Government subsidies and environmental costs

The economic and trade distortions caused by ill-conceived government support for sectors ranging from agriculture, fisheries and fossil fuels to aluminium (2019, 2021), steel and semiconductors are enormous.

While this is explicitly recognized by G7, G20 and APEC member governments, amongst others, the pace of subsidy reform remains glacial. If the economic arguments are not sufficiently compelling, perhaps consideration of the considerable environmental costs of inefficient state support can help overcome global policy inertia. In that context, this brief looks at publicly available OECD estimates of government support for three commodity sectors - agriculture, fisheries, and fossil fuels - and one energy intensive and trade exposed industrial sector - aluminium.

Agriculture

Agriculture, forestry, and other land use change are responsible for more than 20% of global GHG emissions. Support to the sector currently averages more than 720 billion USD per year, fully 338 billion USD of which is directly tied to farm input use and output quantities, which is amongst the most environmentally harmful forms of support available. Phasing out this long-standing production-linked support in favor of modern policy approaches that encourage efficient resource use, address climate change, increase productivity, and enhance livelihood opportunities – sustainably – would improve climate, environment, and economic outcomes. Increased public and private investments in digitalization of agriculture and food systems offer particular promise.

Fisheries

UN SDG 14 includes a target to restore all fish stocks “at least to levels that can produce maximum sustainable yield as determined by their biological characteristics”. Average annual government support (2016-2018) to 39 countries with substantial fisheries sectors totals over 9 billion USD, or approximately 10% of the average value of landings. Much of that support lowers the cost of fisheries inputs and contributes to excess fishing capacity, overfishing, and illegal, unreported, and unregulated (IUU) fishing. Shifting support away from building fishing capacity and towards improving stock surveillance and management, while providing temporary income support to disadvantaged fishers, would help restore fish stocks to sustainable levels.

Fossil fuels

Subsidies for the production and consumption of fossil fuels declined in 2020 alongside a drop in oil prices, but still total more than 345 billion USD per year. Stated differently, many governments continue to subsidize the supply of carbon even as they prioritize investments in clean energy and the transition to net zero GHG emissions globally. To improve climate outcomes more needs to be done by governments and the private sector, over time, to enable a circular economy and to create clean sources of energy. But progress on better climate outcomes can also be made by starting now to progressively phase out fossil fuel subsidies.

Aluminium

Industrial subsidies have attracted a great deal of international attention in a context of widespread concerns about unfair competition and the growing role of state enterprises in international markets, but relatively little consideration of the environmental costs. The aluminium sector offers a compelling illustration. Between 2013-17 just five large firms operating across the aluminium value chain received an estimated 60 billion USD in state support. These subsidies primarily encourage extraction, production, processing, and export in high GHG emitting production systems, notably those based on fossil fuels. As CO2 emitted per metric tonne of aluminium produced is ten times higher for coal-based systems than for hydro-based systems, these subsidies contribute directly to a much higher than otherwise carbon footprint across the sector globally.

The generation of electricity accounts for about 60% of current aluminium industry GHG emissions, and recent analysis by the International Aluminium Institute (IAI) highlights electricity decarbonization as essential to industry emissions reduction. The IAI emphasizes that this will only be possible with massive new investments to introduce a range of alternative clean energy sources, from renewables to nuclear.

Yet existing industrial subsidies incentivize exactly the opposite behaviour – a continued reliance on fossil fuel-based systems by those firms in receipt of subsidies. At the same time, reduced returns and growth opportunities in unsubsidized production systems discourage new private investment and innovation in cleaner energy sources and in waste-reducing recycling systems. The latter is particularly important as aluminium is 100% recyclable and recycling requires just 5% of the energy required to produce the primary metal.

As countries step up efforts to achieve the goals of the Paris Agreement, global demand for aluminium is expected to increase up to 80% by 2050, providing essential components of renewable energy systems, lightweight vehicles, intelligent buildings, and protective consumer packaging. To meet this demand while contributing to global net zero GHG emissions, the industry will effectively need to decarbonize; this is simply not possible as long as state support across the aluminium value chain favors firms and production systems that rely on fossil fuels.

A compelling case for subsidy reform?

The economic case for subsidy reform is well understood in most government and business circles but is thus far not inspiring new policy approaches. Building a wider understanding as well of the huge environmental costs of many current subsidies should make the case for subsidy reform even more compelling. But is even this sufficient?

Removing subsidies is very easy to write about but is much harder to do in practice. There are major consequences for the individuals, families, and firms that currently benefit from subsidies, trade protection, and the resulting industry structure. Not all will be able to make the transition to a new living and working environment on their own. To be effective, and socially responsible, subsidy reform should happen progressively over time and be accompanied by adjustment assistance for those unable to make the transition on their own. Societal acceptance of eliminating subsidies at home would also be greatly facilitated if undertaken in the context of multilateral cooperation, where all countries agree to ensure an international level playing field and to avoid the temptation to increase global market share based on discriminatory regulations and subsidies.

Finally, much more work will be needed before there is sufficient light shining in the murky world of subsidies. Some of the data highlighted above has been available for decades (e.g., agriculture), but some has only been developed within the past two years (e.g., aluminium). There are other sectors, and many forms of government support, for which there is still little credible information available. Better and more widely shared information on the scale and nature of government support would allow robust analysis of its economic, environmental, and social impacts – enabling domestic policy makers to take well-informed decisions and international negotiators to target the most egregious forms of trade distorting and environmentally damaging support.

So, in brief, yes, “It’s the economy, stupid.” But it’s the environment too.

Ken Ash is an Independent Consultant, IIT Visiting Fellow, and former OECD Director of Trade and Agriculture.

The views expressed here are the author’s, and may not represent the views of the Institute for International Trade.

Photo by Thomas Richter on Unsplash