An Environmental SAM and SAM-based CGE Modelling. for Environmental Policy Problems

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1 An Environmental SAM and SAM-based CGE Modelling for Environmental Policy Problems Paper prepared for International Workshop for Interactive Analysis on Economy and Environment, Cabinet Office, the Government of Japan, 4 th March 2006 Noritoshi Ariyoshi Faculty of Environmental Studies Nagasaki University Itsuo Sakuma School of Economics Senshu University Akihiko Taniguchi Graduate School of Economics Senshu University

2 1. Introduction The purpose of this paper is twofold. First, concerning data aspects, it attempts to construct a data matrix (DATA SAM) from Japanese NAMEA 1 (or hybrid accounts) compiled by ESRI. The data matrix which the authors will formulate contains national accounts data as well as SEEA 2 (ver.iv.2) type economic-environmental data. In doing so, imputed environmental cost, one of the main features of SEEA veriv.2, will be estimated for each industry. It should be stressed that the estimation of imputed environmental cost or maintenance cost is highly important because by doing so what the government should do for the environment will be clarified and obliged at least logically. NAMEA as such, on the contrary, dose not contain any information of this sort. This DATA SAM will be called DATA ENVIRONMENTAL SAM. Second, concerning modelling aspects, it attempts to conduct SAM-based CGE analyses. To do this, the second version of Environmental SAMs must be created. This second version of environmental SAM will be called MODEL ENVIRONMENTAL SAM in which environmental and national accounts data are arranged to accommodate a specific general equilibrium modelling structure. The authors attempt to conduct a computable general equilibrium (CGE) analysis with this model environmental SAM as a base. Finally, some (policy or other) simulation results will be presented and commented. 2. A general explanation of Japanese NAMEA (Hybrid Accounts) In this section, the authors would like to give a very condensed account of Japanese NAMEA or Hybrid Accounts recently compiled by the ESRI (Economic and Social Research Institute), Cabinet Office of Japan. A sketch and a summary of Japanese NAMEA are given in Figure 2.1 and Table 2.1. the simplest utline of Japanese NAMEA is as follows. 1) It is based on the original NAMEA by the Netherlands, and estimates for 90, 95, and 00 2) It has twofold parallel structure: national accounting matrix (NAM) at monetary term and environmental accounts (EA) at physical term. 3) It has twofold structure of EA : substance accounts and environmental problem accounts. Because further explanation of Japanese NAMEA is given in Ariyoshi (2006), it is omitted in this paper. 1 NAMEA is an acronym for National Accounting Matrix including Environmental Accounts. See de Haan, M. and S. J. Keuning [1996], Department of National Accounts[2004], and Ariyoshi[2006]. 2 SEEA is an acronym for System for Integrated Environmental and Economic Accounting. See United Nations [1993]. 1

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5 3. From NAMEA to a SEEA-type SAM with Monetary Valuation of Environmental Pressure Table 3.1 is a summary version of a SEEA-type SAM with monetary valuation of environmental pressure. In order to obtain this table, the two processes are needed. To begin with, imputed environmental costs are calculated by maintenance cost methods using the estimates of environmental pressure in Japanese NAMEA for 1995 and the additional pollutants (SPM). Then, table 3.1 is obtained by incorporating these imputed environmental costs into Japanese NAMEA. Table 3.2 shows imputed environmental cost (eco-margins) by origin of industries calculated by the maintenance cost method. According to the table, the largest eco-margin is found in non-metallic mineral products. Table 3.3 shows imputed environmental cost by type of environmental pressure. According to the table, CO2 has the largest eco-margin. The most notable difference between the two statistical efforts made by the Government of Japan (new NAMEA and old SEEA) might be that in their positions on monetary valuation of environmental pressure. However, it is no use listing up pros and cons on monetary valuation of environmental pressure in general. Thus, the authors are pro the maintenance cost concept, but con the concept of green GDP. If green GDP were used as a substitute for GDP in the ordinary sense, it might justify inappropriate growth-accelerating policies which may worsen the environment. In this section, the authors will attempt to construct a SEEA-ver.IV.2-type matrix from Japanese NAMEA. In doing so, imputed environmental cost must be estimated by using the maintenance cost concept. This imputation is considered to be highly important because it can clarify what the government should do for the environment as noted before. In this paper, however, only imputed environmental cost the origin of which is industries (=market producers in 93SNA) are considered, because it is necessary to take the extension of production boundary into consideration in order to deal with consumption-related imputed environmental costs. 3 Except for CO2, the assumption of zero-emission is posited in order to calculate imputed environmental cost about each environmental pressure category. Concerning CO2, the 94% of the emission level of CO2 in 1990 is assumed, according to the Kyoto Protocol. Two tables below summarise imputed environmental costs (=eco-margins) by sources and by environmental pressure types (matters). More detailed tables including a table for description of the method of calculation are attached at the end of the paper. 3 Shifting was a device in 93SEEA to deal with imputed environmental cost originated in non-producers. 4

