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The impact of climate change policies on employment in the coalmining industry

By Cain Polidano

Part 2

2. Analytical framework

MEGABARE, as a tool to examine international climate change policies, contains detailed accounting of carbon dioxide emissions from fossil fuel combustion as a by-product of different economic activities. MEGABARE incorporates the fact that different fossil fuels release different amounts of carbon dioxide. This means that the projected emission level for a region in a given period is a function of the mix and quantity of fossil fuel consumption in that region in that period. Alternative emission abatement policies can be analysed by modelling the impact on economic variables of restrictions on growth in emissions.

MEGABARE is an intertemporal model which can track growth in variables over time. Population growth and capital accumulation are determined endogenously (within the model). This is in contrast to comparative static models which compare two equilibriums, one before a policy change and one following, but with no growth in the factors of production. The intertemporal nature of MEGABARE is important when analysing climate change policies, since both the timing of policy changes and the adjustment path that the economy follows are highly relevant in the policy debate (issues surrounding timing of policy changes and optimal hedging strategies can be found in Manne and Richels 1992).

A number of other global general equilibrium models have been developed and used extensively to analyse climate change policies. These include ERM (Edmonds and Reilly 1983), GREEN (Burniaux, et al. 1991), WEDGE (Industry Commission 1991), Whalley and Wigle (1991), Global 2100 (MR) (Manne and Richels 1992), G-Cubed (McKibbin and Wilcoxen 1992) CRTM (Rutherford 1993), Second Generation Model (Edmonds, et al. 1995), EPPA (Yang, et al. 1996) and the International Impact Assessment Model (Bernstein, Montgomery and Rutherford 1996).

At its most disaggregated level MEGABARE consists of equations and data that describe the production, consumption, trade and investment behaviour of representative producers and consumers in 30 regions across 41 sectoral groupings. The database used to simulate the impact of the various emission abatement policies in this report has been aggregated to the 16 commodity groups and 18 regions presented in table 1. This particular aggregation was chosen to allow a focus on the links between fossil fuel industries and energy-intensive sectors and to explore any impact on trade arising from greenhouse gas abatement.

A key feature of the MEGABARE model is the unique "technology bundle" approach to modelling fuel substitution possibilities. In MEGABARE electricity can be generated from coal, oil, gas, nuclear, hydro or renewable-based technologies, while iron and steel can be produced using blast furnace or less coal-intensive electric arc technologies.

Explicit modelling of the alternative methods of production available to them enables the electricity and iron and steel industries to substitute between technologies in response to relative price changes or restrictions on input use, including the use of fossil fuels. A more detailed description of this approach to modelling fuel substitution and its advantages over commonly used alternatives is found in appendix A of Brown, et al. (1997). Table 1. Regions and sectors contained in MEGABARE simulations

In the MEGABARE model, industries combine factors of production (land, labour and capital) and intermediate inputs (including energy inputs) to produce a single commodity. Substitution is permitted between labour and capital, thereby allowing industries to adjust the labour intensity of production in response to movements in real wages (relative to the price of capital). Substitution between other inputs is not permitted, to prevent unrealistic substitutions between, for example, energy inputs and labour.

The MEGABARE simulation of labour demand in the coal industry is shown in figure 1. Labour is not directly substitutable with intermediate inputs used in the production of coal (represented as commodities A to C) such as electricity, petroleum products and construction goods. Instead, labour is substituted with capital and land as part of the endowment factor bundle. It is assumed that land, capital and labour can be substituted according to a CES (constant elasticity of substitution) technology which assumes that the rate at which the three primary factors are substituted remains fixed. The elasticity of substitution between labour and capital is assumed to be low in the coal sector, reflecting the difficulty of real world substitution. The endowment factor bundle is applied with intermediate inputs in fixed proportions to produce coal (Leontief technology).

Although MEGABARE models labour demand at the industry level, it does not explicitly model unemployment over time. MEGABARE assumes that labour is perfectly mobile within a region, so that wage adjustment ensures equilibrium in the labour market (or a fixed unemployment rate over time).

