American Geological Institute

Government Affairs Program


Reports on Potential Economic Impacts of Binding Emissions Reduction Standards (11-20-98)

A number of economic impact studies have been performed recently in an attempt to pinpoint the economic impacts of reducing carbon emissions. They are summarized below. The Administration's Interagency Analytical Team released a draft report of an interagency study in July 1997. The Department of Energy contracted with the Argonne National Laboratory to perform a series of workshops involving industry representatives. The World Resources Institute also published a report dealing with the assumptions of economic modeling. Information from these studies is included below. Janet Yellen presented the Administration's preliminary analysis of the costs of complying with the Kyoto Protocol at congressional hearings in March 1998. Those findings were finalized in July but were contradicted by an October 1998 Energy Information Administration analysis and a Standards and Poor assessment. Overall, however, the economic studies that have been performed thus far indicate that the economy will be able to absorb the effects of binding emissions targets if appropriate targets and implementation schemes are selected.

Background
In Kyoto, Japan last December, the U.S. and other nations negotiated a treaty to stabilize and reduce greenhouse gas emissions. There is widespread consensus that any emissions restrictions will have economic impacts. However, whether those impacts are positive or negative will depend on how the emissions standards are implemented. The current treaty calls for binding emissions standards for developed nations only. In contrast, developing nations would be faced with voluntary emissions reductions, with the possibility of phasing in binding commitments over time. Such a policy has the potential to negatively impact the competitiveness of U.S. industry. The Senate has already indicated that it will not stand for such a policy. The Byrd Resolution, Senate Resolution 98, states that the U.S. should not be a signatory to any treaty or protocol that would harm the U.S. economy and that does not hold developing countries to the same mandates as developed countries. On July 25, 1997, the Senate voted 95-0 to approve S. Res. 98. On the other hand, a policy strategy that employs market-based mechanisms and incentives to industry and developing nations might actually promote economic growth. According to Dr. Janet Yellen, Chair of the President's Council of Economic Advisors, "it just boils down to this. If we do it dumb, it could cost a lot, but if we do it smart, it will cost much less, and indeed could produce net benefits in the long run."

When Yellen speaks of "doing it smart," she is referring to the many strategies for minimizing the potential economic hazards of global emissions standards. These strategies include: revenue recycling, joint implementation, reliance on market-based mechanisms to achieve the defined goals, and setting up an international market for emissions permit trading. Revenue recycling involves using the revenues generated through policy mechanisms to make cuts in other more burdensome taxes on labor and capital, such as income and payroll taxes. This revenue strategy can stimulate, rather then retard, economic growth. Joint implementation is a strategy that awards credit to U.S. firms for undertaking emissions reductions in countries with low abatement costs. International joint implementation would allow a major multinational company to achieve a targeted emissions reduction by energy-saving measures at any of its facilities around the world. In order to retain emissions reductions within the market structure, several economists have suggested that U.S. policy employ a market-based mechanism to achieve the desired reductions. Dr. Dale Jorgenson, a Harvard economist, recommended a carbon tax to achieve emissions reduction goals in testimony before the Senate Environment and Public Works Committee. Dr. Jorgenson's proposal conforms to the Economists' Statement on Climate Change, a statement sent to the members of the American Economic Association and endorsed by "over 2,000 economists including six Nobel laureates." An additional strategy to reduce the potential economic impacts of emissions standards is more controversial: a system of permit trading. The Sierra Club has stated its opposition to such a policy, claiming that trading schemes are fundamentally unenforceable. On the other hand, the Environmental Defense Fund has come out in favor of international permit-trading schemes.

For more background information on climate change, visit the update and hearing summary on this site, or the Committee for the National Institute for the Environment (CNIE) website, which includes reports from the Congressional Research Service on climate change and other environmental issues. Included are "Global Climate Change" and "Climate Change: Three Policy Perspectives." CRS reports are also available by calling your local representative or senator.

