Denmark has been a frontrunner in policies that reduce greenhouse gas emissions and now plans to achieve carbon neutrality by 2050. Emissions of greenhouse gases peaked in the mid-1990s and have since declined by about 47 million tonnes. Achieving carbon neutrality will require additional cuts of a similar amount. Denmark plans to frontload this effort and more than halve its emissions by 2030. Achieving these ambitious targets would contribute to global efforts to control climate change, but the transition towards carbon neutrality will have large macroeconomic consequences and entail significant financial risks. Rapid changes in consumer behaviour, large amounts of private and public investments, and a reallocation of labour across sectors will be required. The impact of climate policy on public debt will be increased by unavoidable spending to protect the country from changing weather patterns. This makes it crucial to adopt well-designed policies that contain both types of costs and promote the benefits of adaptation to climate change. This chapter outlines a cost-effective, inclusive and comprehensive strategy to decarbonise the Danish economy. It reviews progress so far, discusses macroeconomic consequences of climate policies, and recommends a package of policies.
OECD Economic Surveys: Denmark 2021
2. An effective, inclusive and comprehensive strategy for a decarbonised economy
Abstract
This chapter discusses an effective, inclusive and comprehensive strategy to cut Denmark’s greenhouse gas (GHG) emissions by 70% by 2030 from 1990 and reach carbon neutrality in 2050, as currently planned.1 First, it assesses the current situation, including the exposure of Denmark to climate risks and its strategy to cut emissions (section 2.1). Second, it discusses the economic and employment consequences of rapid cuts in carbon emissions (section 2.2). Finally, it proposes various policy options and their associated risks (section 2.3). Following this analysis, Chapter 3 will delve into the details of three specific sectors. The two chapters follow the framework discussed by the Working Party No.1 of the Economic Policy Committee in March 2021 (ECO/CPE/WP1(2021)9).
The climate strategy in Denmark
Denmark is at the forefront of efforts to reduce greenhouse gas (GHG) emissions. The country succeeded by 2019 in cutting its emissions by 36% relative to 1990 and now has adopted the ambition to halve emissions from their current levels by 2030 and then progress further towards carbon neutrality in 2050. Reflecting its ambition to be a global leader and provide an example of how emission cuts can be achieved, Denmark does not plan to meet its goals through offsets from funding emission cuts abroad even though this could offer cheaper abatement opportunities. Denmark’s targets imply that the pace of carbon cuts needs to accelerate from progress achieved so far – a considerable endeavour with large macroeconomic and financial consequences.
Denmark is exposed directly and indirectly to the impacts of climate change
Despite its location in the temperate zone, climate change is likely to have a negative impact on Denmark, and catastrophic events could occur in extreme scenarios. The country is not expected to suffer substantially from new drought episodes (IPCC, 2014[1]) (World Bank Group, n.d.[2]), but rain episodes will be more concentrated and heavier in the winter season by the end of the century (Danmarks Klimacenter, 2014[3]). The frequency of extreme weather events (storms, long and heavy rains) will increase in the coming decades (World Bank Group, n.d.[2]), as in the rest of Northern Europe, with possible catastrophic losses of lives and properties. A collapse of the Gulf Stream and its effect on northern Europe’s climate could trigger more extreme weather, including colder winters and more intense storms (Jackson et al., 2015[4]) that could increase domestic energy demand. There is medium confidence that the Gulf Stream will weaken this century, but it is not expected to change much or shut down totally (IPCC, 2021[5]).
A sharp worsening of climate change could hit Denmark severely. Its geography consists of the Jutland peninsula with a highest point of 170m above sea level and more than 400 islands, which makes it particularly vulnerable to flooding and erosion from rising sea levels due to melting glaciers and ice sheets. Vulnerability is concentrated in areas of high asset values around Copenhagen (Figure 2.1). Partly reflecting high asset values and insurance coverage, Denmark has already been particularly exposed to extreme events such as storms and flooding: although losses in Denmark have been small in aggregate (EUR 50 per capita per year), on the basis of information from insurance associations and local informers they were estimated to be among the highest per capita in the European Union between 1980 and 2019 (European Environment Agency, 2021[6]). Rising seas, extreme events and floods could threaten the provision of basic goods and service by damaging or destroying water and transport infrastructure (OECD, 2018[7]), and would undermine activity in ports and coastal areas (Danish Ministry of Energy, 2017[8]). Crops could be more exposed to flooding and farmers may have to cope with heavier rains and adjust their pesticide and fertiliser use to reflect a higher risk of run-off. Drier summers might affect the availability of groundwater, used for agriculture and household consumption.
Global warming will also have indirect effects on Denmark and its trade-dependent economy. There is little doubt that increasing temperatures will threaten ecosystems and cause more frequent and serious wildfires and drought globally, particularly in subtropical areas (IPCC, 2014[1]). Although food production might increase in certain areas, including in Denmark, climate change is projected to undermine global food security, decreasing wheat, rice and maize production in tropical and temperate regions (IPCC, 2014[1]). Migration and the tensions on resources that might emerge (MoCEU, 2020[9]) can undermine trade and access to some commodities. Danish agriculture, with a major livestock sector, might have to cope with higher and more variable feed prices.
Figure 2.1. Much of Denmark is exposed to flood risk, particularly the greater Copenhagen area
Note: The map shows the share of exposures collateralised by real estate at risk of flooding in proportion to the total number of exposures collateralised by real estate. The exposures are by the end of 2020. The shares are by municipality. Based on the worst-case scenario in 2071‑2100.
Source: Danmarks NationalBank (2021),"Flood Risk Can Potentially Affect a Large Share of Credit Institutions' Exposures", Analysis No.13.
Adaptation of the economy and society to climate change is critical to manage the socioeconomic effects. Costs of adaptation are highly uncertain, centring around 0.1% to 0.5% of GDP for developed countries (Stern (2006[10]); UNEP (2021[11]); Agrawala et al (2010[12]) but potentially higher in the near-term if retrofitting and coastal protection is brought forward (IMF, 2021[13]). There are important roles for government to embed climate considerations in risk management (including spatial planning), protect the vulnerable, provide localised information and ensure sufficient flexibility in regulatory settings to allow households and firms to manage risks. There are opportunities to adapt while also reducing emissions, such as restoration of wetlands that reduce exposure to flood risks, but also trade-offs such as higher energy use in buildings to maintain comfort levels in a changing climate (OECD, 2021[14]). Denmark in 2008 launched its strategy for adaptation and followed up with an action plan for a climate-proof Denmark in 2012. An update to incorporate the latest climate science and risk assessment would be timely.
Denmark has reduced its GHG emissions and set ambitious new targets
Danish GHG emissions have consistently decreased since 1996. The electricity generation sector has been driving the trend, reducing its GHG emissions by two thirds between 1990 and 2019, thanks to a fast-growing use of renewables. As a result, emission intensity is among the lowest in OECD countries (Figure 2.2). Most energy use is for transport and residential purposes and emissions from the transport sector are now higher than those from electricity generation (29% vs. 19% in 2019). Importantly, Denmark has reduced its energy intensity (the total energy supply per unit of GDP) by a quarter over the last decade, contributing further to the transition of the economy towards climate neutrality. Renewables account for a relatively high share of total energy supply, particularly biofuels and wind power (Figure 2.3). Denmark’s high levels of consumption and low emissions-intensity in production contribute to larger demand-based emissions – which include emissions embodied in imports – than production-based emissions, though demand-based emissions have consistently declined over the past fifteen years (Figure 2.4).
Figure 2.2. Denmark has among the lowest emission intensities in OECD countries
Green house gas emission intensity, 2019 data
Note: GHG emission intensity is calculated as total gross greenhouse gases excluding land use, land use change and forestry per unit of GDP expressed in thousand 2015 USD PPP. Emission accountings also exclude international transport, although they substantially contribute to GDP (transport and trade being responsible for 20% of the total net value added in Denmark in 2020 according to Statistics Denmark).
Source: OECD, Environment Statistics (Air and Climate) - GHG emissions database.
Consistent with evidence from other OECD countries, emission cuts have not derailed economic growth or employment. Denmark is one of many OECD countries to have decoupled its GHG emissions from economic growth during the last three decades (Figure 2.5). OECD-wide evidence indicates that implementing stringent environmental policies has had little aggregate effect on economic performance so far despite achieving significant environmental benefits (OECD, 2021[15]). For Denmark, the highest environmental policy stringency in the OECD has not prevented one of the highest employment rates of 75% of the working age population (Botta and Koźluk, 2014[16]; OECD, 2021[17]). However, environmental policies generate winners and losers and trigger a reallocation of capital and labour from high-emission to low-emission industries and firms. For example in Denmark, employment in fossil-fuel fired electricity generation has contracted over the past two decades while employment in renewable generation, especially wind, has grown. Employment in renewable energy production grew by 4.6% annually between 2012 and 2018, well above the EU average of 0.4% per year (Eurostat, 2021[18]).