Although labour demand in the reference case simulation is determined endogenously in the model, the magnitude of the labour demand changes are determined by macroeconomic projections that are fed exogenously into the model. The impact of emission abatement policies on labour demand in a particular industry is reported as deviations from the reference case simulation, which is a simulation assuming unabated emission growth. Labour demand in a particular industry under the reference case scenario depends on the assumed rate of GDP growth per person over the simulation period which is fed exogenously into the model. Labour productivity, as well as the productivity of other inputs, such as land and captial, are assumed to converge toward those of developed regions.

The MEGABARE simulations described in this paper embody the following assumptions about the economic environment:

* population and labour supply are determined endogenously by the demographics in the model and are linked to economic variables (particularly income) via birth and mortality rates; and a constant net migration rate is assumed;

* population growth and age structure are important determinants of each region's labour supply and level of savings;

* capital is mobile internationally -- it is assumed that savings will always finance investment in the region of origin before financing investment abroad;

* rates of return are equalized across sectors within a particular region;

* rates of return across regions are assumed eventually to equalize, allowing some imperfections in the international capital market;

* the unemployment rate across regions is assumed to remain constant through adjustments in wages;

* all prices in the model are determined relative to the global price of savings -- the global price of savings is termed the numeraire;

* nuclear and hydro power are assumed to be constrained to reference case levels because of both physical and potential political constraints to their expansion; other renewables, however, are assumed to be free to expand in response to emission constraints.

3. Policy simulation

For this analysis the following uniform abatement policies were chosen:

Less stringent scenario: Annex I countries stabilize their carbon dioxide emissions from fossil fuel combustion at 1990 levels by 2010.

More stringent scenario: Annex I countries reduce their carbon dioxide emissions from fossil fuel combustion by 15 per cent below 1990 levels by 2010.

The less stringent scenario is based on a ten-year delay in achieving the implicit commitment contained in Article 4.2 of the Framework Convention on Climate Change that Annex I Parties aim to reduce their emissions to 1990 levels by 2000 (at this point, few Annex I countries will achieve this aim). The more stringent scenario represents a policy consistent with that proposed by the Group of 77 and China Parties at the international climate change negotiations held in Bonn in October 1997. Developing countries are not required to restrict their emissions growth in either scenario. This assumption is based on the requirement that the outcome of the Berlin Mandate negotiations will not require developing countries to take on new commitments.

It is assumed that, in achieving the emission reductions, governments adopt policy instruments that impose the smallest possible cost on their economies. In MEGABARE, least-cost modelling of emission abatement involves imposing a tax on emissions of carbon dioxide in each period for which emission restrictions apply. The tax increases the costs associated with carbon dioxide emission-intensive activities and encourages a shift of resources into less emission-intensive activities, thereby reducing emissions.

A carbon tax is representative of the broad class of economic instruments that could be used by governments to reduce emissions, including nationally based tradable emission quota schemes. In the context of the MEGABARE simulations, the carbon tax associated with achieving a given level of emission abatement can also be interpreted as the unit price of nationally traded emission quotas (Hinchy, Thorpe and Fisher 1993). In more general terms, the carbon tax can be interpreted as the marginal cost to the economy associated with any least-cost policy or set of policies designed to achieve a given level of emission abatement. Revenue from the tax is assumed to be returned to the economy in a lump sum fashion.

4. Aggregate impact of policies on economies

(Per cent relative to the reference case)

The key source of economic loss in Annex I countries is an increase in the costs of industrial production and in consumer prices as the assumed emission restrictions force producers and consumers in Annex I countries to move away from carbon-intensive fossil fuel use into more costly alternatives. The increased costs to industry tend to dampen economic activity. The resulting decline in demand for labour and capital reduces real returns to capital and labour (defined as the gains in output associated with adding an extra unit of capital and labour, respectively, to the economy), in turn leading to reduced income and economic losses.

The impact of Annex I policies on international trade can be significant for both Annex I and non-Annex I economies. For example, both Annex I and non-Annex I fossil fuel exporters can be expected to experience a decline in demand and prices for their fossil fuel exports. Also, Annex I countries with significant exports of fossil fuel-intensive products (such as iron and steel, or aluminium) could face a reduction in export demand as these industries begin to relocate to developing countries to take advantage of increased price competitiveness. While, on average, Annex I exporters of fossil fuel-intensive products lose competitiveness, non-Annex I exporters of these products gain in competitiveness, leading to carbon leakage and contributing positively to GNE changes in some non-Annex I countries.

