MR. ADLER: The last panel we heard was, domestic impacts of the Climate Change Treaty and in particular some of the proposals that are on the table. But obviously, any policy to reduce greenhouse gas emissions will necessarily effect other countries. Not only those countries that participate in the treaty, but as some of the speakers will discuss, even if some countries are no participating, the economic ramifications of an international treaty will be truly global.
To moderate our panel on this aspect of the issue is John Merline, who is Washington Bureau Chief of Investor’s Business Daily. John asked me not to give any more of an introduction for him than that. So with no further ado I will turn this panel over to him.
MR. JOHN MERLINE: Thank you very much. I don’t know if the planners of this conference were aware of it or not, but today happens to be the 20 th anniversary, to the day, that president Jimmy Carter announced a blue ribbon commission to study the effects of global cooling.
So the timing is fortuitous, although today obviously is a very hot day. A little story – it seems that we have an international panel here so I thought this would be appropriate. A congressional staffer, was escorting a member of a foreign delegation around Washington recently and this person was from a country that has many political parties. And he was explaining to him that in the United States we have only two major political parties: one he said is called the “Stupid party” and the is called the “Evil Party”. He explained that every so often one party comes to dominate does something either stupid or evil. But occasionally, they get together and do something that is both stupid and evil and that is was we call bi-partisanship.
Unfortunately, that could very well be the outcome of the upcoming meeting in Japan and the effects of any treaty that is signed there. Unless, I think, the public is informed about the real world effects of attempts to limit greenhouse gases. With us this afternoon is a distinguished panel of experts who will talk about the global economic effects of any such efforts. What do developing countries need to grow? How will restrictions on the use of energy effect them as well as advanced countries. With all attention focused on the alleged risks from global warming, I think that these are questions that too often not only go unanswered, but unasked.
Our speakers include Dr. David Montgomery, vice president and head of environmental practice at Charles River Associates Incorporated; Dr. Brian Fisher, executive director of the Australian Bureau of Agriculture and Resource Economics; Mr. Deepak Lal, professor of International Development Studies and the University of California at Los Angeles. I will longer introductions before each speaker begins his presentation.
First, just a few ground rules, each speaker will make a 15 minute presentation and I will enforce that with an iron fist. After which we will open the floor to any questions.
Our first speaker is Dr. Davis Montgomery – as I said, vice president and head of environmental practice at Charles River Associates Incorporated, an economic consulting firm. Prior to joining Charles River, Dr. Montgomery directed economic impact studies for the U.S. Energy Information Administration and the Office of the Secretary of Defense. He was also an assistant director at the Congressional Budget Office where he studied the economic effects of environmental and energy policies. Dr. Montgomery has led studies of the national economic effects of climate change policy, most recently developing the International Impact Assessment model. To talk about the global economic effects of cutting greenhouse gases, please welcome, please welcome Dr. David Montgomery.
DR. DAVID MONTGOMERY: Thank you, it’s a pleasure to be here today. I will join the slide turners and begin by putting up a title for my talk. The moderator and I were just having a discussion of whether he could borrow my wristwatch or not in order to enforce with an iron hand. And I decided that since we’re all in favor of volunteerism and free market approaches, I would enforce my time slot.
Well, how about if I just talk louder rather than spending any more time hooking me up. Can everybody hear me adequately? Okay.
Let me begin just with a brief review of where we stand, and key features of the negotiating process. The Conference of the Parties in Berlin set up the negotiating process that is currently going on, leading to the Kyoto and the objective of this process is to develop some kind of protocol or other legally binding instrument to be signed in Kyoto with some ground rules that were set up by the conference of parties. And there are three of them that are really important for determining the impacts on different countries. And so more for the purpose of bringing that point out than reviewing the whole process, that I wanted to begin this point.
There are three key parts of the ground rules. The first is that they are to focus on quantified emission limitation and reduction objectives. That’s the new terminology for what we used to call targets. And dates of 2005, 2010, and 2015 are the timetables that keep coming up. And these dates are very close to the present for the kinds of severe cutbacks in emissions that are being proposed in some of these targets. And the third point is that under the ground rules, the developing countries are to be excluded from any additional commitments for reducing emissions. I will bring out some of the implications of the point in looking at the international impacts.
