The Impact of CO 2 Emission Cuts on Income

Transcription

1 The Impact of CO 2 Emsson Cuts on Income Xaobng Zhao The W. A. Franke College of Busness, PO Box Northern Arzona Unversty Flagstaff, AZ E-mal: Xaobng.Zhao@nau.edu Phone: (928) Fax: (928) Selected Paper prepared for presentaton at the Agrcultural & Appled Economcs Assocaton s 2011 AAEA & NAREA Jont Annual Meetng, Pttsburgh, Pennsylvana, July 24-26, 2011 Copyrght 2011 by Xaobng Zhao. All rghts reserved. Readers may make verbatm copes of ths document for non-commercal purposes by any means, provded that ths copyrght notce appears on all such copes. 1

2 Abstract We study how carbon doxde (CO 2 ) emsson cuts affect ncome for 23 OECD countres over the perod. The mportance of ths queston s manfested n the dsagreements at the 2009 Unted Natons Clmate Change Conference n Copenhagen and the 2010 State of the Unon Address by Unted States Presdent Barack Obama. We start by dervng an ncome-co 2 relatonshp based on a structural producton functon, whch s a natural way to model the relatonshp among ncome, energy consumpton, and CO 2 emssons. We then use a smlar emprcal methodology as Tucker (1995) to estmate the ncome-co 2 relatonshp. Such an approach not only allows us to focus on the long-run relatonshp but also enables us to project the relatonshp between ncome and CO 2 emssons for future years. Our fndngs suggest that the economc cost of CO 2 emsson cuts s sgnfcant. To reduce emssons 50% below 1990 levels by 2050, the economc cost per year for developed countres s about 0.3% reducton n GDP per capta whch represents a 15% slowdown n economc growth. Keywords: Carbon Doxde Emssons; Income; Global Warmng; Producton Functon 2

3 The Impact of CO 2 Emsson Cuts on Income 1. Introducton Poneered by Grossman and Krueger s (1991, 1995) and Shafk and Bandyopadyay (1992), there s a volumnous lterature on the envronmental Kuznets curve (EKC) hypothess. 1 Ths hypothess postulates an nverted U-shaped relatonshp between (logarthm of) levels of polluton or emssons of wastes per capta and (logarthm of) ncome per capta. That s, at low ncome levels, emssons are hypotheszed to ncrease wth ncome but at a slower pace; beyond a crtcal ncome level (.e., the turnng pont) emssons are conjectured to decrease as ncome further ncreases. If ths hypothess were true, t would suggest that countres mght not need to make sgnfcant carbon doxde (CO 2 ) emsson cuts envsaged by the Kyoto Protocol snce economc growth wll eventually lead to envronmental mprovement. An overvew artcle by Dasgupta et al. (2002) presents three dfferent vews about the shape of the EKC conventonal (the standard nverted U shape), pessmstc (the EKC wll flatten or ncrease beyond the turnng pont), and optmstc (the turnng pont occurs at lower levels of ncome and polluton s lower at each level of economc development). Ths artcle ndcates that the optmstc vew s the most lkely due to ncreasng effectveness of envronmental regulaton, greater publc awareness of polluton, etc. Unfortunately, emprcal evdence n support of the EKC hypothess and the optmstc vew s very weak as soon as econometrcs problems n early studes are taken 1 See for nstance Holtz-Eakn and Selden (1995), Galeott and Lanza (1999), Djkgraaf and Vollebergh (2001), Martnez-Zarzoso and Bengochea-Morancho (2004), and Galeott, Lanza, and Paul (2006) among others. 3

4 nto account. Econometrc crtcsms of the EKC are generally dvded nto four groups heteroskedastcty, smultanety, omtted varables bas, and contegraton ssues. 2 Now the central queston s not whether we should make emsson cuts or not, but how much we should cut. The mportance of ths queston s manfested n the dsagreements at the 2009 Unted Natons Clmate Change Conference n Copenhagen (Müller 2010) and the 2010 State of the Unon Address by Unted States Presdent Barack Obama (State of the Unon Address Lbrary 2010). To answer ths queston, we need to study a reverse EKC. That s, we need to nvestgate how emssons and emsson cuts affect ncome (not how ncome affects emssons as n the EKC studes). If the adverse mpact of emsson cuts on ncome s small, t may be sensble to make sgnfcant cuts, vce verse. 3 We focus on the reverse EKC relatonshp for CO 2 emssons due to ts partcular mportance. CO 2 emssons are beleved to be the major drvng force of global warmng (IPCC 2007). The mportance of CO 2 emsson reducton s emphaszed n a Wall Street Journal artcle, n whch Robert Stavns from Harvard Unversty and Steven Hayward from the Amercan Enterprse Insttute for Publc Polcy Research debate whether carbon emsson cuts can hurt economc growth (Wall Street Journal 21 September 2009). We start by dervng an ncome-co 2 relatonshp based on a structural producton functon, whch captures the dea that ncome/output depends on energy consumpton and therefore CO 2 emssons. Our structural model enables us to dentfy and nclude all relevant economc varables n our emprcal regresson model. We then use a smlar 2 See Stern and Common (2001), Perman and Stern (2003), and Stern (2004). 3 There s a volumnous lterature on the relatonshp between energy consumpton and economc growth. See Ozturk (2010) for a comprehensve revew. We n ths paper nstead focus on the relatonshp between emsson cuts and ncome. 4

