Location: Europe

Who Benefitted from the Gasoline Tax Cut in Sweden?

Posted on September 2, 2022 | Policy Brief

20220902 Who Benefitted from the Gasoline Tax Image 01

Against the background of fast rising gasoline and diesel prices in 2022, a number of European countries have reduced fuel tax rates, often in the form of temporary “gas tax holidays”. Sweden reduced its fuel tax rate by 1.81 SEK (€0.17) per litre on May 1st 2022, of which 1.31 SEK is a temporary reduction set to expire at the end of September. When the tax holiday was announced, Finance Minister Mikael Damberg commented “I am pragmatic, for me it is important that we can compensate households” (Davidsson and Nilsson, 2022). However, just one month after implementation, the pump price for gasoline rose to a new high, which gives rise to the question of how much of the tax cut has actually been passed through to the consumers. In this policy brief, we analyse the tax incidence by comparing the gasoline price development in Sweden to that in Denmark, where the fuel tax rate remained unchanged. We find that the tax reduction was fully reflected in consumer prices, with a pass-through rate of around 100 percent. Nevertheless, we argue that spill-over effects pushing up gasoline prices outside of Sweden are likely biasing our estimate. Based on economic theory, we conclude that our estimate of the pass-through rate needs to be corrected downwards, meaning that only a part of the tax cut benefit was passed along to Swedish consumers.

Introduction to Tax Incidence

In standard economic theory, the pass-through rate to consumers from a change in gasoline tax rates is determined by the equation:

20220902 Equation

where p is the tax inclusive price, t is the tax, and η and ε are the price elasticities of supply and demand, respectively. The price elasticities give us the percentage change in quantity when the price changes by one percent. It follows from this equation that the relatively inelastic side of the market bears most of the tax burden from a tax increase – or most of the benefit from a tax reduction. Under normal circumstances, short-run demand for gasoline is highly inelastic in Sweden, with ε close to zero (Gren and Tirkaso, 2020; Dahl, 2012). In contrast, short-run supply is considered relatively elastic due to the competitive nature of the industry. Thus, changes in gasoline tax rates in Sweden are usually passed through fully to the consumers (Andersson, 2019). This implies that consumers bear the entire burden in the case of a tax increase but reap all the benefits in the case of a tax reduction.

Using Denmark as a Counterfactual

The problem is that existing price elasticity estimates – computed using historical price data – do not capture the temporary supply restrictions in the context of the war in Ukraine or the supply and demand shocks from the Covid-19 pandemic. In the lack of reliable estimates of current price elasticities, we revert to analysing the tax incidence using a quasi-experimental and empirical approach. This requires a counterfactual – a comparison unit that captures the evolution of gasoline prices in Sweden had the tax cut never been implemented. Denmark is well suited for this purpose given that it is geographically close, socio-economically comparable, and has similar levels of gasoline tax rates as Sweden. More importantly, Denmark has not made any recent fuel tax rates changes.

Figure 1. Gasoline pump price in 2022

Figure 1. Gasoline pump price in 2022

Source: Gasoline prices in Sweden and Denmark are provided by CirkleK (2022). Daily exchange rates are provided by Riksbanken (2022).

Figure 1 shows that the gasoline price in Sweden and Denmark track each other closely, displaying parallel trends in the time period leading up to the announcement of the tax cut on March 14. This reassures us that Denmark is a credible comparison unit for Sweden. Gasoline prices start diverging in the interim period of around 7 weeks between the announcement and the implementation of the policy. The fact that the gasoline price in Sweden is slightly higher during this period than in Denmark provides some speculative evidence that suppliers in Sweden intentionally raised prices in anticipation of the tax cut, allowing them to capture parts of the benefit. As soon as the tax cut enters into effect, the gasoline price is notably lower in Sweden compared to Denmark, although prices continue to rise until June.

Figure 2. Gap plot of price difference

Figure 2. Gap plot of price difference

Note: The figure plots the difference between the Swedish and Danish gasoline prices from Figure 1.

It can be observed graphically from the gap plot in Figure 2 that most of the tax cut of 1.81 SEK was immediately passed through to Swedish consumers on May 1. Furthermore, there are no obvious signs of the effect wearing off over time; the pass-through rate remains fairly constant over the three months following the tax cut.

In order to obtain estimates of the pass-through rate, we run a simple difference-in-differences regression – comparing the average difference in gasoline price between Sweden and Denmark both before and after the tax cut. The price reduction after the introduction of the tax holiday is estimated at -1.89 SEK per litre compared to the price level before the introduction. This estimate is statistically significant and indicates a pass-through rate slightly above 100 percent. But since the price development in the interim period raises concerns about strategic price setting, it appears more appropriate to use the price level before the announcement as a baseline. By doing that, we find a relative reduction in the Swedish gasoline price of -1.82 SEK per litre, matching the size of the tax cut almost exactly, with a pass-through rate of 101 percent.

The Estimated Pass-through Rate Is Biased

Our finding is in line with recent work on the German counterpart – known as the “Tankrabatt“. On June 1st 2022, the German Government lowered taxes on fuels for a duration of three months, amounting to a total tax relief of around 35 cent for gasoline and 17 cent for diesel, respectively. A number of studies find a full or close to full pass-through rate from the Tankrabatt, with estimates ranging between 85 and 102 percent (Fuest et al., 2022; Dovern et al., 2022; Montag and Schnitzer, 2022). Analogous to our approach, these studies rely on a comparison with a counterfactual unit, either France or a weighted average of Germany’s neighbouring countries.

Yet, by focusing on the pass-through rate at the national level only, we risk not capturing the full tax incidence. The supply of gasoline is more inelastic at the EU level than at the national level. As Sweden cuts the tax on gasoline, the after-tax price falls and this leads to an increase in demand; supply adjusts as more gasoline comes in from neighbouring countries. At the aggregate level however, supply is more constrained, so the tax cut in Sweden results in a marginal increase in gasoline prices across countries in the EU. This marginal increase in prices amplifies as more countries implement their own tax cuts. Indeed, Sweden and Germany are not the only countries to have implemented tax cuts in response to increasing oil prices, but are part of a larger group of countries to have done so, including Belgium, Italy and Poland (Sgaravatti, Tagliapietra, and Zachmann, 2022).

The spill-over effect from the tax cuts onto gasoline prices in “untreated” countries has two important implications for our analysis. First, our estimated pass-through rate to consumers in Sweden is biased upwards. The gasoline price development in Denmark can only act as a credible counterfactual for that in Sweden in the absence of the tax cut provided that it is not affected by the tax cut itself. But this condition is not fulfilled as the tax cuts employed in Sweden and elsewhere can be suspected to have led the gasoline price in Denmark to increase more than it would have otherwise. Estimates of pass-through rates near 100 percent thus appear overstated and consumers likely benefit less from the tax relief in reality. Second, the benefit to consumers in countries that implement gasoline tax cuts comes at the expense of consumers in countries without such measures in place. An analysis of tax incidence at the national level may find that most of the benefit from the tax cut is captured by consumers, whereas an analysis at the EU level as a whole would instead find that a much larger share of the benefit is actually captured by the supply side – in and outside of Sweden. This demonstrates that the national incidence of the tax cut is different from an international one.

The Swedish Tax Cut Benefits Producers and Richer Households

The prevalence of spill-over effects makes it difficult to conduct causal inference analysis and estimate the true effect of transport fuel tax cuts empirically. Still, the previously outlined theoretical framework on tax incidence can help provide valuable insights. As discussed, gasoline demand is much more inelastic than supply in normal times, so we could expect the tax cut to be passed through to consumers at fairly high rates. However, gasoline supply today is likely more inelastic than usual in light of the repercussions from the economic fallout of the Covid-19 pandemic and the Russian invasion of Ukraine: with oil companies unable to ramp up production in the short term because of underinvestment into existing and new fields during the pandemic (Ashraf et al., 2022). In Europe, Russia accounts for more than 20 percent of the oil supply but production in Russia has gone down since the launch of the war in Ukraine. Many European companies had started to engage in self-sanctioning by cutting ties with the Russian energy sector even before the European Council agreed to embargo most oil imports from Russia by the end of the year 2022 (Adolfsen et al., 2022). Furthermore, the refining industry is facing capacity constraints due to shutdowns that took place in the course of the Covid-19 pandemic as well as high prices for gas powering its operations. All of these factors together illustrate why gasoline supply at the EU level has become more inelastic in the past weeks and months. As a consequence, the relative elasticity of gasoline supply and demand is distorted towards benefitting the producers more than usual. Hence, we can infer from economic theory that not all of the benefit from the gasoline tax cut went to Swedish consumers, but that producers in Sweden and abroad captured some of it.

Apart from this, the tax cut does not benefit all households equally. Among the 20 percent of households with the lowest disposable income in Sweden, only about half have a direct expenditure on transport fuel. But among the 20 percent of richest households, around 95 percent have positive transport fuel expenditures (Statistics Sweden, 2020). A cut in transport fuel tax rates therefore disproportionately benefits high-income households in Sweden.

Finally, it is important to keep in mind that the transport fuel tax cuts employed in various countries do not come without a price tag – they represent a cost to the state budget and ultimately its citizens in the form of foregone tax revenues. In the case of Sweden, this amounts to 6.2 billion SEK in 2022, or around $60 per person (Swedish Government, 2022; Ministry of Finance, 2022). A broader evaluation of the welfare effect of the tax cut needs to take into consideration what the tax revenue would have been spent on had the tax cut not been implemented.

Conclusion

In mid-August, a report published by Konjunkturinstitutet (National Institute of Economic Research) stirred up the public debate on the gasoline tax holiday in Sweden. According to their report, considering what they call a notification and a pick-up effect (Konjunkturinstitutet, 2022), only 62 percent of the tax reduction on gasoline was passed on to Swedish consumers. The authors claim that sellers of gasoline exploited their market power through charging higher prices in the weeks leading up to the introduction of the tax reduction – the notification effect – and again shortly after the introduction – the pick-up effect. In this policy brief, we obtain a considerably higher estimate of the pass through rate of around 100 percent. In addition, we only find evidence for a weak notification effect and do not share the view that a pick-up effect has taken place.  Even though our studies have in common that we consider Denmark as a counterfactual, we see several advantages in our empirical methodology that may explain the different results: The data we use for both Sweden and Denmark come from the same gasoline company, which improves the comparability of prices. The time period we study after the tax cut covers three months instead of only one, and our finding is robust to the inclusion of a time trend, whereas the main results in the report by Konjunkturinstitutet (2022) rely heavily on the addition of such variable in their model.

What we would like to emphasise in the present case is that any methodology based on counterfactuals is prone to bias. If you shift the level of analysis from a single country in isolation to the whole of the European Union, it becomes clear that the Swedish gasoline tax cut brings about a marginal increase in gasoline prices outside of Sweden. This is why our estimates are likely biased upwards, revealing a flaw in both this study and the report by Konjunkturinstitutet (2022). In order to pin down the true pass-through rate to a precise number, a more comprehensive analysis is needed, although this may prove difficult. Without reliable empirical results, we should trust economic theory until now. The conclusions we can already draw are the following:

  • Firstly, some of the benefits from the tax reduction is passed through to Swedish consumers but a full pass-through is an overstatement. It is important to note that even if gasoline companies only capture a small percentage of the benefit, this can still amount to large profits in absolute terms.
  • Secondly, the gain from the tax reduction in Sweden produces losses for consumers in countries that have not lowered their tax rates.
  • Thirdly, the policy favours high-income groups as the gains are not distributed equally among consumers within Sweden.
  • Lastly, the corresponding loss in government revenue could potentially reduce welfare where expenditure is cut.

At the bottom line, the above economic reasoning suggests that the pass-through of the gasoline tax reduction to Swedish consumers is limited. And while we arrive at a similar conclusion as the report by Konjunkturinstitutet (2022), we follow a different line of argument. In our view, the reason for the imperfect pass-through to consumers does not necessarily lie exclusively in strategic price setting on the part of gasoline companies, but in the dynamics of the global market.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Hedging EU’s “Winter Risk” by Curbing Gas Demand: Solidarity, Nudge, and Market Solutions

Posted on July 27, 2022 | Policy Brief

20220727 Hedging EU Winter Risk 01

The concern of Russian gas supply disruption and its implications has never been as serious. Experts agree that supply-side measures would not be enough to cover the shortage. Demand cuts are needed. The EC has just proposed a solidarity-based plan of 15% gas demand reduction across the EU Member states. However, getting all EU countries to commit to this plan has been challenging due to asymmetries in their exposure to the Russian gas crisis. As a result, the EU approved a compromise plan with numerous exemptions. This brief argues that market-based solutions may improve participation incentives helping the EU to coordinate decreasing gas demand.  Nudging energy consumers to lower their demand may be an efficient complementary solution. All member states should adopt this latter strategy now, as it takes time to trigger behavior changes in energy consumption. Acting now should strengthen resilience in the coming winter.

