV surge is still a major challenge, as financial and economic factors are not always fully considered. OECD countries will be leading the EV surge, but emerging markets or high-subsidized fuel markets will be lagging. Costs of EVs and available electricity grids will also be a major constraining factor. The share of EVs is projected to reach around 5 per cent in 2030, 13 per cent in 2040 and more than 16 per cent in 2045. Natural gas vehicles (NGVs) will number around 120 million by then but are overtaken by EVs around 2030. 2.3

Peak Oil and Post-COVID-19 Fossil Fuel Impact

At present, oil and gas companies are facing risks not only to their future but also their present operations. Since the 1970s, due to the Club of Rome report and peak oil discussions, the world has tried to get to grips with the term and impact of finite resources. Most of the assessments have focused on supply shortages. At the end of the 1990s, analysts started to realize that the concept of hydrocarbon shortages was possibly too pessimistic. Peak oil assessments were slowly substituted by statements that ‘the Stone Age did not end due to shortage of stones’, implying that peak oil supply should become ‘peak oil demand’. The peak oil supply discussion came to a full stop after the discovery not only of major new oil plays, such as the North Sea, deepwater offshore oil and gas plays, including Sub-Salt Brazil, and a dramatic change in the position of natural gas in the discussion. All resulted in major upward revisions of global crude oil and gas reserves. IOCs, led by Shell, and independents such as British Gas (BG), opening a new global game changer called natural gas, even led the Paris-based IEA to produce a major report, entitled Are We Entering a Golden Age of Gas? After focusing for almost a century mainly on oil, natural gas emerged as a profit-maker. A new hydrocarbon powerplay emerged, bringing a new fuel of choice to the market. Combined oil and gas reserves hit historic levels, far outpacing all demand growth predictions. Still, the peak oil discussion did not falter, as growing global demand, especially the emergence of Asian tigers such as China and India, opened new hydrocarbon demand at unforeseen levels. Demand and supply volumes started to reach an equilibrium in which potential shortages in the market re-emerged. Demand was even expected to outpace supply very soon in the twenty-first century. All eyes were on the detrimental developments in the USA, as the former largest oil producer was looking at a steep decline in production volumes. The latter, in combination with a decline in offshore production, especially North Sea and Gulf of Mexico, was painting a doomsday scenario again. Even though peak oil re-emerged in discussions, analysts have not been keeping their eyes on technology developments, not only causing production costs to tumble but also introducing new breakthrough developments, such as fracking. The latter became a major game changer, as it opened an unexpected unconventional hydrocarbon resource called shale oil and gas. New technology (fracking), efficiency and positive legal and financial environments in the

Hydrocarbons during energy transition  381 USA made it possible to bring enormous unconventional oil and gas reserves to the market. The unexpected productivity of the new play, also available in other parts of the world, has reshuffled all available scenarios and planning. The US shale productivity, resulting in an abundance of oil and gas, pushed the market to oversupply. Demand growth worldwide was not able to counter the multimillion barrels of oil equivalent entering the market. A new market constellation was set up, taking some of the power out of the hands of IOCs and their national counterparts (Aramco, Gazprom, ADNOC, etc.). US oil and gas re-emerged as the major player at the start of the twenty-first century, pushing the USA again to the top of its power. Peak oil, which was based on a supplier’s market, is now removed from power by a buyer’s-market situation, as oversupply has become the main driver. Since the shale revolution, oversupply has been the main underlying driver and reason for several severe oil market crises, increased volatility and major supply-demand shocks. The structure of the market has changed dramatically. After being ruled and regulated by the Texas Railroad Commission (TRRC), the Seven Sisters (Shell, BP, ExxonMobil, Texaco, Total and ENI) and OPEC, US global market power increased while OPEC and non-OPEC producers were forced to merge their market strategies. OPEC+, a combination of OPEC members and mainly Former Soviet Union (FSU) producers, led by Saudi Arabia, the United Arab Emirates (UAE) and Russia, was set up to stabilize the market. The OPEC+ cooperation, mainly between Saudi Arabia, UAE and Russia (non-OPEC) has been followed through by the oil cartel’s members and mainstream non-OPEC producers. In 2020, OPEC+ and the USA have even come to a working arrangement, in which, despite major market differences and political disputes, all parties have agreed to a market mechanism in which all producer countries have agreed to remove major volumes from the market to counter the almost 20 million bpd demand destruction caused by COVID-19. At the same time, international oil companies and oilfield service companies have been hit by a major financial plunge, as their overall market capitalization plummeted to unforeseen levels. A long list of oil and gas companies have already been forced to file for bankruptcy or Chapter 11. Consolidation of the privately owned or listed companies is on track to reshape the market even further. In October 2020, reports showed that the combined market cap of the top-five oils in the USA fell by 45 per cent to $367 billion, in comparison to $690 billion in December 2019 or $674 billion in October 2019 (Energy Northern Perspective, 2020; StockApps, 2020). The impact of the COVID-19 crisis has been immense, as the sector was faced with slumping prices even before the pandemic. The main drivers for this financial crunch, excluding COVID-19, are global macro-economic drivers, such as the US–China trade war and continuing oil overproduction. The demand destruction by COVID-19 sent prices even lower. In March 2020, the oil market was confronted by a new crisis as Russia and Saudi Arabia went for confrontation. Both already disagreed about OPEC+ strategies, but now openly confronted each other. In a move to pressure Moscow, Riyadh decided to increase production and lower oil prices even further. Moscow answered the Riyadh move by opening the valves too. Prices crashed by over 60 per cent in the weeks after. Due to growing international pressure, also known as the Trump Tweets, OPEC+ leaders came to an understanding again, but the damage was done. Prices even plunged to negative on the US markets (in West Texas Intermediate – WTI), while average price levels were still very low in 2020. The main outcome of this instability in the market was not only lower revenues and increased market cooperation, but also a major ‘tsunami’ of bankruptcies, divestments and

382  Handbook of sustainable politics and economics of natural resources consolidation. Not only were oil producers and services hit, but natural gas was also looking at a price and revenue plunge. US shale oil and gas were hit on both sides. Super majors such as Shell, Exxon and BP have been hit by all these market factors. For the financial world it was a major shock when one of the main pillars of the Dow Jones Industrial Average, ExxonMobil – once the world’s largest publicly traded company – was dropped in August 2020. As the largest oil and gas producer in the United States, the company suffered the most significant market cap drop in 2020, falling from $300 billion in September 2019 to $144 billion in October 2020 (StockApps, 2020), as shown in Figure 24.2. American giants such as Chevron, Phillips 66, EOG Resources and ConocoPhillips have all shown the same negative price slump (Figure 24.2).

Source:

StockApps (2020).

Figure 24.2

Market capitalization of the leading US oil and gas companies, from September 2019 to October 2020, in billion US dollars

The picture painted for US-based oil and gas companies is not extraordinary, as its European compatriots are showing the same. Almost all 25 North American and European oil and gas companies faced a market capitalization slump in 2020 (Table 24.1). According to S&P Global Intelligence (S&P, 2020) 12 of the 25 companies were worth more at the end of the third quarter than they were at the end of the first. Of the 12, only five are engaged in upstream activities, including exploration and production and drilling. Meanwhile, all the large integrated oil and gas companies on the list are worth less than they were six months ago. European super majors Royal Dutch Shell and BP, who are in the midst of diversifying their businesses, declined in value by 33.5 per cent and 34.5 per cent, respectively. As broader market equities recovered in the third quarter, energy equities suffered. From the end of June through to the end of September, the S&P 500 was up 8.9 per cent, while the S&P 500 Energy Index declined by 19.7 per cent. On 17 December 2020 the index is still 33.3 per cent lower than at the start of the year 2020 (S&P Dow Jones Indices, 2020).

