Implementation of a Green Growth Strategy in Kazakhstan Impact assessment and proposal for successful transition to Green Economy

Transcription

1 Implementation of a Green Growth Strategy Impact assessment and proposal for successful transition to Green Economy Policy-oriented Summary Berlin, 14. March 2014

2 DIW econ GmbH Dr. Ferdinand Pavel Mohrenstraße Berlin Germany Phone Fax ii

3 Abstract By decree of its President, Kazakhstan has adopted a concept for transition to Green Economy in May The implementation of the strategy requires drastic modernization of key infrastructure and production technologies based on energy-efficient technologies. The largest part of these investments is to be raised from private investors funds. Thus, investment attractiveness of measures for efficient use of resources through fair tariff and price setting in resource markets is stressed as main principle of transition to Green Economy. This analysis attempts to quantify the impact of the Green Growth Strategy on the economy and to develop policy proposals for ensuring successful implementation at the macroeconomic as well as at the sector level. Using an empirical model of the Kazakh economy we find that relative to the existing trajectory of the economy the proposed strategy is a driver for modernisation and implementation will generate additional income through improved resource and energy productivity while reducing emissions of Greenhouse Gases (GHGs). However, implementation of the strategy is not a certainty. In particular, utility providers are expected to lose income because the proposed measures reduce demand for energy and utility services due to higher prices and improved energy efficiency. Hence, while most of the proposed modernisation measures require investments in the utility sector, incentives for doing so are insufficient. Accordingly, strategy implementation has to be accompanied by an incentive-framework for key economic sectors. To this end, we suggest public subsidies to co-finance investments in utilities and, in particular, heat supply. For re-financing these additional public expenditures, we suggest introducing a price on GHG emissions for the main emitting industries. This way, manufacturing industries while benefiting from the reform through improved resource and energy productivity also contribute more strongly towards covering the costs of modernisation measures in the economy. Moreover, we demonstrate that by appropriate fine-tuning of prices for GHG emissions, manufacturing industries can even be incentivised to contribute more strongly to emission abatement without risking their competitiveness. iii

4 Table of contents 1. Introduction Strategy of the Analysis GREEN versus BROWN economy Incentivising Green Investments Innovation Strategy Conclusion...21 iv

5 1. Introduction By decree of its President in May 2013, Kazakhstan has adopted a concept for transition to Green Economy (henceforth the Green Growth Strategy). 1 The priority goals of the strategy are: 1. Increased resource productivity, including water, land, biological resources, and resource management efficiency; 2. Increased population well-being and quality of the environment, achieved though profitable measures reducing environmental footprint; 3. Increased national security, including water supply. The implementation of the strategy requires drastic modernization of key infrastructure and production technologies based on energy-efficient technologies. As stipulated in the presidential decree, this requires investments totalling to about USD 119 billion or USD 3-4 billion per year until The largest part of these investments is to be raised from private investors funds. Thus, investment attractiveness of measures for efficient use of resources through fair tariff and price setting in resource markets is stressed as main principle of transition to Green Economy. The analysis in this report attempts to quantify the impact of the Green Growth Strategy on the economy and to develop policy proposals for ensuring successful implementation at the macroeconomic as well as at the sector level. Using an empirical model of the Kazakh economy we find that relative to the existing trajectory of the economy the proposed modernisation can generate additional income through improved resource and energy productivity while reducing emissions of Greenhouse Gases (GHGs). However, implementation of the strategy is not a certainty. In particular, utility providers risk losing income because the proposed measures tend to increase prices and improve energy efficiency and thus, reduce demand for energy and utility services. Hence, while most of the proposed modernisation measures require investments in the utility sector, incentives for 1 Concept for Transition of the Republic of Kazakhstan to a Green Economy, approved by the Decree of the President of the Republic of Kazakhstan in May

6 doing so are so far not sufficient. 2 As a solution, we suggest public subsidies to co-finance investments in utilities and, in particular, heat supply. For re-financing these additional public expenditures, we suggest introducing a price on GHG emissions for the main emitting industries. In this way, manufacturing industries while benefiting from the reform through improved resource and energy productivity would also contribute more strongly towards covering the costs of modernisation measures in the economy. In addition, we demonstrate how prices on GHG emissions can even provide incentives for manufacturing industries to contribute more strongly to emission abatement without risking their competitiveness. In the next sections, we outline the strategy of our analysis (section 2) and present key insights on the impact of the Green Growth Strategy (section 3). Based on these findings, we move on to develop a proposal for strengthening investment incentives of key stakeholders (section 4), followed by a discussion on the potential contribution of domestic innovations to the required modernisation process (section 5). The final section concludes. 2 The analysis of policy instruments for implementing green growth considers the relevant policy schemes that exist or are currently planned. In particular, this includes a trading scheme for GHG emission allowances as it is currently implemented. One of the contributions of our analysis is that it explicitly stresses the role of those policy schemes for a successful implementation of the Green Growth Strategy. 2

