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This marker identifies the place of a tabbed divider. Given our
digitization capabilities, we are sometimes unable to adequately
scan such dividers. The title from the original document is
indicated below.
K
Divider Title:
Institute
The Global
Climate Debate:
Keeping the Economy
Warm and the Planet
Cool
Economic Y STRATEGY
Impact on Five Key Industries:
Airlines, Automobiles, Chemicals,
Semiconductors and Steel
Andrew Z. Szamosszegi
Lawrence Chimerine
Clyde V. Prestowitz, Jr.
September 1997
© 1997, Economic Strategy Institute
1401 H Street NW, Suite 750
Washington, DC 20005
To date, the debate on global warming has focused primarily on
scientific issues and the macroeconomic effects of reduced greenhouse
gas emissions.
Because such analysis is based on numerous assumptions and
aggregation of numbers, it often misses important elements that can
have large effects on individual industries.
The Economic Strategy Institute (ESI) therefore has taken a
"bottoms up" approach in this study and looked at the impact of
emissions reductions on output, trade and competitiveness of a range
of key industries including:
airlines
automobiles
chemicals
semiconductors
steel
We believe these are representative of a range of other industries we
did not have the time to analyze.
Finally, we would remiss if we failed to acknowledge the assistance
of Hilary Dauer, Andrew Harig, Lisa Hill and Yee Wong in the
completion of this report.
-- The authors
Table of Contents
List of Tables and Figures
iii
Introduction
v
Chapter I: Introduction
1
Chapter II: Putting U.S. Emissions Performance in Perspective
7
Chapter III: Proposals for Kyoto - What's Out There
17
Chapter IV: Measuring the Macroeconomic Impact of Emission
Control
23
Chapter V: Impact of a Potential Carbon Tax on the Chemical
and Steel Industries
37
Chapter VI: Impact of a Carbon Tax on Autos, Air Transportation,
and Semiconductors
55
Chapter VII: Conclusions and Recommendations
79
List of Exhibits
ES.1 Change in Total Final Energy Consumption per Unit of GDP
vi
ES.2 Changes in Real U.S. Prices of Various Energy Sources,
1973-1987 Versus Expected Changes Due to a Carbon Tax
vii
ES.3 Average Growth Rates of Real GDP 1960-1973 and 1973-1989
vii
ES.4 Estimated Impact of a $100 per Ton Carbon Tax Summary of
Output and Trade Effects by 2010 Percent Change for Base Case
viii
II.1 Share of Coal in Total Energy Supply, 1995
9
II.2 Share of Nuclear Energy in Total Energy Supply, 1995
10
II.3 Annual Changes in Global CO2 Emissions, Population, and Per
Capita Emission 1950-1974
11
II.4 Population Density and Emission, as a Share of GDP, in Select
OECD Countries, 1990
12
II.5 Shares of Final Consumption of Energy in OECD Transport
Sectors, 1993
13
II.6 Energy Consumption and Road Length in the OECD
13
II.7 Change in Total Energy Consumption per Unit of GDP
14
II.8 Changes in Emissions Levels and GDP
15
III.1 Change in Emissions of Carbon Dioxide 1990-1995 Annex I
vs. Non-Annex I Countries
19
IV.1 U.S. Energy Consumption, Real GDP Index 1960-1995
24
IV.2 Real Long-Term U.S. Interest Rates, 1977-1996
32
IV.3 Post War Recessions Peak-to-Trough Declines in Real Chain
Weighted GDP
34
IV.4 Average Growth Rates of Real GDP 1960-1973 and 1973-1989
35
IV.5 Changes in Real U.S. Prices of Various Energy Sources 1973-1987
Versus Expected Changes Due to a Carbon Tax
35
V.1 Output, Employment and Trade of the U.S. Chemical Industry, 1995
38
V.2 U.S. Chemical Industry's Energy Consumption, by Fuel Source
1974 and 1990
39
V.3 Global Chemical Sales, by Region, 1995
40
V.4 Chemicals Trade of Western Europe, the United States, and Japan, 1995
42
V.5 Energy Prices Faced in Europe, Japan, and the United States, 1994
43
V.6 U.S. and E.U. Product Mix, Ranked by Energy Intensity
44
V.7 U.S. Chemicals Trade with Annex I and Non-Annex I Countries, 1995
45
V.8 Chemical Industry Output and Trade Estimated Impact of
a $100 per Ton Carbon Tax by 2010
46
V.9 Output, Employment and Trade of the U.S. Steel Industry, 1995
47
V.10 U.S. Steel Industry's Energy Consumption by Fuel Source, 1991
49
V.11 Global Production of Crude Steel, by Region, 1995
49
V.12 U.S. Steel Trade with Annex I and Non-Annex I Countries, 1995
51
V.13 Steel industry Output and Estimated Impact of $100 per Ton
Carbon Tax by 2010
53
VI.1 Output, Employment and Trade of the U.S. Automobile
Industry, 1995
56
VI.2 Estimated Direct and Indirect Effects of a 100 Percent Increase
in Energy Costs Passenger Cars and Trucks (SIC 3711)
57
VI.3 Estimated Impact of a Carbon Tax on Operating and
Ownership Costs
58
VI.4 Global Production of Automobiles, by Region, 1995
60
VI.5 U.S. Automotive Trade with Annex I and Non-Annex I
Countries, 1995
61
VI.6 U.S. Vehicle Market, by Size and Import Share, 1995
62
VI.7 Motor Vehicle Industry Output and Trade Estimated
Impact of a $100 per Ton Carbon Tax by 2010
63
VI.8 Potential Impact of a Shift in Vehicle Purchases toward
Mid-Sized Cars
64
VI.9 Output, Employment and Trade of the U.S. Airline Industry, 1995
65
VI.10 Energy Expenditures as a Share of Direct Operating Costs, 1995
66
VI.11 Long-Term Income Elasticities for Selected Consumption
Categories
67
VI.12 Global Scheduled Passenger Kilometers Performs,
by Countries, 1995
68
VI.13 Passenger Airline Services Trade with Annex I and
Non-Annex I Countries, 1995
69
VI.14 Airline Services Industry Revenue and Trade Estimated
Impact of a $100 per Ton Carbon Tax by 2010
70
VI.15 Output, Employment and Trade of the U.S. Semiconductor
Industry, 1995
71
VI.16 Global Semiconductor Market Share, by Region of Capital
Affiliation 1990 and 1995
73
VI.17 U.S. Semiconductor Trade with Annex I and Non-Annex
I Countries, 1995
75
VI.18 Semiconductor Industry Output and Trade Estimated
Impact of a $100 per Ton Carbon Tax and PFC Restrictions by 2010
77
Executive Summary
The Issue
In December 1997, representatives of the world's governments will meet in
Kyoto, Japan, to conclude an agreement committing developed countries to
mandatory reductions of greenhouse gas emissions to at least 1990 levels by
2010.
Developing countries are not expected to be included in this agreement, and
thus would have no commitments with regard to greenhouse gas emissions,
despite the fact that their emissions are rising rapidly and will soon exceed
advanced country emissions.
Such an agreement would have significant implications for the United States,
because it could result in substantially higher energy costs and the
elimination of production processes that are essential to several key
industries.
The Economic Strategy Institute (ESI) has attempted to estimate the impact of
any agreement on the overall U.S. economy, as well as on several key
industries (chemicals, steel, autos, passenger airline services, and
semiconductors) from the point of view of competitiveness and trade. The
key results of this study are summarized below.
The Science of the Issue
The science of global climate change is in dispute. Global climate models
show temperatures should be rising, but satellite and weather balloon data
show temperatures have been stable. ESI's purpose is not to contest the
science, but to look at the impact of proposals for dealing with a problem that
has not been conclusively proven to exist.
Status of the United States
Other governments and commentators have asserted that the United States is
particularly at fault. This is not the case. U.S. emissions of carbon dioxide per
unit of output are below the world average, and most of the rise in U.S.
emissions since 1990, the baseline for emissions proposals, reflect population
growth and economic expansion, not declining energy efficiency. In fact, U.S.
Economic Strategy Institute
the
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
energy efficiency since 1980 has improved more than that of most
industrialized countries.
Exhibit ES.1
Change in Total Final Energy Consumption per Unit of GDP
1980 - 1993
lire.
U.S.
Den.
Can.
Nor.
Jap.
Swe.
Fra.
Net.
Bel.
U.K.
Austria
Ita.
Spa.
Tur.
Australia
Swi.
Fin.
Gre.
Por.
N.Z.
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
Percent Change in Final Energy Consumption per Unit of GDP
Source: OECD
Survey of Existing Models
Most of the estimates of the economic impact are based on models which
incorporate key economic variables and behavioral relationships. These
models contain flaws which lead them to underestimate the economic impact
of a greenhouse tax or other measures required to return U.S. emissions to
1990 levels. Optímistic assumptions include:
-understating the emissions tax necessary to reduce emissions,
-assuming away the higher costs that would result from increased
regulation, and
-discounting the likelihood that offsetting tax cuts would be used
unwisely.
ESI has concluded that the overall impact on the U.S. economy would be
somewhat larger than many models are predicting. This assessment is based
on the U.S. experience during and after the oil crises of the 1970s, and on
recent model simulations which do not include the rosy assumptions of other
estimates. One such simulation, by The WEFA Group, shows that much
larger tax levels, perhaps two times larger than the $100 per metric ton of
carbon assumed in recent administration simulations, would be required to
reduce U.S. emission levels to 1990 levels by 2010.
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool vii
Exhibit ES.2
Changes in Real U.S. Prices of Various Energy Sources, 1973-1987
Versus Expected Changes Due to a Carbon Tax
1973-1987
1994-2010
Oil
67%
70%
Natural Gas
223%
45%
Coal
24%
198%
Sources: Derived from data in Gary W. Yohe, Climate Change Policies, Living Standards, and Real Wage Growth;
Argonne National Laboratory, The Impact of High Energy Price Scenarios on Energy Intensive Sectors:
Perspectives from Industry Workshops; and ESI Calculations.
Exhibit ES.3
Average Growth Rates of Real GDP
1960-1973 and 1973-1989
1960-1973
1973-1989
United States
3.95%
2.42%
European Union
4.68%
2.27%
OECD
4.82%
2.63%
OECD Europe
4.67%
2.31%
Japan
9.57%
3.84%
Note: EU, OECD and OECD Europe refer to 1991
membership
Source: OECD
Analysis of Key Industries
To determine the impact of emissions reduction policies on specific
industries, ESI used a bottom-up approach which took into account energy
intensities, trade and output levels, the level of sectoral trade with developing
countries, foreign direct investment patterns, and the other industry-specific
factors. The results show that damage from a greenhouse gas tax would
extend to high tech and service industries, as well as to traditional
manufacturers. Losses in output and competitiveness would be substantial.
Economic Strategy Institute
viii
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Exhibit ES.4
Estimated Impact of a $100 per Ton Carbon Tax
Summary of Output and Trade Effects by 2010
Percent Change from Base Case
Output
Exports
Imports
Chemicals
-with feedstock exemption
-3.3
-3.6
3.5
-without feedstock exemption
-4.6
-7.2
7.0
Steel
-21.9
-18.0
14.3
Automobiles
-5.8
-3.8
3.6
Airline Services
-6.5
-3.0
2.8
Semiconductors*
-8.0
-6.0
5.8
"Semiconductor estimates include the effect of regulations on PFC production
ESI Calculations
The disturbingly high losses in the semiconductor industry reflect the
likelihood that perfluorocarbon emissions (PFCs) would be reduced through
regulation. Since there are currently no substitutes for PFCs in the
semiconductor manufacturing process, drastic emissions limits would put
U.S. manufacturers at a major disadvantage against unregulated competitors
from developing countries.
Exempting developing countries from greenhouse gas limits would
dramatically increase the U.S. deficit. With tensions over trade with
developing countries already high, support for the World Trade Organization
would almost certainly erode. This development would run counter to
efforts by this and previous U.S. administrations to open markets and expand
free trade.
Conclusions and Recommendations
Given the ambiguity surrounding the science of global warming and the
substantial economic costs of reducing greenhouse gas emissions though
taxation and regulation, the U.S. government should be extremely cautious in
dealing with the Kyoto agenda. In particular, it should not agree to
proposals being made by other countries for mandatory reduction of
emissions by 2010.
The United States should resist efforts to exempt developing countries from
emissions reduction efforts and encourage cooperative arrangements,
financing, and technology transfers that would lead to emissions reductions
in developing countries.
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool ix
Participants at Kyoto should consider cooperatively financing a Manhattan-
type project to achieve massive increases in energy efficiency.
Economic Strategy Institute
Chapter I: Introduction
In early December 1997, representatives of the world's governments gathering in
Kyoto, Japan are expected to finalize a pact committing dozens of countries,
including the United States, to reduce emissions of greenhouse gases.¹
Most man-made emissions are the byproduct of burning fossil fuel for energy,
which enables production of goods and services, transportation of goods and
people, and simplification of day-to-day tasks. Because energy from fossil fuels
has become the driving force of human economic activity, any decisions coming
out of Kyoto that affect energy use will inevitably have a far-reaching impact on
the global economy. In particular, as the world's largest economy and biggest
consumer of fossil fuels, America has much riding on the outcome of these
discussions.
Background
In June 1992, at the United Nations Conference on Economic Development in Rio
de Janeiro, Brazil, representatives of 154 governments signed the Framework
Convention on Climate Change. The ultimate aim of this treaty, which took
force on March 21, 1994, is to prevent any climate change that could result from
high concentrations of atmospheric greenhouse gas. As part of efforts to reach
this goal, Annex I countries (the OECD countries as of 1992, plus Eastern Europe
and the old Soviet Union) voluntarily committed to reduce greenhouse gas
emissions to 1990 levels by the year 2000.2
Since Rio, there have been two major meetings of the Climate Change
Convention. The first conference of the parties (COP-1), occurred in Berlin in late
1995. Participating ministers concluded that the voluntary commitment
mechanism was insufficient and consequently adopted the Berlin Mandate,
which exempted developing countries from emissions limits while beginning the
process of setting post-2000, mandatory limits on developed country emissions.
The Ad Hoc Group of the Berlin Mandate was tasked to devise a legal
1 Greenhouse gases are carbon dioxide, water vapor, methane, nitrous oxide and tropospheric
ozone. Man-made chemicals, such as chlorofluorocarbons, hydrofluorocarbons and
perfluorocarbons, act as greenhouse gases and could be affected by Kyoto discussions as well.
2 The United States objected to an explicit treaty commitment during negotiations, but changed its
stance in April 1993.
Economic Strategy Institute
2
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
instrument that would commit developed countries to more stringent targets
after 2000.
In July 1996, at COP-2 in Geneva, Switzerland, participants stressed the need to
strengthen the Climate Change Convention. The Kyoto meeting in December
1997 will be the third conference of the parties, and is aimed at agreeing to strict,
mandatory emissions limits for Annex I countries.
Issues
From the outset, the treaty has been controversial. Many scientists worry that
the science underlying climate change predictions is too uncertain to warrant
hasty, drastic action. Outside the scientific community, concern is mounting that
the proposals to be discussed at Kyoto represent unrealistic, panicked reactions
that could lead to slower economic growth and lower living standards - a high
price to pay for solving an uncertain problem.
The Science
Though the scientific debate is beyond the scope of this paper, it deserves
mention because the Intergovernmental Panel on Climate Change (IPCC), an
international network of scientists, presents itself as representing the scientific
consensus on global climate change. IPCC scientists have concluded that the
balance of evidence suggests that there is a discernible human influence on
global climate;"³ that man-made greenhouse gases will lead to significantly
warmer weather during the next hundred years; and that warmer temperatures
will result in more extreme weather changes in some areas, including more
severe or less severe floods and droughts.
The IPCC's predictions of impending global warming and its impact, however,
are not universally accepted. Hundreds of scientists at the Rio conference signed
the Heidelberg Appeal, which warned against concluding a treaty without a
proper scientific basis. In 1996, nearly one hundred climate scientists signed the
Leipzig Declaration, questioning the validity of global warming forecasts based
on computer model simulations.⁴
The record of the models predicting climate change is uncertain at best. In the
mid-1980s, available models were forecasting a 5.2°C (9.4° F) average rise in
global temperatures by 2100. By 1992, the IPCC had modified that estimate to a
range of 1° to 4.5°C (1.8° to 8.1°F) through 2050. For its second assessment, the
group revised its upper bound estimate down to 3.5°C (6.3°F) by 2100.
3 IPCC, Climate Change 1995: The Science of Climate Change, Working Group 1 (Cambridge, UK:
Cambridge University Press, 1996), 6.
4 S. Fred Singer, "Scrap the Climate Treaty," The Journal of Commerce (March 6, 1997).
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
3
Scientists who disagree with even these most recent projections argue that the
computer models generating these estimates do a poor job of reflecting natural
climatic variability.⁵ They also cite data from satellites and balloon-borne sensors
showing little-to-no climate change since 1979 and little, if any, warming since
1945, even though seventy percent of all manmade greenhouse gases have been
added to the atmosphere during the past fifty years.6 They conclude that there
will be warming, but much less than the IPCC predicts, and it will have benign,
perhaps even beneficial, consequences.⁷
Dissension within the scientific community is not an excuse for inaction.
However, the many unanswered questions surrounding this scientific debate
suggest a prudent, measured approach toward abatement is warranted.
The Proposals
The Ad Hoc Group of the Berlin Mandate has waded through emissions control
proposals submitted by various countries and has combined them into a
negotiating text that will be modified and adopted in Kyoto. Though no firm
targets for emissions reductions have been chosen, it is clear that the emissions
reductions proposals now under consideration, if adopted, would have a major
impact on the global economy during the next several decades. Key points of
contention include:
1) Emissions targets and timetables - Proposals range from reducing
carbon dioxide emission levels to 1990 levels by 2010 to cutting twenty
percent from 1990 levels by 2020. Earlier target dates and deeper
emissions cuts will mean more severe economic adjustments.
2) Developing-country exemption - Emissions from non-Annex I
countries are expected to surpass Annex I emissions by 2050, yet the
Berlin Mandate has decreed that their emissions will be allowed to
grow for the foreseeable future. Any plan that exempts developing
countries would encourage the migration of energy-intensive
production processes to developing countries and would result in little
net emissions reduction.
5 William K. Stevens, "Warming Skeptic Says It's a Lot of Hot Air,"
6 Patrick J. Michaels and Paul C. Knappenberger, "The United Nations Intergovernmental Panel
on Climate Change and the Scientific 'Consensus' on Global Warming," in John Emsley, Ed., The
Global Warming Debate (London: The European Science and Environmental Forum, 1996), 165-166.
7 Some believe that such slightly higher temperatures and carbon dioxide levels will lead plant
life and human civilization to thrive. See, for example, Sherwood Idso, "Plant responses to
Rising Levels of Atmospheric Carbon Dioxide," in Emsley, Ed., The Global Warming Debate
(London: The European Science and Environmental Forum, 1996), 28-39; and Thomas Gale
Moore, "Why Global Warming Will Be Good for You," The Public Interest (Winter 1995), 83-99.
Economic Strategy Institute
4
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
3) Differentiated targets - The European Union expects to reach its target
by allowing some members to increases emissions while others reduce
theirs. Some countries are arguing that all Annex I countries should
have the targets appropriate to their economic profile.
4) Flexible reduction strategies - There are alternatives to achieving a
target by a certain date. The United States, for instance, has suggested
an approach that would allow for emissions budgets to be achieved
over a number of years. Washington has also suggested emissions
trading and joint implementation, schemes which would, in essence,
enable developed countries to get credit for encouraging "offshore"
emissions reductions.
Regardless of which proposal emerges from COP-3, any amendment to the treaty
that mandates emissions reductions will ultimately affect the choices of both
firms and consumers. Whether Annex 1 governments decide to reduce emissions
by implementing tough new standards, typically referred to as command and
control measures, or by implementing market-oriented measures, such as carbon
taxes or tradable permits, there will likely be a decline in the growth of Annex I
GDP. These losses would occur because emissions reduction policies would
compel companies to make investments that are more expensive than those that
would have taken place in the absence of such policies.
During the past decade, dozens of studies have attempted to estimate the
economic costs of mitigation. A clear majority of them conclude that GDP in
OECD countries would decline from the levels that would be expected to occur
in the absence of mitigation policies.⁸ Of the ninety-four studies of individual
OECD countries cited in the IPCC's second assessment, only seven show gains to
baseline GDP from the reduction of carbon dioxide emissions. All twenty-three
global impact studies cited by the IPCC conclude that global output will decline
as a result of carbon abatement efforts.⁹
Most of these estimates were derived from top-down models that look at the
aggregate macroeconomy as a whole. There have been a small number of
bottom-up, energy-based, models as well.
This Study's Contribution
Despite the number of studies already completed, there are a wide range of
topics that have not yet received adequate attention. For instance, the effects of
mitigation policies on employment, inflation, trade and competitiveness at both
8 IPCC, Climate Change 1995: Economic and Social Dimensions of Climate Change, Working Group III
(Cambridge, UK: Cambridge University Press, 1996), 303-322.
9 Climate Change 1995: Economic and Social Dimensions of Climate Change, 336.
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
5
the aggregate and sectoral level have barely been analyzed.¹⁰ In addition,
analysts have ignored the potential impact of an ill-conceived, growth-distorting
climate change agreement on advanced-country support for free trade. A climate
change agreement that results in slower advanced-country growth, higher
unemployment, and a sharp rise in developing-country imports could give
substantial ammunition to people arguing that trade with developing countries
is intrinsically bad.
With this in mind, the Economic Strategy Institute (ESI) has undertaken a
bottom-up study that quantifies the potential impact of carbon abatement
measures on key U.S. industries, covering both high-tech manufacturing and
service sectors. In particular, ESI has focused on the chemical, iron and steel,
automobile, air transport, and semiconductor industries. The analysis focuses on
the absolute economic impact on those industries, as well as the relative impact
that proposed measures would have on their competitiveness and on trade
flows.
These industries represent a broad cross section of the U.S. economy. Steel and
chemicals are traditional "smokestack" industries. Steel is an important input in
a variety of manufactured goods, and it increasingly faces competition from
developing countries and transition economies. The U.S. chemical industry is
also energy intensive and is dominated by multinational corporations capable of
shifting production to developing countries. The automobile and airline
industries are less energy intensive, but demand for their end-use products and
services will be significantly affected by abatement policies that raise gasoline
prices and reduce economic growth. The semiconductor industry, a key player in
America's industrial renaissance and high-tech revolution, is not energy
intensive but, nonetheless, is a major energy user and uses a greenhouse gas in
the production process. The potential impact of abatement policies on this
cutting edge industry is particularly worth exploring in view of the expectation
that U.S. industry will increasingly move from smokestack to high-tech sectors.
10 See, for example, Climate Change 1995:Economic and Social Dimensions of Climate Change, 13; and
"Research on Linkages between Trade, Environment and Sustainable Development - A
Preliminary Note," posted online by the United Nations Department for Policy Coordination and
Sustainable Development at gopher://gopher.un.org/00/esc/cn17/1996/backgrnd/research.txt
Economic Strategy Institute
Chapter II: Putting U.S. Emissions
Performance in Perspective
Since enacting the National Environmental Policy Act in 1969, the United States
has played a leading role in addressing global environmental problems.¹¹
Despite this positive record on environmental issues, the United States this year
has come under increasing criticism for its policy toward global climate change.
Specifically, European leaders and environmentalists around the globe have been
taking the U.S. government to task for not making more progress toward the
goal of reducing U.S. carbon dioxide emissions to 1990 levels by 2000, and for not
embracing a European plan to reduce emissions further by 2010. Continental
leaders, such as British Foreign Secretary Robin Cook, have criticized Americans
for being " still very much in a culture of large, extravagant private cars and
generous consumption of energy as a cheap commodity."12 Europeans are also
fond of pointing out that the United States is responsible for more than one-fifth
of global carbon dioxide emissions.
For its part, Europe is portraying itself as the defender of the planet. The
European Union as a whole could very well reach its 2000 goal, and European
leaders have embraced the goal of cutting emissions fifteen percent below 1990
levels by 2010.
European efforts to caricature the United States as the bad boy of global climate
change are misguided, however. The timing of the E.U. cacophony - it began in
June 1997 at the G-7 Summit in Denver - suggests it was part of a concerted
effort to deflect attention from crawling economies and high unemployment
back home. More telling, the data simply do not back European assertions.
Though it is true that the United States emits more than twenty percent of the
world's carbon dioxide, the United States is responsible for only eighteen percent
of total greenhouse gas emissions.¹³ Since the United States produces more than
twenty percent of the world's economic output, the country's greenhouse
emissions per unit of growth are actually better than average.
11 Organization for Economic Cooperation and Development (OECD), Environmental Performance
Reviews - United States (Paris: OECD, 1996), 215.
12 See, for example, "G-7 Summit Split over Greenhouse Gases," San Jose Mercury News (June 21,
1997).
13 OECD, Environmental Performance Reviews, p. 217. Sulfur dioxide and nitrous oxides are also
considered greenhouse gases.
Economic Strategy Institute
8
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
The reality, then, is quite different from what E.U. leaders would have us to
believe. The United States has done much to reduce greenhouse gas emissions
over the years, and other factors, less sensational than the pejorative
"extravagant culture," help explain current U.S. emission levels.
Poor Timing
The decision at Rio to base future emissions targets on 1990 emissions levels has
placed an added burden on the U.S. economy, making it even more difficult for
the United States to keep its year-2000 promise. Saddam Hussein's invasion of
Kuwait nudged the U.S. economy into recession in 1990. Since energy use, and
thus emissions, tend to ebb and flow in tandem with economic activity, U.S.
emissions of carbon dioxide that year were 125 metric tons below 1989 levels and
did not surpass 1989 levels until 1993.14 By contrast, the economies of Japan and
Europe were in the midst of expansions that lasted until 1992.¹⁵ Thus, meeting
any targets based on 1990 levels will be relatively less taxing for Europe and
Japan than for the United States.
In fact, the choice of 1990 as a baseline year has been beneficial to Europe. For
example, both Germany and Great Britain will likely attain their targets for 2000.
Their success, however, has nothing to do with climate change policies and
everything to do with timing.
Germany is receiving credit for emissions reductions occurring in the former East
Germany, where coal was the main energy source and energy use was inefficient.
Since 1990, the united Germany has been dismantling noncompetitive
production facilities in the eastern part of the country, and many of the
remaining factories are underutilized. 16 Germany's emissions picture, therefore,
has brightened dramatically. In Denver, and at the United Nations meeting on
climate change that followed, German Prime Minister Kohl was among those
critical of the United States, despite the fact that carbon dioxide emissions in
western Germany have actually risen since 1990.¹⁷
In Great Britain, the story is similar. During the late 1980s, Britain's Conservative
government decided to cut back on massive subsidies supporting the country's
inefficient mining operations, a decision that had nothing to do with climate
14 OECD, OECD Environmental Data Compendium 1995 (Paris: OECD, 1995), 39.
15 The United Kingdom is the exception. Its recession also began in 1990.
16 See, for example, Paul M. Bernstein, W. David Montgomery and Thomas F. Rutherford, World
Economic Impacts of U.S. Commitments to Medium Term Carbon Emissions Limits, CRA No. 837-06
(Washington, DC: American Petroleum Institute, January 1997), 18.
17 Jeff Rubin, "A Betrayal of Rio," ABCNEWS.com (June 28, 1997).
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9
change policies and everything to do with fiscal necessities. As a result, Britain's
deregulated electric power generating industry has abandoned coal for cheaper
and cleaner natural gas, causing Britain's emissions to plummet. Prime Minister
Tony Blair and Foreign Secretary Robin Cook have subsequently voiced the
loudest criticism of the United States, which seems ironic in view of the fact that,
as shadow trade and industry secretary of the Labor Party, Cook had virulently
opposed Conservative efforts during the 1980s and 1990s to reduce coal mine
subsidies.
Factor Endowments
It is often said that America's greatest assets are its natural resources and its
people. Interestingly, this interplay of people and resources - coal and land, in
particular - goes a long way toward explaining current U.S. emissions levels.
The United States, like Australia, has been blessed with large coal reserves.
Unlike Great Britain and Germany, where mining has been heavily subsidized
and inefficient, U.S. mines are extremely efficient and cost effective. Naturally,
the U.S. electric power industry, as well as energy-intensive industries that
generate their own power, long ago turned to coal as a primary source of energy.
In 1995, the United States supplied more than one-fifth of its total energy
consumption and fifty-four percent of its electricity with coal, more than most
other advanced economies (see exhibit II.1).
Exhibit II.1
Share of Coal in Total Energy Supply, 1995
France
Italy
Canada
Japan
United Kingdom
United States
Germany
Australia
0%
5%
10%
15%
20%
25%
30%
35%
40%
Coal as a Share of Energy Supply
Source: International Energy Agency
This dependence on coal makes good economic sense, but it increases U.S.
emissions levels, because coal is the most carbon-intensive of the fossil fuels. One
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coul CO2 886
unit of coal produces about eighty percent more carbon dioxide than does one
thereal
unit of natural gas, and twenty percent more than one unit of petroleum. 18
Like other countries, the United States has turned to non-fossil-based energy
sources, such as nuclear energy. Due in large measure to protests by
environmental groups, however, nuclear energy supplies less than ten percent of
U.S. energy consumption, well below penetration levels in France and Japan (see
exhibit II.2). In 1980, nuclear energy accounted for about eight percent of France's
primary energy supply, versus about four percent in the United States. The
nuclear share of French energy is now about forty percent, five times higher than
in the United States, and French carbon dioxide emissions from energy use have
declined more than twenty percent from 1980 levels. With federal licenses for
many U.S. nuclear power plants beginning to lapse, and with deregulation of the
U.S. electricity market around the corner, experts predict that the nuclear share
of the America's electricity market will be halved in twenty years. 19
Exhibit II.2
Share of Nuclear Energy in Total Energy Supply, 1995
Italy
Australia
United States
United Kingdom
Germany
Canada
Japan
France
0%
5%
10%
15%
20%
25%
30%
35%
40%
Nuclear Energy as a Share of Energy Supply
Source: International Energy Agency
Emissions growth in the United States is also a function of rising U.S. population
and employment levels. All other things being equal, a growing population leads
to higher energy usage and, thus, to higher carbon emissions. In fact, during the
past two decades, global emissions levels have been driven by population
growth, but per capita emissions of carbon dioxide have actually been declining
(see exhibit II.3).
18 Intergovernmental Panel on Climate Control, Climate Change 1995 - Impacts, Adaptations and
Mitigation of Climate Change: Scientific-Technical Analysis (Cambridge, UK: Cambridge University
Press, 1996), 14.
19 Margaret Kriz, "Fuel Fight," National Journal (June 7, 1997), 1128.
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Exhibit II.3
Annual Changes in Global CO2 Emissions, Population, and Per Capita Emissions
1950-1974
4.6%
2.6%
2.0%
1.7%
1.4%
1950-1973
1973-1994
-0.3%
Emissons
Population
Emissions per Capita
Thus, looking solely at national emissions growth over time can be deceptive.
For instance, the United States is being criticized because it is going to miss its
2000 target by an estimated thirteen percent. Japan, on the other hand, is
expected to fall short by only six percent. However, the difference in emissions
growth can be explained entirely by differences in population growth. According
to the U.S. Bureau of the Census, the U.S. population is expected to expand by
10.7 percent between 1990 and 2000, while Japan's population is expected to
advance by only 3.3 percent.2 In other words, per capita emissions in both
countries are expected to rise by roughly 2.5 percent.
The United States' low population density is another reason U.S. emissions levels
are relatively high. Exhibit II.4 plots a statistically significant relationship
between population density and emissions, as a share of GDP, in nineteen OECD
countries. On the graph, these countries are divided into two groups, each with a
trend line. Both trend lines have negative slopes, indicating that countries with
lower population densities are associated with higher emissions levels.
20 National Trade Data Bank, "Total Mid-Year Population & Projections to 2050."
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We're Not That Bad
As the Kyoto meeting approaches, critics increasingly will portray the United
States as an environmentally unfriendly country. The reality is quite different.
