Issues in food miles and carbon labelling

Analytical framework

In this chapter, an analytical framework is presented to examine the economic rationale for carbon labelling. From an economic perspective, a product label should address identified information market failures and the benefits from implementing a product label should outweigh the costs. The analytical framework is presented in three parts: identifying market failures in climate change, particularly those relevant to product labelling; presenting an overview of the international policy response to climate change; and examining the economic rationale for information policies and product labelling in the climate change policy response.

Market failures in climate change

Greenhouse gas emissions — an international negative environmental externality

The failure of private markets to produce a socially optimal level of goods and services provides the economic rationale for considering government intervention. Greenhouse gas emissions are a negative externality, the key market failure in the climate change debate. In general terms, externalities occur as a by-product or side effect of the production or consumption of a good or service. A negative externality occurs when the actions of an individual — production or consumption decisions by a firm or consumer respectively — have a negative effect on others (third parties), where these effects are not fully reflected in the price of the good or service.

An important issue for environmental assets is that prices do not exist or understate the services provided by the environment. As a consequence, the price mechanism fails to provide the appropriate signal to markets about the value of the asset. This causes a divergence between optimal private behaviour and optimising the community’s wellbeing (utility or social welfare).

Greenhouse gas emissions associated with human activity are a complex international and intergenerational issue (see, for example, IPCC 2007a,b,c; Stern 2007; and Garnaut 2008a,b). It is now widely recognised that there are likely to be major costs and risks associated with future global climate change resulting from the warming effect of increased concentrations of greenhouse gases in the atmosphere (Garnaut 2008a,b). While there continue to be significant uncertainties about the timing, nature and extent of climate change effects, achieving greenhouse gas emissions reductions has become an important policy priority in Australia and elsewhere (information on climate change policy assessments and priorities in Australia is presented in Wong 2008; Australian Government Department of Climate Change 2008a,b; and Australian Government Treasury 2008).

Other sources of market failure

The climate change policy response also needs to take into account the presence of other market failures. For example, Gupta et al. (2007, p.766) note that ‘several authors describe situations in which a combination of policies might be desirable’ and highlight market failures in technology development and diffusion, and lack of information. Stern (2007) and Garnaut (2008a,b) also highlight the importance of technology policy and policies to remove barriers to behavioural change (including information policies).

Information market failures

Information is a pure public good if it is not possible to exclude individuals from using it (non-excludable) and one individual’s use of the good does not prevent others from using it (non-rival). The public good nature of information results in a free rider problem and, as a consequence, private markets provide an inadequate level of information.

Garnaut (2008a,b) discusses situations where, even with access to sufficient information, consumers and producers may not be able to make optimal decisions because of limited knowledge and processing abilities (referred to as bounded rationality). For example, consumers and producers may adopt rules of thumb in decision-making to avoid gathering and processing costs (an example of a rule of thumb is the payback period for a capital investment).

Asymmetric information occurs when information about the attributes of a good differs between buyers and sellers, or between the generators of externalities and the affected third parties. There are two types of asymmetric information problems: moral hazard and adverse selection. The moral hazard problem occurs when the actions of one individual are not observable to others. The adverse selection problem occurs when one individual cannot identify the type or character of others and, as a consequence, cannot assess the quality of a potential good or service.

Innovation market failures

Positive externalities in the technology innovation process result in private investment in research, development and deployment (RD&D) that are less than socially optimal, since these additional benefits are not incorporated in the decision-making processes of individual private companies. Market failures in innovation are discussed in some detail in Garnaut (2008a,b), including the public good nature of basic research. ABARE has also undertaken several studies on the technology innovation process (see, for example, Heaney et al. 2005 and Hogan et al. 2007).

