Many political economists see effective states as those stemming from ‘top-down’ directives by governments. Investments into state capacity by incumbents, such as establishing an effective bureaucracy, increase the range of policies a government can implement successfully. Citizen compliance with policies is either assumed or, alternatively, achieved via coercion by law enforcement.

A second approach to state building stresses the role of individuals. Here, citizens and the government work in a mutually reinforcing, reciprocal relationship (Besley, 2021). ‘Bottom-up’ private action can similarly enhance state effectiveness.

If government is perceived to be trustworthy, people will be more likely to comply with public policies via consent. Public trust in government and the state is therefore crucial for increasing voluntary compliance.

Governments can achieve more if they know that citizens trust that policy-makers have their best interests at heart. And while it is easy to see how public trust can be eroded, (re)building trust is pivotal and can be challenging.

The importance of public trust

Trust in government and the state matters for a variety of reasons. Primarily, it increases voluntary compliance towards public policies. If we think of state capacity broadly as ’the government’s ability to accomplish its intended policy goals’, it stands to reason that compliance serves an essential purpose (Dincecco, 2017).

The archetypal example of state capacity is fiscal capacity – referring to the state’s ability to increase tax revenues to fund public goods and services for society (Besley and Persson, 2011). Investments into fiscal capacity typically involve strengthening bureaucracies and establishing fair and transparent tax systems, part of which involves improved monitoring. Citizen compliance with paying one’s taxes is therefore a direct function of the state’s oversight and reach to enforce tax policy (Allingham and Sandmo, 1972).

At the same time, if people think that tax revenues are well spent on public goods and services – with government proving its trustworthiness against profligacy as a result – this should increase society’s intrinsic willingness to pay taxes (Levi, 1988). In economics, this is sometimes known as ‘tax morale’ (Luttmer and Singhal, 2014).

Trust in government is crucial to establishing norms of compliance towards taxes (OECD, 2019). And compliance via consent, as opposed to compulsion, is a substantially cheaper method to implement effective policies (Tyler, 2006).

Supporting fiscal capacity via tax morale is one example of how voluntary compliance enhances state capacity via trust in government. But there are a range of other policies that require high levels of compliance to be successful, beyond just taxes. And there are also a host of activities by which citizens interact with the state on key issues which require public trust.

The Covid-19 pandemic is a useful setting to explore this idea further. Across countries, vaccine rollouts have almost exclusively been administered by the state (as opposed to private companies). Trust in government has therefore been necessary to incentivise people to get vaccinated (and to thwart conspiracy theories that go against government-backed scientific advice).

Even before the pandemic, there was evidence of a strong association between public trust and inoculation willingness (Blair et al, 2017). Political trust during Covid-19 has also been associated with greater compliance with lockdown policies (Bargain and Aminjonov, 2020). Clearly, with a public health emergency like Covid-19, trust in government has been a vital asset for delivering effective interventions such as the vaccine rollout.  

Direct measures of compliance are possible on a policy-by-policy basis. But micro-data can provide some insights into cross-national trends. An index of voluntary compliance can be constructed by looking at respondents’ willingness to fight for their country, pay taxes and accept higher taxes to prevent environmental pollution (Besley, 2022). Conscription and taxes are two well-studied areas of compliance-based interactions with the state (Levi, 1997).

This work shows a strong positive correlation between the proportion of respondents who report high confidence in government and the voluntary compliance index (see Figure 1). Although not causal evidence, it highlights that trust and compliance are closely related.

Figure 1: Trust and compliance, by country

Source: Integrated Values Survey

Levels of political trust across the UK

Trust in government is relevant to every country’s political life. Recent political events have focused significant attention on this to the UK. In the first Conservative Party leadership debate to replace Boris Johnson, trust was the first issue highlighted, and was subsequently discussed at length.

Indeed, only 35% of the UK population trust the government, according to new data from the Office for National Statistics (ONS). This is below the OECD average of 41%.

While trust in government is crucial, there are several other branches of the state that citizens can have faith in. Local government is typically deemed more trustworthy than national government. This is partly because people have more interaction with local public services and have greater access to, say, local councillors compared with MPs in Westminster (Jennings, 1998).

The ONS findings show that 42% of people in the UK trust local government – a notably higher share than for national government. The data also indicate that trust is higher in the civil service, at 55%. Given civil servants are impartial bureaucrats, this should overcome public trust as being driven purely by partisan ties (for example, Conservative voters will be more likely to trust a Conservative government versus a Labour one). Political parties are actually the state institution with the lowest level of trust among the public, at 20%.

Figure 2: Trust in political institutions

Source: ONS

The ONS findings are a static snapshot of the distribution of public trust in 2022. Ideally, we also want to understand how trust has evolved over time. The available data from the OECD going back to 2010 show that trust in government dropped to around 35% in 2019, where it has remained since.

This stands below the 2010-2020 average of 42% (the pale blue line in Figure 3). Although speculative, it seems that Brexit, Boris Johnson’s premiership and Covid-19 are plausible drivers of this trend.

Figure 3: Trust in UK government (2010-2020)

Source: OECD

Why should governments build trust?

Declining public trust in government is worrying. The Covid-19 pandemic has tested public trust around the world. As the worst of the crisis subsides, (re)building trust will be pivotal not only to expand state capacity as a long-term project, but to also tackle future crises.

There are a range of issues which require government and their citizens to work together. The threat of climate change is a clear example. Governments must implement the right environmental policies to encourage a green transition.

Evidence suggests that such policies can help shift households’ habits towards greener patterns of consumption – although this logic is yet to be extended to firms and production tendencies (Nyborg et al, 2016; Mattauch et al, 2022). But for these theoretical ideas to work in practice, compliance will be necessary and cannot be taken for granted.

The OECD’s trust survey report shows that across OECD countries, half of individuals think that climate change should be prioritised by government, but only one-third are confident in policy success on this issue.

Across UK regions and the devolved nations there is also a positive correlation between confidence in government and citizens’ willingness to sacrifice income for the environment (see Figure 4). This relates to growing evidence on linking trust to climate policy preferences (Klenert et al, 2018; Dechezleprêtre et al, 2022). This also indicates that political trust matters for enhancing voluntary compliance to solve crises such as climate change, by increasing the range of policies available to policy-makers.

Figure 4: Political trust and environmental preferences, by UK nation/region

Source: Integrated Values Survey

How to build trust in government?

The drivers of mistrust in government are to some extent fairly obvious. Corruption is a case in point. If people see politicians using public office for private gain, they will be less likely to believe that government has their best interests at heart. Why would any household or firm pay taxes if they knew the money was being used to line politicians’ pockets?

Evidence that policy-makers are not following the rules, regulations or laws that they set also decreases public trust. ‘Partygate’ and the Dominic Cummings affair in the UK are evidence of this. Respect for the rule of law by those working in government is paramount for maintaining trust, ensuring there is sufficient compliance for delivering effective policy.

In terms of building trust in the state, proving policy competence is one method. Successful delivery of public goods and services, to increase the welfare of citizens, can be highly effective. The United States in the 1930s is a clear historical example. Recent evidence suggests that Americans who benefited from President Franklin  D. Roosevelt’s ‘New Deal’ – at the time, an unprecedented expansion of the state – were far more willing to voluntarily contribute to the war effort during the Second World War (Caprettini and Voth, 2022).

As with the case for tax morale, people are more likely to trust government, and voluntarily comply with policies, if government is perceived to work in citizens’ best interests.

Increasing the scope of public engagement with politics is also an important driver of public trust (Kumagai and Iorio, 2020). Legal scholars have emphasised the importance of ‘legitimacy’ – individuals tend to obey the law not from fear of sanctions, but because they see the law as a legitimate moderator of human behaviour (Levi et al, 2012).

A greater commitment to procedural fairness and amplifying people’s voices in the political process can help ensure policy decisions are seen as being legitimate, thereby strengthening trust.

Developing a strong social contract between government and the governed is no easy task. Healthy scepticism towards politicians is important so that government remains accountable to an active and vigilant citizenry.

Nevertheless, public trust is critical to expanding state capacity for the long run and to tackling future crises, such as climate change.

Where can I find out more?

• Rebuilding trust in government: article from Deloitte Insights on building public trust, with a focus on the United States.
• Trust in public institutions: policy brief by the United Nations Department of Economic and Social Affairs.
• Policymaking, trust, and the demand for public services: Gianmarco León-Ciliotta, Dijana Zejcirovic and Fernando Fernandez show that disclosure of forced sterilisations of women and human rights violations in Peru under Alberto Fujimori decreased trust in public institutions and reduced demand for public health services.

Who are experts on this question?

• Tim Besley
• Chris Dann
• Imran Rasul
• Paola Giuliano

Author: Chris Dann

Photo by f11photo from iStock

The post Does public trust in government matter for effective policy-making? appeared first on Economics Observatory.

On Tuesday, the temperature reached 40.3°C in Coningsby, Lincolnshire. This made it the hottest day ever recorded in England, and the latest peak in an alarming upward trend. According to the Met Office, nine of the ten warmest days ever recorded in the UK have been since 1990.

