Global Climate Change Policies: The Impact on Economic Growth, U.S. Consumers, and Environmental Quality

Special Report Summary

This WEFA study examines the economic impact of climate change policies that would stabilize U.S. carbon emissions at 1990 levels by 2010.While the analysis was completed before the Clinton Administration released its climate mitigation proposal in October 1997, the assumptions in this study are similar to those in the Administration’s proposal, the major difference being that WEFA follows the 1995 “Berlin Mandate” which exempts developing nations from having to reduce carbon emissions. Although the Administration has called for participation by developing countries at some future date, binding commitments by China, India, and others to reduce emissions are highly unlikely. In addition, the Administration proposal calls for unspecified reductions below 1990 levels in the five years following the 2008-2012 period. Thus, WEFA’s analysis for the 2010-2020 period underestimates the impact of the Administration’s proposal because WEFA assumed stabilization at 1990 levels.

Stabilizing carbon emissions at 1990 levels by 2010 would, through its impact on energy costs, act as a series of mini-shocks on the U.S. economy much like the Arab oil embargo and the Iranian oil crisis. The plan would permanently reduce economic performance; GDP would be 2.4 percent lower in 2010 and 1.7 percent lower in 2020 than baseline estimates. The total loss of income per household would average almost $30,000 over the 2001-2020 time period. It would also put the U.S. economy at a competitive disadvantage, and reduce resources available for needs such as education, health care, and aid to low-income households. Households would be squeezed between higher costs for essential goods and services and lower income. Further, unless developing countries participate in the plan, the impact on global carbon emissions would be relatively small. 

Introduction

There has been considerable debate about whether increasing concentrations of carbon dioxide and other gases, referred to as greenhouse gas (GHG) emissions, are causing or would cause significant global warming.

Despite the uncertainty about the significance of global warming and the expected high costs of plans to reduce carbon emissions, the Administration has announced a framework for a potential agreement to reduce U.S. greenhouse gas emissions. The Administration has proposed a target of reducing GHG emissions to 1990 levels for the 2008-2012 period, with undefined reductions below that level in the post-2012 period. The Administration plans to reach this target through the introduction of domestic tradable permits whose costs can be refunded to consumers. More severe constraints on GHG emissions are also on the table.

The proposed framework includes a goal of global participation in achieving specific reductions in GHG emissions. However, this goal is effectively negated as the framework would allow developing countries such as Mexico, China, India, and Brazil to participate on a much-delayed timetable.

Impact on Economic Growth

Despite projected improvements in energy efficiency of more than twice the rate experienced during the previous decade and an increasing market share of fuels which emit less carbon, the WEFA baseline projections call for carbon emissions to be 27 percent above 1990 levels by 2010 and 46 percent above 1990 levels by 2020 (see Figure 1). This increase in carbon emissions is a result of economic and demographic growth and the retirement of nuclear plants.

[Figure 1: Growth in U.S. Carbon Emissions From Energy Use
Percent increase from 1990 emission levels with no stabilization policy in place]

Stabilizing emissions at 1990 levels will require that consumers and businesses pay for a permit to consume energy, effectively causing energy prices to increase. To meet the target emission level, domestic tradable carbon permit fees of $200 per metric ton would be required by 2010. Consumers would see energy price increases of 30 percent to 55 percent over baseline projections by 2010 and 40 percent to 90 percent by 2020.

Raising the price of energy results in a prolonged series of mini-shocks to the U.S. economy. These shocks cause major changes in production patterns and processes. As with the oil price shocks in the 1970s and early 1980s, inflation increases, economic activity is reduced, and unemployment rises. Following the Arab oil embargo in 1973, real GDP fell 1 percent, and after the Iranian oil crisis, real GDP declined 2 percent.

Limiting carbon emissions from the combustion of fossil fuels would affect the overall economy through higher energy prices, as the purchaser of fossil fuel pays for a permit to consume the fuel. Since energy is used in the production of all goods and services, all other prices rise as well. Energy prices are much higher, while all other prices are affected to a lesser extent, depending on the energy content of that product. Higher prices impose a burden on the U.S. economy-workers and producers must adjust to an environment with radically different relative prices.