Since 1980, U.S. final consumption of energy per unit of output has declined
dramatically. The exhibit below indicates that, by this measure, the United States
has improved twenty-two percent, more than all but one industrialized country
(see exhibit II.7). U.S. emissions intensity, the ratio of carbon emissions to GDP,
declined twenty-one percent during the period. Clearly, in the absence of
improved energy efficiency, U.S. emissions in 1993 would have been much
worse.
Exhibit II.7
Change in Total Final Energy Consumption per Unit of GDP
1980 - 1993
Ire.
U.S.
Den.
Can.
Nor.
Jap.
Swe.
Fra.
Net.
Bel
U.K.
Austria
Its.
Spa.
Tur.
Australia
Swi.
Fin.
Gre.
Por.
N.Z
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
Percent Change in Final Energy Consumption per Unit of GDP
Source: OECD
Even in more recent years, the United States performance has continued to be
admirable. From 1990 to 1993, the latest year for which complete OECD
emissions data is available, the United States was among eleven OECD countries
that reduced emissions levels while increasing economic output (see exhibit II.8).
From 1990 to 1995, the United States reduced emissions per unit of output by
seven percent, versus a one percent reduction for Canada and a one percent
increase for Japan.²⁴
24 For GDP based on 1991 purchasing power parities, see OECD, Environmental Data Compendium.
For emissions data, see EIA, Emissions of Greenhouse Gases in the United States; Giles Gherson,
"PM's Eco-ambivalence," The Edmonton Journal (June 27, 1997); and httpp:/www.geic.or.jp/geic-
jpinfo.html.
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12 The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Exhibit II.4
Population Density and Emissions, as a Share of GDP,
in Select OECD Countries, 1990
0.5
y = -0.189x + 0.5382
R² - 0.7271
0.0
Emissions
(natural logs, tons/$000, PPPs)
8
O
-0.5
y - -0.217x + 0.0016
-1.0
R² - 0.7577
-1.5
-2.0
1
2
3
4
5
6
Population Density
(natural logs, inhabitants/knf)
Source: IEA and OECD
It is intuitive that countries with geographically dispersed populations, such as
the United States, Canada and Australia, would require more energy than would
more crowded industrialized countries. An analysis by the International Energy
Agency (IEA) of the OECD supports this interpretation. According to surveys,
lower population density within U.S. cities and towns appears to compel
Americans to use automobiles for local trips that would be convenient enough
for Europeans and Japanese to make by bicycle, foot, or local transit. 21 Lower
population density also encourages greater use of air travel and results in greater
energy use and emissions in the transport of freight, especially raw materials,
because U.S. freight forwarders must ship goods further than do their
counterparts in other countries.²²
21 International Energy Agency (IEA), Indicators of Energy Use and Efficiency, (Paris: OECD, 1997),
103.
22 IEA, Indicators, 117.
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basis, the U.S. record holds up quite well, both in the aggregate and in specific
sectors. The analysis in this chapter also indicates that proposals that do not take
into account economic growth and population growth discriminate against
countries with faster growing economies and populations. This and other
shortcomings of existing proposals will be discussed in Chapter III.
Economic Strategy Institute
Chapter III: Proposals for Kyoto -
What's Out There?
Since COP-1 concluded that further measures would be needed to reduce
greenhouse gas emissions in developing countries beyond 2000, several countries
have tabled proposals and have suggested specific policies. The Ad Hoc Group
of the Berlin Mandate is in the process of sifting through the various proposals
with the goal of drafting an accord that will be the subject of the Kyoto meeting
in December. With December fast approaching, a number of issues remain the
subject of intense discussion, and all of them are important to the United States.
In the near future, U.S. negotiators will have to take a stand on each of these
issues.
Emissions Targets and Timetables
One of the more contentious issues is how deeply, and over what time period,
the Annex I countries should cut their carbon dioxide emissions. Earlier target
dates and deeper emissions cuts imply more severe economic adjustments for the
United States and other developed countries.
The most draconian proposal, proffered by the Association of Small Island States
(AOSIS), calls on the Annex I countries to cut their carbon dioxide emissions
twenty percent below 1990 levels by 2005. Because it is becoming increasingly
clear that most Annex I countries will be unable to cut their emissions to 1990
levels by 2000, this proposal is destined to fail. Earlier this year, the European
Union proposed that developed countries cut emissions of a basket of
greenhouse gases fifteen percent below 1990 levels by 2010. Though more
reasonable than the AOSIS plan, the E.U. proposal is probably unobtainable as
well.
Japan, the host of COP-3, has a special interest in seeing negotiations succeed. In
August, the Japanese government proposed a two-phase plan that is less taxing
than the E.U. and AOSIS proposals. During the first phase, the developed
countries would be required to cut annual per capita carbon dioxide emissions to
three metric tons per person. During the second phase, average annual emissions
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The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
from 2010 to 2015 would have to equal the 1990 baseline. In essence, the Japanese
proposal delays the Rio goal by fifteen years.
The United States has not yet come out in favor of any specific targets or
timetables, but has proposed an "emissions budget" in lieu of a single year
target. According to the U.S. proposal, each Annex I country would be allocated
an emissions budget, which it would draw down over a given period of time.
Any amount not used during the budget period could be used in future budget
periods. Conversely, countries could borrow emissions from the future, but
would be assessed a penalty.
Today's controversy over targets and timetables exists because Rio set the bar
too high. 27 The likely failure of all but two OECD countries to reach their targets
indicates that the goal of returning to 1990 emissions levels by 2000, agreed upon
in 1992, was ill-conceived. Moreover, Germany and the United Kingdom, the
countries with a chance of meeting the 2000 deadline, have benefited from
special circumstances (see Chapter III). Eight years is simply not enough time for
governments to build a durable political consensus or to make the necessary
policy changes, nor is it enough time for consumers and businesses to alter their
investment and consumption patterns in a way that would minimize the impact
of such policies on economic growth.
Likewise, some other proposals currently before the Ad Hoc Group, if adopted,
would fail for similar reasons. Proposals promoting draconian targets even
earlier than Rio's less sweeping goals have been achieved have understandably
heightened the worries of businesses and their workers alike. More reasonable
emissions targets, phased in over a longer period of time, would be more
credible, evoke less opposition, and give policymakers time to devise measures
to minimize the adverse economic consequences of carbon abatement.
Of course, building a durable consensus on the need for targets and timetables
would require unassailable evidence that anthropogenic emissions are indeed
responsible for global climate change, and that climate change poses a serious
danger to the environment. As long as scientific uncertainty continues to exist,
extended timetables are more appropriate.
Developing-Country Exemption
Emissions from non-Annex I countries are growing rapidly and should surpass
Annex I emissions by 2020, yet the Berlin Mandate decreed that developing
country emissions will be off the table at Kyoto. The rationale for this exemption
is straightforward. Increased energy usage typically occurs hand-in-hand with
27 Roger Bate, "Rio Set the Bar Too High," Wall Street Journal (),
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19
economic development. Developing countries argue that limiting their emissions
now would hamper their ability to increase living standards.
If the global community is serious about controlling carbon dioxide emissions,
however, there is no alternative to bringing the non-Annex I countries into the
process as soon as possible. As the figure below demonstrates, these countries'
emissions have risen faster between 1990 and 1995 than have Annex I emissions.
Exhibit III.1
Change in Emissions of Carbon Dioxide, 1990-1995
Annex I vs. Non-Annex I Countries
20.7%
-5.8%
Annex I
Non-Annex I
Annex I
Non-Annex I
Sources: http://www.eia.doe.gov/oiaf/ieo96/appal.html: ESI calculations
Though it is true that the emissions levels of OECD countries in Annex I also
grew during this period, no one doubts that emissions of developing countries,
with their rising populations, growing economies and greater dependence on
solid fuels, will surpass those of advanced countries. The implication of this
trend is clear. Even if Annex I emissions are kept at 1990 levels, global emissions
will continue to grow unless something is done to harness developing-country
emissions.
Despite the Berlin Mandate's prohibition of targets for developing-country
emissions, the United States has suggested a mechanism that would reduce non-
Annex I emissions without stunting growth. Known as "joint implementation," it
would allow developing countries, with the help of technology and financial aid
provided by an Annex I country, to create emissions reduction credits by
undertaking projects that lead to lower emissions. These credits would then be
acquired by the Annex I country that helped implement the emissions reducing
project.
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It should also be recognized that the extraction of commitments from non-Annex
I countries has implications beyond the global climate change negotiations. In
particular, failure to get non-Annex I countries involved will color U.S. attitudes
toward trade deals with developing countries. Securing such deals has been a
major trade policy goal of the current administration and many members of
Congress, but past debates on the merits of these agreements have been
contentious and divisive. Whether it was the hyperbole accompanying the actual
debates, or the adverse impact of the peso crisis on the U.S. trade balance with
Mexico after the NAFTA, many believe that trade with developing countries has
worked against the United States. A Kyoto accord that gives developing
countries a competitive advantage over the United States could only inflame
these feelings, making support for future market-opening deals less likely.
Differentiated Targets
Some countries, notably Australia, argue that requiring equal emissions
reductions among Annex I countries unfairly discriminates against countries
with energy-intensive industrial structures and growing populations. Australian
officials contend that Annex I countries should have targets appropriate to their
economic profiles. The European Union, in fact, which expects to reduce
emissions fifteen percent by 2010, has embraced this approach for its members.
For example, Great Britain has promised to reduce emissions by twenty percent
while Portugal will be allowed to expand its emissions by forty percent.
Curiously, the European Union has argued against extending this approach to
other Annex I members.
The Australian position makes more sense than the cookie-cutter approach.
Given the variations among Annex I economies, it seems unreasonable to expect
every country to be able to achieve the same level of reductions over an
equivalent period of time. This is especially important for the United States,
because, as indicated earlier, the U.S. record in controlling emissions is better
than the critics suggest, and also because many of the current proposals would
place an unfair burden on the United States. The budgeting idea proposed by the
administration, discussed above, takes a small step in the appropriate direction.
by providing additional flexibility over the "x" percent reduction-by-date-certain
approach fashioned at Rio.
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21
Emissions Reduction Strategies
Negotiators are also wrestling over what specific abatement policies or measures,
if any, should be included in the document to be considered at the Kyoto
meeting. Among the many alternatives are removal of energy and transport
subsidies ("no regrets" policies), financial incentives to promote energy
efficiency, carbon and energy taxes, energy efficiency standards for traded
products, and voluntary public-private agreements.
Washington has promoted the idea of emissions trading among countries, which
would enable Annex I countries or their companies to purchase emissions credits
from countries that have substantially reduced their emissions. The practical
hurdles to creating an emissions trading regime are daunting, however.
Emissions trading on a global basis would require some type of centralized
monitoring institution and a formula for calculating initial emissions budgets.
Obviously, if mandatory reductions come out of Kyoto, it is in the United States'
best interest to preserve the flexibility to reduce emissions in the least costly
manner.
Economic Strategy Institute
Chapter IV: Measuring the
Macroeconomic Impact of Emissions
Control
This chapter focuses on the question of how to measure the potential economic
impacts of global warming proposals. A careful examination of existing estimates
suggest that the short-to-medium-term costs are likely to be much higher than
commonly believed. Estimates indicating that the transitional economic costs
would be small, and only temporary, are particularly flawed.
How Will The Economy Be Affected?
Almost all manmade CO₂ emissions come from the burning of fossil fuels.
Reducing emissions requires reversing the growth of energy consumption,
and/or shifting to energy sources that produce less emissions. This could only be
accomplished in one of three ways: by improving energy efficiency (i.e., reducing
the ratio of energy consumption to GDP), by slowing economic growth (to
reduce energy demand), or by developing commercially viable energy
alternatives. The more difficult it is to improve energy efficiency or develop fossil
fuel alternatives, the greater the slowdown in economic growth needed to
achieve any targeted level of energy savings. For example, limiting America's
energy consumption in the year 2010 to 1990 levels would require an
improvement in energy efficiency of about 2.3 percent per year (the expected
trend in real GDP growth) to avoid any adverse effect on real output - a level of
improvement far above recent efficiency gains (see exhibit IV.1). In the absence of
commercially viable energy substitutes, anything less would mean slower
economic growth.
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Exhibit IV.1
U.S. Energy Consumption, Real GDP Index, 1960-1995
Index values
120
100
80
60
40
20
0
1960
1965
1970
1975
1980
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996*
*
Preliminary figure
Sources: U.S. Department of Energy/Energy Information Agency; and Economic Report of the President 1997
Theoretically, improvements in energy efficiency can be encouraged through
regulatory change or energy taxes. For simplicity's sake, most existing
quantitative studies combine all energy conservation measures into ar
equivalent carbon tax on all fossil fuels.
A tax increase is generally considered more effective, and less costly, than
command-and-control regulations because it works through market mechanisms.
However, taxes affect the economy in a number of ways and ultimately
influence overall economic growth, employment levels, and living standards.
The magnitude of these effects are determined by a number of factors, including:
The sensitivity of energy efficiency to the tax increase. Significant
improvements in efficiency through fuel substitution, pure
conservation, and modernization, would limit economic costs.
The impact on U.S. inflation. The level of inflation will be determined
by the level of changes in energy prices, and by how these price
increases affect other the prices of consumer and capital goods and
services.
The impact on disposable income and corporate profits. The level of
disposable income will depend upon the increase in inflation at t
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25
consumer level. Profits will reflect higher production costs of many
key industries.
The effect on financial markets. Financial markets, especially the bond
and money markets, respond to the change in inflation. The effects of
these changes will be determined by whether, and to what extent,
Federal Reserve policy is altered.
The effect on productivity. Perhaps the most important factor, the
impact on productivity will depend on several responses, including
the impact of carbon tax increases on the level of saving and
investment, the mix between investment designed to conserve energy
and investment that might have a larger impact on productivity, and
the shifts in the composition of economic activity.
The effect on U.S. competitiveness. The increase in production costs of
energy-sensitive industries caused by higher energy prices; the degree
to which costs rise in other countries; and the effect of interest rate
changes and other factors on exchange rates will all determine the
impact on U.S. competitiveness.
These impacts will then work through the economy altering consumer demand,
new investment, trade flows, etc., which, in turn, will bring about changes in
output, jobs, and income. In addition, spillovers and multiplier effects will
develop. Ultimately, when all of the adjustments take place, a new level of
economic activity, and a new trend rate of economic growth, will be reached.
Why Do the Models Vary?
Dozens of quantitative estimates assessing the impact of proposals to reduce CO2
emissions are now available. All of these estimates have been made with
econometric models which, to varying degrees, incorporate variables that
measure key aspects and sectors of the economy, and behavioral relationships
designed to capture the cause and effect relationships between them. Three types
of econometric models have been used in the global warming studies:
computable general equilibrium (CGE) models, standard macroeconometric
models, and energy-based models.
CGE models generally attempt to determine how price changes will impact the
demand and supply for various goods and services, and based on these
relationships, the price levels that would result in market clearing. All of these
models assume profit maximization by producers, and that consumers maximize
their welfare based on some assumed relationship between welfare and present
and future consumption. Implied in CGE models is the assumption that
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The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
individuals and firms respond in an efficient manner to policy actions, and
usually, that these responses occur relatively quickly. Unfortunately, these and
other simplifying assumptions are probably not realistic over relatively long
periods, let alone in the short term. However, short to intermediate term
economic effects are perhaps the most important in evaluating different climate
protection proposals, both because they are potentially very large and because
such effects may reduce political support for continuation of these measures. It
is thus not surprising that some, although not all, of the relatively optimistic
studies are based on simulations of CGE models.
Macroeconometric models are designed to estimate the actual elasticities and
sensitivities that underlie economic behavior (unlike CGE models, which
frequently assume them), using standard estimation techniques applied to
historical data. When used to simulate the impact of policy changes, these
models theoretically can depict the actual adjustments that will take place, and
the timing of such adjustments.
Standard macroeconometric models are thus more reliable in measuring the
short term effects, but nonetheless also contain the potential for sizable
predictive errors. This largely reflects such problems as the inability to develop
quantitative measures for certain aspects of economic behavior, measurement
errors in economic statistics, the limited power of the estimation techniques
(which prevent them from perfectly separating the simultaneous influence of
many factors), etc., which skew estimates of the key elasticities. These problems
can not only undermine their model reliability, but often can cause two models
to generate dramatically opposite results.
Finally, the energy-based models used in many of the global warming studies
focus on the technological and other changes that are likely in response to energy
tax increases, and the likely fuel substitution and other adjustments in various
sectors of the economy that are implemented to reduce energy consumption.
These technology-based energy models are perhaps the most flawed of all,
because the assumptions embodied in them regarding the development of new
energy-saving technologies or new energy sources cannot be known with any
precision, and because they generally ignore important factors that prevent or
delay the implementation of new energy-saving techniques (such as lack of
information, high capital costs, risk avoidance, retrofitting, etc.).
The range of predictions of the economic effects of policy actions to reduce
greenhouse gas emissions is large, in part because different types of models
generally produce different results, and in part because of differences in the
structure of models of the same general type. For example, the behavioral
relationships within standard macroeconometric models can vary significantly
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
because the models may have been estimated over different historical ti
periods, using different data sources and variables, and with different estimati
techniques. These factors can cause significant differences in the key coefficier.
or elasticities from one model to the next. In fact, it is very possible that
relationships among some variables may be completely absent in one model, yet
may be very significant in another. Thus, no econometric model perfectly
captures the structure of the economy of the historical period for which it is
estimated. Furthermore, the economy's structure may change, either because of
changes in the relationships between some variables, or because new factors may
emerge during the forecast or simulation period, both of which can also cause
large forecast or simulation errors.
The large variation in the range of predictions among the global warming studies
also reflects another factor - significant differences in the key assumptions that
underlie the simulations. All models contain what are called exogenous
variables -- factors which measure some aspects of the economy, and which
impact other variables embodied in the model, but which themselves are not
forecast by the model. Judgments regarding the future of these variables must be
made (assumed) before the model can forecast future trends, or simulate the
potential impact of any policy change in the future. Generally, these variables
are those which are determined by the political process, or for which factors
S
cannot be identified or measured to explain their movement over time.
In the global warming studies, the key assumptions include whether the energy
tax increases assumed are recycled back into the economy with offsetting tax
cuts; the type of tax cuts assumed; etc. Two models with the exact same
structure might forecast different responses to any given global warming
proposal because they may be driven by different assumptions made on these
S
and other key exogenous variables.
S
Why Do Models Underestimate the Economic Cost of Climate
Protection?
There is really no way of knowing with any degree of certainty what the
transitional and long term costs to the U.S. economy would be from major policy
r
actions designed to reduce CO2 emissions. The wide range of predictions among
available studies is indicative of this uncertainty. However, some of the studies
show little, if any, negative impact from energy taxes designed to limit
greenhouse gas emissions. ESI believes that several favorable assumptions, and
e
major model omissions, are causing a huge potential understatement of these
S
economic costs in many available studies, even those which do indicate
significant effects. These include the following:
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Size of the energy tax increase. As indicated earlier, all of the model
simulations begin with an assumption regarding the size of the carbor
tax increase that would be needed to reduce CO₂ emissions to a
desired level. These assumptions are largely based on elasticities of
energy demand, incorporating several estimated responses that are
likely to occur if carbon taxes are raised, such as fuel substitution, pure
conservation, and the development of alternative fuel sources.
However, recent experience has underscored the difficulty of
developing new energy sources and technologies which can compete
with, and partially displace, fossil fuels within a reasonable period of
time (nuclear energy is a case in point). Furthermore, much of the easy
energy savings by consumers and businesses occurred in the 1970s and
early 1980s. Investments needed to improve fuel efficiency further,
will have to be even larger than in the past. This efficiency enhancing
investment will divert funds from other uses, dampening productivity
growth and/or reducing capacity expansion in many industries.
Thus, even higher energy prices may be needed to reduce fossil fuel
consumption and emissions to desired levels than the general
assumption of $100 per ton of carbon. Several other considerations
reinforce this conclusion. First, energy prices have in general been
very subdued in recent years, after the oil price shocks of the 1970s
Spending patterns and investments may have been re-adjusted to thi
era of lower energy prices, and relatively large price increases ma
now be required to produce meaningful shifts back toward energy
conservation. Second, many economic entities may assume that the
tax increases will be reversed by future administrations and
Congresses, limiting the response to a tax hike even further. Finally, a
substantial amount of relatively new equipment is years away from
being fully depreciated, and recent purchases of autos, household
appliances, and other consumer durables have years of service ahead
of them. Encouraging businesses and consumers to replace this
equipment much earlier than planned will be difficult. These
considerations imply a relatively modest and drawn out improvement
in energy efficiency is likely and suggest that a sizable slowdown in
economic growth will be needed to meet ambitious emissions targets.
Revenue recycling. Many simulations assume that higher energy taxes
will be recycled back into the economy dollar for dollar through tax
cuts, making these levies revenue neutral. It is also assumed that
offsetting tax cuts will favor savings and investment, over
consumption. Because policies stimulating savings and investme;
produce higher growth rates in these models, such assumptions bi
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
29
economic costs estimates downward. It is not clear, however, that
taxes will be cut; they may be used to pay for the burgeoning costs of
the health care and other federal entitlement programs that will occur
as baby boomer retire. Even if taxes are reduced, it is far from certain
e
that the political will exists to reduce them in a way that stimulates
e
savings and investment. It is more likely that any offsetting tax cuts
S.
will be designed to restore some or all of the squeeze on consumer
of
income and purchasing power caused by tax-related increases in
te
energy costs. In any case, these models generally overstate the
response of saving and investment to tax incentives. As we saw
y
clearly in the 1980s, the effect of so-called supply-side tax cuts on the
d
levels of saving and investment is very low. Thus, the stimulus to
r,
economic growth from such tax cuts is likely to be considerably less
ig
than many models are forecasting.
ty
Announcement effect. Several studies assume that merely announcing
an agreement to reduce emissions will encourage consumers and
el
businesses to improve energy efficiency, thereby reducing the
al
potentially adverse tax-related economic effects. However, there is
ns
absolutely no evidence that this will occur, nor any acceptable
en
historical precedent.
)s
is
a
Benefits. Many studies have factored in sizable economic benefits from
gy
the assumed reduction in energy use and the slowing of the global
he
warming process. These benefits include a reduction in health care
nd
costs because of cleaner air, higher crop yields, and more stable
a
weather patterns. These benefits are generally super-imposed on the
om
model results, with very little empirical support. Though there will be
old
some benefits, history has shown that they could take decades to
ad
appear, and are likely to occur well after the negative impact of global-
his
warming related tax increases is felt.
ese
ent
Other countries. Some studies assumed joint implementation, which
in
would allow the so-called Annex I countries to acquire emissions
6.
credits for helping underdeveloped countries to curb their energy
consumption. Obviously, such an assumption lowers the estimated
xes
costs to the U.S. economy because it spreads the burden of reducing
tax
CO2 emissions across more countries, and mitigates the adverse effects
hat
on U.S. competitiveness. However, it is far from clear that such an
ver
arrangement is workable, let alone effective. Thus, there is a clear
ent
downside risk in this assumption, with very little on the up side.
,:
Economic Strategy Institute
30
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Production shifting. Optimistic predictions, in particular, fail to
address the effect of energy tax increases on U.S. competitiveness, or, if
they do, understate such effects. However, as will be seen in Chapters
V and VI, production costs in many U.S. industries will rise
substantially, putting those industries at a huge competitive
disadvantage. This is likely to have a drastic effect on U.S. trade flows.
Moreover, greater mobility of capital and technology in recent
decades, and the proliferation of developing country policies that
demand investment as a prerequisite for market access, are likely to
lead to significant shifts in production to locations outside the United
States.
Interest rates. Most of the model simulations that predict slightly
negative, or even positive, impacts from higher energy taxes in the
long run, also expect significantly lower real interest rates in the
future. This results from a direct assumption that the Federal Reserve
will ease monetary policy, and/or from interest rate equations within
these models that predict a decline in long term and money market
rates. However, both are highly questionable. First, energy tax
increases will significantly increase the overall rate of inflation, at least
in the short to intermediate term - the amount of added inflation will
depend on the size of the tax increase, the time period over which it is
phased in, and possible spillovers into wages and other prices. It is
unlikely that real, market-based, interest rates would decline und
these conditions, at least until markets can determine the amount of
added inflation that would occur. Second, the Federal Reserve likely
will raise interest rates to prevent inflation from spiraling out of as it
did after the oil shock in the early 1970s. Furthermore, a strong case
can be made that the U.S. economy is more sensitive to nominal and
real interest rates than in the past because of the increased use of
variable rate mortgages. Now, when interest rates rise, these
mortgages (which now account for almost 50 percent of all home
mortgages) are re-priced upward, which raises monthly payments,
squeezes discretionary purchasing power, and reduces consumer
spending. Thus, consumers could experience a double whammy if
energy taxes are raised substantially: purchasing power would be
squeezed both by higher costs for energy and other goods and
services, and by higher mortgage rates. In short,, if real interest rates
do not decline as much as forecast, the effect on the economy would be
far larger than the optimistic scenarios are currently suggesting.
Regulation versus price impact. Virtually all the economic impact stud
assume the imposition of a carbon tax in order to permit mode'
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool 31
However, mandated industry emissions targets or other regulations could
also be used to reduce U.S. energy consumption. Because command-and
control-solutions are generally less efficient than market-based solutions,
e
models based on a carbon tax are really depicting a best case scenario,
because at least some regulatory solutions are likely to be imposed.
The Administration's Analysis - a Reality Check
The administration is on record as supporting strong measures to reduce CO2
d
emissions in the years ahead because of its assumption that global warming is a
serious environmental issue that must be addressed as soon as possible. As part
of their efforts on this issue, the administration has formed an Interagency
y
Analytical Team (IAT) to study the economic effects of global climate change
e
policies. The task force used a group of economic models of the type discussed
e
earlier to make these assessments, with the starting point that carbon taxes
would be increased by about $100 per ton of carbon, which allegedly would lead
in
to a reduction in greenhouse gas emissions in 2010 to 1990 levels.
et
1X
The simulations commissioned by the IAT essentially predict that only a very
st
small loss in the level of economic output (less than 1 percent) would occur
ill
within the first ten years after the tax increases are enacted, and that output will
is
then return to the assumed base case, or to even higher levels, within a few years
is
thereafter. In addition, their results indicate that the use of cross border trading
of emissions rights could prevent most of these very modest transitional
of
economic losses.
ly
it
However, there are several major flaws in the administration analysis, most of
se
which, as discussed earlier, also account for the likely understatement of the
nd
economic costs in many of the published studies. These include the following:
of
:se
The IAT simulations include the assumption that the announcement of
ne
an agreement among countries to reduce CO2 emissions will by itself
ts,
produce a 25 percent increase in the rate of improvement in energy
er
efficiency, based on the assumption that consumers and businesses
if
will respond immediately to the prospect of higher carbon taxes, or a
be
carbon permit fee, by adjusting their spending and capital decisions
nd
even before these fees are implemented. This is highly questionable at
tes
best and, while the administration did not provide simulation results
be
without such an assumption, it is clear that the negative impact on
jobs, income, and output would be considerably larger. The
announcement effect is also supposed to encourage a speed-up in R&D
to expand the search for new energy-related technologies, again a
ies
dubious assumption.
Economic Strategy Institute
32
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
The IAT simulations factor in a two hundred basis point decline in real
long term interest rates, to almost 2 percent, level, a unseen in many
decades (see exhibit IV.2). This is a heroic assumption, because, i.
anything, new taxes and cost increases that threaten to push up the
rate of inflation frequently raise real interest rates.
Exhibit IV.2
Real Long-Term U.S. Interest Rates, 1977-1996
Percent
9
8
7
6
5
4
3
2
1
0
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
Source: Economic Report of the President 1997
The IAT also included benefits from reducing target emission levels
through non-carbon emission reductions. The administration task
force study indicates that taking into account the costs associated with
such reductions would increase the economic impact by at least 25
percent, but this was not factored into the simulations.
The auctionable, tradable permit system assumed in some of the
simulations did not include an estimate of the potentially large costs
associated with the development, implementation, and monitoring of
the program.
While these are the most grievous sources of understatement, the IAT analysis
suffers from other shortcomings. It does not take into account the adverse effects
on U.S. competitiveness and potential shifting of production by producers in the
United States; the drag on productivity of a likely shift in the mix of investmen
spending toward energy conservation and away from more productive uses;
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
33
eal
the incorporation of tax offsets which supposedly will accelerate economic
5
growth by stimulating savings and investment.
the
A recent simulation made with the WEFA model, one of the oldest and most
respected macroeconomic models now in use, illustrates how much greater the
economic cost could be if more realistic assumptions are used. The WEFA
simulation results indicate that:
A carbon tax of $200 per metric ton would be required to meet the 2010
emissions target.
This would raise gasoline prices by nearly $0.50 per gallon.
Home energy costs would rise by more than $1,200 each year.
U.S. GDP would decline by $228 billion (more than 2.5 percent) from
the base case forecast.
GDP would remain substantially below the base case for at least 25
years after the enactment of the tax.
1
million jobs would be lost.
The U.S. trade deficit would jump sharply.
97
The growth in real income over an extended period would fall by 15
percent.
vels
In short, by assumption and by omission, the administration's analysis biases the
task
results towards minimizing the economic costs in both the short and long term.
vith
In fact, with more realistic assumptions, a simulation with one of the models
t 25
used in the administration analysis shows much more severe economic impacts
that are in line with the results of the WEFA study.
the
The 1970s Experience
osts
g of
It is thus increasingly clear that the economic costs associated with climate
protection could be very substantial, far greater than the estimates that are
currently available. These conclusions are reinforced by an examination of U.S.
ysis
and global economic performance following the oil shocks of the 1970's. For
ects
example, the large oil price increases following the embargo in the early 1970s
the
produced one of the deepest recessions in the United States since World War II
(see exhibit IV.3).
in
Economic Strategy Institute
34
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Exhibit IV.3
Postwar Recessions
Peak-to-Trough Declines in Real Chain-Weighted GDP
Percent Decline
Recession Period
in GDP
1969-70
0.7
1974-75
3.1
1980
2.5
1981-82
3.0
1990-91
2.0
Furthermore, average economic growth in the United States since 1973 has 1
about a percentage point lower than it was in the prior 13 years (see exhibit -).
This accumulates to a difference of about 20 percent in the level of real GDP by
the end of 1989, relative to the level which would have occurred if the historical
growth rate had continued. The slowdown in the rate of increase in industrial
production was even larger. And much of the differential in growth reflects
differences in the rate of increase in productivity, and not simply population or
other demographic factors. While it is clear that not all of this decline in growth
can be attributed to the energy price shocks, it does call into question those
studies that suggest that the maximum impact on the level of GDP after
extremely large carbon tax increases would be on the order of 1 percent or less.
It is also worth noting that both productivity growth and overall economic
growth decelerated dramatically in most other industrialized countries as well
after the huge spike in oil prices in the 1970s (see exhibit IV.4). Again, while this
is not conclusive by itself, it does suggest that the "not to worry" attitude, based
on currently available studies of the economic effects of global warming
measures, can result in a sense of complacency that will be harmful to U
economic interests.
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool 35
Exhibit IV.4
Average Growth Rates of Real GDP
1960-1973 and 1973-1989
1960-1973
1973-1989
United States
3.95%
2.42%
European Union
4.68%
2.27%
OECD
4.82%
2.63%
OECD Europe
4.67%
2.31%
Japan
9.57%
3.84%
Note: EU, OECD and OECD Europe refer to 1991 membership
Source: OECD
Quite the opposite, these carbon tax increases are likely to cause a sizable
recession and/or dramatically slow economic growth over a relatively long
period of time, put U.S. industry at a significant competitive disadvantage in
world markets, push up the trade deficit, lower living standards, and raise
unemployment. This is reinforced by the fact that the increases in energy prices
that are likely in the years ahead in response to carbon tax appears relatively
close to those which occurred in the 1970s and early 1980s (see exhibit IV.5)
?.
Exhibit IV.5
2).