Even as the sun set, it barely cooled down. Provisional data suggest that from Monday into Tuesday the country experienced its hottest night on record, with parts of the East of England remaining above 25°C from dusk until dawn.

Such extreme heat poses serious dangers, not only to people but to animals, plants and infrastructure. This week zoos were closed, trees burst into flames and several train services were cancelled for fear that the metal in the tracks would warp and buckle under the blistering sun.

As fires erupted across the UK and continental Europe, emergency services were put under substantial pressure. On Tuesday the London Fire Brigade were called out to over 2,600 incidents, making it their busiest day since the Second World War. In Gironde, in south-west France, tens of thousands of people have been evacuated from their homes as nearby forests burn.

Further afield, temperatures also rose above 40°C in North America, the Middle East and Asia. Looking at the global data, Steve Pawson, Chief of the Global Modelling and Assimilation Office at NASA, concluded that the recent record-breaking heat is ‘another clear indicator… that human activity is causing weather extremes that impact our living conditions’. The latest global heatwave is a dangerous backward step for mankind.

Extreme weather costs

These extreme weather events also have significant economic costs, as highlighted in an Economics Observatory article by Ilan Noy (Te Herenga Waka - Victoria University of Wellington). The piece – first posted as part of our COP26 collection – explores how economists calculate the costs of extreme weather. He argues that the true economic impact of these disasters, and their effects on equality, are being underestimated. This means economists and policy-makers may also be misjudging the urgency required to implement cost-effective mitigation policies.

A particularly alarming chart from the article plots the first full-flowering day of cherry blossom in Kyoto over time (see Figure 1). Using data running back over a millennium, the graphic highlights how the trees are coming into flower earlier and earlier each year, particularly since 1900. In 2021, the trees blossomed on 26 March. This is the earliest they have done so in more than 1,200 years.

Figure 1: First full-flowering day of the cherry blossom in Kyoto, Japan

Source: NOAA, based on Aono, Kazui, 2008; Aono, Saito, 2010; and Aono, 2012

People face different levels of risk from extreme weather events. For Ilan, climate change ‘is not an equal opportunity menace’. In fact, its impact on minority and low-income families is potentially much higher. It is the poorest in society that are most vulnerable to floods, fires and freak events. This makes combatting climate change a social justice issue as well as an environmental one. Stopping its effects is the only way to ensure equal economic opportunities, as well as basic security, for millions of people around the world.

The numbers behind the crisis

The increasing cost of living is another crisis from which there is little respite. Prices are continuing to rise, as shown by new data from the Office for National Statistics (ONS) released this week.

Inflation rates in the UK have reached levels not seen for decades, with the consumer prices index (CPI) up 9.4% over the past year (see Figure 2). Wages are failing to keep up – as data released on Tuesday show – meaning that British workers are witnessing the value of their real-term pay shrink drastically.

Figure 2: CPI (1988-2022)

Source: ONS

But what is actually causing the crisis? Economics Observatory Director, Richard Davies, has dug deeper into the data, exploring which products are causing the biggest surge in people’s day-to-day living costs.

To understand what’s going on, it’s important to consider how measures like CPI are calculated – something discussed in detail in a recent Observatory article by Jason Lennard (LSE) and Ryland Thomas (Bank of England).

In his article this week, Richard highlights how the numbers that underpin the ONS’s findings – known as the ‘micro data’ – are the individual prices collected in shops and businesses up and down the country. This dataset is huge, with over 40 million prices recorded since 1988, which allows economists and policy-makers to take a closer look at how, and why, inflation is surging.

In normal times, there is substantial flux in the data. This means that even when headline inflation is rising, there are some shops or businesses that are cutting their prices. In short, prices tend to ebb and flow, overall.

But Richard shows that recently the shares of prices rising and falling have diverged (see Figure 3). This means there are fewer price cuts taking place, demonstrating just how widespread the current inflation facing the country has become.

Figure 3: Month-on-month price changes

Source: ONS; Davies, 2022

Worse still, it is food items that dominate the list of prices that are rising. According to the micro-data, milk, spaghetti, baked beans, salmon fillets, bacon, lettuce, cucumbers and eggs are all increasing in cost. Normally these are exactly the type of items that see a great deal of flux. But with price cuts very rare at present, these price jumps look likely to become ‘locked in’.

The competition heats up

Whoever takes over from Boris Johnson as prime minister in September will face tough policy challenges. Climate change and extreme weather events will continue to pose significant risks to people’s economic and physical wellbeing. The cost of living crisis looks set to deepen, with the Bank of England predicting that inflation could reach 11% before the end of the year. And a struggling NHS, the war in Ukraine and a battered education system will also each require urgent and sustained attention.

High inflation is not just squeezing ordinary people at checkouts and petrol pumps. New data released on Thursday show that the country’s public finances are under substantial strain, with interest payments paid by the government hitting £19.4 billion in June. This level of debt burden is largely a result of higher inflation, as the rate paid on government bonds is linked to the retail prices index, which hit 11.8% in June.

The two remaining leadership hopefuls, Rishi Sunak and Liz Truss, have each made claims that they are the most well-equipped to manage to country’s economic policies. At the centre of both their campaigns are promises to fight inflation while promoting growth. Although they differ on the nature and timings of tax cuts, both candidates are trying to convince Conservative party members that they are ready to make the difficult calls and restore the party’s tarnished reputation.

Addressing the manifold and connected economic challenges seems likely to make or break the UK’s next leader. Controlling inflation and servicing the country’s swelling debt, all while appeasing calls to cut taxes, will be extremely difficult. Getting the balance right will be critical.

Observatory news

This will be our last newsletter for a couple of weeks. We will be back on Friday 19 August. In the meantime, keep an eye out for some exciting announcements for the autumn.

Author: Charlie Meyrick

Picture by ???? ?????? on iStock

The post Overheating appeared first on Economics Observatory.

The United Nations (UN) process to tackle climate change recognises finance as one of its three pillars and includes the only agreed international treaty on providing finance to developing countries. The legally binding Paris Agreement of 2015 reinforced this commitment. So, are rich countries doing enough; and what would ‘enough’ be?

Developed countries are expecting to meet a collective goal of mobilising $100 billion per year in climate finance in 2023, three years after they made this commitment.

While that amount is substantial, the design of the target means that much of the money has been rebadged or diverted from other development objectives such as economic development and poverty reduction. Policy officials at the UN and within individual countries are beginning work, mandated by the Paris Agreement, to agree a post-2025 climate finance goal from a floor of $100 billion per year.

While economic analysis of the externalities of climate change – effects not experienced by the company or country causing them – could justify a much larger figure, if the design of the target doesn’t improve, that money may not make a difference to those dealing with the worst effects.

Despite the importance of combating climate change, high quality economic research on it is still lacking. In 2019, a study assessed nine of the top economic journals and identified just 57 papers on climate change out of a total of around 77,000 (Oswald and Stern, 2019).

The authors suggest that this may reflect a bias towards ‘conventional’ topics among editors and authors. It may also reflect the absence of reliable data – but the result is relatively thin research on arguably the most important issue of our time.

What are the costs of climate change and adaptation?

It is well understood that emissions of greenhouse gases such as carbon dioxide are trapping the sun’s heat, raising temperatures and affecting weather patterns. Each tonne of carbon dioxide, wherever it is emitted, is damaging to the environment and has associated costs.

Various reports have estimated these costs, although doing so relies on taking a view on how badly the planet and the economy will be damaged if and when emissions peak.

If climate change ultimately destroys much of the planet, the cost of each tonne of carbon will be extremely high, relative to one where the goals of the Paris Agreement – which commits to limiting temperature increases well below 2°C – are achieved. One authoritative summary, led by the US government puts the cost at $40 per tonne in 2020.

We have used that figure to look at historical emissions and their cost. Even if we discount the externality cost historically, and don’t count emissions at all before 1979 – when awareness grew and the first world climate conference was held – the costs are very significant.

They are estimated at $34 trillion globally, or $15 trillion for OECD countries – around 28% of their national income (Robinson et al, 2021). Paying off just the OECD’s historical liability would cost $190 billion per year to 2100.

The costs of climate change could also be estimated by aggregating government or business costs of mitigating emissions and adapting to the effects of climate change. The true costs would be those relative to a scenario or ‘counterfactual’ without climate change.

But this is a difficult calculation. Even for, say, flood defences, it requires attributing some share of the cost to changed climate; and there is no automatic reason for governments or businesses to do so.

But under the Paris Agreement, every country must produce a nationally determined contribution (NDC), which estimates emissions pathways and includes financing costs in many cases. As these develop over time, they may give a fuller picture of national costs.

These estimates of costs are different from the climate finance target. The latter is a negotiated outcome as part of an agreement to reduce emissions, not an attempt to set finance to match the costs of climate. But clearly any ‘liability’ for climate damage is relevant to that negotiation.

The COP process has a separate track on ‘loss and damage’ (article 8 of the Paris Agreement), which is where discussions of compensation take place. But these have made little progress as industrialised countries have been unwilling to agree to liability – although Scotland made the first financial contribution of £2 million under this article at COP26 in Glasgow in late 2021.