Though the incremental rise in the carbon permit rate might appear small each year, it imposes a rising burden on producers and consumers, necessitating an adjustment in behavior. For businesses, the rising price of energy (relative to other inputs) hurts their bottom line, discourages their use of energy, and encourages the use of more energy-efficient capital equipment and some additional labor to produce their products. Businesses respond by shifting their use of energy, labor, and capital, but the net effect is an increase in costs, which reduces U.S. real GDP growth and competitiveness in the global economy.

  • GDP Is LowerIf U.S. emissions were stabilized at 1990 levels, real GDP would be 2.4 percent below the baseline 2010 estimate, and 1.7 percent below the 2020 estimate (see Figure 2). These reductions amount to a huge economic impact. The lost GDP, just in the year 2010, is more than $227 billion (1992 dollars), approximately equal to total federal, state, and local expenditures on elementary and secondary education. From the inception of the carbon permit program in 2001 through 2020, the cumulative lost real GDP amounts to $3.3 trillion, approximately 48 percent of real GDP in 1996. Raising energy costs would put the economy on a permanently lower growth path.

[Figure 2: Real GDP: Carbon Stabilization Case and Base Case
(billions of 1992 dollars)]

  • Competitiveness Is ReducedOne key reason for the lower level of real GDP is reduced global competitiveness. Because the imposition of the carbon permit is not borne by all countries-only the developed economies of the OECD are required to reduce carbon emissions, while the developing countries are not-U.S. exports are relatively more expensive on the world market, while the price of many imported goods falls. As a consequence, exports are lowered dramatically, while imports are increased substantially. Moreover, while business investment and consumer spending begin to adjust after 2010 to the shift in energy prices, there is no reason why exports and imports would adjust. Without a major depreciation in the value of the dollar, the worsened trade balance would continue.

Consumers Caught in the Middle

  • Household Income DeclinesWhile economists often measure the impact of proposed policies using broad aggregates such as real GDP, it is important to keep in mind what these “small numbers” mean to people. Although percentage losses in real GDP and other aggregate measures can appear small, they represent billions of dollars, a significant change in standards of living, and potentially a significant change in the distribution of income among the populace.
  • On a per person or per household basis, the cost of stabilizing emissions at 1990 levels is large. Real GDP loss peaks in 2010 at $838 per person and $2,061 per household (see Table 1).
Table 1 Impact of Carbon Emission Stabilization on Consumer Income
Difference from baseline
Year Real GDP Loss per Person (1996$) Real GDP Loss per Household (1996$)
2005 $445 $1,117
2010 $838 $2,061
2015 $708 $1,715
2020 $665 $1,585

 

Employment and Wages Fall

The impact of stabilizing emissions at 1990 levels on employment and wages is substantial. Under this plan, there would be 1.8 million fewer jobs in 2010 (see Table 2). The cumulative loss of person-years of employment by 2010 is 10.1 million, and by 2020 it is 22.8 million or approximately 19 percent of the employment level in 1996.

Table 2 Impact on Employment and Wages of Carbon Emission Stabilization
Difference from baseline
Year 2005 2010 2015 2020
Employment (percent difference from baseline)
All industries -0.7 -1.3 -0.9 -0.3
Manufacturing -1.9 -2.8 -2.0 -0.5
Employment (difference in millions)
Manufacturing -0.3 -0.5 -0.3 -0.1
Wages, 1992$ (percent difference from baseline)
Avg. Hourly Manufacturing Earnings -1.3 -1.5 -1.1 -1.9
Unemployment Rate (difference) 0.6 1.2 0.8 0.3

 

Consumers face an increase in the cost of energy, encouraging them to reduce spending on gasoline, electricity, and natural gas. Some workers lose their jobs through a weaker economic environment, while other workers lose well-paying manufacturing jobs and find only lower-wage service jobs. Workers who retain their jobs would also be significantly impacted as real wages fall below baseline levels due to the increased competition for fewer jobs. By 2020, real wages in manufacturing are almost 2 percent lower due to GHG reduction policies. All workers face a slowing in their real wage growth as workers compete for fewer professional jobs or accept lower-paying jobs. Although the government compensates workers for their increased energy expenditures-through a refund of fees collected to consume carbon-based energy resources-total real disposable income falls due to reduced employment.

  • Basic Necessities Cost MoreThroughout the forecast period, food, medical care, housing, and energy continue to become more expensive under the carbon stabilization case. By 2020, food is nearly 9 percent more expensive, medical care costs roughly 11 percent more, and housing is 14 percent higher than the base case. Electricity, gasoline, and home heating oil cost 50 percent to 80 percent more by 2020 (see Figure 3).

