Economic impact of abatement strategies

One of the studies referred to above included estimates of the macroeconomic consequences of the proposed emission reduction measures (Australian Commission for the Future 1991). The ACF study is the one in Australia to date which integrates the results of 'bottom up', technology-specific energy modelling with a 'top down' macro-economic model. Two levels of abatement were analysed the demand side measures only, falling somewhat short of emission stabilization; and the demand and electricity supply measures combined, achieving the Toronto target, as described above. The major impact on the economy in both cases comes from the surge in investment expenditure needed to pay for the new, more efficient energy-using and energy-supply equipment. This strategy requires diverting economic resources from consumption to investment, with the result that consumption expenditures fall.

Since the ACF study found that most of the demand side measures were cost effective relative to expected energy prices, it is not surprising that aggressive deployment of these measures alone yields net macro-economic benefits over the long term, as measured by a slightly higher rate of GDP growth than in the base case. Achieving the Toronto target requires that Australia diverts a higher proportion of resources to energy-related investments and that the average unit cost of energy is higher than in the base case. Thus, GDP growth is lower than in the base case by between a half and one per cent, depending on assumptions about how the economy adjusts to change. This outcome is obviously a relatively small change, much less than the changes associated with the normal ups and downs of economic activity. One reason for the change being so small is the study's assumption that Australia takes a unilateral decision to limit greenhouse gas emissions. Domestically produced fossil fuel resources, particularly coal and petroleum, are therefore available to be exported if not required for domestic consumption.

Other economic studies have sought to model the effects of measures to reduce greenhouse gas emissions on the Australian economy or particularly vulnerable sectors of it, most of which have been summarized by the Industry Commission (1991). These studies share the following common features:

1 a 'top clown' approach to modelling the Australian energy economy;
2 the use of a carbon tax as the policy instrument by which emission abatement will be achieved;
3 a focus on the cost of achieving only the Toronto target, with no analysis of the costs of lower levels of abatement;
4 no allowance for improvements in technology which could increase the efficiency of energy supply and use without increasing costs.

This approach assumes that all markets for energy services are perfectly competitive, that is, energy is used throughout the economy with optimal technical efficiency and no cost-less opportunities for efficiency improvement are available. It follows that an increase in energy prices by means of a carbon tax is needed to induce any change in technical efficiency. Of course, this assumption varies sharply from the findings of the sectoral energy use studies described above.

Disagreement over this issue is by no means confined to Australia, but is a persistent theme around the world in debates over energy and greenhouse emissions (see for example Manne and Richels 1990; Williams 1990; Nordhaus 1991). Some have characterized this as a disagreement in perspective between economists and engineers. It could perhaps be more accurately described as a disagreement between those who sit behind desks and theorize about the economy; and those who go out to visit factories and building sites and talk to people who are making decisions about energy-using equipment.

The most detailed study of this kind was undertaken by the Industry Commission (IC) itself (1991). The IC estimated that a carbon tax of A$80 (1988 prices) per tonne of carbon (equivalent to about US$60 per tonne) would be required to reduce emissions to the Toronto target. A tax at this rate was found to reduce GDP by 2 per cent. The effect on the output of the energy industries was considerably greater - the output of the coal industry fell by 26 per cent, that of the electricity industry by 11 per cent, and of the gas industry by 19 per cent. This last result diverges strikingly from the results of the bottom up, technology oriented studies, which project an increase in gas industry output as gas is substituted for coal and electricity. It would appear that the substitution elasticities (between factors of production and between fuels) used in the macro-economic model used for this study do not accurately represent the realistic technical possibilities available in the Australian energy system. The IC recognizes the inadequacies of the modelling approach it has used, commenting that the work has been undertaken for 'illustrative purposes'.

Not surprisingly, given the different assumptions, this estimate of the GDP cost of abatement is somewhat higher than that from the previously cited ACF study. The Industry Commission study assumed that the revenue raised by the carbon tax would offset direct taxes (income tax and company tax). Somewhat surprisingly, it did not model the effect of offsetting the carbon tax by reducing another consumption tax or related tax, such as payroll tax, which is currently the focus of some policy debate in Australian politics. A recent study of the US economy concluded that a moderately severe gasoline tax (a form of one-sector carbon tax) would depress GDP and consumption if the revenue were used to reduce either the budget deficit or direct taxes, but would have virtually no effect on economic activity if used to reduce payroll taxes (Brinner et al, 1991).