The Kyoto Protocol: A High Economic Cost Energy is a building block of economic prosperity. The Kyoto Protocol would impact economic performance through several mechanisms: Limiting carbon emissions from the combustion of fossil fuels would be achieved through higher energy prices. Higher prices impose a burden on the U.S. economy-consumers, workers and producers must adjust to radically different relative prices. Higher energy prices would lead to premature obsolescence of capital stock. Because the imposition of the carbon limit is not borne equally by all countries, U.S. exports become relatively more expensive on the world market, while the relative price of many imported goods falls. While business investment Energy is a building block of economic prosperity. Limiting carbon emissions from the combustion of fossil fuels would affect the overall economy through higher energy prices, as the purchaser of fossil fuel pays for a permit to consume the fuel, in addition to the cost of producing the fuel. Since energy is used in the production of all goods and services, all other prices rise as well. Energy prices are much higher, while all other prices are affected to a lesser extent, depending on the energy content of that product. Higher prices impose a burden on the U.S. economy consumers, workers and producers must adjust to radically different relative prices. Consumers face an increase in the cost of energy, encouraging them to reduce spending on gasoline, home heating oil, electricity and natural gas. For businesses, the rising price of energy (relative to other inputs) hurts their bottom line, discourages their use of energy and encourages the use of more energy-efficient capital equipment and some additional labor to produce their products. The effect is an increase in costs, reducing US wealth and competitiveness in the global economy. Some workers lose their jobs through a weaker economic environment, while other workers lose well-paying manufacturing jobs and find only lower wage service jobs. All workers face a slowing in their real wage growth as workers compete for fewer jobs. Higher fossil fuel energy prices lead to the premature obsolescence or accelerated depreciation of some existing fossil fuel using capital stock. This premature obsolescence lowers productivity growth, at least until the capital stock adjusts to the new price regime. This slowdown in productivity growth is another cause of the slowdown in real wage growth. Although the government compensates workers for their increased energy expenditures, through a refund of the fees collected to consume carbon-based energy resources, total real disposable income falls due to reduced employment and lower real wages. In general, the economy is worse off-the increase in energy prices pushes up inflation and raises interest rates. Higher interest rates reduce housing starts, vehicle sales, and business investment. The stock of housing, vehicles, and machinery and equipment is lowered because of the higher interest rates. With a lower level of productive capital stock, fewer people are employed and real gross domestic product (GDP), the total output of goods and services, is smaller. One key reason for the lower level of real GDP is reduced global competitiveness. Because the imposition of the carbon limit is not borne equally by all countries - the developed economies face comparable energy price increases, but the developing countries do not - U.S. exports become relatively more expensive on the world market, while the relative price of many imported goods falls. As a consequence, exports are lowered dramatically, while imports are increased substantially. Moreover, while business investment and consumer spending begin to adjust after 2010 to the shift in energy prices, there is no reason why exports and imports would adjust. Without a major depreciation in the value of the dollar, the worsened trade balance continues through 2020. GLOBAL WARMING: THE HIGH COST OF THE KYOTO PROTOCOL Measuring the Impact on Economic Growth Real GDP. The level of real gross domestic product is 3.2% lower than the base case in 2010. By about 2020, the economy has adjusted to the pattern of rising energy prices and is somewhat able to compensate for the minishocks of rising prices. Consequently, the percentage reduction in GDP falls to 2.0% Inflation. Inflation increases due to energy costs rising sharply with the rise in permit fees. After 2010, the impact on inflation moderates. This is true for consumer price inflation, the widest measure of inflation, returns to baseline levels. Producer price inflation remains one-half to one percentage point above the baseline level because of the continued rise in energy prices. Employment. Employment is 2.4 million lower, 1.7% below baseline, in 2010. The drop in employment shrinks to about 0.6 million, or about a 0.4% decline relative to the baseline, by 2020. The unemployment rate is higher-up by 1.5 percentage points in 2010, but only 0.3 points higher in 2020. • Consumption. Consumers, reacting to lower real disposable income due to lower real wages and fewer jobs, cut spending Consumer spending is down by 2.4% in 2010, or $151 billion ($1992), then recovers somewhat – down only 0.7% by 2020. Autos. New light duty vehicle sales fall 3.1% or 0.6 million by the year 2010. By the year 2020, sales are slightly higher as delayed purchases increase the need for replacement vehicles greater in the later years. Housing, Housing starts are down by 4.7% or 0.07 million by the year 2010 and recover by the year 2020 to 1.7% above the base case. Due to the sharp reduction in starts during the early years of the imposition of the GHG limits, there is increased activity long run due to demographic pressures. • Non-Residential Fixed Investment. Under this scenario, businesses begin to shift their investments towards more energy-efficient equipment and structures. This shift in investment does not result in an increase in production since it is directed at lowering energy costs, rather than increasing capacity. Also, the mini-shocks from higher energy prices and the economy's weaker international competitive position reduce the need and the ability to invest in the economy. At a second level, there is a price impact that varies by type of investment. For most equipment purchases, businesses evaluate the cost of buying the equipment against the price of hiring more workers to produce the necessary extra product. In the analysis, this resulted in a relative price improvement for equipment. For structures, the cost of the structure is compared to the output price. Hence, structures are affected by a drop in demand and a rise in price, while equipment purchases are affected by a drop in demand and lower relative prices. However, the demand for investment in equipment falls more sharply than structures, since equipment purchases are more sensitive to shifts in demand and price shifts than structures. By 2010, business equipment purchases are down by 3.8%, while structures are down by 2.5% By 2020, both have recovered somewhat and are down by 1.5% and 1.4%, respectively. • Government. Real government spending on purchases of goods and services remains very similar to the baseline projection. Because economic activity is lower and interest rates are higher in this simulation, the deficit is worse in the carbon limits simulation. By 2020, the Unified deficit is $336 billion, compared to $202 billion in the baseline. • International Trade. The largest impact is on international trade. Because only the Annex I countries would be subject to limits on greenhouse gas emissions, the price of imported goods from developing countries does not rise substantially, making their products more attractive. Imports from developing countries rise, while U.S. exports, which have become more expensive, fall. The increase in imports and drop in exports account for $124 billion, or 41%, of the decline in real GDP by 2010. In the analysis, this segment of final demand does not recover by 2020, with net exports of goods and services in that year down by $226 billion. GLOBAL WARMING: THE HIGH COST OF THE KYOTO PROTOCOL |