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Economics Internal Assessment

Key concept: Sustainability

Section of the syllabus: Microeconomics

“Singapore’s carbon tax should be higher than planned to speed up action: MAS’ Menon”

Publication: The Business Times December 04, 2023

https://www.businesstimes.com.sg/esg/singapores-carbon-tax-should-be-higher-planned-
speed-action-mas-menon

[DUBAI] SINGAPORE’s carbon tax needs to go even higher to accelerate climate action to
address global warming, Ravi Menon, the managing director of the Monetary Authority of
Singapore (MAS), said on Monday (Dec 4).

While the city-state has done its part in implementing a carbon tax, Menon said it is “not
quite enough”. Singapore’s carbon tax is currently set at S$5 per tonne of emissions, but will
increase to S$25 per tonne from 2024 and to S$45 per tonne between 2026 and 2027. The
official guidance is for the tax to land between S$50 and S$80 per tonne by 2030.

“But we will be making quite significant steps over the next few years up to 2030. Needs to
go even higher if you ask me,” said Menon at the Singapore pavilion on the sidelines of the
United Nations Climate Change Conference (COP28) in Dubai.

Menon was responding to a question during a panel on his top wish for the future of
climate investment.

“What I would like to see is governments implement the right carbon tax, or a price on
carbon. This is the elephant in the room. Nobody talks about it because governments don’t
feel confident to do it. People don’t like it. And in a democracy, these things don’t fly. Tax is
always bad news,” he added.

If carbon is priced, there is no need to worry about having to lower the cost of capital
through blended finance mechanisms to channel financial flows into energy transition
projects in emerging markets.

“And that is a big tragedy if the world still hasn’t come together to do this. You’re waiting for
one another,” said Menon.

Only 30 per cent of the world’s emissions are subjected to some form of carbon tax, and
only 5 per cent of emissions are subjected to a level of carbon tax that leads to net-zero
outcomes.

Because of the lack of a carbon tax, blended finance and carbon credits are fundamental to
lower the costs of capital so that more funds can flow into energy transition projects in
emerging markets. Investors often price the risks that come with investing in emerging
markets higher than developed markets.

“There is no pathway to net zero without blended finance and carbon credits, and the two
need to go together,” said Menon.
While blended finance can be used to lower the cost of capital, Dilhan Pillay, chief executive
investor of Temasek, said that the rate of return in such financing schemes will also have to
be brought down.

“Ultimately, at the end of the day, if you want to bring energy transition into emerging
markets, it’s not just a blended cost of capital; its also about affordability. That means a
blended return must be there in order to justify the output from what you’re trying to do,”
said Pillay, who was also speaking at the same panel.

When asked why the state investor decided to come on to a partnership focusing on
investing in green and sustainable projects in South-east Asia, Pillay said that Singapore can
thrive only if the region – which is made up mainly of emerging economies – thrives.

“Our region has to be competitive on a global scale... It’s a situation where everyone has got
to come in and figure out how we can all prosper together,” he said.

The partnership, which also involves MAS, Allied Climate Partners and the World Bank’s
International Finance Corporation, is part of a blended finance platform called Financing
Asia’s Transition Partnership that is developed by the central bank.

South-east Asia is emerging as the region of choice for companies opting to diversify their
supply chains away from China. However, the shift from China increases inefficiency in supply
chains.

“So if you want to reconfigure supply chains in a way that allows for resilience globally, and
also allows for efficiency... then we need to make sure that every single piece of it can
actually deliver that level of efficiency, the level of lower-carbon intensity that we need to
make up for the cost of reconfiguring,” said Pillay.

Commentary Words: 823

This article from The Business Times discusses the need for Singapore to further increase its
carbon tax to combat global warming effectively. Menon highlights the importance of
implementing a carbon tax as a crucial step towards addressing climate change, despite the
reluctance of governments and the public due to its perceived negative implications. The
article touches upon the concept of sustainability, emphasizing the necessity of blended
finance mechanisms and carbon credits to facilitate investment in energy transition projects,
particularly in emerging markets like South-east Asia.