Hydrocarbons during energy transition  383 Table 24.1 Rankinga

Oil and gas companies’ market capitalization Q3 2020 Company (Ticker-exchange)

Industry

Headquarters

Market Cap Change in Market Cap (US$ billions)

30/09/20

30/06/20  

 

 

 

(%)b 30/06/20

31/03/20

1

1

Exxon Mobil Corp. (XOM-NYSE)

IO&G

US

145.16

–23.2

–9.6

2

2

Chevron Corp. (CVX-NYSE)

IO&G

US

134.44

–19.3

–0.6

3

3

Royal Dutch Shell plc

IO&G

Netherlands

96.54

–24.2

–33.5 –15.7

(RDSA-ENXTAM) 4

4

TOTAL SE (FP-ENXTPA)

IO&G

France

90.13

–12.6

5

6

Enbridge Inc. (ENB-TSX)

O&GST

Canada

59.13

–5.8

–5.1

6

5

BP plc (BP-LSE)

IO&G

UK

58.64

–26.7

–34.5

7

7

Equinor ASA (EQNR-OSL)

IO&G

Norway

46.7

–4.0

–0.1

8

14

Neste Oyj (NESTE-HLSE)

O&GRM

Finland

40.55

29.2

45.8 –19.6

9

9

TC Energy Corp. (TRP-TSX)

O&GST

Canada

39.44

–3.6

10

8

ConocoPhillips (COP-NYSE)

O&GEP

US

35.22

–21.8

6.6

11

10

Enterprise Products Partners LP

O&GST

US

34.52

–13.1

10.4

12

12

Eni SpA (ENI-MIL)

IO&G

Italy

28.06

–21.2

–27.5

13

11

Kinder Morgan Inc. (KMI-NYSE)

O&GST

US

27.91

–18.6

–11.3

14

20

Williams Cos. Inc. (WMB-NYSE)

O&GST

US

23.85

3.3

38.9

15

13

Phillips 66 (PSX-NYSE)

O&GRM

US

22.64

–27.9

–3.4

16

17

Schlumberger Ltd. (SLB-NYSE)

O&GES

US

21.60

–15.4

15.4

17

15

EOG Resources Inc. (EOG-NYSE)

O&GEP

US

20.93

–29.1

0.1

18

18

Marathon Petroleum Corp.

O&GRM

US

19.09

–21.4

24.3

19

21

Canadian Natural Resources Ltd.

O&GEP

Canada

18.92

–9.4

10.9

(EPD-NYSE)

(MPC-NYSE) (CNQ-TSX) 20

16

Suncor Energy Inc. (SU-TSX)

IO&G

Canada

18.61

–29.0

–27.7

21

19

Valero Energy Corp. (VLO-NYSE)

O&GRM

US

17.66

–26.4

–4.5

22

23

MPLX LP (MPLX-NYSE)

O&GST

US

16.37

–10.5

33.1

23

24

Cheniere Energy Partners LP

O&GST

US

16.0

21.7

57.6

24

22

Energy Transfer LP (ET-NYSE)

O&GST

US

14.61

–23.9

17.9

25

26

Pioneer Natural Resources Co.

O&GEP

US

14.13

–12.0

22.1

–3.6

13.9

(CQP-AMEX)

(PXD-NTSE) Industry median

Notes: a. Ranking based on company market values converted into US dollars. b. Market capitalization percentage changes were calculated based on reported currencies. Data compiled 1 Oct. 2020. Analysis included North American and European oil and gas companies that trade on major stock exchanges. Excludes companies headquartered in Russia. Industry is classified according to the Global Industry Classification Standard or S&P Global Market Intelligence. IO&G = Integrated Oil and Gas; O&GST = Oil and Gas Storage and Transportation; O&GRM = Oil and Gas Refining and Marketing; O&GEP = Oil and Gas Exploration and Production; O&GES = Oil and Gas Equipment and Services. Source: S&P (2020).

3

HYDROCARBON FINANCING CONSTRAINED BY ENERGY TRANSITION?

In recent years, hydrocarbon projects, operators and oilfield services have felt the repercus-

384  Handbook of sustainable politics and economics of natural resources sions of a changing financial environment, not only as a result of lower oil and gas prices, partly due to the technological success stories such as US shale or offshore deepwater, but also due to the increased ‘greening’ of financials. An ever-growing list of financial institutions, pension funds, private equity and activist shareholders have combined their efforts to reconsider investment strategies that include high-profile hydrocarbon-related projects, such as stranded asset risks of oil and gas, high-cost, high-risk Arctic drilling and oil sands projects. In 2020, a major shift has taken place, supported by the unexpected, but watershed, impact of COVID-19, a global economic crisis and an impressive call for new economies, based on renewables, low-carbon or even net-zero production. The financial risk of investing in oil and gas has become almost unbearable for some institutions, such as the World Bank, the International Monetary Fund (IMF), the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB). These four global institutions have been playing a pivotal role in major oil and gas exploration and production (E&P), downstream and/or infrastructure projects. Without the support and part-financing of these institutions, most major pipeline projects, such as the Baku-Tblisi-Ceyhan oil pipeline, the Trans-Adriatic Pipeline (TAP) or NordStream, would not have materialized. At present, several future projects, such as the East Med Offshore Gas Pipeline between Egypt and Israel and Cyprus and Greece or gas pipeline infrastructure in Mozambique, will no longer be feasible due to changing investment strategies or the decision not to invest in hydrocarbon projects and companies at all. As several reports and studies have now concluded (Arezki and Nguyen, 2020; Fattouh and Economou, 2020; IEA, 2020b; OPEC, 2020; Webster et al., 2020), the COVID-19 pandemic has created the largest oil and gas demand shock in history, but the fall-out is much more threatening, as oil and gas companies have severely curtailed their spending on upstream operations. Although upstream investment declined sharply in 2020, and is set to do so again in 2021, ongoing demand for oil and gas will necessitate an increase in the near future. Market volatility is expected to increase in the coming years, mainly caused by the lower investment levels, as oil and gas supply will be reduced. Lower supply volumes, combined with higher prices, will not only slow down global economic growth, but from the start undermine overall energy security. The COVID-19 pandemic has not only forced governments to reassess their budgetary requirements and income generation powers, but has also put immense pressure on upstream, midstream and downstream operators. Most of them had to curtail existing investment programmes, delay or cancel projects, and lower overall targets set for the future. Market attention has gone mainly to the financials, and the results of private or listed oil companies, such as Shell, ExxonMobil and BP, all showing the detrimental effects of the pandemic and its vast demand destruction. The value of listed oil and gas companies plunged to historic low levels, not only threatening their shareholders but also the future of the whole sector. International oil and gas markets are, however, no longer in the hands of the former Seven Sisters, but increasingly ruled and formed by OPEC members, their national oil companies, and, in recent years, in cooperation with non-OPEC producers, such as Russia or Central Asian parties. For all of them, the COVID-19 pandemic has resulted in a difficult and potentially threatening situation. National governments and their respective national oil companies (NOCs) also had to reduce prices, resulting in much lower government revenues. NOCs and IOCs are struggling with significantly lower demand and inflated stockpiles of crude and petroleum products. The global oil storage crisis

Hydrocarbons during energy transition  385 had already started in 2018–19, as production and supply to the market was substantially higher than global demand. The COVID-19-demand destruction issue only increased this. At the same time, the COVID-19 pandemic has only increased the already negative fundamentals in the markets, not on a gradual basis but with one big bang. It forced IOCs and NOCs to cut capital expenditure (CAPEX) in a bid to shore up their balance sheets. As seen in the US shale sector, financials are the lifeline, especially for capital-intensive operations such as shale oil and gas. If a certain fiscal-financial break-even point is removed as demand plunges and prices follow suit, the financial backers of US shale have retreated or called in their debt repayments. For conventional on- and offshore oil and gas, the same picture can be painted, but with a lower decline rate of financing. The overall impact of reduced investments and upstream activities will be become clear in the coming years. Already a vast number of oil and gas projects are being delayed, as shown in natural gas supplies worldwide. The future of new offshore gas reserves, such as the East Med or Red Sea, is currently in doubt, as costs of production are reasonably high, while market prices and investment appetite are low. Reports, such as from the International Energy Forum (IEF) and Boston Consulting Group (BCG), are showing that these lower CAPEX levels appear to be insufficient to deliver the volumes of oil and gas needed to maintain market stability. OPEC also reiterates, as do the IEA and investment banks such as Arab Petroleum Investment Corporation (APICORP), that cumulative oil-related investments are under threat in the future. OPEC estimates that cumulative oil-related investment requirements over the long term will be $12.6 trillion. Reduced upstream investments are seen as a strong downside risk to global supply outlook. According to Norwegian oil consultancy Rystad Energy, a decline is expected of more than 30 per cent in 2020 but will recover to 2019 levels by 2024/25. The latter means that to meet global oil demand, future upstream spending will need to average $380 billion per annum over the long term (Rystad Energy, 2020). When taking this (in 2020 US$), an additional $9.9 trillion is required. Added to $1.5 trillion for the downstream, and $1.2 trillion in the midstream, cumulative oil related investment requirements over the long term will be $12.6 trillion. The need for large-scale new investments is clear, as upstream has already been fighting an uphill battle to get access to the necessary investment volumes in recent years. Larger investments are necessary to avoid a future of higher prices and increased market volatility. Inadequate investment would set off another wave of unwanted boom-and-bust pricing. The threat of underinvestment is increasing, while OECD governments are looking at potential disruptions and higher price settings, and oil- and gas-producing countries are fearing continuously lower revenues to support their economic diversification plans and social contracts. As the IEF stated in a new report Oil and Gas Investments in a New Risk Environment (IEF, 2020), the rising price volatility that this is likely to cause weakens the prospects for the inclusive and sustainable economic recovery that producers, consumers and governments all want. CAPEX investments have already been cut by more than 34 per cent in 2020, which is even more than the initial 28 per cent reduction following the price decline that started in 2014. Oil and gas giants have indicated in their financial reports that CAPEX reductions will also be in place for 2021, and some have even said that 2022 is also doubtful. Oil and gas sector operators and oilfield services have been used to volatility in their investment plans, as the sector, part of global commodities, is used to a boom-and-bust environment. Flexibility in CAPEX/OPEX (operational expenditure) spending has always been in place, as was shown in previous low and high oil price environments. In recent years, major advances were made to cope with lower price settings, as reduced costs of production and exploration