5 methodology that Tucker (1995) employs. That s, we estmate the reverse EKC relatonshp year by year. Such an approach not only crcumvents the non-statonarty ssue but also allows us to project the future relatonshp between ncome and CO 2 emssons. The remander of the paper s organzed as follows: Secton 2 presents the data and our methodology. Secton 3 reports the emprcal results. Secton 4 concludes the paper wth a bref summary. 2. Data and Methodology Methodology Income or output depends on energy consumpton, whch s drectly related to CO 2 emssons. 4 Therefore, a natural way to model the mpact of CO 2 emssons on ncome s to use a producton functon. Specfcally, we consder a Cobb-Douglas type producton functon: 5 Y e AL K E (1) where Y s the total ncome measured by real Gross Domestc Product (GDP), A represents productvty (we assume that the countres n our sample are homogenous n terms of technology level), K represents captal, L stands for labor, E s energy, 4 Coondoo and Dnda (2002) fnd that for developed countres the causalty between ncome and emsson runs from emsson to ncome. 5 See Chonère and Horowtz (2006) for another applcaton: they nvestgate the relatonshp between ncome and temperature usng a Cobb-Douglas producton functon wth temperature added as an nput along wth physcal and human captal. Temperature lowers the margnal product of physcal and human captal n ther model. 5

6 captures the effects of all other varables, and,, 1. Ths model augments the standard Cobb-Douglas producton functon by takng nto account a fact that energy s an nput requred to produce output. Gven the technology level at a pont n tme, there s a drect lnear relatonshp between energy consumpton and CO 2 emssons. 6 That s, E bco2, where CO 2 represents correspondng CO 2 emssons. Then we have, Y b e AL K CO2 (2) To get ncome per capta, we dvde both sdes by L. We further assume that the producton functon exhbts constant returns to scale (.e., 1). Then we get Y K CO 2 b e L A L L (3) Takng log on both sdes, we have Y K CO b A L L 2 log( log( ) log log L (4) Let a log( b A), we fnally have Y K CO a L L 2 log( log log L (5) We focus on Equaton (5) to estmate the reverse EKC relatonshp between ncome and CO 2 emssons. Snce our model apples to countres that are homogenous n terms of technology and productvty, we focus on 23 OECD countres and exclude Mexco, South Korea, Turkey and Eastern European countres whch have substantal lower ncome n the emprcal tests. 6 See Perera and Perera (2010). 6

7 Furthermore, we estmate ths model year by year smlar to Tucker (1995). Ths approach has three advantages compared to the panel regresson approach typcally used n the EKC studes. Frst, ths cross-sectonal approach allows us to focus on the long-run equlbrum relatonshp between CO 2 emssons and ncome (not the short-run transtory relatonshp), whch s more nformatve. Second, t also crcumvents the non-statonarty problem that Perman and Stern (2003) dentfy. Snce the regresson s performed n a cross-sectonal rather than a tme-seres fashon, non-statonarty becomes rrelevant. Thrd, ths approach also allows tme-varaton n the ncome-co 2 relatonshp, whch not only s emprcally appealng but also enables us to project the reverse EKC relatonshp for future years. Data We obtan macroeconomc data of the 23 OECD countres from the Penn World Tables. The Penn World Tables provde natonal ncome accounts-type of varables converted to nternatonal prces. The homogenzaton of natonal accounts to a common numerare allows vald comparsons of ncome across countres. 7 Snce the Penn World Tables do not provde data for captal per capta, we use nvestment share of GDP as a proxy. Intutvely, a country that nvests more n captal should have a hgher captal per capta. We also use populaton as a proxy for labor snce we want to focus on the commonly studed ncome measure real GDP per capta not real GDP per worker. 7 Data comes from Alan Heston, Robert Summers and Bettna Aten, Penn World Table Verson 6.1, Center for Internatonal Comparsons at the Unversty of Pennsylvana, October