Climate change policy response

Kyoto Protocol and the Bali Road Map

The Kyoto Protocol is an international agreement linked to the United Nations Framework Convention on Climate Change (UNFCCC) which was adopted in Kyoto, Japan, in December 1997 and entered into force on 16 February 2005 (see http://unfccc.int). Under the Kyoto Protocol, 37 industrialised countries and the European community have committed to emissions targets which would, in aggregate, reduce their joint emissions of six greenhouse gases (measured as the equivalent of carbon dioxide) by 5 per cent over the five year period from 2008 to 2012, compared with 1990 levels. These countries are listed in Annex B of the Kyoto Protocol and are often referred to as Annex B countries - the agreed emissions targets for these countries are listed in table 1. The 15 countries that were European Union (EU) members in 1990 are regarded as a ‘bubble’, whereby countries have individual emissions targets but there is an overall target for the group of countries under the Kyoto Protocol. The Kyoto Protocol also contains provisions for reporting and compliance.

Annex B countries must meet their emissions targets primarily through national measures. However, the Kyoto Protocol also provides three market-based mechanisms, referred to as flexible mechanisms, to provide greater flexibility for countries in meeting their emissions targets and to encourage developing countries to contribute to emissions reduction efforts through, for example, technology transfer. These are:

emissions trading — based on a cap and trade system, countries that have reduced emissions below their allocated allowance may trade the surplus allowances to others that have exceeded their cap
clean development mechanism (CDM) — project-based mechanism that allows Annex B countries to invest in sustainable development projects that reduce emissions in developing countries
joint implementation (JI) — project-based mechanism which enables Annex B countries to carry out joint implementation projects with other Annex B countries.

1 Kyoto Protocol target commitments for Annex B countries

party	target
	% of base year or period

Australia	108
Austria	92	(87)*
Bulgaria a	92
Canada	94
Croatia	95
Czech Republic	92
Denmark	92	(79)*
Estonia	92
European Community	92
Finland	92	(100)*
France	92	(100)*
Germany	92	(79)*
Greece	92	(125)*
Hungary b	94
Iceland	110
Ireland	92	(113)*
Italy	92	(93.5)*
Japan	94
Latvia	92
Liechtenstein	92
Luxembourg	92	(72)*
Monaco	92*
Netherlands	92	(94)*
New Zealand	100
Norway	101
Poland c	94
Portugal	92	(127)*
Romania a	92
Russian Federation	100
Slovakia	92
Slovenia	92
Spain	92	(115)*
Sweden	92	(104)*
Switzerland	92
Ukraine	100
United Kingdom of Great
Britain and Northern Ireland	92	(87.5)*
United States of America	93

a Base year: 1989. b Base year is average of years 1985-87. c Base year: 1988. * Agreed EU internal burden sharing arrangement.

These flexible mechanisms allow for the trading of carbon credits, or carbon emissions reduction units, that can be used to achieve emissions targets (Carbon Trust 2006c). These mechanisms resulted in the creation of the carbon market, which was valued at US$30 billion in 2006 (see http://unfccc.int). A voluntary carbon market has also emerged that allows organisations and individuals to reduce their carbon emissions by voluntarily purchasing carbon offsets. The compliance carbon market and voluntary carbon market are discussed further in Carbon Trust (2006c).

At the United Nations Climate Change Conference in Bali, held in December 2007, the Bali Road Map for a future international agreement on climate change was adopted. Formal negotiations on a strengthened international agreement on climate change were launched and it was agreed that these negotiations would be concluded by the end of 2009 at the Climate Change Conference in Copenhagen.

Gupta et al. (2007) note that the UNFCCC and Kyoto Protocol have been important first steps toward the implementation of an international response strategy to address climate change, but any future international agreement which does not include a larger share of global emissions will have a higher global cost or be less environmentally effective.

Mitigation policy options

The fourth assessment report of the Intergovernmental Panel on Climate Change (IPCC) provides a summary of the literature on national mitigation policies and international cooperation (see Gupta et al. 2007 and IPCC 2007c). Gupta et al. (2007) assess the policy instruments defined in box 1, including information policies, noting that the design of the policy is important and all policy instruments must be monitored and enforced to be effective. The four principal criteria used to evaluate these policy options are:

environmental effectiveness — the extent to which a policy meets its intended environmental objective
cost effectiveness — the extent to which the policy can achieve its objectives at least cost to society
distributional considerations — the distributional consequences of a policy, including fairness and equity
institutional feasibility — the extent to which a policy option is likely to be viewed as legitimate, gain acceptance and be adopted.