386  Handbook of sustainable politics and economics of natural resources have been put in place due to oilfield service technology development successes. This, however, is not a linear situation, as the current crisis is no longer to be countered by the same amount of new technology developments and cost cutting within oilfield services. The IEF report shows that every dollar of CAPEX that is cut today will have twice as powerful an effect in terms of reducing activity than cuts made following the 2014 fall in prices (IEF, 2020). The report notes that, starting in 2014, oil and gas companies cut CAPEX for two consecutive years. At the same time, service sector companies reduced their costs sharply, which helped to support industry activity. This time around, suppliers have less scope to do that. As a result, the recovery in investments is likely to take longer than it did in the wake of the 2014 price drop. CAPEX cuts are also at the same levels as in 2004, when oil prices were the same. The market is worried that in the coming years, the current combination of low CAPEX and low prices (like in 2004) will result in the same historic high-water mark for oil prices in August 2008. As in 2004, demand for oil and gas is expected to increase again to 2019 levels by late 2021/ early 2022, and keep on growing, at an even lower rate. With low CAPEX, supply will become a major constraint. Comparing the 2004 situation with the current COVID-19 crisis is a flawed approach. In 2004, major new oil and gas reserves were found and developed (US shale), while at present no real new source is available. Investment in existing or known resources is needed, but at present is not available. Current energy market analysis is partly countering the picture painted above by stating that new demand for energy and fuels will be delivered by renewables, nuclear and other sources, such as hydrogen. The market makers, however, tend to forget that to keep demand for oil and gas at even lower levels than 2019, industry would still need to make significant investments to compensate for production declines (natural oil and gas production decreases over the life of a well as the deposit it taps is depleted). Without real investments put in place, oil and gas production on existing fields tends to show a production decline of an average of 6–7 per cent, but larger oil fields such as the Saudi, Russian or offshore fields can hit much higher levels. Shale production also has much steeper decline rates if no new investments are made. Simply said, with global oil and gas production of 100 million bpd, investments are needed to produce and/or find at least 7 million bpd of reserves to counter normal decline rates. OPEC, IEA and others currently believe that total oil demand will peak within the next decade. Even taking into account the effects of the COVID-19-related demand destruction, this still means that another 27 to 30 mboe will be needed by 2022 to close the gap between production decline and demand levels. To cope with total demand growth before the peak hits, both groups warn that required volumes need to increase to 68 to 70 mboe by 2030. This immense amount of new oil and gas to be additionally discovered and produced is not showing a peak oil demand scenario, but a peak oil investment crisis. When considering the current financials of most IOCs and leading NOCs, peak investment requirements are not going to be met, as uncertainty and unavailability is playing an increased constraining role. As the IEF report clearly states, industry investment will have to rise over the next three years by at least 25 per cent annually from 2020 levels to stave off a crisis (IEF, 2020). Substantially greater sums will be needed by the end of the decade to ensure enough production to guarantee market stability. Even if demand were to peak and begin to decline in the near term, peak demand would still need to be met with increased investment above 2020 levels. In this event, the production gap would still be more than 90 per cent of the gap that would exist if demand continued to grow incrementally. Overall, it can be argued that the future of oil and gas production is at risk. The COVID-19 pandemic, global economic crisis and uncertainty

Hydrocarbons during energy transition  387 about volatility in the markets are not a breeding ground for investment appetite or trust. At the same time, another major threat is emerging, as governments, international organizations, non-governmental organizations and activist shareholders are increasing pressure to divest or reduce investment and financing of projects in hydrocarbon sectors.

4

HYDROCARBON DIVESTMENT THREAT

Lower CAPEX/OPEX is not the only threat to the future of oil and gas. Fossil fuel divestment, supported by international governments, international financial institutions and investors, is a current and future threat pushing oil and gas companies into the abyss. In recent years, an ever-growing group of institutional investors, international organizations and activist investors are lining up their efforts to force a multi-trillion dollar divestment push from oil and gas. In recent months, a group of 12 major cities in the EU, USA and Africa all pledged to divest from coal, oil and gas. These cities are home to more than 36 million residents and hold over $295 billion in assets. As noted in Widdershoven (2020), activist investors, in line with the growing Western media onslaught on hydrocarbon production and use, are not only putting the future of international oil and gas producers at risk, but also increasingly removing the necessary equilibrium between independent (privately owned) oil and gas producers and the national oil companies. For decades, global oil and gas production has been built on several mainstream structures, including the Texas Railroad Commission, the Seven Sisters and OPEC. These structures have helped to stabilize and structure the market to benefit producers, shareholders and consumers at the same time. The power balance between the Seven Sisters (which in its modern form consists of Shell, BP, ExxonMobil and Chevron) and OPEC producers has regulated the $1.7–1.8 trillion oil market through times of financial crisis, regional wars and Black Swan events. This necessary cooperation or power equilibrium is now being undermined by investors and politicians, threatening not only energy and petroleum product supply to global markets but also diminishing the influence of consumer countries on producers, such as OPEC. An increasing number of international financial giants, such as Dutch asset manager Robeco, are committed to excluding investments in thermal coal, oil sands and Arctic drilling from all their mutual funds. The Dutch fund stated in 2020 that it will bar companies that derive 25 per cent or more of their revenues from thermal coal or oil sands, or 10 per cent or more from Arctic drilling (ibid.). The Dutch asset manager, holding around 155 billion euros ($181 billion), has already excluded thermal coal investment from its sustainable funds. European insurers, asset managers and pension funds are not the only ones. Recent reports indicate that global investors have already excluded $5.4 trillion from fossil fuels. In the eyes of most investors and activists/governments, divesting fossil fuel companies will be a major step forward. Some investors are arguing that it is economically sensible to divest, based on the stranded asset argument put forward in a major report from the Bank of England (Widdershoven, 2020). Bank, equity and pension funds are worried that the intrinsic value of fossil fuel assets is much lower than current market valuations. Even if the total value of hydrocarbon producers on stock exchanges has dwindled, the impact of divestment on asset allocation and returns will be immense. Fossil fuel producers make up around 6 per cent of the global stock market and over 12 per cent of the UK market. As some have already stated, excluding an entire sector impacts asset allocation, resulting in