Trade-related economic losses can also arise because the increased costs of production in Annex I countries (resulting from their efforts to restrict emissions) are passed to consumers of Annex I country products, including consumers in developing countries. For example, the prices of capital goods sold by Japan to all countries, including non-Annex I countries, will rise with the imposition of emission abatement policies in Japan. All other things being equal, countries with significant imports of emission-intensive products from Annex I countries can be expected to experience more significant economic losses than countries with less significant imports of those products.

A key feature of the results from the MEGABARE analysis is, that under certain policy simulations, trade effects lead to economic losses in a number of non-Annex I countries even though they do not take any direct action to reduce their emissions. Non-Annex I countries are projected to experience a loss of 0.6 per cent of gross national expenditure at 2010 under the less stringent policy (table 2). Under the more stringent policy, non-Annex I countries are projected to experience a larger (1.1 per cent) decline in gross national expenditure by 2010. In 2010 the intensified negative trade impact (larger Annex I losses) on non-Annex I regions under the more stringent scenario dominates the subdued positive effect of carbon leakage. There is insufficient time to allow factors of production to be transferred from Annex I to non-Annex I regions to facilitate the positive effects of carbon leakage (see Shneider, et al. 1997).

Carbon leakage and structural change

Table 3. Changes in CO2 emissions at 2010 due to emission reductions in Annex I regions

(Per cent relative to the reference case)

At the same time, carbon dioxide emissions from non-Annex I countries are projected to rise by 2.7 per cent and 4.5 per cent at 2010 under the less and more stringent scenarios respectively relative to the reference case. This phenomenon is known as "carbon leakage".

Carbon leakage is the partial offsetting of emission abatement achieved in Annex I countries by increases in emissions from non-Annex I countries. In the MEGABARE simulations, Annex I countries impose policies to reduce fossil fuel use to reduce emissions. These policies increase production costs in fossil fuel- intensive industries such as iron and steel and nonferrous metals production in Annex I countries. As a result, non-Annex I countries obtain a competitive advantage over Annex I countries in fossil fuel-intensive production. In response, there is a partial shift of emission intensive industries from Annex I to non-Annex I countries. For example, iron and steel production is projected to fall in Annex I regions and increase in non-Annex I regions (table 4). Table

4. Changes in iron & steel production at 2010 due to emission reductions in Annex I regions

(Per cent relative to reference case)

The changes in global CO₂ emissions shown in table 3 are associated with changes in the global use of fossil fuels which, in turn, are driven by their reduced use in Annex I countries. Projected changes in the world's use of coal, oil and gas are shown in table 5.

Table 5. Changes in global primary energy use at 2010 due to emission reductions in Annex I regions

(Per cent relative to reference case)

Global coal use is projected to decline by 28.9 per cent and 41.2 per cent at 2010 under the less and more stringent scenarios respectively relative to the reference case. This significant decline in coal use can be attributed largely to a greater substitution of coal in electricity production than is the case for less carbon-intensive energy sources such as oil or gas. The projected decline in global oil use is less than that for coal and gas, mainly because oil products are used extensively in the transport sector where substitution possibilities are more limited than in the power generation sector where coal and gas use is more widespread.

Lower coal demand from Annex I regions is projected to have an impact on Annex I and non-Annex I coal production (table 6). Non-Annex I coal production is projected to fall by 7.6 per cent and 8.1 per cent respectively under the less and more stringent scenarios at 2010. Despite higher domestic demand from fossil fuel-intensive sectors, non-Annex I coal production is projected to fall because of a significant fall in coal exports to Annex I regions. Although exports comprise only 9 per cent of non-Annex I coal production, non-Annex I coal exports to Annex I regions comprise 65 per cent of total coal exports (1992), resulting in a 34.5 per cent fall in non-Annex I exports. Annex I coal production is projected to fall by more than non-Annex I coal production because of lower domestic demand from fossil fuel-intensive sectors associated with lower aggregate demand and fuel switching to meet emission abatement targets.

Table 6. Changes in coal production due to emission reductions in Annex I regions

(Per cent relative to the reference case)

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