1. Introduction
Since the historic meeting of the United Nations Framework Convention on Climate Change (UNFCCC) in 1994, numerous efforts have been made to find the optimal path toward worldwide sustainable development. At Paris in 2015, the 21st session of the Conference of the Parties (COP) agreed to keep the increase in the global average temperature to below two degrees centigrade above the pre-industrial level. The session also agreed to pursue efforts to limit the temperature increase to 1.5 degrees centigrade above the pre-industrial level. These agreements recognized that temperature-control efforts would significantly reduce the risks and impacts of climate change. In order to achieve the UNFCCC’s goals, all 195 member countries are required to make clear and measurable efforts for worldwide sustainable development. As one of the leading countries, Korea has promoted its version of green growth policies since the government hosted the G20 Seoul Summit in 2010. Since then, using one of the most powerful market-oriented frames, the Korean government has prepared and promoted its nationwide emissions trading scheme (ETS). This scheme became regulated in 2015; however, it has caused diverse conflict among politicians, industrial leaders, and even academic experts. Thus, the government has provided a cautious pilot scheme that involves a weak and constrained ETS. Emissions trading rights are traded only among regulated companies. Moreover, emissions targets have been initially set at 95% of the regime. Because of this loose, yet uncomfortable, arrangement among ETS interest groups, it is easy for regulated companies not to invest in the sustainable performance of green productivity and to avoid the extra burden of carbon targets in the short run. Consequently, even though many trials have evaluated the effectiveness of ETS-related policies, it is difficult to measure the performance or efficiency of such policies from a field-oriented company perspective. This paper aims to analyze, from a company perspective, whether the milestone policy of ETS in Korea is successful in terms of decreasing carbon emissions efficiently. Since carbon emissions form most greenhouse gas (GHG) emissions, we evaluate the GHG emissions of companies based on their efforts to decrease ETS targets.
In 2012, total GHG emissions in Korea were 688.3 million tons. This figure represents a 133% increase compared with the base year of 1990. Carbon dioxide (CO2) emissions overall were 593 million equivalent tons, a figure that places Korea as the seventh highest producer of such emissions in the world. Carbon emissions per person were 11.7 tons, which places Korea as the 18th highest producer of carbon emissions per person in the world and places it sixth among Organization for Economic Cooperation and Development (OECD) countries. These rankings imply that many other developing countries are more proactive than Korea; thus, Korea should be more aggressive in its attempts to decrease GHG emissions and carbon dioxide. The Korean government set its own target in November 2009, saying that it would reduce GHG emissions by 30% from BAU (business as usual) levels by 2020. In the Paris agreement of 2015, the Korean government decided to reduce GHG emissions by 37% from BAU levels by 2030. In order to achieve this target, the government published an emissions trading master plan (2015–2025) in 2014. It also implemented its ETS nationwide in 2015. Unfortunately, however, in spite of these proactive government efforts, the carbon trading market is regarded as a failure because very few transactions took place in the first year. Many experts blame the unreliable carbon price for this failure. They say that the carbon price is so low that companies with emissions permits are reluctant to sell them. Moreover, regulated companies are uninterested in green technology investment because of the low opportunity costs for such innovation. During most of 2015, the carbon price barely exceeded US $10, resulting in the lack of trading. Thus, it is important to analyze whether this price is appropriate or not for achieving the future sustainable performance of the Korean ETS. This issue is the basic motivation of the current research.
In order to monitor and measure efficient carbon reduction, many researchers have conducted carbon efficiency studies based on the distance function because of its reliable clarity about relative efficiency. Although there are numerous sustainable performance modeling methods, the distance function approach has become popular because it can simultaneously model joint-production technology with eco-friendly desirable and undesirable output. Another benefit of the distance function approach is that compared with other cost functions, it does not require any price-specific functional form that is relatively difficult to obtain. Given the quantity of data for input and output, which are comparatively easy to obtain, various critical environmental production characteristics can be formally analyzed. These include environmental technical efficiency, environmental productivity growth, the shadow prices of pollutants, and intra-factor substitution possibilities [
1].