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7 Table 3.2 Imputed Environmental Cost by origin of industries Industries Eco-margins Distribution Distribution of of Value (Billion yen) Eco-margin Added (%) (%) Agriculture,forestry and fishing Mining Food products and beverages Textiles Pulp, paper and paper products Chemicals Petroleum and coal products Non-metallic mineral products Iron and steel Non-ferrous metals Fabricated metal products and Machinery Other Manufacturing Construction Electricity, gas and water supply Wholesale and retail trade Finance and insurance Real estate Transport and communications Service activities Total Industries

8 Table 3.3 Imputed Environmental Cost by type of environmental pressure Types of Environmental Pressure Eco-margins CO N2O 11.7 Green House Effects CH4 4.5 HFCs 88.2 Discharges PFCs 50.7 SF Acidification NOX SO SPM 59.4 T-P Quality of Water T-N Waste Water Wastes Final Disposition Total A CGE Analysis The authors will attempt to conduct a CGE analysis in this section. A few words may be necessary about the terminology before going into the subject. 4-1.AGE and CGE Although the term CGE (Computable General Equilibrium) is often used as a synonym for AGE (Applied General Equilibrium), these two terms are considered to be reflecting different genealogy of a sort. The latter term suggests that the study in question lies in the tradition of Scarf and his successors. The former term would identify the study as being in the World Bank s tradition of development modelling. As is well known, Scarf and his colleagues attempted to find the exact location of a general equilibrium not just its existence. They developed and improved algorithms for finding a fixed point so that they could conduct various policy simulations. On the other hand, the modellers in the World Bank who had used SAM multiplier analyses to draw up development policies felt that their tool should be more flexible. In fact, the SAM multiplier analyses confine their application only in the cases where the prices are constant and production functions and consumption functions are linear. The computation of general equilibrium has made it possible for them to generalise SAM 7

9 multiplier analyses to SAM-based CGE analyses. The CGE models in this tradition have several common features. Of course, one common formal feature is that they are SAM-based. SAMs (Social Accounting Matrices) are in the centre of World Bank s modelling attempts. As is well known, Professor Graham Pyatt played a leading role in development of SAM-based CGE modelling, in which much use was made of SAMs both as a framework of data housing and model presentation, whence consistency of modelling as well as data set was assured. 4 It is often said that S (social) in SAM suggests something social is involved in the data set. For example, the sub-sectoring of the households may be done so that the incomes of the sub-sectors of household sector may be analysed and forecast. In fact, the development strategy of the World Bank until the middle of 80 s was characterised by its emphasis on income distribution. Thus, one more common feature of the CGE models, substantive rather than formal, may their focus on income distribution. In our modelling, however, this feature (detailed institutional distribution rather than factorial distribution) does not appear so explicitly because necessary sub-sectoring is not done in our modelling due to lack of data. A seemingly closely related feature may be that they do not often rely upon utility-function-based welfare measures to evaluate alternative economic situations which alternative policy schemes would lead to. Instead, distribution measures like the Gini coefficient or others are often used. Among other features is a distinctive production structure used in the models, in which wide use is made of the so-called Armington assumption and CET (Constant Elasticity of Transformation) production functions. See Figure4.1 below Features of the modelling in the present paper The main purpose of estimating imputed environmental cost is to make clear what the environmental policy target should be. The policy makers should use whatever regulation measures are necessary to make the eco-margin measure reduce to zero. The policy measures should be those designed to reduce the emission by the amount that is indicated through the measurement of the imputed environmental cost. The policy measures may be direct policy instruments or indirect ones to reduce the emission. Thus, naturally, the environmental SAM modelling is strongly policy-oriented. The authors attempt to construct two alternative models. They are both SAM-based CGE models for environmental policy analyses. In the main model, certain policy measures are incorporated into the model from the very first. They could be interpreted as emission permits of a sort that should be paid for by the producers who want to use the environment. The environment may be treated as 4 See Pyatt[1988]. 8