The $100 billion climate finance and other development finance targets

In practice, the $100 billion per year target, originally agreed in 2009 at the 15^th COP and reaffirmed by the Paris Agreement, is currently the only active mechanism for redistribution.

The other well-known international agreement on development finance is the 60-year-old UN agreement to provide 0.7% of gross national income (GNI) in official development assistance.

This long-standing target is accepted in principle by many high-income countries (but not by the United States or Switzerland), although in practice few have met it consistently. Across the 29 rich countries that comprise the OECD’s Development Assistance Committee, development assistance has typically amounted to 0.32% of GNI or $161.2 billion in 2020.

These efforts overlap with the COP climate finance target – nearly a quarter of official development assistance is now badged as climate finance (and counts towards the $100 billion target).

Climate finance was originally intended to be additional to existing development finance efforts. The first UN meeting of the conference on climate change (UNFCCC) in 1992 called for ‘new and additional’ resources. This language has appeared consistently in COP agreements, including the 2009 Copenhagen Accord, which set the $100 billion per year goal, and the Paris Agreement that reaffirmed it.

In practice, rich countries have shifted resources from aid programmes or rebadged activities to make progress on the climate goal. By 2019, the OECD suggests that climate finance grew to $78.9 billion but that was within an increase of all development finance of just $43.6 billion.

This suggests that only around half of climate finance was additional in absolute terms. Relative to national income, the picture is even worse: high-income countries’ contributions have remained unchanged as a share.

This failure to commit additional funds is particularly obvious in the case of the UK. The country is the current COP president and aims to double its climate finance to total £2 billion annually until 2026.

Despite this commitment, the UK has reduced its wider aid budget by £4.5 billion per year. During 2021, nearly all of the UK’s aid partners saw their support fall by a third or more, while the UK claimed to be increasing its support for climate.

The climate finance target was not defined clearly – it lacked a measure, baseline or any attempt to assess additionality. It also counts loans as equivalent to grants.

This has led to major disagreements in the past. Ahead of the Paris negotiations, India’s government famously suggested that credibly new and additional climate finance actually disbursed (rather than just ‘committed’) was more like $2.2 billion in 2014, far below the OECD’s claim of $62 billion for the same year.

Not only has this meant fewer resources to tackle climate change, but the lack of definition and progress has also undermined trust in the Paris Agreement. Without trust, countries do not have the incentives to make major adjustments to their policies or emissions.

Where next on climate finance?

At COP26 in Glasgow, developed countries set out a ‘delivery plan’ that would ensure the $100 billion target will be met three years late, from 2023 onwards. Although this is no guarantee of additional resources, for which there are acute needs in low-income countries to deal with the health and economic fallout from Covid-19, a food price crisis exacerbated by Russia’s invasion of Ukraine and record levels of humanitarian demand mainly due to the conflicts in Syria, Ukraine and Yemen.

The Paris Agreement commits to a new climate finance target from a floor of $100 billion per year from 2025 ‘taking into account the needs and priorities of developing countries’. Officials are starting work on the design of that target now.

This work will be crucial both in financing development, but also ensuring trust between nations as they look to transform their economies in the coming decades. Industrialised nations will need to recognise their responsibility for the damage caused by emissions and be prepared to provide financial support to those most vulnerable to deal with their effects on the climate.

Where can I find out more?

• The UN Framework Convention on Climate Change gives an introduction to climate finance and describes the agreements on its provision.
• An analysis of which high-income countries are providing climate finance by the World Resources Institute.
• Ministers from Canada and Germany published a Delivery Plan in autumn 2021, demonstrating how and when developed countries will meet the $100 billion goal by 2023.

Who are experts on this question?

• Joe Thwaites, World Resources Institute
• Clare Shakya, International Institute for Environment and Development
• J. Timmons Roberts, Ittleson Professor of Environmental Studies and Sociology at Brown University
• Nicholas Stern, London School of Economics

Author: Ian Mitchell

Photo by Kongdigital from iStock

The post How much climate finance should rich nations provide? appeared first on Economics Observatory.

The war in Ukraine, as well as sanctions against Russia, have resulted in a massive decline in the supply of major staple foods. This has led to a rise in food prices globally.

Which countries are bearing the brunt of the crisis?

Many developing and emerging market countries rely on food imported from Ukraine and Russia – known as ‘the breadbasket of Europe’ – to augment local food production. For example, the top three importers of Russian wheat in 2018 were Turkey, Vietnam and Indonesia. Similarly Indonesia, the Philippines and Morocco imported the largest share of Ukrainian wheat that year. Instability caused by the war will therefore negatively affect the food supply in these importing nations.

Food shortages precipitated by the war are hurting food prices everywhere, with the hardest hit being developing economies where the world’s poorest live. The United Nations’ Food and Agriculture Organization (FAO) reports that the global Food Price Index (FPI) averaged 159.3 points in March 2022, up 17.9 points (12.6%) from February. This is the highest level since its inception in 1990. The latest increase reflects new all-time highs for vegetable oils (248.6 points) and cereals (170.1 points), highlighting the direct negative effect of the conflict.

Focusing on country-level statistics, the largest leap in food price inflation between February and March 2022 has been in developing/emerging regions such as sub-Saharan Africa. Several of these countries have experienced higher food price inflation than the global average (12.6%) over this period. For example, Lebanon (396%), Zimbabwe (75%) and Turkey (70%) experienced the highest rate of food price inflation between February and March (see Figure 1).

Figure 1: Developing and emerging market economies with the highest food price inflation change between February and March 2022

Source: FAO Food Price Monitoring and Analysis, 2022

Households in these countries devote a greater proportion of their total expenditure to the provision of food (see Figure 2). Specifically, the World Bank estimates that poor households in sub-Saharan Africa spend approximately 75% of their income on food. This compares with 10.8% for the average UK household in 2019/20.

Consequently, rising food prices reduce the real incomes of households, pushing more people into the food poverty trap – a situation where more individuals and households are unable to afford adequate and nutritious diet.

Figure 2: Share of income spent on food, by selected country

Source: Economic Research Service (ERS), United States Department of Agriculture

Sanctions on Russian oil companies and the planned bans on Russian energy exports have triggered further increases in energy prices in the international market. While the European Union (EU) is the largest collective buyer of Russian oil – buying 42% of Russia’s oil output in 2021 – the constituent countries have managed to diversify their economic base and begin importing more oil from elsewhere.

In contrast, many developing/emerging markets run a ‘monocultural economy’ –meaning they are highly reliant on single basic resources such as oil. For example, while oil accounts for 40% of Nigerian GDP, 70% of its budget revenues, and 95% of foreign exchange earnings, Nigeria remains the only member of the Organization of the Petroleum Exporting Countries (OPEC) that imports 95% of refined petrol for domestic use.

Consequently, movements in the international oil market affect local fuel prices in these markets. Eventually, the burden of higher costs of production, storage and transport is passed on to the consumers in the form of higher food prices.

Going back to Figure 1, countries with the highest rate of food price inflation are also often conflict-prone economies. Before the war broke out in Ukraine, some developing/emerging markets were already experiencing higher food bills due to internal conflicts or climate-related challenges.

For example, in 2016 the United Nations (UN) reported that Boko Haram bombings in Northern Nigeria disrupted trade routes between Chad and Nigeria, interrupting the supply of basic goods and causing local price hikes. It is likely that the war in Ukraine has worsened existing food price crises in some developing economies.

What next for food security around the world?

More research is needed to disentangle the extent to which current food price inflation can be attributed to internal crises in developing economies or the war in Ukraine. But we do know that the effects of both situations on food prices reinforce one another.

Situations where food becomes increasingly expensive or insufficient can incite further civil conflicts. This was seen during the Arab spring in the early 2010s – an event that emerged partly in reaction to high cereal prices. These anti-government protests in the Middle East followed international food price inflation, bad weather conditions and shrinking farmlands, together with high unemployment and dissatisfaction with the corrupt political classes.

A decade later, a similar set of factors could combine and cause both political turbulence and a further escalation of prices. The combination of fragile institutions, political instability and non-diversified economic structures are central factors that amplify the effects of the Russian invasion of Ukraine on food prices in emerging economies. Where these challenges are not addressed, it may be that food prices in these economies do not revert to the pre-crisis era, even if the war in Ukraine were to end.

Where can I find out more?

• The World Bank blog gives an insight into amplifying effect of the conflict in Ukraine on food crisis in Africa.
• The United Nations Brief provides an in-depth discourse on the impact of war in Ukraine on global food systems.
• The International Monetary Fund blog details how the war in Ukraine is affecting different sectors in several parts of the world.

Who are experts on this question?

• Lotanna Emediegwu
• Sascha O. Becker
• David Ubilava
• Alfons Weersink

Author: Lotanna Emediegwu

Photo by AndrijTer from iStock

The post How is the war in Ukraine affecting global food prices? appeared first on Economics Observatory.

Housing retrofits – whereby existing buildings are changed to improve their energy efficiency and reduce emissions – are useful case studies of these challenges and the progress being made to overcome them.