Even if Shepherd distance function provides a basic logical frame for the treatment of multi-input/output analysis [
2], it is limited in the sense that it treats desirable and undesirable output proportionately; thus, it overlooks the possibility that it decreases undesirable output without any loss in desirable output. Consequently, most directional function research uses the directional distance function (DDF) introduced by Chambers, Chung, and Färe [
3]. According to the literature review of Zhang and Choi [
1], more than 100 papers have analyzed energy efficiency and the shadow prices of industrial emissions by using distance function models. Studies that use the DDF method employ either the parametric method [
4] or the nonparametric method based on data envelopment analysis (DEA) [
3,
5]. The former can easily calculate the shadow price but has to compute the theoretic distance function coefficients; the latter does not need to preset functional forms and thus can analyze the shadow prices of pollutants in all directions with significant flexible implications. Since it is not easy to accept a specific production possibility curve a priori without significant in-depth analysis on the characteristics of the decision units, this research is based on the DDF_DEA.
Most early research on the DDF is based on a radial model that estimates efficiency proportionately for all output [
3]. However, several later studies have reported limitations regarding this radial approach. First, radial measures may overestimate efficiency when slack exists [
6]. Second, the radial model has relatively weak discriminating power when ranking entities that require evaluation [
7]. Third, a radial efficiency measure cannot provide a single-factor efficiency measure, such as energy efficiency, because the DDF can only give the same rate of inefficiency [
8]. Because of these limitations, a number of studies have extended the conventional DDF to a non-radial DDF by considering slacks [
6,
9,
10,
11]. Thus, we employ the non-radial DEA-based DDF to examine the sustainable performance of the eco-friendly policies of Korea’s ETS.
Most studies in this field have been conducted in the power plant sector [
12,
13,
14,
15,
16], the steel and iron sector [
17,
18,
19], the electricity sector [
20,
21,
22], and other sectors such as the chemical, cement, and ceramic industries. Nearly all of these sectors emit a great deal of CO
2 [
23,
24,
25,
26]. Although these studies have employed the DDF to measure the performance of environmental policies, to the best of our knowledge no research has yet been conducted using company data related to real ETS trading. Moreover, Korea is the only country in the world to promote a nationwide, and not a regional or localized, ETS frame.
Since Korea is in a transitional stage between a developing and developed economy, this research has insightful implications about a stepwise approach to performance-oriented sustainable development. Moreover, this research has potential practical importance because it is based on a comparison between the shadow price and the price in the real world. Further, it evaluates the sustainability of the unduly cautious ETS policies in Korea. In this paper, the sustainability of ETS policies is analyzed from three perspectives. First, the Korean government’s ETS policies are excessively price-oriented; thus, we need to check that the semi-regulated market price of carbon emissions permits is acceptable compared with their shadow prices. If the market price is too low, it may result in low investment in green IT technologies, which is contrary to the government’s ultimate goal. Of course, the shadow price of carbon could be unrelated to the market carbon price for one important reason: the carbon allowances are given for free and all firms are allocated 100% of the allowances they need for at least in the first stage of three years. Under these conditions, it is reasonable for carbon allowances to have a low market value in the first few years of the ETS. Hence, it is hard to argue that the shadow prices reflect what the market price should be. However, the government should narrow this gap between the shadow price and market price as early and effectively as possible, and thus if the government stimulates companies to invest more on green technology, the price gap will be more effectively decreased. According to Oestreich and Tsiakas [
27], during the first few years of the scheme, firms that received free carbon emission allowances on average significantly outperformed firms that did not in the European Union Emissions Trading Scheme (EU ETS). Even if this kind of transition trial and errors on the inappropriate carbon market price, however, they found that this kind of carbon premium is present for a specific period that commences about one year before the beginning of Phase I and disappears about one year into Phase II [
27]. If this is true, then the Korean government should make this trial and error on the carbon market price as short as possible. In this paper, we will check the feasibility of this carbon premium in terms of the price gap between the shadow price and market price.
Second, in order to boost investment in energy-saving green technologies by ETS member companies, there must be significant elastic substitutability between energy and other input. Third, it is necessary to check whether the potential sustainability of ETS policies is increasing the eco-friendly efficiency of participating companies. If not, such companies have no incentive to exert too much effort in proactively participating in ETS trading.
Thus, the purpose of this paper is to examine these three points regarding the sustainability of governmental policies. In this context, we use the ETS data of participating member companies. However, the Korean ETS covers 525 companies from diverse industries. Consequently, since the clarity and credibility of the implications are important in order to check the sustainability of the ETS policies, this research focuses on the petrochemical industry. This industry is the largest in the ETS with 85 companies, which represent 16% of all ETS members. Thus, based on the arguments regarding an examination of the ETS policies’ sustainability, this paper estimates the eco-friendly efficiency of the participating member companies in the major field of the petrochemical industry. It compares the shadow price with the market trading carbon price and considers the potential of green investment in terms of Morishima elasticity between capital and energy.