We’ve actually been looking at the economic impacts of climate change policies in the United States, and other countries, for quite a long time. And the key, consistent finding that the countries that undertake targets and timetables, that undertake to abide by targets for near term reductions in emissions, will face significant economic costs. And we, in many ways, concentrated on those countries in the last five or six years of our analysis.
So there has been increasing attention paid in the negotiating process to what potential impacts are on countries that do not undertake commitments to reduce their emissions. That’s the subject that we began working on several years ago at Charles River Associates, to try to understand what are the actual economic implications of the negotiating process for the developing countries as well as for the advanced countries that are being asked to undertake limits on emissions. And Brian Fisher at ABARE has also been one of the leaders in addressing this set of questions.
Finally, a third point that has come out, I think, of all of the serious economic studies which has looked at this question which is that the realization that it is actually quite unnecessary for either the advanced world, the industrial world or the developing world to incur any of these kinds of costs in order to deal responsibly with climate change, no matter what one’s opinion is about the climate science and the degree of protection which is ultimately appropriate for the world’s climate and the world’s environment. It’s unnecessary to undertake, to undergo the kinds of costs that would come out of the Berlin mandate and the kind of proposals that are now being negotiated to achieve any of the benefits that someone would like to achieve. And I will try to finish up with that point.
Let me summarize the overall view of what the different proposals for reducing emissions might do to different groups of countries. I put on this chart three groups of countries. Being, OECD countries, and for today’s purposes I’m excluding from emission limits any of the emerging economies of Eastern Europe, the former Soviet Union, and other Eastern European countries, technically, as far as the Berlin Mandate goes, they’re part of Annex I countries and they’re expected to be negotiating about emission limits. We’re assuming that they will not adopt such emission limits, and are including them with the rest of the world.
The second group that we put here are the energy exporting countries, which include the oil producing countries of the Persian Gulf, but also include any countries that are — have more fixed economies and are both energy exporters and producers of other goods.
And finally we have developing countries that are not major exporters of energy products. And we — I put down here something that I’ll continue to carry through this presentation, which is one proposal, which I’ve called a stabilization proposal. This would be a proposal to limit emissions from the industrial countries to equal 1990 emissions in the year 2010 and from then on out. So it’s to bring emissions back to 1990 levels in 2010 and then stay there. The reduction proposal is one of reducing emissions to 10 percent below 1990 levels in 2010 and staying at that level thereafter.
These two proposals are probably somewhere between what the U.S. government has been looking at recently, as possible emissions that the U.S. would support, and the actual proposal of the European Union, which was for a 15 percent reduction in emissions below 1990 levels in 2010. So these are among the more modest proposals that are currently under discussion. So all the impacts that I’m talking about will be bigger if something worse ends up coming out of the negotiations.
Interesting point is that for the developing countries we see these two proposals as producing, on average, losses of 2 percent to 3 percent in their gross domestic product, by the year 2030. I pick 2030 because that’s long enough for some of the consequences of this kind of an emission limit to show themselves, in the economies. And also for the growing demand for energy services after this fixed cap is put in place, to begin to show up in putting pressure on energy prices and costs.
The developing countries lost some 2 to 3 percent of GDP, below the level that is would otherwise reach at that time. For the U.S. that’s somewhere in the order of $200 to $300 billion per year by the year 2030. For the energy exporting countries, the loss is every bit as big as they would be in the industrial world. And that’s — I will talk about the reasons, but that’s not a surprise.
Interestingly, what we find and what has been found by most international trade models, and international trade analysts, who have looked at this question the way we have, is that for the bulk of the developing countries, they would also be harmed by the industrial countries undertaking limits on their carbon dioxide emissions. Even if the developing countries are not asked to do a thing to participate in those emission limitations.