We know that more than 80% of the housing stock that the UK will have in 2045 already exists. In other words, the required retrofit is a massive financial and physical programme lying ahead. It is made even more challenging by the fact that the country’s housing stock is comparatively old and highly variable in terms of quality and condition.

Can tenement buildings offer an example?

Scottish cities – and Glasgow in particular – have an instantly recognisable built form: the traditional pre-1919 tenement of walk-up flats fronted by red or blond sandstone exteriors. There are 73,000 such flats in Glasgow, more than a fifth of the city’s stock.

They form part of successful high-density neighbourhoods across the city, and come in all housing tenures, often mixed within a given close(that is, a group of flats linked by a common stair and front entrance). Some are in poor condition and in need of repair, and they suffer from the problem of coordinating common repairs among multiple owners.

Tenements also leak carbon and are expensive to heat and insulate – problems exacerbated by net-zero ambitions and rising fuel prices. Plans to retrofit these buildings also need to be consistent with a strong heritage conservation constituency, which seeks to maintain traditional design, materials and the wider aesthetics of tenement living.

This is the context that Glasgow and urban Scotland more generally faces when contemplating how to secure a future for a low-emissions tenement sector.

It was against this background that a unique partnership was formed in 2019 to work through a deep (EnerPHit) retrofit, a near equivalent to PassivHaus for existing properties. Both EnerPHit and PassivHaus are building standards that seek to reduce energy demand and generate net-zero emissions through construction methods, intelligent insulation and renewable heating and power. 

The aim has been to launch a demonstration project to prove that this kind of retrofit could be done for pre-1919 tenements. It also seeks to draw replicable lessons for the city's tenement strategy.

An eight-flat property in Niddrie Road on the inner south side of the city was taken over from a private landlord by a Southside housing association. City council and housing association funding was supplemented by Scottish government funding for the renewable element.

The project was slowed by Covid-19, but it will nonetheless deliver the high degree of 'fabric-first' airtight internal and external insulation, mechanical ventilation, waste water recovery as well as other key features (for example, half the properties deploy air source heat pumps).

The fabric-first approach involves a focus on physical property retrofit as opposed to simply changing from fossil fuel energy to something renewable. It recognises that the buildings themselves need to be made energy efficient through better insulation, ventilation and the like to make the most of reduced energy demand.

The properties will be handed over to new social tenants in June 2022.

Evaluation

The project’s evaluation, resourced by the Scottish Funding Council, consists of several discrete but integrated elements:

• A decision-making account recording the process of undertaking the project and the key decisions made internally and externally, in real time.
• A formal cost-benefit analysis drawing on HM Treasury’s Green Book of appraisal of public investments, as well as the government’s environmental accounting estimates for carbon (including scenarios for future valuations of carbon), complete with realistic counterfactuals (including demolish/rebuild; achieving the current Scottish government social housing target EPC ‘B’ in retrofit; and the net-zero EnerPHit retrofit). Central estimates are compared and contrasted by varying key assumptions and conducting sensitivity analysis.
• A technical building energy consumption assessment and evaluation of the extent to which EnerPHit levels of retrofit are achieved in practice.
• A pre- and post-occupancy survey of the tenants, asking about their experiences of living in the retrofitted property.

Early evaluation suggests that this type of project scores well in cost-benefit terms, but it is nevertheless expensive. While there are important lessons from aspects of the demonstration project and it can serve as a model for other retrofits in the UK, challenges remain. The latter two elements of the evaluation will be completed in the winter of 2022/23.

What does the decision-making account indicate for these types of projects?

First, this kind of project can be done, but it is a major realisation and requires commitment from partners and strong leadership.

Second, it is precedent-setting and has to engage closely with what city planners are willing to modify within their existing planning policy for traditional tenements.

Third, winning the Scottish Funding Council evaluation helped to bring in other public funds for the project.

Fourth, there are many second order questions or multiple objectives that had to be resolved in real time as the project evolved during lockdown. Examples include determining what was required to achieve the EnerPHit standard; how best to overcome technical issues with the fabric-first approach given the poor quality of the building; and deciding on the feasibility of different renewable solutions, such as air source heat pumps versus gas boilers or electric heating.

Lastly, it is apparent that the project had advantages that would not always be applicable in other retrofits. In particular, the eight properties were unoccupied and hence there were no temporary alternatives required for residents (known as decanting). Further, there were no housing tenure complications, which would ordinarily be common across Glasgow as individual tenement blocks often house multiple tenures.

Nonetheless, the council have confirmed that there are already evident lessons that can inform how they take their city tenement strategy forward. Examples include the scope for deep retrofit with most, though not all, of the gains associated with this demonstration project and at lower cost. There are also lessons about which components generate impacts, for example, the importance of airtight insulation and good ventilation, and the need for good training and support for residents moving into such properties.

As a result of the project, the construction firm also recognised that there were opportunities for creative phasing of the retrofit works over a period of time, perhaps across larger blocks of properties, which could reduce the disruption for residents.

What does the cost-benefit analysis tell us?

In absolute terms, the cost of the demonstration project was high. Each unit cost a combination of £60,000 for initial acquisition, £44,000 for the basic refurbishment and a further £32,000 for the EnerPHit standard and a £12,000 contingency charge for uncertainties that arose (£148,000 in total).

This was in part because the standard of retrofit was so high, but also because of the poor condition of the property itself. About half of the costs were met by direct grant funding from the city council (primarily) and the Scottish government, with the other half to be repaid out of rents.

The baseline analysis indicates that under a range of scenarios, the EnerPHit retrofit or the lower level refurbishment (equivalent to EPC level B) are always better options than to demolish and rebuild. It is less clear financially whether the net benefit is better for one or other of the retrofit options (it varies across sensitivity analysis options). But only the EnerPHit version delivers net zero and radical reductions of 80-90% in average fuel costs (both in theory and observed in comparable non-tenement projects).

What are the wider implications?

While it will be the spring of 2023 before a comprehensive picture of the retrofit evaluation is available, some lessons can be drawn from the project.

EnerPHit is expensive, but what matters for retrofits is the use of fabric-first airtight insulation plus good ventilation. Not all properties will require the extent of refurbishment required in the demonstration project. The focus should be on fabric and renewables combined rather than the specific choice of renewable alone. This allows for a wider choice of energy renewable systems for the residential sector. This will have relevance for other older property archetypes, as well as tenements.

One important challenge is how to give owners (including landlords) the incentives to make these changes to their properties. Further, how do we solve the classic problems of the tenement built form – that is, organising and paying for collective or common repairs across different flat owners? How do we package together small area-based programmes and sequence them to reduce disruption and resident decanting during the works phases?

The Scottish Law Commission is currently examining legal reform to promote ownership associations, sinking funds and mandatory property inspections. It also looks as if other housing associations with tenement properties in Glasgow are exploring close to EnerPHit alternatives that may be a little more affordable as investments.

Mass retrofit requires significant economic restructuring and the greening of supply chains, and a host of services relating to domestic energy use. But the lesson from this demonstration project, as well as elsewhere, is that retrofitting must be fabric-first and thereby reduce the energy demand that households require. This implies considerable new work for construction sector trades, even if it is not at the demanding level that EnerPHit requires of a pre-1919 tenement.

Where can I find out more?

• A cost-benefit analysis of a traditional Glasgow tenement net-zero retrofit: Report by Anthony Higney and Kenneth Gibb.
• UK Collaborative Centre for Housing Evidence, CaCHE.
• John Gilbert Architects.
• Low Carbon Homes.
• What is EnerPHit?

Who are experts on this question?

• Tim Sharpe, University of Strathclyde
• Kenneth Gibb, University of Glasgow
• Aimee Ambrose, Sheffield Hallam University

Author: Kenneth Gibb

Photo by Drimafilm from iStock

The post Retrofitting the UK housing stock: what lessons from Scotland’s tenements? appeared first on Economics Observatory.

At the same time, ecosystems are degrading fast – leading not only to the loss of species but also the ‘services’ that they provide, such as temperature regulation, water purification, carbon storage, crop pollination and their myriad benefits for human life.

Nature is our strongest ally in the struggle to keep the earth at a habitable temperature. Climate change solutions based in nature may also help to address the economic and social problems of inequality, government budgets under pressure and finite natural resources.

What are nature-based solutions?

‘Nature-based solutions’ are based on a simple – and old – idea. When nature is healthy, it delivers multiple benefits and services – not only for the environment, but also for human health and wellbeing, as well as for economies and societies.

These solutions, based in nature, generally need to ‘solve’ multiple challenges – benefitting both humans and nature simultaneously.

Nature-based solutions can include:

• Green infrastructure – such as permeable surfaces, green walls and green roofs.
• Soil conservation and recovery – for example, by increasing soil moisture, organic matter and biodiversity and reducing soil erosion through sustainable land-use schemes, careful, evidence-based planting and organic agriculture.
• Protecting settlements from floods and seas – including through restoring or creating wetland areas, saltmarshes and riparian parks.
• Enhancing biodiversity and its services – for example, by restoring ecosystems or creating insect-friendly urban green spaces.
• Regenerating places and connecting communities – including through urban food growing and community gardens,
• Improving air quality and lowering temperatures in our cities – such as increasing green planting schemes and the abundance of city trees.

