years and intense analytical effort to hammer out. The changes in the Framework Convention will be agreed to after just over two years of negotiation, almost none of which has paid any attention to their international economic consequences.

In particular, developing countries need to better understand the impacts of changes in trade relationships on them. Industrial countries have a responsibility to understand how their national economies and key industries will be affected by the trade distortions emissions will create. More research is also needed on the possible implications of efforts to exempt energy-intensive sectors from emission reduction requirements, and the effects of efforts to implement tariffs or other trade restrictions to offset those distortions. Most economists familiar with international trade would probably agree that distorting trade through unilateral emission limits and then compensating by erecting tariff barriers would be a major setback in the progress we have seen since the Second World War in trade liberalization.

Similar issues arise about how introduction of an international trading of emission rights would affect other trade patterns. Recent research reported in the Oslo IPCC meeting in August suggested that there could be large, unintended spillover effects of introducing emission trading. These spillover effects could change the prices of other goods exchanged in international trade in unexpected ways. Some analysts found that introducing emission trading would reduce costs for the United States, and others found that it would increase costs.

It is also necessary to understand better how emission trading would affect capital flows. If, for example, Russia (an Annex 1 country) is allocated emission rights equal to its 1990 emissions, it is likely to become a major seller of rights without taking any further action to reduce emissions, since the universal expectation is that its current course will take Russia to emissions far below 1990 levels in 2010. One group, ABARE, estimates that Russia would be receiving payments for emission rights equal to about 10% of its GDP by 2010. Emission trading is not a magical instrument for making costs disappear. It is a major change in the economic environment that can have wide-ranging economic effects not yet fully understood.

Without greater understanding of these possible fundamental changes in trade relationships among countries, negotiators do not have the information they need to protect their national interests in the negotiating process. No other multilateral trade negotiation has proceeded to this stage so quickly, or with so little attention to its economic consequences. That is the key area for research.

If a commitment could be made at Kyoto to a reasonable process for initiating R&D and involving developing countries - without specific emission reduction targets-- a whole new menu of important research topics emerge. The most important research projects, I believe, are on how to design policies that will stimulate effective private sector R&D into the range of possibilities for reducing carbon emissions in the absence of near term emission limits. These could include public-private partnerships modeled on the Partnership for a New Generation Vehicle, or other mechanisms in which public funding is used to change the direction of private research without "picking winners." These studies should not try to select technologies and guess at what their cost and energy savings would be, as past studies have done. Rather, the focus should be on

policies that can stimulate more private R&D and shift it into directions more likely to produce innovations that lower the cost of replacing fossil fuels.

A second direction of research should be on how to make sure this technology is applicable to the developing countries where most emission reductions will have to take place, and how to transfer this technology effectively.

To recap my testimony, let me make a series of points.

The proposals now under consideration in negotiations on the United Nations climate treaty could have significant economic impacts on the United States.

•· They would increase energy costs in the United States relative to competing countries that are not being asked to make commitments to reduce carbon emissions.

These cost increases are likely to confer trade advantages on industries in the same developing countries.

• Energy-producing and energy-intensive industries are likely to suffer losses in output and employment if any of these proposals are adopted.

Failure to include developing countries in any agreement to limit emissions results in carbon leakage that significantly increases the cost of achieving the goals of climate policy.

Technology development can reduce costs, but that requires considerably more flexibility in timing than a 2010 target allows.

The most important uncertainties are that economic models underestimate costs by assuming efficient, market-based policies. If regulatory approaches are used to conceal costs, the real costs to the U.S. economy could be much higher than estimated by standard economic models.

Thank you for your invitation to address the Subcommittee. I will be happy to answer your questions.

W. David Montgomery

Biographical Sketch

Dr. Montgomery is Vice President of Charles River Associates and an internationally recognized authority on the economic impacts of climate change policies. He was a Principal Lead Author of the Second Assessment Report of the Intergovernmental Panel on Climate Change (IPCC), Working Group III, and the author of a number of studies of climate change policy over the past 7 years. His testimony on climate change issues has been requested on numerous occasions by the U. S. Congress. Dr. Montgomery directs the group at Charles River Associates that developed a set of integrated economic models for the analysis of international, national, and industry impacts of proposed emission limits. He and his colleagues have been participating over the past year in IPCC studies assessing benefits of allowing flexibility in timing of emission limits and economic impacts on developing countries.

Prior to joining Charles River Associates, Dr. Montgomery held a number of senior positions in the United States Government. He was Assistant Director of the U. S. Congressional Budget Office and Deputy Assistant Secretary for Policy in the U. S. Department of Energy. He also headed forecasting and economic analysis activities of the Energy Information Administration for a number of years. Dr. Montgomery taught economics at the California Institute of Technology and Stanford University, and was a Senior Fellow at Resources for the Future. Dr. Montgomery has written two books on energy policy and regulation, published by Resources for the Future, and numerous articles in professional journals on applied microeconomic theory. His article on "Markets in Licenses and Efficient Pollution Control Programs," (Journal of Economic Theory 1972), is widely cited as the seminal work in the development of emission trading policies. Dr. Montgomery holds a Ph. D. in Economics from Harvard University and was a Fulbright Scholar at Cambridge University.

