Climate policy uncertainty could cost as much as 1% of GDP, report finds

The investor uncertainty caused by a continuing climate policy war would push power prices up by more than the policies proposed by either the government or Labor, according to a leading modeller.

Modelling by the former Reserve Bank of Australia board member Warwick McKibbin, done for the former Abbott government, found the Coalition’s promise to cut emissions by between 26% and 28% – if achieved with efficient policies – would shave between 0.2% and 0.3% from GDP in 2030, whereas Labor’s 45% target would reduce GDP by between 0.5% and 0.7%.

But the same modelling found the difference between the two policies (0.3% of GDP), or even the cost of the Labor target, would be dwarfed by the potential cost of continued investor uncertainty – which could be as high as 1% of GDP.

“Uncertainty increases the cost of capital for electricity generation and that increases electricity prices, which flows through the whole economy. Those price increases can be significantly larger than the price rises flowing from any of the policies to achieve a modest reduction in emissions,” McKibbin told Guardian Australia.

“The most critical thing is to achieve clear bipartisanship; continued political deadlock and disagreement increases uncertainty and means investors need a higher rate of return. Bipartisan policy gives you real economic benefits, and uncertainty costs as least as much as any difference in the estimated costs of meeting the targets proposed by each of the major parties,” he said.

McKibbin has raised concerns that, in practice, Labor’s target might be difficult to achieve.

He also says the government will struggle to meet its target using its current policy, largely relying on buying emissions reduction with the $2.5bn emissions reduction fund.

“The problem with the government’s existing policy is it’s very difficult to scale up. They will almost certainly have to modify it so it became a baseline and credit trading scheme and get it off budget.

“If the government did that there would be an overlap there with Labor’s policy on the electricity policy.”

Labor is now proposing a separate “emissions intensity” trading scheme for the electricity sector in which generators with higher emissions than an industry-wide baseline would have to buy credits from those with lower emissions. This is a big shift from the “cap and trade” scheme it previously introduced. The Coalition’s “Direct Action” scheme includes provisions that – with adjustment – could become the same kind of trading scheme.

McKibbin joins the economist and adviser to the Coalition government Danny Price and the Business Council of Australia in pointing out that these similarities provide a possible basis for a bipartisan policy.

Price, the chief executive of Frontier Economics, who advised the Coalition on “Direct Action”, told Guardian Australia the Labor plan was very similar to a scheme advocated by Malcolm Turnbull in 2009, and to the scheme that could be formed from “Direct Action”.

“The emissions intensity part of Labor’s plan appears to be exactly what we were proposing for Malcolm Turnbull and Nick Xenophon in 2009,” he said.

Price modelled the scheme for Turnbull and Xenophon when Turnbull was the opposition leader and was considering his response to the then Labor government’s cap-and-trade ETS.

Turnbull lauded it as a “cheaper, greener, smarter scheme” and said it could deliver deeper cuts to greenhouse emissions but imposed far lower increases in electricity prices. But the then prime minister Kevin Rudd dismissed it as a “magic pudding”. The then climate minister Penny Wong, now the leader of the opposition in the Senate, also dismissed the scheme that now forms part of Labor’s policy.

And Price – who the government recently appointed to the Climate Change Authority and who acted as an adviser on Direct Action – also said the Coalition would probably have to move to a similar scheme itself to meet its own emissions reduction targets.

“The government’s Direct Action plan – its safeguard mechanism – could be modified to create exactly this same type of scheme,” he said. “I’ve always thought that was the most likely way for them to go after the review they have scheduled for 2017, because they are obviously going to have to make changes to meet even their existing targets and this is a low-cost way to do it.

“It is actually emerging as an idea with the potential to be adopted by both major parties.”

Under Direct Action, the “safeguards mechanism” is supposed to ensure that increased emissions from heavy industry and electricity generators do not undo the reductions bought through the government’s $2.5bn scheme, by setting baselines for their emissions.

At present, the baselines are lenient, ensuring industries don’t “go rogue” by not seeking to reduce their greenhouse emissions. But many observers, including business groups, expect they will have to be tightened after 2017 to gradually reduce industrial emissions. And that would turn Direct Action into much the same scheme as Labor is proposing.

But the Turnbull government immediately attacked Labor’s policy as an “electricity tax”. The treasurer, Scott Morrison, called it a “big, thumping electricity tax” and the deputy prime minister, Barnaby Joyce, said Labor, the Greens and the independents wanted to “make people poorer because it’s good for you, because it’s righteous”.