The steep reduction of GHG emissions, particularly in electricity-generation and district-heating, is the result of a strong and consistent political will over many years, targeted support and a long history of co-operation between public and private actors for innovation. Both domestic targets and international commitments, particularly at the EU level, are driving this action. The European Union committed in December 2020 to reduce its emissions by at least 55% by 2030, compared to 1990, in order to achieve climate neutrality by 2050 (European Union, 2020[19]). The climate mitigation policy of Denmark is embedded in the EU Emissions Trading System (ETS), the European carbon market for large emitters, covering more than 10 000 installations and 40% of emissions of the European Union, Iceland, Liechtenstein and Norway. Denmark’s mitigation commitments frequently exceed EU averages, for instance a -39% reduction between 2005 and 2030 in GHG emissions that are not covered by the EU ETS (mainly transport, residential, agriculture and waste), exceeding the EU-wide target of -30%.
Figure 2.3. Renewables, including biofuels, are relatively important sources of energy in Denmark
As a percentage of total energy supply, 2020 data
Note: OECD is the average of 37 member countries excluding Costa Rica. Other includes heat, oil shale and oil sands, and peat and peat products. The shares of "Other", geothermal, hydro and nuclear are negligible or nil for Denmark.
Source: IEA, World Energy Balances database.
Figure 2.4. Carbon emissions based on Danish consumption are much higher, but also declining
Note: Based on CO2 emissions from energy use, excluding indirect effects and net emissions from land use, land use change and forestry.
Source: OECD, Green Growth Indicators database.
Figure 2.5. Carbon emission cuts have not prevented strong economic growth in a number of OECD countries
Total growth over the period 1990-2019
Note: 1991-2019 for Germany. CO2 emissions exclude land use, land use change and forestry and are consumption-based: emissions caused in the production of imported goods are included while emissions embedded in exports are excluded.
Source: OECD, Economic Outlook database; Our World in Data.
The new Danish Climate Law, voted in June 2020, steps up ambitions through a legal commitment to climate neutrality by 2050 and a 70% reduction of GHG emissions in 2030 relative to 1990 levels. In May 2021, a trans-partisan agreement was made on setting a 50-54% intermediate target for 2025. Moreover, the Danish Parliament agreed to phase-out oil and gas extraction in the North Sea by 2050. The Climate Law provides a strong supporting framework: targets should be revised every 5 years for a 10-year horizon. Furthermore, the government is required to define a climate programme yearly, including an assessment of whether current policies are consistent with official targets. Actions are categorised into a near-term “implementation track” and a longer term “development track” (MoCEU, 2020[9]).
Strong engagement of stakeholders is at the heart of the Danish climate strategy. The Climate Act defines four guiding principles for climate effort2, including maintaining “a strong welfare society, where cohesion and social balance are secured”. In order to build its climate strategy, the government launched Climate partnerships in thirteen sectors and a “Green Business Forum” to identify challenges and opportunities with the support of businesses and trade unions. Specific partnerships are also made with big GHG emitters such as the cement producer Aalborg Portland (Box 2.4 below). An advisory citizen assembly with 99 randomly chosen members will be involved in the strategy. This approach is similar to the French Convention Citoyenne pour le Climat, but with a more limited mandate, as the Danish assembly will focus on how citizens can contribute to climate action and will discuss the dilemmas they face in the transition.
Accounting for 0.1% of global emissions, Denmark aims to mitigate climate change also using international diplomacy with its own success as an example. The country takes an active role in climate talks and partnerships, including under the UN Framework Convention on Climate Change (UNFCCC) and Conference of the Parties (COP). In 2009, Denmark hosted COP15, which led to the Copenhagen Accord with a long-term goal to limit average temperature increase below 2°C, together with a call to consider limiting it to 1.5°C. Being “a leading nation in the international climate effort” is a guiding principle for the country’s climate action. In 2018, Denmark signed the Helsinki’s principles together with 26 other countries, to highlight the role of fiscal policy and the use of public finance. A total of DKK 2.9 billion has been allocated to climate and environmental efforts in developing countries in 2021, and 36.8% of Denmark’s bilateral aid supported the environment in 2019 (OECD, 2021[20]). In March 2020, Denmark initiated a concerted call with 11 other EU countries for more ambitious emission reduction targets within the union.
Climate targets call for accelerated action, but this will have socio-economic impacts
Reaching the 2030 target requires a faster pace of emission cuts than achieved so far. Under policies currently implemented and agreed upon, emissions will decline by 55% in 2030, not enough to achieve the government’s goal of -70% (Danish Climate Council, 2021[21]) (Danish Ministry of Climate, 20121[22]), which will jeopardise the goal of carbon neutrality in 2050. Hence, Denmark’s climate policy needs to become more ambitious. Further investment in renewable energy will help, but this will not suffice. The sectors of transport, buildings, agriculture, non-ETS industry and waste will need to accelerate also their decarbonisation to meet the 2030 target (Figure 2.6), as noted by the European Commission (2020[23]).
Figure 2.6. Denmark will miss its carbon targets under unchanged policies
Greenhouse gas emissions
Note: The GHG emissions include carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride. The latest historic year is 2019 which forms the basis of the projection. The emissions are projected to 2040 using a scenario which includes the estimated effects of policies and measures implemented or decided by May 2020 on Denmark's GHG emissions based on unchanged policies. Oil and mineral extraction covers fugitive emissions from fuels. Other sectors include combustion in commercial/institutional, residential and agricultural plants. The 2030 target reflects a 70% reduction of the 1990 emission level. LULUCF stands for land use, land use change and forestry.
Source: UNFCCC, GHG Data Interface (1990-2019); Danish Centre for Environment and Energy, Projection of greenhouse gas emissions - 2020 to 2040 data.
Faster decarbonisation to meet Denmark’s ambitious carbon targets will have macroeconomic and financial consequences. Long-term costs depend crucially on the efficiency of policy and availability of new technologies (Box 2.1). During the transition, large changes in consumer behaviour will be required to reduce the use of fossil fuels, as well as significant household spending on new vehicles and energy efficient appliances. Sufficient resources will need to be allocated to finance new investments in low-carbon capital assets, some equipment will lose economic value and some plants will have to close (Pisani-Ferry, 2021[24]). Retirement of carbon-intensive capital before the end of its productive economic life will entail stranded assets and consequent financial risks. Labour will need to be reallocated between sectors, with risks that workers will be left behind. Further public spending can address these issues, but potentially at the cost of inflating government debt.
A strategy to mitigate macroeconomic and financial consequences
The exposure of households and firms to the economic consequences of emission abatement will vary according to their capacity to adapt to the new policy environment. Higher costs of emission-intensive goods and services will not impact all households in the same manner, depending on their capacity to invest in new vehicles, appliances or energy efficiency. The consequences of higher costs for firms will vary depending on their initial conditions – notably their financial strength, their dependence on emission-intensive inputs and their capacity to pass on price increases. Higher costs from more stringent climate policy could damage international competitiveness of some Danish firms.
Although some firms will be put under pressure, others will benefit from this rapid transformation, as Denmark already experienced with the emergence of thriving firms that have become world-leaders in offshore wind. The Porter Hypothesis posits that a redesign of production processes or reallocation of resources within firms could trigger productivity increases. Empirical evidence indicates that larger, more productive, low-emission and well-managed firms are better equipped to respond to more stringent policies and are thus able to raise their productivity and gain higher market shares, while other firms can suffer negative effects (Albrizio, Kozluk and Zipperer, 2017[25]; Dechezleprêtre et al., 2019[26]). As a result, the climate strategy will continue to have winners and losers: creating opportunities for some firms (such as those building green infrastructure) while others carry disproportionate adjustment costs.
Framework conditions allowing “creative destruction” processes to operate are important to allow innovative firms to bring low-carbon technologies to the market and displace high-carbon firms. This includes policies to improve the business environment, reduce entry barriers for new firms, strengthen competition, and enable the exit of loss-making firms. Denmark’s legislation generally underpins a competitive business environment that facilitates market entries (OECD, 2018[27]) but key sectors for climate can be opened further to new entrants. More specifically, the passenger rail system is dominated by a state-owned company and the EU Commission highlighted in June 2021 the country’s limited effort to transpose the EU directive for a European railway area (European Commission, 2021[28]). Recent reforms to provide greater power to the competition authority are welcome and outcomes should be monitored (Chapter 1).
Box 2.1. Welfare implications of climate policy: model simulations
Assuming that Denmark’s policies are cost-efficient, holding policies constant in other countries, the Danish Economic Councils (2021[29]) estimates that reaching a 70% cut in GHG emissions in 2030 would entail a modest annual welfare cost of DKK 4 billion in 2030 (0.15% of GDP). Gross value added is estimated to decline by DKK 7 billion as it becomes more expensive to produce emissions-intensive goods in Denmark, reducing real household income and consumption to a similar extent. This is partly offset by DKK 2 billion in benefits from reduced air pollution and DKK 1 billion from reduced nitrogen discharges. Benefits from reducing climate damages, traffic congestion, noise and other agricultural pollution are excluded, as are the transition costs from the path to a new equilibrium.