How can they help society and the economy?

Nature-based solutions can create green jobs and business opportunities, for example, in landscape architecture, ground maintenance, construction, horticulture and agro-forestry. Other roles include wildlife officers, outdoor educators, urban farmers and more.

As well as creating sustainable occupations, nature-based solutions can also save money. Improved water management or recreational services can help to save money at household and government levels – for example, roof gardens and urban parks provide cooling, which would have otherwise been artificially produced via air conditioning. Studies suggest that green roofs can bring energy savings of between 15% and 45% of annual energy consumption from reduced cooling costs (Anderson and Gough, 2022).

They have also been shown to reduce the concentration of air pollutants, specifically ozone and nitrogen dioxide (Anderson and Gough, 2020). One European project – Green City Solutions – has developed the ‘CityTree’: vertical panels that contain hardy, pollution-processing plants such as moss, which can help to clean the air at a fraction of the cost and space of conventional plantings, and can be set up in transport hubs and school playgrounds.

Before 1998, Augustenborg in Sweden was an area that suffered from socio-economic decline and frequent flooding from overflowing drainage systems. But retrofitting sustainable urban drainage systems in the neighbourhood – done by creating ditches, retention ponds, green roofs and green spaces – has been found to have positive effects on biodiversity, rainwater runoff rates and community cohesion, while lowering unemployment and tenancy turnover rates.

Further, other nature-based solutions, such as urban farming, can improve diets and food security, connect communities and give a potentially important boost to household budgets.

Basing solutions on nature's designs is often effective and frugal, as is the case with urban green spaces. These lower the impact of the ‘urban heat island effect’ – when natural land is replaced by buildings and pavements, which absorb and retain heat (Jandaghian and Berardi, 2019).

This is especially important when we consider that there is a physiological upper limit to humans’ capacity to adapt to rising temperatures (see Figure 1). There are business benefits too: ecosystem-based adaptation to prevent climate-related flooding, for example, can prevent damage to infrastructure, saving private companies and insurers lost revenue.

Figure 1: Wet bulb global temperature

Source: Science for Environment Policy, adapted from Ariel’s checklist.
Note: based on temperature and humidity, assuming a clear sky (maximum solar load) and atmospheric pressure of 1 ATA (760 mm Hg).

But these approaches do not necessarily represent a silver bullet to the environmental challenges we face. Climate mitigation policies can lead to the pursuit of nature-based solutions with low biodiversity value, such as planting non-native monocultures. In China, for example, this practice has led to a drastic reduction in the water table.

Further, not every kind of ‘green’ intervention is sustainable and they can have other unintended effects – even if many are well intentioned. For example, ecological gentrification of city areas can raise property prices, and alter housing opportunities and the commercial infrastructure supporting lower-income communities.

Evidence on the extent of their impact is also limited at present and what is available focuses more on environmental impact than health and social effects (Seddon et al, 2020). It is also skewed in favour of the Global North, while the Global South remains more vulnerable to the effects of climate change (Chausson et al, 2020).

A recent handbook presents a comprehensive framework for more robust evaluation and monitoring to determine their performance, cost effectiveness and the conditions required for effective delivery (Dumitru and Wendling, eds, 2021).

Despite the lack of consistent, accurate data, one comprehensive review found that 59% of nature-based interventions reduced the effects of climate change, including flooding, soil erosion and loss of food production (Chausson et al, 2020). Other work has shown their effectiveness at reducing temperatures in the long term (Girardin et al, 2021).

What do nature-based solutions cost?

The value of the total benefits from nature-based solutions are complicated to calculate and riddled with assumptions. But some initial attempts show that, generally, the value of the benefits would easily exceed the cost, as nature is doing much of the work.

For example, at the global level, the cumulative costs of inaction to address land degradation are high: between 1997 and 2011, the world lost an estimated $6-11 trillion (£5-9 trillion) per year from land degradation. The costs of restoring natural ecosystems, rewarding agriculture that keeps soils healthy, and incentivising greener business models have been estimated to cost far less at $2.7 trillion per year (£2.2 trillion).

The global benefits of restoration have been estimated to exceed the costs by an average margin of ten to one. One example of land restoration on a massive scale is the Great Green Wall project – an African-led solution aiming to grow an 8,000km natural barrier to desertification stretching the entire width of Sahelian Africa. The project will also help to provide food security, jobs and livelihoods for the millions who live along its path.

Evidence suggests that these investments are worth making and prevent further spending down the road (Anderson and Gough, 2022). Analysis from an urban forestry project in Toronto indicates that every dollar spent returns $1.35-3.20 worth of benefits to the city’s residents.

Indeed, the returns from a regenerative restoration economy that reduces greenhouse gas emissions, land degradation, and biodiversity loss are estimated to be worth $125-140 trillion annually – up to one and a half times global GDP of $93 trillion in 2021. Nature-positive business models have also been estimated to create 395 million jobs by 2030.

It is worth emphasising that at any scale, equitable, inclusive governance of nature-based solutions can be expected to lead to fairer distribution of the benefits, leading to better socio-economic outcomes.

It has also been estimated that nature-based solutions also have the potential to deliver over a third of the climate mitigation effort needed until 2030 to keep global warming well below 2°C. Currently, only a tiny proportion of climate funding is invested in these types of interventions.

We know that significant investments are needed to decarbonise the economy and tackle climate change – why not use that money to benefit health, wealth and nature at the same time?

Where can I find out more?

• Nature-based solutions can help cool the planet — if we act now: Analysis on green interventions in Nature.
• Evaluating the impact of nature-based solutions: a handbook for practitioners: a detailed assessment framework from the European Commission.
• Future Brief: the solution is in nature: Report from Science for Environment Policy.

Who are experts on this question?

• Nature-based Solutions Initiative, University of Oxford

Author: Ruth Larbey

Photo by ball141030 from Adobe Stock

The post Is investing in nature a solution to economic and environmental problems? appeared first on Economics Observatory.

After months of resisting pressures to introduce a windfall tax on oil and gas companies, the UK government has reversed course. On Thursday, Chancellor Rishi Sunak announced what he calls a ‘temporary targeted energy profits levy’, as part of a series of measures to address the cost of living crisis.

The new tax will help to fund a £15 billion support package from Westminster, including £650 one-off booster payments for roughly eight million low-income households. The £200 loan scheme for energy bills announced earlier this year has also been scrapped and will be replaced by a £400 grant for all households.

Last week, the Economics Observatory posted an article discussing the economic case for and against such a tax. The piece, by Barry Naisbitt, Urvish Patel and Stephen Millard (National Institute of Economic and Social Research, NIESR), focuses on the lack of a robust evidence base against which to assess a windfall tax on oil and gas companies, largely due to the lack of past examples. Despite this uncertainty, the authors provide useful context for the recent performance of these firms.

Energy companies have benefitted from the rise in global oil and gas prices in the post-Covid-19 recovery period, they argue. These firms have also profited from the sharp spike in energy prices following Russia’s invasion of Ukraine. For example, BP announced underlying profits of $6.2 billion in the first quarter of 2022 (up from $4.1 billion in the final quarter of 2021). Similarly, Shell announced adjusted earnings of $9.1 billion in the first quarter of 2022, up from $6.4 billion in the previous quarter.

With household energy bills increasing, and news this week that they are set to rise by a further £800 in October, this level of profit seems unfair to many, sparking much of the debate on the windfall tax ahead of this week’s announcement.

Beyond the battlefields

Two Observatory pieces this week have provided explainers of why UK energy prices are rising (by Richard Green at Imperial College) and how those increases affect fuel poverty and affordability (by David Deller at the University of East Anglia).

The impact of the war in Ukraine on energy markets and the wider global economy has been discussed further by Helen Thompson (University of Cambridge) in an article on Thursday, and by Corrado Macchiarelli (NIESR) this morning.

Helen argues that the economic and geopolitical impact of Russia’s invasion extends far beyond the initial oil price shock. As the world’s biggest exporter of natural gas, the second largest crude oil exporter and the third most significant coal exporter, Russia is heavily dependent on overseas buyers. In fact, around three-quarters of Russia’s gas exports go to Europe and Turkey, with most of this westward-bound gas arriving via pipelines.

Russia is going to have to find new customers, and fast. To expand its exports to Asia – to compensate for the European market share that it may lose over the next few years due to sanctions – Helen argues that Russia will have to build a second gas pipeline to China and substantially increase its liquified natural gas (LNG) capacity. This will come at an enormous cost to Russia itself and it will reshape the global network of energy supply and the wider market.

Corrado builds on this, exploring how the energy shock and crises of energy supply will affect the wider global macroeconomy. He argues that the main effects of the invasion will not only be higher energy prices, but also weaker confidence in the economy and financial markets.

Both the war and the sanctions imposed on Russia will also have a substantial effect on output, with global GDP likely to fall (see Figure 1 below). This contraction is set to be particularly dramatic in Russia with GDP predicted to fall by at least 10% in 2023.