388  Handbook of sustainable politics and economics of natural resources increased benchmark risk (relative to the market) and potentially higher volatility. Research by investment bank Schroders shows that over the long term, the impact of exclusions on investment returns is minimal (ibid.). However, it can increase volatility in the short term. Investors are leaving the market, share prices are plunging, company strategies are being changed and production is in danger. Assessments about the major asset re-evaluations by privately owned oil companies in recent months should be taken with a grain of salt. Even if the world’s biggest oil companies were to slash the value of reserves and current projects in 2020, such as French major Total writing down about $7 billion of Canadian oil sands assets, or Shell’s $4.7 billion hit in the second quarter relating to assets in North America, Brazil and Europe and a project in Nigeria, the real value is a book value. Not only do shareholders feel the pain of lower revenues and dividends in times like these, but hydrocarbon projects become uneconomical. By removing multibillion-dollar hydrocarbon investment projects around the world though, supply will be hit hard in the coming years while demand will continue to grow. Already in 2019, the market was shocked by a threat to oil and gas markets of around $47 trillion, when around 130 international banks, all present at the UN climate change summit in New York, committed themselves to decrease their support and investment in the oil and gas sector in the future. The banking groups have signed the so-called Principles for Responsible Banking, which include a promise by financial institutions to fully support the implementation of the Paris Agreement, by decreasing hydrocarbon investments, while promoting renewables. This statement is a major earthquake for oil and gas companies, threatening upstream and downstream operations worldwide, forcing oil and gas producers to either reduce their impact on the environment or to seek new sources of investment. It is already becoming more difficult for oil and gas companies to find new financing, and on top of this, a large group of institutional investors, representing a value of $11 trillion, are already actively divesting their oil and gas assets. In October 2020, another major report came out, this time based on a tracker developed by the Institute for Energy Economics and Financial Analysis (IEEFA, 2020a). The IEEFA report stated that ‘momentum is built against financing of oil and gas projects’. IEEFA’s Tim Buckley, director of energy finance studies and co-author of a new briefing note on global financial institutions divesting from oil and gas stated that ‘[o]ver 140 global financial institutions have already restricted thermal coal financing, insurance and/or investment and we are now seeing a similar accelerating shift of capital away from oil and gas exploration, starting with high risk oil sands development and drilling in the Arctic. This momentum in fossil fuel divestment globally means we expect a continuation of new announcements from other financial institutions seeking to better manage increasing climate risk’ (IEEFA, 2020b). With its tracker, IEEFA has identified 50 significant global financial institutions to date with restrictions on financing oil sands and/or Arctic drilling projects, including HSBC, Banco Santander, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Citigroup, Wells Fargo and Morgan Stanley. The European Investment Bank (EIB) holds the strictest and best policy, announcing in 2019 that it will be out of all oil and gas by the end of 2021. As indicated by IEEFA (2020b), European financial institutions have taken the lead in exiting oil and gas. To date, 36 European financial institutions have announced a formal policy, including HSBC, Banco Santander, BNP Paribas and Deutsche Bank. The financial institutions exiting oil and gas that are closest to achieving best practice policy are ABN Amro, BNP Paribas and Banco Santander. These agencies have policies containing fewer loopholes, while those with the most stringent policies are Agence Française de Développement (AFD) and Crédit Agricole Group.

Hydrocarbons during energy transition  389 Removing financial support to the hydrocarbon sectors worldwide will put supply under severe pressure. Continuous (re-)financing is needed by oil and gas companies not only to keep current production volumes at the same level, but also to increase production to meet global demand growth (IEA, 2020a). Until now, renewable energy output, even if it is showing exponential growth figures, is not able to meet even yearly demand growth worldwide. Conventional energy sources, including coal and nuclear, are still needed to supply the ever-growing demand for energy. Economic growth outside of the OECD regions is the real reason for this soaring demand, and the ongoing renewables drive in the West is not having an effect on this at all. Another issue that has not been discussed or assessed is the fact that a quick transition to renewable energy is unlikely in non-OECD countries, as oil, gas and coal will remain the main sources of energy in the next couple of decades. Removing financial support for hydrocarbon companies will put a major bomb under the future of emerging economies. At this moment, hydrocarbons are the main source of energy in most countries around the globe. To prevent a collapse of the global economy, steady financing will be needed, even more than before. Some figures are even showing that in the coming years, more than $11 trillion in energy investment is needed. Widdershoven (2019) argues that ‘without even looking at the Paris Climate Agreement, the current pressure building up on hydrocarbons, and the unilateral decision by banks shown now at the UN, also threatens OECD countries. Energy consumers are not only going to reap the rewards of the energy transition but will also feel the negative financial aspects of a possible hydrocarbon sector meltdown’. Last, global security is another issue, as indicated by reports by the IEA and others. Destabilization in oil-producing countries could occur as soon as oil revenues start falling. For the West, the main negative outcome would be if conventional energy producers, squeezed by big banks, look at non-western parties to become involved. To have an overwhelming majority of future energy supply being paid and owned by non-OECD countries, such as China, Russia, or sovereign wealth funds (SWFs) is not a great outlook at all (ibid.).

5

CONCLUDING REMARKS

The golden era of oil is over, at least when looking at its attractiveness for investors, financial institutions and shareholders (Broda, 2020; Calstrom, 2020; UltraLong, 2010). Old adages such as ‘Never Sell Shell’ have been thrown out by mainstream investors, as oil and gas are no longer seen as the backbone of economic prosperity and growth. The latter is, however, for the coming decades still valid, looking at the need for trillions of dollars to finance necessary oil and gas projects worldwide to supply and quench the thirst of billions of customers worldwide. The main message is also that hydrocarbons and renewables are not in competition, but should support or substitute each other, as both will be needed for decades to come. The targeted energy transition, put in place after the Paris Agreement, supported by the UN, EU, OECD and others, is only going to be possible in a stable supply and investment environment. Current conflicts and the potential for negative fall-out from a real conflict between hydrocarbons and renewables should be prevented, as without one side (oil and gas and even coal) the other will not have the time and the opportunity to mature into a full-scale energy provider on which developed and emerging markets can build their future. For decades

390  Handbook of sustainable politics and economics of natural resources to come, oil and gas will be playing a significant role in the energy transition as the two are primary sources and transport options of energy, affordable and readily available. The impact of renewables, especially wind, solar, biomass or even hydrogen, still need to mature as costs/ benefits are not yet available for all or grid connections do not even exist. To have lopsided investment and policy strategies put in place without acknowledging the impact on security of energy supplies if only renewables are being promoted and supported will lead to blackouts, increased energy competition and possible conflict. The energy transition should include a whole economic transition, as most current economic and production factors are still based on the availability of oil and gas. By removing access to finance or equity investments, a major cornerstone of the global economy is being put at risk. Trillions of dollars are needed on both sides, making such finance prudently available will be a major support for the energy transition and a net-zero carbon-free future (or a lower-carbon future). The current developments are clearly not going to be sustainable as major energy supply sources are put at risk, while energy revenues for emerging markets or whole continents are also being removed. Sustainability not only means carbon-free, but also refers to welfare and economic prosperity, or simply access to energy and freedom. Thus, hydrocarbons are, and will continue to be, a major cornerstone of sustainability. Markets and politicians should also understand that not all oil and gas is in the hands of the hydrocarbon sector parties currently targeted. Putting pressure on Shell, BP and Total, or institutional investors and banks, only addresses one side of the energy coin. Most of the hydrocarbon reserves are still owned and will in future be produced by national governments and their respective national oil companies. The current hydrocarbon divestment schemes are effective and painful for the ones listed on Western stock exchanges and those who must listen to activist shareholders and activists. When looking at the reserve-holders, such as Saudi Arabia, Russia, Iran-Iraq and Egypt, international financial powers are limited. The Saudi Aramco initial public offering (IPO) has shown that targeted financial revenues can be reached without listings on the New York or London Stock Exchanges (Gross, 2019). By removing international or institutional financial backing for energy (mainly hydrocarbon-related), projects in emerging or underdeveloped countries, such as Mozambique, Suriname or Chad, the future of whole countries or regions is put at risk. The western-centric approach to all of this is causing hidden casualties. It is already reshaping regional and global alliances, as rentier states and emerging markets fear not only for their financial future but also for the stability of their respective regimes. The COVID-19 pandemic has shown one clear thing: the world is more interconnected than most understood. It looks as though for hydrocarbons and the energy transition, the so-called butterfly effect (FS, 2020) is also pertinent. If you act on one side, the other will be forced to counteract.

REFERENCES Arezki, R. and Nguyen, H. (2020, 14 April). Coping with a dual shock: COVID-19 and oil prices. World Bank brief. Accessed 8 January 2021 at https://​www​.worldbank​.org/​en/​region/​mena/​brief/​coping​ -with​-a​-dual​-shock​-coronavirus​-covid​-19​-and​-oil​-prices. Broda, B. (2020, 25 March), ‘Big Oil needs to accept that its golden age is over and invest in wind and solar’. Rechargenews.com. Accessed 8 January 2021 at https://​www​.rechargenews​.com/​transition/​big​ -oil​-needs​-to​-accept​-that​-its​-golden​-age​-is​-over​-and​-invest​-in​-wind​-and​-solar/​2​-1​-780616.