Background

Since the beginning of the conflict between Ukraine and Russia, both politicians and analysts have expressed concerns about cuts in Russian gas supply and their implications for the European economy. These concerns have only deepened as the crisis has unfolded. First, Russia stopped gas deliveries to five EU member states in April 2022 following their refusal to pay for gas in rubles. Then, Gazprom cut the capacity of the NordStream pipeline, initially by 40% and then by another 20% in June 2022, claiming technical problems originating from sanctions (i.e., a sanction-driven late return of a gas turbine repaired in Canada).

Gazprom’s July 18th announcement of its inability to deliver contracted gas amounts due to “force majeure” further added to the concern. Meanwhile the EU has dismissed the alleged technical failure stressing political reasons. According to EC President Ursula von der Leyen, the delivery stop reflects a “use of energy as a weapon”.
The panic somewhat settled on July 21, 2022, when Russian gas shipments via Nord Stream resumed at 40% of its original capacity, i.e., the mid-June level. However, Gazprom just announced another cut to 20% of the original capacity from July 27th. Overall, Russian gas exports to the EU are unprecedently low, see Figure 1.

Figure 1. Russian gas exports 2021 vs. 2022

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Source: McWilliams, B., G. Sgaravatti, G. Zachmann (2021) ‘European natural gas imports’, Bruegel Dataset, based on Entsog

Whether Russian gas supplies are likely to be stopped completely in a very close future is unclear. In similar vein, the IEA Executive Director, Dr Fatih Birol, warns that “…it would be unwise to exclude the possibility that Russia could decide to forgo the revenue it gets from exporting gas to Europe in order to gain political leverage”. Regardless of this risk, large-scale adjustments are necessary even under the more optimistic scenario with Russian gas supplies kept at the current level.

The most direct way to tackle the shortage of Russian gas is from the supply side. It can be done via three main channels: diversification of gas suppliers, replacement by alternative fuels, or use of storage. Multiple sources have studied these options extensively (see, e.g., SITE (2022) for an overview of earlier assessments, as well as Di Bella et al. (2022) for more recent estimates and a literature overview). Despite different shortage estimates across reports, experts agree that supply adjustment will not be enough to compensate for ‘the missing Russian gas. This suggests that curbing demand will be a substantial part of gas crisis management.

Most of the demand-linked measures decided by the EU member states have been to counteract the sky-rocking gas prices and subsidize gas consumption by setting a price cap or providing an energy check (see von der Fehr et al. 2022 for an overview). While such measures may protect consumers against increased energy bills in the short run, they foster energy consumption rather than curb it. However, on July 20th, the European Commission issued a plan for the EU nations to cut their gas consumption by 15% between August 2022 and March 2023. This move is part of a wider EU strategy to respond to the gas crisis by pushing for a solidarity mechanism between the member states, including pooling (i.e., sharing) of economic losses. While the targets in this plan would be voluntary, the restrictions could become binding in an emergency. The main demand restrictions would apply to the industrial consumers, but countries are also expected to facilitate households’ demand adjustments. This plan faced resistance from a range of EU Member states, claiming unfairness of 15% cut for their countries, or objecting binding demand cuts for their countries. The resulting compromise agreement, accepted by the EU states on July 26th, incorporated numerous exemptions for both countries and industries.

This brief focuses on the current options in the EU to curb energy demand. We discuss the feasibility of a solidarity mechanism in this context and offer economic mechanisms that may improve its functionality. We also stress the important policy features in incentivizing consumer response.

Solidarity Rule and Market Mechanism

Solidarity and coordination between Member states constitute a crucial part of EU’s response to the current gas crisis. Implementing these rules would limit the direct (gas shortage) and indirect (price-driven) shocks through, e.g., mutual backing-up and buyer power (see, e.g., Le Coq and Paltseva, 2012, 2022 or IEA, 2022).

The solidarity approach was discussed long before the current gas crisis, at least since 2006 (EC, 2006). However, its implementation has proven challenging because of the energy-related asymmetries between Member states in terms of import dependency, diversification of suppliers, energy portfolio, etc. These asymmetries undermine a “one size fits all” policy approach and make some countries consistently benefit more from solidarity mechanisms than others. The solidarity mechanism may also create moral hazard problems (Le Coq and Paltseva, 2008). As a result, the EU could never fully adopt a common energy policy approach.

The recent EU call to cut energy demand by 15% is subject to the same shortcomings. The EU countries are unequally affected by the current gas crisis due to differences in their exposure to Russian gas, access to storage or alternative fuels, gas transportation bottlenecks, etc. These differences undermine countries’ willingness to coordinate as witnessed by Portugal’s and Spain’s explicit opposition to the call on the ground that their energy reduction would be unfair given their energy portfolio with almost no Russian gas. Poland, whose gas storage is full, and Hungary, whose government imposed an export ban on gas earlier in July, have also objected the deal.

There are several ways to improve coordination: one could provide part-taking incentives via a monetary transfer scheme, incorporate demand-side energy cuts into a larger political agenda so that the (asymmetric) losses in one area are compensated by gains in another one (Le Coq and Paltseva, 2008). However, both solutions are likely unfeasible in the current, relatively short-run context, as they require the collection of large volumes of information to determine the correct transfer size. Additionally, the incentives for EU countries to correctly report such details might be low. One can also design a mutual support scheme with country-specific participation requirements/exemptions. This solution, while also informationally demanding, may be easier to achieve. It is likely to improve participation incentives, but the effects of solidarity may be weaker than under a plan without exemptions.

The EU decided to follow this latter route: On July 26th, the EU managed to reach an agreement on a softer plan with multiple exemptions from the 15% cut, accounting for countries’ energy market asymmetries (as well as much more demanding procedure to make the demand cut binding). While this agreement is definitely a step forward, it is currently uncertain whether it would be sufficient to meet the gas demand challenges in the coming winter.

A number of market solutions can potentially improve on the situation. For example, one could establish a market for energy demand reduction quotas in line with the cap-and-trade program designed for CO2 emissions. Alternatively, an emergency gas auction (like the one discussed in Germany for industrial firms) could allow gas savings to be offered in an auction. The winning, cheapest bid would get a market-price level compensation. Of course, such market mechanisms are likely to imply (at least some) consumers will face surging gas prices, but this appears inevitable in view of the difficulties to implement rationing mechanisms to cope with the reduced gas supply.

Market solutions could also be implemented at member state level. However, such an implementation would likely limit solidarity between member states and increase the costs associated with reduced gas consumption. Indeed, purely national solutions (almost by definition) lack solidarity mechanisms between member states and in addition inhibit that the gas reductions take place where they are the least costly.

Nudging and Information Campaign

Given the gas crisis and implementation frictions, the EU should benefit from complementing the regulatory and market solutions (mainly targeting the industry) by incentivizing the demand-cutting behavior of private consumers. There are many ways to trigger behavioral change, from changing legislation to nudging consumers to persuade them to lower their gas (and energy) consumption. Some nudging policies have been successful in the past. One example is Japan’s “setsuden” (electricity-saving) campaign, run after the 2011 Fukushima nuclear plant disaster. It started as an unofficial movement and continued into regulatory restrictions for large firms and voluntary but highly encouraged household targets. The information campaign stressed how close the country was to blackout and successfully prevented blackouts.

In the current crisis the EU states’ policies towards consumers were concentrating on shielding them from high energy prices (see von der Fehr et al, 2022 for an overview). Nudging and energy-saving information campaigns in the EU are yet to gain momentum. Some of the larger EU members are leading the movement. For example, in France, the president called for an immediate “energy sobriety” on the last National Day. Businesses and public buildings were asked to switch off the light at night and anticipate a lower winter heating consumption. While fines for infringement are under discussion, the French government is hoping for a nudging effect. Similarly, Germany has started an intense information campaign to convince individuals to reduce their electricity consumption by taking fewer showers and turning down the air conditioning. However, much broader, intensive energy-saving campaigning is urgently needed to lower energy demand effectively.

Several results from the experimental economic literature motivate such campaigns. The first point concerns the usefulness of nudging in the energy context. The evidence on the effect of incentivizing consumers’ energy saving behavior via monetary or non-monetary interventions is mixed (see Andor and Fels, 2018 and Lingyun Mi et al., 2022 for an overview). However, a recent meta-study combining the results from 112 field trials between 1976 and 2021 (Lingyun Mi et al., 2022) supports the effectiveness of non-monetary incentives (such as nudging by providing information or offering social comparisons) in creating energy-saving behavior. Moreover, it finds that non-monetary incentives are also more effective and longer lasting in promoting energy conservation than the monetary ones. One possible reason for this finding is that non-monetary incentives may affect individual’s values and their intrinsic motivation to save energy. This result implies that information campaigns, target-setting, and providing social comparisons can be an effective and relatively cost-efficient way to lower energy demand.

The second question concerns the timing of such intervention. Again, while there is no clear-cut evidence concerning the long-term impact of nudging, some literature documents effects lasting months and even years after the intervention stopped (Andor and Fels, 2018 overview a few such studies). Further, the same meta-study by Lingyun Mi et al., 2022 found that interventions lasting 1–6 months were the most effective. A combination of antecedent (before actual behavior, such as goal setting) and consequence (when the incentives to act are affected by the results of the action) nudge-based interventions produced the best energy-saving effect. These findings suggest that campaigns should start now to be ready for the winter 2022-23 season.

Last but not least, there is evidence that energy conservation goal-setting is effective only when the goals are realistic. For example, in Harding and Hsiaw (2014), a moderate energy saving goal set by a household led to a sizable consumption reduction, and the effect lasted for one and a half years. With more ambitious goals the initial strong response quickly vanished. Finally, there is no consumption adjustment pattern with unrealistically high goals. One possible, even if somewhat stretched, interpretation of these results could be that a drastic change in consumption may be more challenging to incentivize through nudging than a series of more minor adjustments. This consideration provides another rationale for the early start of nudging policies, suggesting a meager initial consumption reduction, and gradually increasing the threshold.

Conclusion

Cutbacks in gas consumption are essential to surviving the EU energy crisis, especially in case of a complete Russian gas halt. The EC has recently proposed a plan for the EU nations to decrease their gas consumption by 15% between August 2022 and March 2023. This plan is included in a wider solidarity approach to EU energy crisis management. However, approval of this plan by the EU nations faced difficulties due to asymmetries in exposure to Russian gas across EU member states and the resulting unwillingness to share the costs of the crisis. The resulting compromise plan features multiple exemptions from the 15% rule. Market solutions, such as trade in demand reduction quotas, may help to improve EU coordination on demand reduction. Another essential component of crisis management is the EU-wide nudging of private consumers encouraging energy saving behavior. Based on historical examples and the experimental literature such nudge-based policy may be effective and cost-efficient if started now.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

The Energy and Climate Crisis Facing Europe: How to Strike the Right Balance

Posted on May 24, 2022 | Policy Brief

20220524 The Energy and Climate Crisis Image 01

Policymakers in Europe are currently faced with the difficult task of reducing our reliance on Russian oil and gas without worsening the situation for firms and households that are struggling with high energy prices. The two options available are either to substitute fossil fuel imports from Russia with imports from other countries and cut energy tax rates to reduce the impacts on firms and household budgets, or to reduce our reliance on fossil fuels entirely by investing heavily in low-carbon energy production. In this policy brief, we argue that policymakers need to also take the climate crisis into account, and avoid making short-term decisions that risk making the low-carbon transition more challenging. The current energy crisis and the climate crisis cannot be treated as two separate issues, as the decisions made today will impact future energy and climate policies. To exemplify how large-scale energy policy reforms may have long-term consequences, we look at historical examples from France, the UK, and Germany, and the lessons we can learn to help guide us in the current situation.

The war in Ukraine and the subsequent sanctions against Russia have led to a sharp increase in energy prices in the EU since the end of February 2022. This price increase came after a year when global energy prices had already surged. For instance, import prices for energy more than doubled in the EU during 2021 due to an unusually cold winter and hot summer, as well as the global economic recovery following the pandemic and multiple supply chain issues. Figure 1 shows that the price of natural gas traded in the European Union has increased steadily since the summer of 2021, with a strong hike in March 2022 following the beginning of the war.

Figure 1. Evolution of EU gas prices, July 2021-May 2022

Source: https://tradingeconomics.com/commodity/eu-natural-gas

Concerns about energy dependency, towards Russian gas in particular, are now high on national and EU political agendas. An embargo on imports of Russian oil and gas into the EU is currently discussed, but European governments are worried about the effects on domestic energy prices, and the economic impact and social unrest that could follow. Multiple economic analyses argue, however, that the economic effect in the EU of an embargo on Russian oil and gas would be far from catastrophic, with estimated reductions in GDP ranging from 1.2-2.2 percent. But a reduction in the supply of fossil fuels from Russia would need to be compensated with energy from other sources, and possibly supplemented with demand reductions.