Chairman CALVERT. Thank you, Mr. Montgomery. You'll have plenty of opportunity to answer some questions later.

Mr. Chupka, next.

TESTIMONY OF MARC W. CHUPKA, ACTING ASSISTANT SECRETARY FOR POLICY AND INTERNATIONAL AFFAIRS, U.S. DEPARTMENT OF ENERGY

Mr. CHUPKA. Mr. Chairman and members of the Subcommittee, I appreciate the opportunity to discuss the report titled, "The Impact of High-Energy Price Scenarios on Energy-Intensive Sectors: Perspectives from Industry Workshops," which was prepared by Argonne National Laboratory under contract with the Department's Office of Policy and International Affairs.

The Argonne report summarizes a series of industry-specific workshops that were convened in June and July of 1996.

The workshop participants discussed the effect of hypothetical energy price increase scenarios on the future competitiveness of six energy-intensive industries- aluminum, cement, chemicals, paper, petroleum refining, and steel-that together account for over 70 percent of the manufacturing use of energy.

The workshop participants included industry experts from trade associations, environmental groups, labor unions, government, the academic and financial communities, as well as from companies in each industry.

For each industry workshop, Argonne commissioned an expert to write a discussion paper to circulate to workshop participants to help focus the dialogue.

The experts and the participants were provided with a baseline scenario and energy price increase scenarios suggested from preliminary analyses of policies that did not incorporate many important features of the subsequent U.S. protocol submission of January 1997.

In particular, international emissions training, joint implementation, multi-year emission budgets, and developing country commitments were not stipulated in the price scenarios given to workshop participants, and no additional support for technology R&D was assumed.

Nevertheless, under the scenarios examined, the workshop participants painted rather grim portraits of potential impacts, such as gradual reductions in output and employment, reduced exports, and/or increased imports of these products, possible plant closures, and an increased incentive to locate production facilities in other countries.

Our response to the findings outlined in the Argonne report has been to advocate policies that will assure that the energy price scenarios assumed for purposes of the workshop do not occur.

It is important to note that the workshop findings were based on specific energy price scenarios assumed in mid-1996, which do not reflect the flexible approach that the U.S. Government has vigorously advocated in international negotiations in the intervening year-and-a-half.

Such provisions would substantially lower the cost of achieving greenhouse gas emission reductions and would, by design, avoid the industry impacts discussed in the Argonne workshops.

In this regard, it is particularly important to note that the U.S. position is that developing countries should assume additional obligations in the near future to reduce their projected rapid growth of greenhouse gas emissions.

No such actions were reflected in the workshop scenarios, and many of the Argonne workshop participants identified the absence of commitments in developing countries as the most critical competitiveness issue

Many participants have also expressed their appreciation to the Department for the opportunity to convey their concerns in these workshops.

These workshops highlight this Administration's proactive dialogue with important stakeholders in the climate change issue, and our response demonstrates this Administration takes their input very seriously as we formulate policy.

To sum up, both the Argonne study and the five-labs study that Joe will talk about in a moment have strengthened our resolve to craft policies that respond to environmental threats in an economically responsible way.

From the Argonne report, we learn that any policy that dramatically raised energy prices for energy-intensive industries could have adverse effects on those industries.

That key insight has influenced the evolution of the U.S. policy position toward the pursuit of flexibility in global climate change policies, including a reasonable timetable, realistic and achievable objectives, international emissions trading, joint implementation, and has strengthened our belief that developing countries must participate in a global effort to mitigate greenhouse gas emissions. From the five-labs study, as Joe will describe shortly, we learn that a vigorous national commitment to develop and deploy energyefficient and low-carbon technologies has the potential to cost-effectively reduce U.S. carbon dioxide emissions and that technology improvements hold the key to long-term emission reductions consistent with continued economic growth.

Climate change is an important national and global issue. In the process of developing policy that will meet our environmental objectives without disrupting our economy, this Administration has assumed the need for a variety of market-oriented flexible measures, both at home and abroad, accelerated research and development into new technologies, and an international regime involving the participation of all nations.

I appreciate this opportunity and will be happy to answer any questions.

Chairman CALVERT. Thank you, Mr. Chupka. Dr. Romm.

TESTIMONY OF JOSEPH J. ROMM, ACTING ASSISTANT SECRETARY FOR ENERGY EFFICIENCY AND RENEWABLE ENERGY, U.S. DEPARTMENT OF ENERGY

Mr. ROMM. Mr. Chairman and members of the Subcommittee, I appreciate the opportunity to come before you and discuss the results of our in-depth, peer-reviewed "Scenarios of U.S. Carbon Reductions: Potential Impacts of Energy Technologies by 2010 and Beyond."