I’d like to focus, and let’s talk just for a minute about why we see these patterns. The first point is, the OECD countries unambiguously face negative impacts. The OECD countries would be limiting carbon emissions, shifting to higher cost forms of energy, possibly imposing carbon taxes, basically reducing their ability to produce goods and services for their citizens, because of higher energy costs. In addition, the industrial countries would be facing a loss of their competitive advantage, relative to developing countries. Developing countries would not be incurring these costs, if they don’t undertake carbon limits.
In the developing countries there are offsetting effects. I like to call it the income effect, and the substitution effect. That kind of goes back first year economics. The income effect comes from the fact that developing countries are connected to the industrial world through trade. Most of their exports go to the industrial countries. Most of their imports come from the industrial countries. If the industrial countries are worse off, they’re going to demand fewer of the goods that are produced by developing countries and that’s going to make the developing countries worse off, too. In addition, the industrial countries will be charging more for the goods they export to the developing countries, because it costs more to produce them in the industrial countries.
So that’s the bad news for the developing countries. The possible good news is, what we might call the substitution effect. The developing countries will have lower costs, especially in producing energy intensive goods for the industrial countries. So maybe they’ll gain a larger share of the export market. So the demand for exports will shrink, the demand for the kind of goods that these developing countries produce will shrink. But, they may be able to get a larger share of that shrinking market, because of their lower energy costs. And the issue for individual developing countries is which of these two offsetting effects are important.
Oil producing countries, clearly the effects are the most negative. They face a loss in oil sales and a loss in oil revenues, because oil is an important form of energy. Less oil will be used in the industrial countries if we impose carbon limits, which means any country that’s an oil exporter is going to suffer from lower energy prices and lower demand for its exports.
That’s true for Canada as much as it’s true for Saudi Arabia. And also we include coal, it’s clearly important for countries like Australia.
Now, there are actually significant differences in impact across each of these groups of countries. I’m going to start out talking about the industrial countries. You can see, even here, that their competitive imbalances, and uniform targets, as are being talked about now in the negotiating process, don’t produce uniform impacts. The U.S., under these assumptions, would be one of the more severely impacted countries. Canada and Australia, because they’re export oriented, highly energy intensive, exported energy goods, will be even more severely affected.
Germany and the United Kingdom, which have been pushing for tight targets, actually will have an easy time of it, because of reasons that have nothing to do with climate change. Their emissions are not expected to grow for the next ten years. In the case of Great Britain it’s because of deregulation of electric power, a shift to natural gas, taking apart their coal industry. In the case of Germany it’s because Germany — West Germany, united with East Germany, and it shut down the East German economy which produces a big reduction in emissions in an economy that was very heavily coal intensive. So we see big differences across the industrial countries.
Let me turn now to developing countries. This is I think the striking feature of thinking about international impacts of climate change policies. The original intention of the framework of the Convention was basically to exempt the developing countries from having to do anything for a long time. But the global trading system makes this impossible, because all the countries are connected through international trade. Essentially what happens is that the cost of reducing emissions in the industrial countries is in part exported to the developing countries, in the form of lower prices that are paid for your goods and higher prices that are charged for the goods that are sent to them by the industrial countries.
But, there are differences across the developing countries. It depends in part on what happens to the world oil prices. The more world oil prices fall, the more likely it is that some of the oil importing developing countries would benefit from climate change policy. The demand for their exports from developing countries and the cost of their imports all play a part. Fortunately, we get right to, as I’ve been given my time warning, what these impacts are likely to look like.
This is not intended to be an eye test, though I’d urge all of you who can’t see it to go visit your local optometrist. But, to give a picture of overall — plot the effects, on the developing world, of the kind of emissions limits that are under negotiation, are likely to look like. At the bottom here, facing serious GDP losses are the oil exporting countries. I see Kuwait, the United Arab Emirates, and Saudi Arabia.