7 2. Strategy of the Analysis Our analysis is based on a detailed model of the Kazakh economy (see Box 1 for details). To assess the Green Growth potential we run different scenarios that simulate the development of the national economy until 2050 (simulation period). Box 1: A Computable General Equilibrium (CGE) model for Kazakhstan The CGE model for Kazakhstan covers the entire economy including private households, production (split into agriculture, four mining industries, nine manufacturing industries, four utility providers, three transportation sectors and trade and services), the government (i.e. public households) as well as the external sector (exports, imports, balance of payments and current account). Specific emphasis is given on the power sector to account for the impact of different technologies and fuel types. The model simulates supply on demand for a total of 22 product markets as well as factor markets for labour, capital, capital formation (investment) and foreign exchange. Special emphasis is given on modelling production of different commodities with particular focus on energy consumption and emissions of Greenhouse Gases (GHG). Investments are modelled so as to replace depreciated capital and to generate economic growth, which in turn depends on population and productivity growth. Additional investments, e.g. for further advances in energy efficiency, are directly reflected in this setting. The database is fully consistent with official statistics on the Kazakh economy, in particular national accounts data, energy balance and the GHG emissions inventory. The model is dynamic in a sense that it simulates the development of the national economy over the period 2011 till We start by simulating the impact of key measures under the Green Growth Strategy (GREEN scenario), mainly focussing on increasing energy efficiency through investments in modern production technology and infrastructure in selected sectors. To identify the specific contribution of those measures over the simulation period, we need to isolate it from the impact of developments such as population growth or the depletion of national oil reserves that are expected to occur independently of whether or not the Green Growth Strategy is implemented. We do this by running a counterfactual scenario which simulates future economic developments under the assumption that the Kazakh economy continues following 3

8 its existing trajectory without implementation of the Green Growth strategy (see Box 2 for details). Box 2: BROWN economy as counterfactual scenario The counterfactual scenario simulates the hypothetical development of the economy without implementation of the Green Growth strategy. The key assumptions of our counterfactual scenario are: Growth of GDP is consistent with macro-projections by the International Monetary Fund (IMF); GDP growth after 2020 is determined by continuation of historical developments of total factor productivity; Energy efficiency (i.e. energy input per output) increases in line with historical developments over the past ten years; Global gas and oil prices develop as projected by the International Energy Agency (IEA); Exports of crude oil develop in line with IEA projections; Crude oil extraction rates start decreasing after 2035 due to depletion of available resources; Labour productivity in service and manufacturing is assumed to increase so as to compensate for losses from lower oil exports. Aggregate Investments (Gross Fixed Capital Formation) raise the stock of available capital to compensate for depreciation and to ensure that income (i.e. GDP) grows in line with population and productivity growth. Electricity will be mostly generated from coal in the counterfactual scenario. While the share of coal in the fuel mix will decline from its very high present level (>70%), it will remain by almost 50% till Hence, we refer to the counterfactual scenario as BROWN economy. By comparing the impact under the Green scenario and the counterfactual BROWN economy scenario we quantify the Green Growth potential of Kazakhstan. Our initial focus is on aggregate, economy-wide variables such as GDP as a measure of national income, Greenhouse Gas (GHG) emissions as a measure of environmental impact, and real household consumption as a measure of wellbeing of private households. The performance of these measures allows for assessing the overall impact of Green Growth on the economy. In particular, an increase in GDP and real household consumption or a decrease in GHG emissions indicates that Green Growth is beneficial or desirable from a national, economywide point of view. 4