A carbon tax directly addresses the negative production externality associated with carbon
emissions, a form of market failure. Carbon emissions from activities such as burning fossil
fuels for energy production generate harmful effects on the environment and public health,
contributing to climate change and air pollution. The diagram below illustrates the negative
externality arising from carbon emissions:
Graph showing the negative production externality arising from carbon emissions
S= Marginal
Social Cost (MSC)
Price ($) Welfare loss

S= Marginal
Private Cost
(MPC)
P*where
MSC=MSB
Negative
P1 externality

D= Marginal Social
Benefit (MSB)

0 Q* Q1 Quantity of
carbon in tonnes

The supply curve given by MPC reflects the firm’s private costs of production and the
marginal social cost curve given by MSC represents the full cost of production to society. The
vertical difference between MPC and MSC represents negative externality. Therefore for
each level of output, Q1, social costs given by MSC are greater than the firm’s private costs
by the amount of externality. The optimal production quantity is Q*, but the negative
externality results in production of Q1. The deadweight welfare loss is shown in blue.

In Singapore, the market for carbon emissions exhibits a negative production externality,
where the Marginal Social Cost (MSC) exceeds the Marginal Private Cost (MPC). This
discrepancy arises as the private cost of emitting carbon does not fully capture the societal
costs associated with pollution and climate change.

From society's viewpoint, the optimal quantity of carbon emissions should align with the
intersection of the MSC and the demand for carbon emissions, denoted as Q*. However, due
to the lower MPC, the actual quantity of carbon emissions (Q1) in the market surpasses the
socially optimal level, resulting in overproduction. The vertical difference between the MSC
and MPC curves illustrates the negative externality stemming from carbon emissions,
representing the gap between the private costs borne by producers and the true societal
costs incurred by society.

Consequently, Singapore is emitting a quantity (Q1) of carbon that exceeds the socially
optimal level (Q*), leading to an inefficient allocation of resources and a welfare loss. This
welfare loss, depicted by the area between the MSC and MPC curves from Q1 to Q*, signifies
the magnitude of the negative impact on societal welfare resulting from the overproduction
of carbon emissions.
The Singaporean government choosing to raise the carbon tax to even higher prices to
reduce the impact of the externality. The graph bellow shows the impact of the raised
carbon tax:

Graph illustrating the effect of the new tax on carbon emissions

MSC
Price ($) New smaller MPC+tax
welfare loss

MPC

Reduced
p*
externality
P2

P1 Welfare loss
reduced

D=MSB

0
Q* Q1
Quantity of
carbon in tonnes
Q2

Imposing a carbon tax on carbon emissions in Singapore leads to significant changes in the
market dynamics. Initially, the market operates without intervention, resulting in a quantity
of emissions (Q1) that exceeds the socially optimal level (Q*), reflecting the negative
externality associated with carbon emissions.

With the introduction of a carbon tax, the government imposes a tax per unit of emissions.
This tax causes the Marginal Private Cost (MPC) curve to shift upwards by the amount of the
tax, altering the market equilibrium.

Because of the carbon tax, the equilibrium quantity of emissions shifts from Q1 to a new
quantity (Q2), and the equilibrium price increases from P1 to a new price (P2). This
adjustment signifies a reduction in the quantity of emissions and an increase in the price of
emissions.

The reduction in emissions from Q1 to Q2 represents a mitigation of the negative


externality, aligning the quantity emitted more closely with the socially optimal level (Q*).
Additionally, the welfare loss, indicated by the shaded area between the Marginal Social Cost
(MSC) and MPC curves, decreases due to the carbon tax.

The welfare loss reduction is visually represented by the blue area, while the expected
smaller welfare loss is depicted by the purple triangle. Furthermore, the imposition of the
carbon tax leads to a decrease in producer revenue, transitioning from the initial revenue
level of P1Q1 to a lower level of P2Q2.
The higher carbon tax helps internalize the external costs associated with carbon emissions.
By pricing carbon, the tax holds businesses accountable for their environmental impact and
encourages the adoption of cleaner technologies and practices. Additionally, the revenue
generated from the carbon tax can be reinvested in initiatives aimed at further reducing
carbon emissions and promoting sustainable development. This financial support can
accelerate the transition to a low-carbon economy.

However, high carbon taxes could potentially impact the competitiveness of Singaporean
industries that rely heavily on carbon-intensive processes. This may lead to increased
production costs and affect the country's economic competitiveness on the global stage.
Furthermore, the incomplete coverage of carbon pricing mechanisms globally limits the
effectiveness of carbon taxes in addressing climate change. Without broader international
cooperation and coordination, achieving meaningful reductions in carbon emissions remains
a challenge.

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