At the top we see the countries that may well be able to take advantage of their lower energy costs by increasing their exports and taking advantage of their competitive position to beat out the industries in the industrial world. And up there we see countries like Jamaica, South Korea, India. The reason that those countries are there is that they have the industrial base, that they are ready to expand production if they get a competitive advantage in world markets, and not being part of the climate change treaty will give them that advantage. Jamaica is at the top, because Jamaica is an oil importing country and it produces bauxite, an extremely energy intensive product which competes with the U.S. aluminum industry.
But, what we find for the most part is that the poorer countries of the world, the average developing countries are all going to face economic losses, because of the emission limits that are undertaken by the developing countries. So they’re in an interesting position. They are likely to be irritated with the industrial countries, because industries in the industrial world are likely to be shifting towards the developing countries. You can see that just by looking here. But, at the same time the developing countries are going to be worse off, because of, in the aggregate, losing demand for their products. And they are beginning to realize that in the international negotiations and part of the claims that are now coming up are requests by the developing countries for some form of compensation for the damage that they will be facing.
The other side of it, and let me just mention as a final note of pessimism, all the impacts I’ve been talking about on developing countries assume essentially that the free trade continues throughout the world. But, the most likely thing we would see, if this were a consequence of climate change policy, this appearance, the big reduction in output of not ferrous metals in industrial countries, increases in the developing world. This non-ferrous metals industry would put in claims for some form of protection that they were being unfairly competed with by developing countries. If that happens nobody gains, every country in the developing world would be a loser in the trading system that would come out of that. Once again, the point is that there are serious negative consequences for the developing countries coming out of these negotiations, that many of them are being realized in the process.
MR. MERLINE: Everybody is a loser, it sounds like the perfect outcome of an international treaty.
Our next speaker is Dr. Brian Fisher. He’s the executive director of the Australian Bureau of Agricultural Resource Economics. The bureau gets 60 percent of its funding from the Australian government, 40 percent from private sources and it’s an independent research group. Dr. Fisher also served on the United Nations intergovernmental panel on climate change and on Australia’s National Committee for Climate and Global Change. In November 1995, Dr. Fisher became a fellow of the Academy of Social Sciences in Australia.
Here to talk also about the international economic effects of a global climate treaty, please welcome Dr. Brian Fisher.
MR. FISHER: Thanks very much, Mr. Chairman.
Without further ado, what I’ll do this morning for you is to follow-up from David’s presentation and make quite a similar presentation. First of all let me just quickly describe the model we used.
The model we used is called MEGABARE. That’s a particularly Australian name, I guess. It’s means big model in our case. This model is over a million equations. It’s a trade model. We basically think that this is a trade issue and, therefore, we built a trade model to describe it. It contains 30 regions and 41 sectors or industries. We’ve gone to particular trouble to model the energy sector and we used this, both forecasting and policy scenario analysis. Now, if you want to drag down the over a million equations from our webpage and check the things out, then please do so. The specification is there on the web for people to read. If you want to run the model then I suggest that you can type it in but clearly it’s more effective to just give me a call on the phone and we’ll run it for you at a competitive price. So if you would like to do some of that just call and we will be at your service.
In terms of the baseline emission projections from our model, our model basically has CO2 emissions from energy use doubling between 1990 and 2020, on a global basis. By 2016, non-Annex I countries, pass Annex I countries in terms of global emissions. So by about 2020 fifty-two percent of global emissions will be coming from countries that are currently, under the Berlin mandate, not called upon to make commitments at Kyoto. It’s crucial in these negotiations, if we’re going to do something for the environment, that over the long haul we have a framework that involves developing countries. I would submit to you that the current proposals for uniform emission reductions will not, will not solve that particular problem. No developing country is going to take on uniform emission reductions from their already low base. But unfortunately, in terms of total global emissions the lion’s share of emissions growth in the future will come from developing countries, just those countries that are currently not involved.
Now, in terms of analyzing the economic costs of emission reduction scenarios, we need not only to look at the domestic production costs, but also the trade costs. And in our model we divide these costs up into domestic adjustment effects, which is effectively driven by the magnitude of the emission reduction that you try to do and the unit cost of abatement, in other words how much it costs you to reduce or take out a ton of carbon out of the economy domestically. And the other side of the equation is the international costs.