9 In practice, however, economic reforms are often not undertaken despite their overall positive impact. For example, if specific sectors or stakeholders are expected to lose they might lack the incentive to support the reform or even oppose it. This is of particular relevance for a successful implementation of the Green Growth Strategy, where most of the proposed investment measures are to be financed by private sources. In fact, if the relevant stakeholders view key measures under the strategy as non-profitable, this prevents the successful implementation of the whole strategy. To analyse investment incentives of different industries, we assess the impact of the Green Growth Strategy at the industry level. We focus on value added and emissions as well as profits (i.e. the difference between gross operating surplus and capital expenditures). Incentives are positive if investments in a given industry under the Green Growth strategy result in higher value added and industry profits. Finally, based on the insights from our analysis we develop proposals for concrete policies to ensure, that the implementation of measures which are found to generate positive net benefits for the overall economy will be supported by sufficient investment incentives at the industry level. 5

10 3. GREEN versus BROWN economy The impact of the Green Growth Strategy is captured by five key measures: Green power sector: shift of electricity generation from a coal-based to a gas-based system, combined with a significant increase in the share of renewable energies (i.e. wind, solar and hydro) by up to 45% by (see Figure 1). Energy Efficiency (EE) in manufacturing: additional investments in energy-saving technologies in key manufacturing sectors (including metals, chemicals, minerals, food, paper and pulp, construction and machinery). EE in transport: additional investments in energy-saving transportation technologies EE in heat supply: additional investments in efficiency of heat plants, loss reduction in district heating networks and energy saving in buildings Sustainable agriculture: Investments in water efficiency and land productivity Implementing these measures requires significant investments which are included as additional capital expenditures on top of the investment volume under BROWN Economy. 4 As a result, aggregate investments in the economy (the so-called gross fixed capital formation) increase by more than 15% (relative to their level in 2011) in 2020 and remain at levels between 8% and 6% until Heat supply accounts for most of the additional expenditure, followed by agriculture and buildings. On the contrary, additional investments in manufacturing and transport industries are relatively small. 3 This is consistent with the target indicators for the power sector as specified in the Concept for Transition of the Republic of Kazakhstan to a Green Economy (Exhibit 1, p.7): a) share of gas power plants in electricity production 20% (2020), 25% (2030) and 30% (2050); b) share of solar and wind not less than 3% by 2020; and c) share of alternative sources defined as renewable energies (solar, wind, hydro) and nuclear in electricity production 30% (2030) and 50% (2050). 4 In the model, these additional investments are explicitly enforced and are thus not the result of optimising behaviour. 6

11 Figure 1: Fuel mix of electricity generation (in percent of total generation, GREEN scenario) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 10% 10% 9% 10% 8% 10% 18% 20% 25% 10% 37% 9% 28% 8% 37% 72% 63% 35% 43% 25% 12% Nuclear Solar & Wind Hydro Gas Coal Source: DIW and DIW econ To assess the impact of the Green Growth Strategy we measure the difference between the GREEN scenario and BROWN Economy. Our first finding is that implementing the key measures under Green Growth Strategy leads to higher GDP growth and consumer welfare as compared to Brown Economy, while GHG emissions are considerably lower (Figure 2). Starting from a common level in 2011, GDP grows faster under the GREEN scenario and exceeds its benchmark level under Brown Economy by up to 3.4% in At the same time, we find that GHG emissions under the GREEN scenario are about 16.4% lower than under Brown Economy. Finally, we observe that the impact of the Green Growth measures on real household consumption (i.e. consumer welfare) differs during the simulation period. In the early periods after strategy implementation, real household consumption declines (i.e. by up to -2.5% in 2014) because investments in heat supply let heat prices rise. However, in the course of the simulation period, households benefit from higher income triggered by GDP growth. Hence, real consumption eventually develops in parallel with GDP and increases its benchmark level (Brown Economy) by 3.7% in

12 Figure 2: Impact of the GREEN scenario relative to Brown Economy (BAU scenario) 5% 0% % -10% -15% -20% GDP Household consumption GHG emissions Source: DIW econ Figure 2 allows for assessing the overall impact of the Green Growth Strategy on the wellbeing of private households. After implementation of the five key measures, households suffer losses in real income due to the price increases for electricity and in particular heat. At the same time, however, heat consumption by private households declines relative to BAU due to a range of measures aiming at energy saving in residential buildings. Moreover, stronger growth of GDP benefits private households through increased labour and capital incomes. On balance, the overall impact of the Green Growth Strategy on private households becomes positive already before Thus, the medium- and long-term impact on private households is clearly positive. In the short term, however, the assessment is different. In particular, it can be expected that the proposed measures have short-term negative consequences for private households. Mitigating for the consequences of this development must therefore be addressed in a policy design towards successful implementation of the Green Growth Strategy. Before analysing the impact of the Green Growth Strategy and the corresponding investment incentives for different industries, the next figure decomposes the overall impact into the contributions of the five key measures. As we observe, the impact of specific measures on GDP and GHG emissions is very different. In particular, power sector modernization based on gas and renewable energies induces a GDP loss of almost one percent until About 8