In parallel, on April 4th, the Intergovernmental Panel on Climate Change (IPCC) released a new report on climate change. One chapter analyses different energy scenarios, and finds that all scenarios that are compatible with keeping the global temperature increase below 2°C involve a strong decrease in the use of all fossil fuels (Dhakal et al, 2022). This reduction in fossil fuel usage over the coming decades is illustrated in red in Figure 2.

It is thus important that, while EU countries try to decrease their dependency on Russian fossil fuels and cushion the effect of energy-related price increases, they also accelerate the transition to a low-carbon economy. And how they manage to balance these short- and long-run objectives will depend on the energy policy decisions they make. For instance, if policymakers substitute Russian oil and gas with increased coal usage and new import terminals for LNG, this can lead to a “carbon lock in” and make the low-carbon transition more challenging.  In this policy brief, we analyze what lessons can be drawn from past historical events that lead to large-scale structural changes in energy policy. Events that all shaped our current energy systems and conditions for climate policy.

Figure 2. Four energy scenarios compatible with a 2°C temperature increase by 2100.

Source: IPCC sixth assessment report on Mitigation of Climate Change, chapter 3, p23

Structural Changes in Energy Policy in France, the UK, and Germany

We focus on three “energy policy turning points” triggered by three geopolitical, political or environmental crises: the French nuclear plan triggered by the 1973 oil crisis; the UK early closure of coal mines and the subsequent dash for gas in the 1990s, influenced by the election of Margaret Thatcher in 1979; and the German nuclear phase-out triggered by the 2011 Fukushima catastrophe.

In response to the global oil price shock of 1973, France adopted the “Messmer plan”. The aim was to rapidly transition the country away from dependence on imported oil by building enough nuclear capacity to meet all the country’s electricity needs. Two slogans summarised its goals: “all electric, all nuclear”, and “in France, we may not have oil, but we have ideas” (Hecht 2009). The first commissioned plants came online in 1980, and between 1979-1988 the number of reactors in operation in France increased from 16 to 55. As a consequence, the share of nuclear power in the total electricity production rose from 8 to 80 percent, while the share of fossil fuels fell from 65 to 8 percent.

Figure 3. French electricity mix

Source: Data on electricity and heat production in France is provided by the IEA (2022).

In the UK, the election of Margaret Thatcher in 1979 opened the way for large market-based reform of the energy sector. Thatcher’s plan to close dozens of coal pits triggered a year-long coal miners’ strike in 1984-85. The ruling Conservative party eventually won against the miners’ unions and the coal industry was deeply restructured, with a decrease in domestic employment – not without social costs (Aragon et al, 2018) – and an increase in coal imports. At the same time, the electricity market’s liberalization in the 1990s facilitated the development of gas infrastructure. As an indirect and unintended consequence, when climate change became a prominent issue at the global level in the 2000s, there was no strong pro-coal coalition left in the UK (Rentier et al, 2019). Aided by a portfolio of policies making coal-fired electricity more expensive – a carbon tax in particular – the coal phase-out was relatively easy and fast (Wilson and Staffel, 2018, Leroutier 2022): between 2012 and 2020, the share of coal in the electricity production dropped from 40 to 2 percent.

In 2011, the Fukushima nuclear catastrophe in Japan triggered an early and unexpected phase-out of nuclear energy in Germany. The 2011 “Energiewende” (energy transition) mandated a phase-out of nuclear power plants by 2022, while including provisions to reduce the share of fossil fuel from over 80 percent in 2011 to 20 percent in 2050. The share of nuclear energy in the electricity production in Germany was halved in a decade, from 22 percent in 2010 to 11 percent in 2020. At the same time, the share of renewable energy increased from 13 to 36 percent, and that of natural gas from 14 to 17 percent.

In these three examples, climate objectives were never the main driver of the decision. Nevertheless, in the case of France and the UK, the crisis resulted in an energy sector that is arguably more low-carbon than it would have been without the crisis. Although the German nuclear phase-out was accompanied by large subsidies to renewable energies, its effect on the energy transition is ambiguous: some argue that the reduction in nuclear electricity production was primarily offset by an increase in coal-fired production (Jarvis et al, 2022).

The three crises also had different consequences in terms of dependence on fossil fuel imports. The French nuclear plan resulted in an arguably lower energy dependency on imported fossil fuels. The closure of coal mines in the UK had ambiguous effects on energy security, with an increase in coal imports and the use of domestic gas from the North Sea. Finally, Germany’s nuclear phase-out, combined with the objective of phasing out coal, has been associated with an increase in the use of fossil fuels from Russia: gas imports remained stable between 2011 and 2020, but the share coming from Russia increased by 60 percent over the period. In 2020, Russia stood for 66 percent of German gas imports (Source: Eurostat). Which brings us back to the current war in Ukraine.

The Current Crisis is Different

The context in which the current energy crisis is unfolding is different from the three above-mentioned events in two important ways.

First, scientific evidence on the relationship between fossil fuel use, CO2 emissions and climate damages has never been clearer: we know quite precisely where the planet is heading if we do not drastically reduce fossil fuel use in the coming decade. From recent research in economics, we also know that price signals work and that increased prices on fossil fuels result in lower demand and emission reductions (Andersson 2019; Colmer et al. 2020; Leroutier 2022). High fuel prices can also have long-term impacts on consumption patterns: US commuters that came of driving age during the oil prices of the 70s, when gasoline prices were high, still drive less today (Severen and van Benthem, 2022). The other way around, low fossil fuel prices have the potential to lock in energy-intensive production: plants that open when electricity and fossil fuel prices are low have been found to consume more energy throughout their lifetime, regardless of current prices (Hawkins-Pierot and Wagner, 2022).

Second, alternatives to fossil fuels have never been cheaper. It is most obvious in the case of electricity production, where technological progress and economies of scale have led to a sharp decrease in the cost of renewable compared to fossil fuel technologies. As shown in Figure 4, between 2010 and 2020 the cost of producing electricity from solar PV has decreased by 85 percent and that of producing electricity from wind by 68 percent. From being the most expensive technologies in 2010, solar PV and wind are now the cheapest. Given the intermittency of these technologies, managing the transition to renewables requires developing electricity storage technologies. Here too, prices are expected to decrease: total installed costs for battery electricity storage systems could decrease by 50 to 60 percent by 2030 according to the International Renewable Agency.

Finding alternatives to fossil fuels has historically been more challenging in the transport sector. However, recent reductions in battery costs, and an increase in the variety of electric vehicles available to customers, have led to EVs taking market share away from gasoline and diesel-powered cars in Europe and elsewhere. The costs of the battery packs that go into electric vehicles have fallen, on average, by 89 percent in real terms from 2010 to 2021.

Figure 4. Evolution of the Mean Levelised Cost of Energy by Technology in the US

Source: Lazard

Options for Policy-Makers

Faced with a strong increase in fossil fuel prices and an incentive to reduce our reliance on oil and gas from Russia, policy-makers have two options: increase the availability and decrease the price of low-carbon substitutes – by, for example, building more renewable energy capacity and subsidizing electric vehicles – or cut taxes on fossil fuels and increase their supply, both domestically and from other countries.

Governments have pursued both options so far. On the one hand, the Netherlands, the UK, and Italy announced an expansion of wind capacities compared to what was planned, in an attempt to reduce their dependence on Russian gas, and France ended gas heaters subsidies. On the other hand, half of EU member states have cut fuel taxes for a total cost of €9 billion by the end of March 2022, the UK plans to expand oil and gas drilling in the North Sea, and Italy might re-open coal-fired plants.

To guide policymakers faced with the current energy crisis, there are valuable lessons to draw from the experiences of energy policy reform in France, the UK and Germany. France’s push for nuclear energy in the 1970s shows that large-scale structural reform of electricity and heat production is possible and may lead to large drops in CO2 emissions and an economy less dependent on domestic or foreign supplies of fossil fuels. A similar “Messmer plan” could be implemented in the EU today, with the goal of replacing power plants using coal and natural gas with large-scale solar PV parks, wind farms and batteries for storage. Similarly, the German experience shows the potential danger of implementing a policy to alleviate one concern – the risk of nuclear accidents – with the consequence of facing a different concern later on – the dependence on fossil fuel imports.

One additional challenge is that the current energy crisis calls for a short-term response, while investments in low-carbon technologies made today will only deliver in a few years. Short-term energy demand reduction policies can help, on top of long-term energy efficiency measures. For example, a 1°C decrease in the temperature of buildings heated with gas would decrease gas use by 10 billion cubic meters a year in Europe, that is, 7 percent of imports from Russia. Similarly, demand-side policies could reduce oil demand by 6 percent in four months, according to the International Energy Agency.

Ending the reliance on Russian fossil fuels and alleviating energy costs for firms and households is clearly an important objective for policymakers. However, by signing new long-term supply agreements for natural gas and cutting energy taxes, policymakers in the EU may create a carbon lock-in and increase fossil fuel usage by households, thereby making the inevitable low-carbon transition even more difficult. The solutions thus need to take the looming climate crisis into account. For example, any tax relief or increased domestic fossil fuel generation should have a clear time limit; more generally, all policies decided today should be evaluated in terms of their contribution to domestic and European climate objectives. In this way, the current energy crisis is not only a challenge but also a historic opportunity to accelerate the low-carbon transition.

References

  • Andersson, Julius J. 2019. “Carbon Taxes and CO2 Emissions: Sweden as a Case Study.” American Economic Journal: Economic Policy, 11(4): 1-30.
  • Aragón, F. M., Rud, J. P., & Toews, G. 2018. “Resource shocks, employment, and gender: Evidence from the collapse of the UK coal industry.” Labour Economics, 52, 54–67. doi: 10.1016/j.labeco.2018.03.007
  • Colmer, Jonathan, et al. 2020. “Does pricing carbon mitigate climate change? Firm-level evidence from the European Union emissions trading scheme.” Centre for Economic Performance Discussion Paper, No. 1728, November 2020.
  • Dhakal, S., J.C. Minx, F.L. Toth, A. Abdel-Aziz, M.J. Figueroa Meza, K. Hubacek, I.G.C. Jonckheere, Yong-Gun Kim, G.F. Nemet, S. Pachauri, X.C. Tan, T. Wiedmann, 2022: Emissions Trends and Drivers. In IPCC, 2022: Climate Change 2022: Mitigation of Climate Change. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change [P.R. Shukla, J. Skea, R. Slade, A. Al Khourdajie, R. van Diemen, D. McCollum, M. Pathak, S. Some, P. Vyas, R. Fradera, M. Belkacemi, A. Hasija, G. Lisboa, S. Luz, J. Malley, (eds.)]. Cambridge University Press, Cambridge, UK and New York, NY, USA. doi: 10.1017/9781009157926.004
  • IPCC. 2022. Climate Change 2022: Mitigation of Climate Change. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change [P.R. Shukla, J. Skea, R. Slade, A. Al hourdajie, R. van Diemen, D. McCollum, M. Pathak, S. Some, P. Vyas, R. Fradera, M. Belkacemi, A. Hasija, G. Lisboa, S. Luz, J. Malley, (eds.)]. Cambridge University Press, Cambridge, UK and New York, NY, USA. doi: 10.1017/9781009157926
  • Hawkins-Pierot, J & Wagner, K. 2022, “Technology Lock-In and Optimal Carbon Pricing,” Working Paper
  • Hecht, Gabrielle. 2009. The Radiance of France: Nuclear Power and National Identity after World War II. MIT press.
  • Jarvis, S., Deschenes, O., & Jha, A. 2022. “The Private and External Costs of Germany’s Nuclear Phase-Out.” Journal of the European Economic Association, jvac007. doi: 10.1093/jeea/jvac007
  • Leroutier, M. 2022. “Carbon pricing and power sector decarbonization: Evidence from the UK.” Journal of Environmental Economics and Management, 111, 102580. doi: 10.1016/j.jeem.2021.102580
  • Le Coq, C & Paltseva,E. 2022. “What does the Gas Crisis Reveal About European Energy Security?” FREE Policy Brief
  • Rentier, G., Lelieveldt, H., & Kramer, G. J. 2019. “Varieties of coal-fired power phase-out across Europe.” Energy Policy, 132, 620–632. doi: 10.1016/j.enpol.2019.05.042
  • Severen, C., & van Benthem, A. A. (2022). “Formative Experiences and the Price of Gasoline.” American Economic Journal: Applied Economics, 14(2), 256–84. doi: 10.1257/app.20200407 :
  • Wilson, I.A.G., Staffell, I., 2018. “Rapid fuel switching from coal to natural gas through effective carbon pricing.” Nature Energy 3 (5), 365–372.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

#AcademicsStandWithUkraine

Posted on March, 2022 | News

20220301 Ukraine support

The Forum for Research on Eastern Europe and Emerging Economies (FREE Network) stands for peace, security and democracy and condemns Russia’s invasion of the independent and democratic nation of Ukraine and violation of international law.