They’re divided it into the terms of trade effects, basically the price effects, the changes in the price of your exports, compared to the price you have to pay for your imports. And any international investment flow effects, the tendency for industries in industrial countries that are trying to do something about their emissions, to move off to developing countries, who have no commitments.
Now, most of the models that you’ve heard about produce macroeconomic effects that are pretty much the same in terms of the overall effects. There are differences in those models. But, generally speaking, the macroeconomic effects are comparable. What we try and do with our model, is to trace the impact on the gross national expenditure over time. And we use gross national expenditure as a measure, as a welfare measure in our model, because it takes account of the domestic production effects, the GDP as well as any terms of trade impacts.
You’ll see from this next graph that for a country like Japan, for example, the impact at the very beginning if you impose a stabilization target and the type of target we’re talking about here is stabilization at 1990 levels by 2010, and a 10 percent reduction on those levels by 2020. So it’s effectively moving the commitment in the convention at the moment for stabilization from 2000 to 2010, and then doing some reduction. Now, if you do that, you impose that sort of policy, in a country like Japan, in the very beginning, Japan potentially benefits. The reason that we get that result is because Japan is a strong, very large net fossil fuel importer. To get fossil fuel content out of domestic economies, you’d have to impose some sort of tax or some other regulation. Effectively that means that the price of fossil fuels rises, domestically, the demand falls, therefore the world price of fossil fuels falls. Because Japan is net importer of fossil fuels, it has some trade gains in the very short term.
But, over the long term it has to do substantial reduction and in Japan the use of fossil fuel abatement is very high. And as a consequence of that, over the long term it starts to cost Japan more and more. So by about 2020 it is costing 3 percent, 3 percent of GNE per annum, in Japan to meet the stabilization target rising from basically nothing in the year 2000.
Compare that to the European Union, the most strident set of countries in this negotiation, it’s costing them relatively very little to hit that sort of target for the sorts of reasons that David Montgomery has already discussed. It’s a very, very large diverse set of economies and of course if you disaggregate the EU you get different results for the individual countries. But for the EU aggregate it is costing them not much. This negotiation is unfair in that sense. There are substantial differences in the cost potentially being forced on the individual players. And as a consequence to that, that’s leading to substantial difficulty in this negotiation.
Now, one of the most important things to think about, in terms of the political economy of this negotiation is the impact on individual sectors within an economy. And just let me illustrate some of these by putting up a graph of Japan. Now remember, this is the policy that tries to stabilize emissions by 2010. Effectively, what we’d have to see in Japan to achieve that is around about an 18 percent reduction in the iron and steel industry in Japan. About a 100 million tons of iron that are still being produced at the moment in Japan. Based on our model a slight reduction in steel production out over time, and we’re not talking about — around about an 18 billion ton reduction against that baseline. And a similar pattern is happening in other energy intensive industries in Japan.
Now, where do you think that production is going? Well our model says most of that production ends up in Korea. Korea, even though its an OECD country, is not an Annex I country. We’ve assumed that it will not be taking on commitments. Of course there is strong pressure on Korea to take on commitments in this negotiation. But, at the moment it is not an Annex I country. Under the Berlin mandate it is not called upon to take on commitments. If it doesn’t take on commitments, then most of that iron and steel industry in Japan goes out towards Korea, new blast furnaces will be built, effectively replacing those that leave Japan, some go into China, but most go into Korea.
Now, we haven’t budgied up this model. That’s what the model results suggest. And that’s intuitively appealing. It makes sense that that’s the sort of result that you’re going to have, when you’ve got the world divided into two halves, one set part of the world doing something about this in a policy sense, and the other — the other part of the world not doing anything at all.
Now, the United States, basically when you look at the impact on sectoral or product level, country by country, the major impact of climate policy must be on the coal industry. Coal is the most carbon intensive of the fossil fuels, therefore it will take the lion’s share of the adjustment. In the United States, we estimate that about a 45 percent reduction in coal output by 2010, against business as usual. Now, that’s a substantial adjustment in the coal industry, and therefore, that will mean substantial regional impacts. There have to be substantial regional impacts. And given the changes in competitiveness in countries like South Korea, then you’d expect manufacturing also in the United States to come under some pressure, particularly manufacturing dependent on energy intensive inputs.