13 half of these losses, however, are already compensated for by positive contributions of energy efficiency measures in manufacturing, transport and heat supply. Finally, investments in in water efficiency and land productivity in agriculture generate the by far largest contribution to GDP to ensure the overall net impact of 3.4%. On the contrary, more efficient production in agriculture generates additional GHG emissions. However, significant abatement effects from power sector modernisation and increased energy efficiency in heat supply as well as to a lesser extent energy efficiency measures in manufacturing in transport are sufficient to generate an overall abatement volume of 16.4% relative to the BROWN scenario. So far, our results demonstrate that the intended combination of economic growth (i.e. higher GDP) at reduced levels of GHG emissions can be achieved by implementing the five key measures of the Green Growth Strategy as a package. However, a detailed assessment of costs and benefits reveals severe imbalances which must be addressed for ensuring successful implementation of the strategy. First, the ambiguous impact of the different measures on private households needs to be addressed, in particular during the early years after strategy implementation. Second, investment incentives are insufficient. In particular, we find that utilities (i.e. suppliers of electricity and heat) play the key role in reducing GHG emissions while facing significant investment costs and value added losses. Conversely, the manufacturing sector contributes only little to GHG emission abatement but accounts for significant value added gains (Figure 4). Hence, utilities have no apparent incentive to invest in power sector modernisation and higher energy efficiency in heat supply. Given the high socio-economic relevance of the sector as well as the substantial contributions of those measures to overall emission abatement, this has the potential to threaten the overall success of the Green Growth Strategy. 9

14 Figure 3: GDP and GHG emissions in the GREEN scenario Impact of GREEN scenario on GDP in 2050 (by key measures, difference to BROWN scenario in percent) 4.0% 3.5% +3.78% +3.38% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -0.99% Green power sector +0.33% EE in manufacturing +0.04% +0.22% EE in transport EE in heat supply Sustainable agriculture Total effect Impact of GREEN scenario on GHG emissions in 2050 (by key measures, difference to BROWN scenario in percent) 0.0% -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% -14.0% -8.55% -1.39% -1.82% -16.0% -18.0% -5.18% +1.13% % -20.0% Green power sector EE in manufacturing EE in transport EE in heat supply Sustainable agriculture Total effect Source: DIW econ 10

15 Emissions impact Gross value added impact Figure 4: Impact of the GREEN scenario on Gross Value Added and GHG emissions by key industries (average difference to Brown Economy in in percent) 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% 30% 20% 10% 0% -10% -20% -30% -40% -50% -60% Agriculture Mining Manufacturing Utilities Transportation Trade and other services 3 Mt -2 Mt -3 Mt -47 Mt -6 Mt 1 Mt Agriculture Mining Manufacturing Utilities Transportation Trade and other services Source: DIW econ 11

16 4. Incentivising Green Investments In fact, the key problem is obvious: modernisation of generation technologies and network infrastructure in electricity and heat supply requires significant capital expenses (investments). To cover these additional costs, firms must raise tariffs for heat (by up to 50% relative to Brown Economy) and electricity (by up to 13%). At the same time demand grows less than under Brown Economy because of higher energy efficiency in industrial production as well as in response to higher prices. Hence, also output and value added remain below their counterfactual levels under Brown Economy and the resulting capital income to utility providers is not sufficient to cover the full costs of investment. Overcoming this problem requires providing additional funds, in particular to heat suppliers. For example, using public funds to co-finance investments eases the pressure on the companies balance sheets and reduces the need for raising tariffs. However, this shifts the burden of financing modernisation investments from utilities to public households and raises the issue of re-financing. Carbon pricing for example implemented through the existing emissions trading system which sets a cap on GHG emissions of the largest emitting industries are a mean to generate such funds. However, carbon prices need to be introduced with care. If set at too high levels, they can undermine economic growth and even revert the positive impact on GDP that the Green Growth Strategy intends to generate. On the other hand, carbon prices can also incentivise further investments into energy efficiency since this helps firms reducing GHG emissions and the associated costs. Finally, carbon prices need to be sufficient for rebalancing the complex costs and benefits to utilities. In particular, utilities face additional costs because their GHG emissions are also subject to carbon taxes. On the other hand, they benefit from subsidies on investment in energy-saving technologies which in turn helps them reducing their costs from GHG emissions. 12

