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An Economic Perspective on Climate Change Policies

A monograph published February 1996 by the ACCF Center for Policy Research.

Introduction

Over the past decade and a half, the ACCF Center for Policy Research has sponsored groundbreaking research on tax and environmental policies to encourage capital formation. The Center has also underwritten a series of blue-ribbon forums on the impact of environmental policy on U.S. capital costs, investment, and economic growth.

This volume contains the edited papers presented at the Center's September 1995 symposium, "An Economic Perspective on Climate Change Policies." The research presented at the Center's forum analyzed, for the first time, how alternative policies to address climate change would impact both U.S. economic growth, the world economy, and concentrations of carbon dioxide (CO2) in the atmosphere.

This research is extremely timely because policies and plans to restrict CO2 emissions are receiving increased attention in the international community as well as in the United States. The 1992 Rio de Janeiro conference produced the Framework Convention on Climate Change, which 160 nations signed. In Berlin in March 1995, the Conference of the Parties to the Framework Convention on Climate Change met and set up a process that would "aim to elaborate policies and measures" as well as "to set quantified limitation and reduction objectives within specified time frames, such as 2005, 2010, and 2020, for greenhouse gas emissions by sources and removals by sinks." This process is to be completed six months prior to the Conference of the Parties currently scheduled for the third quarter of 1997.

A major reason for analyzing the economic impact of climate change policies under discussion is that stringent near-term actions to reduce U.S. emissions will, as demonstrated in the papers included in this volume, reduce U.S. saving, investment, and economic growth with little or no benefit in terms of global CO2 emissions or concentrations in the atmosphere.

Between 1963 and 1994, real U.S. gross domestic product (GDP) increased at an average rate of 3.1 percent per year. The average growth rate of 3.1 percent over the past thirty years marks an important point: growth over the 1963-1972 period averaged 4.2 percent compared to a relatively slow 2.6 percent over the past two decades.

Investment spending in the United States in recent years compares unfavorably with that of other nations as well as with our own past experience. From 1973 to 1992, gross nonresidential investment as a percentage of GDP was lower for the United States than for any of our major competitors. The U.S. net saving rate during the same period was also low relative to other countries, averaging 4.6 percent compared to 19.0 percent in Japan, 10.6 percent in Germany, and 7.5 percent in Canada.

Even more disturbing is the fact that net business investment in this country has in recent years fallen to only half the level of the 1960s and 1970s. Net private domestic investment averaged 7.2 percent of GDP from 1960 to 1980; since 1991 it has averaged only 3.4 percent. The U.S. net domestic saving rate, a key determinant of U.S. investment, has also fallen sharply, from an average of 7.6 percent in the 1960-1980 period to only 2.2 percent in the 1990s. While larger federal budget deficits are part of the reason for the saving rate's decline, personal and business saving rates have also declined. U.S. saving and investment rates must increase if U.S. workers are to enjoy better jobs and higher living standards, and if this country is to retain its leading role in world affairs.

Given the need to increase U.S. economic growth, policymakers should weigh carefully the pros and cons of near-term reductions in U.S. CO2 emissions. In his study, "Developing a Framework for Short- and Long-Run Decisions on Climate Change Policies," presented at the Center's forum, W. David Montgomery of Charles River Associates advocated an economically rational approach to climate change policies that addresses three related questions: (1) What actions can be supported on the basis of current understanding of climate science and economics; (2) How to make the best use of the new information that current scientific research and technology development will provide; and (3) When should emission reductions begin? Montgomery argued that the Berlin Mandate prejudges all these issues by concentrating on near-term targets for emissions from industrial countries. He also suggested that "Specific policies and measures must be evaluated, not general goals. No goal can be assessed without specifying the policies likely to be used to achieve it."

Stanford Professor Alan S. Manne's research for the Center forum concluded that "an aggressive CO2 abatement policy is unwarranted for the near term." He did not discount the possibility of global warming, but noted that CO2 buildup is not likely to cause a near-term rise in global temperatures. The most prudent course of action for the next several decades, he argued, is a " hedging strategy" that delays taking strong measures to reduce CO2 emissions until more is known about specific risks to the environment.

The consensus of the scholarly research on the costs and benefits of emission reduction presented at the ACCF Center for Policy Research's forum is that stabilization of CO2 concentrations in the atmosphere should be a gradual process which would take place over the next 75 to 100 years. As Jae Edmonds and Marshall Wise of Battelle, Pacific Northwest Laboratories pointed out in their study, minimizing the economic burden to society of reductions in CO2 emissions would require three distinct but related stages. First, from 1995 to 2020, carbon emissions should be allowed to rise approximately as forecasted. Second, from 2020 to 2050, emissions growth would rise very slowly, then level off as new energy technologies gain widespread use. Third, from 2050 to 2100, emissions would decline to 1990 levels as carbon-emitting technologies are phased out. Adopting a climate change policy such as that advocated by Edmonds and Wise would both enhance U.S. and global economic growth and lead to long-term stabilization of carbon concentrations in the atmosphere.

The impact of CO2 reductions on consumer lifestyles was analyzed at the Center forum by Lawrence M. Horwitz of DRI/McGraw-Hill. He found that reducing greenhouse gas emissions through the use of carbon taxes to 1990 levels would reduce GDP by 2.3 percent by 2010 or $832 less for every adult that year, and would have a significant negative impact on expenditures such as household electricity consumption, purchase of consumer durables, and other goods and services.

Kenneth Richards of Batelle, Pacific Northwest Laboratories presented an assessment of prospects for joint implementation of CO2 reductions and described the importance of developing a system with relatively low transaction costs. He concluded that only modest results can be expected due to the low level of incentives for joint implementation provided by the Framework Convention and the subsequent decisions of the Conference of the Parties.

Thomas F. Rutherford of the University of Colorado analyzed the impact of CO2 restrictions on international trade and competitiveness. He found that CO2 restrictions would cause many industries in developed countries to be vulnerable and would result in substantial adjustment costs. The costs of unilateral carbon restrictions would be magnified by trade with nonparticipating regions. There would also be significant "leakage" in CO2 emissions as energy-intensive industries migrate to nonparticipating countries.

The forum's keynote address was given by Senator Frank H. Murkowski (R-AK), chairman of the Committee on Energy and Natural Resources. Senator Murkowski supported the need to back climate change negotiations with rigorous economic analysis to insure that the consequences of mandated greenhouse gas reductions for U.S. growth, jobs, and the economy as a whole are known.

The ACCF Center for Policy Research is grateful to our presenters and respondents for their contributions that made this symposium and book possible.

The Center will continue to focus its attention and resources on economic growth through sound tax and environmental policies. We look forward to sharing new information, analyses, and proposals with you, and welcome your thoughts and inquiries about this and all other ACCF Center for Policy Research programs.

Charls E. Walker
Chairman

Mark A. Bloomfield
President

Margo Thorning
Director of Research