Changes in Real U.S. Prices of Various Energy Sources, 1973-1987
by
Versus Expected Changes Due to a Carbon Tax
al
al
1973-1987
1994-2010
its
Oil
67%
70%
or
Natural Gas
223%
45%
th
Coal
24%
198%
se
er
Sources: Derived from data in Gary W. Yohe, Climate Change Policies, Living Standards, and Real Wage Growth;
Argonne National Laboratory, The Impact of High Energy Price Scenarios on Energy Intensive Sectors:
Perspectives from Industry Workshops; and ESI Calculations.
nic
ell
is
ed
ng
.S.
Economic Strategy Institute
Chapter V: Impact of a Potential
Carbon Tax on the Chemical and Steel
Industries
This chapter examines the impact of a potential carbon tax on the chemical and
steel industries. Both sectors are big users of energy, consuming more energy per
unit of output than all other manufacturing industries on average. That being the
case, any increase in fuel prices brought about by a carbon tax or its equivalent
would significantly raise their manufacturing costs, leading to higher-priced
outputs. Because the outputs of these industries are key intermediate inputs in
other industries, manufacturing costs for a host of products would rise as well.
The ripple effect would have profound implications for the international
competitiveness of the United States, especially if similar measures are not
undertaken by developing countries.
Chemicals
The chemical industry (SIC 28) is one of the United States' most important and
competitive manufacturing industries. In 1995, it logged $362 billion in
shipments, employed almost 840,000 individuals, and recorded a trade surplus of
$21 billion (see exhibit V.1).
The industry is also a major user of energy. According to the Chemical
Manufacturers Association, energy expenditures in 1995 totaled $26 billion. 28
Considering that producers in the United States face strong competition from
producers in both developed and developing countries, it is clear that a carbon
tax would have an adverse impact on the U.S. industry's output and
competitiveness.
28 Swift, 4.
Economic Strategy Institute
38
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Exhibit V.1
Output, Employment and Trade of the U.S. Chemical Industry, 1995
Share of Total
Units
Chemicals
Manufacturing
Output
Shipments
$ bil.
362
10.1%
Value added
$ bil.
196
11.5%
Employees
thou.
839
4.5%
Trade
Exports
$bil.
59
12.1%
Imports
$bil.
38
6.1%
Balance
$bil.
21
NA
Sources: Bureau of the Census, and International Trade Administration
Energy Use Issues
Treatment of Feedstock
The chemical industry is an energy-intensive industry. Its energy intensity,
21,000 BTUs (British thermal units) per dollar of value added, is seventy-five
percent higher than that of the manufacturing sector as a whole.29 In addition,
chemical producers use fossil fuels as a raw material (feedstock). Of the $26
billion spent on energy in 1995, roughly half served as feedstock in the
production process. Since feedstock is not burned, it is not an immediate source
of carbon dioxide emissions. Thus, a carbon tax or any other carbon abatement
measure that does not distinguish between feedstock and power uses of fossil
fuels would essentially double the impact on the chemical industry's energy
costs without appreciably reducing carbon emissions.
Few Cheap Alternatives Exist
A carbon tax is expected to reduce greenhouse gas emissions by raising energy
prices for fossil fuels. Higher prices, in turn, would encourage firms and
individuals to use less energy and to use cleaner fossil fuels. Chemical firms, for
instance, would reduce their energy dependence by increasing production of less
energy-intensive products, by developing new technologies that require less
fossil fuel, or by switching to less carbon-intensive energy sources.
Neither of these remedies would be cheap, or easy. It is generally acknowledged
that the marginal cost of improving energy efficiency rises as an economy
becomes more energy efficient. That is, incremental increases in energy efficiency
29 Energy Information Administration, Manufacturing Consumption of Energy in 1991 (Washington,
DC: U.S. Government Printing Office, December, 1994), 97.
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
39
become progressively more expensive to achieve. In fact, advocates of aggressive
emissions reduction strategies argue that, because a high share of U.S. electricity
is generated from coal-fired power plants, emissions reduction in the United
States will be relatively inexpensive.
Although fuel switching may be an option for some utilities, its potential is
limited for the U.S. chemical industry. Only about ten percent of the industry's
energy needs are supplied by high carbon-content solid fuels, and reliance on
energy from distillate and residual fuel oils has already been reduced by seventy-
three percent since 1974. Natural gas, the cleanest burning fossil fuel, already
accounts for sixty percent of chemical industry energy consumption (see exhibit
V.2).
Exhibit V.2
U.S. Chemical Industry's Energy Consumption, by Fuel Source
1974 and 1990
1974
1990
trillion BTUs
share
trillion BTUs
share
y,
Distillate fuel oil
120
4.2%
13
0.5%
e
Residual fuel oil
165
5.8%
64
2.4%
n,
LPG
3
0.1%
3
0.1%
26
Natural gas
1,635
57.6%
1,637
60.6%
e
Coal
205
7.2%
269
10.0%
ce
Coal & breeze
6
0.2%
3
0.1%
nt
Electricity
437
15.4%
485
18.0%
sil
Other
266
9.4%
226
8.4%
Total
2,837
100.0%
2,700
100.0%
y
Source: Chemical Manufacturers Association
Change Will Take Time
The chemical industry would be able to make some adjustments to the rising fuel
y
d
costs ushered in by a carbon tax, but those adjustments would take time. Higher
energy prices would encourage companies to make energy-saving capital
or
investments. Given the new energy price levels, firms would minimize
SS
production expenditures by substituting capital expenditures for energy
SS
expenditures. Since a chemical plant's economic life is ten to twenty-five years,
and sunk costs are high, companies would be unlikely to abandon existing plants
ed
right away. Instead, they would choose to retrofit existing facilities and to adjust
the level of employment until a new plant is built. Since retrofitting can not
ny
provide the energy efficiency of a new plant, the full impact of a carbon tax on
energy usage and emissions would not be felt for twenty or more years. This
suggests that the ten-to-fifteen-year targets envisioned by parties to the
n,
Convention on Climate Change are inappropriate for the chemical industry.
Economic Strategy Institute
40
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Competitiveness Issues
A Truly Global Industry
The chemical industry is one of the world's most fiercely contested sectors, with
competitors in both advanced and developing countries. The United States is the
largest national producer of chemicals, recording $362 billion in sales during
1995. Turnover was $255 billion in Japan and $120 billion in Germany during the
same period, and the European Union, if considered as a whole, had sales of
nearly $450 billion in 1995. Together, the United States, Japan, and the European
Union were responsible for seventy-three percent of global chemical sales. Non-
OECD chemical production is significant as well. Asia (excluding Japan), Latin
America, and central and eastern European countries accounted for twenty
percent of global turnover in 1995 (see exhibit V.3).³⁰ In this environment, it is
clear that price increases induced by a carbon tax on U.S. and other OECD
producers would alter the distribution of global production.31
Exhibit V.3
Global Chemical Sales, by Region, 1995
Share
Value
Annex I
84%
1,234
European Union
32%
475
USA
25%
362
Japan
17%
250
Other Western Europe
2%
29
Central and Eastern Europe
4%
59
Other Annex 1
4%
59
Non-Annex I
16%
235
Asia
12%
177
Latin America
4%
59
Total
100%
1,471
Source: European Chemical Industry Council
The Relocation Decision
That the United States is a major chemical producer is no accident. The country
possesses abundant human capital, competitive supplier industries, domestic
30 Facts and Figures - The European Chemical Industry in a Worldwide Perspective (Brussels: European
Chemical Industry Council, 1996), 7.
31 Central and Eastern European countries are considered part of Annex I, but it is not yet clear
that they will be forced to adhere to any targets coming out of Kyoto.
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
41
supplies of key raw materials, and high levels of domestic chemical demand.
Low energy prices, therefore, are only a partial explanation for the U.S.
industry's competitiveness. The industry has enough advantages to ensure its
survival, even if carbon taxes are applied only on Annex I countries.
That being said, a carbon tax in Annex I countries would clearly damage the U.S.
chemical industry's competitiveness, and would encourage manufacturers in the
United States to locate a larger share of their facilities overseas. According to a
study performed by Argonne National Laboratory, in the event of a carbon tax,
energy prices faced by chemical manufacturers in the United States would
increase substantially more than energy prices in Europe, in both relative and
absolute terms. 32
S
Producers in the United States also would be hurt vis-a-vis the developing
world. There is already substantial non-Annex I production capable of reaping
substantial price advantages from a carbon tax on developed countries.
Production shifting is made more likely by competitive dynamics within the
industry. The chemical industry is dominated by multinational corporations.
Foreign chemical manufacturers, primarily European, have a strong U.S.
presence; United States chemical firms have global production networks as well.
In 1994 (the latest year for which data is available), value added by foreign
affiliates of U.S. multinational chemical manufacturers totaled $56 billion, almost
fifty percent of the value added by their U.S. parents.³³ In short, both U.S. and
foreign multinationals have the ability to expand their oversees facilities if
conditions warrant.
Evidence suggests that location decisions by the chemical industry are, in part,
determined by energy costs. Within the United States, for example, the
production of energy-intensive chemical products has gravitated toward regions
with natural gas production. As a result, chemical manufacturers' energy costs
for natural gas and electricity are lower than the U.S. average.³⁴
Such production shifting can also occur across countries. Production of energy-
intensive chemicals, such as ethylene derivatives, has already begun gravitating
toward the Middle East, where energy prices are even lower than they are in the
United States. Because the location of chemical production is clearly sensitive to
y
ic
32 Dan Steinmeyer, "The Chemical Industry in the USA - The Role of Energy and the Impact of
Energy Price Increases," in Ronald J. Sutherland, ed., The Impact of High Energy Price Scenarios on
Energy Intensive Sectors: Perspectives from Industry Workshops (Argonne, Illinois: Argonne National
Laboratory, July 1997), CH-44-45.
33 See Bureau of Economic Analysis, U.S. Direct Investment Abroad - 1994 Benchmark Survey,
Preliminary Results (Washington, DC: U.S. Government Printing Office, January 1997).
34 Steinmeyer, CH-37-38.
Economic Strategy Institute
42
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
energy costs, an energy tax would cause more U.S. chemical manufacturers, over
time, to relocate more of their manufacturing operations overseas than would
otherwise be the case.
International Trade
The chemical industry has been a bright spot in the generally dismal U.S. trade
picture. It is one of the few manufacturing sectors consistently producing trade
surpluses. Yet, given the current competitive realities, it seems a foregone
conclusion that a carbon tax affecting only Annex I countries would lead to a
higher trade deficit for the U.S. chemical industry.
If measured in terms of import share, the U.S. market is the most open among
major chemical producers. The United States has a higher import ratio than
either Europe or Japan, and exports less of its output than does Europe (see
exhibit V.4).
Exhibit V.4
Chemicals Trade of Western Europe, the United States, and Japan, 1995
20%
15%
10%
5%
0%
Western Europe*
United States
Japan
Export Share of Output
Import Share of Consumption
Source: European Chemical Industry Council
Despite facing higher energy costs, the European industry is extremely
competitive in international markets. E.U. exports to Asia (excluding Japan)
reached $22.8 billion in 1995, $8 billion more than U.S. exports to the region.
Europe also exported $1.5 billion more to Japan than did the United States. The
U.S. industry, however, exported $4 billion more to Latin America than Europe
did. Europe's performance is remarkable in light of the fact that its energy costs
are significantly higher than U.S. costs (see exhibit V.5).
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
43
er
Id
de
de
ne
a
Exhibit V.5
ng
Energy Prices Faced in Europe, Japan, and the United States, 1994
an
ee
Natural
Heavy
Coal*
Electricity**
Gas*
Oil*
United States
3.07
2.44
1.29
4.7
OECD Europe
4.03
3.37
3.68
7.5
Japan
12.3
4.46
1.69
17.3
*Dollars per million BTUs
**Cents per kilowatt hour
Source: International Energy Agency
European trade competitiveness is explained, in part, by lower labor costs.
According to OECD statistics, labor costs in the E.U. chemical industry in 1995
were about twenty percent lower than they were in Japan and the United States.
For their part, major producers in developing Asia and Latin America face
substantially lower costs than do advanced country producers. In 1993, Korean
labor costs in the industry were fifty-four percent lower than European costs,
and Mexican costs were even lower.³⁵
The impact on trade in U.S. chemicals would be large for two reasons. First,
ely
unlike production, trade is concentrated in energy-intensive products. U.S.
in)
chemical production is split roughly even between high energy-intensive
products, such as inorganic and organic chemicals, plastics, and agricultural
on.
he
chemicals, and low energy-intensive products like pharmaceuticals (see exhibit
V.6). European production is slightly weighted toward less energy-intensive
pe
goods.
sts
35 Facts and Figures, 54.
Economic Strategy Institute
44 The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Exhibit V.6
U.S. and E.U. Product Mix, Ranked by Energy Intensity
Energy
U.S. Product
E.U. Product
Intensity*
Mix*'
Mix
High Energy-Intensive Subsectors
Inorganic chemicals
18%
7%
8%
Organic chemicals
12%
21%
15%
Plastic materials and synthetic resins
8%
17%
18%
Agricultural chemicals
8%
6%
5%
Total
NA
51%
46%
Low Energy-Intensive Subsectors
Chemicals not elsewhere classified
4%
7%
12%
Soaps, detergents, cleaners, etc.
1%
14%
12%
Paints, varnishes and allied products
1%
5%
6%
Drugs
1%
23%
23%
Total
NA
49%
53%
*Energy Cost divided by value added; calculated with 1995 U.S. data.
**U.S. data is disaggregated on an SIC basis
Sources: U.S. Bureau of the Census, U.S. International Trade Administration, European Industry Council,
and ESI estimates.
U.S. trade, on the other hand, is weighted in favor of high energy-intensive
products. In 1995 and 1996, high energy-intensive chemicals accounted for
seventy-one percent of U.S. chemical exports and sixty-five percent of chemical
imports.³⁶ The two-year U.S. trade surplus in these products was $31 billion,
which is equivalent to eighty-four percent of the combined chemicals trade
surplus in 1995 and 1996. Because U.S. production costs for these products would
be hardest hit by a carbon tax, the likely outcome of a tax would be to lower
exports and raise imports in the one manufacturing sector where the United
States currently runs a substantial trade surplus.
The geographic composition of U.S. trade flows also suggests that a carbon tax
on Annex I countries would adversely affect the U.S. trade balance in chemicals.
The U.S. chemicals industry registered only a small trade surplus of $0.43 billion
with Annex I countries in 1995.37 In contrast, the U.S. chemicals surplus with
developing countries was $20.9 billion in that same year (see exhibit V.7). A
carbon tax levied only on industrial countries would therefore have a much
36 The chemicals trade figures in this paragraph are based on the 1987 SIC definition of the
chemical industry. This allows for a direct comparison with the value-added and energy data
needed to calculated U.S. energy intensities in the chemical industry.
37 The chemicals trade figures in this paragraph are based on the SITC Rev. 3 definition.
Economic Strategy Institute
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larger impact on U.S. trade with developing countries than it would on U.S.
trade with Annex I countries, and it would almost certainly result in a lower
trade surplus with developing countries. The small surplus with Annex I
countries could disappear, due to Europe's labor cost advantage in this industry
and due to the lower expected increase in European natural gas prices.
Exhibit V.7
U.S. Chemicals Trade with Annex I and Non-Annex I Countries, 1995
$ bil.
70
60
50
40
30
20
10
0
Exports
Imports
Balance
Annex I
Non-Annex I
Source: U.S. Bureau of the Census, Foreign Trade Division
Impact of a Carbon Tax on the Chemical Industry Output and
or
Trade
al
In order to quantify the impact of a $100 per ton carbon tax on U.S. chemical
le
industry output and trade flows by 2010, ESI used a partial equilibrium model
Id
based on the following assumptions:
er
The 2010 GDP would decline 1.5 percent below baseline GDP. Most
ed
estimates predict a decline in the range of 0.5 to 1 percent, but those
models assume that abatement policies would be phased-in beginning in
1990. The shorter phase-in period now being envisioned should result in a
ax
greater decline from baseline GDP than what has been predicted by earlier
Is.
models. Moreover, as discussed in Chapter IV, several other factors have
on
biased previous estimates downward as well. Thus, the 1.5 percent decline
th
used here is conservative.
A
There would be a $100 per ton carbon tax. Such a tax would result, on
ch
average, in a hundred percent increase in the energy prices faced by the
U.S. chemical industry.
There would be a carbon tax of similar magnitude for other Annex I
countries. This is a simplifying assumption; fuel prices would likely rise
more in Japan, less in Europe.
Economic Strategy Institute
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Energy intensity would range from 3.5 percent of shipments (includes a
feedstock exemption) to seven percent of shipments (no feedstock
exemption).
The price elasticity of demand would be minus 0.11. This is a weighted
average of price elasticities for five major product categories.
The income elasticity of demand would be 1.43. This is a weighted
average of income elasticities for five major product categories.
Export and import elasticities would be minus one and one, respectively.
The results, summarized below (exhibit V.8), imply a decline in output ranging
from $16.1 to $22.3 billion, and a decline in the U.S. trade surplus ranging from
$4.6 to $9.3 billion. On the trade front, the beneficiaries would be European
producers, whose energy costs would rise less than U.S. energy costs, and
producers in developing countries.
Exhibit V.8
Chemical Industry Output and Trade
Estimated Impact of a $100 per Ton Carbon Tax by 2010
Base Case
Carbon Tax
With exemption
Without exemption
Value
% change
Value
% change
Domestic Demand
459.57
448.15
-2.5%
446.56
-2.8%
Shipments
487.32
471.26
-3.3%
465.04
-4.6%
Exports
79.15
76.31
-3.6%
73.47
-7.2%
Imports
51.40
53.20
3.5%
54.99
7.0%
Trade Balance
27.75
23.11
-16.7%
18.48
-33.4%
Exports as a Share of Output
16.24
16.19
-0.3%
15.80
-2.7%
Import Penetration
11.19
11.87
6.1%
12.31
10.1%
Source: ESI Estimates
Steel
The steel industry (SIC 331), despite falling on hard times during the early 1980s,
remains an important and growing industry in the United States. Dismissed as
an also-ran only a decade earlier, the industry shipped $74.6 billion of product in
1995 and employed 224,300 people. Though many experts consider the industry
to be the low-cost producer for the U.S. market, imports continue to supply a
significant portion of domestic demand, and the U.S. trade deficit in steel is
about $10 billion (see exhibit V.9).
Economic Strategy Institute
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Exhibit V.9
Output, Employment and Trade of the U.S. Steel Industry, 1995
Share of Total
Units
Steel
Manufacturing
Output
Shipments
$ bil.
75
2.1%
Value added
$ bil.
29
1.7%
Employees
thou.
224
1.2%
Trade
Exports
$bil.
5
1.1%
Imports
$bil.
14
2.3%
Balance
$bil.
-9
NA
Sources: Bureau of the Census, and International Trade Administration
The steel industry has all the characteristics of an industry that would be hit hard
by carbon abatement policies. Like chemical producers, steel makers are major
energy users and face substantial competition from developing countries. One
important difference between the two sectors is the steel industry's dependence
on coal, the fossil fuel that will experience the largest price increase as a result of
carbon abatement policies. Thus, the impact on the steel industry will be even
more severe than on the chemical industry.
Energy Use Issues
Extremely Energy-Intensive Production
Steel production is one of the most energy-intensive manufacturing operations.
In 1991, the latest year for which detailed energy consumption data is available,
the industry required 108,000 BTUs per dollar of value added, nine times higher
than the average for all U.S. manufacturing and five times higher than the
chemical industry average.³⁸ Steel manufacturers also face substantial, indirect
energy expenditures as well, due to the transportation requirements of both the
traditional integrated mills and the newer minimills, which require large
quantities of coal and scrap metal, respectively. This high level of energy
dependence ensures that carbon abatement policies that rely on energy price
hikes to reduce consumption would raise steel prices significantly.
38 Manufacturing Consumption of Energy in 1991, 97.
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Bifurcated Industry
The steel industry consists of two types of companies: integrated mills, which
typically produce steel with "blast furnace/basic oxygen furnace" technology,
and the so-called minimills, which produce steel with "electric arc furnace"
technology and scrap metal. These technologies have different energy needs.
Coal is the primary energy source of the integrated mills, while electricity is the
main source of minimill power.
Because coal prices are expected to increase more than electricity prices in the
event of a carbon tax, the energy prices faced by minimills should rise by less
than those faced by the integrated companies. According to R.J. Fruehan's
analysis for Argonne National Laboratory, the minimills' energy cost advantage,
currently $10 per ton, could rise to more than $50 per ton by 2010.³⁹ Thus, carbon
abatement policies that placed taxes or other restrictions only on advanced
countries would not only favor foreign producers at the expense of domestic
ones, but would also favor minimills over the integrated firms. However, the
decline of integrated producers in the United States would result in higher prices
for scrap steel, which would further hurt minimills' price competitiveness vis à
vis producers in developing countries.⁴⁰
Potential for Improvement Is Limited
The improvements in energy efficiency that carbon taxes are expected to
promote will be hard to realize in the steel sector, for three reasons. First, as with
chemicals, steel makers already have improved their energy efficiency
dramatically. Consumption of energy has declined by forty-five percent during
the past two decades, while value added has increased by seventy percent.
Second, the potential for fuel switching within the industry is limited. Despite
the increasing prominence of the minimills, coal remains the dominant source of
energy in the industry (see exhibit V.10), and, unfortunately, there are few
feasible alternatives to coal and coke in the steel making process. Technologies
that rely on natural gas are available but, even if these are used, the resulting
savings would still leave the integrated producers uncompetitive. Third, there
are certain minimum energy requirements for certain steel making processes
that, according to one expert, will be approached around 2010.41 In short,
dramatic improvements in steel industry energy efficiency are unlikely.
39 R. J. Fruehan, "The Effect of Increased Energy Prices on the Steel Industry," Ronald J.
Sutherland, ed., The Impact of High Energy Price Scenarios on Energy Intensive Sectors: Perspectives
from Industry Workshops (Argonne, Illinois: Argonne National Laboratory, July 1997), ST-38.
40 Fruehan, ST-30.
41 Freuhan, ST 30-34.
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool 49
Exhibit V.10
U.S. Steel Industry's Energy Consumption By Fuel Source, 1991
trillion BTUs
share
Natural gas
421
24.6%
Coal
841
49.1%
Coke & breeze
243
14.2%
Electricity
144
8.4%
Other
65
3.8%
Total
1,714
100.0%
Source: Department of Energy/Energy Information Agency
Competitiveness Issues
A Significant Developing-Country Presence
As in the chemical industry, both advanced and developing economies maintain
steel industries with internationally competitive companies. However, the
developing countries play a more important role in steel than they do in
chemicals, in large measure because many developing-country governments
view the development of a domestic steel industry as an important component of
industrial policies to promote high value-added manufacturing. In 1995, the non-
Annex I countries accounted for thirty-two percent of crude steel output and, in
1996, the Chinese steel industry replaced Japan's as the world's largest. The
United States is the third largest national producer (see exhibit V.11).
Exhibit V.11
Global Production of Crude Steel, by Region, 1995
Share
Value
Annex I
68%
501
European Union
21%
156
USA
13%
94
Japan
14%
102
Other Western Europe
2%
14
Eastern Europe & Former Soviet Union
15%
113
Other Annex 1
3%
24
Non-Annex I
32%
231
Asia
22%
163
Latin America
5%
35
Total
100%
732
Source: International Iron & Steel Institute, http://www.amm.com/ref/0123ch2.htm
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Relocation Decision
The United States steel industry has been a net recipient of foreign investment. In
other words, foreign steel manufacturers have invested more in the United States
than U.S. steel makers have invested abroad. This pattern would likely be
reversed if the burden of carbon dioxide reduction were to fall solely on the
shoulders of advanced countries.
The U.S. steel industry historically has focused on serving demand in the U.S.
market with domestic production. Export sales have been limited to less than ten
percent of total shipments, one third of which typically go to Canada, and direct
investment in foreign countries (FDI) has been miniscule. U.S. steel firms,
therefore, are far less "multinational" than their counterparts in other U.S.
manufacturing industries. In the chemical industry, for example, foreign affiliates
of U.S. multinationals register forty-four cents in sales for every dollar in U.S.
parent companies sales. For steel, that ratio is 0.06 to one. In contrast, foreign
participation in the U.S. steel market is rather high. Foreign-owned
manufacturers in the United States accounted for roughly twenty-five percent of
industry-wide value added in 1995.
Because foreign companies operating in the United States are more
internationalized than are their U.S. competitors, they would be able to shift
production more quickly from their U.S. facilities to take advantage of price
differentials arising from a discriminatory carbon tax. Moreover, they would
likely choose developing-country locations for their future mills, in order to skirt
the tax's competitive consequences. At the same time, U.S. steel firms would be
more likely to invest overseas, particularly in non-Annex I countries. The bottom
line: inward FDI would likely stagnate or reverse, while outward FDI would
increase.
International Trade
The United States remains a net importer of steel, but the picture has improved
markedly since the mid-1980s, when import penetration in value terms
approached twenty percent. Import penetration in 1995 was still a high
seventeen percent and, with domestic capacity expected to increase in the near
future, that figure is expected to remain relatively stable.
A steel industry burdened by a carbon tax would be an entirely different story,
however. With energy prices faced by the industry likely to rise by more than a
hundred percent, the impact on American steel's international competitiveness
would be devastating, especially for the coal-reliant integrated mills. The
integrated firms could either shut down entirely, leaving the field to imports and
domestic minimills; abandon the most energy-intensive processes and import
semi-finished product from developing countries; or invest in developing
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The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
51
countries. Either way, U.S. value added and employment in the industry would
decline. True, U.S. foreign direct investment in manufacturing tends to be
"market seeking" and, more often than not, produces trade surpluses for the
United States, but outward FDI resulting from a carbon tax would also be cost-
driven and, thus, would enlarge the U.S. trade deficit in steel.
The composition of U.S. steel trade implies that a carbon tax would stifle U.S.
competitiveness in developing countries, the very markets where U.S. exports
are currently competitive. The United States does export more to Annex I
countries, but most of this trade flows to Canada. If Canada is excluded from
Annex I exports, U.S. steel exports are actually higher to the developing world
than to other advanced countries (see exhibit V.12). The U.S. import market is
currently dominated by Annex I product, but a carbon tax would tip the scales in
favor of the developing countries. Brazil, Mexico, South Korea and South Africa,
which currently export a combined $3.2 billion to the United States, as well as
China, would be the big winners.
Exhibit V.12
U.S. Steel Trade with Annex I and Non-Annex I Countries, 1995
$ bil.
15
10
5
0
-5
-10
Exports
Imports
Balance
Annex I, less Canada
Canada
Non-Annex I
Source: U.S. Bureau of the Census, Foreign Trade Division
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The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
Impact of a Carbon Tax on Steel Industry Output and Trade
In order to quantify the impact of a $100 per ton carbon tax on the U.S. steel
industry's output and trade flows by 2010, ESI used a partial equilibrium model
based on many of the same assumptions used in analyzing the chemical
industry. Differences include:
The $100 per ton carbon tax would result, on average, in a 120 percent
increase in the energy prices faced by the U.S. steel industry.
The energy intensity would be fifteen percent of shipments.
The price elasticity of demand would be minus 0.96. This is an average of
various elasticities from two different studies. 42
The income elasticity of demand would be 1.035. This is an average of the
high-end and low-end estimates of an industry study.43
The import elasticity would be 0.94. This is taken from a recent ITC
study.44
The results, summarized below (exhibit V.13), imply a $19 billion decline in U.S.
industry shipments from base levels, a $3.7 billion dollar increase in the steel
trade deficit, and a rise in import penetration, by value, to twenty-four percent.
The integrated producers would bear the brunt of this adjustment, because the
price of coal would rise more than the price of electricity, the minimills' main
energy source.
42 See Stephen H. Karlson, "Modeling Location and Production: An Application to U.S. Fully
Integrated Steel Plants," The Review of Economic and Statistics (1982); and John S. Hekman, "An
Analysis of the Changing Location of Iron and Steel Production in the Twentieth Century,"
American Economic Review (March 1978).
43 See Hekman, 124-132.
44 Kenneth A. Reinert and Clinton R. Shields, Estimated Elasticities of Substitution of a North
American Free Trade Area, U.S. ITC Staff Research Study No. 19 (Washington, DC: U.S.
International Trade Commission), 29-41.
Economic
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Exhibit V.13
Steel Industry Output and Trade
Estimated Impact of a $100 per Ton Carbon Tax by 2010
Base Case
Carbon Tax
Value
Mil.
Value
%
Mil.
%
($ Bil.)
Metric
($ Bil.)
change
Metric
change
tons
tons
Domestic Demand
99.96
125.0
84.28
-15.7%
98.9
-21%
Shipments
88.3
105.0
69.0
-21.9%
73.0
-30%
Exports
6.3
7.6
5.1
-18.0%
5.6
-26%
Imports
17.9
27.6
20.4
14.3%
31.5
14%
Trade Balance
(11.6)
(20.0)
(15.3)
31.6%
(25.9)
30%
Exports as a Share of Output (Percent)
7.1
7.2
7.4
5.0%
7.7
7%
Import Penetration (Percent)
17.9
22.1
24.2
35.5%
31.9
44%
Source: ESI Estimates
Key Points
It is clear that both the chemical and steel industries would be hit hard by a
carbon tax, especially if it were levied only on Annex I countries. The industries
would no doubt survive, but they would survive with lower levels of output
and, consequently, employment, and with more of their energy-intensive
manufacturing processes occurring overseas.
The trade losses in both sectors would be concentrated in trade with developing
countries, major export markets for both industries. The chemical trade surplus
with non-Annex I countries, which accounts for nearly all the surplus in this
sector, could decline by almost $9 billion if there is no feedstock exemption. In
steel, the deficit with developing countries, currently much smaller than the
deficit with Annex-I countries, would increase substantially.
Because competitors in Europe and Japan would also face energy price increases,
the competitive impact among developed countries should be less dramatic.
Prices of natural gas and coal, the primary energy sources for the chemical and
steel industries, respectively, could be expected to rise less in Europe than in the
United States or Japan, giving manufacturers in Europe a slight competitive
advantage.
Moreover, those who expect a carbon tax to induce rapid gains in energy
efficiency in these industries would be disappointed. Both sectors have already
increased energy efficiency markedly since the mid-1970s through incremental
technical innovations and, in the case of chemicals, through changes in product
mix. Given higher marginal costs for future improvements, the long depreciation
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periods of these industries' capital stock, and the incremental nature of technical
progress, rapid gains by 2010 are probably not achievable.
Economic Strategy Institute
Chapter VI: Impact of a Carbon Tax on
Autos, Air Transportation, and
Semiconductors
The impact of a carbon tax would by no means be confined to the traditional
smokestack manufacturers, such as chemicals and steel. Less energy-intensive
manufacturers, and even service industries, would also be affected. This chapter
examines the potential impact of such a tax on two of the less energy-intensive
manufacturing industries, automobiles and semiconductor, and on air
transportation services. The ripple effect of higher chemical and steel prices
would be felt in these sectors, raising the cost of end-use products and services
and thereby dampening demand.
Automobiles
The automobile industry (SIC 371), which employed 1.5 million people in 1995, is
different from chemicals and steel in several ways. For instance, most of its
output is sold directly to consumers, not to other industries. Moreover, the actual
process of manufacturing a vehicle consumes little energy relative to chemicals
and steel. Nevertheless, a carbon tax would have a substantial impact on this
industry's costs, because it is a major consumer of energy-intensive intermediate
goods, such as plastic, steel, and aluminum. Also, consumer demand for
automobiles could be dramatically affected by the twenty-six-cent increase that a
carbon tax is expected to add to the price of gasoline.
The industry's vital statistics are shown in exhibit VI.1.
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Exhibit VI.1
Output, Employment and Trade of the U.S. Automobile Industry, 1995
Units
Autos and
Share of Total
Parts
Manufacturing
Output
Shipments
$ bil.
326
9.1%
Value added
$ bil.
105
6.2%
Employees
thou.
1,544
8.2%
Trade
Exports
$bil.
50
10.2%
Imports
$bil.
105
16.8%
Balance
$bil.