17 Box 3: Identifying potential for GHG emission reductions in Kazakh manufacturing Identifying potentials for higher energy efficiency requires detailed analyses at the sector level. Our approach includes economic viability as well as environmental sustainability of different industrial activities. We focus on the metal industry and the non-metallic mineral products industry (i.e. production of clinker, lime, glass and soda ash). The analysis is based on an international benchmarking approach following the economic concept of efficiency. Our yardstick for comparing the performance of industrial activities in different countries is determined by: High levels of desired outputs (production volumes or revenues), Low levels of undesired outputs (greenhouse gas emissions), and Low levels of factor inputs (labour, capital, energy). The analysis includes the following steps: First, comparison of different industrial activities across countries to identify the countries with most-efficient industries (i.e. highest volumes of gross output with lowest level of GHG emissions from a given set of inputs). Next, analysis of the impact of sector-specific characteristics such as the volume of aluminium production in the metal industry on estimated efficiency levels. Third, assessment of the impact of country-specific factors such as overall economic development or specific regulatory conditions. Following this approach we determine a technological yardstick of international best practices. Against this benchmark, we quantify the potential for reducing greenhouse gas (GHG) emissions in the two industrial sectors. The estimated potential for GHG emission reductions is as follows: Metal industry: up to 5.1 Mt of CO2 equivalents (or equivalently 19 percent of the sector s emission level in 2007) once sector-specific and country-specific characteristics are considered; 6.4 Mt of CO2 equivalents (or equivalently 24 percent of the sector s emission level in 2007) without consideration of sector-specific and country-specific characteristics. Non-metallic minerals industry: up to 2.2 Mt of CO2 equivalents (or equivalently 47 percent of the sector s emission level in 2007). in contrast to the metal industry, there seems to be no significant impact of sector-specific or country-specific characteristics on these estimates. Further details on this analysis as well as the results are provided in a spate report by DIW econ on Benchmarking for sustainable and economically viable technology options. Source: DIW econ 13

18 Based on our model of the Kazakh economy, we can assess in detail how carbon pricing can be used to generate the investment incentives necessary for a successful implementation of the Green Growth Strategy. Manufacturing industries are an obvious starting point. As shown in Figure 4 above, they enjoy significant value added gains under the Green Growth Strategy while contributing only little to GHG emission abatement. Hence, as long as carbon prices do not skim away all of those extra gains, the sufficient overall benefits of the Green Growth Strategy should remain. In addition, a meaningful analysis of the impact of manufacturing industries on carbon prices needs to consider the significant potential for further emission reductions. For example, based on own detailed assessments we identify such potential in the metal industry and on the non-metallic mineral products industry (i.e. production of clinker, lime, glass and soda ash). In particular we find that by switching to international best-practice technologies, GHG emissions in these sectors could be reduced by 19% and 24%, respectively, without losing international competitiveness (Box 3). Other empirical studies on energy saving and GHG mitigation potentials in particular NERA (2011) 5 find evidence for similar potential in other industries such as transportation, buildings, heat supply, agriculture or waste management. To account for this potential, we also consider an alternative, Enhanced Green scenario to simulate the impact of additional investments in the modernisation of production technologies and infrastructure, focussing on heat supply and manufacturing (Box 4). 5 NERA (2011). The Demand for Greenhouse Gas Emissions Reduction Investments: An Investors Marginal Abatement Cost Curve for Kazakhstan. Prepared for EBRD. 14