[Figure 3: Impact on Prices Paid by Households of Carbon Emission Stabilization
Percent difference from base case]

Low-Income Households Suffer the Most

Most people would experience a significant change in lifestyle due to higher energy prices and the reduced performance of the economy caused by stabilizing emissions at 1990 levels. However, lower-income families would bear a greater share of the burden since energy consumption represents a larger proportion of their household budget.

As shown in Table 3, average household energy expenditures are regressive. Lower-income groups spend a remarkably high share of their total income on energy, ranging from 9.8 percent to 19.5 percent for families with income between $5,000 and $9,999 per year. The share falls off sharply, however, as the difference in household energy expenditures ranges from $977 to $1,809, while incomes range from $10,000 to $75,000.

Source: Energy Information Administration, Household Energy Consumption and Expenditures

 

Table 3

Expenditures on Major Fuels as a Share of Household Income
Household Income Expenditures per Household Percent of Income (range)
$5,000 to $9,999 $977 9.8-19.5%
$10,000 to $14,999 $1,051 7.0-10.5%
$15,000 to $19,999 $1,163 5.8-7.7%
$20,000 to $24,999 $1,182 4.7-5.9%
$25,000 to $34,999 $1,302 3.7-5.2%
$35,000 to $49,999 $1,379 2.75-3.9%
$50,000 to $74,999 $1,493 2.0-3.0%
$75,000 and greater $1,809 2.4%

 

  • Lifestyle Impacts From Energy Price IncreasesUnder the carbon reduction plan espoused by the Administration, residential energy prices would rise approximately 50 percent above baseline levels by 2010. Most homeowners faced with these increases would be hard-pressed to pay the additional cost, and could be expected to attempt to reduce the impact somewhat by reducing their use of energy services. Options for immediately reducing energy use include: lowering the thermostat, unplugging the extra refrigerator, reducing the use of room or central air conditioners, and using fewer entertainment appliances. Absent any of these changes, the average increase in home energy expenditure would be approximately $600 per year (a 50 percent increase in price from a base of $1,200 per annum average energy expenditure.) Cutting back on energy use is expected to reduce the average increase to $500 per year.

    Similarly, personal transportation costs could be expected to rise dramatically. Motor gasoline prices would increase nearly 36 percent by 2010 under the Administration’s plan. A typical car owner purchases approximately 720 gallons of gasoline per car each year. If a carbon permit fee of $0.50 per gallon is imposed, a homeowner’s gasoline bill would increase nearly $360 per car per annum. Most middle-income homes have 1.8-2.0 cars, resulting in an average cost increase between $600 and $800 per year. While the proposed policy would encourage the long-run turnover of the cars and light trucks, the short-run impact would be a reduction in transportation services.

Minuscule Environmental Gains

Even if the United States and other developed countries were to meet the ambitious goal of stabilizing emissions at 1990 levels, the impact on greenhouse gas concentrations would be minuscule. Due to population increases, economic expansion, and an increasing reliance on commercial fuels, the developing countries, which are not required to reduce carbon emissions, will sharply increase their carbon emissions (see Figure 4).

[Figure 4: World Carbon Emissions From Energy Use (million metric tons)]

Conclusions

WEFA’s analysis shows high economic costs of taking early actions to stabilize greenhouse gas emissions. Dramatically increasing energy costs without equivalent participation by developing countries would substantially reduce U.S. economic performance with little or no global environmental benefits.

Business investment would fall, and government tax receipts would be lower. U.S. international competitiveness would be decreased due to higher energy costs.

While the toll on all consumers would be great, low-income consumers would be particularly hard hit because the cost of energy and other basic necessities such as food, medical care, and housing would all increase substantially. The projected 35 percent to 55 percent increase in energy prices would have a dramatic impact on low-income households. The toll on lower-income consumers would be devastating.

Summary of a paper by Mary Novak, Senior Vice President, WEFA, Inc., a macroeconomic forecasting firm.This paper was prepared for a September 24, 1997, policy conference sponsored by the ACCF Center for Policy Research, and will be published in the ACCF’s forthcoming book, Climate Change Policy, Economic Growth, and Environmental Quality.