The FREE Network has an extensive history of building networks and partnerships with leading academic experts on economic issues in Central and Eastern Europe and emerging markets.

The FREE Network invites academics from the region and beyond to express their solidarity with the Ukrainian people, academics, educators, and students suffering from Russia’s invasion into the democratic nation of Ukraine.

To speak out on Russia’s aggression against Ukraine, please use the hashtag #AcademicsStandWithUkraine.

Donations for humanitarian aid are organized by the Kyiv School of Economics, a member of the FREE Network.

20220227 KSE fund raising

From East to West: A Paper Curtain in Swedish Foreign News Coverage?

Posted on February 7, 2022 | Policy Brief

Selective Focus Photography of Magazines representing Media Freedom Eastern Europe

How much a country is talked about in the media can determine its place in the public debate. In this brief, we collect data on the mentions of Eastern and Western European countries in the main Swedish newspapers over the past decades. We find consistently more coverage devoted to Western compared to Eastern Europe in the Swedish press. We investigate several factors that could explain this pattern. We find that while Eastern European countries are on average not more geographically distant from Sweden, Sweden tends to have closer trade links with Western European countries. Sweden is more culturally similar to the average Western European country in terms of language, religion and attitudes, cultural values and social norms. Trade relations and cultural proximity are associated with higher media coverage.

The media plays a vital role in modern societies by keeping the public informed and policymakers accountable. Whether and how events are covered by the news determines their relevance in the public debate. There is ample empirical evidence on the agenda-setting power of the news media. For example, Snyder and Strömberg (2010) show that local press coverage affects how informed US voters are about their representatives and in turn how much their politicians work in the interest of their constituencies. Eisensee and Strömberg (2007) find that news coverage affects how much disaster relief the US sends to foreign countries.

In this brief, we study the amount of news coverage devoted to European countries in the Swedish press. We document a systematic difference between Western and Eastern Europe and explore underlying factors that could be important in explaining this East-West divide.

The East-West Divide

We choose the four most widely read Swedish newspapers (Aftonbladet, Expressen, Dagens Nyheter, and Svenska Dagbladet) and use the newspaper database Retriever Research Media Archive to obtain statistics on the number of mentions of each country between 1995 and 2021. A country mention is an article in which the name of a country appears. Since two or more countries can be named in the same article, the total number of mentions does not correspond to the number of articles. As a percentage of all articles published by the four newspapers in 2021, roughly 20% mention at least one of these countries. While this simple measure of news coverage can be informative, it does not take into account many other aspects of a country’s prominence in the news, such as the length of articles, where articles appear, the tone of coverage, etc.

Figure 1 plots the sum of annual number of mentions by region over time. We see a clear difference in the amount of coverage devoted to Eastern and Western European countries. Over the entire time period, the 21 Western European countries were mentioned on average 2.7 times more than the 22 Eastern European countries.

While there does not appear to be a trend in relative coverage, there is considerable variation from year to year. The year when the relative difference in the number of mentions is smallest is 2014. The two most mentioned Eastern European countries in that year were Russia and Ukraine. Coverage likely increased due to the Crimean Crisis, when Russia invaded and annexed the Crimean Peninsula in Southern Ukraine. The relative difference was also low in 2008, coinciding with the Russo-Georgian war in August. In that year, other newsworthy events, such as the Global Financial Crisis or the UEFA European Football Championship, have a more ambiguous effect on relative media coverage.

Figure 1. Country mentions in Swedish newspapers

Note: Countries included in Eastern Europe: Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Latvia, Lithuania, Moldova, Montenegro, North Macedonia, Poland, Russia, Serbia, Slovakia, Slovenia, Ukraine. Countries included in Western Europe: Andorra, Austria, Belgium, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, Liechtenstein, Luxembourg, Malta, Monaco, Netherlands, Norway, Portugal, San Marino, Spain, Switzerland, United Kingdom.

What Explains This Discrepancy Between East and West?

There are a number of potential reasons why some countries systematically receive more attention in the press. In this section, we correlate the mean annual mentions of each country between 2019 and 2021 with different aspects of that country’s relationship with Sweden.

Distance and Population

Figure 2 shows how news coverage of a country depends on its geographic distance to Sweden and its population size. Overall, the further a country is from Sweden, the less that country is covered in the Swedish press. On average, Eastern European countries (in yellow) are covered less than Western European countries (in blue), for a given distance to Sweden. For example, Poland and Germany are both around 1000km away from Sweden, but Germany is mentioned almost twice as often in the Swedish press. As we measure the distance between the most populous city of each country and Stockholm, some of this difference in coverage is driven by the fact that countries sharing a border with Sweden receive extensive coverage. For instance, Denmark, Finland, and Norway are on average covered more than six times as much as Latvia.

Population also plays a role, that is, larger countries (e.g., Germany, Russia, Spain, and Poland) receive more coverage than smaller countries (e.g., Lithuania, Ireland, and Estonia). As Eastern European countries have on average smaller populations than Western European countries, population can partly explain the East-West difference in news coverage. One counterexample is Russia, which has more than twice as many people as France or the UK, but receives less coverage in the Swedish press.

Figure 2. Geographical distance and population

Note: Geodesic distances are calculated between the latitudes and longitudes of the most populous city of each country and Stockholm. Marker sizes are weighted by population averaged over 2019-2021, and fitted line is unweighted. Source: CEPII’s GeoDist dataset (Mayer and Zignago, 2006) and the World Bank. See Figure 1 for a list of countries included.

Trade and GDP

Figure 3 shows that Sweden’s economic relationship with a country affects how much the country features in Swedish news. We find a strong positive correlation of 0.8 between a country’s total trade volume with Sweden and country mentions in Swedish newspapers. As Sweden’s largest trading partners tend to be in Western Europe, this partly explains the relative coverage of East and West. Another factor is the overall size of a country’s economy (as measured by its GDP). Swedish newspapers more commonly mention countries with higher GDP, and these are more likely to be in Western than Eastern Europe.

 Figure 3. Trade and GDP

Note: Trade data are from 2019. Marker sizes are weighted by national GDP, and fitted line is unweighted. GDP figures are averaged over 2019-2021 and measured in current prices, PPP adjusted, international dollars. Source: The World Bank’s WITS database and the IMF World Economic Outlook, October 2021. See Figure 1 for a list of included countries.

Culture

There is a large literature documenting the link between cultural factors and the economic relationship between nations. For instance, studies show that similarities in ancestry, language, religion, norms and values can influence bilateral trade (Melitz, 2008; Guiso et al., 2009) and the diffusion of technology (Spolaore et al., 2009). In this section, we show how the amount of press coverage correlates with differences in language, religion, and values and norms using cultural distance data from Spolaore and Wacziarg (2016).

Figure 4.a shows that Swedish newspapers are more prone to cover countries whose languages are similar to Swedish. The language similarity measure originally developed by Fearon (2003) is based on the prevalence of languages within a country and distance between languages. The distance measure is calculated using linguistic trees provided in Ethnologue. It ranges from 0 (close) to 1 (distant) and reflects the expected number of common linguistic nodes between two randomly chosen individuals from each country and takes into account that countries can be linguistically heterogeneous (for more details, see Fearon 2003). Norway and Denmark are linguistically closest to Sweden, however, these are also two neighboring countries with which Sweden conducts extensive trade. On average, Eastern European countries are more linguistically distant from Sweden, although some Western European countries (such as France and Spain) are as linguistically distant from Sweden as many of the Eastern European countries and receive considerably more press coverage.

The religious distance measure by Spolaore and Wacziarg (2016) is calculated analogously to the linguistic distance measurement. It is based on the prevalence of different religions within a country and the distance between religions. Figure 4.b shows that countries that are religiously different from Sweden receive less coverage in the Swedish media. With the exception of the three Scandinavian countries, Eastern and Western European countries have similar levels of religious distance to Sweden. Based solely on this metric, the Swedish press mentions Eastern European countries less (and Western European countries more) than their religious distance to Sweden would predict.

Figure 4.c shows an index of a country’s cultural proximity to Sweden, that is, its distance in terms of cultural values, attitudes and norms based on average responses to the World Value Surveys from 1981 to 2010 (see Spolaore and Wacziarg, 2016). This cultural proximity index aggregates the Euclidian distances in survey responses between each country and Sweden. The index is standardized so that 0 shows the average country’s cultural distance to Sweden and negative (positive) values indicate above (below) average cultural similarity. Western European countries are significantly closer to Sweden than Eastern European countries based on this measure. As Swedish press coverage is on average declining in a country’s cultural distance to Sweden, this difference in country’s values and attitudes can explain some of the East-West difference in media coverage.

 Figure 4. Cultural distance

Panel a. Linguistic distance

Note: We use the indicator of tree-based weighted linguistic distance from Spolaore and Wacziarg (2016) and originally developed in Fearon (2003). This measure is an estimate of the expected or weighted number of common linguistic nodes between two randomly chosen individuals from each country. The data on language prevalence is compiled from a number of different sources and assembled in Fearon (2003). Countries included in Eastern Europe: Albania, Armenia, Azerbaijan, Belarus, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Latvia, Lithuania, Moldova, Poland, Russia, Slovakia, Slovenia, Ukraine. Countries included in Western Europe: Austria, Belgium, Denmark, Finland, France, Germany (average between East and West Germany), Ireland, Italy, Netherlands, Norway, Portugal, Spain, Switzerland, United Kingdom

Panel b. Religious distance

Note: We use the tree-based weighted religious distance from Spolaore and Wacziarg (2016). This measure is an estimate of the expected distance between the religions of two randomly chosen individuals from each country. See Figure 4.a for a list of included countries.

 Panel c. Distance in cultural values, attitudes, and norms

Note: We use the distance in cultural norms and values from Spolaore and Wacziarg (2016).  This measure is based on all value-related questions from the World Values Survey Integrated Questionnaire from 1981–2010. The mean distance across countries is standardized to zero. See Figure 4.a for a list of countries included.

Conclusion

As the public and policymakers primarily receive information from the mass media, news coverage can have profound effects on public debate and policy decisions. Using data on the content of the four most widely read Swedish newspapers over the past decades, we measure how much the Swedish press covers Eastern and Western European countries. We find that over the past 25 years, there have been 2.7 times more mentions of Western than Eastern European countries. We find that the Swedish press is more likely to mention countries that are geographically closer, more populous, have a larger GDP and more trade with Sweden. Cultural proximity (as measured by language, religion and values, attitudes and social norms) also correlates with higher coverage. These factors are of course not independent from each other. For instance, the other Scandinavian countries with whom Sweden shares a border and a history, are culturally similar to Sweden and some of Sweden’s most important trading partners. They are also some of the countries that are most covered by the Swedish press. Some of these factors, such as sharing similar values, appear to explain the gap in coverage between East and West, while others, such as geographic distance, do not. More recently, concerns over energy security in the EU (see e.g., Le Coq and Paltseva, 2022) and the rise in military tension between Russia and Ukraine illustrate how developments in Eastern Europe can directly affect life here in Sweden. Perhaps it is time for Sweden to pay more attention to her eastern neighbours?

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Vaccination Progress and the Opening Up of Economies

Posted on July 5, 2021 | Policy Brief

20210622 Reopening Soon Webinar Image 01

In this brief, we report on the FREE network webinar on the state of vaccinations and the challenges ahead for opening up economies while containing the pandemic, held on June 22, 2021. The current state of the pandemic in each respective country was presented, suggesting that infection rates have gone down quite substantially recently in all countries of the network, except in Russia which is currently facing a surge in infections driven by the delta-version of the virus. Vaccination progress is very uneven, limited by lacking access to vaccines (primarily Ukraine and Georgia) and vaccine scepticism among the population (primarily in Russia and Belarus but for certain groups also in Latvia, Poland and to some extent Sweden). This also creates challenges for governments eager to open their societies to benefit their economies and ease the social consequences of the restrictions on mobility and social gatherings. Finally, the medium to long term consequences for labour markets reveal challenges but also potential opportunities through wider availability of work–from-home policies. 

Background

In many countries in Europe, citizens and governments are starting to see an end to the most intense impact of the Covid-19 pandemic on their societies. Infection and death rates are coming down and governments are starting to put in place policies for a gradual opening up of societies, as reflected in the Covid-19 stringency index developed by Oxford University. These developments are partially seasonal, but also largely a function of the progress of vaccination programs reaching an increasing share of the adult population. These developments, though, are taking place to different degrees and at different pace across countries.  This is very evident at a global level, but also within Europe and among the countries represented in the FREE network. This has implications for the development within Europe as a whole, but also for the persistent inequalities we see across countries.   

Short overview of the current situation

The current epidemiological situation in Latvia, Sweden, Ukraine, and Georgia looks pretty similar in terms of Covid-19 cases and deaths but when it comes to the vaccination status there is substantial variation.