(56)
NA
Sources: Bureau of the Census, and International Trade Administration
Energy Use Issues
Indirect Effect is Key
The car industry's energy intensity, the best measure of its direct energy usage, is
well below the manufacturing average of 12,000 BTUs per dollar of value added.
In 1991, the production of finished vehicles consumed 2,300 BTUs per dollar of
value added. By itself, this low intensity suggests that manufacturing costs
would barely be affected by a carbon tax.
Direct energy costs are only part of the picture, however. The cost impact of a
carbon tax would be driven, in large measure, by rising costs of energy-intensive
intermediate inputs. In fact, the automobile industry's importance to the U.S.
economy stems largely from its role as a major purchaser of goods and services
from other industries. For instance, in 1987, the last year for which detailed U.S.
input and output (I-O) tables were published, the vehicle industry (SIC 3711,
which excludes parts) purchased four dollars in inputs for every one dollar of
value added, compared to a 0.79 ratio for U.S. industry as a whole. The parts
industry (SIC 3713-5) purchased $1.62 in inputs per dollar of value added.45 A
large share of these inputs (e.g., plastics, aluminum, and steel) are energy
intensive. As exhibit VI.2 shows, the direct impact of a doubling of energy prices
on the value of vehicle shipments would be less than the indirect impact of
higher energy costs on just a few major inputs.⁴⁶
45 See "Benchmark Input-Output Accounts for the U.S. Economy, 1987," Survey of Current Business
(March 1994), 73-115.
46 The indirect impact measured here only considers three commodities in addition to energy and,
thus, understates the actual indirect impact of an energy tax on automobile industry costs.
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool 57
Exhibit VI.2
Estimated Direct and Indirect Effects of a 100 Percent Increase in Energy Costs
Passenger Cars and Trucks (SIC 3711)
Impact
Units
Rise in direct energy cost
1,132
$ million
Rise in cost of plastic, steel, and aluminum consumed directly by
129
$ million
SIC 3711
Rise in cost of vehicle bodies, part, and accessories inputs (SIC 3713-5)
1,345
$ million
due to consumption of energy, plastic, steel, and aluminum
Total
2,606
$ million
Memorandum:
Total output of SIC 3711
134,115
$ million
Direct impact as a share of output
0.8
percent
Indirect impact as a share of output
1.10
percent
Sources: Bureau of Economic Analysis and ESI estimates
Behavior of End-Users Will Also Be Affected
A carbon tax would raise not only manufacturing costs, but also the cost of
operating a vehicle. According to recent analyses by the administration and
others, a $100 per ton carbon tax would translate into a gasoline tax of at least
twenty-six cents per gallon. As exhibit VI.3 indicates, a tax of that magnitude
would increase the cost of operating a vehicle by thirteen percent. The total price
increase to consumers (operating costs plus depreciation plus other costs) would
be about 5.5 percent,
Economic Strategy Institute
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Exhibit VI.3
Estimated Impact of a Carbon Tax on Operating and Ownership Costs
Per Mile* Cost of Ownership without a Tax ($)
Gas & oil
Operating
Depreciation
Other
Total
costs
Small
0.056
0.095
0.184
0.105
0.384
Mid-sized
0.066
0.108
0.218
0.121
0.447
Large
0.077
0.121
0.253
0.139
0.513
Light trucks
0.074
0.118
0.228
0.154
0.500
Per Mile* Cost of Ownership with a Tax ($)
Gas & oil
Operating
Depreciation
Other
Total
costs
Small
0.068
0.107
0.193
0.105
0.405
Mid-sized
0.080
0.122
0.229
0.121
0.472
Large
0.093
0.137
0.265
0.139
0.542
Light trucks
0.089
0.133
0.240
0.154
0.526
Cost of a Tax
Gas & oil
Operating
Depreciation
Other
Total
costs
Small
20.8%
12.3%
5.0%
0.0%
5.4%
Mid-sized
20.8%
12.7%
5.0%
0.0%
5.5%
Large
20.8%
13.2%
5.0%
0.0%
5.6%
Light trucks
20.8%
13.1%
5.0%
0.0%
5.4%
*Assumes that direct and indirect effects of higher energy costs on
manufacturing costs raises automobile prices 5 percent above their baseline
levels; based on 15,000 miles of driving per year.
Sources: Automobile Association of America and ESI estimates
It is naturally to be expected that consumers at the margin would respond to
higher costs by driving less, by purchasing smaller cars and/or by postponing
vehicle purchases. These behavioral changes would result in lower levels of
output and employment in the industry.
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59
Energy Efficiency Has Already Improved Substantially
As has been the case with chemicals and steel, the U.S. automobile industry has
already taken major steps to increase energy efficiency and, by extension, to
reduce carbon emissions. The figures are striking. Since 1974, the fuel economy of
new cars has more than doubled, while light truck fuel economy has increased
by fifty-five percent. In 1992, average fuel consumption per vehicle had dropped
106 gallons below 1975 levels. These gains were made possible, in large part, by
technological improvements and by reductions in the length, weight and engine
size of typical vehicles.
Further increases in fuel efficiency will result from additional technological
breakthroughs, such as electric cars and other forms of low- and zero-emissions
vehicles. Both U.S. and non-U.S. manufacturers already are making impressive
strides toward bringing such products to market. Given this situation, it is
unclear how a carbon tax, which would reduce available funds for investment in
research and development, could hasten this beneficial development.
Competitiveness Issues
The Global Picture
The automobile industry is dominated by companies in advanced countries. In
1995, Annex-I countries produced eighty-one percent of all vehicles (see exhibit
VI.4) The United States is the largest national producer, followed by Japan.
Developing-country industrial policies, foreign direct investment, and increased
wealth in developing countries are causing increased production levels in non-
Annex I countries. Though production in these countries is substantial, only cars
from South Korea, Mexico, Malaysia, and Yugoslavia have made inroads into
advanced-country markets.
Economic Strategy Institute
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Exhibit VI.4
Global Production of Automobiles, by Region, 1995
Share
Units
Annex I
81%
43,046
Western Europe
30%
16,075
USA
22%
11,904
Canada
4%
2,391
Japan
19%
10,197
Eastern Europe & Former Soviet Union
4%
2,074
Other Annex 1
1%
405
Non-Annex I
19%
10,291
Asia
12%
6,353
Latin America
6%
3,062
Africa and Middle East
2%
877
Total
100%
53,338
Source: Automotive News 1997 Market Data Book
Relocation Decision
Annex I automobile companies have already made substantial investments in
non-Annex I markets but, in most cases, production at these facilities is for the
"local" market. Since final vehicle assembly in most advanced-country markets
takes place in the country where cars are consumed, and because energy
intensity of the assembly function is low, increased production shifting by
vehicle makers, as opposed to parts makers, is unlikely.
Parts makers in the United States, however, face a different set of pressures, due
to their greater consumption of energy-intensive inputs. Higher energy prices
would likely increase the speed at which parts production would be localized in
Mexico, especially for cars aimed at the local market. In order to remain
competitive in Mexico, U.S. parts producers would likely be forced to increase
their FDI there.
The need to remain competitive with parts made in other developing countries
would also encourage U.S.-based parts makers to increase their FDI in
developing countries. The main competition would come from Korea. Korean
vehicle makers traditionally have relied heavily on foreign-made parts and
components. In order to lessen this dependence, the Korean government is
nurturing domestic parts producers with the aim of eventually becoming a net
exporter of parts. A carbon tax that gave Korean producers a greater price
advantage over parts makers in developed countries would do much to advance
this goal, particularly in other non-Annex I markets. This price advantage would
also help secure markets in the Annex I countries of Eastern Europe and the
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61
former Soviet Union, where Korean firms are investing heavily in automotive
capacity.
International Trade
As illustrated in exhibit VI.5, U.S. automotive trade is dominated by Annex I
countries. Canada plays an especially prominent role, both as an export market
and an import source. The deficit with Canada would probably not change much
in the event of a carbon tax, because the U.S. and Canadian industries are highly
integrated.
Exhibit VI.5
U.S. Automotive Trade with Annex I and Non-Annex I Countries, 1995
$bil.
120
100
80
60
40
20
0
-20
-40
-60
Exports
Imports
Balance
Annex I Less Can.
Canada
Mexico
Non-Annex I less Mex.
Source: Bureau of the Census, Foreign Trade Division
On the other hand, the deficit with the rest of Annex I would probably rise. U.S.
firms produce more of the larger, non-luxury cars and light trucks than do
foreign nameplates. Sales of these larger vehicles would be hit harder by a
carbon tax than would either small cars or luxury cars. Thus, sales of North
American products should decline disproportionately more than sales of
imported vehicles (see exhibit VI.6). Japanese and South Korean nameplates
would benefit most from these changing preferences. Korean companies, of
course, would also have the added competitive advantage of being located in a
non-Annex I country.
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Exhibit VI.6
U.S. Vehicle Market, by Size and Import Share, 1995
Total Units
Market
Import
Sold
Share
Share
Small
2,338,612
15.5%
22.0%
Mid-sized
4,190,978
27.7%
10.4%
Large
932,174
6.2%
0.0%
Luxury
1,173,234
7.8%
47.8%
Truck
6,481,357
42.9%
6.5%
Source: American Automobile Manufacturers Association
The FDI flows described above, as well as South Korea's price advantage borne
of its non-Annex I status, would both tend to increase the U.S. deficit with non-
Annex I countries. Because increased FDI to Mexico would be cost driven, parts
exports would fall and imports would rise, adding to an already large
automotive deficit with Mexico. The small surplus that the United States has
with other developing countries, $4.7 billion in 1995, would likely become a
deficit as U.S. exports to developing countries were replaced with local parts
production, and competitive parts imports from South Korea and other
developing countries expanded.
In sum, a carbon tax would hurt the competitiveness of U.S. motor vehicles vis à
vis Japan, thereby increasing the already huge bilateral automotive deficit;
expand imports from developing countries, especially from Mexico and Korea;
reduce U.S. exports of parts and components to developing countries; and hurt
U.S. parts manufacturers' chances of exporting to the markets of Eastern Europe
and the former Soviet Union.
Impact of a Carbon Tax on Motor Vehicle Industry Output and
Trade
Estimating the impact of a $100 per ton carbon tax on the vehicle industry is
complicated by the fact that the impact of a carbon tax on both vehicle and gas
prices would lead a significant number of people to purchase mid-size vehicles
instead of light trucks. To get an idea of the potential impact that this forced
change in preferences would have on U.S. output, ESI has illustrated the
potential impact on U.S. vehicle output and trade if just ten percent of light truck
purchasers opted to buy a mid-sized vehicle instead of a light truck.
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The basic model has similar assumptions to those used in the models for the
chemical and steel industries. Differences include:
The $100 per ton carbon tax would translate into a $0.26 per gallon
gasoline tax, about a twenty-one percent increase from current price
levels.
The compound growth rate of vehicle demand in the base scenario would
be equal to 0.7 percent annually.
A price elasticity of demand would be minus 0.25, because most of the
substitution caused by higher prices occurs within the industry.
The income elasticity of demand would be 1.08.47
The import elasticity would be 0.98, taken from a recent ITC study.48
The results imply a six percent drop in shipped units, declining vehicle exports, a
seven percent increase in import penetration, and a six percent increase in the
trade deficit, in unit terms (see exhibit VI.7).
Exhibit VI.7
Motor Vehicle Industry Output and Trade
Estimated Impact of a $100 per Ton Carbon Tax by 2010
Base Case
Carbon Tax
Domestic Demand (Units)
16,783.36
16,280.7
-3.0%
Shipments (Units)
12,861.8
12,115.1
-5.8%
Exports (Units)
1,381.2
1,328.7
-3.8%
Imports (Units)
5,302.8
5,494.4
3.6%
Trade Balance (Units)
(3,921.6)
(4,165.6)
6.2%
Exports as a Share of Output (Percent)
10.7
11.0
2.1%
Import Penetration (Percent)
31.6
33.7
6.8%
Source: ESI Estimates
Though significant, these results actually understate the impact that the carbon
tax would have on the U.S. auto industry. In dollar terms, the impact would be
much larger for two reasons. First, the shift away from light trucks and large-
sized passenger vehicles, which together account for more than half of U.S.
47 Lawrence Horowitz, "The Impact of Carbon Taxes on Consumer Living Standards," in Charles
E. Walker, ed., An American Perspective on Climate Change Policies (Washington, DC: American
Council for Capital Formation, February 1996), 145.
48 Kenneth A. Reinert and Clinton R. Shields, 29-41.
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vehicle demand, would result in less per-car sales revenue for U.S. firms. Second,
this shift would result in more imports, because the import share of the light-
truck/large-car market is substantially lower than it is for mid-sized cars. Exhibit
VI.8 illustrates this impact, based on a ten percent shift from light trucks and
large vehicles to mid-sized cars, and assuming a $10,000 premium for larger cars.
This shift would translate into higher imports, lower domestic production, and a
$9 billion decline in U.S. revenue.
Exhibit VI.8
Potential Impact of a Shift in Vehicle Purchases toward Mid-Sized Cars
Base case
Total
Imports
Domestic
Domestic
(units)
(units)
(units)
Revenue
($thou.)
Light trucks + large vehicles
8,694,498
463,222
8,231,276
230,475,729
Mid-sized vehicles
4,653,261
485,004
4,168,257
75,028,626
Total
13,347,760
948,227
12,399,533
305,504,355
With 10 percent shift toward mid-sized cars
Total
Imports
Domestic
Domestic
(units)
(units)
(units)
Revenue
($thou.)
Light trucks + large vehicles
7,825,049
416,900
7,408,148
207,428,156
Mid-sized vehicles
5,522,711
575,626
4,947,085
89,047,531
Total
13,347,760
992,526
12,355,233
296,475,687
Change from base case
Total
Imports
Domestic
Domestic
(units)
(units)
(units)
Revenue
($thou.)
Light trucks + large vehicles
(869,450)
(46,322)
(823,128)
(23,047,573)
Mid-sized vehicles
869,450
90,622
778,828
14,018,905
Total
-0-
44,300
(44,300)
(9,028,668)
Base case assumes a compound annual growth rate of 0.7 percent, import share in 2010
the same as in 1995, and per-vehicle revenue of $28,000 for light trucks and $18,000 for
mid-sized cars.
Source: ESI estimates
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Air Transportation
The airline industry (SIC 45) does not generally come to mind when one thinks of
global climate change. Yet, the effects on this industry of a carbon tax, or other
mitigation strategy that relies on higher energy prices, would, in many ways,
parallel the effects on the automobile industry. The air transportation industry
would be hurt not only by the general decline in aggregate demand that a tax
would cause, but also by higher aircraft costs, higher fuel costs, and increases in
other travel-related expenses, which would impact the frequency of travel in
general.
The airline industry is a major employer, responsible for more than a million jobs
in the U.S. alone. Its value added is also about seventy-five percent higher than
the steel industry's value added (see exhibit VI.9)
Exhibit VI.9.
Output, Employment and Trade of the U.S. Airline Industry, 1995
Units
Air Transportation
Share of Total
Services
Transportation Services
Output
Value added*
$ bil.
51
22.9%
Employees
thou.
1,068
27.4%
Trade
Exports
$bil.
19
17.4%
Imports
$bil.
14
16.3%
Balance
$bil.
5
NA
* Value added is for 1994.
Sources: Bureau of the Census, and International Trade Administration
Energy Use Issues
Direct Fuel Costs Are High
Though the air transportation industry does not manufacture anything, it is a
major energy user. At 0.25 to one, its ratio of energy use to value added is about
twice as high as that of the chemical industry. Furthermore, fuel costs make up
twenty-to-thirty percent of the direct operating costs for most major airlines (see
exhibit VI.10). Since direct operating costs typically account for thirty-to-forty
percent of total airline costs, every ten percent rise in the price of fuel is
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accompanied by a subsequent one percent increase in total costs. Moreover, a
carbon tax would come on top of the user fees that airlines already pay, and on
top of the so-called ticket tax that was enacted as part of this year's budget
accord.
Exhibit VI.10
Energy Expenditures as a Share of Direct Operating Costs, 1995
Fuel Costs as Share
Fuel Oil
of Total Direct
($ bil.)
Operating Costs
Air Canada
328.7
30.5%
Air France
736.7
25.9%
Lufthansa
819.0
24.2%
JAL
1,303.2
28.1%
British Airways
943.1
29.0%
American
1,482.3
24.1%
Northwest
1,031.5
28.8%
United
1,583.5
24.4%
Source: ICAO
Indirect Energy Use Is Substantial As Well
Like the motor vehicle industry, the air transport industry also purchases
energy-intensive products. Its major input, of course, is aircraft, and aircraft
prices would be sure to rise if an energy tax were implemented, because their
major material inputs include aluminum, steel, plastic, and rubber. Those inputs
alone account for about seven percent of the value of aircraft shipments.
Consequently, a fifteen percent rise in the price of those products would increase
aircraft prices by about 1.1 percent. Also, the increase in direct energy costs to
aircraft manufacturers would increase aircraft prices by another one percent.
Given that prices for products such as metal working machinery and other
capital equipment would rise as well, the total price effect of direct and indirect
energy use would likely be in the neighborhood of four-to-five percent. Unless
aircraft manufacturers replaced their domestic production with imports from
non-Annex I countries, airlines would have to pay higher prices for their planes.
The cost of these extra expenditures would ultimately be borne by consumers.
Higher Ticket Prices and Lower Incomes Would Mean Fewer Travelers
As in the case of automobiles, consumers affected by slowed income growth and
by the higher prices resulting from a carbon tax would change their behavior.
Specifically, travelers sensitive to shifts in price and income would either use less
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costly forms of transportation, downsize their vacations by flying closer to ho
put more effort into tracking down discounted flights, or choose not to trave
all. As exhibit VI.11 indicates, fliers are especially sensitive to changes in income.
For airline services, a one percent decline in income translates into a 1.63 percent
decline in expenditures on air travel, over the long run.
Exhibit VI.11
Long-Term Income Elasticities for Selected Consumption Categories
Income
Elasticity
Airline service
1.63
Other durable goods
1.51
Furniture and appliances
1.28
Other non-durables
1.23
Motor vehicles and parts
1.08
Financial services
0.89
Clothing and shoes
0.86
Electricity
0.82
Natural gas
0.70
Medical services
0.61
Gasoline
0.60
Food and beverages
0.54
Telephone service
0.36
Housing
0.17
Source: DRI
Competitiveness Issues
The Global Picture
OECD countries dominate airline services, accounting for seventy-three percent
of scheduled passenger kilometers worldwide (see exhibit VI.12). The United
States, generally considered to have the most competitive airline services sector,
is the largest national market within this group of countries. The market share of
carriers based in the United States and other Annex I nations would likely be
even higher if trade in airline services were as open as trade in goods. However,
governments in both OECD and non-OECD countries closely regulate access to
their domestic markets.
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Exhibit VI.12
Global Scheduled Passenger Kilometers Performed, by Country, 1995
Share
Passenger Kilometers Performed
(millions)
OECD
73%
1,602.6
United States
39%
853.4
Germany
3%
62.2
France
3%
66.9
United Kingdom
7%
152.5
Japan
6%
130.0
Other
15%
337.6
Non-OECD
27%
607.1
China
2%
54.2
Singapore
2%
45.4
Russia
3%
61.0
Brazil
2%
34.3
Argentina
1%
11.9
Other
18%
400.3
Total
100%
2,209.7
Source: International Civil Aviation Organization and ESI Calculations
International Trade
Unlike the industries previously covered, the competitiveness impact of a carbon
tax would likely be slight in the case of the airline industry, especially if it is
applied "at the pump." Most major competitors are from Annex I countries, and
carriers from developing countries flying to and from the United States would
likely have to purchase at least some of their fuel in the United States. Likewise,
U.S. carriers flying to developing countries could purchase fuel for their return
trips in the developing countries, thereby avoiding the tax on at least one leg of
their journey.
A system could be devised, however, that would allow carriers from non-Annex
I countries to receive a tax rebate on fuel purchased in developed countries.
Under such a scenario, Annex I carriers, including those from the United States,
would be at a competitive disadvantage and would likely lose international
customers to developing-country airlines. The United States is already running a
deficit in passenger airline services trade with developing countries, and this
shortfall would likely expand if abatement policies were shouldered solely by
advanced-country airlines (see exhibit VI.13 below)
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Exhibit VI.13
Passenger Airline Services Trade with Annex I and Non-Annex I Countries,
1995
$bil.
14
12
10
8
6
4
2
0
Exports
Imports
Balance
-2
Annex I
Non-Annex I
Source: Bureau of Economic Analysis
The competitiveness effect of a carbon tax on the U.S. airline services industry,
therefore, would depend on how the tax was implemented. The impact of a tax
without a rebate system would likely be small, but a tax that discriminated
against Annex I countries would damage their carriers' competitiveness.
Unfortunately, since price-sensitive international travelers would simply shift to
non-Annex I carriers, the discriminatory tax would have no impact on energy
consumption or, by extension, on global carbon emissions.
Impact of a Carbon Tax on Airline Services Industry Revenue
and Trade
ESI has attempted to estimate the potential effects of a carbon tax on airline
revenue, using a methodology and assumptions similar to those used for the
previously discussed industries. Though current uncertainty surrounding the
cross-border implementation of a carbon tax makes any effort to quantify its
impact on trade purely speculative, ESI has also included a small trade effect.
Assumptions specific to airline services include:
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A $100 per ton carbon tax would translate into a $0.34 per gallon increase
in finished aviation fuel costs.
Domestic demand for, and imports of, airline services would expand three
percent per year through 2010 in the base scenario.
Airline services exports would expand six percent per year, due to
increased economic growth in, and travel to and from, developing
countries.
Price elasticity of demand would be minus one.
Income elasticity of demand would be two.49
Export and import elasticities would be minus one and one, respectively.
The results, shown in exhibit VI.14, imply a 6.5 percent revenue decline from the
base scenario, driven primarily by a decline in domestic demand for airline
services. The trade impact would be smaller than it would be in the other
industries examined, but the U.S. airline services surplus would still decline 8.5
percent below baseline levels.
Exhibit VI.14
Airline Services Industry Revenue and Trade
Estimated Impact of a $100 per Ton Carbon Tax by 2010
Base Case
Carbon Tax
Value
Value
% Change
Domestic Revenue ($ bil.)
140.0
131.4
-6.2%
Total Revenue ($ bil.)
163.4
152.8
-6.5%
Exports ($ bil.)
45.8
44.5
-3.0%
Imports ($ bil.)
22.5
23.1
2.8%
Trade Balance ($ bil.)
23.3
21.4
-8.5%
Export Receipts as a Share of Revenue (Percent)
28.1
29.1
3.8%
Import Penetration (Percent)
16.1
17.6
9.5%
Source: ESI Estimates
The impact of a decline in airline travel on the domestic economy would be much
larger if a less efficient mechanism for reducing carbon emissions were
employed. For instance, the Campbell Aviation Group has estimated that the
direct, indirect, and induced effects of keeping the industry's fuel consumption at
1990 levels could have a negative economic impact on the United States
amounting to $770 billion by 2010.
49 This elasticity is higher than the one in exhibit VI.11, reflecting the increasing sensitivity of air
travel to income fluctuations.
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71
Semiconductors
The semiconductor industry (SIC 3674), after almost succumbing to the
onslaught of predatory Japanese dumping during the mid-1980s, has been a
driving force in the high-technology revolution that has helped to remake the
U.S. economy during the 1990s. Industry shipments in 1995 totaled $65.6 billion,
a whopping 120 percent increase over 1991 shipments. Semiconductor
manufacturers employed 193,400 people in high-value-added jobs in 1995. The
value added per employee was a staggering $265,000 per person. However,
despite obvious U.S. competitiveness in this sector, the United States ran a trade
deficit of more than $16 billion (see exhibit VI.15).
Exhibit VI.15.
Output, Employment and Trade of the U.S. Semiconductor Industry, 1995
Share of Total
Units
Semiconductors
Manufacturing
Output
Shipments
$ bil.
65.6
1.8%
Value added
$ bil.
51.3
3.0%
Employees
thou.
193.4
1.0%
Trade
Exports
$bil.
22.4
4.6%
Imports
$bil.
38.9
6.2%
Balance
$bil.
(16.5)
NA
Sources: Bureau of the Census, and International Trade Administration
At first glance, the semiconductor industry does not seem to fit the profile of an
industry that could be damaged by deliberations in Kyoto. It is certainly not a
smokestack industry. Its expenditures on electricity in 1995 amounted to only 0.8
percent of value added. Rising production costs resulting from an energy tax,
therefore, would have only a very small impact on the price of the average
semiconductor.
In this case, however, first impressions are deceiving. Semiconductors are
essential components in a wide and increasing range of consumer and capital
goods. A drop in demand induced by an energy tax, therefore, would
substantially affect semiconductor sales. Moreover, perflourocarbons (PFCs),
manmade greenhouse gases that will be discussed at the Kyoto meeting in
December, are an integral part of the semiconductor manufacturing process.
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Energy Use Issues
Microprocessors Versus DRAMs
The industry's low energy intensity is somewhat misleading, because it lumps
together different products having vastly different energy intensities. While
energy costs, as a share of revenue, are low for high-margin products such as
microprocessors, they are high for low-margin products such as dynamic
random access memory chips (DRAMs). DRAM imports are already substantial,
especially from developing-country producers, but some U.S. producers are
extremely competitive, recording profits even though memory prices have
declined precipitously during the past eighteen months. An energy tax applied
only on Annex I countries would put U.S. DRAM manufacturers at a severe
competitive disadvantage, perhaps completing the job begun by Japanese
dumpers during the 1980s.
No Substitute for Perflourocarbons
Though the attention in Kyoto will be focused heavily on CO2, PFC mitigation
strategies likely will be a topic of discussion as well. Given the key role of PFCs
in the manufacturing process, rushed and ill-conceived efforts to limit PFC use in
Annex I countries would have a chilling effect on semiconductor manufacturing
in the United States.
Perfluoroethane serves as a purging agent in the production of semiconductors.
The process results in emissions of PFCs (gases usually associated with
aluminum smelting) and sulfur hexafluoride. Because there are currently no
substitutes for perfluoroethane in the manufacturing process, any usage limits,
or taxes to produce an equivalent reduction, would raise domestic
manufacturing costs dramatically. Obviously, such a development would give
producers in non-Annex I countries a major advantage.
The U.S. semiconductor industry has been proactive in its efforts to reduce PFC
emissions. Individual companies have signed a memorandum of understanding
with the Environmental Protection Agency, committing them to work toward
emissions reduction. SEMATECH and individual companies have undertaken
major research efforts aimed at finding a commercially viable alternative to
perfluoroethane.
Current and Past Developments Offer Long-Term Energy Savings Potential
The rapidly growing capabilities and falling prices among the semiconductor
and other high-tech industries, such as computers and telecommunications, have
led to increased consumption of these products. Concurrently, increased
manufacturing activity in these sectors has led to higher levels of U.S. energy
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73
consumption and, by extension, greater greenhouse gas emissions. On the other
hand, these high-tech industries may actually lead to less energy consumption in
the long run, as teleconferencing, telecommuting, and e-mail reduce energy
consumption associated with travel and postal services. Efforts to harness high-
tech industries through higher energy taxes, or other policies, risk a slowdown in
the pace of technological change, thus delaying the advent of energy-saving
technologies that would produce lower levels of greenhouse gas emissions in the
long run.
Competitiveness Issues
The Global Picture
Annex I producers, particularly those based in the United States and Japan,
account for the vast majority of global semiconductor sales. Producers based in
other Asia-Pacific countries, such as South Korea, have made impressive strides
during the 1990s, with market share tripling between 1990 and 1995 (see exhibit
VI.16) Asia-Pacific producers are especially strong in DRAM production, and
industrial policies in several countries throughout the region are aimed at
developing indigenous semiconductor industries. The goal of Korean industrial
policy is to shift the country's product mix away from DRAMs and toward
microprocessors and other products currently produced in the United States.
Exhibit VI.16
Global Semiconductor Market Share, by Region of Capital Affiliation
1990 and 1995
1990
1995
(percent)
(percent)
Annex I
96.1
87.9
United States
38.6
39.8
Japan
46.3
39.5
Europe
11.2
8.6
Non-Annex I
3.9
12.1
Asia-Pacific (excl. Japan)
3.9
12.1
Source: ESI, Prospects for U.S.-Japanese Semiconductor Trade in the 21st Century
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The Relocation Decision
Semiconductor manufacturers based in the United States, Japan, Europe and
Korea have been active foreign investors. The U.S. market is home to Japanese,
European, and Korean-owned firms, and U.S.-based firms have production
outlets throughout the world. Though much of this cross-investment has been
market seeking, cost-driven FDI has also occurred. Major producers long ago
relocated low-value-added, labor-intensive functions to lower-wage countries. In
short, the semiconductor industry is mobile and sensitive to cost differences
across countries.
As a production site, the United States now has enough advantages to ensure a
viable domestic industry, even in the face of energy taxes. Yet, a tax levied only
on Annex I countries would provide a powerful incentive for Annex I producers
to shift production of low-margin, energy-intensive products like DRAMs to
countries exempted from a carbon-based energy tax. All other things being
equal, a tax on Annex I countries would result in less FDI in the United States
and more U.S. FDI in non-Annex I countries than would otherwise be the case.
International Trade
Despite its competitiveness, the United States is a net importer of
semiconductors.50 Japan is the largest national source of U.S. imports, followed
by Korea, Malaysia, Taiwan, and Singapore - all non-Annex I countries. In fact,
the majority of U.S. semiconductor imports come from non-Annex I countries
(see exhibit VI.17).
50 Statistics offer a somewhat confusing picture of semiconductor trade. According to the SIC-
based trade numbers, the U.S. deficit in "semiconductors and related devices" was 16.5 percent in
1995. According to SITC-based trade statistics, the U.S. deficit in "integrated circuits" was only
$4.5 billion in 1995. The country-by-country discussion in this section is based on SITC
definitions.
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Exhibit VI.17
U.S. Semiconductor Trade with Annex I and Non-Annex I Countries, 1995
$bil.
25
20
15
10
5
0
-5
Exports
Imports
Balance
Annex I
Non-Annex I
Note: Trade figures based on SITC Rev. 3 classification
Source: Bureau of the Census, Foreign Trade Division
An energy tax on Annex I countries clearly would aggravate the U.S. trade
shortfall, for three reasons. First, the change in FDI flows resulting from a carbon
tax would lead to more production in non-Annex I countries and less production
in the United States than would otherwise occur. Second, producers based in
Korea and other developing countries would gain a cost advantage in DRAMs
and other low-margin products, potentially rendering U.S. makers of these
products uncompetitive. Third, the lower rise in European electricity prices
would encourage U.S. producers to service a greater share of European demand
with their production facilities on the continent. Because manufacturers in Japan
and the United States are expected to face similar increases in electricity costs,
the overall impact on competitiveness between the two should be relatively
minor.
Furthermore, erosion of the U.S. balance of trade with developing countries
would be magnified greatly if advanced countries were burdened by PFC
restrictions. Such restrictions would make the addition of capacity in the United
States nearly impossible and would compel U.S.-based makers to shift even more
production to developing countries, in order to serve rapidly growing U.S.
semiconductor demand. PFC policies that undercut U.S. competitiveness would
be a boon to DRAM producers in Korea and Taiwan with high capacity levels.
Because production would merely be shifting, this U.S. "sacrifice" would
produce no net, global change in PFC emissions levels.
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Impact of an Energy Tax on Semiconductor Industry Output
and Trade
In addition to estimating the effect of a $100 carbon tax, ESI has attempted to
capture the impact of restrictions or tax increases on PFCs. Assumptions for
these estimates include:
The $100 per ton carbon tax and PFC mitigation policies would translate
into an average five percent increase in semiconductor prices.
Domestic demand for semiconductors in the base scenario would rise
seven percent per year from 1995 levels.
Due to U.S. competitiveness in high-value-added product lines, U.S.
semiconductor exports would rise seven percent per year, versus a five
percent growth rate for imports.
A low price elasticity of minus 0.2 would reflect the paucity of substitutes
for semiconductors.