The actual costs of the transition are highly uncertain and will depend critically on the efficiency of policy and the availability of low-emission technologies. The Climate Council (2020[30]) has estimated a somewhat higher cost of 0.7-1% of GDP to meet the 2030 target, in part from assuming lower availability of abatement technologies. Past trends show a rapid reduction in the costs of renewables that reduced the costs of cutting energy emissions (IRENA, 2020[31]), but future costs will depend on whether this progress is maintained and broadened to other sectors and technologies, including carbon capture use and storage. Welfare costs could be three times higher if the agriculture sector was excluded from action, or higher again if subsidies were the principal policy tool (Danish Economic Councils, 2021[29]).
Curbing labour market adjustment costs
Effects on employment are also expected to be very heterogeneous, reflecting differences in the capacity of firms and sectors to adapt to a low-emissions economy. Various studies suggest that, with the right policy mix, the overall employment impact of a policy package leading to a 70% emission cut by 2030 can be very small. However, climate policy will generate movement within the labour market with shifts between jobs and between sectors. As many as one in four jobs could be lost in agriculture (-3.1% per year) and almost one in ten in the food industry (-1.3% per year) (Table 2.1), although these sectors amount for a small share of overall employment. Job losses are also likely to affect specific parts of broader industries where emissions are concentrated among a small number of firms, such as in cement production (Box 2.2), sugar and oil refining. More disaggregated modelling is needed to better understand the scale and location of these effects (section 2.3.7). Job losses are likely to entail losses of income. Historically more than one displaced worker in three has faced an earnings loss of at least 10% in the year following displacement and Danish agricultural workers are particularly vulnerable as they have lower re-employment prospects than workers from other sectors (OECD, 2016[32]). At the same time, adjustment in agriculture will be enabled by the high share of geographically mobile foreign workers.
The extent of job losses in broad industries is not expected to be exceptional by historical comparison: agriculture (‑2.4% per year) and food (-3.1%) also contracted substantially between 2000 and 2010 (Danish Economic Councils, 2021[29]). In addition, the number of “green jobs”, such as those in renewable energy and building renovations, has potential to increase by tens of thousands in coming decades with an ongoing commitment to supportive policy, technological development and training (CONCITO, 2019[33]) (Cedefop, 2018[34]). In 2016, the number of environmental jobs in Denmark amounted to 71,000 (Statistics Denmark, 2018[35]). Managing the implications for gender equality in the labour market by ensuring there are real opportunities for women will be important: men are more affected by shrinking extractive industries, but also more likely to work in green construction (ILO, 2019[36]).
Table 2.1. Estimated effect of climate mitigation policy on employment by sector
Note: Based on a scenario where existing energy taxes are phased out, financed by a uniform greenhouse tax to achieve the 70% target. The changes in employment in 2030 in the first two columns are relative to the level of employment in the baseline scenario in 2030. The agriculture sector also covers horticulture. Food industry covers the food, beverage and tobacco industry. Supply covers North Sea production, oil refineries, electricity, gas, heat and water supply as well as waste incineration. Industry covers other industry and processing, and ”other” covers forestry, fishing, construction and public services. The total in the first column does not sum precisely due to rounding.
Source: Danish Economic Council (2021).
Box 2.2. Reducing emissions from cement production in Denmark
The Danish cement industry consists of a single producer, Aalborg Portland, which is the world’s largest exporter of white cement. The company has just over 350 employees in Denmark, mostly located in and around Aalborg, Denmark’s third largest city. As the only cement producer, Aalborg Portland has strong specific skill needs and internal training, with the highest share of apprentices per employee among Danish process companies.
Aalborg Portland is by far the largest single emitter of CO2 in Denmark, responsible for more than 4% of national emissions in 2018 (2.2 million tonnes). Industrial process emissions from cement production are subject to emission pricing under the EU ETS. The government has entered into a cooperation agreement with Aalborg Portland that secures greenhouse gas emission reductions of 0.5 million tonnes of CO2e by 2030. Rather than reducing production, the emphasis is on replacing fossil fuels, using clay instead of chalk to reduce process emissions and using excess heat for district heating of homes in Aalborg. More expensive technologies, notably carbon capture, may be needed to make further cuts.
Source: (Danish Economic Councils, 2021[29]); (Danish Economic Councils, 2019[37]); (DI Business, 2020[38]); (Aalborg Portland, 2021[39])
Apart from agriculture, regional employment effects of climate policy are not likely to be as severe in Denmark as in countries with a strong geographical concentration of emission-intensive activity. Denmark does not have regions reliant on coal mining activity as in Germany, for example. The phase out of oil and gas activity will be gradual, and workers often have skills that can be used in offshore wind. A survey of the UK oil and gas workforce found that more than half would be interested in retraining in offshore wind (Windpower Monthly, 2020[40]). In agriculture, job losses will be concentrated in key livestock provinces of South and West Jutland, where there are less alternative employment opportunities than in the major cities. However, the contraction in agricultural employment in the decade to 2010 was managed without pushing unemployment rates in these provinces above the national average. Historical experience suggests new green jobs are also likely to be concentrated in South and West Jutland (and more broadly in Southern and Central Denmark) (CONCITO, 2019[33]). Nonetheless, the potential for job losses to be regionally-concentrated in agriculture increases the importance of removing barriers to labour mobility, such as reducing housing market inefficiencies.
Denmark has a strong policy starting point to facilitate the deep structural transformation needed to reach net zero emissions. The Danish framework of “flexicurity”, which is based on ensuring mobility between jobs while providing a comprehensive safety net for the unemployed and strong active labour market policy, should help to promote a smooth reallocation of labour in the context of the green transition. A recent example of large-scale restructuring was the manufacturing industry during the 2008 financial crisis, when its share of Danish employment fell from 13% to 11% over two years as foreign demand collapsed. Displacement rates in manufacturing tripled from 1.8% to 5.7% and laid-off workers faced lower re-employment prospects than those from most other sectors (OECD, 2016[32]). While unemployment spiked, a sustained increase in structural unemployment was avoided as the flexicurity system enabled a large proportion of the jobless to find employment relatively quickly (Eriksson, 2012[41]) and further strengthening of activation policies made the system more robust (OECD, 2016[32]).
Skill formation and a social safety net that protects people rather than jobs will become increasingly important. International experience shows that workers in the construction sector, once reskilled, are well-suited to working in renewable energy and energy efficiency renovations (Kane and Shivaram, 2020[42]; NABTU, 2020[43]). Construction employment fell substantially in Denmark during the 2008 financial crisis, but it has been one of the first industries to show signs of skill shortages during the recovery from the COVID-19 crisis, in part due to government support for energy efficiency renovations.
The strong involvement of trade unions and the private sector in skill development in Denmark is an asset for supporting workers’ transition to a low-carbon economy. Social partners hold a key role in vocational training centres and can help anticipate future needs. Vocational training will become increasingly important, as green activities in Denmark employ 10% more vocationally trained staff than the country-wide average (CONCITO, 2019[33]). This is consistent with experience in the EU that climate policies benefit technician jobs at the expense of manual workers (Marin and Vona, 2019[44]). The Green Business Forum has set up a collaboration on green skills to help ensure the availability of skills required for green initiatives. Several vocational education programmes have been overhauled to meet the demand for green skills, such as qualifications for environmental technologists, “energy-plumbers” and wind turbine operators (Cedefop, 2018[45]). However, there is no skill development strategy clearly related to the environmental and climate strategies and the need for green jobs is poorly assessed (Cedefop, 2018[46]). As most green activities in Denmark are concentrated in the energy sector, assessing the skills needed in other sectors could enahance their contribution to the transition (such as land management, and carbon capture and storage (CCS)).
The risk of emission leakage through international trade will have to be assessed and curbed to allow for an effective domestic strategy
Being a frontrunner towards carbon neutrality, with more ambitious targets than its trading partners, Denmark is exposed to the risk of losing international competitiveness if its firms have to bear the burden of higher energy costs. Production and emissions could shift to foreign countries as a result of increasing climate policy stringency. Emission leakage reduces the global effectiveness of climate policies and, through the threat of job and competitiveness losses, undermines political support.
Most empirical evidence based on past experience point at small emission leakage effects resulting from pricing emissions (Aldy and Pizer, 2015[47]; Sato and Dechezleprêtre, 2015[48]; Naegele and Zaklan, 2019[49]; Borghesi, Franco and Marin, 2019[50]). However, Denmark’s ambitious reforms and the openness of its economy increase the concern of large emission leakage and call for policy intervention. Recent modelling results from the Danish Economic Councils (2021[29]) show that an uncompensated carbon tax would cause a 21% leakage rate, with differences across industries. The most affected industries are expected to be those more exposed to European and international competition, such as agriculture and the food industry, and those in which relocation is easier.