Latvia experienced a somewhat weaker third wave in the spring of 2021 after being hit badly in the second wave during the fall and winter of 2020 (see Figure 1). The Latvian government started vaccinating at the beginning of 2021, and by early June, 26% of the Latvian population had been fully vaccinated.

Sweden, that chose a somewhat controversial strategy to the pandemic built on individual responsibility, had reached almost 15 thousand Covid-19 deaths by the end of June of 2021, the second highest among the FREE network member countries relative to population size. The spread of the pandemic has slowed down substantially, though, during the early summer, and the percentage of fully vaccinated is about to reach 30% of the population.

Figure 1. Cumulative Covid-19 deaths 

Source: Aggregated data sources from the COVID-19 Data Repository by the Center for Systems Science and Engineering (CSSE) at Johns Hopkins University, compiled by Our World in Data.

Following a severe second wave, the number of infected in Ukraine started to go down in the winter of 2020, with the total deaths settling at about 27 thousand in the month of February. Then the third wave hit in the spring, but the number of new daily cases has decreased again and is currently three times lower than at the beginning of the lastwave. However, a large part of the reduction is likely not thanks to successful epidemiological policies but rather due to low detection rates and seasonal variation. 

In June 2021, Georgia faces a similar situation as Ukraine and Latvia, with the number of cumulative Covid-19 deaths per million inhabitants reaching around 1300 (in total 2500 people) following a rather detrimental spring 2021 wave. At the moment, both Georgia and Ukraine have very low vaccination coverage relative to other countries in the region(see Figure 5).

In contrast to the above countries, Russia started vaccinating early. Unfortunately, the country is now experiencing an increase in the number of cases (as can be seen in Figure 2), contrary to most other countries in the region. This negative development is likely due to the fact that the new Covid-19 delta variant is spreading in the country, particularly in Moscow and St. Petersburg. Despite the early start to vaccinations, though, the total number of vaccinated people remains low, only reaching 10.5% of the population.

Figure 2. New Covid-19 cases

Source: Aggregated data sources from the COVID-19 Data Repository by the Center for Systems Science and Engineering (CSSE) at Johns Hopkins University, compiled by Our World in Data.

In some ways similar to Sweden, the government of Belarus did not impose any formal restrictions on individuals’ mobility. According to the official statistics, in the month of June, the rise in the cumulative number of covid-19 deaths and new daily infections has declined rapidly and reached about 400 deceased and 800 infections per one million inhabitants, respectively. Vaccination goes slowly, and by now, around 8% of the population has gotten the first dose and 5% have received the second.

There were two major waves in Poland during the autumn 2020 and spring 2021. In the latter period, the country experienced a vast number of deaths.  As can be seen in Figure 3, the excess mortality P-score – the percentage difference between the weekly number of deaths in 2020-2021 and the average number of deaths over the years 2015-2019 – peaked in November 2020, reaching approximately 115%. The excess deaths numbers in Poland were also the highest among the FREE Network countries in the Spring of 2021, culminating at about 70% higher compared to the baseline. By mid-June, the number of deaths and cases have steeply declined and 36% of the country’s population is fully vaccinated.

Figure 3. Excess deaths

Turning to the economy, after a devastating year, almost all countries are expected to bounce back by the end of 2021 according to the IMF (see Figure 4). Much of these predictions build on the expectations that governments across the region will lift Covid-19 restrictions. These forecasts may not be unrealistic for the countries where vaccinations have come relatively far and restrictions have started to ease. However, for countries where vaccination rates remain low and new variations of the virus is spreading, the downside risk is still very present, and forecasts contain much uncertainty.

 Figure 4. GDP-growth

Vaccination challenges

Since immunization plays such a central role in re-opening the economy and society going back to normal, issues related to vaccinations were an important and recurring topic at the event. The variation in progress and speed is substantial across the countries, though.

Ukraine and Georgia are still facing big challenges with vaccine availability and have fully vaccinated only 1.3% and 2.3% of the population by the end of June, respectively. Vaccination rates have in the recent month started to pick up, but both countries face an uphill battle before reaching levels close to the more successful countries.

Figure 5. Percent fully vaccinated

Other countries a bit further ahead in the vaccine race are still facing difficulties in increasing the vaccination coverage, though not so much due to lack of availability but instead because of vaccine skepticism. In Belarus, a country that initially had bottleneck issues similar to Ukraine and Georgia, all citizens have the opportunity to get vaccinated. However, Lev Lvovskiy, Senior Research Fellow at BEROC in Belarus, argued that vaccination rates are still low largely because many Belarusians feel reluctant towards the vaccine at offer (Sputnik V).

This vaccination scepticism turns out to be a common theme in many countries. According to different survey results presented by the participants at the webinar, the percentage of people willing or planning to get vaccinated is 30% in Belarus and 44% in Russia. In Latvia, this number also varies significantly across different groups as vaccination rates are significantly lower among older age cohorts and in regions with a higher share of Russian-speaking residents, according to Sergejs Gubins, Research Fellow at BICEPS in Latvia.

Webinar participants discussed potential solutions to these issues. First, there seemed to be consensus that offering people the opportunity to choose which vaccine they get will likely be effective in increasing the uptake rate. Second, governments need to improve their communication regarding the benefits of vaccinations to the public. Several countries in the region, such as Poland and Belarus, have had statements made by officials that deviate from one another, potentially harming the government’s credibility with regards to vaccine recommendations. In Belarus, there have even been government sponsored disinformation campaigns against particular vaccines. In Latvia, the main problem is rather the need to reach and convince groups who are generally more reluctant to get vaccinated. Iurii Ganychenko, Senior Researcher at KSE in Ukraine, exemplified how Ukraine has attempted to overcome this problem by launching campaigns specifically designed to persuade certain age cohorts to get vaccinated. Natalya Volchkova, Director of CEFIR at NES in Russia, argued that new, more modern channels of information, such as professional influencers, need to be explored and that the current model of information delivery is not working.

Giorgi Papava, Lead Economist at ISET PI in Georgia, suggested that researchers can contribute to solving vaccine uptake issues by studying incentive mechanisms such as monetary rewards for those taking the vaccine, for instance in the form of lottery tickets. 

Labour markets looking forward

Participants at the webinar also discussed how the pandemic has affected labour markets and whether its consequences will bring about any long-term changes.

Regarding unemployment statistics, Michal Myck, the Director of CenEA in Poland, made the important point that some of the relatively low unemployment numbers that we have seen in the region during this pandemic are misleading. This is because the traditional definition of being unemployed implies that an individual is actively searching for work, and lockdowns and other mobility restrictions have limited this possibility. Official data on unemployment thus underestimates the drop in employment that has happened, as those losing their jobs in many cases have left the labour market altogether. We thus need to see how labor markets will develop in the next couple of months as economies open up to give a more precise verdict.

Jesper Roine, Professor at SITE in Sweden, stressed that unemployment will be the biggest challenge for Sweden since its economy depends on high labor force participation and high employment rates. He explained that the pandemic and economic crisis has disproportionately affected the labor market status of certain groups. Foreign-born and young people, two groups with relatively high unemployment rates already prior to the pandemic, have become unemployed to an even greater extent. Many are worried that these groups will face issues with re-entering the labour market as in particular long-term unemployment has increased. At the same time, there have been more positive discussions about structural changes to the labour market following the pandemic. Particularly how more employers will allow for distance work, a step already confirmed by several large Swedish firms for instance.

In Russia, a country with a labour market that allowed for very little distance work before the pandemic, similar discussions are now taking place. Natalya Volchkova reported that, in Russia, the number of vacancies which assumed distance-work increased by 10% each month starting from last year, according to one of Russia’s leading job-search platforms HeadHunter. These developments could be particularly beneficial for the regional development in Russia, as firms in more remote regions can hire workers living in other parts of the country.

Concluding Remarks

It has been over a year since the Covid-19 virus was declared a pandemic by the World Health Organization. This webinar highlighted that, though vaccination campaigns in principle have been rolled out across the region, their reach varies greatly, and countries are facing different challenges of re-opening and recovering from the pandemic recession. Ukraine and Georgia have gotten a very slow start to their vaccination effort due to a combination of lack of access to vaccines and vaccine skepticism. Countries like Belarus and Latvia have had better access to vaccines but are suffering from widespread vaccine skepticism, in particular in some segments of the population and to certain vaccines. Russia, which is also dealing with a broad reluctance towards vaccines, is on top of that dealing with a surge in infections caused by the delta-version of the virus.

IMF Economic Outlook suggests that most economies in the region are expected to bounce back in their GDP growth in 2021. While this positive prognosis is encouraging, the webinar reminded us that there is a great deal of uncertainty remaining not only from an epidemiological perspective but also in terms of the medium to long-term economic consequences of the pandemic.

Participants

  • Iurii Ganychenko, Senior Researcher at Kyiv School of Economics (KSE/Ukraine)
  • Sergejs Gubins, Research Fellow at the Baltic International Centre for Economic Policy Studies (BICEPS/ Latvia)
  • Natalya Volchkova, Director of the Centre for Economic and Financial Research at New Economic School (CEFIR at NES/ Russia)
  • Giorgi Papava, Lead Economist at the ISET Policy Institute (ISET PI/ Georgia)
  • Lev Lvovskiy, Senior Research Fellow at the Belarusian Economic Research and Outreach Center (BEROC/ Belarus)
  • Jesper Roine, Professor at the Stockholm Institute of Transition Economics (SITE / Sweden)
  • Michal Myck, Director of the Centre for Economic Analysis (CenEA / Poland)
  • Anders Olofsgård, Deputy Director of SITE and Associate Professor at the Stockholm School of Economics (SITE / Sweden)

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Green Concerns and Salience of Environmental Issues in Eastern Europe

Posted on June 7, 2021 | Policy Brief

Flooded street in Germany representing climate change risk perceptions

Changes in individual behavior are an essential component of the planet’s effort to reduce carbon emissions. But such changes would not be possible without individuals acknowledging the threat of anthropogenic climate change. This brief discusses the climate change risk perceptions across Europe. We show that people in Eastern Europe are, on average, less concerned about climate change than those in Western Europe. Using detailed survey data, we find evidence that the personal experience of extreme weather events is a key driver of green concern, and even more so in the non-EU Eastern part of Europe. We argue that this association might be explained by the relatively low quality and informativeness of public messages concerning global warming in this part of Europe. If information is scarce or perceived as biased, personal experience will resonate more.

Introduction

Climate change is one of the main threats to humanity. Tackling it entails a combined effort from all parts of society, from regulatory changes and industries adopting new greener business models to consumers adjusting their behavior. While an individual’s contribution to climate change may appear insignificant, research shows that the aggregate effect of mobilizing already known changes in consumer behavior may allow the European Union (EU) to reduce its carbon footprint by about 25% (Moran et al., 2020).

However, the first step for people to adjust their consumption patterns is to acknowledge the threat of anthropogenic climate change. Public ignorance about climate change’s impacts remains high across the world. Furthermore, citizens of more polluting countries are often relatively less concerned about climate change. This lack of awareness is not well-understood, in part due to the multi-dimensional local factors affecting it (Farrell et al., 2019).

This brief discusses the potential drivers of climate risk perceptions, focusing on the differences between Western Europe, Eastern European states that are part of the EU, and non-EU Eastern European countries. We first present the climate change concerns across these regions. We then discuss to which extent the country’s pollution exposure measures and individuals’ socio-economic characteristics can explain these differences. We show that the personal experience of extreme weather events is a key driver of green concern, and even more so in the non-EU part of Eastern Europe. We relate this result to the relatively low salience and informativeness of public messages concerning climate in this part of Europe and discuss potential policy implications.

Green Concerns and Pollution Exposure Across Europe

Figure 1 compares, across Europe, the share of poll respondents who see climate change as a major threat, based on the data from the Lloyd’s Register Foundation World Risk Poll 2020.  While there is a significant variation in climate risk perception within each region, respondents in Eastern Europe are, on average, less concerned about climate change than those in Western Europe. We observe a similar pattern between the EU and non-EU parts of Eastern Europe. 

Exposure to pollution does not seem to clearly explain these differences. Moreover, the patterns of correlation between climate concern and pollution differ across regions and measures of pollution exposure. The left panel of Figure 2 presents averages across the regions for two pollution measures: carbon emissions (which is, perhaps, reflecting climate threat in general) and air quality (which is more directly associated with health risks). We can see that CO2 emissions are the highest in the non-EU part of Eastern Europe, the least environmentally concerned region. Still, the EU part of Eastern Europe has the lowest average emissions per capita across the three regions (this ranking likely results from the interaction between reliance on fossil fuels, industrial structure, and level of development across the three regions). At the same time, when it comes to the average air quality (measured as the percentage of population exposed to at least 10 micrograms of PM2.5/m3), the non-EU EasternEuropean region is doing better than its EU counterpart, which is more climate concerned. Here, better average air quality in the non-EU Eastern European region is due to its relatively low population density, and consequently, low PM2.5 exposure in large parts of Russia. (See, more on the air quality gap within the EU in Lehne, 2021).