A high income elasticity of 1.75 would reflect the high and growing
semiconductor content of durable consumer and capital goods, which
generally have higher than average elasticities.
Export and import elasticities of minus 1.2 and 1.2, respectively, would be
slightly higher than average, reflecting the fact that a high proportion of
U.S. semiconductor trade would occur with developing countries and
would be price sensitive.
The potential impact on the semiconductor industry of a combination of energy
tax and PFC mitigation policies would be even larger, in percentage terms, than
the impact on the auto industry (see exhibit VI.18). Shipments in 2010 would be
down eight percent from base levels, while exports would fall six percent and
imports would expand 5.8 percent. The trade deficit would be $8.4 billion higher
than would otherwise be the case.
Economic Strategy Institute
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
77
Exhibit VI.18
Semiconductor Industry Output and Trade
Estimated Impact of a $100 per Ton Carbon Tax and PFC Restrictions by 2010
Base Case
Carbon Tax
Value
Value
% change
Domestic Demand ($ bil.)
226.7
218.5
-3.6%
Shipments ($ bil.)
207.5
191.0
-8.0%
Exports ($ bil.)
61.8
58.1
-6.0%
Imports ($ bil.)
80.9
85.6
5.8%
Trade Balance ($ bil.)
-19.1
-27.5
43.9%
Exports as a Share of Output (Percent)
29.8
30.4
2.1%
Import Penetration (Percent)
35.7
39.2
9.7%
Source: ESI Estimates
Key Points
The automobile, airline services, and semiconductor industries in the United
States, like their smokestack brethren, can expect significant declines in output
and competitiveness if U.S. negotiators agree to an energy tax aimed at
constraining U.S. emissions to 1990 levels, especially if steps are not taken to
constrain developing-country emissions. The potentially large impact on the
automobile industry is not surprising, because the cutting of energy
consumption due to automobile use is a major goal of proposals now on the
table. The potentially large effects on airline services and semiconductors,
however, is surprising, as well as alarming, because these industries have been
considered to be the engines of a "new" U.S. economy driven by services and
high-tech manufacturing. The bottom line? A carbon-based energy tax levied
only on advanced countries would deal a very hard blow to just about all sectors
of the U.S. economy.
Contrary to popular perceptions, U.S.-made autos and parts, like U.S.-made
chemicals and steel, compete relatively well in developing-country markets, a
situation that a carbon tax would almost certainly alter. By 2010, U.S. trade
balances in the auto, airline, and semiconductor sectors would deteriorate
sharply, driven mainly, but not exclusively, by trade with non-Annex I countries.
Ironically, even the "new economy" sectors of airline services and
semiconductors ran trade deficits with developing countries in 1995, and they
would run even larger deficits by 2010 if a discriminatory energy tax were to
become reality. Such developments could only poison American popular
attitudes toward trade with developing countries, thus undercutting decade-long
efforts to open those markets through bilateral and multilateral negotiations.
Economic Strategy Institute
78
The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
At present, promising efforts to reduce greenhouse gas emissions are ongoing in
the auto and semiconductor industries. To penalize them with a tax on energy
would hamstring those activities, because lower sales revenues and higher
operating costs inevitably translate into less R&D expenditures. In this sense,
many of the mitigation options aiming to shunt energy consumption back to
1990 levels by 2010 are misguided.
Economic Strategy Institute
Chapter VII: Conclusions and
Recommendations
In summary:
Evidence that man-made greenhouse gases will raise temperatures
significantly in the decades ahead is ambiguous. While computer
models project such a trend, actual satellite data does not conform to
the projections and indicates there has been little, if any, global
warming since World War II even though most of the man-made
greenhouse gases now in the atmosphere have been added since that
time. Further, the likely consequences of warming are a matter of
dispute among scientists.
Contrary to much popular commentary and assertions by other
governments, the U.S. record on emissions is quite good. In fact, most
of the increase in emissions in the United States since 1990, the
baseline in many emission reduction proposals, reflects population
growth and the strong economic expansion following the recession
that occurred in 1990, rather than declining energy efficiency. Indeed,
U. S. final consumption of energy per unit of output has actually
declined sharply since 1990, even more rapidly than in most other
countries.
The most rapidly growing rates of emissions are occurring in
developing countries. Indeed, their emissions are so large and
growing so rapidly that any projected reduction by industrialized
countries would be overwhelmed by developing countries 'emissions
if they are not parties to any agreement.
The economic costs associated with current emission reduction proposals
are likely to be large, and to extend over a long period. Advocates of emissions
control measures are using flawed models and assumptions which dramatically
understate these effects. Most significantly, carbon taxes and other measures
designed to reduce emissions will put U.S. companies across a wide range of
industries at a severe competitive disadvantage in global markets, especially
relative to those countries that may be exempt from emissions control, or that
Economic Strategy Institute
80 The Global Climate Debate: Keeping the Economy Warm and the Planet Cool
don't live up to commitments that they might make in Kyoto. This will put huge
upward pressure on the already large and rising U.S. trade deficit, and will be at
cross purposes with current trade policy initiatives which are designed to open
foreign markets and reduce the U.S. trade imbalances. U.S. consumers would
also be hurt - higher energy costs, rising overall inflation, and higher interest
rates would squeeze real income and purchasing power, and significantly reduce
living standards for several decades at least.
The United States government, therefore, should be extremely cautious in
dealing with the Kyoto agenda. In particular, it should not agree to proposals
being made by other countries for mandatory reduction of emissions to 1990
levels by the year 2010. This would require increases in energy efficiency
between now and 2010 that are virtually impossible. The only way to achieve
that target would be to reduce the growth in energy consumption that results
from higher levels of economic activity, thus dramatically slowing economic
growth.
Nor should the United States enter into any agreement that excludes developing
countries. Because the easiest and least costly emissions reductions can be
achieved in developing countries, the U.S. should encourage cooperative
arrangements, technology transfer and low cost finances for installation of up to
date equipment in these areas. For example, a leaking gas line in the Ukraine
was recently made 100 percent cleaner through the addition of joint strapping to
stop the leaks. These kinds of simple inexpensive measures in countries that
have not already attacked the easy problems would be a much better
cost/benefit profile than draconian measures in the United States where
efficiency has already been much improved.
Finally, if the Kyoto convention is really serious, it might consider cooperative
financing by all attendees of a Manhattan type of project to achieve the kind of
massive increases on energy efficiency that will be necessary to reduce emissions
without reducing the world to poverty.
Economic Strategy Institute
Clinton Presidential Records
Digital Records Marker
This is not a presidential record. This is used as an administrative
marker by the William J. Clinton Presidential Library Staff.
This marker identifies the place of a tabbed divider. Given our
digitization capabilities, we are sometimes unable to adequately
scan such dividers. The title from the original document is
indicated below.
L
Divider Title:
DRAFT --May 30, 1997
Economic Effects of
Global Climate Change Policies
Results of the Research Efforts of the
Interagency Analytical Team
June 1997
Executive Summary
Using a group of economic models with different strengths and weaknesses, the Administration's
Interagency Analytic Team has analyzed the economic effects of policies to limit emissions that
lead to changes in global climate.
The starting point for this analysis was a scenario in which carbon emissions in the year 2010
were reduced to their 1990 levels. This starting point was selected because it was presented in
previous Administration analyses of the issue and because it has been the subject of numerous
analyses by academic researchers. Cross-border trading of emissions rights (or permits) was then
allowed to reduce transitional economic losses created by such a policy. This is particularly true
in the short term. A dramatic acceleration of technological progress also has made the potential
to reduce further economic losses, if it can be achieved, but over a longer time period. The
economic losses are also reduced by policies that use any resulting revenues for the Federal
budget deficit reduction or other policies, which favor investment and long-term growth.
The starting point scenario would raise the implicit price of carbon in the economy by about
$100 per ton of carbon. (Actual household burdens would be somewhat offset by conservation
and presumed subsequent efficiency improvements.) These higher energy costs would produce
GDP losses, at peak, between 0.2 percent and 1.0 percent of GDP. The economy would
thereafter bounce back, or in the worst case stabilize, so that it would soon reach its pre-policy
growth path. Thus, the losses of economic output resulting from such a policy are real. but
relatively small and transient. These losses are disproportionately greater for stricter targets and
disproportionately smaller for more lenient ones. However, if international permit trading were
established it would moderate the losses to GDP. The maximum effect on GDP under
international permit trading is about half of that under no trading.
While the economy-wide losses are small. some sectors bear large burdens. particularly energy
producers. Energy-intensive industries also face greater losses. But there is no evidence of a
wholesale "capital flight" from the United States resulting from an emissions reduction policy.
Moreover, some industries expand as the economy undergoes the adjustment to a world with
fewer carbon emissions.
DRAFT -May 30, 1997
Introduction
In June 1996, the Department of Energy (DOE) and the Environmental Protection Agency (EPA)
sponsored a joint workshop where more than 50 experts from inside and outside the government
made presentations on technical issues associated with our emissions trends and capability to
reduce emissions trends in the next century. As a part of that workshop, the Interagency
Analytical Team (IAT) released what were then preliminary results on the economic effects of
emissions reduction proposals.
Since that June 1996 workshop, the IAT has reviewed its work, selected new modeling
instruments, improved its approach to old ones, and developed a new set of modeling runs that
lead to a better understanding of the economic dimensions of the climate change policy problem.
This paper describes those efforts. It first summarizes the IAT model selection process. Second,
it discusses the (pre-policy) base case used to measure the effects of various policy options.
Third, it discusses the IAT's core emissions reduction scenario. Finally, the bulk of this paper
discusses the results of the IAT's analysis.
The modeling work performed for this analysis was döne by economists at DOE and EPA. The
IAT also included members from the Departments of Commerce, Treasury, Labor, and State, as
well as members of the White House staff. The majority of the IAT members are still primarily
from DOE and EPA -the agencies that have the primary responsibility for the Administration's
energy and environmental policies.
Model Selection
The first task that the IAT confronted was to review the analytic "toolbox" to assure that it had
all the tools necessary to specify the economic effects of a broad range of climate change
proposals. At the time, the IAT relied primarily on the Data Resources, Inc. (DRI) macro model
to measure economic effects. After this reevaluation of our modeling needs, it was apparent that
the complexity of the analysis would require a broader range of analytical tools.
At a public meeting last November, the IAT announced the selection of three models for its
analysis. It decided to continue to use the DRI model, but also included two additional models:
the Second Generation Model (SGM) and the Markal-Macro model. Each of these three models
met the criteria of being available in the public sphere; being well documented; having a track
record of analysis in the climate change area; being widely understood within the energy-
environment community; and bringing a unique capability to the IAT's work. Used separately,
but in concert with each other, they provide the broad analytical capability needed to examine the
many complex economic effects of potential global climate change policies.
The DRI model is a large disequilibrium model of the domestic economy that is particularly well
suited to identify transition issues based on short-run behavior embedded into a long-run model.
The DRI macroeconomic model is linked to energy, regional, and industry sub-models so that
macroeconomic effects of policies are translated into the effects on specific industries and
regions of the country. The link to energy sub-models provides specific detailed information
DRAFT --May 30, 1997
about the interaction of the energy sector with the rest of the economy.¹ The DRI model also
includes the interaction of the financial markets with markets for goods and services and enables
the analysis of the interaction of fiscal and monetary policy with the rest of the economy.
The SGM model is a computable general equilibrium good at identifying an economy's long-
term trends in response to climate policies. As such, it is particularly good at describing the
economy's long-term path while not as good at describing short-term transition issues. In this
sense, its strengths and weaknesses are counterpoised to those of DRI. International in scope,
SGM also provides detail for 12 global regions that allows the IAT to examine the effects of
permit trading and joint implementation. SGM assesses the impacts of greenhouse gas emissions
policies on economic growth, consumption, and energy.
The DRI model and SGM can be thought of as lying at opposite ends of an axis that measures
time horizons. A second dimension of the climate change problem concerns the role of
technology. Both DRI and SGM allow technological progress to move forward in response to
the parameters of their models. But given the unpredictable character of innovation, the IAT
concluded that a second approach would be helpful. The Markal-Macro model consists of an
integrated energy supply and demand modeling system (Markal) and a macroeconomic model
(Macro) useful for translating technological assumptions into economic outcomes.
The Markal-Macro model is particularly useful in answering the question, "How do we get there
from here?" Markal-Macro identifies optimal, under perfect foresight, for achieving and
quantified goal. Markal-Macro allows the user to control technology innovation and diffusion
and its cost to the user in order to determine the levels of energy efficiencies that might be
expected from a long-term policy announcement. This model also allows us to understand the
implications of technology and its interaction with the economy, and helps us determine whether
expected energy efficient technologies hold the key to continued economic growth.
The DRI model and the SGM model in some sense provide notional brackets for estimates of the
economic effects of carbon-limiting policies. The DRI model is focused on short-term
transitions and measures the economy in quarters. In some sectors, the DRI model has forward-
looking behavior, but it is structured to examine the effects of short-term changes in the
economy, and is often held to overstate the transitions created by broad, secular changes in the
economy (and, as will be discussed below, might overstates subsequent economic improvements
as well). The SGM model focuses on long-term transitions and measures the economy in five-
year intervals. Thus, it risks racing past short-term transition issues, while identifying the
economy's ultimate destination.
1
The majority of the DRI results reported by the IAT use DRI's own Energy sub-model. In a limited
number of cases. DOE's National Energy Modeling System (NEMS) has been also used been used in conjunction
with the DRI model to analyze various sensitivities.
3
DRAFT --May 30, 1997
The Base Case
The domestic energy and emissions baseline forecasts were taken from the Energy Information
Administration's 1997 Annual Energy Outlook (AEO97). The DRI baseline is DRI's own
October 1996 long-term forecast, adjusted in part for the Climate Change Action Plan (CCAP).
It is very similar to the AEO97 forecast, but not specifically calibrated to it. The international
baseline forecast was taken from the International Energy Agency's World Energy Outlook,
except for the baseline forecast of the Former Soviet Union (FSU), which came from World
Bank projections. The IAT then imposed, as best possible, consistency across the models with
regard to projections of baseline GDP, total energy consumption, and carbon emissions. Once
these were calibrated into the 3 models, the models solved for energy prices by fuel type. Thus,
the baselines of the three models are consistent, but not identical.
Tables 1 and 2 summarize the IAT baseline. In the baseline, U.S. economic growth is projected
to slow over the next several decades, as the retirement of baby boom" workers slows labor
force growth and reduces the economy's potential growth rate Energy demand therefore grows
somewhat more slowly than it now does. Energy intensity, measured as energy use per dollar of
GDP (the E/GDP ratio), is a key ingredient in the AEO97 forecast, because it measures the
growing efficiency with which the economy uses energy. In the 1970s and 1980s, the E/GDP
rate of decline averaged almost 2 percent annually-1.5 percent due to price effects and 0.5
percent due to non-price effects. Moderate price increases and the growth of more energy-
intensive industries in the late 1980s led to a stabilization of energy intensity. The baseline
projection used for this study incorporates a 1.0 percent annual reduction in energy consumption
per unit of real output, which is taken from the EIA's Annual Energy Outlook. With these
improvements included, energy demand grows at an annual rate of about 0.8 percent over the
period from 1995 to 2020, tailing off at the end of the period as does economic growth.
Carbon emissions in the baseline are projected to increase by about 1.2 percent a year through
2010, and by 0.6 percent annually from 2010 to 2020, reaching 1805 million metric tons in 2020.
In 1990, the year most frequently used in the international negotiating process as the reference
level of carbon, carbon emissions were 1,340 million metric tons, 22 percent below EIA's
projection for 2010 and 36 percent below DRI's projection for 2020.
DRAFT --May 30, 1997
Table 1: IAT Domestic Baseline
Year
Average Annual Growth Rate (percent) I
1990
1995
2000
2005
2010
2015
2020
90-95
95-00
00-05
05-10
10-15
15-20
Population
DRI-DRI Energy
250
263
276
287
299
311
323
1.0
0.9
0.8
0.8
0.8
0.7
AEO97 (NEMS)
250
264
276
287
299
311
n/a
1.0
0.9
0.8
0.8
0.8
n/a
SGM
250
263
276
287
299
311
323
1.0
0.9
0.8
0.8
0.8
0.7
Markal-Macro
250
263
276
287
299
311
323
1.0
1.0
0.8
0.8
0.8
0.8
GDP (Billion 1992S)
DRI-DRI Energy
$6,139
$6,743
$7,515
$8.320
$9,163
$9,996
$10.670
1.9
22
21
1.9
1.8
1.3
AEO97 (NEMS)
$6,139
$6,739
$7.544
$8,390
$9,185
$9,880
n/a
1.9
23
21
1.8
1.5
n/a
SGM
$6.139
$6.739
$7.544
$8.390
$9.185
$9,880
$10,591
1.9
23
21
1.8
1.5
1.4
Markal-Macro
$6,139
$6,739
$7.549
$8.384
$9,198
$9.880
$10,498
1.9
2.3
21
19
1.4
12
OMB
$6.142
$6,721
$7,470
$8,343
$9,225
$9,929
$10,581
1.8
2.1
2.2
2.0
1.5
1.3
Total Energy Consumption (Quads) 4
DRI-DRI Energy
82.6
88.9
95.9
101.0
105.3
107.4
108.9
1.5
1.5
1.0
0.8
0.4
0.3
AEO97 (NEMS)
83.7
90.0
97.9
103.4
107.9
110.9
n/a
1.5
1.7
1.1
0.9
0.5
n/a
SGM
81.2
90.6
96.0
102.0
107.0
110.3
113.0
22
1.2
1.2
1.0
0.6
0.5
Markal-Macro
83.7
90.9
98.0
103.7
107.8
110.7
115.3
1.7
1.5
1.1
0.8
0.5
0.8
Energy Intensity (TBtu/S92GDP)
DRI-DRI Energy
13.5
13.2
12.8
12.1
11.5
10.7
10.2
-0.4
-0.7
-1.0
-1.1
-1.3
-1.0
AEO97 (NEMS)
13.6
13.4
13.0
12.3
11.7
11.2
n/a
-0.4
-0.6
-1.0
-1.0
-0.9
n/a
SGM
13.2
13.5
12.8
12.2
11.6
11.2
10.7
0.4
-1.0
-1.0
-1.0
-0.9
-0.9
Markal-Macro
13.6
13.5
13.0
12.4
11.7
11.2
11.0
-0.2
-0.8
-1.0
-1.1
-0.9
-0.4
Minemouth Coal Price ($95/ton)
DRI-DRI Energy
$23.92
$18.45
$15.28
$14.41
$13.76
$13.16
$12.70
-5.1
-3.7
-1.2
-0.9
-0.9
-0.7
AEO97 (NEMS)
$19.88
$18.83
$18.38
$17.47
$16.92
$15.46
n/a
-1.1
-0.5
-1.0
-0.6
-1.8
n/a
SGM
$19.88
$19.45
$18.48
$17.30
$16.47
$15.73
$14.96
-0.4
-1.0
-1.3
-1.0
-0.9
-1.0
Markal-Macro
$19.88
$18.83
$17.37
$16.39
$15.90
$16.39
$16.14
-1.1
-1.6
-1.2
-0.6
0.6
-0.3
World Oil Price (S95/Barrel)
DRI-DRI Energy
$25.23
$17.14
$16.18
$18.93
$21.24
$22.86
$23.95
-7.4
-1.1
3.2
2.3
1.5
0.9
AEO97 (NEMS)
$24.87
$17.26
$18.20
$19.72
$20.41
$20.98
n/a
-7.0
1.1
1.6
0.7
0.6
n/a
SGM
$24.87
$17.26
$18.20
$19.72
$20.41
$20.98
$21.57
-7.0
1.1
1.6
0.7
0.6
0.6
Markal-Macro
$24.87
$17.26
$18.59
$19.75
$20.29
$21.05
$22.20
-7.0
1.5
1.2
0.5
0.7
1.1
Natural Gas Price (wellhead S95/Mcf)
DRI-DRI Energy
$1.81
$1.46
$1.87
$2.15
$2.42
$2.54
$2.65
-4.2
5.1
2.8
2.4
1.0
0.9
AEO97 (NEMS)
$1.97
$1.61
$1.82
$1.94
$2.01
$2.13
n/a
-4.0
2.5
1.3
0.7
1.2
n/a
SGM
$1.97
$1.99
$2.07
$2.10
$2.16
$2.11
$1.97
0.2
0.9
0.2
0.6
-0.5
-1.4
Markal-Macro
$1.71
$1.55
$2.22
$2.28
$2.46
$2.77
$2.97
-1.9
7.4
0.5
1.6
2.4
1.4
Gasoline Prices ($95/Gal) 5
DRI-DRI Energy
$1.40
$1.21
$1.20
$1.26
$1.31
$1.37
$1.40
-2.9
-0.1
1.0
0.8
0.8
0.4
AEO97 (NEMS)
$1.34
$1.15
$1.19
$1.21
$1.22
$1.17
n/a
-3.1
0.8
0.3
0.1
-0.7
n/a
SGM
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
Markal-Macro
$1.34
$1.15
$1.34
$1.39
$1.40
$1.41
$1.44
-3.0
3.1
0.7
0.1
0.1
0.4
Carbon Emissions (MMTC) - Total
DRI-DRI Energy
1338
1413
1516
1612
1693
1767
1805
1.1
1.4
1.2
1.0
0.9
0.4
AEO97 (NEMS)
1339
1424
1543
1639
1722
1799
n/a
1.2
1.6
12
1.0
09
n/a
SGM
1350
1480
1550
1637
1729
1808
1871
1.9
0.9
1.1
11
0.9
0.7
Markal-Macro
1338
1459
1574
1674
1741
1806
1914
17
1.5
1.2
08
0.7
1.2
I Growth rates are calculated from non-rounded levels. 2 AEO97 projections extend only to 2015. ; Office of Management and Budget fiscal
year 1998 assumptions. 4 SGM projections do not include geothermal. wind. biomass waste. and other municipal waste. 5 The SGM model
does not include gasoline.
5
DRAFT -May 30, 1997
Table 2: IAT International Baseline
Average Annual Growth Rates (percent)
Real Economic Growth
Energy Growth
Emissions Growth
(GDP)
(Quads)
(MMTC)
1990-00
2000-10
2010-20
1990-00
2000-10
2010-20
1990-00
2000-10
2010-20
Australia
2.8
2.8
2.6
2.1
1.5
0.9
2.0
rs
0.9
Canada
2.6
2.5
1.2
1.7
1.0
0.4
2.2
14
0.7
China
8.4
7.5
5.8
3.9
2.8
2.1
3.8
2.8
2.2
Former Soviet Union
-3.5
4.6
4.2
-3.5
1.8
1.2
4:0
1.8
1.2
Eastern Europe
-4.5
4.2
4.3
-3.0
13
1.2
3.5
1.3
1.2
India
4.1
4.5
3.9
3.9
3.1
2.1
3.3
Japan
2.1
1.7
0.9
2.2
$0.9
0.1
2.1
.09
0.1
Korea
5.0
5.9
4.4
4.0
2.6
2.9
Mexico
4.0
4.0
3.2
4.2
2.3
4.2
29
2.4
Western Europe
2.3
2.5
2.4
1.5
14
0.6
1.2
1.4
0.6
United States
2.1
2.2
1.4
1.7
Id
0.6
1.4
1.1
0.8
Rest-Of-World
3.6
3.4
3.0
3.0
#20
2.0
3.0
2.2
2.2
The Analytical "Starting Point"
The IAT began its analysis of emissions reductions policies by examining one core emissions
reduction scenario. Then we explored the economic effect of changes to this scenario. The
central policy modeled -- the "starting point" scenario -- is aimed at reducing carbon and other
greenhouse gas emissions by stabilizing them at 1990 levels. The "starting point" scenario
pursues those reductions by issuing tradable emission permits at the earliest point of energy
production or when imported into the United States. The policy is announced in 2000 and its
restrictions are phased-in over a ten year period, so that the policy takes full effect in 2010. The
permits are initially auctioned so that all revenues generated through permits would be recycled
through the economy through deficit reduction. The initial discussion of the "starting point"
scenario assumes no international cooperation. An option incorporating international trading is
discussed once the dynamics of the no trading "starting point" scenario have been established.
Estimates of reductions of non-carbon emissions, such as methane and forest carbon sinks, are
obtained from engineering estimates outside the models. Early in the process, the IAT estimated
a strike-price for these sources of $70 per ton (which turned out to be low). Appendix Table A
shows baselines for, and the quantities of emissions obtained from, these non-carbon sources at
this price. These carbon tons were subtracted from the emissions targets being modeled. But the
cost of obtaining them was not factored back into the models and, is therefore missing. While
the engineering estimates are uncertain. the cost of abating non-carbon sources could increase the
estimates of economic effects by as much as 14 percent.
The "starting point" scenario was employed as an analytical starting point for this analysis
primarily because it has already been the subject of much attention within the analytical
literature. Most analysts of climate change policies have used an emissions freeze in the year
6
DRAFT --May 30, 1997
2010 at 1990 levels as their framework. The IAT, therefore, used this scenario in order to
facilitate comparisons of its work to that of other researchers.
Industry and regional effects, as presented here, show only the effects of the climate change
policy on the industry's output (shipments plus inventory change). We considered this our first
step in understanding the likely sectoral consequences of emissions reductions.
The "starting point" scenario incorporates a slight improvement in energy intensity (E/GDP) over
the EIA/AEO baseline, which declines by 1.0 percent per year. This improvement could come
about because the climate change policy undertaken generates foreseeable increases in the future
price of energy, or because of the implementation of the Climate Change Action Plan (CCAP), or
other policies. The prospective "announcement effect," therefore, is what allows the model to
distinguish between a change in future policy regarding carbon emissions and an exogenous
shock, such as the two oil price increases in the 1970s. This leads to somewhat faster rate of
diffusion of energy efficient technologies and a higher rate of innovation through R&D in
anticipation of future higher energy prices. The IAT assumes an improvement in energy-
intensity of 0.25 percent so that the total annual change in the ratio of energy to GDP is 1.25
percent per year. A faster technology alternative is also investigated. (More detail on energy-
efficient technology improvement is provided later in this paper.)
Unless otherwise stated, the tables and figures that follow were derived using the
DRI model and using the "starting point" scenario, which does not incorporate
international emissions trading. These estimates, therefore, will be at the high end
of the likely range, due to both model structure and the absence of trading.
"Starting Point" Results
Estimates of permit prices are around $100 per ton of carbon in 2010 and rising slightly
thereafter, and are consistent across models. While the three models used for this analysis vary
in structure and often in terms of macroeconomic outcomes, they generate fairly consistent
results as to the implicit price of carbon in the economy. Table 3 presents the results obtained
by the three models for the value of a permit to emit a ton of carbon. Figure 1 shows the path for
the value of carbon in these models. All of these estimates pertain to the "starting point" option
in which emissions are frozen at their 1990 level in 2010 and thereafter.
7
DRAFT --May 30, 1997
Table 3: The Implicit Price of Carbon (1995$) in 2010 and 2020
1990 Level Case, No International Trading
2010
2020
DRI-DRI Energy
95
125
SGM
81
106
Markal-Macro
145
130
NEMS
n/a
n/a
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP. SGM permit prices are calculated using the rate of change in carbon to GDP (C/GDP). which incorporate
emission rates by the different fuel types. NEMS estimates are forthcoming.
Figure 1: Price Path of the Implicit Price of Carbon (1995$)
1990 Level Case, No International Trading
250
225
200
175
150
Implict Price of Carbon (1995
125
100
75
50
25
0
2000
2005
2010
2015
2020
DRI (1990 Level Case)
SGM (1990 Level Case)
Markal-Macro (1990 Level Case)
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP. SGM permit prices are calculated using the rate of change in C/GDP. SGM and Markal-Macro models use
data and generate results in five year intervals.
The DRI model concludes that an implicit price of $95 (1995$) per ton of carbon in 2010 would
result in stabilization. The Markal-Macro model estimated $145 (1995$) while the SGM model
predicted about $81 (1995$). in 2010.² A permit price of $100 per ton is the equivalent of a price
increase of 26 cents per gallon of refined petroleum product, $1.49 per thousand cubic feet of
natural gas. $52.52 per ton of coal, and 2 cents per kilowatt hour of electricity produced.
manning
$100
Right
increase
2 The higher permit price from the Markal-Macro model reflects. in part. differences in model structure.
but results mostly from differences in the calibrations of baseline emissions.
in
prices
bazu?
carl
8
DRAFT --May 30, 1997
The models also agree that this implicit price of carbon grows somewhat over time. This reflects
the fact that the 1990 emission ceiling becomes a progressively more binding constraint over
time, given projected growth in base case emissions. By the year 2020, the implicit price of
carbon rises to $125, $106 and $130 per ton (1995$) in the DRI, SGM, and Markal-Macro
models, respectively.
Emissions reductions lead to small reductions in short-term economic growth (GDP). but growth
later appears to recover. The burden of reducing carbon and other greenhouse gas emissions
leads to short-term reductions in economic growth as measured by GDP: These reductions,
however, are not large and, in many instances, are recovered in later years.
Results from the DRI model are presented in Figure 2. The results indicate that there is an initial
GDP loss as the emission-limiting policy begins to be phased in These losses cumulate to a
peak loss of about one percent of total economic output in the year 2005 -- that is, the economy's
growth slows until the size of the economy is, at worst, about one percent smaller in that year
when compared to the base case. After 2005, the economy actually grows faster than it would
have absent climate change policy and starts to make up the lost ground. By the year 2013, the
economy is back to the point at which it would have been had no policy been enacted. In
subsequent years, the economy improves slightly compared to the "no policy" base case--this
differential reaches 0.3 percent by 2020, the last year of the model run.
Figure 2: DRI-DRI Energy 1990 Level Case,
No International Trading-Gross Domestic Product
0 40%
0.20%
0.00%
GDP (percent change from the base case)
-0.20%
0
-0 40%
-0 60%
-0 80%
-1 00%
-1.20%
2000
2005
2010
2015
2020
Note. Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP
9
DRAFT --May 30, 1997
This improvement occurs in the DRI model because the emissions reduction policies modeled
have some effects that favor savings and investment at the expense of consumption. If the
Federal government auctions off emissions permits, it acquires the wherewithal to reduce the
deficit (or retire debt) and, in effect, increase the nation's savings. This allows the cost of capital
to fall and favors investment. The marginal profitability of investment also rises under these
policies because new investment allows firms to neutralize higher energy costs. In effect, capital
is a long-term substitute for energy and is favored after a transition period. Thus, the cost of
investment falls and the incentive to invest is strengthened. This faster rate of investment
(discussed in greater detail below) gives the economy a newer and larger capital stock: as a result
the economy's ability to grow improves until it actually reaches a modestly higher growth path in
the years following the transition.
Figure 3 shows comparable results for the SGM and Markal Macro models. In contrast to the
DRI model, which focuses on short-term transition issues and may, therefore, tend to produce
larger estimates of GDP losses, the SGM and Markal-Macro models move quickly through these
issues and focus on longer-term prospects. The SGM model estimates peak losses for the
economy of 0.17 percent of GDP in 2015, but the economy then stabilizes through 2020.
Figure 3: SGM and Markal-Macro 1990 Level Case
No International Trading, Gross Domestic Product
0.40%
0.20%
0.00%
GOP (percent change from base case)
-0.20%
-0.40%
-0 50%
-080%
-100%
-1.20%
2000
2005
2010
2015
2020
SGM
Markal-Macro
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in C/GDP.
The Markal-Macro simulation results show a reduction in GDP of 0.60 percent from baseline in
2010 in the stabilization case. GDP remains below baseline levels throughout the forecast
horizon. The GDP impact profile reflects the model structure. which represents the base case
solution as a set of optimal energy use and technology choices given fuel prices. technology
10
DRAFT --May 30, 1997
characteristics, and discount rates. Since a carbon constraint limits the use of fuels and
technologies that would otherwise be chosen, projected GDP must fall. Moreover, since the
balance between investment and consumption is optimized within each case considered,
economic welfare cannot be increased by an investment-oriented revenue recycling scheme.