Figure 1: The GDP cost of the war for the global economy

Source: National Institute Global Econometric Model (NiGEM) simulations

The war will simultaneously harm growth and put upward pressures on inflation, which is already at very high levels in many countries around the world. Whether this sharp contraction in GDP, together with surging energy and other commodity prices, will combine to cause a large global recession will depend on how the next phase of the conflict plays out. How policy-makers and central banks respond over the next few weeks and months matters too.

Communicating data

This week, the Observatory team have been in Glasgow, taking part in the 2022 Economic Statistics Centre of Excellence (ESCoE) conference on economic measurement at the University of Strathclyde. As well as showcasing our Data Hub and presenting the latest editions of ECO magazine, we also ran our first data masterclass. The session focused on how best to communicate economic data visually, and the skills that are needed for cleaning and presenting quantitative stories.

We first laid out our data philosophy in December 2020. In part a response to a disturbing report by colleagues from ESCoE, our approach seeks to push back against two of the report’s headline findings: a shortfall in public understanding of economics; and a lack of trust in data.

Since January 2021, almost all charts posted on our website have been built using embedded data (rather than static pictures). This means that anyone can download the underlying data and code, as well as verify and challenge them (try it with Figure 1 by clicking the dotted icon at the top right-hand side of the graphic). This approach was at the core of our data masterclass, and we hope that participants shared our belief that the fight against misinformation and the lack of trust begins with this transparent and replicable methodology.

Yesterday, the conference closed with a panel discussion co-organised by ESCoE and the Observatory. Sam Beckett (second permanent secretary at the Office for National Statistics, ONS and joint head of the Government Economic Service) chaired the session, which included Johnny Runge (NIESR, and one of the authors of the report on public understanding of economics), Owen Brace (director of communications and digital publishing at the ONS) and Ainslie Johnstone and James Fransham (both data journalists at The Economist).

The panellists covered a wide range of topics relating to communicating economic data –  from improving the way we gather information to the framing of headline metrics. Two shared conclusions, and ones that sit at the heart of our own philosophy, are the importance of balanced, impartial and objective analysis and the need to relate the facts and figures to the real world and the lives of people they affect.

Building trust and improving understanding in economics requires data communication of the highest standard. As the war in Ukraine grinds on, and people around the world continue to struggle under the weight of escalating energy and food prices, effective communication is as important as ever.

Author: Charlie Meyrick

Photo by monkeybusinessimages on iStock

The post Measure for measure appeared first on Economics Observatory.

During the first two weeks of the war, Brent prices – the European oil benchmark – increased by more than 25%. By the end of March, European gas prices were around 580% higher than a year earlier. While they have fallen back since then, this is in part because many European companies have accommodated Russia’s demands to pay for exports to a non-sanctioned Russian bank to facilitate Gazprom (Russia’s majority state-owned energy company) receiving roubles.

In Europe, the continent’s acute foreign energy dependency has proven divisive. At a summit on 10-11 March, the countries of the European Union (EU) collectively agreed to phase out imports of Russian energy. But where immediate sanctions are concerned, national interests and geopolitical judgements prevail.

Five weeks into the war, the Baltic states suspended purchases of Russian gas. By contrast, over the same weekend, politicians in Berlin took to the TV studios to explain the likely systemic consequences for the EU’s industrial powerhouse of reducing energy supplies from Russia. Where oil is concerned, the EU has been discussing a sanctions package for some weeks without being able to reach an agreement.

The war-induced energy shock is far from the only disruptive force around energy coursing through the world economy. There are now three different structural shocks at work, each with geopolitical implications.

The first comes from the disturbance that Russia has inflicted on itself. The country is the world’s biggest exporter of natural gas, the second largest crude oil exporter and the third most significant coal exporter. Around three-quarters of Russia’s gas exports go to Europe and Turkey. Most of this westward-bound gas arrives via pipelines.

To expand imports to Asia to compensate for the European market share that it may lose over the next few years, Russia will have to build a second gas pipeline to China and substantially increase its liquified natural gas (LNG) capacity at Sakhalin 2 on the Okhotsk Sea.

Here, the corporate partners of Gazprom have been both European (the Anglo-Dutch company Shell) and Asian (the Japanese companies Mitsui and Mitsubishi). Shell has announced that it will quit its equity partnerships with the Russian gas behemoth, while Mitsui and Mitsubishi have promised to stay. This means that a parting of ways between Europe and Asia over corporate partnerships with Russian firms is under way.

The second shock is rising gas demand in Asia, especially China. The growth rate of Chinese consumption has accelerated since 2016. In 2021, it surged, as China recovered from the pandemic and accelerated its moves to replace coal with gas in domestic heating. With the country’s LNG imports rising by 19% over just 12 months, China took over from Japan as the world’s largest LNG importer.

Even though Europe’s largest economy, Germany, does not import seaborne gas, EU gas futures rose more than tenfold between March and late December 2021. The price spike that December was so severe that American LNG ships heading for Asia made an about turn towards European ports, pricing Asian countries out of the American spot market for the first time.

With European countries committed, for the medium term, to substituting American and Qatari LNG for pipelined Russian gas, this European-Asian gas competition can only intensify.

The third shock comes from the United States. For the best part of the 2010s, the shale boom supplied the oil that allowed the world economy to avoid an energy-driven slump. At the start of 2020, American output was 13 million barrels per day (bpd). But even when oil demand began to recover from the pandemic shutdown, the shale sector did not.

By the end of 2021, American production stood at only 11.6 million bpd. Burned by the pandemic-induced crash in oil prices in March 2020, investors began demanding that the heavily indebted shale companies practice greater capital discipline and prioritise returns over short-term output.

Meanwhile, the large Bakken field in North Dakota that initially drove the boom appears to be in decline. Without spare domestic capacity, the Biden administration has resorted to asking the Arab members of OPEC Plus (the producer cartel formed by Saudi Arabia and Russia in November 2016) to provide more oil, but the Saudis see little reason to oblige Washington.

The geopolitics of both energy consumption and energy production are now destabilising. These problems will intensify the desire to speed up the move to increase renewable energy output and reduce fossil fuel energy consumption. But the multiple energy shocks are also driving up the manufacturing and supply chain costs around renewable energy.

For the foreseeable future, high fossil fuel energy costs are entrenched in the world economy and will only come down through slower growth and eventually recession.

Where can I find out more?

• The Oxford Institute for Energy Studies.
• Energy Digital.
• Energy Live News.
• Disorder: Hard times in the 21^st century: A new book by Helen Thompson shows how much of the geopolitical turbulence of recent years originated in problems generated by fossil fuel energies.

Who are experts on this question?

• Michal Meidan
• Javier Blas
• Daniel Yergin
• Jonas Nahm
• Helen Thompson

Author: Helen Thompson

Photo by In Stock from iStock

The post What does the war in Ukraine mean for the geopolitics of energy prices? appeared first on Economics Observatory.

From 1 April 2022, the energy price cap increased by £693 or £708 for around 22 million customers in Great Britain. This increase is linked to the rising wholesale gas price, which rose from a monthly average of 46p per therm (a unit of heat) in February 2021 to 188p per therm in February 2022 (see Figure 1). These increases are passed on to consumers, raising household bills.

Figure 1: Average monthly wholesale gas prices for gas received the following day in Great Britain, February 2019 to February 2022

Source: Ofgem

The affordability of energy is often framed in terms of fuel (or energy) poverty. Understanding levels of fuel poverty is one way to consider the effects of these rising prices. But a multitude of fuel poverty indicators have been suggested by researchers. In England, three different official definitions have been used, while Scotland and Wales use their own definitions.

Without appreciating the variety of metrics, simple quotations of fuel poverty rates may provide a misleading sense of precision. Whether headline rates of fuel poverty pick up fluctuations in household energy bills over time depends on the statistical definition used.

How should we frame energy affordability and fuel poverty?

Why might we be concerned about energy affordability? When considering this, two things are worth remembering. First, households are concerned about the services that energy provides – in other words, heat and light – rather than gas or electricity itself. Second, a household’s energy expenditure is part of their overall decisions about how to spend their income on different goods and services.

When energy prices increase, concerns about energy affordability boil down to three possibilities:

• Households reduce the energy services that they consume.
• Higher energy expenditures reduce households’ consumption of other products.
• Consumption of energy services and other products is maintained by households incurring debt and/or drawing down savings.

This also assumes that society can agree on a minimum level of energy services (and other products) that it deems necessary or reasonable. Fuel poverty can therefore be said to be occurring when the minimum level of energy services is deemed unaffordable.

Several observations follow from this framing:

• Energy efficiency can improve energy affordability by increasing the quantity of energy services that can be bought with the same expenditure.
• Income is central to energy affordability – lower incomes make it more challenging to pay for a given level of consumption.
• Both high and low levels of energy expenditure could indicate energy affordability challenges.
• How households choose to adjust their consumption following an energy price shock will depend on their individual preferences for energy services and other products.

These four points explain why measuring fuel poverty and energy affordability is more complex than the presence of official fuel poverty statistics may suggest. Different metrics will be stronger at capturing different elements of these four observations.

What is the long-run assessment of energy affordability?