To minimise carbon leakage, Denmark should continue engaging at the EU level, for example supporting the strengthening of the EU ETS, and globally, encouraging the adoption of ambitious climate policies elsewhere. When designing unilateral climate measures, the government should take into account existing European policies, including measures to reduce carbon leakage. An ambitious Danish policy, such as more stringent standards or a carbon price floor in the industries covered by the EU ETS, would reduce domestic emissions and thus reduce demand for EU ETS allowances, spreading the excess elsewhere in Europe. This effect can be partially limited via the EU ETS market stability reserve, or by cancelling allowances proportional to reductions in electricity generation capacity (electricity production is about one third of Danish EU ETS emissions). A more broad-based but fiscally costly solution would be for the government to purchase and hold allowances equal to the reduction caused by domestic policies.
Denmark can choose among several unilateral instruments to reduce emission leakage, with different trade-offs (Table 2.2). Rebates on domestic emission pricing, delinked from emissions, can be designed to shield industries from competitiveness loss but calculating them based on vintage or historic criteria (e.g. past emissions or past output) provides unfair advantages to incumbent firms and those firms able to pass-through carbon costs to consumers (Branger and Quirion, 2013[51]). Rebates calculated on current production (“output-based rebates”) provide a lower incentive to reduce output and thus to decarbonise (Sterner and Muller, 2007[52]). Such rebates provide stronger abatement incentives than preferential (lower) emission tax rates, as even under output-based rebates firms maintain a strong incentive to reduce emissions per unit produced. Unilateral border carbon adjustments seek to make the price of imported products reflect the costs they would have incurred had they been regulated under the destination market’s greenhouse gas emission regime (Cosbey et al., 2012[53]). While border carbon adjustments could minimise carbon leakage and favour the mitigation of GHG emissions, they are not a good unilateral option, as they could evoke risk of “green protectionism”, encountering retaliation from trade partners and possibly insurmountable legal hurdles within the EU and WTO rules (OECD, 2020[54]).
For Denmark, output-based rebates calculated on the basis of current production are likely to strike the best overall balance between protecting competitiveness and maintaining abatement incentives. Output-based rebates dull incentives to reduce output of emissions-intensive goods but this output reduction, concentrated in export-exposed sectors in a small open economy, would translate almost entirely into carbon leakage. A commitment to progressively phase-out compensation will strengthen the incentive to reduce production of emissions-intensive goods, while giving firms enough time to adjust.
A precise assessment of leakage risk, using clear criteria, is needed to calibrate rebates. The results from the Danish Economic Councils (2021[29]) improve significantly on earlier studies (Danish Economic Councils, 2019[37]), but cannot be used to calibrate product-specific compensations as they do not overcome common methodological shortcomings, including the sensitivity to the model parametrisation (Alexeeva-Talebi et al., 2012[55]) and insufficient industry disaggregation (Fowlie and Reguant, 2018[56]). The government should also commit to regularly update leakage rate estimates, which is necessary to take into account changes in trading partners’ efforts to reduce emissions and international policy conditions.
The Danish Economic Councils also proposes an excise tax on final and intermediate goods in industries benefiting from rebates. Such a tax would be levied on domestic production and imports but, if allowed by WTO and EU regulation (Fischer and Fox, 2012[57]), not on exports. An excise tax on carbon-intensive goods, in addition to emission pricing and the output-based rebates, can restore mitigation incentives (Böhringer, Rosendahl and Storrøsten, 2017[58]; Neuhoff et al., 2016[59]). Its main disadvantage is that, because such a tax would be levied at the consumption stage, it requires keeping track of all the materials used in the value chain, including imported ones (Neuhoff et al., 2016[59]). This would pose further administrative costs and data requirements, especially in heterogeneous and finished goods.
Table 2.2. Policy options to reduce emission leakage: strengths and weaknesses of selected instruments
1. Output-based rebates are rebates on the emission pricing proportional to the firm’s share in domestic production. 2. Providing a flat rebate, not calibrated on leakage rates, only to Emission Intensive and Trade Exposed (EITE) industries.
Key policy instruments for a net-zero economy
Accelerating the pace of decarbonisation will require an ambitious package of new policy measures. This section argues that emission pricing should remain a keystone of climate policy. However, public resistance and adverse income distribution effects limit what can be done in the short term. Hence, flanking measures will continue to be needed to complement carbon pricing such as regulation, public investment, innovation incentives, and other institutional reforms.
The policy instruments that are specified in this section can be used for curbing either the supply or the demand for emission-intensive goods. Although policies affecting demand would have a smaller impact on direct emissions and domestic objectives, they will contribute to decrease the emission footprint of Denmark (Figure 2.6 above) and reduce the risk of carbon leakage. Leveraging the demand for emission-intensive goods, notably by providing sustainable alternatives, can contribute significantly to reaching the global objectives of the Paris agreement and offers synergies with other sustainable development goals such as food security and air quality (Allen et al., 2018[60]). Sectoral examples of such policies are presented in Chapter 3 in energy, transport and agriculture.
Aligning emission pricing to accelerate the transition
Denmark has been a pioneer in environmental taxation and first implemented carbon pricing in 1992. This carbon tax now amounts to DKK 178.5 per tonne of CO2 (EUR 24/tCO2) and is applied to sales of transport fuel and non-district heating. Other carbon pricing mechanisms include the excise taxes on fuels and EU ETS. The government intends to retain carbon pricing as a keystone of its decarbonisation strategy. The Energy and Industry Agreement of June 2020 between government and other parties contains a proposal for green tax reform. The first phase of the reform consists of an increased tax rate on fossil fuels used in industries’ processes as soon as 2023, along with compensation measures. The second phase will consist of a uniform carbon tax. An expert group on carbon pricing convened by the government will publish the first part of its recommendations for uniform CO2e taxation by the end of 2021, before a final report in 2022, so a decision on coverage and the future pathway of emission taxation cannot be expected before 2022 at the earliest.
Keeping carbon pricing as a key instrument of decarbonisation is welcome and all the more efficient if the strategy is clarified soon enough for actors to adjust. Putting a price on emissions discourages the production and consumption of goods with strong carbon content. It also provides a clear signal to investors about the interest of investing in low-carbon technologies and encourages innovations that reduce GHG emissions (OECD, 2021[61]). Experience has shown that a strong carbon price effectively reduces carbon emissions. After the United Kingdom added a Carbon Price Floor to EU ETS prices in the electricity sector in 2013, emissions decreased by 53% by 2018 and the share of coal in generation went from 37% to 2% (Hirst and Keep, 2018[62]; IEA, 2021[63]). Making the carbon price uniform across energy sources and sectors is particularly important: it makes the instrument technologically neutral and does not require supervision to determine or anticipate which technology or process is the most effective – it leaves firms to innovate and determine the best approach in their own context. Carbon pricing also provides revenue that can be used to reduce other taxes or compensate those worst affected, at least temporarily before success in reducing emissions erodes the tax base.
However, while emission pricing is the most cost-effective tool in theory (OECD, 2019[64]), it creates both winners and losers and there can be resistance to such policies, compromising the efforts to cut GHG emissions (OECD, 2019[65]). Even though the notion of a uniform emission tax is supported by a large part of the population (FH, 2020[66]), its concrete application can face opposition. A new international OECD survey of over 2 000 respondents in Denmark in several countries investigates the public acceptability of carbon pricing and other mitigation policies (Figure 2.7 and Box 2.3). Similar to other countries studied, a large majority in Denmark (81%) considers that climate change is an important problem and that it is their country’s responsibility to fight it (77%). Danes are more prone to accept stringent measures, such as taxes and regulation on polluting goods or service and more than half of them are willing to pay up to USD 300 a year for climate action. However, the implementation of a USD 45/tCO2 tax on fossil fuel is supported by only a minority of Danes (44%), while the population is rather supportive of a tax on flying or local ban for polluting cars.
Figure 2.7. Denmark’s population is rather supportive of climate policies, except a fossil fuel tax
Proportion of people supporting the following measures, 2021 data
Source: Boone, L., Dechezleprêtre, A., Fabre, A., Kruse, T., Planterose, B., Sanchez-Chico, A., and Stantcheva, S. (forthcoming), Understanding public acceptability of climate change mitigation policies across OECD and non-OECD countries, OECD publishing, Paris.
Box 2.3. Acceptability of climate change mitigation policy instruments in Denmark
The OECD led a survey on the acceptability of climate policies in Denmark, France and the United States. In Denmark, it was made on a sample of 2 011 respondents, representative along gender, age, income, region and rural/urban dimensions.
Survey results indicate that fewer Danes support a tax on fossil fuels than other climate policies presented, and this opposition varies little with the level of income. Other types of climate policies are generally better supported by high income groups. Support for carbon taxation is higher when revenue is used for targeted investment and support for green technologies. When Danish survey participants were provided with information on the local impacts of climate change and the effect of climate policies, they tended to be more supportive of climate policies, particularly a carbon tax with transfers.
