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Carbon Leakage and Creative Accounting, by Kaj Löfgren

Reassessing Australia’s emissions profile

Published: 3 Dec 2019

When Greta Thunberg recently rejected an AU$75,000 environmental award from the Nordic Council, media headlines largely reported this as a rejection of symbolism in a moment in history that simply demands action. While that was part of the motivation, Thunberg’s reasons were a more nuanced and direct critique of creative carbon accounting:

The Nordic countries have a great reputation around the world when it comes to climate and environmental issues… But when it comes to our actual emissions and our ecological footprints per capita—if we include our consumption, our imports as well as aviation and shipping—then it’s a whole other story.

Thunberg’s detailed understanding of climate science and carbon accounting often goes unremarked in our quest for a simple hero narrative. In a speech to the UK parliament in April, she accused policymakers of ‘very creative carbon accounting’. She explained that although the United Kingdom has achieved large reductions in production emissions since 1990, once aviation, import and export emissions are included these numbers look less than impressive. Or as The Economist recently noted, ‘through a production lens, Britain looks relatively virtuous. Through a consumption lens, it does not’. While the mechanics of production- and consumption-based emissions measurement are somewhat complex, at the core is a simple question: should those benefiting from the consumption of goods bear the moral and economic responsibility for the associated emissions?

The climate emergency is occurring in a landscape of rampant globalisation, fragmented production and ever-increasing trade. The wholesale offshoring of production to lower-cost environments has driven economic growth and prosperity in the West while simultaneously offshoring associated emissions. This critical connection between emissions and trade is ignored in national emissions-measurement frameworks and international agreements. Instead, Production Based Accounting (PBA) is used, assigning responsibility for all emissions to the country where those emissions were generated. Using PBA, developed countries such as Thunberg’s Sweden have reported a decoupling of economic growth and territorial emissions. This fits with a narrative known as the Environmental Kuznet’s Curve (EKC), which argues that as a country develops, its environmental impact lessens over time. However, the PBA method and the EKC theory ignore the role of demand and consumption in driving global production. The PBA methodology incentivises countries to decarbonise their economies while relying on the importation of carbon-intensive goods from other nations. This has become known as carbon leakage.

In response to the inherent deficiencies of PBA, the Consumption Based Accounting (CBA) methodology was developed. This approach assigns responsibility for emissions generated from production to the country in which the final goods are consumed. The emissions associated with each step in the globalised production process become embodied in the product. These embodied emissions can then be tracked using trade tables and assigned to the country of consumption. This makes sense from an intuitive perspective: those who benefit from a process (in the act of consumption) should carry responsibility for associated emissions. Furthermore, it is clearly the increasing consumer demand in the affluent West that is placing the environment under unsustainable pressure.

Ultimately, there are two competing stories about emissions in the developed world. The first is positive, centred on the stagnating or declining production emissions across many developed countries. The second is negative, based on the dramatic increase in consumption emissions in these same countries. It is of course little wonder that Western countries choose to focus on the role of production emissions. In a globalised world it is the difference between production and consumption emissions that holds the key to understanding the importance of trade in a country’s carbon footprint. This difference is known as the Balance of Emissions Embodied in Trade (BEET), and if this number is negative then the country is outsourcing its emissions responsibilities to its trading partners. (See ‘Calculating emissions embodied in trade’, below.)

So how does Australia’s emissions profile look under closer examination? In an in-depth study using the World Input–Output Database (WIOD), I found that Australia’s production emissions increased steadily between 1995 and 2001 and then stagnated until 2009. However, our consumption emissions continued to rise and in 2002 Australia’s BEET turned negative: Australia became an outsourcer of emissions. This was driven by China’s becoming a member of the World Trade Organization in December 2001 and its rise to become Australia’s primary import and export trading partner by 2009. This shifted our emissions profile in two key ways. First, and most significantly, China’s rise resulted in a large increase in emissions embodied in our imports and a significant growth in overall consumption emissions. This was driven by an increase in the total value of our imports, combined with China’s carbon-intensive production system taking a growing share of our imports. Second, a sectoral breakdown of import emissions reveals the start of a structural shift in Australia towards less energy-intensive production and an increased reliance on the importation of energy-intensive goods. Put simply, instead of making things here, we have increasingly outsourced production to China.

Since the plateauing of our production emissions around 2009 and the momentary fall of these emissions as a result of our short-lived Emissions Trading Scheme (2012–14), the last decade has seen our production emissions hit record highs. Although recent emissions data is limited in WIOD, this rampant upswing in production emissions, combined with an increasing balance of trade with China and the gradual fall in the carbon intensity of Chinese production, may have reduced Australia’s emissions outsourcing in recent years. However, the global problem remains. As The Economist reported recently, ‘Britain consumes about 40% more carbon emissions than it produces; the European Union as a whole, 19%. In America the difference comes in at 8%’. The only reason Australia no longer makes this list is that our production emissions are, shamefully, skyrocketing.

From a policy perspective environmental activists and labour unions have long advocated for the extension of free trade agreements to cover common environmental standards and labour conditions. It is clearly unfair for countries to gain a potential comparative advantage by cutting corners in these critical areas of human dignity and environmental sustainability. Furthermore, carbon-border adjustments are being considered in the EU. This would apply a tariff on imported goods that don’t meet EU environmental standards. It is becoming increasingly clear that production-based emissions measurement is a woefully inadequate measure of a country’s true carbon footprint. However, it will take a considerable effort by sophisticated campaigners such as Thunberg to create the political momentum for a meaningful shift in international policy. Without this, we will likely see more and more developed countries deceptively claim the decoupling of emissions and economic growth.

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Calculating emissions embodied in trade

The nature of emissions embodied in trade can be highlighted by the simple example of the production of a car. The emissions associated with each step in the production process (for example, mining in Australia, manufacturing in China and assembly in Germany), become embodied in the car itself. These embodied emissions are then transferred to the point of sale anywhere around the world.

In technical terms, CBA emissions are calculated as PBA emissions plus the emissions embodied in imports, minus the emissions embodied in exports (as these are consumed elsewhere). The calculation of these trade-based emissions is completed using multi-region Input–Output (IO) tables and IO analysis. The data in a multi-region IO table describes the flow of products from each sector in each country (producers) to all domestic sectors and to all sectors across all other countries (consumers). Mathematically, this can be described as a series of linear equations and solved using matrix algebra. Wassily Leontief developed IO analysis in the 1930s, and in 1973 he received the Nobel Memorial Prize in Economic Sciences for this work. The IO framework created an entire field of study dedicated to the understanding of interlinkages within and between economies. The basic framework and underlying mathematics have now been extended across many fields of study, including the analysis of energy and emissions. IO analysis began with complex matrix mathematics completed by hand, over days and weeks. Modern IO studies utilise a range of mathematical programming languages and software. My study was completed using MATLAB (by MathWorks).

Note: Kaj Löfgren recently returned from studying a Masters of Economic History at Lund University and writing a thesis on Australia’s emissions history. The full thesis (Reassessing Emissions in the Lucky Country: Consumption, Production & Outsourcing in Australia) can be accessed at <https://lup.lub.lu.se/student-papers/search/publication/8986219>

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