The Kyoto Protocol, Climate Change Policy,
And U.S. Economic Growths

American Council for Capital Formation
October 1998
By Margo Thorning

Executive Summary

For more than two decades, the ACCF Center for Policy Research has sponsored groundbreaking research on tax and environmental policies to encourage capital formation and enhance environmental quality. As the United States prepares for a series of meetings over the next year to develop policies to comply with the Kyoto Protocol to limit future carbon emissions, beginning with the Conference of the Parties in Buenos Aires in November, 1998, the Center offers this Special Report to help focus the climate debate regarding economic policy issues.

Introduction

Research conducted over the past decade for the ACCF Center for Policy Research by top climate change scholars such as Professor Gary W. Yohe of Wesleyan University, Professor Alan Manne of Stanford University, Dr. Richard Richels of EPRI, Ms. Mary H. Novak of WEFA, Inc., Dr. W. David Montgomery of Charles River Associates (CRA), and Dr. Joyce Brinner of Standard & Poor's DRI, and others, concludes that the cost of stabilizing carbon dioxide (CO₂) emissions in the near term would impose a heavy burden on U.S. households and industry. These studies, as well as the U.S. Department of Energy's Energy Information Administration report released October, 1998, stand in sharp contrast to the optimistic projections contained in the Administration's economic analysis which was prepared by the Council of Economic Advisers (CEA), released in July, 1998.

This Special Report is based on testimony delivered before the Subcommittee on Energy and Power of the House Committee on Commerce on October 6, 1998, as well as studies sponsored by the ACCF Center for Policy Research, all available at accf.org. These studies, some of which were released at the Center's September 23, 1998, symposium, Climate Change Policy: Practical Strategies to Promote Economic Growth and Environmental Quality, describe the economic costs of near-term limitations on growth in U.S. carbon emissions; the limitations of engineering studies in predicting the pace of technological change; issues for developing an international trading system for CO₂ emissions as well as other policy issues; and long-term options for stabilizing CO₂ concentrations.

Four key issues for U.S. climate policy are addressed in this Special Report:

• The impact of CO₂ reductions on U.S. economic growth;
  
  
• The Administration (CEA)'s economic analysis of the Kyoto Protocol;
  
  
• U.S. goals for Buenos Aires; and
  
  
• Strategies for the future.

Economic Impact of Emission Reductions

A broad range of estimates from climate policy experts in academia, consulting firms, and the Department of Energy's Energy Information Administration show that near-term stabilization at the Kyoto Protocol target of 7 percent below 1990 levels would reduce U.S. GDP growth by about 1.0 percent to over 4.0 percent annually (see Figure 1). This translates into losses of $100 billion to almost $400 billion in GDP each year compared to the baseline forecast for energy use. GDP losses of this magnitude would make the funding of other national priorities more difficult. For example, "saving" the Social Security system through tax increases so that today's baby boomers are able to enjoy the same level of benefits that the current retired generation receives would require substantially higher federal taxes: an additional $80 billion in 1998 rising to $90 billion annually (in inflation-adjusted dollars) by 2010. Thus, even the lowest-cost estimate for stabilizing emissions exceeds the cost of preserving Social Security.

 

Figure 1	Impact of Stabilizing CO2 Emissions on U.S. GDP Growth, 2008-2012

International trading of emissions permits would reduce the cost of near-term stabilization considerably, although experts agree that full global trading (involving developing countries such as China and India) is unlikely in the near term and that many complexities remain (see Manne and Richels, "Economic Impacts"). Even if developing countries agree to participate fully, two major obstacles to developing a trading system would remain: allocating CO₂ emissions rights and distributing the revenue (see Ellerman, "Obstacles to Global CO₂Trading"). Note that the Administration's cost estimate, which assumes full global trading, is only 0.01 percent of GDP, a tiny fraction of what a range of respected climate policy experts predict.