Consequently, although investment will adjust, the maximization of economic welfare under a
carbon constraint does not lead to higher GDP in the future years in the Markal-Macro model.
The models used by the IAT offer a similar picture in some regards-all show initial losses in
aggregate economic output that are not very large (even the DRI peak loss is spread over five
years). But they also differ in predictable ways, given their structure. A recent analysis by Dr.
Robert Repetto and Dr. Dunkin Austin of the World Resources Institute examined 162 analyses
of climate change policy and found that model structure can account for two-thirds of the
difference in results, if environmental benefits are ignored.
Disequilibrium macro models, such as DRI, tend to identify deeper transitional losses and steeper
transitional rebounds. Computable general equilibrium models, such as SGM, see more sanguine
short-term effects and see the economy stabilizing after a more frictionless adjustment. The
SGM model, however, is less flexible than some computable general equilibrium model because
it does not allow instantaneous shifts in capital The SGM model maintains vintaged capital
stock in the electricity sector and retires old electricity related capital only when it cannot cover
operating expenses or reaches its fixed lifetime. This feature allows the analysis to incorporate
the costs of reallocating capital stock.
Which, then, is right? DRI's transitional losses may be overstated, but so would be the rebound
and the shift to a higher growth path it estimates for later years. SGM and Markal-Macro
probably understate the transitional problem, but also avoid the later-year growth surge that DRI
sees as driven by higher levels of investment. The models probably serve as brackets for the
range of reasonable estimates of the economic effects of an emissions freeze at 1990 levels in
2010 and thereafter.
Unemployment and Inflation. The effect of the emissions stabilization policy results in
approximately a 0.2 percentage point increase in the unemployment rate from 2001 through
2011, with a peak increase of about 0.4 percentage points in 2015, as estimated using the DRI
model. The unemployment rate first rises as GDP falls, but then returns to its pre-policy level by
2012, as shown in Figure 4. The inflation rate increases by about 0.3 percentage points until
2009, measured by the annual rate of change in the Consumer Price Index (CPI). The annual rate
of change in the CPI declines by about 0.1 to 0.2 percentage points per year for 2010 through
2020, as shown in Figure 5.
;
Reperto. Robert and Dunkin Austin. "The Cost of Controlling CO2 Emissions: A Guide for the
Perplexed." 11 orld Resources Institute (Forthcoming).
DRAFT -May 30, 1997
Figure 4: DRI-DRI Energy 1990 Level Case, No International
Trading-Unemployment Rate
1
0.8
Unemployment Rate (change from the base case)
0.6
0.4
0.2
0
-0.2
2000
2005
2010
2016
2020
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP.
Figure 5: DRI-DRI Energy 1990 Level Case, No International
Trading-Inflation Rate
0.4
0.3
02
Inflation Rate (change from the base case)
01
0
9
-01
-0.2
-03
2000
2005
2010
2015
2020
Note. Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP
12
DRAFT --May 30, 1997
Investment policies are key to getting the economy back on track. In the baseline forecast, slow
labor force growth of 0.8% per year leads to slow potential GDP growth, which results in slow
capital stock turnover. The slower rate at which the capital stock is renewed is of direct
consequence to mitigating carbon and other related emissions, since improvements in energy-
efficiency or carbon-abating technologies generally must be embodied in the capital stock in
order to be effective. Thus, any global climate change policy, to be effective, must focus on
investment at the expense of consumption. The deficit reduction policy option, one of the
several revenue recycling options examined, promotes savings, which boosts this investment.
The DRI model suggests that investment under a climate, change policy scenario begins to exceed
investment in the baseline by 2006, as seen in Figure 6. By the time the policy is fully
implemented in 2010, investment exceeds the baseline by about $50 billion (1992$), with this
difference rising to about $100 billion in 2020. Personal Consumption Expenditures (PCE), on
the other hand, remain below the baseline level throughout the forecast period, so that PCE drops
by about $80 billion in 2008, as seen in Figure 7. After the trough in 2008, PCE gradually
moves toward baseline by 2020.
Figure 6: DRI-DRI Energy 1990 Level Case, No International
Trading-Investment
6.00%
5.00%
4.00%
Investment (percent change from the base case)
100%
2.00%
1.00%
0.00%
-1.00%
-2.00%
2000
2005
2010
2015
2020
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP.
The faster rate of investment drives the rebounding of real economic growth in the later years of
the model simulation. But it should be noted that consumption does not rebound in the same
manner. although it does recover from its peak losses. as seen in Figure 7. But consumption can
be taken as the measure of economic activity that is closer to consumer "welfare" than total GDP.
13
DRAFT -May 30, 1997
which includes investment, because consumption includes all activities that are of direct
consequence to households. Thus, while increases in investment drive the economy's growth
path back to and perhaps even above its original trend, it does so by diverting resources away
from uses that allow consumers to enjoy them directly in the short term.
Figure 7: DRI-DRI Energy 1990 Level Case, No International
Trading-Consumption
0.50%
0.30%
0.10%
-0.10%
Consumption (percent change from the base case
-0.30%
-0.50%
-0.70%
-0.90%
-1.10%
-1.30%
-1.50%
2000
2005
2010
2015
2020
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP.
The paths of consumption and investment following the imposition of a climate change policy
depend critically on assumptions regarding the manner in which revenue flows related to the
allocation of emissions permits are managed and the conduct of monetary policy by the Federal
Reserve. These sensitivities are discussed in a later section.
Among fuels. demand for coal bears the brunt of greenhouse gas stabilization The reduction in
energy-related greenhouse emissions in the 2010 time frame will require a combination of three
types of energy system changes: increased end-use efficiency, reduced end-use activity, or fuel-
switching towards an increased market share of low- and no-carbon fuels in the energy mix.
Increased end-use efficiency or reduced end-use activity tends to lower the demand for all fuels.
while fuel-switching favors low- and no-carbon fuels, such as natural gas and renewable energy,
relative to coal. The three models used by the IAT place different emphasis on these three
strategies. with corresponding differences in projected fossil fuel impacts.
Table 4 presents the effects of carbon-limiting policies on the economy's energy consumption
and fuel mix. Using the DRI model, total energy consumption falls from 105 quadrillion Btus
(quads) in the base case in 2010 to a level of 88 quads under the policy, a reduction of 16 percent
14
DRAFT --May 30, 1997
in that year. By 2020, energy consumption in the economy has declined by 20 percent, from 109
quads to 87 quads, when compared to the base case for that year. The table shows comparable
results using the Markal-Macro model, when the 1990-level emissions freeze produces a decline
in projected energy consumption of 14 percent in 2010 and 16 percent in 2020. SGM model
results are similar to both the DRI and Markal-Macro results; energy consumption drops by 15
percent in 2010, and 20 percent in 2020.
Table 4: Effects of Carbon Stabilization on
Energy Consumption and Fuel Mix (quadrillion Btus)
1990
2010
2020
Actual
Base case
1990 Level
Base case
1990 Level Case,
Gase, No
No International
International
Trading
Trading
DRI-DRI Energy
Total U.S. Energy Consumption
84.3
105.3
882
108.9
86.7
Natural Gas
19.3
27.4
29.8
24.9
Oil
33.6
41.1
35.6
44.1
37.4
Coal
19.0
24.3
17.2
25.8
15.2
SGM
Total U.S. Energy Consumption
84.3
107.0
91.4
113.0
90.0
Natural Gas
19.3
33.2
33.1
37.7
36.7
Oil
33.6
36.5
33.1
39.0
34.0
Coal
19.0
23.9
113
25.8
8.5
Markal-Macro1
Total U.S. Energy Consumption
84.3
107.8
92.6
115.6
96.7
Natural Gas
19.3
29.0
30.7
35.1
36.7
Oil
33.6
43.4
37.9
45.0
40.1
Coal
19.0
22.5
9.4
24.6
4.7
NEMS
Total U.S. Energy Consumption
n/a
n/a
n/a
n/a
n/a
Natural Gas
n/a
n/a
n/a
n/a
n/a
Oil
n/a
n/a
n/a
n/a
n/a
Coal
n/a
n/a
n/a
n/a
n/a
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP. SGM uses a similar rate of change in C/GDP. 1. Under the Markal-Macro results. the increase in the use of
renewable energy sources. such as wind, account for the difference the total U.S. energy consumption and the sum of the component fuels.
NEMS estimates are forthcoming.
DRI, Markal-Macro, and SGM demonstrate that dampened energy consumption and reduced
carbon emissions are concentrated in coal use. As seen in Table 5, DRI results show that about
57 percent of the total emissions reductions in 2010 result from reduced demand for coal, 30
percent from oil, and 13 percent from natural gas. By 2020, 65 percent of emission reductions
are generated from reductions in demand for coal. This translates to a 25 percent total emission
reduction for coal in 2010 and a 36 percent reduction in 2020. Markal-Macro produces
somewhat similar results: it shows that about 57 percent of total emissions reductions in 2010
occur due to reduced coal use: and 16 percent due to reduced oil use: while natural gas
consumption is 5 percent above the base case. By 2020. coal accounts for about 80 percent of
15
DRAFT -May 30, 1997
emissions reductions. The SGM model results are also similar; i.e., coal is responsible for 80
percent of emissions reductions in 2010 and 2020.
The different spread of percent of total emissions reductions by fuel occurs because renewable
energy sources and increases in the consumption of natural gas play important roles in the
Markal-Macro and SGM models. It is also true because DRI's model sees strong transportation
demands and more limited technological prospects for serving it, while transportation choices do
not take into account price expectations. This is in contrast to DRI's treatment of the utility
sector, which is relatively forward looking when examining fuel choices.
Table 5: 1990 Level Case, No International Trading--
Percent of Total Emissions Reduction by Fuel
2010
2020
DRI-DRI Energy
Natural Gas
13
8
Oil
30
28
Coal
57
65
SGM
Natural Gas
0
3
Oil
18
18
Coal
82
79
Markal-Macro
Natural Gas
-5
T
Oil
16
15
Coal
57
80
NEMS
Natural Gas
n/a
n/a
Oil
n/a
n/a
Coal
n/a
n/a
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP. NEMS estimates are forthcoming.
On the demand side, according to DRI, about 46 percent of total emission reductions in 2010
come from the electric sector due to fuel switching and decreases in demand for electricity, 26
percent come from reduced demand for transportation and 19 percent come from reduced
demand by the industrial sector, as shown in Table 6. The commercial and residential sectors
contribute a combined 8 percent to the total of emissions reductions. The corresponding
estimates obtained from the Markal-Macro model show that electricity uses account for 40
percent of total reduction in emissions, and transportation, industrial, and residential and
commercial uses for 16 percent, 17 percent, and 15 percent. respectively.
16
DRAFT --May 30, 1997
Table 6: 1990 Level Case, No International Trading
Percent of Total Emissions Reduction by Demand Sector
2010
2020
DRI-DRI Energy
Residential
5
4
Commercial
3
2
Industrial
19
21
Transportation
27
25
Electricity
46
47
SGM
Residential
n/a
Commercial
n/a
Industrial
n/a
Transportation
n/a
n/a
Electricity
n/a
n/a
Markal-Macro
Residential and Commercial
15
15
Industrial
17
22
Transportation
16
17
Electricity
40
53
NEMS
Residential
n/a
n/a
Commercial
n/a
n/a
Industrial
n/a
n/a
Transportation
n/a
n/a
Electricity
n/a
n/a
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase- Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP. SGM uses a similar rate of change in C/GDP. SGM does not generate data by demand sector. NEMS
estimates are forthcoming.
Thus, across models and when viewed from different perspectives, the majority of reductions in
emissions obtained under the broadest strategies comes from reducing utility consumption of
coal. Reducing coal use under utility boilers is generally the largest, cheapest option to reduce
carbon emissions in the economy. This is accomplished through better operating rates and
through the substitution of gas-fired combined-cycle units for coal-fired units. The implicit price
of carbon obtained in most model runs is usually the one that accomplishes this transition in
electricity baseload. The range of carbon values -- generally about $100 per ton in the no trading
cases -- is as high as it is because most coal-fired units are fairly old and already fully amortized.
Thus, their product costs mainly consist of fuel and operating and maintenance expenses but not
capital costs. The price of coal, therefore, must rise considerably to make coal-fired electricity
more expensive on the margin than electricity generated by a new gas-fired plant that entails new
capital costs.
International trading of carbon permits among the Annex I countries leads to sizable reductions
in costs needed to stabilize emissions. The discussion so far has centered on the how the U.S.
economy reacts when the United States independently reduces emissions. However. establishing
an international market to trade emissions permits is a preferred to unilateral action that has been
DRAFT --May 30, 1997
proposed by the United States for inclusion in a multinational agreement. The purpose of such a
market would be to increase the efficiency and lower the cost of reducing global emissions by
giving all emitters the incentive to search for least-cost solutions across national boundaries.
In brief, under a system of tradable permits, a country could either reduce emissions domestically
or purchase additional emissions "rights" (i.e., permits) from other countries. Countries with
opportunities to reduce emissions that cost less than the going permit price would have an
incentive to reduce emissions and sell their "right to emit" for cash. Countries that had only high
cost options to reduce emissions (that is, reduction options that cost more than the permit prices)
could purchase emission permits. The forces of supply and demand would set the permit price
and the market incentives would push the trading group, as a whole, to institute the least cost
emissions reductions first. As a result, it costs less for the trading group, as a whole, to reach the
target emissions-levels, than it would for each country unilaterally to reduce its emissions to the
target levels. Such a policy, of course, raises a variety of legal.and institutional questions
regarding how it would be implemented with certainty. These issues are not addressed here:
instead, the simple assumption is made that the policy works as intended and least-cost
approaches to abating carbon are identified and traded.
Using the SGM model, the IAT modeled two international trading scenarios. In the first, it
examined the affects of establishing a permit market among the United States, Canada, Western
Europe, Eastern Europe, Japan, the Former Soviet Union (FSU), and Australia (collectively
known as Annex I countries under the Climate Convention). In the second scenario, it examined
the effects of Joint Implementation, that is, establishing a wider permit market that includes the
rest of the world. These scenarios are compared to a scenario in which each of the Annex I
countries independently implemented our "starting point" scenario for stabilizing carbon
emissions; that is, stabilizing emissions at 1990 levels in 2010 with a ten year phase in, where
revenues are used to reduce the deficit, and under the assumption of moderate technological
change (i,e., a 0.25 percent increase over the baseline in the annual increase in energy or carbon
efficiency).
International emissions trading calls into question one of the basic assumptions regarding
international compliance when performing the estimates. This concerns the case of the FSU.
The "starting point" case assumes that all countries are restricted to their 1990 emissions level
before they trade. The FSU nations, however, will have emissions below their 1990 levels for
years to come. Thus, under this rule, they would be able to sell to other nations their "right to
emit" up to their 1990 levels, but would not have to perform any actual emissions reductions.
Thus, emissions trades would not result in "corresponding reductions" in annual emissions.
The IAT performed its analysis both with and without "corresponding reductions." The case
without "corresponding reductions" allows the FSU to sell emissions rights up to its 1990 base.
The case with "corresponding reductions" does not allow these trades. Instead the IAT specified
that if a nation's emissions were below their 1990 level in the base case, its baseline for the
purposes of trading was shifted down from the 1990 level to whatever the nation's actual
emissions would be. For example, the FSU had carbon emissions of 1050 million metric tons
(MMT) in 1990, and is projected to have emissions of 836 MMT in 2010. Their baseline in
18
DRAFT --May 30, 1997
2010, therefore, is 836 MMT, even though it is lower than the 1990 level. Thus, any tons "sold"
from the FSU in these simulations represent actual emissions reductions. The results obtained
using the SGM model appear in Tables 7a and 7b.
Under the Annex I trading scenario, the United States, Canada, Western Europe, Japan, and
Australia each bear real costs for emissions reduction. The losses experienced by the different
nations reflect the economic assumptions made for them (which are presented earlier in this
report, in Table 2) and their energy policies to date. Japan, for example, is projected to have
relatively slow economic growth and already has relatively high energy prices and an extensive
nuclear program. Thus, it is not projected to have strong growth in emissions over the next few
decades. Japan has a high implicit price of carbon ($268 per ton) as shown in Table 8. Western
Europe fares somewhat worse than the United States, since its economic growth is projected to
be stronger, and its energy policies have already been raised.
Table 7a: SGM 1990 Level Case-GDP Impacts to Annex I Countries
No Trading vs. Annex I Trading,
No Trading
Annex I Trading
(With Corresponding Reductions)
2000
2005
2010
2015
2020
2000
2005
2010
2015
2020
Australia
0.0%
-0.2%
-0.5%
-0.4%
-0.2%
0.0%
-0.1%
-0.3%
-0.2%
-0.1%
Canada
0.0%
-0.4%
-1.1%
-1.1%
-1:1%
0.0%
-0.1%
-0.4%
-0.3%
-0.2%
Eastern Europe
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.3%
0.3%
0.3%
Former Soviet Union
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.1%
0.5%
0.6%
0.5%
Japan
0.0%
-0.2%
-0.6%
-0.4%
-0.3%
0.0%
-0.1%
-0.2%
-0.1%
-0.1%
Western Europe
0.0%
-0.2%
-0.7%
-0.4%
-0.2%
0.0%
-0.1%
-0.3%
-0.2%
-0.1%
United States
0.0%
-0.1%
-0.2%
-0.2%
-0.2%
0.0%
-0.1%
-0.1%
-0.1%
-0.1%
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in C/GDP.
Table 7b: SGM 1990 Level Case-GDP Impacts to Annex I Countries
No Trading vs. Annex I Trading
No Trading
Annex I Trading
(With out Corresponding Reductions)
2000
2005
2010
2015
2020
2000
2005
2010
2015
2020
Australia
0.0%
-0.2%
-0.5%
-0.4%
-0.2%
0.0%
0.0%
-0.1%
-0.2%
-0.1%
Canada
0.0%
-0.4%
-1.1%
-1.1%
-1.1%
0.0%
0.0%
-0.2%
-0.2%
-0.2%
Eastern Europe
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.7%
0.7%
0.5%
Former Soviet Union
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.4%
0.5%
0.5%
Japan
0.0%
-0.2%
-0.6%
-0.4%
-0.3%
0.0%
0.0%
-0.1%
-0.1%
-0.1%
Western Europe
0.0%
-0.2%
-0.7%
-0.4%
-0.2%
0.0%
0.0%
-0.2%
-0.2%
-0.1%
United States
0.0%
-0.1%
-0.2%
-0.2%
-0.2%
0.0%
0.0%
-0.1%
-0.1%
-0.1%
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in C/GDP.
GDP losses in Canada are the most severe among the Annex I countries. Canada is already less
carbon intensive, but not as energy efficient as other Annex I countries. For example. Canada's
carbon to population ratio is about 17 percent below that of the United States. while its energy to
GDP ratio is about 46 percent higher. Canada also relies more heavily on non-carbon sources of
19
DRAFT --May 30, 1997
energy, such as hydroelectrical generation, making emissions reductions more difficult to come
by.
Table 8 shows the implicit price of carbon by country without trading, trading with Annex I
countries, and with Joint Implementation with the developing countries. The United States
shows smaller output losses than Japan or Western Europe predominantly because it has more
"cheap" carbon-abating opportunities. Thus, it is somewhat easier for the United States to reach
emission targets than other regions, which have already "picked the low fruit."
Table 8: Implicit Price of Carbon (1995$) Under Annex I Trading and Joint
Implementation-SGM 1990 Level Case
2010
2020
No
Annex I Trading
Joint
No
Annex 1 Trading
Joint
Trading
Implementation
Trading
Implementation
with
without
with
without
with
without
with
without
CR
CR
CR
CR
CR
CR
CR
CR
Australia
132
56
23
20
9
126
150
35
16
12
Canada
222
56
23
20
9
252
50
35
16
12
China
n/a
n/a
20
n/a
n/a
16
12
Former Soviet
0
56
23
20
9
0
50
35
16
12
Union
Eastern Europe
0
56
23
20
9
50
35
16
12
India
n/a
n/a
20
49
n/a
n/a
16
12
Japan
268
56
23
20
9
257
50
35
16
12
Korea
n/a
n/a
20
9
n/a
n/a
16
12
Mexico
n/a
n/a
20
9
n/a
n/a
16
12
Western Europe
130
56
23
20
9
139
50
35
16
12
United States
82
56
23
20
9
107
50
35
16
12
Rest of World
n/a
n/a
20
9
n/a
n/a
16
12
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in C/GDP. indicates the cell is blank because the country is a non-Annex I country. CR=corresponding reductions.
Under Annex I trading with "corresponding reductions," the implicit price of carbon falls
dramatically--to $56 in 2010 and $50 in 2020. All countries gain through these lower permit
prices, because as a whole they achieve stabilization at 1990 levels more cheaply. The source of
these cheap emissions is the FSU and the Eastern European nations. The implicit price of carbon
falls because it is cheaper for all of the industrialized nations to pay for carbon abatements in
those nations (due to lax environmental standards and slow economic growth) than to pursue
domestic options only. These nations gain as they become emissions permit sellers under Annex
I trading. If "corresponding reductions" are not required, the FSU would be allowed to sell
permits up to its 1990 level further depressing the price to $23 per ton in 2010 and $35 in 2020.
Under Annex I trading with "corresponding reductions." the United States purchases 72 million
metric tons of permits from the FSU and Eastern Europe in 2010 at a cost of $4 billion ($95),
which offsets $5 billion of abatement expenditures within the United States. U.S. purchases of
permits abroad increases to 157 million metric tons of permits in 2020 at a cost of $7.8 billion.
which offsets $12.2 billion of cost increases that would have occurred domestically if the U.S.
did not participate in international trading.
20
DRAFT --May 30, 1997
Joint Implementation with developing countries reduce the costs of permit prices even further.
Joint implementation -- emissions trading on a global scale -- reduces the permit price further, to
$20 in 2010 and $16 in 2020 (with corresponding reductions). If corresponding reductions are
not required the implicit price of carbon falls to $9 in 2010 and $12 in 2020. Under this broader
market for tradeable emissions permits the FSU and Eastern Europe lose their monopoly on
permit sales. Specifically, Joint Implementation encourages China and India to reduce their use
of coal and enter the market as emissions permit sellers. As shown in Figure 8, imports of
carbon permits are greater under Joint Implementation than under Annex] trading.
Figure 8: U.S. Imports of Carbon Permits Under Alternate Mitigation
Targets-Annex I Trading and Joint Implementation
70%
60%
50%
Percent of Required Reductions
40%
30%
20%
10%
0%
-10%
2000
2005
2010
2015
2020
2025
2030
Annex I Trading-1990 Level Case
Annex I Trading-90% of 1990 Levels
Annex I Trading-110% of 1990 Levels
Joint Implementation- 1990 Level Case
Joint Implementation-90% of 1990 Level Case
Joint implementation-110% of 1990 Level Case
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in C/GDP.
Using the SGM implicit carbon prices from Annex I trading to simulate macroeconomic
conditions for the DRI Model moderates the short-term economic effects of emissions reductions.
The IAT incorporate Annex I implied permit prices estimated by the SGM model under permit
trading, with corresponding reductions into the DRI model. For in 2010 SGM's Annex I trading
implicit price of carbon estimate ($56) was incorporated into the DRI model.
The results from the DRI model using the SGM permit trading implied permit prices are
represented in Figures 9, 10, and 11. As shown in Figure 9, the maximum effect on GDP is less
than half, 0.5 percent less than the baseline in 2006 compared with about one percent in 2005.
The lower permit prices also has a somewhat dampening effect on the increase in investment
under the no trading case, but shows a much improved effect on the impact on consumption. a
-0.7 percent change in 2010 compared with a - 1.4 percent change in 2008. and reaches the
baseline consumption estimates in 2018.
21
DRAFT --May 30, 1997
Figure 9: DRI-DRI Energy 1990 Level Case with and without Annex I
Trading-GDP
0.60%
0.40%
0.20%
0.00%
GDP (percent change from base case)
-0.20%
-0.40%
-0.60%
-0.80%
-1.00%
-1.20%
2000
2005
2010
2015
2020
DRI 1990 Level Case. No International Trading
DRI 1990 Level Case. with carbon prices from the SGM Annex 1 trading case
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP.
Figure 10: DRI-DRI Energy 1990 Level Case with and without
Annex I Trading-Investment
6.00%
5.00%
4.00%
Investment (percent change from base case)
100%
2.00%
1.00%
0.00%
-100%
-2.00%
2000
2005
2010
2015
2020
DRI 1990 Level Case No International Trading
DRI 1990 Level Case with carbon prices from the SGM Annex I trading case
lote: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25 I
percent annual decrease in E/GDP.
22
DRAFT --May 30, 1997
Figure 11: DRI-DRI Energy 1990 Level Case with and without
Annex I Trading-Consumption
0.20%
0.00%
-0.20%
-0.40%
Consumption (percent change from base case)
-0.60%
-0.80%
-1.00%
-1.20%
-1.40%
-1.60%
2000
2005
2010
2018
2020
ORI 1990 Level Case. No International Trading
DRI 1990 Level Case. with carbon prices from the SGM Annex I trading case
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for Federal deficit reduction and assuming a 1.25
percent annual decrease in E/GDP.
Important Sensitivities
The following represents a number of variations from the "starting point" scenario that the IAT
analysts examined to address a number of factors that will influence the climate change policy
process. These include the effects of: (1) timing, including different transition periods to full
implementation and delaying implementation; (2) lower or higher emission level targets; (3)
different revenue recycling options, including comparing the deficit reduction case with
scenarios where revenues are distributed to consumers, distributed to business, and a
combination of both consumers and business; (4) policy announcement on the rate if
technological innovation and diffusion as well as the steps needed to achieve a higher level of
innovation and diffusion; (5) other collateral environmental benefits; and (6) international trade;
and (7) Federal Reserve reaction assumptions in the DRI model.
Increasing the implementation period from 5 to 10 years dampens the negative effects on GDP
Delaying implementation until 2015 does little to improve GDP effects. The IAT examined
differing effects on GDP of a 5-year and a 10-year implementation period for the "starting point"
scenario with the NEMS model. These results are shown in Figure 12. A 5-year ramp-up
between 2005 and 2010 results in a maximum output loss in 2010 that is 65 percent greater than
that associated with a ten year ramp-up and a return to the baseline two years later. Thus. shorter
transition periods result in a more pronounced economic cycle in response to policy--a sharper
downturn and deferred recovery.
23
DRAFT --May 30, 1997
Figure 12: NEMS 1990 Level Case, No International Trading--
Sensitivity to the Length of the Implementation Period and to
Implementation Timing
1.50%
1.00%
0.50%
0.00%
GDP (percent change from the base case)
-0.50%
-1.00%
-1.50%
-2.00%
-2.50%
-3.00%
2000
2005
2015
2020
5-year Ramp
10-year Ramp
Delay to 2015
Note: These simulations were conducted using DRI and the NEMS Energy Model and they do not conform in detail to those conducted using
DRI and the DRI Energy Model. 5-Year and 10-Year Ramp to 1990 Levels in 2010; 1990 Levels in 2015 using a 5-Year ramp-up. Revenues
are used for Federal deficit reduction, assuming 1.25 percent annual decrease in E/GDP.
Figure 12 also shows the result of delaying the implementation by 5 years, to 2015 combined
with the shorter 5-year ramp-up period. GDP effects for the delayed case are less severe in the
initial period, but become greater than either the 5-year or 10-year ramp-up to stabilization in
2010.
Raising or lowering emission targets lead to obvious results--more stringent emission targets
lead 10 greater economic losses while less stringent ones have less severe impacts The three
models were used to analyze how changes in the level of emissions affect the implicit price of
carbon. If the emission target for the year 2010 and beyond is raised (made less severe) to a level
equal to 110 percent of the 1990 emissions level (that is, to a target of 1,472 million tons as
opposed to 1,338 million tons), then the DRI model estimated that the implicit price of carbon
drop almost by half -- to about $50 per ton of carbon, while the SGM model dropped from $81 to
$37. The very large decline in the implicit price of carbon reflects the fact that additional
emissions reductions are progressively harder to find. On the other hand, a more stringent target,
one that freezes emissions at 90 percent of their 1990 level in the year 2010 and beyond, leads to
an implicit price of carbon of $200 per ton in 2010 and $150 per ton in 2020, according to the
DRI model. The SGM model estimated that the implicit price of carbon would be $145 and
$183 in 2010 and 2020, respectively. The implicit price of carbon generated by Markal-Macro
for the 90 percent of the 1990 level case with no international trading would be $187 and $207 in
2010 and 2020. respectively. Table 9 and Figures 13 and 14 describe the sensitivity of these
results using DRI. SGM. and Markal-Macro.
24
DRAFT - -May 30, 1997
Table 9: Sensitivity of the Implicit Price of Carbon
to the Stringency of the Emissions Target
No International Trading
2010
2020
DRI-DRI Energy
Carbon Emissions 90% of 1990 Level Case
200
150
Carbon Emissions 110% of 1990 Level Case
50
85
SGM
Carbon Emissions 90% of 1990 Level Case
145
183
Carbon Emissions 110% of 1990 Level Case
37
56
Markal-Macro
Carbon Emissions 90% ef 1990 Level Case
187
207
Carbon Emissions 110% of 1990 Level Case
101
93
Note: 10 year phase-in with revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in E/GDP. SGM uses a
similar rate of change in C/GDP.
Figure 13: DRI-DRI Energy No International Trading-Sensitivity of
the Implicit Price of Carbon to the Stringency of the Emissions Target
250
225
200
175
Implicit Price of Carbon (1995 $)
150
125
100
75
50
25
0
2000
2005
2010
2015
2020
DRI (1990 Level Case)
DRI (110% of 1990 Level Case)
DRI (90% of 1990 Level Case)
Note: 10 year phase-in with revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in E/GDP.
25
DRAFT -May 30, 1997
Figure 14: SGM No International Trading-Sensitivity of the Implicit
Price of Carbon to the Stringency of the Emissions Target
200
180
160
140
Implick Price of Carbon (1955 $)
120
100
80
60
40
20
0
2000
2005
2010
2015
2020
SGM (1990 Level Case)
SGM (110% of 1990 Level Case)
SGM (90% of 1990 Level Case)
Note: 10 year phase-in with revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in C/GDP.
In 2020, permit prices rise to about $85 compared with the $125 permit price under stabilization.
Using the DRI model, an emissions target of 90 percent of 1990 level results in an implicit price
of carbon of $200 per ton in 2010 and $150 in 2020. Unlike in the other cases, the implicit price
of carbon falls after 2010. This is because the initial price increase is large enough to set in
motion a series of capital stock improvements, particularly in utilities, that reduce the ongoing
level of emissions by enough to allow the implicit price to fall in the future. Thus, this result is
predicated on the idea that future price expectations could be wrong. In fact, if decision makers
had perfect price expectations, the implicit price of carbon would lie somewhere between these
two values over the period.
It is no surprise that the 90 percent of 1990 emissions case results in a more severe decline of
GDP in the transition period. But what is surprising, and questionable, is that this scenario also
has a greater long-term potential for economic recovery. As shown in Figure 15, GDP declines
to a peak loss of 1.9 percent below the base case in 2005. It recovers to the base case level in
2013 and increases to 1.0 percent above the base case in 2020. The long-term rebound effect
results from a greater amount of revenue used for deficit reduction (or debt retirement), which
pushes interest rates down substantially and drives up investment. The magnitude of this result
is questionable.
The DRI model. as discussed. is prone to depicting large effects of interest rates on investment.
Thus. when confronted with a very large implicit price of carbon and. in turn. large amounts of
forced saving. either through deficit reduction or by grandfathering these new property rights to
26
DRAFT --May 30, 1997
firms, it produces much higher levels of investment and a higher long-term growth path. The
reality is probably more moderate at both ends. In essence, this case appears to tax the ability of
the model to manage these revenue flows.
Figure 15: DRI-DRI Energy No International Trading-Sensitivity of
GDP to the Stringency of the Emissions Target
1.50%
1.00%
0.50%
GDP (percent change from the base case)
0.00%
-0.50%
-1.00%
-1.50%
-2.00%
2000
2005
2010
2015
2020
1990 Level Case
110% of 1990 Level Case
90% of 1990 Level Case
Note: 10 year phase-in with revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in E/GDP.