To gain a first impression of energy affordability over the long run, we can look at average (mean) household expenditure on non-motoring fuels, divided by average (median) equivalised household disposable income in the UK between 1977 and 2019/20 (see Figure 2).

Figure 2: Ratio of mean household energy expenditures over median equivalised disposable income, 1977 to 2019/20

Source: Adapted from Deller, 2022

Figure 2 indicates that the proportion of households’ income devoted to energy was much higher in the late 1970s and early 1980s than it has been since the early 2000s. Even when energy costs were last the focus of media attention (in the early 2010s), the proportion of income devoted to energy was only as high as it was in the early 1990s.

Since heat and light are necessities, the quantity of energy consumed responds by a relatively small amount to changes in price or income, at least in the short run. Economists refer to this as energy being both price inelastic and income inelastic (Labandeira et al, 2017; Zhu et al, 2018).

Specifically, when there is an energy price increase, the percentage fall in the volume of energy consumed will be lower than the percentage increase in price. Similarly, when incomes go up, the percentage increase in the volume of energy consumed will be lower than the percentage increase in income. As a result, a higher share of income devoted to energy is an indicator of worsening energy affordability.

Where might energy affordability be later in 2022?

In 2019/20, the average household expenditure on non-motoring fuels was £1,284. The value of the ratio between expenditure on these fuels and median household income (used in Figure 2) was 4.3%.

But Figure 2 is based on survey data from the Office for National Statistics (ONS), which will only become available for 2022 sometime in the future. To gain a more accurate idea of where energy affordability might be later this year, we can use the Office for Budget Responsibility’s (OBR) nominal GDP forecasts. These data can be used to estimate the median equivalised household income in 2022/23 (currently £32,270), and then plug potential energy expenditures into the ratio.

An obvious energy expenditure figure to use is £1,971 – the new level of the default tariff cap for direct debit consumers set by Ofgem, the regulator for gas and electricity markets in Great Britain. This results in a ratio of 6.1% – the highest since 1988.

One projection for Ofgem’s tariff cap for the winter of 2022/23 indicates that it could reach £2,600 (Cornwall Insight, 2022), implying a ratio of 8.1%. Such a value would be heading towards the peaks of the late 1970s and early 1980s. To surpass the 1985 peak of 9.3% would require average annual energy expenditures in the coming year to exceed £2,997.

The conclusion is that this year’s energy affordability pressures are likely to be the most serious for a generation.

What does Ofgem’s default tariff cap show?

A degree of caution with these projections is necessary. Ofgem’s cap is not the actual amount that households will spend on energy, nor is it directly comparable with the average energy expenditures in Figure 2.

Ofgem’s values are generated by assuming that households consume fixed quantities of electricity and gas, labelled ‘typical domestic consumption values’ (TDCVs). Households consuming different quantities to the TDCVs will have different energy expenditures, and not all households have a mains gas supply.

As the TDCVs are fixed quantities, the quoted figures for Ofgem’s cap do not reflect the fact that households will respond to higher energy prices by reducing their energy consumption to some extent. Only future releases of the Living Costs and Food Survey will allow the time series data in Figure 1 to be extended in a fully comparable fashion.

How have official definitions of fuel poverty varied over time?

That consumption responds to price changes highlights one of the trade-offs when measuring energy affordability and fuel poverty.

Figure 2 is based on households’ actual energy expenditures. For identifying households that cannot afford energy, a concern with using a high ratio of actual energy expenditure to income is that it may fail to pick up households that respond to affordability pressures by limiting their energy expenditure.

To address this issue, the official fuel poverty statistics in England are based on an engineering model that estimates the energy expenditures required to achieve a pre-specified temperature. The trade-offs from this approach are that differences in households’ temperature preferences are ignored and that the estimates are only as valid as the engineering model’s own assumptions. While using required energy expenditures is done for valid reasons, it also implies a potential gap between official fuel poverty statistics and the energy bills that households actually pay.

In England, there have been three official fuel poverty definitions. These changes in definition, as well as the complexity of calculating required energy expenditures, mean that there are no time series data on the official fuel poverty rate comparable to Figure 2.

Table 1 provides the core definitions of the official fuel poverty metrics (for the full definitions of income etc., see bre, 2020 and bre, 2022). Figure 3 charts the official data that are available.

Table 1: Official fuel poverty definitions in England

In Wales, the 10% metric continues to be used, while Scotland is turning to a two-part metric that combines the 10% threshold with the requirement that a fuel-poor household has an income – after housing, fuel and childcare costs – that is below the level needed for an acceptable standard of living.

Figure 3: Official headline rates of 10%, LIHC and LILEE fuel poverty in England (available data)

Source: Combines data from Department for Business, Energy and Industrial Strategy, BEIS, 2021; BEIS, 2022 and BEIS, 2013

Figure 3 shows how the different fuel poverty definitions have a noticeable impact on the percentage of households identified as fuel-poor, as well as the time trend for fuel poverty.

In particular, the rate of low income-high cost (LIHC) fuel poverty shows very little variation over time. This is because it is a ‘relative’ metric – what constitutes high energy costs is measured relative to median energy costs.

A sharp rise in energy prices will lead to a sharp increase not only in energy costs for individual households, but also in median energy costs. As a result, the ability of the headline rate of LIHC fuel poverty to represent fluctuations in energy bills and energy affordability over time is limited.

The 10% fuel poverty metric has a time trend that shows some similarity to the relevant section of Figure 2. This is because it is based on a related ratio and, being a fixed threshold, the number of households exceeding the 10% threshold will increase as energy prices rise.

Low income-low energy efficiency (LILEE) fuel poverty shows a continuously declining trend, which is likely to be related to the average energy efficiency of dwellings increasing over time. Households in homes with a high energy efficiency rating are excluded from LILEE fuel poverty by design.

An important consideration is the extent to which the LILEE fuel poverty rate will rise with the recent increase in energy bills. Higher energy prices will result in more households being captured by the second part of the LILEE definition – that income after the deduction of required fuel costs is below the official poverty line – but this will be tempered if the proportion of energy efficient homes increases over time.

Growing numbers of energy efficient homes is especially likely if some households respond to price increases by installing energy saving technologies. It seems plausible that the increase in LILEE fuel poverty over the coming year will be lower than if fuel poverty were still measured by the 10% metric.

The takeaway: fuel poverty statistics need to be interpreted with caution

The relationship between energy bills and rates of fuel poverty all depends on the indicator being used. Policy-makers basing decisions on the fuel poverty rate need to understand the implications of the definition of the statistic that they are observing.

For example, under the LILEE indicator, someone living in an energy efficient dwelling but struggling to afford energy due to a very low income would not be identified as fuel-poor. They would simply be identified as income-poor. In contrast, using the 10% metric, the same individual could be identified as fuel-poor.

Identifying the best fuel poverty metric is likely to depend on the intended purpose. A 10% metric would be good at identifying changes in energy affordability linked to fluctuating energy prices, as we are seeing at the moment. On the other hand, the LILEE metric is reasonable for tracking the roll-out of energy efficiency upgrades in low-income households.

An alternative approach to assessing fuel poverty would be to measure energy services directly and identify the households that are dissatisfied with the services that they can afford.

For example, if a primary concern is households living in the cold, it would seem desirable to measure the temperatures achieved in homes, as well as households’ temperature preferences (Deller et al, 2021).

While such an approach would require investment in new data and methods, it would directly tie assessments of fuel poverty to households’ views of their lived experience.

Where can I find out more?

• Official English fuel poverty statistics: a comprehensive set of data and reports with lots of detailed breakdowns.
• Energy Economics special issue – Energy poverty: trends and perspectives – the latest economics research on energy (fuel) poverty from a global perspective.
• Fairness in retail energy markets? Evidence from the UK: the final report of a UK Energy Research Centre project combining economic, legal, sociological and political science perspectives.
• Ofgem data portal: a comprehensive set of charts on the functioning of British energy markets.
• National Energy Action: the leading UK charity campaigning on fuel poverty.

Who are experts on this question?

• Catherine Waddams
• Andrew Burlinson
• Stefan Bouzarovski
• Carolyn Snell
• Brenda Boardman
• Benjamin Sovacool
• Harriet Thomson

Author: David Deller

Photo by fiorigianluigi from iStock

The post How will rising UK energy bills affect fuel poverty and affordability? appeared first on Economics Observatory.

How are UK energy prices determined?

The price that we pay for electricity has to cover a range of costs. These include the costs of buying gas and electricity in wholesale markets, getting it to customers through pipes and wires, and a range of government policies that seek to help vulnerable consumers and to reduce carbon emissions.

Prices in the wholesale spot market are for next-day delivery and depend on what is happening now: as a result, they can be very volatile and affected by world events, such as the war in Ukraine. Companies can also buy in a forward market, whereby they are able to lock in prices for future delivery, months or even years ahead.

Most households are covered by price caps set by Ofgem, the industry’s regulator (explained in more detail below). But these caps rose sharply in April. For individual households, the size of their bills and the amount by which these rose depends on how much energy is consumed.