The Economists' Statement on Climate Change

The Economists' Statement on Climate Change -- endorsed by over 2500 Economists including eight Nobel Laureates provides a three-pronged statement:

The Interagency Analytical Team (IAT) Study
In July 1997, the Clinton administration released a long-anticipated draft report of the economic effects of climate change options. The study was conducted by an interagency team consisting of members from the Department of Energy (DOE), the Environmental Protection Agency, and the Departments of Commerce, Treasury, Labor, and State. By using a "starting point scenario" where carbon dioxide emissions in the U.S. were reduced to 1990 levels by 2010, the report found that the implicit price of carbon would increase by about $100 per ton - a $52.52 per ton price increase for coal. The administration does acknowledge that the cost of complying with such reductions would fall mainly to energy producers, but the draft report also concludes: "These higher energy costs would produce GDP losses, at peak, between .02 percent and .01 percent of GDP. The economy would therefore bounce back, or in the worst case stabilize, so that it would soon reach its pre-policy growth path."

The IAT study utilized three economic models with different strengths and weaknesses in their analysis. According to Yellen, the one clear conclusion reached by the study is that "the effort to develop a model or set of models that can give us a definitive answer as to the economic impacts of a given climate change policy is futile." Rather, economic modeling offers a "range of potential impacts." The study found that a policy which allows for flexibility in both the timing and the location of emissions reductions and employs the economic strategies discussed above may produce net economic benefits in the long run. While the study acknowledged that some industries (energy-intensive) will face greater losses, they found "no evidence of a wholesale 'capital flight' from the U.S. resulting from an emissions reduction policy."

The National Mining Association, on the other hand, believes the potential results to be much more dramatic. In an NMA study, it was found that American coal, which produces 57 percent of the nation's energy, would experience a 173 percent increase in price and a 25 percent production decrease as a result of a $100 per ton increase. Coal interests, and most of industry for that matter, label Clinton's draft report as inaccurate.

The Argonne National Laboratory Study
The Argonne National Laboratory released the results of a study performed in 1996 entitled, "The Impact of High Energy Price Scenarios on Energy Intensive Sectors: Perspectives From Industry Workshops." The study examined the effects of large, hypothetical energy price increases on six energy-intensive industries by holding a series of six workshops for industry representatives. Representatives from the basic chemicals, aluminum, steel, paper and allied products, petroleum refining, and cement industries were presented with energy price increases and asked to comment on the expected effects in the following categories: the competitive positions of U.S. producers, the impacts on output and unemployment, and the locations where plants will be most likely to open and close. The price scenarios presented were based on analyses of proposals advanced by other countries at the time, and do not reflect the policies currently advocated by the administration. The scenarios also do not take into account the impact of economic mitigation strategies, nor do they include obligations for developing countries. The Department of Energy has since referred to the price scenarios examined as "outdated" and "restrictive."

Not surprisingly, under these prohibitive pricing conditions, the effects on the U.S. economy are severe. In general, the industry representatives predicted significant dislocation of U.S. industry to developing nations and significant reductions in output and employment. More specifically, all of the primary aluminum plants in the country would close by the year 2010 and the basic chemicals industry would experience job losses as high as 200,000. In addition, it is likely that environmental objectives would not be achieved as emissions would simply be redistributed and could even increase if investments made in non-participating countries are less energy-efficient. The study certainly points out the wrong way to enact binding emissions policy.

The DOE press release concludes, "what we have learned affirms the wisdom of this administration's approach - to negotiate an agreement based on a set of flexible policies and the participation of all nations."

The World Resources Institute Study
An economic study recently released by the World Resources Institute (WRI), entitled "The Costs of Climate Protection: A Guide for the Perplexed," examined sixteen widely-used economic models and identified the key assumptions which account for more than eighty percent of the disparities in model predictions. Some economic models predict that reducing harmful greenhouse gas emissions will cause a sharp fall in GDP. Others predict that reducing greenhouse gases will stimulate growth. The assumptions pinpointed by the study include the following: whether non-fossil energy alternatives will be available at comparable prices, whether expenditures will be reallocated efficiently, whether joint implementation and permit trading strategies are considered, whether revenue recycling is implemented, and whether reduced fossil fuel consumption will decrease air pollution. The study examined the same policy as the IAT study described above, stabilizing carbon dioxide emissions at 1990 levels by the year 2010.