Figure 2.8. Stated support to climate policies
Denmark, 2021 data
Source: Boone, L., Dechezleprêtre, A., Fabre, A., Kruse, T., Planterose, B., Sanchez-Chico, A., and Stantcheva, S. (forthcoming), Understanding public acceptability of climate change mitigation policies across OECD and non-OECD countries, OECD publishing, Paris.
Box 2.4. Building acceptability for carbon pricing: the case of Switzerland
Switzerland’s carbon intensity is the lowest in Europe and OECD countries due to low energy intensity and a large share of energy from hydro and nuclear power. In order to meet its annual carbon target, the country implemented in 2008 strong carbon pricing on heating fuels, which has been set at CHF 96/tCO2 (about EUR 88/tCO2) since 2018. In that year, 75% of CO2 emissions from energy used were priced and 69% of them at a rate exceeding EUR 60/tCO2 (OECD, 2019[64]).
This policy raised distributional and competitiveness concerns, which the federal government addressed through a transparent processes and accountability. Eligible firms can be exempted if they commit to undertake specific abatement measures or targets. About two-thirds of the tax revenue was redistributed through a lump-sum rebate of social security contributions of around EUR 80 per person and reimbursement of firms proportional to their wage bill. The remaining third of tax revenue is earmarked for retrofitting works and the development of sustainable heating fuels.
The level of the carbon tax depends on the country’s climate performance and its success in meeting annual objectives, adding another incentive for abatement. In June 2021, a federal vote rejected increasing the maximum tax rate up to CHF 210/tCO2 (EUR 194/tCO2) and broadening the tax base.
Broad support for climate policies and emission pricing can be ensured in Denmark with transparent use of new tax revenue during the transition and education measures. A large share of Danes would oppose a carbon tax used for reducing corporate taxes, but the share of people opposed would fall by more than two-thirds if it was used to fund green technologies and infrastructure (Figure 2.8 above). Moreover, providing information on climate change and the effectiveness of policies substantially increases public support for these policies (Boone et al., forthcoming[67]).
Policy design is therefore crucial. Popular support could be boosted by involving stakeholders in the design of policy measures. Past experience in British Columbia showed that negotiations with businesses prior to the launch of the measure and strong political leadership can help public support to gain momentum over time (Harrison, 2013[68]; Murray and Rivers, 2015[69]). Clear communication and transparency on climate targets and the tools to reach them are also key. Transparent use of revenues from emission pricing can restrict government choices, but also contribute to a broad endorsement of tax measures. A study across 40 countries showed that a large majority of emission pricing revenues are subject to constraints on their use (Marten and van Dender, 2019[70]). Switzerland offers a good example of an effective carbon tax that gained public support through transparent revenue use and flexibility (Box 2.4 above).
While gaining public acceptance for strong measures can be a challenge, Denmark has scope to catch up with countries that implement emission pricing more effectively. The OECD indicator on Effective Carbon Rates show that many emissions are priced in Denmark at low levels by international comparison (Figure 2.9), particularly compared with other European countries. Neighbouring countries such as Germany (Box 2.5), the Netherlands (Box 2.6) and the United Kingdom have plans to implement carbon pricing more effectively. Indeed, countries with the most effective carbon pricing (in terms of level and coverage) have the lowest carbon intensity (OECD, 2021[61]) (Figure 2.9).
As noted, emission pricing needs to be uniform to be technologically neutral and provide incentives to all actors. Gases other than CO2, such as methane (CH4) and nitrous oxide (N2O), are key for the future of climate (Allen et al., 2018[60]), and cuts in methane emissions are particularly important to meet medium-term international climate targets (UNEP - UN Environment Programme, 2021[71]). Uniform pricing of GHG emissions also means that negative emissions, and therefore CCS (from cogeneration plants, waste incineration, cement, etc), are supported through a subsidy at the same price. Such support would greatly accelerate the development of Danish CCS technologies, which could contribute up to a third of total abatement by 2030 according to the Danish Economic Councils (2021[29]). While there are no CCS projects in full-scale operation in Denmark as yet, pilot projects are underway and the technology is being deployed in other countries such as Norway and the United States. Delivery of CCS and other technological solutions to reduce emissions without reducing output could reduce the risk of emissions leakage through international trade. Subsidies for negative emissions would also pave the way for accelerated carbon capture in restored land in the longer term.
Box 2.5. Increasing emissions pricing in non-EU ETS sectors: the case of Germany
Germany’s Climate Action Plan 2030 includes a carbon pricing system in transport and heating that became operational in January 2021. It operates in parallel to the EU ETS and covers the bulk of emissions not included in the EU ETS. During the initial phase (2021-2025) emissions allowances have a fixed price (equivalent to a tax), starting at EUR 25/tCO2 in 2021 and increasing to EUR 55/tCO2 in 2025. In 2026, emission permits will be auctioned with a price range of EUR 55 to 65/tCO2, transitioning to a market price with an option for price corridors from 2027.
The government expects the system to generate revenue of EUR 40 billion from 2021 to 2024, which will be used to lower the renewables surcharge on electricity, for other relief measures and to support climate action. The government adopted a regulation in March 2021 to reduce leakage by providing compensation in emissions-intensive trade-exposed industries, under the proviso that companies undertake emission reduction measures and invest at least 50% (from 2023) to 80% (from 2025) of compensation payments from the previous year in economically-viable energy-efficiency measures. Compensation payments are scaled between 65% and 95% depending on emissions intensity, with subsidy levels set by benchmarking against the 10% best-performing plants in the sector.
Source: (Clean Energy Wire, 2020[72]; Clean Energy Wire, 2021[73])
Figure 2.9. Emission intensity is negatively correlated with coverage of carbon pricing
2018 data
Note: The GHG emissions include non-CO2 emissions such as methane and nitrous oxyde but exclude LULUCF. The effective carbon rate is the sum of taxes and tradeable permits that put a price on carbon emissions. The carbon pricing score answers the question how close countries are to price carbon in line with carbon costs. In this chart, the carbon pricing score refers to the EUR 60 per tonne of CO2.
Source: OECD, Environment database and Effective Carbon Rates (ECR).
Box 2.6. Increasing emissions pricing in EU ETS sectors: the case of the Netherlands
The Netherlands has the ambition of reducing its GHG emissions by 49% by 2030 and 95% by 2050 relative to 1990, while reducing industry emissions by 59% by 2050. The country is heavily reliant on fossil fuels, with a concentration of emission-intensive industries. Energy, manufacturing and construction are responsible for 46% of GHG emissions. Like Denmark, it is a small country, open to international trade and embedded in the EU climate policy.
The first pillar of the Dutch strategy is a carbon levy on industrial emissions which applies if EU ETS prices fall under a certain level. In this case, emitters pay the differential to the floor price. Implemented in 2021 with a clear pathway, it is expected to reach a total of EUR 125 per tCO2 in 2030 (including EU ETS prices) adding some certainty to sectors subject to variable prices under the EU ETS. In order to avoid carbon leakage and loss of competitiveness, the government has granted tax exemptions, in the form of regressive energy tax and emission allowances to energy-intensive industries. This erodes the carbon pricing signal and advantages large incumbents over small firms, which typically face much higher energy and carbon prices. Generous allocation of “dispensation rights” based on EU ETS benchmarks mean that less than 10% of emissions in key sectors are subject to the carbon levy in 2021, but long-term incentives are stronger as this ramps up to 45% by 2030.
The second pillar of the strategy is support to new technology development for mitigation. Public tenders of the main support programme are allocated on the basis of least-cost abatement, to ensure an efficient distribution of subsidies. The development of markets for low-carbon hydrogen is a key issue, with the potential to partly replace natural gas and fuels in hard to abate sectors (such as international transport).
Source: (Anderson et al., 2021[74]), (IEA, 2020[75])
However, Denmark fails to apply a uniform carbon price, creating a pricing gap between sectors and industries (Figure 2.10). In 2021, 61% of carbon emissions from energy use are priced, but rates are relatively low and heterogeneous. Only 39% of carbon emissions from energy use were priced above EUR 60 per tonne of CO2, which is a midpoint estimate of the carbon price in 2020 that would be consistent with the Paris Agreement, and a low-end estimate for 2030 (OECD, 2021[61]). Road transport produces most of the priced emissions, which have an average effective carbon price (through excise taxes and carbon pricing) of EUR 197.7 per tonne of CO2. This is lower than in most neighbouring countries (OECD, 2019[64]) and excise taxes, not based on a fuel’s carbon content, constitute a very large majority.
Eliminating the carbon pricing gap by pricing all emissions at a minimum of EUR 60/tonne would provide more consistent price signals and thus contribute to cost-effective abatement. Government revenue would be increased by 1.2 billion (almost DKK 9 billion), more than half from the pricing of agricultural emissions (Table 2.3). Without behavioural adjustment, this would have the biggest effect on energy emissions in industry, as well as on electricity production. Behavioural adjustment would reduce government revenue, with a smaller reduction in costs for firms as substitution to lower emissions technologies will generally carry costs. The tax burden for biomass, now poorly priced, would exceed 40% of the increased tax revenue (EUR 550 million) in the energy sector if it is priced according to its average life-cycle CO2 emissions. Burning biomass emits CO2, but where it is harvested from forests that are managed sustainably then regrowth offsets these emissions, with the precise environmental effects dependent on the type and source of biomass (Chapter 3). Implementing a minimum price on all GHG emissions would entail a significant cost for agriculture, responsible for both CO2 and non-CO2 emissions. The risk of leakage from the expansion of emission pricing to traded sectors should be addressed directly via temporary rebates (section 2.2.2).