Figure 1: Climate concerns in Eastern and Western Europe

Source: Authors’ calculations based on Lloyd’s Register Foundation World Risk Poll 2020, question 5 “Do you think that climate change is a very serious threat, a somewhat serious threat, or not a threat at all to the people in this country in the next 20 years?”. Averages are calculated with population-representative weights.

The right panel of Figure 2 shows correlations between (country-level) climate concerns and pollution. For CO2, the correlation is negative in all three regions, suggesting that, within each region, more emitting countries are less concerned. This negative correlation, however, is the strongest in the EU-part of Eastern Europe and almost absent in the non-EU part. The differences between the regions are even more striking for the correlation between climate concerns and air quality: both in Western Europe and in the EU part of Eastern Europe, citizens of countries with worse air quality are more concerned about climate change. However, in non-EU Eastern Europe, the relation is the exact opposite: lower concerns about climate change go hand-in-hand with worse quality of air.

Figure 2: Emissions vs. Climate concerns in Eastern and Western Europe, 2018

Source: Authors’ calculations based on www.climatewatchdata.org, OECD and World Risk Poll 2020. The climate concern variable is a country-level weighted average of answers “Very high risk” to the World Risk Poll 2020 question 5, see note to Figure 1.

Green Concerns and Socio-economic Characteristics

Lower climate concerns in EU-part of the Eastern bloc have been documented before; they are often explained by the Eastern-European economies’ high reliance on coal and other fossil fuels, low-income levels, and other immediate problems that lower the priority of climate issues (e.g., Lorenzoni and Pidgeon 2006, Poortinga et al., 2018, or Marquart-Pyatt et al., 2019). Additionally, the literature suggests that climate beliefs are linked to individuals’ socio-economic characteristics, such as level of education, income, or gender (see, e.g., Poortinga, 2019), which may be different across the regions.

However, the regional differences in climate beliefs also persist when we use individual-level data and control for respondents’ individual characteristics, as well as for country-level variables, such as GDP per capita, oil, gas, and coal dependence of the economies, and exposure to emissions (at the country level, as our individual data does not have this information). This is illustrated in Column 1 of Table 1.

Table 1: Climate change beliefs determinants, individual-level cross-section data.

Source: This is an outcome of logistic regression. Experience =1 if the respondent answered “yes” to the World Risk Poll 2020 question L8D “Have you or someone you personally know, experienced serious harm from severe weather events, such as floods or violent storms in the past TWO years?” Media Freedom is based on 2018 Freedom House data, and scores media between 0 (worst) and 4 (best). Controls include age, gender, education, personal feelings about household income, income quantile, urban/rural, size of household, number of children under 15, las well as log of GDP per capita, log of CO2 per capita, mean exposure to PM2.5, and oil, gas and coal rents as a share of GDP. Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1

In what follows, we explore another key driver, the personal experience of extreme weather events. While there is a sizable literature on the effect of experience on climate beliefs, that factor was never, to our knowledge, considered to understand the difference in climate risk perception between the EU- and non-EU parts of Eastern Europe.  

Green Concern and Salience of Environmental Issues

In line with the recent climate risk perceptions literature (e.g., Van der Linden, 2015), we show that personal experience increases the likelihood of considering climate change as a major threat across all three regions (see column 2 in Table 1). The association is stronger in the EU part of Eastern Europe and even more so in the non-EU part (even if the difference between the last two is not statistically significant). This finding is confirmed when we control for (observable and unobservable) country-specific effects, such as social norms, via the inclusion of country-level fixed effects. In this case, extreme weather events make respondents more climate-conscious within each country (Column 3 of Table 1). In this specification, the effect differs statistically between the two groups of Eastern-European countries, even if only at a 10% significance level. To put it differently, the impact of personal experience with extreme weather events seems to close a sizable part of the gap in climate risk perceptions across the regions and more so in the non-EU part of Eastern Europe.

Our preferred explanation for this finding is that personal experience resonates with the quality and informativeness of public messages concerning global warming. If information is scarce or perceived as biased, personal experience will resonate more. The low political salience of environmental issues in Eastern Europe, inherited from its Soviet past (McCright, 2015), and lower media quality in Eastern Europe (see e.g., Zuang, 2021) are likely to affect the quality of public discourse concerning the risks of climate change, and, consequently, the information available to individuals.

The climate-related legislative effort across Eastern Europe reflects the low political importance of climate change in the region. According to the data from Grantham Research Institute on Climate Change and the Environment, non-EU transition countries, on average, have adopted 8 climate-related laws and policies, while the corresponding figure is 11.5 for EU transition countries and 18 for the countries in Western Europe. Further, Figure 3 shows a positive correlation between climate change concerns and the number of climate-related laws for Western Europe and the EU-part of Eastern Europe but a negative one for the non-EU part of Eastern Europe and Caucasus countries. One possible interpretation of these differences is that climate change is relatively low on the political agenda of (populist) regimes in the non-EU part of Eastern Europe, as climate-related legislative activity (proxied by, admittedly rough, a measure of the number of laws) does not reflect the intensity of population climate preferences.

Figure 3: Climate concern vs. Climate legislation

Source: Authors’ calculations based on climate legislation data from Grantham Research Institute on Climate Change and the Environment, and World Risk Poll 2020

Regarding the influence of media quality, column (4) of Table 1 shows that the effect of personal experience on climate change concern is negatively correlated with media freedom. One interpretation could be that individuals in countries with freer media infer less from their extreme weather experience because more accurate media coverage about climate risks improves the population’s knowledge on the issue.

Of course, the causality of the climate belief-experience relationship could also go in the other direction – people who are more concerned about climate change could be more likely to interpret their personal experience as weather-related extreme events. It is impossible to distinguish with the data at hand. However, Myers et al. (2013) show that both channels are present in the US, and the former channel dominates for the people less engaged in the climate issue. Stretching this finding to the Eastern Europe case, we argue that more precise information on the importance of climate change may partially have the same effect as experience – i.e., it will increase people’s awareness and concern about the consequences of global warming.

Conclusion

This brief addresses the differences in climate change beliefs between Eastern and Western Europe, as well as within Eastern Europe. It discusses the determinants of these differences and stresses the importance of personal experience, especially in the non-EU part of Eastern Europe. It relates this finding to the relatively low accuracy of information and quality of public discourse about climate change in the region.

We know already that tackling climate change requires reliable and accurate sources of information. This is especially crucial given what we outline in this brief. This issue resonates with the current social science analysis of the diffusion of climate change denial (see e.g., Farell et al., 2019, on the significant organized effort in spreading misinformation about climate change). Such contrarian information that relays uncertainty and doubt regarding the severity of the global climate change threat could have a severe impact, especially in situations with low political salience of climate change, like in non-EU Eastern Europe. A significant effort of both governments and civil society is needed to provide adequate information and mobilize the population in our common fight against climate change.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Jurisdictional Competition for FDI in Developing and Developed Countries

Posted on May 31, 2021 | Policy Brief

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This brief is based on research studying jurisdictional competition between countries and its influence on the inflow of foreign direct investments (FDI). The study compares jurisdictional competition among the developing Central and Eastern European (CEE) countries with competition among developed EU countries. As instruments of jurisdictional competition for FDI, we consider governments’ efforts to improve the rule of law, corporate governance, and tax policies. The results suggest the presence of proactive jurisdictional competition via the quality of corporate governance regulation both in the CEE and the EU countries. The CEE states also attract FDI by competing in tax policies.

Introduction

The determinants of FDI inflows have been examined in numerous studies. A substantial number of them consider the influence of institutions, which are defined as particular organizational entities, procedural devices, and regulatory frameworks (IMF, 2003).

The quality of institutions is a particularly important FDI determinant for less-developed countries because the poor institutional quality and weak law enforcement increase the costs of running a business, create barriers for financial market efficiency, and increase the probability of foreign assets expropriation (Blonigen, 2005).

However, governments interested in attracting FDI to boost job creation, new technologies, and tax revenues to their countries are not only concerned about the internal institutional environment. They are also competing with other countries in attracting foreign investments, engaging in what is often referred to as “jurisdictional competition”. In a broad sense,  this can be thought of as governments’ efforts to outcompete one another in offering foreign companies more favorable institutional and fiscal conditions for capital placements.

This brief summarizes the results of a study on the jurisdictional competition for FDI among the developing CEE and among developed EU countries (Mazol and Mazol, 2021). The research explores the precondition for proactive jurisdictional competition between economies for FDI – namely, how the economic and institutional environment within a country impacts the inflow of FDI both domestically and to its neighboring states, – by using a spatial econometric approach. The brief emphasizes the difference in the FDI policy responses implemented by developing CEE and developed EU countries.

Data and Methodology

In our econometric analysis, we use the FDI inward stock (i.e., the value of capital and reserves in the economy attributable to a parent enterprise resident in a different economy) as the dependent variable. The explanatory variables indicating jurisdictional competition include quality of corporate governance, rule of law, political stability, and tax policy. We employ balanced panel datasets for 26 developing CEE countries and 15 developed EU countries for the period 2006-2018. The dataset is derived from the World Bank and UNCTAD databases.

The analysis is based on a panel spatial Durbin error model (SDEM) with fixed effects (LeSage, 2014). Parameter estimates in the SDEM contain a range of information on the relationships between spatial units (in our case, countries). A change in a single observation associated with any given explanatory variable will affect the spatial unit itself (a direct effect) and potentially affect all other spatial units indirectly (a spillover effect) (Elhorst, 2014). The spatial spillover effect is viewed here as the impact of the change in the institutional or economic factor in one country on the performance of other economies (LeSage & Pace, 2009).

In our case, the direct effect is the effect on the FDI in country i of the changes in the studied instrument of jurisdictional competition in country i. The spillover effect is the change in FDI in country j following a change in the studied instrument of jurisdictional competition in country i.

Results

The results of our estimation are suggestive of a proactive jurisdictional competition in taxes among the CEE countries and in corporate governance quality both among the CEE and EU countries. Analyses of other factors (i.e., political stability and rule of law) show no significant interrelation between policy measures implemented by neighboring countries in order to attract FDI.

The precondition for the presence of proactive jurisdictional competition in a particular factor is to have statistical significance in both its direct and spillover effects (Elhorst and Freret, 2009). Such findings may indicate that policy measures in one economy trigger a policy response in a neighboring economy, which, in turn, influences the level of FDI in both countries.

Table 1. Estimation results of SDEM models – direct effects

Notes: *** – significance at 1% level, **  – significance at 5% level, *  – significance at 10% level. ln – denotes the logarithm of the underlying variable. lagt – denotes lagged underlying variable by one period (year) in time. Values of t statistics in parenthesis. CEE countries: Albania, Armenia, Azerbaijan, Belarus, Estonia, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Georgia, Hungary, Kazakhstan, Kyrgyz Republic, Latvia, Lithuania, Macedonia, Moldova, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, Tajikistan, Ukraine, Uzbekistan. EU countries: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland. Source: Author’s estimates based on World Bank and UNCTAD databases.

Our results for the direct and indirect response to a tax policy in CEE countries illustrate this logic. Decreasing tax_rateincreases FDI to the CEE economy enacting this change (see Table 1), as well as to its neighboring countries (see Table 2). This finding is consistent with jurisdictional competition in taxes. That is, a reduction in domestic tax_rate may entail a decrease in the tax rate of a neighboring economy, resulting in a subsequent increase in FDI. (To explicitly confirm the suggested channel, further tax policy analysis would be needed). Interestingly, our results suggest that jurisdictional competition in taxes is only present among CEE economies, but not among EU countries.

In turn, an increase in corp_governance, a measure of corporate governance quality, increases FDI in neighboring countries both in the EU and in the CEE region (see Table 2).  A possible interpretation is that an increase in corp_governance in one country may entail an increase in corp_governance in its neighboring economies, resulting in a subsequent increase in FDI.  This result suggests proactive competition via corporate governance policy both among the EU countries and the CEE countries.

However, the direct effect differs between the regions. In the EU, an increase in corp_governance increases FDI to the EU economy in question, in line with common wisdom (see Table 1). At the same time, in the CEE region, an increase in corp_governance is followed by a decrease in FDI to that country.

Table 2. Estimation results of SDEM models – spillover effects

Notes: ***  – significance at 1% level, **  – significance at 5% level, *  – significance at 10% level. ln – denotes the logarithm of the underlying variable. Values of t statistics in parenthesis. lagt_lags – denotes spatially lagged underlying variable (multiplied by spatial weight matrix) lagged by one period (year) in time. Source: Author’s estimates based on World Bank and UNCTAD databases.