Hydrocarbons during energy transition  391 Calstrom, G. (2020, 17 November). ‘The end of a golden age for oil producers. The Economist. Accessed 8 January 2021 at https://​www​.economist​.com/​the​-world​-ahead/​2020/​11/​17/​the​-end​-of​-a​-golden​-age​ -for​-oil​-producers. Energy Northern Perspective (2020, 22 October). Five largest US oil and gas companies take a 45% market capitalisation plunge amid COVID-19 crisis. Accessed 8 January 2021 at https://​energynorthern​.com/​ 2020/​10/​22/​five​-largest​-us​-oil​-and​-gas​-companies​-take​-a​-45​-market​-capitalisation​-plunge​-amid​ -COVID​-19​-crisis/​. Fattouh, B. and Economou, A. (2020). Oil supply shock in the time of the coronavirus. The Oxford Institute for Energy Studies. Accessed 8 January 2021 at https://​www​.oxfordenergy​.org/​publications/​ oil​-supply​-shock​-in​-the​-time​-of​-the​-coronavirus/​. FS (2020). The butterfly effect: everything you need to know about this powerful mental model. FSblog. Accessed 23 December 2020 at https://​fs​.blog/​2017/​08/​the​-butterfly​-effect/​. Gross, S. (2019, 11 December.). The Saudi Aramco IPO breaks records but falls short of expectations. Brookings.edu. Accessed 20 December 2020 at https://​www​.brookings​.edu/​blog/​order​-from​ -chaos/​2019/​12/​11/​the​-saudi​-aramco​-ipo​-breaks​-records​-but​-falls​-short​-of​-expectations/​#:​~:​text​ =​On​%20December​%2011​%2C​%202019​%2C​%20shares​,values​%20Aramco​%20at​%20​%241​.7​ %20trillion. International Energy Agency (IEA) (2020a). Global oil demand by scenario, 2010–2040. Accessed 20 December 2020 at https://​www​.iea​.org/​data​-and​-statistics/​charts/​global​-oil​-demand​-by​-scenario​ -2010​-2040. International Energy Agency (IEA) (2020b). The Oil and Gas Industry in Energy Transitions. Accessed 8 January 2021 at https://​www​.iea​.org/​reports/​the​-oil​-and​-gas​-industry​-in​-energy​-transitions. International Energy Forum (IEF) (2020). Oil and Gas Investment in the New Risk Environment. An International Energy Forum Report with Boston Consulting Group. Accessed 8 January 2021 at https://​www​.ief​.org/​investmentreport. Institute for Energy Economics and Financial Analysis (IEEFA) (2020a). Finance is leaving oil and gas. Accessed 8 January 2021 at https://​ieefa​.org/​finance​-exiting​-oil​-and​-gas/​. Institute for Energy Economics and Financial Analysis (IEEFA) (2020b, 19 October). IEEFA: from zero to fifty, global financial corporations get cracking on major oil/gas lending exits. Accessed 8 January 2021 at https://​ieefa​.org/​ieefa​-from​-zero​-to​-fifty​-global​-financial​-corporations​-get​-cracking​ -on​-major​-oil​-gas​-lending​-exits/​. Organization of the Petroleum Exporting Countries (OPEC) (2020, 14 December). Monthly oil report. Accessed 8 January 2021 at https://​www​.opec​.org/​opec​_web/​static​_files​_project/​media/​downloads/​ publications/​OPEC​_MOMR​_December​-2020​.pdf. Rystad Energy (2020). Oil market analytics. Accessed 20 December 2020 at https://​www​.rystadenergy​ .com/​energy​-themes/​commodity​-markets/​oil/​oil​-market​-analytics/​. S&P (2020). Top oil and gas companies see market cap spiral lower in Q3. Accessed 20 December 2020 at https://​www​.spglobal​.com/​marketintelligence/​en/​news​-insights/​latest​-news​-headlines/​top​-oil​-and​ -gas​-companies​-see​-market​-cap​-spiral​-lower​-in​-q3​-60646533. S&P Dow Jones Indices (2020). S&P Oil & Gas Exploration & Production Select Industry Index. Accessed 20 December 2020 at https://​www​.spglobal​.com/​spdji/​en/​indices/​equity/​sp​-oil​-gas​ -exploration​-production​-select​-industry​-index/​#overview. StockApps (2020). https://​stockapps​.com/​five​-largest​-us​-oil​-and​-gas​-companies​-lost​-307bn​-in​-market​ -cap​-yoy​-a​-45​-plunge​-amid​-COVID​-19​-crisis/​. Last accessed 20 December 2020. UltraLong (2010, 25 October). The end of oil’s golden age. 25 October 2010. Seekingalpha.com. Accessed 8 January 2021 at https://​seekingalpha​.com/​article/​231957​-the​-end​-of​-oils​-golden​-age. Webster, J., Fitz, R., Dewar, R. and Alkadiri, R. (2020, 13 March). The oil price shock(s) of 2020. BCG. com. Accessed 8 January 2021 at https://​www​.bcg​.com/​publications/​2020/​covid​-oil​-gas​-price​-impact​ %20. Widdershoven, C. (2019, 23 September). The $47 trillion death sentence for oil & gas. Oilprice.com. Accessed 8 January 20201 at https://​oilprice​.com/​Energy/​Energy​-General/​The​-47​-Trillion​-Death​ -Sentence​-For​-Oil​-Gas​.html. Widdershoven, C. (2020, 27 September). The unintended consequences of fossil fuel divestment. Oilprice.com. Accessed 8 January 2021 at https://​oilprice​.com/​Energy/​Crude​-Oil/​The​-Unintended​ -Consequences​-Of​-Fossil​-Fuel​-Divestment​.html.

392  Handbook of sustainable politics and economics of natural resources World Oil Outlook (WOO) (2020). Website accessed 20 December 2020 at https://​woo​.opec​.org/​.

Index

Africa Integrated Maritime (AIM) Strategy 211–12 African Development Bank 198, 211 African natural resources 209–14 agriculture 210 economic growth and development 209 past, present and future policies 210–14 resource curse 209–10 resource-related conflicts 213 African Union Commission 207, 211, 212 Africa’s Agenda 2063 212 agency phenomenon 278 agriculture and ASM 188–91 diversified livelihood portfolios 188, 191 foreign direct investment 189 structural adjustment programmes 188–9 natural resources, Africa 210 allocative efficiency 64 ambiguity 348–62 Choquet ambiguity 355–6 earnings before interest and taxes 353 frameworks 354–5 geometric Brownian motion 353 green bond pricing 356–9 misspecification concerns 359–60 modelling 350–52 conceptual difference 351 multiple-priors approach 351, 352 non-additive probabilities 351 objective risk 350–51 probability distributions 351 variational preferences 352 optimal portfolio allocation, green vs. brown bonds 360–62 overview of 348–50 Ambitious Policy scenario 140, 142, 143, 146 anti-mining activism 54 Aral Sea Basin 154–9 hydropower generation 183 hydropower installed capacity 182 artisanal and small-scale mining (ASM) 7, 41, 186–201 agriculture and 188–91 diversified livelihood portfolios 188, 191 foreign direct investment 189

structural adjustment programmes 188–9 illegality 187 smallholder farming and 197–201 coping with desertification in Mali 200–201 coping with famine in Malawi 199–200 policy machinery 198–9 ASEAN see Association of Southeast Asian Nations ASM see artisanal and small-scale mining Association of Southeast Asian Nations (ASEAN) 45–58 coal in anti-mining activism 54 compound average annual growth rate 47 consumption 47–8 powered plants 50 resistance to coal-fired power plants 55–7 resistance to coal mining in Indonesia 54–5 economies 4 behavioral effectiveness 293 between-effect regression 309–10, 316–18 biodiversity 170, 172, 174 biodiversity conservation 306–10 between-effect regression 309–10 panel data 306–8 random-effect regression 308–9 biodiversity loss and climate change 206 Bloomberg, Michael 327 bottom-up engineering models 136–7 brown bonds 360–62 Brownian motion 354–5 business-as-usual (BAU) scenario 116 capital scarcity 224 Carbon Tracker Initiative 320 CBI see Climate Bond Initiative Central Southeast Asia (CA) 152–77 Aral Sea Basin 154–9 comparative analysis of 175–7 direct/indirect socio-economic and environmental effects biodiversity 170, 172