Costs for tradable permits to emit a ton of carbon are another measure of the burden which near-term emission stabilization would place on the U.S. economy. These costs, which vary dramatically depending upon how much trading takes place, range from about $120 per metric ton to $348 per metric ton for stabilizing U.S. emissions at the Kyoto target. (Note: further reductions beyond the Kyoto target are contemplated by the Administration.) The Administration (CEA)'s estimated tradable permit price, which assumes full global trading, is only $14 per ton.

U.S. consumers suffer declines in wage growth and the distribution of income worsens under CO₂ stabilization policies. Professor Yohe estimates that stabilizing emissions at 1990 levels (the pre-Kyoto target) would reduce wage growth by 5 to 10 percent annually, and that the lowest quintile of the population would see its share of the economic "pie" shrink by about 10 percent (see "Climate Change Policies"). Texas A&M University professor John Moroney estimates that U.S. living standards would fall by 15 percent under the Kyoto Protocol compared to the base case energy forecast (see "Energy").

U.S. households also face much higher prices for energy under near-term stabilization. A range of estimates by various experts concludes that prices for gasoline would rise from almost 30 percent to over 50 percent and that electricity prices would go up by anywhere from 50 percent to over 80 percent (see Figure 2). The Administration (CEA) predictions (a 2.7 percent increase in gasoline prices and 3.4 percent higher prices for electricity) are far below those of widely respected climate policy modelers.

Figure 2	U.S. Household Energy Costs: Impact of Stabilizing CO2 Emissions, 2008-2012

U.S. competitiveness also declines under near-term stabilization policies. Professor Manne and Dr. Richels predict that the output of the energy-intensive sector of the economy (including paper, oil, chemicals, and steel) would fall by 15 percent by 2020 (see "Economic Impacts"). U.S. exports of agricultural products also drop due to higher energy prices required to stabilize CO₂ emissions (see Francl et al., "Impact on Agriculture").

The Administration (CEA)'s Economic Analysis Is Seriously Flawed

The Administration's July, 1998, economic analysis of the impact of stabilizing CO₂ emissions at 7 percent below 1990 levels is seriously flawed for three reasons:

• The Administration (CEA)'s cost estimates assume full global trading in tradable emissions permits (including trading with China and India). Most top climate policy experts conclude that this assumption is extremely unrealistic since the Protocol does not require developing nations to reduce their emissions and many have stated that they will not do so.
  
  
• The Administration (CEA)'s cost estimates assume that an international CO₂ emissions trading system can be developed and operating by 2008-2012. This assumption is unrealistic, according to Professor Ellerman's analysis (see "Obstacles to Global CO₂ Trading").
  
  
• The cost estimates are based on the Second Generation Model (SGM) developed by Pacific Northwest National Laboratory. The SGM appears to assume cost-less, instantaneous adjustments in all markets; the model is not appropriate for analyzing the Protocol's near-term economic impacts, according to Dr. Montgomery. As Massachusetts Institute of Technology professor Henry Jacoby observes, there are no short-term technical changes that would significantly lower U.S. carbon emissions (see "Technology Development").

Goals for the Buenos Aires Meeting

U.S. objectives should include:

• Developing an international trading system in order to realize the cost saving yielded by reducing emissions where it is cheapest--i.e., "where" flexibility.
  
  
• Securing emission reduction commitments from all developing countries. Most new emissions will come from developing countries; thus, their participation is essential if CO₂ emissions and concentrations are to be reduced (see Figure 3; and Manne and Richels, "Economic Impacts").

Figure 3	Global Carbon Emissions: Reference Case
Source: Manne and Richels, October 1998

• Avoiding caps on the amount of emissions trading that can take place.
  
  
• Clarifying the role of the developed countries that will be paying the bills in flexible mechanisms, i.e., joint implementation, the Clean Development Mechanism, and emissions trading.