Figure 2.10. Effective carbon rates are heterogeneous in Denmark in 2021
Note: Effective carbon rates are the sum of fuel excise, carbon taxes, and emissions permit prices. The figure shows the effective carbon rates across all energy-related (respectively fossil fuel) CO2 emissions, sorted from lowest to highest rates by total emission percentile (some emissions where they account for less than 1% of total emissions therefore do not appear). Tax rates are those applicable on 1 April 2021, the emissions permit price is the average EU ETS price for the first half of 2021. Emissions are calculated based on energy use data for 2018. For panel A, emissions from the combustion of biomass and biofuels, are included, whereas these are excluded under the IPCC Guidelines for emissions from energy use and in panel B.
Source: OECD (work in progress), Taxing Energy Use 2022.
Table 2.3. Budgetary impact of a uniform GHG emission price of EUR 60 per tCO2e
Note: The reference EU ETS price amounts to 43.96 EUR as the average futures daily close price in December 2020. Emissions from solid biomass are priced according to the 25% midpoint of the emission saving requirement for biomass from the EU 2018 Renewable Energy Directive, based on most of the gross emissions being offset by forest regrowth. Direct emissions from solid biomass are therefore here subject to a minimum EUR 15/tCO2 price. Energy emissions from municipal waste and biogas are not covered by the increase in pricing.
Source: OECD calculations from OECD data on effective carbon rate for energy emissions (year 2021) and on domestic emissions for non-energy emissions (year 2018)
EU ETS permit prices are more than twice as high as the Danish carbon tax, creating different price signals across sectors. Broadening the application of a minimum emission price of EUR 60/tonne would be roughly consistent with the prevailing EU ETS permit price in the third quarter of 2021, thus increasing efficiency through greater uniformity in prices across sectors and facilities within and outside the system. The EU ETS is now in its fourth phase, during which the reduction of free allocations and reinforcement of the market stability reserve should support a price on emissions that is broadly consistent with Denmark’s climate ambitions. The proposal made by the European Commission in July 2021 to lower emission caps further and phase out free allowances for aviation confirms the intent to strengthen the EU ETS (Box 2.7). Cooperating to strengthen the EU ETS should be Denmark’s priority, as the EU-wide system also alleviates the risk of leakage between neighbouring countries in key sectors.
Denmark is a strong advocate of reforming support to fossil fuels, and, since 2010, has been an active member of the informal group of countries “Friends of Fossil Fuel Subsidy Reform”. Support to fossil fuels is a common tool worldwide to reduce costs for energy users, at the expense of climate targets, blurring price signals to the benefit of technologies with high emissions. Although Denmark’s support measures are relatively weak, total public fossil fuel support amounted to DNK 1.6 billion in 2019, most of which (1.3 billion) consisted of a reduced diesel tax rate for buses, lorries and tractors (OECD, 2021[76]). This sectoral support can be shifted to more efficient types of subsidies that do not encourage the use of and investment in technologies that are detrimental to climate objectives.
As prices of goods and services will be affected, the distributional impacts of increased pricing should be anticipated and offset. Government revenues from carbon pricing might provide some fiscal space to implement such compensatory measures, including direct transfers or accompanying measures, even if only temporarily. These measures should not blur the carbon price signal by subsidising current emissions or long-term unprofitable activities. Targeted support to households rather than sectors can be viable options, as well as temporary measures helping with the transition, depending on the sector and populations affected. For instance, carbon pricing on energy products affects all households throughout the income distribution and households can be compensated on the basis of their income. By contrast, climate measures in agriculture might be detrimental to farmers, but also rural regions dependent on farming. Temporary accompanying measures and subsidies for carbon sequestration would support mitigation actions and avoid widespread bankruptcies of firms that would otherwise be profitable.
Redistributing proceeds and continuing to reduce electricity taxation can avoid negative distributional effects from emission pricing. Households with low incomes are likely to carry a disproportionate burden, because of the higher share of goods with a high climate impact (transport, heating, food) in their consumption or disposable income. Using the revenue to reduce electricity taxes (Chapter 3) and provide a climate bonus to every citizen would reverse the distributional outcome, with the possibility for households in the first two deciles to benefit overall (Kraka and Deloitte, 2020[77]).
Even with measures to attenuate the social impact of higher carbon prices, it may be difficult politically to raise carbon prices rapidly to the levels estimated by the Danish Economic Council as needed to meet the 2030 target levels (EUR 135 to 160 per tonne of CO2 uniformly). Alternatively, gradual increases in emission pricing could be complemented by other instruments that are available in Denmark (Table 2.4) to form an inclusive and acceptable climate strategy.
Table 2.4. Impact assessment criteria and the Danish implementation of climate policy tools
Source: Adapted from (OECD, 2021[78]).
Box 2.7. Cutting EU emissions by 55%: an ambitious package from the European Commission
In July 2021, the European Commission (EC) launched a package of proposals for the EU to reduce its GHG emissions by at least 55% by 2030 compared to 1990 levels and reach climate neutrality by 2050. Although the 2030 target at the EU level is less stringent than the 70% target in Denmark, specific measures in the EU package, and more particularly in the transport sector imply faster action than expected so far. An EU-wide package, by defining a coordinated action between countries can also reduce the risk of leakage and facilitate the implementation of bold domestic strategies.
The Commission’s plan includes stronger and more efficient carbon pricing and more stringent regulations, with a major focus on transport emissions. According to this proposal:
The EU ETS will be strengthened through the broadening of its scope to emissions from the maritime sector, the decrease of the annual cap of emissions and phasing-out free allowances. Revenues from ETS will be used for climate and energy-related projects.
Strengthened emission reduction targets will be assigned to member states in sectors currently not covered by the EU ETS through the Effort Sharing Regulation.
Emissions from road transport and buildings will be priced from 2026 through the creation of a separate emission trading system based on fuel distribution in these sectors, leading to a 43% reduction of targeted emissions in 2030 relative to 2005.
A Carbon Border Adjustment Mechanism will apply to a selection of carbon-intensive products. This will apply from 2026, after a three-year transition, and should be consistent with WTO rules.
The Energy Taxation Directive will be updated to set minimum energy tax rates that encourage energy efficiency and sustainable fuels. Fuel tax exemptions and reductions will be phased out.
New ambitious targets include carbon removal (including a plan for planting 3 billion trees), the share of renewable energy and energy efficiency (energy saving targets being nearly doubled).
More stringent standards for fuel emissions will be applied in the transport sector to pave the way for zero-carbon standards from 2035. This will be accompanied by new requirements for member states to provide adequate electric charging and sustainable fuel provision points. More stringent requirements and easier access to sustainable fuels will also apply to the aviation and maritime sectors.
A “Social Climate Fund” will support vulnerable households and micro-enterprises in the transition, partially financed by new revenue from the ETS in the transport and building sectors.
Most of these proposals from the European Commission will be discussed with the EU Parliament and the Council of the EU, under the ordinary legislative procedure. This entails that both institutions should agree on a text on the basis of the EC’s proposal and the overall process could well exceed a year.
Source: (European Commission, 2021[79]), (European Commission, 2021[80])
Regulation can be a valuable part of the policy mix where cost-effective measures are targeted
Substantial mitigation benefits can be reaped through a clear and predictable regulatory environment (i.e. rules and norms making mitigation actions mandatory) that can directly reduce emissions, but also enhance the effect of pricing measures if well-tailored. The Danish Climate Council recommends a broad set of regulatory measures to reach the 70% target, including a ban on burning coal for electricity or heating by 2025, a ban on conventional-engine vehicles, low-carbon zones in cities, requirements for energy renovation or emissions standards for biogas plants (Danish Climate Council, 2020[81]). Regulation has proven effective to reduce emissions by restricting outright emissions-intensive activity and is mostly more supported by the public than pricing (Box 2.3 above). For instance, stringent regulation and monitoring of fertiliser use and soil management allowed for a 16% reduction of nitrous oxide emissions over two decades in Denmark, though the main objective was the reduction of nitrate in the environment (Section 3.3.).
However, there is a significant risk that the emissions cuts brought by standards and norms entail much larger socioeconomic compliance costs than under a pricing mechanism. Complying to standards and rules may entail substantive abatement costs and fail to target the cheapest emission cuts: for example, studies show that implementing fuel standards may be very expensive, at up to USD 2 900/tCO2 (Gillingham and Stock, 2018[82]). A number of studies indicate that average costs per unit emission reduction via regulations are about double those for a price intervention (Goulder and Parry, 2008[83]). Regulation can also have negative distributive impacts where compliance costs are higher for vulnerable households and firms. These effects are unclear and poorly documented so far, requiring further research (OECD, 2021[84]). Nevertheless, where price responses are muted due to imperfect information or behavioural limitations, such as for household appliances, building insulation, land clearing and waste disposal, regulation can be a valuable part of an overall policy package (Freebairn, 2020[85]).