The increase in the price cap means that a household buying the ‘typical’ amount is seeing its bills rise by 54% from £1,277 a year to £1,971. Pre-payment bills are going up by £708, from £1,309 to £2,017 (Ofgem, 2022).

How does Ofgem’s price cap work?

The price cap for consumers on pre-payment meter energy tariffs was introduced in April 2017, followed by the cap on default energy tariffs (including standard variable tariffs) in January 2019. Collectively, these cover around 15 million energy consumers (Ofgem, 2020). The regulator announces the maximum amount that companies can charge in each six-month period, a couple of months before it starts.

While to date, these caps have limited costs for consumers, overall energy costs have gone up. When setting the price caps, the regulator has to predict energy suppliers’ costs, including those of buying energy over the last four months for delivery over the next 12 months.

These forward market prices essentially doubled between the summer months of 2021 used to set the price cap from October 2021 and the recent period used to set April’s new prices. The annual wholesale cost for an average household rose from £528 to £1,077.

Figure 1: Price cap components

Source: Ofgem, 2022

The cost of delivering energy has also gone up. Some gas is burned in compressors, electricity is lost as heat as it travels along the wires and there are balancing costs as power stations adjust output to keep the system stable. All these costs are linked to the price of gas.

In the autumn of 2021, many energy retailers were caught unprepared by these rising costs. Instead of buying energy in advance, they were relying on the short-term spot markets and had to pay much more than Ofgem assumed when it was setting the price cap.

More than 20 companies, with over four million customers, went bust as they did not have enough funds to cover the losses from selling energy for less than it had cost them to buy. (A company that had bought in advance from February to July 2021, the period used by Ofgem to set October’s price cap, would have been able to recover those costs.)

The failing companies included the crowd-funded People’s Energy with 350,000 customers, Pure Planet with 235,000 and Together Energy, part-owned by Warrington Council, with 176,000. Bulb, with 1.7 million customers, also needed a rescue but continued to trade under a special scheme.

The affected customers (including this author) were protected, usually when a stronger company took over their supplies. But someone has to pick up the cost of these loss-making contracts. This has been averaged over everyone covered by the price cap, and has added £68 to the April cap.

Why have wholesale prices risen?

The main driver for rising wholesale prices is the increasing cost of gas.

The UK has been a net importer of gas since 2004, and prices tend to be similar at each end of the pipelines between Bacton in Norfolk, Belgium and the Netherlands. Gas prices have been rising sharply since the middle of 2021, for several reasons.

Figure 2 shows that the European Union (EU) and Norway produced two-fifths of the gas they needed in 2019. They imported a similar amount from Russia and most of the rest came in the form of liquefied natural gas (LNG).

LNG is super-cooled and transported in large ships and as these ships can move around the world, prices in different importing regions tend to converge. Gas demand in Asia has grown faster than the supply of LNG, and lower European imports have helped to balance the market (Fulwood et al, 2022).

Figure 2: Gas supplies to the UK and EU

EU Gas Sources, 2020

UK Gas Sources, 2020

Source: BP World Energy Statistics and Digest of UK Energy Statistics

This was possible because EU gas storage was very full at the start of the winter of 2020-21, and so more gas than normal could be withdrawn over the colder months. It is normal to refill storage during the summer when gas demand is lower, but less gas than usual went into storage in the summer of 2021.

European demand was lower than in the same period in 2019 (2020 is not a good comparator year as the pandemic made energy demand very unusual), but so was local production, and by more, as Europe’s gas fields were gradually depleted.

Imports from Russia were also lower. The main supplier, Gazprom, was meeting its long-term contracts but usually sold large amounts in the short-term markets as well. By the autumn of 2021, it was becoming clear that European gas storage was much lower than normal levels for the time of year. Consequently, prices rose as companies tried to get hold of enough gas for the coming winter.

Were Gazprom’s reduced exports due to technical problems restricting its ability to supply? Was it ‘simple’ anti-competitive behaviour by a large firm attempting to push prices up, accepting fewer sales in the hope of much higher margins on the remainder? Or was it an attempt to pressure the German government into speeding up the final approvals for the Nordstream 2 gas pipeline, which runs directly from Russia to Germany?

The reasons are unclear. In any case, with less gas available, less could be put into storage, particularly by Gazprom (which owns several storage facilities within the EU).

Exports through Nordstream 2 would replace those that have gone through Ukraine, weakening that country, but the German government blocked its approval on 23 February, following Russia’s recognition of two breakaway provinces and subsequent invasion.

The other panel of Figure 2 shows that the UK produces just over the half of the gas we consume.

Imports from Norway represent a third of consumption, but the UK exports about a third of this amount (not necessarily the same molecules) to Ireland and the continent. About a fifth of our gas consumption arrives as LNG, including about 5% of consumption from Russia.

Those imports could very likely be replaced with cargoes from other countries, so the UK’s physical security of supply is hardly at risk, but we would have to pay whatever the market price turned out to be. Several EU countries are in a much more vulnerable position: they don’t have the import facilities to replace Russian supplies, and other gas exporters don’t have enough spare capacity in any case.

Figure 3: Gas spot prices

p/therm

p/kWh

Source: Ofgem and Statistics Netherlands
Note: p/kWh data missing from March 2013 to September 2017

The impact of this on prices can be seen in Figure 3, with a dramatic increase over the last few months.

There is a direct impact on gas bills, of course, and the rise also feeds into electricity prices because of the way that market works. The demand for electricity varies over the day, and between summer and winter. Generation has to match this demand from second to second, with a little help from electricity storage in batteries and pumped storage hydro stations.

In each half-hour, the owners of the most expensive stations needed to meet demand will want a price that is at least high enough to cover their costs of doing so. The owners of stations with lower operating costs won’t want to settle for much less.

Most markets are like this – sellers aim to receive the most that buyers are willing to pay, even if their costs are well below this level. The price in forward markets is based on what participants expect the spot prices to be at the time the power has to be delivered.

Figure 4: Day-ahead energy prices

p/therm

p/kWh

Source: Ofgem

Figure 4 shows that the short-term (day-ahead) gas and electricity prices do tend to move closely together. The scales are chosen to align the cost of the amount of gas that a typical power station needs to burn to generate a unit of electricity with the price received for it.

The gap between the two lines represents the cost of carbon permits – which has been gradually rising over the period – and the generators’ margin to cover their other costs.

What about the generators that don’t burn gas?

In 2021, Great Britain got 37% of its electricity from gas-fired stations, and 42% from low-carbon hydro, solar, wind and nuclear stations. An additional 7% came from burning biomass (mostly wood pellets), just 2% from coal and the rest was imported.

Nuclear stations have low variable costs, but they sell at the normal market prices, giving their owner (EDF) a windfall when they are high. A previous owner, British Energy, nearly went bankrupt in 2003 when electricity wholesale prices were low.

The older wind farms also sell at market prices and receive a subsidy as retailers have to buy ‘renewable obligation certificates’ from them as well. Renewable generators are given these certificates in proportion to their output and sell them to retailers, which have to show that a proportion of the electricity they sell comes from renewable generators.

But the newest wind farms are supported through ‘contracts for differences’, which effectively set a fixed price. Low wholesale prices are topped up, but the generators give money back when market prices are high. In the last three months of 2021, this saved electricity consumers £133 million compared with the price of buying gas-fired power.

Would fracking have helped?

Energy markets in the United States have been dramatically changed by the rise of fracking – a process that involves drilling a well horizontally (so that it passes through a lot of gas- or oil-bearing rock) and injecting high-pressure water to fracture that rock so that the gas and oil can escape.

By 2015, US gas production was 50% higher than ten years earlier, while the price had fallen by two-thirds. It has risen with the energy crisis but is still less than a quarter of levels in the UK.

Cuadrilla tried to frack wells in Lancashire, but in 2019 the government banned further attempts because of (small) earthquakes. Could restarting the process have the dramatic effects seen in the United States?

Unfortunately, it would take a long time to expand production, if it proves feasible at all. The UK’s geology is different from that in the US shale areas, in ways that make it harder to extract the gas. And the impact of extra supplies on UK gas prices won’t be like that seen in the United States, because North America is an island – in gas terms – and the UK isn’t.

The United States didn’t have the facilities to export natural gas, so their prices had to fall until it was cheap enough to burn in power stations instead of coal. This would have been a good thing for the climate, except that the United States then exported the coal.

The UK, on the other hand, is well connected to the European market. We need gas to come in from the continent during winter, which means that our wholesale prices are normally very similar to those in Belgium and beyond.

To have a significant effect on prices across all of Europe would take much more gas than the UK is likely to be able to produce. The best thing we can do in the short term is to insulate our homes more effectively and to service our boilers to make them run as efficiently as possible.

Where can I find out more?

• The EU plan to reduce Russian gas imports by two-thirds by the end of 2022: Practical realities and implications: Report from the Oxford Institute for Energy Studies.
• Default tariff cap level: 1 April 2022 to 30 September 2022: Publication from Ofgem.

Who are experts on this question?

• Richard Green
• Catherine Waddams
• David Newbery
• Dieter Helm
• Michael Pollitt

Author: Richard Green

Photo by Riverheron from iStock

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