The portion of total emission reductions from coal and oil in both the 90 percent and 110 percent
of 1990 Level Case, No International Trading, increases only slightly--about 5 percentage points-
-while total emission reductions from natural gas change significantly. In 2010, under
stabilization, about 13 percent of total emission reductions are from natural gas. Under a 10
percent increase in the target (that is, a target of 90 percent of 1990 emissions), about 9 percent
of total emission reductions are from natural gas. This occurs because the substitution of gas for
coal in electric utilities is not enough to achieve the bulk of the 90 percent (more stringent)
target. Additional emissions reductions must be found, which forces the burden to be spread
more evenly among fuel types and sectors.
Adopting a revenue recycling option that favors capital formation leads to less impact on the
economy during the transition and greater returns to the economy in the long term. The IAT
looked at a number of revenue recycling policies in addition to the deficit reduction case. These
options are depicted in Figure 16. These include:
"grandfathering" permits to producers, meaning that every carbon-emitter would be given
sufficient permits to allow them to emit at their 1990 level. The permits allowing them to
do so would then be traded freely, allowing a least-cost response to the problem to
emerge;
27
DRAFT -May 30, 1997
a 100 percent recycling of any revenues from permit auctions to consumers through a
reduction in the personal income tax;
a 100 percent return to business through a reduction in the marginal rates of the corporate
income tax; or
a 40/60 split to consumers and businesses, in proportion to their shares ofenergy use,
through tax rate reductions.
Figure 16: DRI-DRI Energy 1990 Level Case, No International
Trading-Sensitivity of GDP to Revenue Recycling Options
0.60%
0.40%
0.20%
0.00%
GDP (percent change from the base case)
-0.20%
-0.40%
-0.60%
-080%
-1.00%
-1.20%
2000
2005
2010
2015
2020
Grandfathered Permits
Auction Deficit Reduction
Auction. 100% Consumers
Auction. 100% Business (marginal rates)
Auction. 40/60 Split (marginal reles)
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Assuming a 1.25 percent annual decrease in E/GDP.
According to the IAT analysis, the revenues generated from the implementation of this policy
have the most positive effect when returned through either the deficit reduction plan,
grandfathered permits, or to business through lower taxes. Revenue recycled to consumers, in
either case, result in a greater and longer-term reductions in GDP, when measured against the
baseline, but would have correspondingly lower impacts on consumption.
The revenue recycling options that lead to better economic outcomes are all those associated with
greater investment and capital formation. Deficit reduction leads to lower interest rates, which
lowers the cost of capital and facilitates investment. Recycling revenues to companies has the
effect of increasing savings through apparent profits and provides the wherewithal for greater
investment spending. Similarly, grandfathering permits to producers allows them to "assetize"
28
DRAFT --May 30, 1997
their right to produce emissions. This allows firms to realize gains on this "right" and again
provides the wherewithal to invest.
Peak GDP losses during the transition period are less severe for the 100 percent to business and
40/60 split when accomplished through reductions in the marginal tax rates, (about 0.7 percent in
2005), compared with the other recycling options, (between 0.8 and 1.0 percent in that year).
Figures 17 and 18 demonstrate the effects of revenue recycling on investment and consumption,
in relation to the effect on GDP, as shown in the previous figure. As these figures show, the key
to economic recovery among the revenue recycling options is to improve investment in the
economy.
Figure 17: DRI 1990 Level Case, No International Trading--
Sensitivity of Investment to Revenue Recycling Options
6.00%
5.00%
400%
Investment (percent change from the base case)
3.00%
2.00%
1 00%
0 00%
-1.00%
-2.00%
2000
2005
2010
2015
2020
Grandfathered Permits
Auction, Deficit Reduction
Auction 100% Consumers
Auction. 100% Business (marginal rates)
Auction 40/60 Spit (marginal rates)
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Assuming a 1.25 percent annual decrease in E/GDP.
29
DRAFT --May 30, 1997
Figure 18: DRI-DRI Energy 1990 Level Case, No International
Trading-- Sensitivity of Consumption to Revenue Recycling Options
0.40%
0.20%
0.00%
-0.20%
Consumption (percent change from the base case
-0.40%
-0.60%
-0.80%
-1.00%
-1.20%
-1.40%
-1.60%
2000
2005
2010
2020
Grandfathered Permits
Auction. Deficit Reduction
Auction. 100% Consumers
Auction, 100% Business (marginal rates)
Auction 40/60 Spit (marginal rates)
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Assuming a 1.25 percent annual decrease in E/GDP.
But the economic effects of these recycling options must be separated from the economic effects
of carbon limitations per se. That is, economic analysis can make the case -- and models are
often structured to demonstrate - - that reducing taxes on capital could improve long-term
economic performance. In order to separate these effects, the 1990 emissions freeze
accompanied by the use of any permit auction revenues to reduce the deficit was compared to a
conventional increase in the personal income tax to achieve a comparable level of deficit
reduction.
An increase in the personal income tax results in smaller economic losses and a more prompt
economic rebound than a "deficit-equivalent" carbon reduction policy, as shown in Figure 19.
Thus, while revenue recycling options can affect significantly the outcome of a carbon-reduction
policy, the gains they create are unrelated to carbon reduction itself.
30
DRAFT -May 30, 1997
Figure 19: DRI-DRI Energy, No International Trading-Comparison
of GDP, Recycling Revenue Recycling through Deficit Reduction and
a Personal Income Tax Increase
0.80%
0.60%
0.40%
0.20%
GDP (percent change from the base case)
0.00%
-0.20%
-0.40%
-0.60%
-0.80%
-1.00%
-1.20%
2000
2005
2015
2020
1990 Level Case
Personal income Tax Case
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Assuming a L25 percent annual decrease in E/GDP.
Technological progress can be very helpful. especially in the long term. In its analysis of
technology, the Markal-Macro model was used to determine whether higher levels of energy to
GDP (E/GDP) savings are realistic. This analysis assumed two benchmarks for technological
progress. In the first, the annual steady-state improvement in the economy's efficient use of
energy was increased from the level of 1.0 percent in the AEO97 projections (found in the "no
policy" base case) to a level of 1.25 percent. In the second case, this improvement in energy
efficiency was increased to 1.75 percent. These two benchmark levels were obtained by
examining the historical record and engineering estimates of potential technical progress. The
point of the analysis was then to determine not only what effect technical progress might have on
the economic effects of climate change policy, but also whether these rates were themselves
technically feasible.
According to results from the Markal-Macro model, an improvement in the energy intensity of
0.25 percent annually, or a total annual decline of 1.25 in energy per unit of real output, can be
achieved without great difficulty using both off the shelf technologies as well as new
technologies that are near commercial viability. For example, such an improvement can be
produced if the "hurdle rates" -- that is, the premium that households and firms appear to place in
their discount rate when considering energy-efficiency investments -- declines by 81 percent.
For example, the discount rate households use when considering installing better insulation
would have to fall from 46 percent to 23 percent). Thus, this improvement can be achieved
through diffusion practices even without assuming a higher rate of innovation and technological
31
DRAFT --May 30, 1997
progress. In fact, some analysts believe that the enactment of the CCAP gets us to the 1.25
annual reduction.
The Markal model demonstrates that the higher technological case -- an increase in the annual
rate of improvement in energy-efficiency of 1.75 percent -- is more difficult to achieve.
Specifically, this higher level of energy savings cannot be achieved through better diffusion of
best technical practices alone. Thus, new innovation must occur if we are to move beyond the
1.25 case. To achieve the 1.75 case, a new set of advanced energy efficiency technologies was
added to the pool of technologies. These are part of the DOE research portfolio. Some of these
technologies are aggressive in their scope: For example, the average fuel efficiency of new cars
entering the vehicle fleet in the year 2020 is 33 miles per. gallon in the 1.25 case, but rises to 55
miles per gallon for new cars entering the vehicle fleet in the 1.75 case. They were all deemed
viable in an outside peer-review of the DOE program. The IAT will be circulating the
technological assumptions necessary to achieve this 1.75 benchmark in a separate paper.
Rather than use the specific technological assumptions developed in Markal, the IAT represented
technological progress in the DRI model by targeting a 1.75 percent annual rate of energy
improvement in the economy for supply and end-use technologies in all sectors. For residential
and commercial sector space heating/cooling and water heating, DRI assumed improved
performance and cost characteristics for various heating and cooling equipment types and
allowed the model to choose the optimal technologies. The model selects equipment based on
life-cycle cost estimates, which include a "first-cost bias" that weights up-front capital costs
more heavily than future fuel costs. This is comparable to the higher discount rates used in
Markal.
For all other residential and commercial sector energy end-uses, the DRI model uses estimates of
the average efficiency of all new and retrofit equipment purchases to determine fuel use
requirements. These average efficiencies were increased to reflect improvements to technology
performance and higher rates of diffusion for more efficient technologies. No changes were
made to the rates of capital stock turnover and replacement.
Table 10 summarizes the effects of higher technological progress (that is, the 1.75 percent annual
rate versus the 1.25 annual rate) on the economic effects of carbon-limiting policies. As seen.
higher rates of technological progress can dramatically cut the implicit price of carbon and the
associated transitional GDP losses. In the IAT "starting point" case (assuming 1.25 percent
annual efficiency improvements), the implicit price of carbon in the three models is $95, $81 and
$145 per ton in 2010 and $125, $106 and $130 per ton in 2020, for DRI, SGM, and Markal-
Macro respectively. In the more advanced technology case, the implicit price of carbon is $88.
$53, and $77 per ton in 2010 and $30, $51. and $35 per ton in 2020, for DRI, SGM and Markal-
Macro respectively.
4 SGM applied the rate of carbon-efficiency for purposes of modeling technological improvement in
energy-efficiency because it is easier for SGM to manage C/GDP than E/GDP. Carbon to GDP is an equally
appropriate target and the differences in the results of the two specifications is not large.
32
DRAFT --May 30, 1997
Table 10: Sensitivity of Implicit Price of Carbon (1995$)
to Rate of Technological Change - -1990 Level Case, No International Trading
2010
2020
1.25 Case
1.75 Case
1.25 Case
1.75 Case
DRI-DRI Energy
95
88
125
30
SGM
81
53
106
51
Markal-Macro
145
77
130
35
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues used for deficit reduction. DRI permit prices are generated
using the annual rate of change in E/GDP. SGM uses a similar rate of change in C/GDP.
The peak GDP losses change accordingly, as shown in Figure 20. Using the DRI model, the
peak output loss of -0.6 percent occurs in 2005, and the economy reaches its pre-policy growth
path by 2012. The economy's shift to a higher growth path is also more pronounced, but here the
result is more believable, because it is achieved through technological progress rather than
revenue recycling that raises savings and fosters investment (in fact, the level of revenue
recycling falls dramatically along with the implicit price of carbon).
The risk, however, is that these output gains may be somewhat overstated, because they do not
account for the cost of the investments needed to reach the higher rate of technological progress.
For example, firms will have to perform R&D that might distract them from other R&D tasks. If
other R&D in the economy fell as energy- and carbon-related R&D was performed, overall
productivity could drop and offset the economy's potential growth elsewhere. Alternatively,
firms might increase total R&D effort, but leave the economy with fewer resources to do other
things. While it is likely that these effects are second-order when compared to the effects of the
improvement in carbon-related efficiency, they are still absent from the analysis.
Figure 20: DRI-DRI Energy 1990 Level Case, No International
Trading-Sensitivity of GDP to the Rate of Technological Progress
1.00%
0.80%
0.50%
0 40%
GDP (percent change from the base case
0 20%
0.00%
-0 20%
.0 40%
-0 60%
-0.80%
-100%
1 20%
2000
2005
2010
2015
2020
1990 Level Case (1 25 E/GDP)
1990 Level Case (1 75 E/GDP)
Note. Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in Revenues used for deficit reduction
33
DRAFT --May 30, 1997
These results indicate how important technological progress especially in the long term. A
substantially higher rate of technological progress will improve short-term results. But it is
capable of moving the analysis significantly once its effects are allowed to accumulate.
Reducing carbon emissions would also reduce other pollutants leading to direct economic
benefit. The release of CO₂ is inherent in the activity of burning fossil fuel under current
technologies. When CO2 emissions in the utility, industrial boiler, and transportation sectors are
reduced--either by using less fuel or by altering the mix of fuels--emissions of nitrogen oxides
(NOx) and sulfur dioxide (SO₂) are also reduced. In the atmosphere, NO and SO, react with
ammonia to form ammonium nitrate and ammonium sulfate-significant components of fine
particulate matter (PM₂.₅), which may cause significant respiratory health problems and
mortality.⁵
To investigate this effect, the NEMS model was used to estimate SO₂ and No, emissions from
electricity generation. When emissions are frozen at 1990 levels without trading, NEMS
estimates decreases in utility NOₓ and SO₂ emissions of 60 percent 47 percent, respectively in
2010.
The NEMS model provided emissions for each of the thirteen NERC regions. These results were
then translated into disaggregated county level emissions by calibrating the NEMS results to the
county specific data from EPA's National Particulate Inventory. The results were then fed
through EPA's climatological regional dispersion model, which calculates the resulting air
quality changes for each county. Finally, these results were used to estimate health and welfare
effects of air pollution using EPA methodology developed under Section 812 of the Clean Air
Act Amendments and reviewed and endorsed by EPA's Science Advisory Board.
Health benefits from reducing utility NOₓ and SO₂ emissions in the "starting point" stabilization
case include avoided mortality, avoided cases of chronic bronchitis, reduced acute bronchitis,
fewer upper and lower respiratory symptoms, and a decline in lost work days. The results are
very sensitive to the value attributed to avoided mortality, here estimated at $5 million per
episode. When monetized these benefits could have a mean value of over $4 billion per quad of
coal based energy generation. Assuming the estimated 7 quad reduction found by DRI (in Table
4), this would yield benefits of about $30 billion.
NOTE TO READERS: The IAT has not yet quantified the NOₓ and SO₂ emission reductions
from the industrial and transportation sectors or estimated the reduction in emissions of other
criteria air pollutants-e.g., carbon monoxide and volatile organic compounds.
5 This analysis assumes that no new regulations to control criteria air pollutants would be implemented at
he Federal or state level. It is important to note that actions are being considered at the Federal and state levels.
including proposed new National Ambient Air Quality Standards. the Clean Air Policy Initiative. and new State
Implementation Plans. that could reduce NO, and SO, emissions from utilities over the next decade independently
of controlling CO₂ emissions.
DRAFT --May 30, 1997
The losses experienced by the United States by handicapping energy-intensive industries in
international trade need not be large. There is widespread and legitimate concern that forcing an
implicit energy price increase on U.S. producers will disadvantage them substantially through
trade, particularly with those countries outside of Annex I that might not be subject to the same
emissions limits. The IAT used the DRI model to examine the overall trade implications of such
a possible energy price differential. Industry trade results are discussed in the Industry Results
section of this report.
The DRI model examines overall trade effects by assuming a rate at which producers who export
to the U.S. experience cost increases. In the aggregate, about 60 percent of imports of
manufactured goods come from Annex I countries that will also experience higher implicit
carbon prices (and, therefore, energy prices). The DRI model, therefore, assumes that
manufactured imports, in general rise by an average of 60 percent of the full cost increase
experienced by U.S. manufacturers.
This assumption, however, can be criticized as being too favorable to U.S. producers. If
exporters from non-Annex I countries do not experience the cost increase that Annex I producers
do, then they will no doubt substitute their production for Annex T production. Given this likely
switching of export sources, the DRI model was also run with the assumption that foreign
producers experience a cost increase equal to, on average, 30 percent as opposed to 60 percent of
the U.S. cost increase.
Figure 21 presents the results under these two cases. The effect of the carbon-limiting policy on
trade is depicted in these runs as surprisingly small. Some of the change in trade flows is
reconciled in the DRI model by allowing the exchange rate to move, but as seen in Figure 22. the
anticipated changes in the exchange rate themselves are not large and do not vary between the
two assumptions. The small differences are not necessarily counterintuitive. There are already
substantial energy price differences and differing environmental restrictions among trading
nations that are larger than the price increase that results from the policies considered here.
This aggregate treatment does not capture the effects that might be borne by specific industries
due to their varying energy intensities. This more detailed examination is presented in Table 13,
in the section on industry effects
35
DRAFT --May 30, 1997
Figure 21: DRI-DRI Energy 1990 Level Case, No International
Trading-Sensitivity of the Trade Balance to International
Price Ratio Assumptions
20
10
0
Trade Balance (change from the base case. 1992 $
-10
-20
-30
-40
-50
-60
2000
2005
2010
2015
2020
1990 Level Case (60% Case)
30% Case
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for deficit reduction and assuming a 1.25 percent annual decrease in E/GDP
Figure 22: DRI-DRI Energy 1990 Level Case, No International
Trading-Sensitivity of the Exchange Rate to International
Price Ratio Assumptions
0.01
0.000
0 006
0 004
Exchange Rate (change from the base case
0 002
0
-0 002
-0004
-0.008
-0.008
-001
2000
2005
2010
2015
2020
1990 Level Case 160% Case)
30% Case
Note: Emissions stabilized at 1990 levels in 2010 Revenues used deficit reduction and assuming a 1.25 percent annual decrease in E:GDP
36
DRAFT --May 30, 1997
Alternative views about Federal Reserve policy can yield significantly different results. The
Federal Reserve reaction function in the DRI model is an empirically derived estimation of likely
Federal Reserve policy responses to changes in price inflation and the unemployment rate,
among other variables. It is seen by DRI as the best proxy for Fed decisions in the model
simulations. In essence, the reaction function will abate unemployment unless doing so would
lead to high rates of inflation. This reaction function was used in the analysis as the default
setting for the assessment of the alternative target profiles and implementation strategies. This
section reports on a set of sensitivity analyses which consider different Federal Reserve actions:
maintaining nominal non-borrowed reserves at baseline levels, and a case where real non-
borrowed reserves are held at baseline. As can be seen from Figure 23, the effects of the
alternative monetary policy assumptions are substantial.
If the Federal Reserve maintains nominal reserves at baseline, the size of the GDP loss is
approximately doubled, from a 1 percent peak loss when the reaction function is on to just over 2
percent peak loss when more restrictive policies are pursued. There is essentially no difference
between holding nominal non-borrowed reserves constant and holding real non-borrowed
reserves constant. (The level of non-borrowed reserves in the banking system is an important
Federal Reserve policy. If the Fed chooses to hold nominal reserves constant, then the funds that
banks have to lend goes down when inflation rises. If real reserves are held constant, banks can
lend more if prices go up.)
The sensitivity cases presented here, however, focus only on using the collected funds to reduce
the federal deficit. The lower deficit (or greater surplus) makes it easier for the Fed to ease credit
conditions without making inflation worse (indeed, as shown in Figure 5 inflation subsides by
2009 and inflation thereafter is lower than in the base case). The Federal Reserve can therefore do
much to ease the economic transition in such an environment. But, the impact of the Federal
Reserve reaction function fundamentally depends on how revenue recycling policy affects price
inflation and the unemployment rate. In cases where price inflation remains high and
unemployment losses are lower, the reaction function would ease credit conditions at a slower
rate. and the divergence between the reaction function results and the nominal reserves at base
case may be much smaller.
37
DRAFT --May 30, 1997
Figure 23: DRI-DRI Energy, No International Trading- Sensitivity of
GDP to Federal Reserve Policy Assumptions
1.00%
0.50%
0.00%
GDP (percent change from the base case)
-0.50%
-1.00%
-1.50%
-2.00%
-2.50%
1995
2000
2005
2010
2015
2020
Federal Reserve Reaction on
Constant Nominal Reserves
Constant Real Reserves
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for deficit reduction and assuming a 1.25 percent annual decrease in E/GDP.
Figures 24, 25, and 26 show projections of the Federal Funds Rate, the 10-year Long Term Bond
Rate, and the Federal Deficit/Surplus, respectively, from the DRI model with the Federal
Reaction Function used in the analysis of the 1990 Level Case, No International Trading
("starting point"). These results show how important the treatment of revenue flows is in the
DRI model. Substantial declines in the deficit (these runs were produced before the agreement to
balance the budget in 2002 was achieved in May) allow interest rates to fall, which is the key to
the economy's investment response.
38
DRAFT - --May 30, 1997
Figure 24: DRI-DRI Energy 1990 Level Case, No International
Trading- Real Federal Funds Rate
5
4
3
Real Federal Funds Rate (percent)
2
1
0
-1
2000
2005
2010
2015
2020
Base case
1990 Level Case
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for deficit reduction and assuming a 1.25 percent annual decrease in E/GDP.
Figure 25: DRI-DRI Energy 1990 Level Case, No International
Trading- Real 10 Year Long-Term Bond Rate
5.00
4.00
3.00
Real 10 Year bond Rate (percent)
2.00
1 00
0 00
-1.00
2000
2005
2010
2015
2020
Base case
1990 Level Case
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for deficit reduction and assuming a 1.25 percent annual decrease in E/GDP
39
DRAFT --May 30, 1997
Figure 26: DRI-DRI Energy 1990 Level Case, No International
Trading-Path of the U.S. Federal Deficit/Surplus
50
0
Path of the Federal Deficit/Surplus (billions 19928 chain-weighted)
-50
-100
-150
-200
-250
-300
2000
2005
2010
2020
Base case
1990 Level Case
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for deficit reduction and assuming a 1.25 percent annual decrease in E/GDP.
The results presented in the sections below on "Industry Results" and "Regional
and Employment Effects" do not include cross-border emissions trading. The IAT
is in the process of generating industry and regional results based on using implicit
carbon prices from SGM Annex I trading results to simulate macro economic
conditions for the DRI model, which will extend the final section of the core results
to the industry and regional levels.
Industry Results
Using the DRI model. the IAT examined both the industry impacts and the impacts to regional
employment associated with carbon-limiting policies. Regional impacts are discussed in the next
section of the report. Table 11 provides impacts to the energy producing industries and to
industries that are considered to be energy intensive. Table 12 lists the industries with the
greatest increase from base case output and the largest decline from base case output in 2010.
Different energy models place different emphasis on three strategies for coping with energy price
increases. with corresponding differences in projected fossil fuel impacts. These strategies
include increased end-use efficiency. reduced end-use activity, or fuel-switching towards an
increased market share of low- and no- carbon fuels. Increased end-use efficiency or reduced
end-use activity tends to lower overall fuel demand. while fuel-switching favors low- and
40
DRAFT --May 30, 1997
no-carbon fuels, such as natural gas and renewable energy, relative to high carbon fuels such as
coal.
The DRI energy model results (reported here) emphasize improved efficiency and reduced
end-use activity. In this model, stabilization reduces the use of all fossil fuels (coal, oil, and
natural gas) relative to baseline levels. In contrast, for example, the NEMS results rely more
heavily on fuel switching opportunities in the utility and transportation sectors, as well as
efficiency improvements in cars. The NEMS stabilization runs show greater reductions in coal
use than the DRI runs, but natural gas use actually increases relative to baseline due to fuel
switching and a higher level of end-use energy demand.
Table 11: DRI-DRI Energy 1990 Level Case, No International Trading
Impact on the Output of Energy Producing Industries and Energy Intensive Industries
(percent change from the base case)
2010
2020
No trading
With International
No trading
With International
Trading
Trading
Energy Producers
Electric Utilities
-11.6%
-17.7%
n/a
Petroleum Refining
-8.8%
n/a
-9.3%
n/a
Coal Mining
-25.9%
n/a
-39.3%
n/a
Natural Gas
-19.9%
n/a
-18.2%
n/a
Gas Utilities
-11.4%
n/a
-10.9%
n/a
Crude Petroleum
-11.8%
n/a
-12.4%
n/a
Fuel Oil
-13.6%
n/a
-16.7%
n/a
"Pipelines. ex. Natural Gas"
-7.8%
n/a
-8.0%
n/a
Energy Intensive Industries
Food and Kindred Products
-0.9%
n/a
0.2%
n/a
Chemical and Allied Products
-1.9%
n/a
-1.6%
n/a
Petroleum and Coal Products
-9.2%
n/a
-10.0%
n/a
Stone. Glass. and Clay Products
0.8%
n/a
2.3%
n/a
Paper and Allied Products
-0.6%
n/a
0.4%
n/a
Primary Metals
-1.0%
n/a
-1.0%
n/a
Note: Emissions stabilized at 1990 levels in 2010 with a 10 year phase-in. Revenues are used for Federal deficit reduction. assuming a 1.25
percent annual decrease in E/GDP. Estimates for the international trading scenario are forthcoming.
Energy intensive industries are put at a disadvantage by higher implicit prices for fossil fuels
following the imposition of policy. This occurs because they are displaced through trade -- an
effect that DRI depicts as relatively minor -- or because the composition of the economy's output
changes in favor of less energy-intensive goods and services. These composition shifts drive the
industry results. For some industries, however, composition may shift in favor of energy
intensive industries because the economy's composition shifts from consumption to investment.
which calls up a different mix of goods itself.
For example, a number of energy intensive manufacturing and construction sectors benefit in the
long-term by the stimulus to investment created by the reduction of the deficit. Table 12 shows
that 6 of the top 10 industries. in terms of output increasing above the base case. are directly or
indirectly related to construction. which reflect the increase to the investment component of the
41
DRAFT --May 30, 1997
economy. Figures 27 and 28 show the short-term output losses and the long-term output gains of
a number of these industries.
On the other hand, industries whose production is used primarily for consumption, particularly
energy products such as petroleum and coal, but also including paper, chemicals, and food and
kindred products, continue to show losses in annual output. The energy producing industries
show losses in output from between 8 percent for pipelines and 26 percent for coal mining.
Consumer non-durable goods producing industries show losses of output that ranges from 1
percent for food processing to 10 percent for rubber and plastic footwear: In the longer-term,
other than the energy producers, the consumption-oriented industries are expected to just about
reach their output levels in the baseline.
This mix effect is particularly and obviously important for energy producers. The DRI model
suggests output of petroleum products will decline by 9 percent in 2010 and in 2020, when
compared to the base case. As seen in Table 12, coal production in the United States will be 26
percent lower in 2010 and 39 percent lower in 2020 when compared to its projected levels in the
base case.
Figure 27: DRI-DRI Energy 1990 Level Case, No International
Trading-Output in Key Industries-New Construction, Mill and
Wood Products, Veneer and Plywood, and Concrete and Gypsum
6.0%
5.0%
40%
3.0%
Output (percent change from base case)
2.0%
1.0%
0.0%
-10%
-2.0%
-3.0%
2000
2005
2010
2015
2020
New Construction
Mell and Wood Products
Veneer and Plywood
Concrete and Gypsum
Cut Stone and Lime
Note: E/GDP. Emissions stabilized at 1990 levels in 2010. Revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in
42
DRAFT --May 30, 1997
Figure 28: DRI-DRI Energy 1990 Level Case, No International
Trading-Output in Key Industries-Motor Vehicles, Steel and Mill
Products, Structural Metal and Plate Work, Aircraft, Aluminum
4.0%
3.0%
2.0%
Output (percent change from base case)
1.0%
0.0%
-1.0%
-2.0%
-3.0%
2000
2005
2010
2015
2020
Motor Vehicles
Aircraft
Steel and Mill Products
Aluminum
Structural Metal and Plate Work
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for deficit reduction and assuming a 1.25 percent annual decrease in E/GDP.
Mining (including coal, oil, and natural gas extraction) employment would be 6 percent and 7
percent lower, respectively, in 2010 and 2020: these declines are lower than output losses
because productivity in the industry is generally anticipated to improve and the nation's coal mix
is projected to shift to more productive coal reserves. These employment losses are particularly
severe in the east and west south central regions.
Electric utilities experience smaller percentage reductions in output, but their losses are larger in
dollar terms. Utility output declines by about $30 billion in 2010 and $52 billion in 2020 when
compared to the base case. Petroleum refining and coal mining also experience larger losses than
other energy-related industries on a dollar basis.
43
DRAFT --May 30, 1997
Table 12: DRI-DRI Energy 1990 Level Case, No International Trading
Impacts on the Output of Selected Industries
(percent change from the base case)
2010
2020
Industries with the Largest Percent Increase in Output
Aircraft
3.0
3.7
Truck Trailers
3.0
3.7
New Construction
2.8
5.4
Truck and Bus Bodies
2.7
3.5
Partitions and Fixtures
2.5
3.9
Lawn and Garden Equipment
2.3
3.3
Elevators and Materials Handling Equipment
2.3
2.8
Structural Metal Products
2.2
29
Concrete and Gypsum
21
43
Plumbing and Heating Equipment
2.1
4.0
Packaging Machinery
21
2.7
Industries with the Largest Percent Decline in Output*
Rubber and Plastic Footwear
-10.3
-3.9
Nonferrous Metals
32
-5.4
Household Audio and Video Equipment
-3.2
-6.1
Chemical and Fertilizer Mining
-3.1
-3.3
Watches and Clocks
-2.8
-4.9
Iron and Ferroalloy Ores
-2.6
-2.8
Other Leather Goods
-2.5
0.4
Nonferrous Wire and Cable
-2.5
-2.8
Misc. Nonferrous Ores
-2.3
-3.7
Industrial Organic and Inorg. Chemicals
-2.2
-2.1
Computers
-2.1
-6.1
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for deficit reduction and assuming a 1.25 percent annual decrease in E/GDP.
Excluding energy producing sectors.
As discussed earlier, the DRI model found that the effect of a carbon-limiting policy on
international trade is relatively small across all industries. However, as Table 13 shows, the trade
impact on some specific industries are relatively large. For example, imports by the cement
industry increase by 13 percent and exports are off by 3 percent, a net trade loss of 16 percent.
Steel imports increase by almost 7 percent while its exports are cut by about 1 percent. a net
trade loss of about 7 percent. On the other hand, fuel oil imports decline by about 39 percent.
while exports increase by about 1 percent, a net trade gain of 40 percent. Imports for the
industries listed in this table generally increase, while exports decline slightly.
DRAFT --May 30, 1997
Table 13: DRI-DRI Energy, 1990 Level Case, No International Trading
Effects on Exports and Imports in 2010
(percent change from base case)
Imports
Exports
Paper and Allied Products
Pulp Mills
0.9%
0.1%
Paper and Paperboard Mills
2.3%
0.5%
Paperboard Boxes and Containers
1.6%
0.2%
Paper Coating and Laminating
1.2%
0.1%
Sanitary Paper Products
0.8%
0.3%
Chemical and Allied Products
Industrial Inorg. and Organic Chemicals
3.6%
1.0%
Fertilizers
53%
2.0%
Pesticides and Agr. Chemicals
102%
0.4%
Petroleum and Coal Products
Petroleum Refining
-7,7%
0.5%
Fuel Oil
-38.6%
0.6%
Stone. Glass, and Clay Products
Cement
13.3%
-2.8%
Concrete and Gypsum
5:3%
-0.2%
Cut Stone and Lime
7.4%
-1.1%
Primary Metals
Steel and Mill Products
6.6%
-1.4%
Iron and Steel Foundries
2.7%
0.0%
Iron and Steel Forgings
3.6%
-0.1%
Aluminum
3.8%
-0.5%
Transportation Equipment
Truck and Bus Bodies
3.4%
0.1%
Truck Trailers
4.7%
0.0%
Motor Vehicles
3.1%
-0.1%
Motor Vehicle Parts and Accessories
1.4%
-0.1%
Aircraft
3.0%
3.7%
Aircraft and Missile Engines and Parts
1.5%
2.5%
Computer and Electronic Equipment
Computers
2.7%
-0.8%
Computer Peripheral Equipment
2.3%
-0.2%
Semiconductors
0.3%
-0.6%
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in
E/GDP.
Regional and Employment Effects
The effects of climate change policy on the various regions of the country are shown in Table 14.