Strategies for the Future

If, as knowledge of climate systems increases, policy changes to reduce CO₂ emissions become necessary, these changes should be implemented in a way that minimizes damage to the U.S. economy. Climate policy experts such as Jae Edmonds, Jim Dooley, and Sonny Kim of Pacific Northwest National Laboratory state that, given the current scientific knowledge of climate systems, the major focus of U.S. climate policy should be increased R&D in energy-efficient technologies. In addition, they conclude that the introduction of carbon capture and sequestration techniques would enable the economy to rely less heavily on carbon-neutral technologies such as commercial biomass harvesting and solar power (which are at an early stage in their technological development) to achieve a particular concentration level, and could reduce the cost of keeping under the 550 parts per million by volume ceiling by more than 70 percent (see "Long-Term Energy Technology"). As Professor Manne and Dr. Richels note, U.S. climate policy should also strive to take advantage of "when" flexibility in reducing CO₂ emissions in order to cut global concentrations over the long term in a cost-effective manner (see "Economic Impacts").

In short, the consensus of the noted climate policy scholars is clear. Given the need to increase U.S. economic growth to address such challenges as a growing population, the retirement of the baby boom generation, and a persistent trade deficit, policymakers need to weigh carefully the Kyoto Protocol's negative economic impacts and its failure to engage developing nations in meaningful action. Adopting a thoughtfully timed climate change policy-based on science, improved climate models, and global participation-is essential to U.S. and global economic growth.

Sources Cited

Bernstein, Paul M., and W. David Montgomery. "How Much Could Kyoto Really Cost? A Reconstruction and Reconciliation of Administration Estimates." Washington, D.C.: Charles River Associates.

Brinner, Joyce. Presentation at symposium sponsored by the American Council for Capital Formation Center for Policy Research, Climate Change Policy: Practical Strategies to Promote Economic Growth and Environmental Quality, National Press Club, Washington, D.C., 23 September 1998.

Council of Economic Advisers, The Kyoto Protocol and the President's Policies to Address Climate Change: Administration Economic Analysis, July 1998.

Edmonds, Jae, Jim Dooley, and Sonny Kim. October 1998. "Long-Term Energy Technology: Needs and Opportunities for Stabilizing Atmospheric CO₂ Concentrations." Washington, D.C.: American Council for Capital Formation Center for Policy Research.

Ellerman, A. Denny. October 1998. "Obstacles to Global CO₂ Trading: A Familiar Problem." Washington, D.C.: American Council for Capital Formation Center for Policy Research.

Francl, Terry, Richard Nadler, and Joseph Bast. October 1998. "The Impact of the Kyoto Protocol on Agriculture." Washington, D.C.: American Council for Capital Formation Center for Policy Research.

Jacoby, Henry D. October 1998. "The Uses and Misuses of Technology Development as a Component of Climate Policy." Washington, D.C.: American Council for Capital Formation Center for Policy Research.

Manne, Alan S., and Richard G. Richels. October 1998. "Economic Impacts of Alternative Emission Reduction Scenarios." Washington, D.C.: American Council for Capital Formation Center for Policy Research.

Moroney, John. October 1998. "Energy, Carbon Dioxide Emissions, and Economic Growth." Washington, D.C.: American Council for Capital Formation Center for Policy Research.

Novak, Mary H. April 1998. Global Climate Change, Environmental Quality, and U.S. Living Standards: The Impact on Consumers. In The Impact of Climate Change Policy on Consumers: Can Tradable Permits Reduce the Cost?, 3-18. Washington, D.C.: American Council for Capital Formation Center for Policy Research.

U.S. Department of Energy, Energy Information Administration, Office of Integrated Analysis and Forecasting. October 1998. "Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity." Washington, D.C.

Yohe, Gary W. June 1997. Climate Change Policies, the Distribution of Income, and U.S. Living Standards. In Climate Change Policy, Risk Prioritization, and U.S. Economic Growth, 13-54. Washington, D.C.: American Council for Capital Formation Center for Policy Research.