Regulation should be tailored and updated to facilitate mitigation actions with minimum costs. The first condition is to curb the potential regulatory barriers to mitigation actions. In France, heavy administrative constraints for solar power tenders might have hampered the development of this renewable energy (OECD, 2021[86]). In Denmark, as CCS is a key element of the government’s climate strategy, legislation needs to clarify the safety conditions, liabilities in case of leakage, adapt and potentially remove barriers to storage (Danish Climate Council, 2020[30]), for instance by facilitating the storage from multiple sources in order to harness economies of scale when security is ensured. Regulation should also be reformed to facilitate the phasing out of households’ boilers from the natural gas network (Danish Climate Council, 2020[81]). Making the legislative environment predictable is a second condition for effective actions. It also has to be regularly updated to exploit opportunities from cutting-edge technologies. In order to keep incentives for the lowest carbon-emitting technology and maintain tax revenues, Israel, for instance, updates the categories of vehicles that are eligible to lower taxation every two years according to a pre-agreed procedure (OECD, 2016[87]).
Private investment is key for meeting climate targets
Investment in low carbon technologies in all sectors is crucial for the transition to a net-zero economy and climate outcomes in the long term. Supporting public and private investment flows in such technologies could accelerate the transition and complement carbon pricing by providing alternatives to emission-intensive technologies. The recent action plan for the financial sector estimates that DKK 600 billion of investment will be needed by 2030 to cut emissions by 70% (Pedersen, 2020[88]), which is three times the capital of the government-supported Danish Green Investment Fund and just over 2% of GDP for the next decade. Illustrating the considerable uncertainty around investment needs, the Trade Union Confederation estimates that financing needs amount to the lower range of DKK 330-440 billion (2020[89]).
Green investment benefits climate stability, but also economic growth and employment. It can be a substantial lever for job creation, particularly in the energy sector (Moszoro, 2021[90]). In the context of unprecedented recovery packages following the COVID-19 crisis, green investment measures such as infrastructure or energy efficiency renovations are among the most effective to support economic growth and climate in high-income countries (Hepburn et al., 2020[91]). Accordingly, the Danish plan for recovery includes substantial support (DKK 3 900 million) for research and development of green technologies (OECD, 2021[92]). While there are upfront costs from reducing consumption to fund investment (Pisani-Ferry, 2021[24]), some funding can come from redirecting investment away from emissions-intensive activities and a large share of green investments will carry long-term welfare and economic benefits: for example, there are large upfront costs from investing in wind generation, but longer-term benefits from savings in fuel costs.
Government action is crucial to accelerate investment in low-carbon or net-zero technologies by supporting private sector investment, direct public investment or regulation. Denmark has led the way by substantially decreasing the cost of renewable energy, particularly offshore wind, through sustained support including feed-in tariffs, spatial planning and ambitious quantitative targets (Chapter 3). A clear and predictable GHG pricing system should make such investments profitable and bring forth liquidity. However, the Green Tax Reform announced by the Danish Government will take some time to be clarified and implemented, while today’s investment choices will affect the country’s capacity to cut GHG emissions by 2030 and 2050. Furthermore, even with significant and predictable carbon pricing, market imperfections might hamper investment. Development of a sound definition of what constitutes “green” investment would facilitate better disclosure and provide new market opportunities, while financial supervision should be updated to reflect systemic physical and transition risks associated with climate change (Section 2.3.5).
The Danish government supports private investment for climate using different tools, including research and development funding, streamlined planning processes, subsidies and ambitious national targets for renewables. Public finance institutions also use co-investment in equity funds to reduce the financial risks for institutional investors in green infrastructure (OECD, 2021[93]). The Green recovery plan, decided in 2020 for the country to overcome the COVID-19 crisis and built from the past agreements on the green transitions of road transportation, on stimulus and green recovery and from the Green tax reform, will constitute a third of the emission cuts from measures decided so far by the current government to reach the 70 percent target (The Danish Government, 2021[94]). It includes tax cuts and up to DKK 700 million grants for investment in green technologies (OECD, 2021[92]). In September 2020, a trans-partisan agreement between the Danish Government and other parties allocated DKK 6 billion to the Danish Green Investment Fund, an independent state loan fund that offers risk capital to promote a green transition. It has the ambition to develop technologies and ecosystems for green innovation and to scale them up in five areas: food and agriculture, energy and utilities, building and infrastructure, materials and resources, transport and mobility. The government also encourages green financial investment and requirements through partnerships with the private sector and investments from its pension funds (see below).
Public support for investment needs to be well targeted to sectors with untapped climate potential and address a specific market imperfection. As technologies become more profitable for private actors, as for much renewable energy, uncertainty decreases and public support should be phased-out gradually, without compromising continued development. Good monitoring of green investment projects and their costs is therefore key. Moreover, when possible, and when the information is available, the abatement cost of projects (the cost of one unit of abated GHG emission) should be one of the criteria used to prioritise. This is the approach already taken by the government when comparing different climate change mitigation measures at the national level (MoCEU, 2020[9]). On the contrary, in Norway, the lack of consideration for economic efficiency throughout the process for transport infrastructure often leads to sub-optimal choices with high early costs and low benefit-cost ratios (OECD, 2017[95]).
Well-targeted public investment needs to play a role
Public investment, possibly paired with the private sector, will be a cost-effective option in some cases, even alongside other mitigation policies. Public money can be spent to cover other externalities that are not included in carbon pricing. This is the case for instance for land restoration that benefits a large number of environmental outcomes (biodiversity, water regulation), or natural monopoly public transport infrastructure that facilitates overall mobility. The choice of one technology over another depends not only on its relative cost, but also on its physical accessibility (for example, the access to a charging station or to the grid), which private markets cannot always provide because of high fixed costs.
The quality of infrastructure is overall high in Denmark, but more public investment is needed to expand electricity networks and access to electrified rail and heating. The definition of a clear strategy for infrastructure in June 2021 for a 2035 horizon for DKK 160 billion (including for a total decarbonisation of train traffic by 2035) also has the benefit of providing some certainty to firms and consumers willing to invest in certain sectors (e.g. Transport or energy). The overall quality of infrastructure is judged to be in the dozen best among OECD countries, but below the OECD average for railroad infrastructure (World Economic Forum, 2018[96]). There is low efficiency of train services and a low share of electrified rail, with delays in plans for electrification (European Commission, 2020[97]). The electricity network will need to expand to accommodate plans to further increase renewables, while investment is also needed to convert district heat generation from biomass combustion to electric heat pumps (Chapter 3). The infrastructure agreement between the government and a broad majority of the parliament released in June 2021 includes more than DKK 86 billion for public transport and DKK 3 billion for new bicycle infrastructure by 2035. Infrastructure planning processes should be improved to prioritise projects according to cost–benefit analysis, particularly at municipal level where there are no long-term strategic plans (Chapter 1; (Vammalle and Bambalaite, 2021[98])).
Integration of a significant emission price in public projects has the capacity to enhance investments for climate change mitigation. It should be included in cost-benefit assessments for public projects, ensuring they do not undermine climate objectives and allowing public authorities to choose between different options. Similarly, emission pricing at a level that is aligned with Danish climate ambitions should be a component of green procurement processes, as DKK 300 million is spent each year for public procurement. Central government nudges local governments for greener processes through guidance and events, but it can go further, for instance by providing a simple carbon footprint calculator for different projects, or by including climate requirements for green procurement in local climate strategies. Such policies are relatively easy to implement and would send a clear signal to private investors.
The green transition has important implications for the finance sector
More information on a credible, consistent and comparable basis is necessary for financial institutions and investors to assess climate-related risks. Financial frictions and asymmetric information in financial markets reduce financial institutions’ ability to correctly price climate risks in investments, limiting opportunities for private low-carbon investments (Battiston et al., 2017[99]). Policies that strengthen the informational tools of banks and institutional investors are critical, such as Environmental, Social and corporate Governance (ESG) indicators for financial assets and the EU’s new taxonomy of environmentally sustainable economic activities. Mandatory disclosure for listed companies and simplified labelling of the climate exposure of financial products, consistent with the EU taxonomy, would help retail investors in particular to make better-informed choices. This information facilitates the flow of capital towards investments consistent with an orderly transition to a low-emissions economy, while better enabling management of climate-related financial stability risks by investors, banks and regulators (Bailey, 2021[100]). Better disclosure will enhance benefits from the plans of Danish pension funds to invest EUR 46 billion in clean energy and climate between 2020 and 2030. Since 2019, EUR 8 billion has already been invested, exceeding expectations. Specific training may be needed in banking, coupled with incentives to overcome short-term biases that impede the reaction to long-term climate risks.