In general. states in the East North Central, East South Central, and West North Central regions
will have proportionally greater losses in population. 150-, 125-, and 75-thousand. respectively.
nd employment, 210-, 165-, and 125-thousand, respectively, than the other regions of the
country. See Figures 29 and 30. Total non-farm employment loss due to the climate change
policy is about 900 thousand in 2005 compared with the baseline total non-farm employment of
45
DRAFT :-May 30, 1997
135.3 million in that year. In 2010, total non-farm employment loss due to the climate change
policy is only 400 thousand, compared with the baseline total non-farm employment of 140.9
million, as the economy starts to recover. The New England, Middle Atlantic, and the Pacific
Southwest are expected to show long-term gains in population of 125-, 110-, and 130 thousand,
respectively, and in employment of 125-, 45-, and 65-thousand, respectively, because of climate
change policy implementation.
Figure 29: DRI-DRI Energy 1990 Level Case, No International
Trading-- Population by Region (change from the base case)
Pactic Southment
Pacific Northwest
West South Central
West North Central
East South Central
East North Central
South Atlantic
Middle Atlantic
in
New England
-0.2
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
Thousands
D 2005
2010
Note: E/GDP. Emissions stabilized at 1990 levels in 2010. Revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in
The key to the regional effects relies on how revenue raised through permit sales is recycled to
the economy. In the policy reviewed for regional effects, revenues are used to reduce the Federal
budget deficit, which supports savings and, thus, increases investment. The climate change
policy favors those states where production in industries support investment in structures and
capital goods equipment, and of course, those areas of the country that are not as dependent on
fossil fuel production. The climate change policy's effects are mitigated in those regions whose
mix of industries favor investment goods industries and where the levels of industry production
are large and can absorb the losses in production in industries that produce consumer goods.
46
DRAFT --May 30, 1997
Figure 30: DRI-DRI Energy 1990 Level Case, No International
Trading-Total Non-Farm Employment by Region
(change from the base case)
Pecrfic Southwest
Pacific Northwest
West South Central
West North Central
East South Central
East North Central
South Atlantic
Middle Atlantic
New England
-300
-250
-200
-150
-100
-50
50
100
150
Thousands
2005
2010
Note: Emissions stabilized at 1990 levels in 2010. Revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in
E/GDP.
As shown in Table 14, although the West South Central region is expected to have the greatest
losses in fossil fuel employment, about 15 thousand in 2010, this represents only about 6 percent
of its total mining employment in that year. On the other hand, the East South Central Region is
expected to lose about 8 thousand in 2010, but this represents about 22 percent of its total fossil
fuel employment in the same year.
47
DRAFT --May 30, 1997
Table 14: DRI-DRI Energy 1990 Level Case, No International Trading
Regional Impacts
Year
New
Middle
South
East North
East South
West
West
Pacific
Pacific
England
Atlantic
Atlantic
Central
Central
North
South
North-west
Southwest
Central
Central
Disposable Income, % change from the base case
2005
0.9
0.4
-0.1
-0.4
-0.5
-0.7
0.2
0.3
0.3
2010
1.9
0.7
-0.1
-1.1
-1.3
-1.2
-0.4
1.1
0.6
2020
2.9
0.9
0.1
-1.4
-1.5
1.9
0.7
1.4
0.7
Total Non-farm employment, % change from the base case
2005
0.3
-0.4
-0.8
-1.0
-1.3
-0.9
-0.8
0.4
0.4
2010
1.7
0.3
-0.4
-1.1
-1.8
-0.8
-0.7
0.8
0.3
2020
2.7
0.5
-0.2
'-1.1
-1.7
-09
-0.8
T1
0.5%
Mining, Oil, and Gas Employment, % change from the base case
2005
0.4
-8.5
-8.3
-5.9
-10.9
C08
-1.4
-2.1
-0.9
2010
4.4
-10.9
-11.6
-7.8
-20.5
1.0
-6.4
-1.1
0.8
2020
9.0
-14.0
-15.6
-6.2
-27.8
4.3
-4:8
-8.3
0.6
Population, change from the base case (millions)
2005
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
2010
0.1
0.1
0.0
-0.2
0.1
-0.1
-0.1
0.1
0.1
2020
0.3
0.2
0.0
-0.3
02
-0.1
-0.1
0.1
0.2
Manufacturing Employment. change from the base case (thousands)
2005
9.6
1.7
-32.5
-77.1
-24.7
19.5
-21.5
-1.0
-0.6
2010
26.5
21.7
-28.4
-116.1
-32.5
-28.3
-28.5
6.7
17.3
2020
36.9
13.9
-33.8
-142.5
-32.7
-35.3
-41.8
7.3
23.9
Transportation. Communication & Utilities, change from the base case (thousands)
2005
1.7
-4.1
12.1
-15.5
4.9
-8.1
-8.7
-1.6
-6.5
2010
5.7
-2.9
16.5
-25.9
-9.4
-13.5
-14.9
0.3
-5.5
2020
8.4
-4:8
18.1
-31.8
-10.0
-16.1
-17.9
0.4
-5.4
Note: E/GDP. Emissions stabilized at 1990 levels in 2010. Revenues used for Federal deficit reduction and assuming a 1.25 percent annual decrease in
48
DRAFT -May 30, 1997
Appendix Table A: Assumptions Regarding
Non-Carbon Greenhouse Gases
(million metric tons of carbon equivalent)
1900
1995
2000
2005
2010
2015
2020
Baseline Emissions
CH4
169
178
150
152
152
154
155
HFC PFC
24
n/a
42
69
91
N5
133
N2O
37
34
31
32
34
36
37
Sinks
-136
-128
-121
-120
19
-111
-103
Total
95
n/a
102
133
158
194
223
Cost Effective Reductions in Emissions (assuming an implicit price of carbon of 570 per ton)
CH4
29
HFC PFC
51
$110
N2O
4
4
Sinks
7
15
15
Total Reduction
97
123
159
Emissions with Cost Effective Reductions
CH4
169
178
150
125
126
126
HFC PFC
24
n/a
42
40
41
23
N2O
37
34
F
32
30
31
33
Sinks
-136
-128
121
-120
-134
-126
-118
Total Other Gas Emissions
95
Min/a
36102
133
61
71
64
Reductions Below 1990 Levels
34
23
31
"e: Million metric ton of carbon equivalent calculated using 100 year Global Warming Potentials (GWP) (IPCC. 1995). The $70 per ton
cit price of carbon was an estimate used by the IAT prior to generating implicit price of carbon using the IAT models.
49
Clinton Presidential Records
Digital Records Marker
This is not a presidential record. This is used as an administrative
marker by the William J. Clinton Presidential Library Staff.
This marker identifies the place of a tabbed divider. Given our
digitization capabilities, we are sometimes unable to adequately
scan such dividers. The title from the original document is
indicated below.
M
Divider Title:
Draft Protocol to the Framework Convention on Climate Change
As released by the Department of State, Bureau of Oceans and International Environmental and
Scientific Affairs, January 28, 1997.
January 17, 1997
U.S. DRAFT PROTOCOL FRAMEWORK
(submitted without prejudice to ultimate form of agreement)
The Parties to this Protocol,
Have agreed as follows:
Article 1
Definitions
For purposes of this Protocol:
1. "The Convention" means the United Nations Framework Convention on Climate Change
done at New York on 9 May 1992.
2. "Party" means Party to this Protocol.
3. "Greenhouse gas" means any greenhouse gas for which a global warming potential is set
forth in Annex C of this Protocol.
4. "Tonne of carbon equivalent" means one metric tonne of carbon, or a quantity of one or
more other greenhouse gases equivalent to one metric tonne based on the global warming
potentials set forth in Annex C of this Protocol.
5. "Net anthropogenic emissions" of greenhouse gases is the calculated difference between
emissions by sources and removals by sinks.
6. [other definitions to be developed or cross-referenced to the Convention as necessary]
Article 2
Emissions Budgets
1. Each Annex A and Annex B Party shall ensure that its net anthropogenic emissions of
greenhouse gases do not exceed its emissions budget for any applicable budget period, as
specified in this Article.
2. For each Annex A and Annex B Party, its emissions budget shall be denominated in
tonnes of carbon equivalent emissions allowed and shall equal:
(a) the tonnes of carbon equivalent emissions it is allowed under paragraph 3 or 4 below,
plus
(b) any tonnes of carbon equivalent emissions allowed that are carried over from a prior
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budget period under paragraph 5 below, plus
(c) up to [ percent] of the tonnes of carbon equivalent emissions allowed under paragraph 3
or 4 below, such as may be borrowed from the subsequent budget period under paragraph 6
below, plus
(d) any tonnes of carbon equivalent emissions allowed that are acquired from another Party
under Article 6 (International Emissions Trading) or Article 7 (Joint Implementation),
minus
(e) any tonnes of carbon equivalent emissions allowed that are transferred to another Party
under Article 6 (International Emissions Trading).
3.
1. (a) For the first budget period, [20 through 20 ], each Annex A Party shall have a number of
tonnes of carbon equivalent allowed equal to [a percentage of] its net anthropogenic emissions of
tonnes of carbon equivalent in 1990, multiplied by [the number of years in this budget period].
(b) For the second budget period, [20 through 20 ], each Annex A Party shall have a number of
tonnes of carbon equivalent emissions allowed equal to [a percentage equal to or less than the
percentage in subparagraph 3(a)] of its net anthropogenic emissions of tonnes of carbon equivalent
in 1990, multiplied by [the number of years in this budget period].
(c) [possible subsequent budget period(s)]
4. For the budget period [20 through 20 ], each Annex B Party (see Annex B for States
included) shall have a number of tonnes of carbon equivalent emissions allowed equal to
[options for Annex B Parties include: budget periods, baseyears, and/or percentages
different from those applicable to Annex A Parties].
5. At the end of a budget period applicable to a Party, any amount by which the Party's
emissions of tonnes of carbon equivalent is under its emissions budget for that period may
be carried over and added to its emissions budget for the next budget period.
6. At the end of a budget period applicable to a Party, any amount of tonnes of carbon
equivalent emissions allowed that is borrowed from the subsequent budget period shall be
subtracted at a rate of [1.2:1] from the subsequent budget period.
7. [Provision requiring control of greenhouse gases not listed in Annex C.]
8. Any State not listed in Annex A may, in its instrument of ratification, acceptance,
approval or accession, or at any time thereafter, notify the Depositary that it intends to be
bound by obligations of Annex A Parties. It will then be an Annex A Party. The Depositary
shall inform the other signatories and Parties of any such notification.
9. Any State not listed in Annex A may, in its instrument of ratification, acceptance,
approval, or accession, or at any time thereafter, notify the Depositary that it intends to be
bound by obligations of Annex B Parties. It will then be an Annex B Party. The Depositary
shall inform the other signatories and Parties of any such notification.
Article 3
Measurement and Reporting
1. Each Annex A and Annex B Party shall have in place by [the first year of its first budget
period] a national system for the accurate measurement of anthropogenic emissions by
sources, and removals by sinks, of greenhouse gases.
2. For the purposes of implementing paragraph 1 and promoting comparability, consistency,
and transparency, the Parties shall, not later than their second Meeting, decide on minimum
standards for the measurement of anthropogenic emissions by sources, and removals by
sinks, of greenhouse gases.
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3. Each Annex A and Annex B Party shall put in place, if it has not already done so,
national compliance and enforcement programs relevant to its implementation of the
obligations under this Protocol.
4. Each Annex A and Annex B Party shall submit to the Secretariat, as part of its
communication under Article 12 of the Convention, information on its implementation of
this Protocol, including policies and measures it is taking to meet its obligations in Article
2. Such submission shall be in accordance with guidelines which the Parties adopt at their
first Meeting, taking into account any relevant guidelines adopted by the Parties to the
Convention. Such submission shall also contain the following information:
(a) once the obligation in paragraph 1 above becomes effective, a description of the national
measurement system that it has in place;
(b) once the obligation in paragraph 1 above becomes effective, the results of its national
measurement system;
(c) a quantitative projection of its net anthropogenic emissions of greenhouse gases through
the budget periods; and
(d) a description of relevant national compliance and enforcement programs it has in place
pursuant to paragraph 3 above, as well as a description of their effectiveness, including
actions taken in cases of non-compliance with national law.
5. In addition to the information required to be submitted under paragraph 4, each Annex A
and Annex B Party shall submit to the Secretariat, on an annual basis and in accordance
with the guidelines referred to in paragraph 4, its current calculation corresponding to each
of the subparagraphs in Article 2.2 and its remaining emissions budget for that budget
period. With respect to any tonnes of carbon equivalent emissions allowed that are acquired
or transferred under Articles 6 or 7, the Party shall specify the quantity, Party of origin or
destination, and the relevant budget period.
6. The first of the submissions referred to in paragraph 5 shall be part of a Party's first
communication that is due after the Protocol has been in force for that Party for two years.
The frequency of subsequent submissions shall be determined by the Parties.
7. Information communicated by Parties under this Article shall be transmitted by the
secretariat as soon as possible to the Parties and to any subsidiary bodies concerned.
8. Without prejudice to the ability of any Party to make public its communication at any
time, the secretariat shall make information communicated by Parties under this Article
publicly available at the time it is submitted to the Parties.
Article 4
Review and Compliance Process
1. In addition to the review of communications conducted under Article 10.2(b) of the
Convention, the Meeting of the Parties shall consider the information submitted by Annex
A and Annex B Parties under Article 3 in order to assess those Parties' implementation of
their obligations.
2. Reviews will be conducted by expert review teams, which will be coordinated by the
secretariat and composed of experts selected from those nominated by Parties and, as
appropriate, by intergovernmental organizations.
3. Reviews will be in accordance with guidelines to be adopted by the Meeting of the
Parties. These guidelines shall, inter alia, provide for how information will be made
available to the public and define mechanisms by which observers and the public may
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provide comments, supplemental data or other information to facilitate and improve
reviews. The guidelines shall be periodically reviewed by the Parties for appropriate
revision.
4. Review teams will review all aspects of a Party's implementation of this Protocol,
including the likelihood that a Party will achieve its emissions budgets obligations. They
will prepare a report assessing a Party's implementation of its obligations, identifying any
areas of apparent non-compliance, as well as potential problems in achieving obligations.
Reports will be provided to a Meeting of the Parties.
5. Based on such reports, a Meeting of the Parties may make recommendations to a Party. In
such case, the Party shall review its implementation, take appropriate action, and report
back to the next Meeting of the Parties on its action.
6. There would also be provisions setting forth various consequences for non-compliance
with obligations, as determined by a Meeting of the Parties. Consequences would
correspond to the type, degree, and frequency of non-compliance. Some would be
automatic, while others might be discretionary. Examples of consequences could include,
e.g.:
(a) denial of the opportunity to sell tonnes of carbon equivalent emissions allowed through
international emissions trading and/or joint implementation;
(b) loss of voting rights and/or other opportunities to participate in processes under the
Protocol.
Article 5
Advancement of the Implementation of
Article 4.1 of the Convention
Recognizing the progress that has been made to date in implementing commitments under
Article 4.1 of the Convention:
1. The Parties reaffirm their commitments under Article 4.1 of the Convention and the need
to continue to advance the implementation of such commitments.
2. Each Party shall strengthen its legal and institutional framework to advance the
implementation of its commitments under Article 4.1 of the Convention.
3. Each Party shall take measures to facilitate investment in climate-friendly technologies.
4. Each Party shall report, as part of its communication under the Convention, on how it is
promoting public education and participation in the development of climate change policy.
5. Each Party that is neither in Annex A nor Annex B shall identify and implement
"no-regrets" measures for mitigating net anthropogenic emissions of greenhouse gases,
including any identified through the review process under paragraph 7 below. In this regard,
each such Party shall also:
(a) quantify the effects of the measures it implements;
(b) evaluate barriers to the adoption of potential measures; and
(c) report to the Secretariat, as part of its communication under the Convention, on the
measures it has implemented, plans to implement, and barriers to the adoption of potential
measures.
6. Each Party that is neither in Annex A nor Annex B shall submit to the Secretariat, on an
annual basis, its inventory of greenhouse gas emissions. Such inventory shall be consistent
with any guidelines adopted by the Parties.
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Drait Protocol to the PTAINWORK Convention on Chimate Change
7. The Parties shall establish a process for reviewing communications received under the
Convention from the Parties identified in paragraphs 5 and 6. The process shall be designed
to:
(a) enable the review of the effects of individual measures described in paragraph 5;
(b) assist such Parties in identifying and implementing "no-regrets" measures for mitigating
net anthropogenic emissions of greenhouse gases;
(c) seek to identify key sectors and technological options within them;
(d) consider possibilities for promoting voluntary arrangements with industry aimed at
identifying and encouraging implementation of "no regrets" measures; and
(e) explore various means through which such Parties could obtain both the know-how and
the technology needed to implement options identified.
Article 6
International Emissions Trading
1. An Annex A or Annex B Party that is in compliance with its obligations under Article 3
(Measurement and Reporting) and that has in place a national mechanism for certification
and verification of trades, may transfer to, or receive from, any Annex A or Annex B Party,
any of its tonnes of carbon equivalent emissions allowed for a budget period, for the
purpose of meeting its obligations under Article 2.
2. A Party may authorize any domestic entity (e.g., government agencies, private firms,
non-governmental organizations, individuals) to participate in actions leading to transfer
and receipt under paragraph 1 of tonnes of carbon equivalent emissions allowed.
3. A Meeting of the Parties may further elaborate guidelines to facilitate the reporting of
emissions trading information.
Article 7
Joint Implementation
1. Any Party that is neither in Annex A nor B may generate tonnes of carbon equivalent
emissions allowed through projects that meet the criteria set forth in paragraph 2.
2. In addition to any criteria adopted by the Parties to this Protocol, the following criteria
shall apply to projects:
(a) Projects must be compatible with and supportive of national environment and
development priorities and strategies, as well as contribute to cost-effectiveness in achieving
global benefits;
(b) Projects must provide a reduction in emissions that is additional to any that would
otherwise occur.
3. [Additional provisions to be added on calculation, measurement, monitoring, verification,
review, reporting]
4. Any Party that generates tonnes of carbon equivalent emissions allowed consistent with
this Article may:
(a) hold such tonnes of carbon equivalent emissions allowed; or
(b) transfer any portion thereof to any Party.
5. An Annex A or Annex B Party may acquire tonnes of carbon equivalent emissions
allowed under this Article for the purpose of meeting its obligations under Article 2.
provided it is in compliance with its obligations under Article 3 (Measurement and
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Reporting).
6. A Party may authorize any domestic entity (e.g., government agencies, private firms,
non-governmental organizations, individuals) to participate in actions leading to generation,
transfer and receipt under this Article of tonnes of carbon equivalent emissions.
7. Any Party that is neither in Annex A nor Annex B that generates or acquires tonnes of
carbon equivalent emissions allowed under this Article shall notify the Secretariat annually
of the quantity, origin, and destination of such tonnes.
Article 8
Science
The Parties shall periodically review this Protocol, and guidelines established thereunder, in
light of evolving scientific knowledge related to climate change.
Article 9
Progress Toward Long-Term Goal
The Parties shall cooperate in the establishment of a long-term goal with respect to
atmospheric concentrations of greenhouse gases.
Article 10
Meetings of the Parties
1. The Parties shall hold meetings at regular intervals. The secretariat shall convene the first
meeting of the Parties not later than one year after the date of the entry into force of this
Protocol and in conjunction with a meeting of the Conference of the Parties to the
Convention.
2. Subsequent meetings of the Parties shall be held, unless the Parties decide otherwise, in
conjunction with meetings of the Conference of the Parties to the Convention. Extraordinary
meetings of the Parties shall be held at such other times as may be deemed necessary by a
meeting of the Parties, or at the written request of a Party, provided that within six months
of such a request being communicated to them by the secretariat, it is supported by at least
one third of the Parties.
3. The Parties, at their first meeting, shall:
(a) adopt, by consensus, rules of procedure for their meetings;
(b) [other].
4. The functions of the meetings of the Parties shall be to:
(a) review the implementation of this Protocol, including the information submitted in
accordance with Article 3;
(b) periodically review the adequacy of this Protocol;
(c) [other].
5. The United Nations, its specialized agencies and the International Atomic Energy
Agency, as well as any State not party to this Protocol, may be represented at meetings of
the Parties as observers. Any body or agency, whether national or international,
governmental or non-governmental, qualified in fields relating to climate change which has
informed the secretariat of its wish to be represented at a meeting of the Parties as an
observer may be admitted unless at least one third of the Parties present object. The
admission and participation of observers shall be subject to the rules of procedure adopted
by the Parties.
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Article 11
Secretariat
1. In accordance with Article 8.2(g) of the Convention, the secretariat of this Protocol shall
be the secretariat of the Convention.
2. The functions of the secretariat shall be:
(a)
Article 12
Subsidiary Body for Scientific and Technological Advice
1. The Subsidiary Body for Scientific and Technological Advice of the Convention shall
serve as the Subsidiary Body for Scientific and Technological Advice of the Protocol.
2. When the Subsidiary Body for Scientific and Technological Advice exercises its
functions with regard to matters concerning the Protocol, decisions shall be taken only by
those of its members that are, at the same time, Parties to the Protocol.
3. When the Subsidiary Body for Scientific and Technological Advice exercises its
functions with regard to matters concerning the Protocol, any member of the bureau of the
Subsidiary Body for Scientific and Technological Advice representing a Party to the
Convention, but, at the same time, not a Party to the Protocol, shall be substituted by an
additional member to be elected by and from the Parties to the Protocol.
Article 13
Subsidiary Body for Implementation
1. The Subsidiary Body for Implementation of the Convention shall serve as the Subsidiary
Body for Implementation of the Protocol.
2. When the Subsidiary Body for Implementation exercises its functions with regard to
matters concerning the Protocol, decisions shall be taken only by those of its members that
are, at the same time, Parties to the Protocol.
3. When the Subsidiary Body for Implementation exercises its functions with regard to
matters concerning the Protocol, any member of the bureau of the Subsidiary Body for
Implementation representing a Party to the Convention, but, at the same time, not a Party to
the Protocol, shall be substituted by an additional member to be elected by and from the
Parties to the Protocol.
Article 14
Multilateral Consultative Process
[The Parties, at their first Meeting or as soon as practicable thereafter, shall consider the
establishment of a multilateral consultative process to promote effective implementation of
the Convention.]
Article 15
Dispute Settlement
[silence, with the result that Article 14 of the Convention would apply to this Protocol.]
[in addition, mandatory, binding dispute settlement [with specific consequences flowing
from a violation] among Annex A and Annex B Parties, as well as against other Parties as
appropriate (e.g., host countries under Article 7)]
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Note: this process would be without prejudice to the review and compliance process under
Article 4
Article 16
Evolution
The Parties shall adopt, by [2005], binding provisions so that all Parties have quantitative
greenhouse gas emissions obligations and so that there is a mechanism for automatic
application of progressive greenhouse gas emissions obligations to Parties, based upon
agreed criteria.
Views on Certain Final Clauses
Adoption and Amendments of Annexes
Depending upon what type of material is eventually included in annexes, it may not be
appropriate to restrict the content of all annexes to "lists, forms and any other material of a
descriptive nature that is of a scientific, technical, procedural or administrative character."
For any substantive annex, it may not be appropriate to provide for tacit
adoption/amendment.
Signature
This provision should state that only Parties to the Convention may be Parties to the
Protocol.
Entry into Force
To ensure effective implementation, as well as to minimize the potential "free rider"
problem, this provision may need to stipulate an entry into force trigger that requires
ratification by States that account for a particular percentage of global emissions of
greenhouse gases.
Annex A
This Annex would include the same States as those listed in Annex I of the Convention,
plus those that join subsequently pursuant to Article 2.
Annex B
This Annex would include those States not listed in Annex A that indicate before adoption
of the protocol that they want to be included in this Annex, plus those that join subsequently
pursuant to Article 2.
Annex C
This Annex would list greenhouse gases not covered by the Montreal Protocol, with the
exception of gases, or particular sources and sinks, for which there is insufficient knowledge
of the GWP or inability to accurately measure emissions or removals. GWPs would be those
developed by the IPCC.
[end of document]
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FACT SHEET ON SUPPLEMENTAL U.S. CLIMATE CHANGE PROPOSALS
June 1997
In January 1997 the United States submitted a draft text for a legal instrument to address
next steps under the United Nations Framework Convention on Climate Change. Several
technical elements left undefined in the January submission (principally those relating to
compliance issues, and to which gases should be included in an agreement) have been further
developed in the attached text; they are described below. The revised U.S. draft protocol proposal
containing these new elements will form the basis for the U.S. position in the next session of the
Ad Hoc Group on the Berlin Mandate (scheduled to meet in late July). Please call Jonathan
Pershing (647-4069) or Linda Strachan (647-3550) of the State Department with any questions.
COMPLIANCE
The January text created "emissions budgets", with targets based on the total emissions over a
period of several years; this revision provides for a penalty to be assessed should a Party
exceed its allowed budget.
The January text created a review process; this revision calls for the review process to build
on the existing Convention review mechanism, authorizes the review of any pertinent
information, allows for consultations with both the Party and others in the course of a review,
calls for the circulation of the completed review to all Parties, and requests the Secretariat to
identify any report that requires further consideration.
The January text provided an option for Parties with budgets to trade emissions; this text
limits trading to Parties that have met all obligations pertaining to measurement and reporting
of budgets, and that have in place national mechanisms for certification and verification of
trades. With respect to a given budget period, it also precludes a Party from trading if it has
exceeded its budget, and provisionally limits a Party's ability to trade if its compliance has
been called into question.
The January text provided for Meetings of the Parties; this text also calls for periodic review
by the Parties of protocol implementation (including of the review process), requires Parties to
implement an appropriate non-compliance regime (including through the development of an
indicative list of consequences for non-compliance), and allows the Parties to establish an
implementation committee to assist them in carrying out these duties.
ANNEX C: WHICH GASES ARE INCLUDED
The January text suggested that all gases for which monitoring and measurement procedures
are available should be included in the agreement; this revision maintains the broad inclusion
of all greenhouse gases, sources, sinks and sectors, and calls upon the Parties to decide on best
available methods for measurement, and to propose adjustments to the measurements in cases
where best available methods are not used. The revision also calls for periodic updating of
measurement methods.
202
Additional U.S. Proposals
(references are to the original U.S. submission)
Article 1 (Definitions)
Replace definition 3 ("Greenhouse gas") with the following:
"Greenhouse gas" means any greenhouse gas covered in
Annex C of this Protocol.
Replace definition 4 ("Tonne of carbon equivalent") with
the following:
"Tonne of carbon equivalent" means one metric tonne of
carbon, or a quantity of one or more other greenhouse
gases equivalent to one metric tonne based on the
global warming potentials decided by the Parties in
accordance with Annex C of this Protocol.
Article 2 (Emissions Budgets)
Delete paragraph 7
Article 3 (Measurement and Reporting)
Replace paragraph 2 with the following:
For the purposes of implementing paragraph 1 and
promoting comparability, consistency, and
transparency, the Parties shall, not later than their
first Meeting, decide on agreed best available methods
for the measurement by Parties of anthropogenic
emissions by sources, and removals by sinks, of
greenhouse gases, taking into account the best
available methods determined by the IPCC and other
expert bodies. They shall also decide on appropriate
adjustments to measurements of emissions and removals
where agreed best available methods have not been
used. The Parties shall periodically update agreed
best available methods and adjustments based on
evolving scientific knowledge, including advice from
the Subsidiary Body for Scientific and Technological
Advice referred to in Article 12.
Annex C
Replace descriptive language with the following:
All greenhouse gases, their sources and sinks, with
global warming potentials as decided by the Parties at
their first meeting (taking into account the IPCC's
global warming potentials for 100-year time horizons)
and as subsequently updated by the Parties to reflect
-
evolving scientific knowledge.
Additional U.S. Proposals
(references are to the original U.S. submission)
In Article 2 of the U.S. proposal (Emissions Budgets),
add a new paragraph 6.bis. as follows:
2.6.bis. At the end of a budget period applicable to a
Party, any amount of tonnes of carbon equivalent
emissions over its emissions budget shall be
subtracted at a rate of [rate greater than that
in paragraph 6] from the subsequent budget period.
In Article 4 of the U.S. proposal (Review and Compliance
Process), substitute for paragraphs 3 to 6 the following text:
4.3 Reviews will be in connection with the review of
communications conducted under Article 10.2 (b) of the
Convention and will be in accordance with guidelines
to be adopted by the Parties at a meeting. These
guidelines shall, inter alia, provide for how
information will be made available to the public and
define mechanisms by which observers and the public
may provide comments, supplemental data or other
information to facilitate and improve reviews. The
guidelines shall be períodically reviewed by the
Parties for appropriate revision.
4.4 Review teams will review all aspects of a Party's
implementation of this Protocol, including the
likelihood that a Party will achieve its emissions
budgets obligations. They will be authorized, inter
alia, to review pertinent information and consult with
the Party in question and others as necessary. They
will prepare a report assessing a Party's
implementation of its obligations, identifying any
areas of apparent non-compliance, as well as potential
problems in achieving obligations.
4.5 Such reports will be circulated by the Secretariat to
all Parties. In addition, the Secretariat will
identify for further consideration any report
indicating a question of implementation.
In Article 6 of the U.S. proposal (International Emissions
Trading), substitute the following text:
6.1. Except as otherwise provided below, any Annex A
or Annex B Party may transfer to, or acquire from, any
Annex A or Annex B Party, any of its tonnes of carbon
equivalent emissions allowed for a budget period, for
the purpose of meeting its obligations under Article 2.
041 0191
-2-
6.2 An Annex A or Annex B Party may not transfer or
acquire any of its tonnes of carbon equivalent
emissions allowed if it is not in compliance with its
obligations under Article 3 (Measurement and
Reporting) or if it does not have in place a national
mechanism for certification and verification of trades.
6.3 An Annex A or Annex B Party may not transfer in a
given budget period any of its tonnes of carbon
equivalent emissions allowed if it has exceeded its
emissions budget for that period.
6.4 If a question of a Party's implementation of the
requirements referred to in paragraph 2 or 3 above is
identified by either the review process under Article
4.5 or by the Secretariat under Article 11.2 (b) :
-- transfers and acquisitions of tonnes allowed (in
the case of paragraph 2) and transfers of tonnes
allowed (in the case of paragraph 3) may continue
to be made after the question has been
identified, provided that any such tonnes may not
be used by any Party to meet its obligations
under Article 2 until any issue of compliance is
resolved. Issues of compliance shall be resolved
as expeditiously as possible.
6.5 A Party may authorize any domestic entity (e.g.,
government agencies, private firms, non-governmental
organizations, individuals) to participate in actions
leading to transfer and acquisition under paragraph 1
of tonnes of carbon equivalent emissions allowed.
6.6 The Parties, at a meeting, may further elaborate
guidelines to facilitate the reporting of emissions
trading information.
In Article 10 of the U.S. proposal (Meetings of the
Parties), for paragraph 4, substitute the following text:
10.4 The Parties:
(a) Protocol; shall periodically review the adequacy of this
(b) shall review the implementation of this Protocol,
including the information submitted in accordance
with Articles 3 and 5, reports received from the
review teams referred to in Article 4, and any
other reports and recommendations received from
processes under this Protocol;
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13:01
0202 041 0191
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(c) shall implement an appropriate regime
to address cases of non-compliance with
obligations under this Protocol, including
through the development of an indicative list of
consequences, taking into account the type,
degree, and frequency of non-compliance;
(d) may establish an implementation committee
consisting of a subset of Parties to assist them,
including by making recommendations, in carrying
out functions referred to in subparagraphs (b)
and (c) above.
In Article 11 of the U.S. proposal (Secretariat),
for paragraph 2, substitute the following:
11.2 The functions of the secretariat shall be:
(a) to maintain and administer records relating
to the accounting of the emissions budgets
of Annex A and Annex B Parties, including
initial budget allocations, adjustments to
budgets consistent with Articles 2, 6, and
7, annual emissions, and remaining budgets
in a given budget period;
(b) to facilitate the review of implementation
of this Protocol through, inter alia,
coordinating the review of Annex A and Annex
B implementation; coordinating the reviews
under Article 5; identifying for the Parties
questions of implementation, including
whether individual reports are consistent
with reporting criteria; and preparing an
annual compilation and synthesis report that
contains inventory and budget information,
and notes any discrepancies in accounting.
(c) [other]
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