An important international equity aspect is the need for the global climate change policy response to be consistent with sustainable economic development in developing economies. That is, energy consumption trends in these countries will need to be consistent with facilitating economic growth and development.

To date, national governments and the European Union have adopted, or are considering, a range of policy options. Gupta et al. (2007) note that there is an increasing amount of research focused on tradable permit schemes which can establish a carbon price and guarantee a particular level of emissions. This option has become an important part of the climate change policy response in Europe and elsewhere. The EU Emissions Trading Scheme (ETS), the world’s largest tradable permit scheme, was initiated on 1 January 2005 and applies to around 11 500 installations across the European Union’s 25 member countries (Gupta et al. 2007). The EU ETS covers around 45 per cent of the European Union’s total carbon emissions and includes electricity and other major industrial sectors.

The New Zealand Government has also introduced an ETS to support the achievement of the country’s international climate change obligations (see www.climatechange.govt.nz). New Zealand’s Climate Change Response (Emissions Trading) Amendment Act 2008 was signed on 25 September 2008 and most of its provisions came into force on 26 September 2008. On 24 September 2009, the government introduced the Climate Change Response (Moderated Emissions Trading) Amendment Bill to Parliament, proposing a number of changes to the New Zealand ETS (see New Zealand Government 2009 for further information). In December 2008, the Australian Government released its Carbon Pollution Reduction Scheme White Paper and medium-term target range for reducing carbon emissions (see Australian Government Department of Climate Change 2008b). Legislation on the Australian Government’s Carbon Pollution Reduction Scheme will be debated in both Houses of Parliament in 2009 (Wong 2008). An ETS is also currently under consideration in Japan (see Ministry of the Environment, Japan 2008).

box 1

Selected mitigation policy options to achieve emissions targets

Mitigation policy options available to governments to achieve emissions targets, based on Gupta et al. (2007, p.750), include:

regulations and standards — these specify the abatement technologies (technology standard) or minimum requirements for pollution output (performance standard) necessary for reducing emissions
taxes and charges — a levy imposed on each unit of undesirable activity by a source
tradable permits — these are also known as marketable permits or cap-and-trade systems. This instrument establishes a limit on aggregate emissions by specified sources, requires each source to hold permits equal to its actual emissions and allows permits to be traded among sources
voluntary agreements — an agreement between a government authority and one or more private parties, with the aim of achieving environmental objectives or improving environmental performance beyond compliance with regulated obligations. Not all voluntary agreements are truly voluntary: some include rewards and/or penalties associated with participating in the agreement or achieving the commitments
subsidies and incentives — direct payments, tax reductions, price supports or the equivalent thereof from a government to an entity for implementing a practice or performing a specified action
information instruments — required public disclosure of environmentally related information, generally by industry to consumers. These include labelling programs and rating and certification systems
research and development (R&D) programs — activities which involve direct government funding and investment aimed at generating innovative approaches to mitigation and/or the physical and social infrastructure to reduce emissions. Examples of these are prizes and incentives for technological advances
non-climate policies — other policies not specifically directed at emissions reduction but which may have significant climate-related effects.

Information policies and product labelling approaches

Information policies

IPCC (2007c), Stern (2007) and Garnaut (2008a,b) advocate a range of information and education policies, including product labelling and mandatory disclosure, to address information market failures. Gupta et al. (2007) note that ‘Article 6 of the UNFCCC on Education, Training and Public Awareness calls on governments to promote the development and implementation of educational and public awareness programmes, promote public access to information and public participation and promote the training of scientific, technical and managerial personnel’ (UNFCCC 2006, pp. 764-5).

Gupta et al. (2007) conclude that information instruments may improve environmental quality by promoting more informed choices and lead to support for government policy, although there is only limited evidence that the provision of information can achieve emissions reductions.

Stern (2007, p. 377) identifies a number of information policies — performance labels, certificates and endorsements; more informative energy bills; wider adoption of energy use displays and meters; the dissemination of best practice; and wider carbon disclosure — the implementation of which would ‘help consumers and firms to make sounder decisions and stimulate more competitive markets for more energy efficient goods and services’.