8 The CO 2 emssons per capta data for the 23 OECD countres are from the US Energy Informaton Admnstraton ( Snce the emssons data start n 1980 and the macroeconomc data from the Penn World Tables end n 2004, our data sample covers the perod from 1980 to Table 1 contans summary statstcs of the varables used n ths paper. Among 23 countres, real GDP per capta ranges from $12,617 n Greece to $34,153 n Luxembourg. Portugal has the lowest rate of CO 2 emsson per capta whch s 4.41 metrc tons whle Luxembourg has the hghest rate of metrc tons per capta. In terms of nvestment share of GDP, t ranges from 17.43% n the Unted Kngdom to 30.58% n Japan. 3. Emprcal Results We estmate Equaton (5) year by year from 1980 to The coeffcent estmates and the adjusted R 2 are reported n Table 2. To save space, we do not report the Whte (1980) heteroscedastcty-consstent t-ratos. The sgnfcant coeffcent estmates at the 5% level for two-sded tests are n bold. As we can see, the mpact of CO 2 emssons on ncome s statstcally sgnfcant n each year. In fact, the coeffcent estmate ncreases from 0.28 n 1980 to 0.35 n 2004, wth an average of That s, holdng constant other relevant varables, a one percent cut n CO 2 emssons wll on average reduce ncome per capta by 0.31%. There are several popular proposals regardng CO 2 emsson cuts. However, a deep lnear cut of 50% below 1990 emssons by 2050 may be more relevant to polcy dscussons. 8 Ths proposal means at least a 1% cut n CO 2 emssons per year. If a 1% 8 See Paltsev, Rellya, Jacobya and Morrs (2009). 8

9 cut n CO 2 emssons wll on average reduce ncome per capta by 0.31% as we show n Table 2, the cost of emsson cuts s not only statstcally but also economcally sgnfcant. Snce the average economc growth rate for the 23 OECD countres from 1980 to 2004 s only about 2% per year based on our data, a 0.31% reducton n GDP per capta per year represents a 15% slowdown n economc growth. 9 Ths s the central fndng of our paper. 10 The above analyss s nformatve but may not be accurate n the sense that t does not take nto account the tme varaton n the mpact of CO 2 emssons on ncome and the tme value of money. Intutvely, f the mpact of CO 2 emssons ncreases over tme fast enough to offset the effects of the tme value of money, the cost of emsson cuts wll ncrease and the average cost estmate we use n the above analyss may underestmate the true cost; vce verse. Next we examne the tme varaton n the mpact of CO 2 emssons on ncome and the effects of the tme value of money. Table 2 ndcates that the mpact of CO 2 emssons on ncome seems to be ncreasng over tme. To estmate the trend, we consder the followng tme-trend model. c dtrend e (6) t t t where t s the mpact estmate n a year estmated from prevous regressons. The results are reported n Table 3. The t-ratos are based on Newey and West (1987) HAC standard errors wth the lag parameter set equal to 1. The tme trend s statstcally sgnfcant at the one percent level. The adjusted R 2 s 47%, ndcatng a reasonable ft of the model s 15% of How much emsson cuts we should make wll also depend on the margnal beneft of emsson cuts whch s beyond the scope of ths paper. 9

10 Snce the coeffcent of the tme trend s 0.002, t suggests that the mpact of CO 2 emssons on ncome ncreases by 0.2% per year over our sample perod of 1980 to If we assume the trend wll contnue, the mpact of CO 2 emssons on ncome wll contnue to ncrease n the future. However, the present value of the mpact stll partly depends on the tme preference of socety or the dscount rate. To see the mpact of the dscount rate, we conduct a smple analyss. Frst, we project the mpact of emssons on ncome n future years based on our tme trend model of Equaton (6). We consder four partcular years for smplcty, 2020, 2030, 2040 and Then, we dscount the mpact back to the present assumng a number of dscount rates as n Heal and Krström (2002). The results are reported n Table 4. As we can see, the present values of the future mpacts are often less than the average mpact we use prevously whch s 0.31 (12 out of 20 or about 60%). Ths fndng suggests that even f we take nto account the tme value of money and the tme varaton n the mpact of emssons, the average mpact analyss we have had n the prevous dscusson may stll be relevant. That s, to reduce emssons by 50% by 2050, the annual economc cost s about 0.3% reducton n ncome for the 23 OECD countres. 4. Concluson We study how CO 2 emsson cuts affect ncome n ths paper. Frst we derve an ncome-co 2 relatonshp based on a structural producton functon, whch s a natural way to model the relatonshp between ncome and CO 2 emssons. We then use a smlar methodology as Tucker (1995) to estmate the ncome-co 2 relatonshp. Such an 10

11 approach not only allows us to focus on the long-run relatonshp but also enables us to project the relatonshp between ncome and CO 2 emssons for future years. Our man fndngs are as follows. Over the perod, for 23 OECD countres, the reverse EKC relatonshp between CO 2 emssons and ncome s statstcally and economcally sgnfcant. To reduce emssons 50% below 1990 levels by 2050, the economc cost per year for developed countres s about 0.3% reducton n GDP per capta whch represents a 15% slowdown n economc growth. 11

