For those of us who have not completely given up on tracking legacy media headlines on climate issues due to the sheer noise-to-signal ratio, there was one recently that made even the most skeptical take notice. “Fossil fuels being subsidised at rate of $13 million a minute, says IMF”, was The Guardian’s lead climate story on 24th August. Citing the International Monetary Fund’s figures, it stated that oil, gas and coal benefited from $7 trillion in support in 2022 “despite being primary cause of climate crisis”. In an age of monstrous deficits and debts, $7 trillion is still a big deal. It translates to over 7% of global GDP, more than double the amount spent on education globally. Total global military expenditure in 2022 was about $2.24 trillion.
The IMF’s $7 trillion figure exceeds the estimate for global fossil fuel subsidies by another major “green” institution, the OECD’s International Energy Agency. The IEA claimed in February that global fossil fuel subsidies amounted to an “all time high” of $1.097 trillion in 2022. Yet another estimate put out just days before the IMF report by climate change think tank International Institute for Sustainable Development, estimated fossil fuel subsidies by the G20 group (which accounts for about 80% of global GDP) at $1.4 trillion for 2022. Why do these estimates vary? The differences in these estimates lie partly in varying methodologies employed to measure subsidies. They also reflect the inherently elastic nature of the subsidy concept.
Are Subsidies As Sweet By Any Other Name?
Why should we care about subsidies? They serve many worthy causes. For instance, they enable poor children to have free nutritional lunches at school, they support unemployed people to re-skill or re-train for newer jobs, or they may support vital medical research that saves lives. But there are limits to government budgets, there is no such thing as a “free lunch” and there are choices to be made regarding which subsidies serve the public interest and which are wasteful or favouring only a narrow section of households or industry.
A subsidy is government expenditure, in cash or kind (for example, a tax credit), in favor of households or firms as financial redistribution in the overall interest of the public. Subsidies can also be justified as a policy tool to correct a market failure when market competition does not lead to an optimal economic outcome. To be sure, “market failures” and “optimal outcomes” are not obvious and their existence in specific cases is open to debate and differing interpretations. Subsidies may be transparent, such as price support for particular farmers, or they may be opaque and hard to measure, for instance a regulatory mandate in favor of a particular industry or technology.
The fossil fuel subsidies identified by the IMF in its 2023 Update on Fossil Fuel Subsidies Data refer to “explicit” and “implicit” subsidies. The former refers to undercharging for observable supply costs of fossil fuels while the latter refers to undercharging implied by not taking into account the hypothesized costs of global warming and local air pollution. The costs of global warming include the familiar litany of collapsing ice-sheets and rising sea-levels which inundate islands and low-lying coastlands, extreme weather, extinction of fauna and flora species, the spread of diseases, the collapse of agriculture and loss of food security. Local air pollution refers to the population health impacts of pollutants such as the oxides of sulfur and nitrogen, fine particulate matter and ground-level ozone.
Explicit subsidies (granting households or industry exemption from high market prices with price caps, grants or tax relief) have more than doubled since 2020 but are still only 18 percent of the total estimated subsidy. The jump in explicit subsidies have been particularly notable in Europe which faced high energy prices from late 2021 onwards as world energy demand recovered from the Covid lockdowns which were accentuated by the sanctions on Russian energy exports.
Implicit subsidies account for 82 percent of the total. These include the costs of undercharging for global warming and local air pollution caused by fossil fuel use as well as the foregone taxes that governments would have raked in with the higher recommended prices of coal, oil and natural gas. According to the IMF, differences between what it calls “efficient” prices and actual retail fuel prices are large and pervasive. For example, 80 percent of global coal consumption was priced at below half of its “efficient” level in 2022.
Full fossil fuel price reform – by which the IMF means imposing carbon taxes on fossil fuels — would reduce global carbon dioxide emissions to an estimated 43 percent below baseline levels in 2030 which would limit global warming to 1.5-2oC above pre-industrial levels. It would, the IMF also claims, also prevent 1.6 million deaths per year caused by local air pollution. It would also raise government tax revenues by 3.6 percent of global GDP.
It is apparent that the big difference in estimated subsidies for 2022 between those cited by the IEA and the IISD ($1 – 1.4 trillion) against those by the IMF ($7 trillion) lies in the latter’s inclusion of “implicit” subsidies. The IMF’s treatment of implicit subsidies relates to what economists call “negative externalities”, defined as an indirect cost to an uninvolved third party that arises as an effect of another party’s (or parties’) activity.