One potential explanation for the negative direct effect of corporate governance quality on FDI in the CEE economies is that improved corporate governance practices can block certain types of FDI, leaving behind foreign investors with a lower “threshold for corruption”. This may decrease FDI to the CEE country in question. However, once the jurisdictional competition results in an improvement of corporate governance across the region, it ultimately has a positive spillover effect.

The above explanation is in line with the theory of regulatory capture (Stigler, 1971), which suggests that the decisions made by public officials might be shaped and sometimes distorted by the efforts of rent-seeking interest groups to increase their influence.

Finally, the estimates do not indicate that the other studied institutional factors, rule of law and political stability, are applied as instruments of jurisdictional competition as neither groups of countries show significant spillover effects. The results, however, show that these factors influence the FDI inflow via the direct effect. More specifically, an increase in political_stability positively influences the FDI inflow to the economies in question, both in CEE and the EU, while rule_of_law is positive and significant only for the CEE countries. If investors are not as responsive to changes in rule_of_law when the initial level is high, the fact that EU countries typically have a higher rule_of_law value compared to CEE countries might explain why this estimate is insignificant for the EU countries.

Conclusion

This brief, first, presents new evidence on the relationship between different economic and institutional factors and FDI using a spatial econometric approach; second, it analyzes the possible existence of jurisdictional competition among developing CEE countries and developed EU countries as well as its effect on FDI.

The results suggest proactive jurisdictional competition in FDI determinants such as corporate governance quality and tax rates. CEE countries competing with one another use both these instruments of jurisdictional competition, while EU countries compete only via corporate governance quality. Furthermore, foreign investors are not sensitive to the quality of rule of law in the EU countries, while this instrument is more important for the FDI inflow to CEE economies.

Our results stress that officials responsible for the FDI policy implementation should pay more attention to the policies undertaken by neighboring governments as such external policies can make their own strategies to attract FDI to their economy less effective.

References

  • Blanton, S., and R. Blanton. (2007). What Attracts Foreign Investors? An Examination of Human Rights and Foreign Direct Investment. The Journal of Politics, 69(1), 143-155.
  • Blonigen, B. (2005). A Review of the Empirical Literature on FDI Determinants. Atlantic Economic Journal, 33(4), 383-403.
  • Elhorst, J. (2014). Spatial Econometrics from Cross-Sectional Data to Spatial Panels. Berlin: Springer.
  • Elhorst, J., and S. Freret. (2009). Evidence of Political Yardstick Competition in France Using a Two-Regime Spatial Durbin Model with Fixed Effects December. Journal of Regional Science, 49(5), 931-951.
  • IMF (2003). World Economic Outlook 2003. International Monetary Fund: Washington DC.
  • LeSage, J. (2014). What Regional Scientists Need to Know About Spatial Econometrics? Working Paper, Texas State University-San Marcos, San Marcos.
  • LeSage, J., and R. Pace. (2009). Introduction to Spatial Econometrics. Boca Raton, FL: CRC Press, Taylor and Francis Group.
  • Mazol, A., and S. Mazol. (2021). Competition of Jurisdictions for FDI: Does Developing and Developed Countries Response Different to Economic Challenges? BEROC Working Paper Series, WP no. 73.
  • Stigler, G. (1971). The Theory of Economic Regulation. Bell Journal of Economic and Management Science, 2, 3-21.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Carbon Tax Regressivity and Income Inequality

Posted on May 17, 2021 | Policy Brief

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A common presumption in economics is that a carbon tax is regressive – that the tax disproportionately burdens low-income households. However, this presumption originates from early research on carbon taxes that used US data, and little is known about the factors that determine the level of regressivity of carbon taxation across countries. In this policy brief, I explore how differences in income inequality may determine the distribution of carbon tax burden across households in Europe. The results indicate that carbon taxation will be regressive in high-income countries with relatively high levels of inequality, but closer to proportional in middle- and low-income countries and in countries with low levels of income inequality.

Introduction

Climate change is one of the main challenges facing us today. To reduce emissions of greenhouse gases, and thereby mitigate climate change, economists recommend the use of a carbon tax. The environmental and economic efficiency of carbon taxation is often highlighted, but the equity story is also of importance: who bears the burden of the tax?

How the burden from a carbon tax is shared across households is important since it affects the political acceptability of the tax. For instance, the “Yellow Vests” protests against the French carbon tax started due to concerns that the tax burden is disproportionately large on middle- and working-class households. Research in economics also shows that people prefer a progressive carbon tax (Brännlund and Persson, 2012).   

In this brief, I explore what we know about the distributional effects of carbon taxes and analyze the link between carbon tax regressivity and levels of income inequality in theory and in application to Sweden as well as other European countries.

Carbon Tax Burden Across Households

It is a common finding in the economics literature that carbon taxes are, or would be, regressive (Hassett et al., 2008; Grainger and Kolstad, 2010). However, most of the earlier literature is based on US data, and the US is unrepresentative of an average high-income country in terms of variables that are arguably important for carbon tax incidence. Compared to most countries in Europe, income in the US is high but unequally distributed, carbon dioxide emissions per capita are high, the gasoline tax rate is low, and the access to public transport is poor. If we want to understand the likely distributional effects of carbon taxes across Europe, we thus need to look beyond the US studies.

A recent study by Feindt et al. (2020) examines the consumer tax burden from a hypothetical EU-wide carbon tax. They find that the distributional effect at the EU-level is regressive, driven by the high carbon intensity of energy consumption in relatively low-income countries in Eastern Europe. At the national level, however, carbon taxation in Eastern European countries is slightly progressive due to car ownership and transport fuel being luxuries. Conversely, in high-income countries – where transport fuel is a necessity – carbon taxation is slightly regressive.

That the incidence of carbon and gasoline taxation varies across countries with different levels of income, has been found in numerous studies (Sterner, 2012; Sager, 2019). To understand the source of this variation, we need to identify the determinants of the incidence of carbon taxes.

The Role of Income Inequality

In a recent paper, I, together with Giles Atkinson at the London School of Economics, present a simple model where the variation in the carbon tax burden across countries and time can be determined by two parameters: the level of income inequality and the income elasticity of demand for the taxed goods (Andersson and Atkinson, 2020). The income elasticity specifies how the demand for a good, such as gasoline, responds to a change in income. If the budget share decreases as income increase, we refer to gasoline as a necessity. If the budget share increases with income, we refer to gasoline as a luxury good. Our model predicts that rising inequality increases the regressivity of a carbon tax on necessities. Similarly, we will see a more progressive incidence if inequality increases and the taxed good is a luxury.

To mitigate climate change, a carbon tax should be applied to goods responsible for the majority of greenhouse gas emissions: transport fuel, electricity, heating, and food. To estimate the distribution of carbon tax burden, we must then first establish if these goods are necessities or luxuries, respectively. Gasoline is typically found to be a luxury good in low-income countries but a necessity in high-income countries (Dahl, 2012). Food, in the aggregate, is consistently found to be a necessity. A carbon tax on food would, however, mainly increase the price of red meat – beef has a magnitude larger carbon footprint than all other food groups – and red meat is generally a luxury good, even in high-income countries (Gallet, 2010). Lastly, electricity and heating are necessities, with little variation across countries in the level of income elasticities.  A broad carbon tax would thus likely be regressive in high-income countries, but more proportional, maybe even progressive, in low-income countries. The overall effect in low-income countries depends on the relative budget shares of transport fuel and meat (luxuries) versus electricity and heating (necessities). A narrow carbon tax on transport fuel has a less ambiguous incidence: it will be regressive in high-income countries where the good is a necessity and proportional to progressive in low-income countries where the good is a luxury.  

The income elasticities of demand, however, only provide half of the picture. To understand the degree of regressivity from carbon taxation, we also need to take into account the level of income inequality in a country. Our model predicts that a carbon tax on necessities will be more regressive in countries with relatively high levels of inequality. And increases in inequality over time may turn a proportional tax incidence into a regressive one.

To test our model’s prediction, we analyze the distributional effects of the Swedish carbon tax on transport fuel and examine previous studies of gasoline tax incidence across high-income countries. 

Empirical Evidence from Sweden

The Swedish carbon tax was implemented in 1991 at $30 per ton of carbon dioxide and the rate was subsequently increased rather rapidly between 2000-2004. Today, in 2021, the rate is above $130 per ton; the world’s highest carbon tax rate imposed on households. The full tax rate is mainly applied to transport fuel, with around 90 percent of the revenue today coming from gasoline and diesel consumption.

 Figure 1. Carbon tax incidence and income inequality in Sweden

Sources: Andersson and Atkinson (2020). Gini coefficients are provided by Statistics Sweden.

Using household-level data on transport fuel expenditures and annual income between 1999-2012, we find that the Swedish carbon tax is increasingly regressive over time, which is highly correlated with an increase in income inequality. Figure 1 shows the strong linear correlation between the incidence of the tax and the level of inequality across our sample period. The progressivity of the tax is measured using the Suits index (Suits, 1977), a summary measure of tax incidence that spans from +1 to -1. Positive (negative) numbers indicate that the tax is overall progressive (regressive) and a proportional tax is given an index of zero. The level of income inequality, in turn, is summarized by the Gini coefficient (0-100), with higher numbers indicating higher levels of inequality.

In 1991, when the Swedish carbon tax was implemented, income inequality was relatively low, with a Gini of 20.8. If we extrapolate, the results presented in Figure 1 indicate that the tax incidence in 1991 was proportional to slightly progressive. Since the early 1990s, however, Sweden has experienced a rise in inequality. Today, the Gini is around 28 and the carbon tax incidence is rather regressive. This can be a potential concern if people start to perceive the distribution of the tax burden as unfair and call for reductions in the tax rate.

Empirical Evidence Across High-Income Countries

Figure 2 presents the results of our analysis of previous studies of gasoline tax incidence across high-income countries. Again, we find a strong correlation with inequality; the higher the level of inequality, the more regressive are gasoline taxes.  In the bottom-right corner, we locate the results from studies on gasoline tax incidence that have used US data. The level of inequality in the US has been persistently high, and the widespread assumption that gasoline and carbon taxation is regressive is thus based to a large part on studies of one highly unequal country. Looking across Europe we find that the tax incidence is more varied, with close to a proportional outcome in the (relatively equal) Nordic countries of Denmark and Sweden.

Figure 2. Gasoline tax incidence and income inequality in OECD countries

Sources: Andersson and Atkinson (2020). Gini coefficients are from the SWIID database (Solt, 2019).

Conclusion

A carbon tax is economists’ preferred instrument to tackle climate change, but its distributional effect may undermine the political acceptability of the tax. This brief shows that to understand the likely distributional effects of carbon taxation we need to take into account the type of goods that are taxed – necessities or luxuries – and the level and direction of income inequality. Carbon taxation will be closer to proportional in European countries with low levels of inequality, whereas in countries with relatively high levels of inequality the carbon tax incidence will be regressive on necessities and progressive for luxury goods.

This insight may explain why we first saw the introduction of carbon taxes in the Nordic countries. Finland, Sweden, Denmark, and Norway all implemented carbon taxes between 1990-1992, and income inequality was relatively, and historically, low in this region at the time. Policymakers in the Nordic countries thus didn’t need to worry about possibly regressive effects. Looking across Europe today, many of the countries that have relatively low levels of inequality have either already implemented carbon taxes or, due to the size of their economies, have a low share of global emissions. In countries that are responsible for a larger share of global emissions – such as, the UK, Germany, and France – inequality is relatively high, and they may find it to be politically more difficult to implement carbon pricing as the equity argument becomes more salient and provides opportunities for opponents to attack the tax.

To increase the political acceptability and perceived fairness of carbon pricing, policymakers in Europe should consider a policy design that offsets regressive effects by returning the revenue back to households, either by lump-sum transfers or by reducing tax rates on labor income.   

References

  • Andersson, Julius and Giles Atkinson. 2020. “The Distributional Effects of a Carbon Tax: The Role of Income Inequality.” Grantham Research Institute on Climate Change and the Environment Working Paper 349. London School of Economics.  
  • Brännlund, Runar and Lars Persson. 2012. “To tax, or not to tax: preferences for climate policy attributes.” Climate Policy 12 (6): 704-721.
  • Dahl, Carol A. 2012. “Measuring global gasoline and diesel price and income elasticities.” Energy Policy 41: 2-13.
  • Feindt, Simon, et al. 2020. “Understanding Regressivity: Challenges and Opportunities of European Carbon Pricing.” SSRN 3703833.
  • Gallet, Craig A. 2010. “The income elasticity of meat: a meta-analysis.” Australian Journal of Agricultural and Resource Economics 54(4): 477-490.
  • Grainger, Corbett A and Charles D Kolstad. 2010. “Who pays a price on carbon?” Environmental and Resource Economics 46(3): 359-376.  
  • Hassett, Kevin A, Aparna Mathur, and Gilbert E Metcalf. 2009. “The consumer burden of a carbon tax on gasoline.” American Enterprise Institute, Working Paper.
  • Sager, Lutz. 2019. “The global consumer incidence of carbon pricing: evidence from trade.” Grantham Research Institute on Climate Change and the Environment Working Paper 320. London School of Economics.  
  • Thomas, Sterner. 2012. Fuel taxes and the poor: the distributional effects of gasoline taxation and their implications for climate policy. Routledge.
  • Suits, Daniel B. 1977. “Measurement of tax progressivity.” American Economic Review 67(4): 747-752.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

On Corporate Wrongdoing in Europe and Its Enablers

Posted on April 13, 2021 | Policy Brief

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In the last two decades, several instances of prolonged and severe corporate wrongdoing by European companies have come to light: from Dieselgate to corruption, money laundering through large European banks, recidivist bid and price rigging, and most recently Wirecard. What allowed European firms to engage in so much wrongdoing? In this brief, we consider some important institutional drivers behind corporate wrongdoing, focusing on the European countries with the largest share of corporate infringers.