10 one of the three production factors the remaining two of which are capital and labour as usual. 5 The environment may be considered to function as a sink of a sort. The authors introduce a fixed price closure rule for the production factor instead of fixed quantity closure rules for the other two production factors. There is a thought behind this treatment. The domestic equilibrium price of the permit will be determined at the level of imputed environmental cost, estimated according to the concept of maintenance cost. Because the firms will not pay for the permit if they can reduce the emission by spending actual environmental protection cost which equals to maintenance cost and is less than the value of the permit. The alternative model may be called Ordinary Economy model because the environment does not play any role of a production factor in this model. In other words, the economy is an ordinary (or actual) one without any environmental imputation. By using this model, the consequence of a certain regulation measure which is designed to reduce the emission by the amount designated by the policy target can be projected. For example, the consequence of direct regulation of the production processes of the firms discharging residuals in an inappropriate manner might be analysed. In the main models, the payment flow (for the environment as a factor of production) is received as if it is owned by the capital owners, who are characterised as those who take any surplus gain in the production process. The government in turn takes up the sum as a kind of transfer payment. But in a base equilibrium, it will be transferred back to the owners of capital to reproduce the actual data in This needs some excuse actually. Thus, imputed environmental cost is the part of value added of the producers which they get through exploiting the environment, so to speak. Firms doing so may not be so aware of the environmental pressure they have made. At the same time, however, it is also the case that the present state of the economy is not the result of zero environmental awareness. In fact, there is, at present, so much pressure on the firms that are responsible to any ill-usage of the environment in the society. For example, the possibility of damage payment in the future may cause the firms to act in a more deliberate manner. Any new system for environmental protection will force the firms to adjust to it. Thus, the models assume that the firms are just ready for the introduction of a national tradable permit system although in reality they do not make any net payment about it. But, this hypothesis may be considered to assume too environment-conscious firms 5 Rather than treating the environment as a production factor, a possible alternative model that we might suggest (but not fully developed here) will be the model where the emission of residuals are treated as a joint production of a sort which might be formulated in terms of CET technologies. This treatment seems to fit quite well with the logical framework of NAMEA. 9

11 in the model. It may be better to think that the present size of eco-margin may be the result of the behaviour of the firms which respond to not full but a half or even one third of the domestic equilibrium price of tradable permits. Thus, it might be more plausible to assume less environment-conscious behaviour of firms in the model. In any case, it will be easy to adapt or reinterpret the model in the way suggested here. However, it should be careful about the implementation and interpretation of the simulation results Production part of the model, which is one of typical World-Bank-type models except for the treatment of the environment, may be schematised in Fig A few comments should be in order. (1) The environmental production factor is combined with mixed production factors by using CES production function form. Aside from a parameter automatically calibrated, the modeller(s) need(s) to set one parameter of the CES production function, namely, the elasticity of substitution. The authors set it to be (2) Domestic goods (and services) stage 1 are domestically produced goods some of which may be further transformed to exports, the rest being (transformed into) domestic goods (and services) stage 2. The CET transformation function indicates the process. (3) Domestic goods (and services) stage 2 combined with imports are transformed into composite goods (and services) that are to be used for the final uses and intermediate consumption. A sketch of the model SAM as a whole is illustrated below in Table 4.1 Figure 4.1 Production Part of the Model 6 If the elasticity parameter is set otherwise, the results will change, but only slightly. 10

12 Table 4.1 Model SAM sketched Factors Institutions Savings.- Com. Activities. ROW including Investment. Company a/c Factors Factor Factor Payment to Payment Capital, From the Labour,, and ROW Environment Institutions Primary Transfer Transfer including Distribution payments from Company Income Generation between ROW account on the Assumption Institutions that payment to including the environment those related goes as if it is with owned by the emission capital owners permits Savings- Savings Investment Commodities Final Capital Intermediate Exports Consumption Formation Input (U) Activities Output (V) Rest of the Factor payment to Transfer to Current Imports World the ROW ROW Balance 11

13 4-3. Results for the main model The increase in the endowments of capital or labour leads to the decrease in imputed environmental cost (eco-margin). In one sense, the environment is ill-used just to save other factors. But size of pressure of the 10% increase in each factor endowment to the industries is different industry by industry. Concerning labour, a large decrease in eco-margin is found in construction, transport and communication, service, etc. Concerning 10% increase in capital, a large decrease in eco-margin is found in real estate, agriculture, wholesale and retail trade, etc. The 10% increase in labour endowment has a larger effect on the reduction of eco-margin than the same proportional increase in capital endowment. The result of the experiment about 10% increase in the price of environment as a production factor may not seem to be so definite. Eco-margins decrease in some industries but increase in other industries. The results of selected experiments will be summarised as follows Table 4.2 Selected Results of the Main Model Industries % changes in eco-margin due to 10% increase in Labour % changes in eco-margin due to 10% increase in Capital % changes in eco-margin due to 10% increase in environmental factor price Agriculture, forestry and fishing Manufacturing Construction Electricity, gas and water supply Wholesale and retail trade Finance and insurance Real estate Transport and communications Service activities