Garnaut (2008b, p. 408) argues that ‘information and education programs have strong synergies with an ETS, as they can help individuals to identify the energy and other costs affected by a carbon price and respond to it’. Garnaut (2008b) further argues that public information programs should provide consumers with information about the benefits of energy efficiency and the costs and benefits of different low emissions practices.

Product labelling

As noted by Karl and Orwat (1999), Harris and Cole (2003) and Garnaut (2008a,b), products and product attributes can be grouped into three categories:

search — product attributes may be checked by searching the product before purchase (for example, by looking at or feeling the product)
experience — product attributes may be checked after the product is consumed or experienced
credence — claims about product attributes may not be reasonably checked by consumers at all, even after consumption.

The environmental quality attributes of a product are typically in the credence category. For example, it is typically not possible for consumers to distinguish between production processes that have different environmental impacts when the final consumer product is the same.

There are three types of eco labels which vary according to the approach used to signal information on credence attributes to consumers (see, for example, Abe et al. 2002; Harris and Cole 2003; Bleda and Valente 2007):

Type I eco labels are criteria based, third party certification programs — these eco labels signal to consumers that criteria, that define a minimum environmental quality level, have been met with verification by a reputable independent organisation.
Type II eco labels are information self-declaration programs.
Type III eco labels are quantified product information label programs, using preset indices — these eco labels are report cards that provide more information to consumers on the environmental quality attributes of the product.

Examples of Type I labels include organic certification, the Fairtrade mark, the dolphin-safe tuna label (eco labels) and the Heart Foundation tick (non-eco label). An example of a Type II label is the aircraft sticker (discussed in the next chapter). Examples of Type III labels include the energy star ratings label, the water star ratings label (eco labels) and nutrition labels (non-eco labels). A carbon label which provides consumers with quantitative information about the carbon footprint of a product is a type III eco label.

Product labelling may provide consumers with information about a credence attribute associated with a particular stage in the product’s life cycle — stages include production and delivery (including processing, storage and transport), consumer use and product disposal. For example, performance labels provide consumers with information about an environmental attribute relevant to the product’s use (such as the energy efficiency and water efficiency of refrigerators and washing machines).

Empirical evidence of behavioural change from product labelling

Teisl et al. (2002) note there have been three important developments in eco labelling in recent years:

knowledge about the environmental attributes of products has become increasingly important to consumers
governments and nongovernmental organisations have responded by organising, implementing and verifying eco labelling programs, which cover thousands of products in more than 20 countries
there have been international efforts to standardise environmental labelling schemes.

Teisl et al. (2002) also note there is significant empirical evidence that non-eco labels, such as nutrition labels, can change market behaviour. Research concerning the impact and effectiveness of eco labels is more limited although there have been a number of empirical studies on the effect of environmental labels on consumer demand. For example, Teisl et al. (2002) found the introduction of the dolphin-safe tuna label increased consumer demand for canned tuna. Bjorner et al. (2004) also found empirical evidence of significant changes in consumer preferences following the introduction of a certified environmental label.

Stern (2007) argues that product labelling can have a significant effect on consumer behaviour, as demonstrated by organic certification and the Fairtrade mark. For example, global sales of Fairtrade products increased by 47 per cent in 2007 to more than €2.3 billion. Fairtrade labelling indicates that specified social and environmental standards are met and that producers receive the Fairtrade minimum price and premium (Fairtrade Labelling Organizations International 2008).

Garnaut (2008a,b) notes there is research to indicate that labelling programs for appliances have been successful in encouraging the uptake of more energy efficient products in Australia and elsewhere (citing George Wilkenfeld and Associates & Energy Efficient Strategies 1999). Australia’s energy performance labels are also discussed in, for example, Holt and Harrington (2002) and Productivity Commission (2005, 2008). The Productivity Commission (2008, p. 136) found that, while ‘the benefits of labelling may have been overstated in regulation impact assessments, it is likely to have produced net benefits for consumers’.