The Harm from and Extent of Corporate Wrongdoing in the EU

In June 2020, the German firm Wirecard AG’s stock price fell from €104 to below €2 in the span of nine days after the firm admitted it could not locate $2 billion missing from its accounts. The firm has since then been accused of a wide range of infringements including money laundering, corruption, and fraudulent inflation of profits and sales, with some allegations going back over a decade. The Germany financial supervisor BaFin has been criticized as allegations about fraud had been made several times in prior years. Yet, BaFin failed to identify the problem and even banned short-selling of the stock, as well as accused journalists who were critical of the firm of market manipulation.

This scandal occurred against a backdrop of several other prolonged corporate scandals and has led many to wonder how extensive corporate wrongdoing is and how to combat it more effectively.

Corporate wrongdoing has a range of negative effects in competitive markets that are frequently overlooked in the public debate. Beyond the immediate damages of corporate wrongdoing, such as the draining of public resources in the case of tax evasion, money laundering, corruption, air pollution and associated health harm in the case of environmental law violations, there are also more general negative effects of corporate wrongdoing.

It attracts investors to the worst part of the industry, as firms that engage in profitable wrongdoing often do better than their competitors. Also, it forces out honest competitors and increases market entry thresholds for new competitors. These effects become more pronounced when the wrongdoing is prolonged, so, in an ideal world, regulators need to act fast.

Instead, several recent cases of European corporate wrongdoing lasted for many years before being detected and sanctioned, and there is a worrying degree of recidivism in several regulatory areas, including financial regulation with several banks being recidivists, but also in antitrust (Marvão, 2016).

What are the drivers and enablers behind these many prolonged cases of wrongdoing, and why do firms feel emboldened to engage in recidivism?

One way to gain some insight is to identify European countries whose firms are most frequently fined for wrongdoing and review the legal, cultural, and political contexts of those countries.

We tackle this issue by using data from Violationtracker, a database with over 400 000 actions by US enforcement agencies and prosecutors (such as the Securities and Exchange Commission and the Department of Justice). Many of these sanctions are against firms with headquarters in EU countries. In Nyreröd and Spagnolo (2021a), we added the fines for firms with headquarters in all respective EU countries for the period 2000-2020. After excluding countries like Switzerland, well known as homes of extensive financial crime linked to their status of international tax havens and off-shore centers, we find that the United Kingdom is the gold medalist in corporate wrongdoing, with Germany coming in second place.

Table 1. Fines across the top six EU countries (2000-2020).

Note: Author’s calculation based on data retrieved from Violationtracker.org. Number of fines in parentheses.

Interestingly, the top of the ranking is preserved no matter which metrics we use. In Nyreröd and Spagnolo (2021a) we weigh the fines by population, GDP, and exports to the US, and the UK and Germany remain stable at the top, with the UK’s first position becoming more pronounced. Therefore, we focus on these two countries, although many of the problems we identify apply to a varying degree to most other EU countries.

Because of the recent headlines made by the Wirecard case we start with the runner-up, Germany.

Germany

The Wirecard case follows a long tradition of large “household” names such as Siemens, Deutsche bank, Thyssenkrupp, and Volkswagen that have engaged in systemic wrongdoing over extended periods of time and are responsible for most of the fines shown in Table 1.

In one of the largest corruption scandals in history, Siemens was fined $1.6 billion by the Department of Justice in 2008 for systematically paying bribes to government officials around the world, amounting to more than $1.4 billion since the mid-1990s. According to the Securities and Exchange Commission’s investigation, bribery at Siemens was “standard operating procedure” for decades, and the SEC concluded that “the company’s tone at the top […] created a corporate culture in which bribery was tolerated and even rewarded at the highest levels of the company”(SEC, 2008).

In 2015 the Dieselgate scandal unraveled, where it was discovered that several car manufacturers had installed “defeat devices” to cheat emissions tests. Volkswagen had installed the device in 11 million vehicles, some of which emitted up to 40 times more than emissions standards allowed (Gates et al, 2017).

Germany’s largest lender Deutsche Bank has since 2000 paid a whopping $18 billion in fines in the US for alleged infringements ranging from facilitating money laundering and tax evasion, to concealing bribe payments and misleading investors (DoJ, 2021). This is by far the greatest amount paid by any EU bank in the period 2000 – 2020 (Violationtracker.org, 2021)..

Finally, there is the steel conglomerate ThyssenKrupp, which was handed a €479 million fine for bid-rigging by the European Commission in 2007, the highest EU bid-rigging fine ever at the time. The size of the fine was motivated by the fact that, in 2007, Thyssenkrupp was already a repeat offender. In 2019, Thyssenkrupp and three other steel manufacturers were fined $719 million for price-rigging between 2002 to 2016. The firm has also been accused of bribe payments on several occasions (see Nyreröd and Spagnolo 2021a for details).

In reviewing local factors that have enabled these incidents, we find that Germany appears to have a particularly lenient stance toward corporate wrongdoing and a notably hard one against whistleblowers disclosing it. With respect to corruption, for example, bribe payments could be deducted from tax in Germany up until 1999 if paid to foreign officials, and up until 2002 if paid to recipients in the business world (Berghoff, 2017). In October of 2003, the United Nations adopted the Convention Against Corruption. On average, European countries had ratified this treaty halfway through 2007, but Germany was one of the last to ratify the treaty, it did it only in 2014 (UNODC, 2020).

Perhaps more importantly, Germany’s institutional environment seems focused on punishing and deterring whistleblowers, rather than listening to their reports in order to fight corporate wrongdoing. This is likely a crucial enabler of the prolonged wrongdoing we discuss in more depth in Nyreröd and Spagnolo (2021a). It is well known that whistleblowers are essential to detecting corporate wrongdoing (ACFE, 2020). Yet, Germany has some of the worst whistleblower protection laws in the EU (Transparency International 2013, Wolfe et al 2014), and one of the worst records in Europe in terms of mistreating the (obviously few) whistleblowers that dared to denounce corporate wrongdoing (Worth 2020a).

The German opposition to the protection of(truth-telling) whistleblowers from employers’ retaliation was on full display when a public consultation was held on the new EU Directive on whistleblower protection (2019/1937). German industry representatives were particularly active in arguing against it, suggesting that whistleblower protection is not necessary and that the new regulations are a clear signal of mistrust towards companies (BDI, 2019). The German parliament discussed improving the poor whistleblower protections in 2013 but did not enact any improvement of whistleblower protection laws. There are several instances of retaliation against truth-telling whistleblowers where they had very little legal recourse (Worth 2020a; Nyreröd and Spagnolo, 2021a).

The hostile regulatory and political environment to whistleblowers is likely a main factor that has enabled so many German corporations to engage in such prolonged wrongdoing with no records of employees reporting it.

The United Kingdom

We now turn to the winner of our contest, the UK. Over $26 billion of the total fines paid by UK firms in Table 1 is accounted for by the British Petroleum’s (BP) Deep Horizon oil spill in 2010 in the Mexican Gulf. It is estimated that 5 million barrels of oil were released into the ocean, a spill regarded as one of the largest environmental disasters in history.

Internal investigations at BP during the decade preceding this spill had warned senior BP managers that the company repeatedly disregarded safety and environmental rules and risked a serious accident if it did not change its ways. A 2004 inquiry found a pattern of intimidating workers who raised safety or environmental concerns (Lustgarten and Knutson, 2010). The company allegedly flouted safety standards by neglecting aging equipment, delayed inspections to cut production costs, and falsified inspection records. Even before the 2010 spill, officials at the US Environmental Protection Agency had considered debarring BP from receiving government contracts (Lustgarten, 2012). Since 2000, BP has been fined 158 times for environment-related offenses in the US, and again over 60 times since the oil spill in 2010.

Then there is the UK banking sector, with many large banks continuously engaging in wrongdoing, and seemingly more so than elsewhere. CASS (2020: 6) shows how, since 2011, the conduct costs of UK banks have far exceeded that of banks based in the US and Euro area when compared to GDP. In 2017, conduct costs for UK banks represented 0.88% of the UK’s annual GDP, while conduct costs for US and Euro area banks represented around 0.10% or less. In 2018, the conduct costs for UK banks shrank and constituted around 0.55% of the UK’s annual GDP.

In 2010, it was discovered that HSBC had systematically laundered money for some of the bloodiest drug cartels in history through its Mexican subsidiary. Despite numerous internal warnings, complaints from regulators, and internal flags, HSBC Mexico continued laundering money for organizations like the Sinaloa cartel, who not only flood the US with illegal drugs but is considered responsible for the gruesome killings of tens of thousands of people, often innocent civilian casualties at home. The UK’s then-chief financial minister, George Osborne, pleaded with the US Treasury Secretary and others that they do not impose criminal sanctions on HSBC (US Congress 2016).

Another major scandal involving UK banks that have cost regular people billions of pounds was the misselling of “payment protection insurance”. This aggressively marketed insurance had profitability of approximately 90% (Laris, 2020). Several barriers were created to inhibit people from claiming the insurance, such as contract exclusions or administrative barriers, and many people who bought these insurances either did not need them or were unsuitable. As of January 2011, UK banks and financial institutions had paid out £37.5 billion in compensation to customers who were wrongly sold the insurance (Coppola, 2019).

One of the main drivers of corporate wrongdoing in the UK appears to have been the lack of effective corporate sanctions. The “identification principle” requires the identification of a directing mind and will of the company (typically a director), and then proving criminal liability through this person’s conduct and state of mind. This principle has been singled out by several experts as making it “impossibly difficulty” for prosecutors to find companies guilty of serious crimes, especially crimes in large companies with devolved business structures (The Law Commission, 2015: 15). Several UK institutions, such as the UK’s Serious Fraud Office and the Crown Prosecution Service, have also pointed to the identification principle as a central hurdle to their ability to bring corporate prosecutions (Corruption Watch, 2019).

Moreover, effective business lobbying and close connection between politicians, regulators and the financial sector have been prevalent in the UK for a long time and may have exacerbated the already accommodating regulatory environment. Several well-known high-level politicians that affected financial regulation and its implementation for years ended up being hired with handsome pay by financial institutions afterwards (see Nyreröd and Spagnolo 2021a for details).

Regarding regulators, Miller & Dinan (2009: 29) notes that of the 36 people that served on the board of the Financial Services Authority (FSA) between 2000 and 2009, 26 of the members had connections at board or senior level with the banking and finance industry either before or after their term of office, whilst nine continued to hold appointments in financial corporations while they were at the FSA”.

The UK also has an outdated and ineffective whistleblower protection law, the “public interest disclosure act” of 1988 (see e.g., Lewis 2008, Thomas Reuter Foundation and Blueprint for Free Speech 2016, All Parliamentary Committee 2020). At the same time, important UK regulatory agencies have been proactive in neglecting the mounting independent academic research highlighting the effectiveness of the US whistleblowers rewards programs (see Nyreröd and Spagnolo 2021b).

Conclusion

Corporate wrongdoing appears widespread in Europe, and recent cases have been prolonged, severe, and sometimes industry-wide.

The UK and Germany stand out, but other EU countries are no angels. In the case of Germany, an acute aversion to whistleblowers by government institutions appears as a central driver that has enabled corporate wrongdoing. With respect to the UK, ineffective corporate sanctions laws, regulatory/political capture, and a lack of whistleblowers, appear to have driven or enabled firms to engage in prolonged corporate wrongdoing. Similar enablers and drivers are likely present in other EU countries to varying degrees.

There is now an EU Directive on whistleblowing, requiring all member states to put in place retaliation protections for those reporting on corporate wrongdoing. But protections have proven insufficient in a variety of ways and are unlikely to be a game-changer in terms of combating corporate wrongdoing (see e.g., GAP and IBA, 2021).

In the light of the strong independent evidence on the effectiveness of whistleblower reward programs at increasing detection and deterring wrongdoing (see, e.g., Nyreröd and Spagnolo 2021b for a survey), EU Member States seriously concerned about corporate wrongdoing should consider introducing them in a wide variety of regulatory areas.

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Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.