12 References Chonère, C. J., and J. K. Horowtz, 2006: A producton functon approach to the GDPtemperature relatonshp. Workng paper, Unversty of Maryland. Coondoo, D., and S. Dnda, 2002: Causalty between ncome and emsson: A country group-specfc econometrc analyss. Ecologcal Economcs, 40, Dasgupta, S., B. Laplaante, H. Wang, and D. Wheeler, 2002: Confrontng the Envronmental Kuznets Curve. Journal of Economc Perspectves, 16(1) (wnter), Djkgraaf, E., and H. R. J. Vollebergh, 2001: A note on testng for envronmental Kuznets curves wth panel data, Fondaznoe En enrco Matte Workng Paper N Galeott, M., and A. Lanza, 1999: Rcher and cleaner? A study on carbon doxde emssons by developng countres. Energy Polcy, 27, Galeott, M., A. Lanza, and F. Paul, 2006: Reassessng the envronmental Kuznets curve for CO 2 emssons: a robustness exercse. Ecologcal Economcs, 57, Grossman, G. M., and A. B. Krueger, 1991: Envronmental mpacts of a North Amercan Free Trade Agreement. Natonal Bureau of Economc Research Workng Paper 3914, NBER, Cambrdge MA. Grossman, G. M., and A. B. Krueger, 1995: Economc growth and the envronment. Quarterly Journal of Economcs, 110(2) (May), Heal, G., and B. Krström, 2002: Uncertanty and clmate change, Envronmental and Resource Economcs, 22,

13 Holtz-Eakn, D., and T. M. Selden, 1995: Stokng the fres? CO 2 emssons and economc growth. Journal of Publc Economcs, 57, Intergovernmental Panel on Clmate Change, 2007: The IPCC Fourth Assessment Report, Martnez-Zarzoso, I., and A. Bengochea-Morancho, 2004: Pooled mean group estmaton for an envronmental Kuznets curve for CO 2. Economcs Letters, 82, Müller, B., 2010: Copenhagen 2009: Falure or fnal wake-up call for our leaders? Oxford Insttute for Energy Studes. Retreved Newey, W. K., and K. D. West, 1987: A smple, postve sem-defnte, heteroskedastcty and autocorrelaton consstent covarance matrx. Econometrca, 55, Ozturk, I., 2010: A lterature survey on energy-growth nexus, Energy Polcy, 38, Paltsev, S., J. M. Rellya, H. D. Jacobya, and J. F. Morrs, 2009: The cost of clmate polcy n the Unted States, Energy Economcs, 31, Supplement 2, S235-S243 Perman, R., and D. I. Stern, 2003: Evdence from panel unt root and contegraton tests that the envronmental Kuznets curve does not exst. Australan Journal of Agrcultural and Resource Economcs, 47, Perera, A. M., and R. M. M. Perera, 2010: Is fuel-swtchng a no-regrets envronmental polcy? VAR evdence on carbon doxde emssons, energy consumpton and economc performance n Portugal, Energy Economcs, 32,

14 Shafk, N., and S. Bandyopadyay, 1992: Economc growth and envronmental qualty, Background Paper for the 1992 World Development Report, The World Bank, Washngton, D.C. State of the Unon Address Lbrary, 2010: Retreved Stern, D. I., 2004: The Rse and Fall of the Envronmental Kuznets Curve. World Development, 32, Stern, D. I., and M. S. Common, 2001: Is there an envronmental Kuznets curve for sulphur? Journal of Envronmental Economcs and Management, 14, Tucker, M., 1995: Carbon doxde emssons and global GDP. Ecologcal Economcs, 15, Wall Street Journal, 21 September 2009: Can countres cut carbon emssons wthout hurtng economc growth? Envronment: The Journal Report. R1. Whte, H., 1980: A heteroskedastcty-consstent covarance matrx estmator and a drect test for heteroskedastcty, Econometrca, 48(4),

15 Table 1 Summary Statstcs Country Real GDP per capta Per Capta CO 2 Emssons Investment Share of GDP (Metrc Tons) Mean Varance Mean Varance Mean Varance Australa Austra Belgum Canada Denmark Fnland France Germany Greece Iceland Ireland Italy Japan Luxembourg Netherlands New Zealand Norway Portugal Span Sweden Swtzerland Unted Kngdom Unted States

16 Table 2 Impact of CO 2 Emssons on Income Year a γ Adj-R

17 Table 3 Tme Trend n the Reverse EKC Relatonshp Coeffcent T-Stat Adj-R 2 Constant Tme trend

18 Table 4 Present Values of Future Impacts Dscount rate γ 2020 = 0.36 γ 2030 = 0.38 γ 2040 = 0.40 γ 2050 = % % % % %