Now, as David has also said these effects flow — because of the links through trade, out to other countries. This slide is illustrating the impact on Indonesia, for example. Again, in Indonesia there’s a substantial impact on coal output, according to our estimates. Now, this is not happening because Indonesia is actually imposing policy itself, it’s happening because industrial countries are reducing the demand for fossil fuels and that reduction in demand flows through to major exporting countries like Indonesia. You’ll notice also, of course, that Indonesia increases its iron and steel industry. Now, that iron and steel industry would have been in Australia. It would now be in Indonesia. So effectively what this policy does, by dividing the world into two, is to encourage companies and investors to move their plants from one place in the world, to another place in the world, not necessarily having an impact on emissions that those plans expect.
Finally, given a very short time indeed, let me just say something about tradable quotas. I understand Americans are extremely fond of tradable quotas. I take my hat off to you, so am I. The reason I’m extremely fond of tradable quotas is because the quota instrument would — or a marketplace instrument would substantially reduce the costs, compared with doing uniform reductions, effecting regulations to uniformly reduce emissions around the world, substantially reduce the cost of that policy our estimate is that it would cost you about $370 a ton of carbon for a carbon tax type solution — $370, I think you can multiply 3.7 by .26 cents to get the impact on gasoline prices in the United States if you want to do that conversion — to get you to stabilization at 2010. A tradable quota solution will cost you exactly half that. Of course, it still costs you the implicit carbon tax associated with tradable quota is a half of $370 U.S. dollars a ton. So there’s no free lunches here. And, of course, for every tradable quota there’s a permanent price , that means there’s an equivalent carbon tax, so don’t let people persuade you that there’s no cost to a cap, to our policy, somebody has to pay for the quota.
Now, the nice thing about a quota, of course, is that it allows you to do this emission abatement in the most cost effective way. It allows countries that find it the cheapest to do the most abatement. Now, in our model, effectively what would happen is, that all of the quotas would be purchased from Eastern Europe and the former Soviet Union, to do this abatement. In the case of Australia, for example, we would have to do around about a 28 percent reduction by the 2010 base, without tradable quotas, to hit stabilization, with tradable quotas we’d do a 5 percent reduction and we’d buy the quota and that’s very nice, that’s an excellent result.
The real problem with this is that there’s going to be massive income transfers associated with that. And this graph effectively gives you some idea the extent of which income will be transferred from industrial OECD countries to the former Soviet Union and Eastern Europe. Around about 12 percent of the former Soviet Union or Eastern Europe’s GNP will be coming from income transfers by 2010. Now, I ask you, is your Senate going to feel comfortable with that? I’ll let you contemplate that.
Now, Mr. Chairman, I must be almost completely out of time.
MR. MERLINE: One minute.
MR. FISHER: I’ve just got one minute. Let met just do a tiny commercial.
All my results are contained in this book. I’m more than pleased to sell you a copy, for 36 Australian dollars. That’s much less in U.S. dollars. Please leave me a business card and I’ll have one directly to you almost instantaneously.
Thank you very much.
MR. MERLINE: All this talk about economic models and mega-models reminds me of a wire story I saw the other day. It seems that climatologists who are struggling to get their computer models to accurately forecast warming trends have decided to chuck the computer models and instead ask super models what they think. Elle McPherson and Cindy Crawford have signed up for that.
Our final speaker is Deepak Lal — I hope I pronounced that correctly — professor of international development studies at the University of California at Los Angeles. Mr. Lal is also a professor emeritus of political economy at University College London. In the early 1980s, Mr. Lal served as an economic advisor to the World Bank and he has advised several other international organizations, such as the OECD. He’s the author of several books and articles on economic development and public policy.
To talk about the key role energy use plays in economic development, please welcome Mr. Deepak Lal.