Under the most favorable assumptions, the study projected a potential 2.4% increase in GDP by the year 2020. Under the most unfavorable assumptions, the study predicts a GDP decrease of 2.4% by the year 2020. The point of agreement uncovered by all of the models analyzed was that "the economic impacts will be much more favorable if policy instruments such as carbon taxes or auctioned emissions permits are used to achieve carbon reduction targets and the revenues are used to make cuts in other taxes." And in future reading of economic impact studies, a WRI word to the wise: "When you hear a prediction about the economic impact of climate protection policies, remember to ask what the underlying assumptions are..."

White House Estimate of Costs

In March 1998, Janet Yellen, chairwoman for the White House Council of Economic Advisors, testified before the House Commerce Energy and Power Subcommittee that the projected expense for the United States to meet the terms of the recently formed Kyoto Protocol would be "modest," especially in comparison to much higher costs associated with not immediately acting to control human-produced greenhouse gas emissions, according to a new analysis from the administration. The report concluded that total U.S. Kyoto-related costs starting in 2008 would be between $7 billion to $12 billion per year and there would be an annual energy price increase per household of between $70 and $110. Yellen's findings assume President Clinton succeeds in ensuring the participation of key developing nations and resolves other technical issues to the Senate's liking. The council also optimistically takes into account the economic benefits of restructuring the electric utility industry and the enactment of unspecified policies to step up energy efficiency between now and the agreement's deadline of 2012.

"A comprehensive evaluation of the economic impacts of the Kyoto Protocol must integrate all of the factors described above: reliance on flexible market-based mechanisms domestically; international trading and joint implementation among Annex I countries; the Clean Development Mechanism; meaningful developing country participation; the potential cost-mitigating role of including six gases and carbon sinks [carbon sequestration from forests]; the benefits of electricity restructuring; and emissions reductions achieved as a consequence of other proposed administration climate change initiatives," Yellen said.

Other details of the report include assumptions that: electricity deregulation would produce cost savings of about $20 billion per year; emissions trading among the now-established umbrella of nations that involves the United States would cut greenhouse gas reduction costs by an estimated 60 percent to 75 percent; the Clean Development Mechanism, whereby U.S. companies would invest in emerging technologies within the developing world, would cut costs by about 20 percent to 25 percent from the reduced costs of emissions trading among Annex I nations; and implementing all existing energy-efficient technologies could cut away a third of the emissions reductions necessary to return to 1990 levels by 2010.

Furthermore, the report predicts the price of carbon-equivalent emissions to be between $14 to $23 per ton, and increased energy prices between 2008 and 2012 would be between 3 percent and 5 percent. This breaks down to "an increase in fuel oil prices of about 5 to 9 percent, natural gas prices of 3 to 5 percent, gasoline prices of between 3 to 4 percent (or around 4 to 6 cents per gallon), and electricity prices of 3 to 4 percent," she said.

But Yellen did acknowledge the large amount of uncertainty involved in estimating the costs of implementing a protocol that has yet to be finalized in many ways. "Since the international effort to reduce greenhouse gas emissions is still in some respects a work-in-progress, it is not yet possible to provide a full authoritative analysis of it," she said.

Many business and industry groups blasted the report as far too optimistic, especially since the large developing countries have reportedly said they will not participate. Bill Kovacs of the U.S. Chamber of Commerce called Yellen's estimates "total fantasy."

