2.4.2.2 Market efficiency

The costs of climate change mitigation policies depend on the efficiency of markets, and market assumptions are important in relation to baseline cases, to policy cases, as well as in relation to the actual cost of implementing policy options. For example, the electricity market (and thereby the price of electricity that private consumers and industry face) has direct implications on the efficiency (and thereby GHG emissions) related to appliances and equipment in use.

In practice, markets and public-sector activities will always exhibit a number of distortions and imperfections, such as lack of information, distorted price signals, lack of competition, and/or institutional failures related to regulation, inadequate delineation of property rights, distortion-inducing fiscal systems, and limited financial markets. Proper mitigation cost analysis should take these imperfections into consideration and assess implementation costs that include these imperfections (see Section 2.4.2.3 for a definition of implementation costs).

Many project level and sectoral mitigation costing studies have identified a potential for GHG reduction options with a negative cost, implying that the benefits, including co-benefits, of implementing these options are greater than the costs. Such negative cost options are commonly referred to as ‘no-regret options’.^[12]

The costs and benefits included in the assessment of no-regret options, in principle, are all impacts of the options including externalities. External impacts can relate to environmental side-impacts, and distortions in markets for labour, land, energy resources, and various other areas. A presumption for the existence of no-regret options is that there are:

• Market imperfections that generate efficiency losses. Reducing the existing market or institutional failures and other barriers that impede adoption of cost-effective emission reduction measures, can lower private costs compared to current practice (Larson et al., 2003; Harris et al., 2000; Vine et al., 2003). This can also reduce private costs overall.
• Co-benefits: Climate change mitigation measures will have effects on other societal issues. For example, reducing carbon emissions will often result in the simultaneous reduction in local and regional air pollution (Dessues and O’Connor, 2003; Dudek et al., 2003; Markandya and Rubbelke, 2004; Gielen and Chen, 2001; O’Connor et al., 2003). It is likely that mitigation strategies will also affect transportation, agriculture, land-use practices and waste management and will have an impact on other issues of social concern, such as employment, and energy security. However, not all of these effects will be positive; careful policy selection and design can better ensure positive effects and minimize negative impacts. In some cases, the magnitude of co-benefits of mitigation may be comparable to the costs of the mitigating measures, adding to the no-regrets potential, although estimates are difficult to make and vary widely.^[13]
• Double dividend: Instruments (such as taxes or auctioned permits) provide revenues to the government. If used to finance reductions in existing distortionary taxes (‘revenue recycling’), these revenues reduce the economic cost of achieving greenhouse gas reductions. The magnitude of this offset depends on the existing tax structure, type of tax cuts, labour market conditions, and method of recycling (Bay and Upmann, 2004; Chiroleu-Assouline and Fodha, 2005; Murray, et al., 2005). Under some circumstances, it is possible that the economic benefits may exceed the costs of mitigation. Contrary, it has also been argued that eventual tax distortions should be eliminated anyway, and that the benefits of reducing these therefore cannot be assigned as a benefit of GHG emission reduction policies.

The existence of market imperfections, or co-benefits, and double dividends that are not integrated into markets are also key factors explaining why no-regret actions are not taken. The no-regret concept has, in practice, been used differently in costing studies, and has usually not included all the external costs and implementation costs associated with a given policy strategy.^[14]