The rest of this paper is organized as follows:
Section 2 presents a methodological framework of the non-radial DDF models with Morishima elasticity and describes the data collection.
Section 3 presents the results of the empirical study of the petrochemical industry.
Section 4 concludes with some policy implications for sustainable governance.
4. Conclusions
One year has passed since the Korean government inaugurated its ETS in 2015; consequently, it may be too early to evaluate the sustainability of the government’s ETS policies. Although there have been problems such as a low volume of carbon trading and unduly low semi-fixed prices, such policies must continue successfully. The reason is that ETS policies are necessary for optimal control of future challenges and for a low carbon society, both of which are goals that the Korean government should pursue because the achievement of low carbon emissions is an engine for future development. From the beginning, there have been excessive claims and opposition from diverse interest groups such as politicians, industrial leaders, business managers, and experts. Because of the complaints from these people, the government has set its carbon-reduction targets at much lower levels than originally planned, resulting in a lack of governance for sustainable performance. In this research, we examined three governance factors of sustainability with regard to Korean ETS policies.
First, the eco-friendly efficiency of CTE shows that companies have significant potential to enhance their efficiency. The average CTE for the 63 ETS member companies in our sample was 0.472. This figure suggests that there is potential for a 52.8% enhancement of such companies’ CTE. In other words, the proactive participation of companies in the ETS should lead to an efficiency improvement that more than doubles the current average. If such companies can obtain information about the best practices of companies on the frontier, they can certainly improve their CTE. Moreover, in order to avoid bipolarization of carbon-reduction performance, the government should make cross-learning from best practices easier and more profitable for the ETS member companies.
Based on this empirical result, we examined the second governance factor of market price appropriateness. Using the shadow price of carbon emissions, the empirical result showed that the market price was approximately half that of the shadow price for almost a year. This result implies that an excessively regulated market price prevents companies from proactively participating in carbon trading. Further, it is clear that there is a missing link in the carbon trading policy of the ETS. In order to find this missing link, we used a third stage of empirical testing in terms of Morishima elasticity between the input and undesirable output of carbon emissions. The findings showed that there is significantly high substitutability between capital and energy input, implying that greater investment in green technology results in higher levels of energy-saving efficiency. This improvement is the ultimate goal of the Korean government’s ETS policies. However, unfortunately, the current severely distorted restriction of unduly generous carbon emissions targets has resulted in poor performance from efficiency and shadow price perspectives. Thus, the empirical results strongly suggest that the Korean government should encourage the ETS member companies to make greater efforts to decrease their carbon emissions. Such encouragement should not rely on a voluntary approach but should be in the form of a stricter regulated system with much lower free allowances for carbon emissions. In particular, CTE is bipolarized, implying that there is significant potential for companies with low CTE to improve easily and effectively. Such improvements can originate from intra-industry technological transfers or the learning effects of best practice taken from those companies on the frontier of the DDF production possibility curve.
This research used duality theory with a non-radial, non-parametric DDF approach to examine diverse production characteristics from the sustainable development perspective. Using input-oriented DDF, CTE was measured in the first stage. Further, by using the dual model of non-radial DDFs, we obtained the shadow prices of carbon emissions and input substitutability. Because the methodology could not reflect the dynamic effect of the ETS, it may have limited implications. Moreover, the empirical test was undertaken in the petrochemical industry only. Thus, even if the research provides clearer insights because of the homogeneity of the DMUs, it still needs to expand its empirical base to encompass diverse industries by using the meta-frontier approach. All the data in the paper is based on the one year of 2015, and it may be too short to infer the significant implications and suggestions. However, since the Korean government initiated the target management system (TMS) five years before ETS, all the covered companies are ready to participate in the ETS and their efforts are relevant to be analyzed even in the short term. Of course, our research need to be complemented with the dynamic changes of the policy effects over time for the future research issue.
Are emissions trading policies sustainable in Korea? This paper showed clearly the lack of governance for a sustainable ETS policy in Korea; thus, the Korean government should engage in greater proactive efforts to upgrade the future sustainable performance of the ETS [
37]. Especially, for the sustainable performance of ETS, the covered companies should make efforts to invest in green technology to improve its environmental efficiency, and the paper showed that there is huge potential for benefits from green investment to enhance environmental efficiency. However, the government should support for the companies to invest on the green technology as early as possible to fill the missing link between the target and the current huge lack of the environmental efficiency.