Energy Information Administration
Science Committee Chair James Sensenbrenner (R-WI) and Ranking Member George Brown (D-CA) requested an analysis of the treaty from the Energy Information Administration (EIA), an independent data collection and analysis group within the Department of Energy. The EIA study shows that even if the Administration is successful during the negotiations the costs of complying with the treaty will still be much higher than estimated by the President's Council of Economic Advisors

EIA Administrator Jay Hakes presented the results of the study at a House Science Committee hearing on October 9, 1998. It examines several scenarios of reduced emissions. One end of the spectrum assumes that carbon emissions are reduced to 7 percent below 1990 levels, which would represent full compliance with the treaty through reducing greenhouse gas emissions without any emissions trading or accounting for carbon sinks. At the other end of the spectrum, the study assumes carbon emissions grow 24 percent above 1990 levels, a case requiring heavy reliance on emissions trading and credits for US carbon reductions in developing countries. Results from these scenarios were compared with a business-as-usual pathway, which assumes carbon emissions will increase 33 percent above 1990 levels.

As expected, the costs increase with the amount that emissions are reduced. Using prices based on the carbon content of each fuel as the mechanism for pricing carbon emissions, EIA estimated that under the strictest program, the price of carbon would be approximately $348/ton in 2010, which translates into a 66 cent/gallon gasoline increase over the predicted $1.25/gallon price. Even the best scenario would have carbon prices of $67/ton, leading to a 14 cent/gallon increase in gasoline. Depending on which reductions are made, the GDP will be $13 billion to $397 less than expected under a baseline business-as-usual scenario. The study points out, however, that even with the greatest impacts, the economy would still be 30 percent larger than in 1996. Over the long term, GDP would not be affected because the economy, "combined with appropriate fiscal and monetary policy, can mitigate a fairly large energy price shock."

These numbers -- even in the best scenario -- are substantially higher than the figures previously provided by the Administration. In March 1998, White House Council of Economic Advisors Chair Janet Yellen testified that the carbon price would be between $14 to $23 per ton, and energy prices between 2008 and 2012 would increase between 3-5 percent. These prices break down to "an increase in fuel oil prices of about 5 to 9 percent, natural gas prices of 3 to 5 percent, gasoline prices of between 3 to 4 percent (or around 4 to 6 cents per gallon), and electricity prices of 3 to 4 percent," she said. In his testimony, Hakes said much of the difference between the two forecasts comes from the models used: the EIA model shows the transitional effects during the 2005-2010 time frame, whereas the Administration and others models show the cumulative effects in later years, which even out costs during the transition period.

The EIA report is available on the EIA website: http://www.eia.doe.gov/oiaf/kyoto/kyotorpt.html

Standard & Poor's DRI
Standard & Poor's DRI prepared a study at the request of the United Mine Workers of America (UMWA) and the Bituminous Coal Operators' Association (BCOA). The study showed that the treaty would cause the loss of 1.3 million to 1.7 million jobs by 2005; decrease GDP by 1.1 percent to 1.6 percent on average during the 2008-2012 compliance period; and increase consumer energy prices by 24 percent to 36 percent, and producer energy prices by 49 percent to 77 percent. The study predicts real household income will fall $1,021 to $1,403 per family annually and household energy expenditures will increase $1,012 to $1,573 per family each year. In addition, the study declares that certain industries, regions and families will bear a disproportionate burden. Coal mining and energy producing sectors are hit especially hard, as are energy-intensive industries. The country's interior regions also will suffer greater harm because of their reliance on fossil fuels. Finally, low income families and senior citizens will shoulder a heavy burden because energy taxes are highly regressive. "The cost of Kyoto will fall heavily on those in our society who are least able to afford it," the report states.

Sources: The Costs of Climate Protection: A Guide for the Perplexed (WRI Report); The New York Times; Estimating the Effects of Global Climate Change Policy (IAT Report); Comments from IAT study reviewers; Impacts of High Energy Price Scenarios on Energy-Intensive Sectors: Perspectives from Industry Workshops (DOE/Argonne Report); Dr. Janet Yellen, statement before the House Commerce Subcommittee on Energy and Power (7/15/97); Greenwire; Energy and Environment Weekly; Dr. Dale Jorgenson, statement before the Senate Committee on Environment and Public Works (7/10/97); The Washington Post


Please send any comments or requests for information to the AGI Government Affairs Program at govt@agiweb.org.

Contributed by Jenna Minicucci, AGI Government Affairs Intern and Kasey Shewey White, AGI Government Affairs Program
Last updated November 20, 1998