393

394  Handbook of sustainable politics and economics of natural resources dislocation 169, 171 economic development 169, 170 energy security 169, 170 fisheries 169, 171 hazards 169–70, 172 hydrological perspective 170, 172 irrigation field 169, 171 salinization 169, 172 sediments 169, 171–2 social acceptance 170, 172 wealth distribution 170, 172 hydropower capacity 160, 161 hydropower potential 159–60, 162–3 installed capacity 164 Mekong Basin 154–9 CES see constant elasticity of substitution Choquet ambiguity 355–6 Choquet-Brownian motion 354, 357, 362 Climate Bond Initiative (CBI) 349–50 climate change and biodiversity loss 206 climate change mitigation 107, 124, 127, 137, 147, 153 climate change policies 107–19 decarbonization 112, 115, 116, 118–19 decentralization 116 digitalization 116 domestic climate policy 111–12 greenhouse gas (GHG) emission 107–8 green menace 116–18 2oC scenario 116 business-as-usual (BAU) scenario 116 INDC scenario 116 international climate change regime 109–11 intended nationally determined contributions 110–11 Kyoto Protocol 109–10 new opportunities 118–19 passivity 112–15 climate skepticism 114–15 economic specialization 112–13 high energy intensity 113–14 Soviet heritage 113–14 Climate Doctrine 111 climate-related stranded assets 324–7 climate skepticism 114–15 coal 45–58 in ASEAN countries anti-mining activism 54 compound average annual growth rate 47 consumption 47–8 powered plants 50 resistance to coal-fired power plants 55–7

resistance to coal mining in Indonesia 54–5 economic impacts 45–6 environmental impacts 45–6 health impacts 45–6 in Southeast Asia 51–3 health impacts 52 opposition to coal-fired power plants 57 opposition to coal mining 54–5 water, agricultural and economic impacts 52–3 commodity prices, Kazakhstan 76–91 alternative explanations 77 background information 78–82 concentration of resources 77 descriptive statistics 83–6 empirical results 86–8 household data interpretation 83 identification strategy 86 labour conflicts evolution 90–91 oil data interpretation 83 oil-related household 76–7, 84, 86, 88–90 ownership of resources 76 resource curse literature 77–8 satisfaction with income 85, 87–9 triple-difference specification 77 commodity sovereign wealth funds 244–9 domestic vs. international returns 246 in low-income countries 245–6 objectives 247–8 permanent income hypothesis 245 revenue volatility 246–7 strategic development funds 248–9 volatility of economy 246–7 see also sovereign wealth funds (SWFs) common pool phenomenon 278 concentrated solar power (CSP) 32 constant elasticity of substitution (CES) 136 corruption and resource curse 218–25 abundance 218–19 good-quality and bad-quality institutions 219 literature support 218–19 natural resources comparative studies forests 222–3 oil 220–21 precious metals and diamonds 221–2 policy implications 223–5 resource revenues 219 COVID-19 pandemic 366–74 creative destruction 329 CSP see concentrated solar power decarbonization 112, 115, 116, 118–19 depleted resources 269 diamonds 221–2

Index  395 diffuse resources 269 diversification 25–6 diversified livelihood portfolio 188, 191 domestic climate policy 111–12 Dutch disease 17, 25, 37, 77, 218, 221, 222, 246, 256, 264–5, 282 earnings before interest and taxes (EBIT) 353 Economic and Monetary Union (EMU) 275 Economic Commission for Africa 211 economic dimension 207 economic diversification 25–6, 124–6 economic specialization 112–13 economy–environment system 10–11 effectiveness of international rules 291–9 behavioral effectiveness 293 future research paths 298–9 legal effectiveness 293 legal indicators 294–8 assessing legal systems 295–6 definition of 294 methodological challenges 296–8 Paris Agreement-specific legal indicators 297–8 meanings/levels 293 overview of 291–3 problem-solving effectiveness 293 efficient market hypothesis (EMH) 321–2 EGDIP see European Green Deal Investment Plan EIB see European Investment Bank EITI see Extractive Industries Transparency Initiative electrification 32 EMH see efficient market hypothesis EMU see Economic and Monetary Union energy–economy models 10, 335 behavioral aspects 341 closer-to-reality 337 cyclical behavior 343 definition of 336 methodological classification of 340 real options modeling 341 selected review studies 338, 339 symmetrical drawbacks of 335 technological explicitness 340–41 energy modeling 334–44 feed-in tariff scheme 343 GEM-E3 model 338 Green-X model 338, 340, 344 learning-by-doing effect 338 NEMESIS model 338 Nexus concept 340 overview of 334–6 policy drivers 336–8 PRIMES model 338

real options studies 341–3 spatial clustering 340 technological development phenomenon 344 TIMES-PanEU model 338 see also energy–economy model energy security 169, 170, 173, 376–90 energy solutions, heterogeneity of 101–5 Germany 102–3 Poland 103–4 Portugal 104–5 energy storage in vehicles 32–3 energy transitions hydrocarbons 383–7 renewable see renewable energy transitions sustainable 128–31 entropy penalization 359 environmental dimension 207 environmental ethics 301–11 biodiversity/water conservation 306–10 between-effect regression 309–10 panel data 306–8 random-effect regression 308–9 empirical literature 301 global sustainability 301–2 religious ethics 301 secular ethics 301 sustainability ethics future generations 304–6 in general and non-humans 302–4 environmental liability systems 72–3 Environmental Performance Index 124 environmental sustainability see environmental ethics ESRB see European Systemic Risk Board European Green Deal 1, 5, 95–101, 128, 335 EGDIP 99 energy mix and dependency 96–7 financing 98 global climate leadership 96 InvestEU 100–101 Just Transition Mechanism 99–100 multiannual financial framework 100 overview of 95 taxonomy for sustainable investment 101 European Green Deal Investment Plan (EGDIP) 99, 100 European Investment Bank (EIB) 99–101 European Systemic Risk Board (ESRB) 325 EU Water Framework Directive 4, 65–6 exchange rate policies 25 Extractive Industries Transparency Initiative (EITI) 213–14, 373 FDI see foreign direct investment Financial Stability Board (FSB) 326–7

396  Handbook of sustainable politics and economics of natural resources financial system with stranded assets 320–28 climate-related risks 324–7 definitions of 320–21 efficient market hypothesis 321–2 irrational apathy 322 market failure 321–3 overview of 320 risk of 321–3 stress testing 324–6 sustainability transitions 327–8 transmission channels 320–21 finite resources 269–70 fiscal policy 24 conduct of 281 cyclicality 270–78 commodity price growth 277–8 empirical literature 276 in neoclassical models 273 resource-rich countries 272, 276–8 tax rates 275–6 terms-of-trade shocks 275 resource-rich countries 278–82 fiscal regime 24 fisheries 169, 171, 173–4 food security 197–201 foreign direct investment (FDI) 26, 153, 189, 224 forests 222–3 FSB see Financial Stability Board fuel cells 33 GBM see geometric Brownian motion GBP see Green Bond Principles Generation Foundation 321 geographic resource concentration 37–9 geometric Brownian motion (GBM) 353 geopolitical energy transition 30 Germany 102–3 global climate leadership 96 global oil demand 378–80 global sustainability 301–2 GLP see Green Loan Principles Green Bond Principles (GBP) 349, 350 green bonds 360–62 greenhouse gas (GHG) emission 6, 45, 107–8, 110–13, 116, 119, 135–6, 139–40, 142–4, 146–8, 297–8 green investment 101 greenium 11, 350, 358 greenium puzzle 358 Green Loan Principles (GLP) 349, 350 green menace 116–18 2oC scenario 116 business-as-usual (BAU) scenario 116 INDC scenario 116 greenness 349

green paradox 126–8 green policies and sustainable development see Saudi Arabia green premium 11 greenwashing 349 Green-X model 338, 340, 344 grid storage 32 hazards 169–70, 172, 174 Herfindahl-Hirschman Index (HHI) 37 HHI see Herfindahl-Hirschman Index human capital 208 hydrocarbons 376–90 divestment threat 387–9 energy transitions 383–7 global oil demand 378–80 market capitalization 382–3 overview of 376 peak oil 380–83 post-COVID-19 fossil fuel impact 380–83 post-pandemic recovery 378 hydropower energy 152–77 Central Southeast Asia (CA) Aral Sea Basin 154–9 comparative analysis of 175–7 direct/indirect socio-economic and environmental effects 169–72 hydropower capacity 160, 161 hydropower potential 159–60, 162–3 installed capacity 164 Mekong Basin 154–9 energy batteries 153 environmental goods and services 153 environmental impacts 154 Mainland Southeast Asia (MSEA) Aral Sea Basin 154–9 comparative analysis of 175–7 direct/indirect socio-economic and environmental effects 169–70, 172–4 hydropower capacity 166 hydropower potential 164–5, 167 installed capacity 168 Mekong Basin 154–9 IEA see International Energy Agency IEEFA see Institute for Energy Economics and Financial Analysis IEL see international environmental law income inequality 264, 265 INDCs see intended nationally determined contributions industrial capacity 235 inflated expectations see commodity prices, Kazakhstan