14 4-4. Results for the ordinary economy model In addition to the main model, an alternative model is formulated to analyse an ordinary or actual economy without environmental imputation. Policy makers may be inclined to think that it is necessary to introduce direct rather than indirect regulation measures in order to reduce the imputed environmental cost known quite immediately to zero. In other words, the imputed cost in the main model needs to be borne actually by the producers of the alternative model. Thus, they must spend some additional cost for the environmental protection instead of discharging residuals. On this assumption, the working of the economy will be simulated by using this model. Additionally, so-called Greened GDP or more adequately Greened Economy GDP in the terminology of SEEA2003 draft manual will be calculated although greened economy SAM may be more meaningful. According to the authors model, Greened Economy GDP seems to be greater than Green GDP by the amount depending on the assumptions made. Some words may be necessary here to compare the two concepts, Green GDP (GDP minus Fixed Capital Consumption minus Imputed Environmental Cost) and Greened Economy GDP. One typical criticism on the former concept may be that it does not take into account various percussion and repercussion of employing one or other residual reduction measures. Some authors advocated Greened Economy GDP instead of Green GDP to respond to the criticism. Numerical comparisons between the two are found in the table below. Table4.3 Green GDP and Greened Economy GDP (Billion yen) GDP AT FACTOR COST 469,870.3 GDP AT MARKET PRICES 509,969.1 FIXED CAPITAL CONSUMPTION 89,116.9 NDP AT MARKET PRICES 420,852.2 ECO - MARGIN in the model 86,025.0 GREEN GDP 334,827.2 GREENED ECONOMY GDP (CASE 1) 407,862.4 at constant prices GREENED ECONOMY GDP (CASE 2) 392,774.6 at constant prices GREENED ECONOMY GDP (CASE 3) 400,739.7 at constant prices CASE 1: Imputed environmental cost replaced by INTERMEDIATE INPUT CASE 2: Imputed environmental cost replaced by FACTOR INPUT CASE 3: Imputed environmental cost replaced by Mixed INTERMEDIATE and FACTOR INPUT 13

15 5. Closing Remarks Firstly, a controversial problem over direct vs. indirect regulations will be spotlighted by the modeling of this sort. Both types of regulations use market mechanisms. The latter induces the economic agents to change their behaviors by using the mechanisms to achieve the policy targets. The former regulates discharging of residuals directly and the market mechanisms work afterwards to achieve a new equilibrium position in which the policy targets are met. The modelling seems to be insufficient to get to any decisive conclusion about the problem raised. Because the key to the problem may be whether any switch of techniques as well as shift in industrial structure is triggered by the policy change. The main model excludes any switch of techniques from consideration. However, plausibly, indirect regulations may bring about insufficient, if not nil, switch of techniques for the accomplishment of the policy target. If this is the case, direct regulation may be better way to achieve the target, for additional consequences brought about by indirect regulations may not necessarily be desirable from the viewpoint of income distribution. Secondly, needless to say, more disaggregated treatment for the environmental pressure categories should be necessary. Green house gases such as CO2 and other residuals cause different environmental problems that need to be solved differently. Lastly, it should be stressed again that monetary valuation of environmental pressure according to the concept of maintenance cost is important in that it not merely gives an estimate of the equilibrium price of an emission permit but clarifies the responsibility of the government for the environment. For, the estimation of imputed environmental costs clearly has an implication that they need to be reduced to zero. References Ariyoshi, N. (2006), "The Development of Japanese NAMEA" the paper prepared for International Workshop for Interactive Analysis on Economy and Environment, Cabinet Office, the Government of Japan, 4th March De Haan, M. and S. J. Keuning (1996), "Taking the Environment into Account:The NAMEA Approach," The Review of Income and Wealth, Series 42, No.2, pp Department of National Accounts, Economic and Social Research Institute (ESRI), Cabinet Office of Japan (2004), New System of Integrated Environment and Economic Accounting: Trial Calculation on Hybrid Accounting System 14

16 Integrating Environmental Pressures and Economic Activities, Pyatt, G. (1985), " A SAM Approach to Modeling, Journal of Policy Modeling, vol.10, pp United Nations (1993), Handbook of National Accounting: Integrated Environmental and Economic Accounting, Interim version, United Nations (ST/ESA/STAT/SER.F/61). 15

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