19 Box 4: Additional measures under the Enhanced GREEN Scenario In addition to the five key measures of the GREEN scenario, building blocks of the Enhanced GREEN scenario are: Heat supply: additional reduction of losses through modernisation of pipes and boiler houses Manufacturing: additional improvements in energy efficiency, focussing on metals, oil refining and the production of non-metallic minerals such as clinker, lime, glass and soda ash. Transport: fuel savings through more fuel-saving vehicles Buildings: additional savings in heat consumption (25% until 2050) through more energy-efficient buildings Agriculture: reduction of GHG emissions through increases in land productivity and arable area, new greenhouses as well as use of modern forage in cattle and other livestock production Waste management: reduction of GHG emissions in municipal and industrial wastewater treatment (e.g. through flaring, waste treatment, anaerobic digestion) and landfills (e.g. through composting, waste treatment, energy generation) Implementation of these measures requires additional capital expenditures on top of the investment volume already foreseen under the GREEN scenario. Hence, aggregate investment (gross fixed capital formation) in 2020 is 28% higher than in 2011 and remains at levels between 10% and 8% until Most of the additional funds focus on heat supply and manufacturing. Source: DIW econ Figure 5 illustrates the basic principle of our analysis. As long as carbon prices (horizontal axis) are zero (left side) or close to zero, industry profits (defined as capital return minus investment expenditure, vertical axis) under the GREEN scenario are higher than under Enhanced GREEN, because the former requires less investment. Hence, with carbon prices close to zero, investment incentives under the Enhanced Scenario are insufficient (i.e., investors would clearly opt for the measures simulated under the Green Scenario). This assessment changes, however, once carbon prices are increased (horizontal axis towards the right). Since modernisation under Enhanced GREEN leads to further emission abatement, the costs from carbon pricing are lower than under the GREEN scenario. At a certain threshold (i.e. around 600 KZT/t in Figure 5), the savings from lower GHG emissions offset the additional investment expenditures under the Enhanced GREEN scenario. Hence, if carbon price are equal or higher than this threshold, investment incentives for Enhanced measures are clearly stronger. In other words, the (negative) impact of carbon pricing on industry profits can be mitigated as long as firms can use the potential for emission abatement through modernisation, despite generally higher investment expenditures. 15

20 Industry profits (mln KZT) Figure 5: Industry profits in manufacturing under alternative carbon prices GREEN scenario Enhanced GREEN scenario Carbon price (KZT/t) Source: DIW econ Figure 6: Profits in the metals and minerals sector at a carbon price of 600 KZT/t (average annual net present value, , mln KZT) Brown Economy GREEN with CO2 price Brown Economy GREEN with CO2 price 2410 Enhanced GREEN with CO2 price 219 Enhanced GREEN with CO2 price Metals 212 Minerals Source: DIW econ Applying this rationale to the case of Kazakhstan, we assess the impact of a rather modest carbon price of 600 KZT (4.00 USD 6 ) per ton of CO2. We start with profits in the two manufacturing industries where we have identified significant potential for higher energy efficiency, metals and minerals (Figure 6). Our first observation is that the selected carbon 6 Based on the exchange rate as of December

21 Average annual Net Present Value (in bln KZT per year) price is sufficiently low because both industries are making higher profits under GREEN and the Enhanced GREEN Scenario than under Brown economy. Second, the selected carbon price is still high enough to stimulate incentives for additional investments in energy-saving technologies, because profits under Enhanced GREEN clearly exceed those under GREEN. Next, we assess the impact of carbon pricing on investment incentives in main sectors of the economy. We also consider that as intended proceeds from carbon pricing are used to co-finance investments in the utility sector. Figure 7 confirms the previous finding that investment incentives under the Enhanced GREEN scenario are stronger than under GREEN economy. What is more, investment incentives for utilities turn from negative to positive. Hence, we find that even a rather moderate carbon price of 600 KZT per ton of CO2 is sufficient for generating the funds required to co-finance investments into the utility sector and create positive investment incentives in this industry. Figure 7: Impact of GREEN scenario and Enhanced GREEN scenario on profits by key industries (average annual difference to Brown Economy, , in bln. KZT) 40,00 35,00 GREEN scenario (no CO2 price) Enhanced GREEN scenario (CO2 price 600 KZT/t) 30,00 25,00 20,00 15,00 10,00 5,00 0,00-5,00-10,00 Agriculture Mining Manufacturing Utilities Source: DIW econ 17