Index  397 Institute for Energy Economics and Financial Analysis (IEEFA) 388 institutional appropriability 219 institutional capacity 230–39 analytical dimensions 235 definition of 233 human resources 237 innovation and change 236–8 sustainable resource management 233–6 institutional economics 263 institutional quality 265 institutional resource policies 7–10 institutions in resource-rich countries 278–82 intended nationally determined contributions (INDCs) 110–11, 116 Intergovernmental Panel on Climate Change (IPCC) 348 Intergovernmental Panel on Climate Change (IPCC) Fifth Assessment Report 95 international climate change regime 109–11 intended nationally determined contributions 110–11 Kyoto Protocol 109–10 International Energy Agency (IEA) 320, 376 international environmental law (IEL) 296 InvestEU programme 100–101 irrational apathy 322 irrigation 169, 171, 173 Israeli Green Deal 135–48 baseline and alternative scenarios 139–46 Ambitious Policy scenario 140, 142, 143, 146 Policy scenario 140, 142–6 scenario assumptions 141 total final energy consumption 145 methodology 136–7 bottom-up engineering models 136–7 top-down general equilibrium models 136–7 modeling framework 137–8 overview of 135–6 policy recommendations 146–8 research structure 138–9

oil data interpretation 83 oil-related household 76–7, 84, 86, 88–90 ownership of resources 76 resource curse literature 77–8 satisfaction with income 85, 87–9 triple-difference specification 77 knowledge capacity 235, 236 knowledge economy, resource-based 26 Kyoto Protocol 107, 109–11, 115, 335

Just Transition Mechanism 99–100

land use, land-use change and forestry (LULUCF) 107–8, 111 learning-by-doing effect 338 legal effectiveness 293 legal indicators 294–8 assessing legal systems 295–6 definition of 294 methodological challenges 296–8 commitment–effort–result framework 297 international environmental law 296 multilateral environmental agreements 296–7 Paris Agreement-specific 297–8 liabilities in SWFs 244 lithium-ion batteries 32–3 local content (LC) policies 230–39 concepts 231–2 definition of 230 innovation and change 236–8 perspectives 231–2 low-carbon energy systems 30–37 distribution and storage electrification and grid storage 32 energy storage in vehicles 32–3 final use 33 metal demand in energy transition 34–7 metals and criticality status 33–4 overview of 30–31 renewable power production concentrated solar power 32 solar photovoltaics 31 wind power 31–2 LULUCF see land use, land-use change and forestry

Kazakhstan, commodity prices 76–91 alternative explanations 77 background information 78–82 concentration of resources 77 descriptive statistics 83–6 empirical results 86–8 household data interpretation 83 identification strategy 86 labour conflicts evolution 90–91

Maastricht Treaty 275 macroeconomic sovereign wealth funds effectiveness of 251–2 performance 249–53 public expenditure 249–50 real exchange rates 250, 253 macroeconomic stabilization policies 22, 25, 27 Mainland Southeast Asia (MSEA) 152–77 Aral Sea Basin 154–9

398  Handbook of sustainable politics and economics of natural resources comparative analysis of 175–7 direct/indirect socio-economic and environmental effects biodiversity 170, 174 dislocation 169, 174 economic development 169, 172–3 energy security 169, 173 fisheries 169, 173–4 hazards 169–70, 174 hydropower development 170, 174 irrigation 169, 173 salinization 169, 174 sediments 169, 174 social acceptance 170, 174 wealth distribution 170, 174 hydropower capacity 166 hydropower potential 164–5, 167 installed capacity 168 Mekong Basin 154–9 Medvedev, Dmitri 110, 114 Mekong Basin 154–9 hydropower generation 185 hydropower installed capacity 184 MFF see multiannual financial framework Minerals and Mining Act 199 mismanagement 253–4 misspecification 359–60 mobilization capacity 235 modelling ambiguity 350–52 conceptual difference 351 multiple-priors approach 351, 352 non-additive probabilities 351 objective risk 350–51 probability distributions 351 variational preferences 352 monetary rate policies 25 multiannual financial framework (MFF) 100 multiple-priors approach 351, 352 National Artisanal and Small-Scale Mining Policy 199 National Energy and Climate Plans 105 natural monopolies 69 natural resource abundance see resource abundance natural resource-based development 15–27 case studies 17–20 obstacles to 15–17 point resources 17 resource dependence and growth, human development and institutional quality 20–22 resource-dependent countries 22–6 economic diversification 25–6 fiscal policy 24

fiscal regime 24 monetary and exchange rate policies 25 primary export group 23 regulatory regime 24 structural policies 26 resource wealth 16–17 underdevelopment trap 17 volatile and exhaustible resource revenues 16 volatile commodity prices 16 natural resources 205–14 in Africa 209–14 agriculture 210 economic growth and development 209 past, present and future policies 210–14 resource curse 209–10 resource-related conflicts 213 climate change vs. biodiversity loss 206 comparative studies, resource curse and corruption forests 222–3 oil 220–21 precious metals and diamonds 221–2 definition of 207 direct and indirect effects of 208 economic growth and development 208 human development aspect 207 non-additive probabilities 351 non-fuel mineral-rich countries 37–41 conflict resources 37, 41 Dutch disease 37 geographic resource concentration 37–9 resource revenues 38–41 subnational impacts 41 non-tariff barriers 25 objective risk 350–51 OECD see Organisation for Economic Co-operation and Development OGCI see Oil & Gas Climate Initiative oil 220–21 oil data interpretation 83 Oil & Gas Climate Initiative (OGCI) 123 oil-related household 76–7, 84, 86, 88–90 OPEC see Organization of Petroleum Exporting Countries operational management 243–4 Organisation for Economic Co-operation and Development (OECD) 142, 276, 278, 307, 376–8, 380, 385, 389 Environmental Performance Reviews 292 Organization of Petroleum Exporting Countries (OPEC) 123, 126, 128, 376–8, 380–81, 384–7 outcome indicators 298 ownership 76, 243

Index  399 Paris Agreement 1, 5, 9, 45, 46, 48, 51–2, 58, 95, 111, 115, 116, 123, 140, 198, 296–8, 323, 329, 335, 377, 388, 389 Paris Agreement-specific legal indicators outcome indicators 298 process indicators 297–8 structural indicators 297 peak oil 380–83 permanent income hypothesis 245 point resources 17, 269, 270 Poland 103–4 Policy scenario 140, 142–6 pollution taxes 71 Portugal 104–5 precious metals 221–2 price volatility 264, 266 primary energy production Germany 102–3 Poland 103–4 Portugal 104–5 problem-solving effectiveness 293 process indicators 297–8 producer-friendly institutions 263 protected area dynamics 310, 316–17 public expenditure 249–50 Putin, Vladimir 110, 115 random-effect regression 308–9, 314–16 real exchange rates 250, 253 regional resource politics 5–7 relational capacity 235 religious ethics 301 renewable energy transitions 30–42 low-carbon energy systems distribution and storage 32–3 final use 33 metal demand in energy transition 34–7 metals and criticality status 33–4 overview of 30–31 renewable power production 31–2 non-fuel mineral-rich countries 37–41 conflict resources 37, 41 Dutch disease 37 geographic resource concentration 37–9 resource revenues 38–41 subnational impacts 41 renewable power production concentrated solar power 32 solar photovoltaics 31 wind power 31–2 rent-seeking effect/models 225, 264, 266 resilience framework 197–201 resource abundance 17, 107–19, 218–19, 222–3, 225–6, 261–82, 366–74 resource-based economic development 3–4