Thus, someone buying gasoline to drive his car also imposes congestion and pollution which affect others in the vicinity that were not party to the gasoline transaction. According to received theory, a Pigouvian tax should be levied to compensate for the costs of negative externalities of that gasoline purchase so that an incentive would be created for the gasoline buyer to take into account the costs he is imposing on others.
While the IMF takes into account negative externalities in its measure of “efficient” fuel prices, it does not consider well-documented positive externalities of fossil fuel use in its report. An important example of the positive externality of carbon dioxide in the atmosphere is the significant greening of a quarter to half of Earth’s vegetated lands over the last 35 years largely due to rising levels of atmospheric carbon dioxide. According to NASA, the greening represents an increase in leaves on plants and trees equivalent in area to two times the continental United States.
Another example of the positive externalities of the use of fossil fuels is the 98% decline in the number of deaths over the past century caused worldwide by extreme weather such as droughts, floods, wildfires, storms (hurricanes, cyclones, tornadoes, typhoons) and extreme temperatures, both hot and cold. It is after all with the economic development and technological improvements enabled by the use of fossil fuels that helped societies to protect against these events and to cope better with them when they do occur.
The Greening of the IMF
The IMF was created by global leaders in 1944 to maintain global financial stability in what became known as the Bretton Woods system. Its stated mission is “to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.” Its traditional package of policy solutions for countries undergoing financial crisis reflected the Washington consensus supporting free trade, competitive markets, entrepreneurship and sound money. It typically called client governments to practice budget austerity, privatize state enterprises, deregulate barriers to entry and exit, and secure property rights.
But what is an institution set up to act as a financial watchdog and first responder to countries in financial crisis doing dishing out advice on climate change? Like the World Bank, the Fund has embraced an expanded role for itself with concerns related to climate change. The IMF supports the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) to promote “green finance” and the climate agenda pursued by governments in the EU and the US. The first signal of a change in the IMF’s mandate occurred in 2012, shortly after Christine Lagarde was appointed as its Managing Director in the previous year.
According to its website, “the IMF’s primary purpose is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries (and their citizens) to transact with each other. The Fund’s mandate was updated in 2012 to include all macroeconomic and financial sector issues that bear on global stability.”
In a 2016 lecture at the Massachusetts Institute of Technology, Christine Lagarde said that although the IMF was not historically concerned with climate policy, it was becoming “more engaged” by producing research on the “right price” of energy and how to remove subsidies. “Energy pricing is key, not only for the public purse, but for the planet…This means more emphasis on energy taxation and less reliance on energy subsidies.” In response to a question, she responded, “We strongly believe that if subsidies were removed and a carbon price properly set … that would go a long way toward addressing the climate change issues the world is facing.”
Cancel Your Critics
Those not familiar with the climate change literature might well be convinced that the IMF’s assessment of implicit subsidies of fossil fuels is fair and unbiased. After all, the IMF, like its sister Bretton Woods institution the World Bank, is a well-funded multilateral institution with almost all of the world’s countries as its constituent fee-paying members. Its large staff is made up of highly qualified professionals with high tax-free salaries. It has among its alumni leading economists of international repute. And most would attest to the excellent research publications issued by the Fund since its inception. Yet the excellence of both these institutions and their research output applies to work done within their areas of institutional competence.
Estimates of the costs and benefits of carbon taxes at the global level are based on integrated assessment models which require a large data base and set of assumptions that tie together climate change processes with human economic activity (a climate model) to measure tangible costs and benefits to human welfare (an economic model) of various levels of greenhouse gases cumulated into the atmosphere over the very long run (the next 50 – 100 years and beyond). These models have crucial assumptions and sensitivities that affect causal relationships between the combustion of fossil fuels, climate change and human welfare that make their use as a basis for policy proposals highly contentious.
For instance, “climate sensitivity” — the expected global warming due to a doubling of accumulated greenhouse gases in the atmosphere — is subject to serious debate among experts and admits no easy resolution. The IMF’s analyses of “implicit subsidies” may create a perception of certainty and precision but that perception is illusory and misleading. Climate science is not settled but the IMF acts as if it is. Its recent cancellation of an IMF-hosted seminar on climate models which featured Nobel Laureate for Physics (2022) Dr. John Clauser is nothing short of ignominious.
Climate policy is clearly beyond the scope of any financial regulator’s expertise. Given the uncertainty within the climate science community itself, there is no reason to believe that the IMF can have any greater understanding of climate risks. Government-appointed financial bureaucrats at the IMF and other financial institutions are incompetent in adjudicating the enormous uncertainties and complexities underlying climate models. Given the considerable influence of the IMF, dabbling in environmental policy advice risks undermining the efficiency of international capital markets. This would subvert the very basis of market capitalism itself.
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