Assessing vulnerability of selected sectors under environmental tax reform: the issue of pricing power

Abstract

Environmental tax reform could bear heavily on manufacturing sectors that are energy intensive and highly traded, in particular if their options for adapting technology are limited. However, to the extent that such sectors can pass on the cost of the environmental taxes through higher prices charged to their customers, they will not suffer a lasting drop in profitability or output. To assess pricing power in key sectors, a model of long-run price setting behaviour is specified and tested. Significant and plausible results emerged from this exercise. Of the six sectors analysed, the Basic metals sector revealed least pricing power and, hence, greatest vulnerability, and the Non-metallic minerals sector revealed most pricing power. The results indicated that the world price, proxied by the US price, was less of a constraint than the EU price, proxied by the German price. Thus, international competitiveness fears are reduced not just where there is good potential for adapting technology but also if application of environmental tax reform is EU-wide.

Keywords:

• price-setting behaviour
• competitiveness
• carbon tax
• market power

Acknowledgements

The authors acknowledge the assistance of the European Commission under the Sixth Framework Programme's initiative ‘Scientific Support to Policies’, Specific Targeted Research Project (STREP).

Notes

1. This study forms part of a larger project, called COMETR (Competitiveness Effects of Environmental Tax Reform, a Specific Targeted Research Project supported by the EU's Sixth Framework Programme for Research and coordinated by the National Environmental Research Institute in Denmark).

2. Other modules of the COMETR study have investigated the effects of ETR on greenhouse gas emissions, GDP and prices, and on uptake of new technology (COMETR, 2007).