22 The comparison of GDP and GHG emissions under the GREEN scenario and the Enhanced GREEN scenario reveals that while additional GDP gains (in comparison to Brown economy) remain almost unchanged (in fact, GDP gains under the Enhanced GREEN scenario are higher by 0.1 percentage point), carbon pricing provides additional incentives for reducing GHG emissions throughout the economy. As a result, emissions in the Enhanced GREEN scenario are more than 30% lower than under Brown economy, while the corresponding impact of GREEN scenario was only 16%. Figure 8: Impact of GREEN and Enhanced GREEN scenario on GDP and GHG emissions (in percent, relative to Brown Economy) 10% 05% 00% -05% -10% -15% -20% -25% -30% -35% GREEN without CO2 price Enhanced GREEN with CO2 price GDP effect GHG emission effect Source: DIW econ Finally, we observe that the proposed scheme of carbon pricing generates sufficient revenue for financing subsidies on energy-saving investments in the heat sector without that private households have to suffer excessive short-term losses due to hikes in heat prices. Between 2011 and 2030, annual heating expenditures of private households in the GREEN scenario are about 15% higher than under Brown economy. On the contrary, the additional measures under the Enhanced GREEN scenario do not only lead to further reduction of physical heat 18

23 consumption, but also generate sufficient revenue (through CO2 prices) such that households can be compensated for their losses due to higher heat prices Innovation Strategy Innovations can play a crucial role for shifting from BROWN to GREEN economy. Understanding the potential of innovations for the case of Kazakhstan requires assessing current innovation capabilities as well as the extent to which innovations contribute to economic growth of the Kazakh economy. To this end, we analyse input and output factors of innovation over the recent past and across economic sectors. Our key findings are as follows: Spending on R&D has been rising at a rate of 8% between 2004 and However, spending on R&D declined if measured as a share in GDP from 0.24% in 2004 to 0.16% in R&D funding fluctuates heavily and has declined between 2009 and 2011 across all science sectors except natural sciences. Patent applications and registrations have remained rather flat, despite the increase in R&D spending. Innovative outputs show a high volatility and sensitivity to business cycle downturns. The share of innovative industrial production has contracted sharply by 60% between 2007 and 2009 and has by 2011 still not reached the pre-crisis levels. The innovation intensity of output varies widely between industrial sectors, with some small sectors showing substantial innovative capacity. When comparing Kazakhstan with other benchmark countries we find that, in general, Kazakhstan spends comparatively little on R&D. To catch up with Russia, Kazakhstan would need to increase spending by a factor of 5.5. Measuring innovation by numbers of patents registered per capita Kazakhstan takes a middle place among the benchmark group, but still reaches only 55% of Russia s or China s. The gap to the advanced economies in EU and North-America remains even larger. 7 In fact, at a price of 600 KZT per ton of CO2 we find that annual heating expenditures of private households in the Enhanced GREEN scenario are 7% lower than under Brown economy between 2011 and

24 Kazakhstan spends exceptionally little R&D per patent. Most advanced economies spend more resources per patent. In this regard, a low level of spending per patent may not be so much a signal of efficiency, but rather an indication that the registered patent is not the result of prolonged domestic innovative research. When evaluating the capacity of patented technology to induce economic growth we find that growth of Kazakh GDP was driven much less by R&D than in other nations, implying that Kazakhstan s domestic capacity for a growth path driven by technological innovation is still limited at the moment. On the other hand, while the potential of innovations for contributing to economic growth is rather limited, there is ample evidence including the results of own benchmarking studies for the metals and non-metallic mineral products industry (see Box 3 above) on significant potential for the national economy to benefit from technology transfers from abroad. Hence, we conclude that the intended shift of the Kazakh economy towards green growth trajectory should initially be based on technology transfers from abroad. This way, a sufficiently large stock of modern technologies can be made available to the economy. Eventually, this will also help boosting domestic innovations. In parallel, this should be accompanied by efforts to increase domestic research capacity. 20

25 6. Conclusion We have analysed the potential for Kazakhstan to benefit from its Green Growth strategy. We find that the strategy can potentially generate positive economic gains while strengthening sustainability. However, we also find that successful implementation of the strategy is not certain since key stakeholders in particular utility operators lack the required investment incentives. As a way out, we propose public subsidies to co-finance specific investments while re-financing the additional public expenditures through introduction of carbon prices. Moreover, we show that by appropriate fine-tuning of prices for GHG emissions, manufacturing industries can even be incentivised to contribute more strongly to emission abatement without risking their competitiveness. While our analysis demonstrates that investment incentives of utilities need to be targeted by explicit policy measures to ensure successful implementation of the strategy, we acknowledge that there will be other areas where investment incentives require further analysis. In particular, we find the growth impact of GREEN economy is mainly driven by investments into sustainable production in agriculture. However, we have not yet analysed the incentive structure of this key sector in detail. This is the suggested direction for further advances and improvements of our modelling work. 21