resource-based knowledge economy 26 resource conservation 301–11 resource curse 15, 30–42 in Africa natural resources 209–10 conflict resources 37, 41 Dutch disease 37 geographic resource concentration 37–9 resource revenues 38–41 subnational impacts 41 resource curse and corruption 218–25 abundance 218–19 good-quality and bad-quality institutions 219 literature support 218–19 natural resources comparative studies forests 222–3 oil 220–21 precious metals and diamonds 221–2 policy implications 223–5 resource revenues 219 resource curse literature 262–70 corruption 264, 266 definitions and benchmarks 267–70 depleted resources 269 diffuse resources 269 finite resources 269–70 point resources 269, 270 resource abundance 267 resource dependence 267 resource-rich countries 268 Dutch disease 264–5 income inequality 264, 265 institutional quality 265 misuse of resource funds 264 paradox of plenty 263 price volatility 264, 266 producer-friendly institutions 263 rent-seeking effect/models 264, 266 structuralist explanations 264 theoretical level 262 resource dependence 267 resource-dependent countries 22–6 economic diversification 25–6 fiscal policy 24 fiscal regime 24 monetary and exchange rate policies 25 primary export group 23 regulatory regime 24 structural policies 26 resource policies change and uncertainty 10–11 economy–environment system 10–11 implications in natural resources 223–5 institutional aspects of 7–10 resource revenues 219 resource-rich countries 268

400  Handbook of sustainable politics and economics of natural resources agency phenomenon 278 common pool phenomenon 278 conduct of fiscal policy 281 fiscal policy 278–82 fiscal policy cyclicality 272, 276–8 institutions 278–82 political institutions and regimes 279 transparency 279–80 revenue volatility 246–7 Russian climate policy 107–19 decarbonization 112, 115, 116, 118–19 decentralization 116 digitalization 116 domestic climate policy 111–12 greenhouse gas (GHG) emission 107–8 green menace 116–18 2oC scenario 116 business-as-usual (BAU) scenario 116 INDC scenario 116 international climate regime 109–11 intended nationally determined contributions 110–11 Kyoto Protocol 109–10 new opportunities 118–19 passivity 112–15 climate skepticism 114–15 economic specialization 112–13 high energy intensity 113–14 Soviet heritage 113–14 salinization 169, 172, 174 Saudi Arabia 123–32 climate agreements 128 COVID-19 pandemic 128, 132 economic diversification 124–6 green paradox 126–8 opportunities 130–31 per capita energy consumption 125 policy dilemmas 126–8 political economy 124–6 sovereign wealth fund 130 sustainable energy transition 128–31 SDGs see Sustainable Development Goals secular ethics 301 SEIP see Sustainable Europe Investment Plan SEZs see special economic zones smallholder farming and ASM 197–201 coping with desertification in Mali 200–201 coping with famine in Malawi 199–200 policy machinery 198–9 see also agriculture social acceptance 170, 172, 174 social dimension 207 socio-technical systems 328 SOFAZ see State Oil Fund of Azerbaijan

solar photovoltaics 31, 129 Southeast Asia Central see Central Southeast Asia (CA) coal in 51–3 health impacts 52 opposition to coal-fired power plants 57 opposition to coal mining 54–5 water, agricultural and economic impacts 52–3 Mainland see Mainland Southeast Asia (MSEA) sovereign wealth funds (SWFs) 8–9, 130, 242–57 commodity 244–9 domestic vs. international returns 246 in low-income countries 245–6 objectives 247–8 permanent income hypothesis 245 revenue volatility 246–7 strategic development funds 248–9 volatility of economy 246–7 definition of 242 failures adverse economic circumstances 254–6 mismanagement 253–4 heterogeneity 242–4 liabilities 244 operational management 243–4 ownership 243 illustrative problems 256 macroeconomic effectiveness of 251–2 macroeconomic performance 249–53 public expenditure 249–50 real exchange rates 250, 253 research perspectives 256–7 Soviet heritage and energy intensity 113–14 spatial clustering 340 special economic zones (SEZs) 26 State Oil Fund of Azerbaijan (SOFAZ) 11, 366–74 accountability 373–4 asset management 369–73 under COVID-19 crisis 366–9 governance 369–73 recommendations 374 transparency policy 373–4 stranded assets 320–28 climate-related risks 324–7 definitions of 320–21 efficient market hypothesis 321–2 irrational apathy 322 market failure 321–3 overview of 320 risk of 321–3 stress testing 324–6 sustainability transitions 327–8

Index  401 transmission channels 320–21 stress testing 324–6 structural indicators 297 structural policies 26 Sub-Saharan Africa 186–201 agenda synchronization 195–7 agriculture and ASM 188–91 diversified livelihood portfolios 188, 191 foreign direct investment 189 structural adjustment programmes 188–9 agriculture for development 187–8, 193–9, 201 food insecurity and undernourishment levels 190 food security 197–201 formalization of ASM 187–8, 191, 193–9 institutional framework 193–5 interconnectedness 187–8 poverty-driven activity 196–7 resilience framework 197–201 rural development indicators 200 smallholder farming and ASM 197–201 coping with desertification in Mali 200–201 coping with famine in Malawi 199–200 policy machinery 198–9 subsidies 71 sustainability ethics 302–6 future generations 304–6 in general and non-humans 302–4 sustainability transitions 327–8 sustainable development African natural resources 209–14 agriculture 210 economic growth and development 209 past, present and future policies 210–14 resource curse 209–10 resource-related conflicts 213 Brundtland Report 207 concept for 207–8 economic dimension 207 environmental dimension 207 natural resources climate change vs. biodiversity loss 206 definition of 207 direct and indirect effects of 208 economic growth and development 208 human development aspect 207 social dimension 207 Sustainable Development Goals (SDGs) 1, 65, 186–201, 207, 292 Sustainable Development Indicator Framework 292

sustainable energy transition 128–31 Sustainable Europe Investment Plan (SEIP) 99 sustainable policymaking 334–44 sustainable resource management institutional capacity 230–39 analytical dimensions 235 definition of 233 human resources 237 innovation and change 236–8 local content (LC) policies 230–39 concepts 231–2 definition of 230 innovation and change 236–8 perspectives 231–2 sustainable water management 64–73 allocative efficiency 64 EU Water Framework Directive 65–6 methodological challenges 66–8 policy challenges 66–8 socio-economic tools 68–73 environmental and resource goods and services 70–71 environmental liability systems 72–3 natural monopolies 69 standards and quotas 72 subsidies 71 tradable permit 72 voluntary agreements 72 water abstraction and pollution taxes 71 water pricing 68–70 SWFs see sovereign wealth funds Task Force on Climate-Related Financial Disclosures (TCFD) 327 TCFD see Task Force on Climate-Related Financial Disclosures terms-of-trade shocks 275 top-down general equilibrium models 136–7 total water cost recovery 66–73 methodological challenges 66–8 policy challenges 66–8 socio-economic approaches 68–73 environmental and resource goods and services 70–71 environmental liability systems 72–3 natural monopolies 69 standards and quotas 72 subsidies 71 tradable permit 72 voluntary agreements 72 water abstraction and pollution taxes 71 water pricing 68–9 tradable permit 72 transmission channels 320–21 transparency 279–80

402  Handbook of sustainable politics and economics of natural resources 2oC scenario 116

voracity effect 261

UNFCCC see United Nations Framework Convention on Climate Change United Nations 2030 Sustainable Development Agenda 1, 5 United Nations Environment Programme (UNEP) Financial Initiative 324, 325 United Nations Framework Convention on Climate Change (UNFCCC) 348 United Nations World Food Programme 199

water abstraction 71 water conservation 306–10 between-effect regression 309–10 panel data 306–8 random-effect regression 308–9 water consumption dynamics 309, 314–15 water pricing 64, 68–70 wealth distribution 170, 172, 174 window-dressing paradigm 111 wind power 31–2 World Bank 193, 268 World Resources Institute 324 World Trade Organization (WTO) 109, 231 WTO see World Trade Organization

volatile commodity prices 16 volatility and economic growth 270–78 volatility of economy 246–7 voluntary agreements 72