The central bank and financial regulators need to take climate-related risks into account in their operations. Updating financial regulation to reflect the systemic risks associated with climate change can reduce (unpriced) financial uncertainty and foster decarbonisation. Climate stress testing is important to gauge the systemic importance of climate-related risks, though methodological limitations remain important: financial institutions have difficulty assessing market risk over such a long time horizon, the mechanisms for transmitting climate shocks to the real and financial economy are not yet well understood and the exercise remains sensitive to the choice of different scenarios (OECD, 2021 forthcoming France survey). As an alternative to a fully-developed climate stress test, the Danish central bank investigated a number of sensitivities, finding that Danish banks are well-equipped to handle risks from the transition to a low-emissions economy, but that a drastic transition over a short time frame could result in a capital shortfall (Danmarks Nationalbank, 2020[101]), with greatest exposures in key industries of agriculture, energy, manufacturing and transport (Figure 2.11, Panel A). Stress testing by the Banque de France showed that insurance companies are particularly exposed to physical risks: the cost of claims could rise by a factor of 5 to 6 in certain French departments between 2020 and 2050. Development of new, scenario-based modelling approaches is necessary to better understand climate-related risks (Svartzman et al., 2020[102]). Central banks cannot entirely substitute for other policies that are lacking. For example, the Danish central bank (2021[103]) has stated that a specific and credible carbon tax will support financial stability by preventing lock-in of unprofitable investments, and by reducing the uncertainty surrounding the transition and thus supporting the pricing of climate-related risks in financial markets.
Figure 2.11. Green bonds are still developing, while lending to high-emissions activities varies considerably by industry
Note: In Panel B, each dot represents one sub-industry within the named industry groupings.
Source: Danmarks Nationalbank (2020), "A Gradual Green Transition Supports Financial Stability", Analysis - Climate, No. 21; Climate Bonds Initiative database.
The Danish government is working towards joining nineteen other countries by issuing its first green bonds. Several models are being considered, including a unique proposal for the issue of separable conventional bonds and green certificates. The bonds and certificates would be sold together at green auctions, but could then be traded separately (Danmarks Nationalbank, 2021[104]). The aim is to support liquidity in the conventional bond market (Bongaerts and Schoenmaker, 2020[105]), but the enduring value of the green certificates is unclear, as these would have no financial commitments (coupons or redemption value) attached. If this adversely affected demand for green bonds at auction it would undermine an important mechanism to fund green investments. An alternative being pursued by Germany is a “twin bond” first issued in September 2020, whereby green bonds can be freely swapped with a conventional bond with the same maturity and coupon. This underpins liquidity while still allowing green bonds to be sold at a premium on the secondary market. The best model for Denmark needs to be chosen after due consultation with primary dealers and investors to establish demand and preferred design features. Improving the credibility of green investment labelling will be important to increase demand for green bonds, including those issued privately, which are a small but growing source of finance (Figure 2.11 above, Panel B). The European green bond standard proposed in July 2021 is an important tool to improve information disclosure, verification and standardisation.
Research and development plays a major role in the Danish climate mitigation strategy
The current climate programme relies on technological advances for two thirds of abatement by 2030. This calls for measures in areas with acknowledged mitigation impacts, but also highlights the need for a significant contribution from innovation, research and development (Danish Climate Council, 2021[21]). Investment in research and development can also benefit employment and job creation, more effectively than direct public investment if this research is done in higher education and the private sector (Moszoro, 2021[90]). The green research strategy is focused on four missions: 1) carbon capture, utilisation and storage, 2) power-to-X (Chapter 3), 3) climate and eco-friendly agriculture and food production, 4) recycling and reduction of plastic waste (MoCEU, 2020[9]).
Research and development for climate and the environment is particularly effective in Denmark. Experience shows that it is a key factor for successful climate change mitigation strategies: economies with a higher share of R&D spending per unit of GDP are also the most innovative for climate (Figure 2.12). The share of GDP allocated to research and development is relatively high in Denmark (3%), and 5% of non-business research and development (accounting for 35% of total R&D) is specifically allocated to energy and the environment. Denmark ranks particularly high among European countries in terms of environmentally-related patents, which accounted for 23% of new patents from Denmark in 2018. Moreover, Denmark ranks particularly high in international comparisons of the number of climate-related patents per unit of GDP (Figure 2.12). As a small country, Denmark’s access to new technology will also depend crucially on innovation in other countries, heightening the important of international collaboration on research that can drive emission reductions.
Figure 2.12. High R&D expenses are correlated with many environmentally-related patents
Climate change mitigation technology patents relative to RD&D expenses
Note: RD&D expenses cover the expenses on energy efficiency (group 1) and renewable energy sources (group 3). Both RD&D expenses and GDP are measured in 2019 USD PPP for 2019. The number of patents is the 2015-2018 average of climate change mitigation technologies related to energy generation, transmission or distribution (family size two and greater), weighted by the 2015-2018 average of the GDP expressed in 2015 USD PPPs billions.
Source: OECD, Environment (Innovation in environment-related technologies - Technology Development) database; OECD, National Accounts database; and IEA, Energy (Energy Technology R&D - RD&D Budget) database.
Strong support for R&D should be broadened to sectors other than energy. Innovation for climate and the environment has been focused so far on the renewable energy sector (61% of environmentally-related patents in 2018), mostly in wind energy. In contrast, a smaller share of environmentally-related patents apply to production processes (15%) or buildings (8%). Carbon capture and sequestration only accounts for 0.5% of innovations in Denmark (against 0.74% in all OECD countries). The current plan for climate research, opening areas of research outside the energy sector, is therefore welcome, all the more because it provides a strong focus on areas with high potential for climate change mitigation.
Enhancing good governance to improve coordination and monitoring
Ensuring good governance of institutions enhances the chances of success of any policy plan, particularly in the case of a climate strategy, where local action should align with national and international objectives. The institutions of Denmark and the fact that the Climate Law builds on political agreements and shared objectives facilitate inter-ministerial coordination. Ambition in non-energy sectors and policy alignment can be further improved by the formation of a ministry of climate or another governmental entity dedicated to climate that is independent from the energy sector, clarifying the crucial role of other sectors like transport or agriculture as the energy sector decarbonises. This cross-sectoral entity might be better suited to address competing priorities in other ministries and sectors.
Local governments have a strong role to play in the transition to carbon neutrality, but it is not their specific responsibility in Denmark. Climate action is covered at the national level and the central government can provide municipalities with wind turbines or biogas plants to reduce their carbon footprints. However, municipalities have some levers for action. They hold relatively high autonomy, with their expenses accounting for 35% of Danish GDP and 28% of public investment (OECD, 2016[106]). Danish municipalities hold some responsibilities regarding crucial tools for climate change mitigation, such as transport, land use planning, waste and district heating. The city of Copenhagen has a plan to reach climate neutrality by 2025 through measures encompassing mobility, energy consumption, and energy production. Alignment of actions between neighbouring municipalities should be enhanced and facilitated as collective action can be more effective, for example in regulating land use or to reduce tensions between a city and peripheral areas transport planning. This can be done by providing independent funding to intermediate authorities (such as regions or metropolitan areas) or building specific projects (OECD, 2009[107]).
Denmark has built a strong framework to monitor the implementation and effectiveness of its climate policy. Regular impact assessment both ex-ante and ex-post is crucial in this strategy, where success relies on uncertain technologies. Policy tools will therefore need to be regularly updated and adjusted according to their results and the evolution of national GHG emissions. Ex-ante monitoring is used to identify and calibrate policy tools, for example modelling work by the Danish Economic Councils. Ex-post assessment provides information on the relative effectiveness of different tools and informs adjustments. As an example, policies aiming at accelerating the roll-out of electric cars, which are among the most expensive measures, should be carefully monitored. The recent Climate Law, which includes the requirement of a yearly climate programme and the revision of targets every five years, paves the way for strong and regular monitoring. It also builds on sound impact assessments by independent advisory bodies such as the Danish Economic Councils or the Danish Climate Council. The development of a new macroeconomic model, GreenReform, will support this approach by providing more disaggregated and dynamic information on the environmental and climate effects of economic policies, as well as the socioeconomic effects of environmental, energy and climate policies. The GreenReform model consists of a main dynamic computable general equilibrium model fully integrated with sub-models covering key sectors including energy, transportation, agriculture and waste management. The project group developing the model is comprised of 15-20 people, supported by a government grant of DKK 14.3 million and DKK 6.55 million in funding from other sources. However, how this model will be used in policy is still unclear and implementation might take some time.
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Notes
← 1. Accounted in carbon dioxide equivalent (CO2e), measuring CO2 and non-CO2 greenhouse gas emissions based on their global warming potential.
← 2. These guiding principles are: 1) being a leading nation in the international climate effort; 2) realising climate targets as cost-effectively as possible; 3) maintaining a strong welfare society; 4) ensuring that domestic measures do not simply relocate all of the GHG emissions outside Denmark’s borders.