Endogenous Climate Policy in a Rich Country:
A CGE Study of the Environmental Kuznets Curve
Annegrete Bruvoll, Taran Fæhn and Birger Strøm,
Statistics Norway
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Abstract:
Observed Environmental Kuznets Curves (EKC) indicate an inverted U-relationship between several
pollution problems and per capita income. By means of dynamic, applied, general equilibrium
simulations we investigate this relationship in projections for a rich, open economy, and quantify the
relative importance of central hypotheses launched. One theory is that demand for environmental
quality increases with growth and provides acceptance for environmental policy. Another emphasizes
technological progress. A third claims the role of compositional changes. A cleaner industry structure
may, however, come at the cost of pollution leakages through import. Our results indicate that
emissions of local and regional pollutants will continue to fall, while climate gas emissions will
increase, but less than GDP/cap. Contributions from endogenous policy and structural changes are
important to these results, as is improved abatement technology for local and regional pollutants.
However, the counterpart of domestic environmental achievements is increasing pollution leakage
abroad.
Keywords:
The Environmental Kuznets Curve; Endogenous Policy; Pollution Leakage; Dynamic CGE Model
JEL classification:
D58; O11; Q25; Q28; Q48
Corresponding author:
Taran Fæhn,
Research Fellow
Statistics Norway,
Research department,
P.O.box 8131 DEP,
N-0033 OSLO,
Norway
Telephone:
+47 21 09 48 37
Fax:
+47 21 09 00 40
E-mail:
tfn@ssb.no
1
1
INTRODUCTION
Over the last decade, a long series of studies have investigated the relationship between pollution and
economic growth per capita. Initial papers by Grossman and Krueger (1993, 1995), Shafik and
Bandyopadhyay (1992) and Selden and Song (1994) presented evidence that some pollutants have
historically followed an inverted U-curve with respect to per capita income. These observations are
usually referred to as Environmental Kuznets Curves (EKC).
Different theories for these observations are launched (see e.g. Borghesi 1999 or Stagl 1999 for
overviews and comparisons of the theories and empirical results from the literature). One branch of
explanations is based on political economy mechanisms. Environmental goods are normal goods in the
economic sense, so that higher income increases the demand for a cleaner environment. Agents
influence the government through economic policy mechanisms like lobbying, voting and other
political activities. An increased willingness to pay for the environment is demonstrated by a higher
acceptance for environmental regulations and taxes.
Another theory emphasizes technological change as a main explanation. General productivity growth
promotes more efficient use of resources and less pollution per produced unit. Increased factor
mobility, international trade and widespread use of ICT are characteristics of the growth process that
contribute to an effective diffusion of innovations. In addition, increased willingness to pay for a
cleaner environment, in accordance with the above-mentioned hypothesis, pushes abatement
technology forward (see e.g. Anderson and Cavendish 2001).
A third branch of explanations claims that at high income levels, structural changes contribute to less
emissions/GDP. Economies become more service based and reliant on human capital, andrelatively
less material- and energy-intensive.
To the extent that industry patterns rely on comparative advantages, a cleaner production pattern in
rich countries will partly be obtained by raising the import shares of dirty products. Environmental
policy may be one of the factors behind altered comparative advantages. The counterpart will be
environmental degradation in other countries through so-called pollution leakage. Typically, pollutionintensive production tends to shift to less developed countries, with less preferences for a clean
environment and hence lower policy ambitions. De Bruyn (1997), Suri and Chapman (1998), Hettige
et al. (1992) and Hettige et al. (1997) indicate that there may be empirical support for such an
hypothesis.
There are two main reasons to concern about pollution leakage: First, a redistribution of environmental
goods is of ethical concern, not only in the short run, but also in a dynamic perspective. Countries that
2
lag behind in terms of welfare and abatement policy, will be less in position to obtain environmental
improvements along with growth, as the potential for exporting pollution problems will gradually
diminish. De Bruyn and Opschoor (1997) claim that reduced domestic emissions resulting from import
substitution should not be credited as environmental improvements. Secondly, if the leakages include
emissions that have transboundary or global effects, no environmental benefit will be obtained by a
pure relocation of the source. In case of climate policy, a long range of studies has been performed to
quantify the extent of carbon leakage (see e.g. Jacoby et al. 1997, Barker1999). For these reasons, we
argue that a possible negative coherence between economic welfare and emissions may have very little
to do with environmental gains, if it is based on increasing import shares and pollution leakage abroad.
The econometric literature on EKC and the various hypotheses is comprehensive, but still the
empirical contributions from applied model studies have been modest. Model analyses are capable of
isolating effects and shed light on the various hypotheses on EKC. Two exemptions are Jansen (2001)
and Andersen and Cavendish (2001), who by means of AGE models treat respectively the endogenous
environmental policy hypothesis and the technology hypothesis. Another method is illustrated by
Bruvoll and Medin (2002), who use a decomposition analysis to isolate the driving forces behind
historically observed emission changes. They find that composition effects as well as more efficient
use of energy and abatement have been the main reasons for the de-linking between emissions and
economic growth the last decades.
In this study, we combine the use of a detailed, dynamic CGE model for Norway that integrates
economic and environmental mechanisms, and the decomposition principle, in order to address and
quantify contributions from all the above-mentioned hypotheses; The endogenous policy hypothesis,
The composition (and leakage) hypothesis, and The technology hypothesis. We investigate whether the
respective contributions of these driving forces may be capable of counteracting the environmental
implications of increased GDP and consumption activity in the next two decades. We also take into
account cross-border leakages.
In principle, a proper modeling of environmental policy should include mechanisms that endogenously
regulate all detrimental emissions. This study concentrates on climate policy. The main reason for
assuming unaltered abatement policy towards regional and local pollutants, is that achievements in
these fields are already high. For example, Norwegian emissions of SO2 have fallen 80 percent the last
two decades, while lead emissions are close to eliminated. As Norway is the fourth richest country in
the world (OECD 2001), this is well in accordance with EKC predictions for local environmental
problems. Today, the climate problem is considered to be one of the greatest challenges in rich
countries' future environmental policy. According to the EKC, the income level should indicate that
Norway may be one of the leading countries when comes to future CO2 abatement policy. Relative to
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emissions with local effects, empirical EKCs studies of CO2 indicate that the downward sloping range
of the EKC appears at very high income levels (see e.g. Holtz-Eakin and Selden 1995).
Many studies point to substantial co-benefits of greenhouse gas regulations on the local/regional
environment (see OECD 2000 and Aunan et al. 2001). Thus, future political actions against CO2
emissions will also significantly affect energy related emissions with locally damaging effects. We
measure environmental impacts in terms of changes in emissions to air of all six climate gases in the
comprehensive approach of the Kyoto Protocol: Carbon Dioxide (CO2), Methane (CH4), Nitrous
Oxide (N2O), Perflourocarbons (PFCs), Sulphur Hexafluoroides (SF6), and Hydrofluorocarbons
(HFCs). We further study the effects on emissions of Sulphur Dioxide (SO2), Nitrogen Oxides (NOx),
Carbon Monoxide (CO), Non-Methane Volatile Organic Compounds (NMVOCs), and Suspended
Particulates (PM1).
The paper proceeds as follows; section 2 describes the method, section 3 presents the main set of
results, while section 4 concludes and summarizes the analysis.
2
METHOD
2.1
The design of the analysis
In order to study the changes in emissions, we decompose future emission projections into four
different effects, by means of model simulations:
1) changes in the scale of the economy,
2) changes in technology, including changed energy and material intensity within production,
changes in energy technology and some projected environmental technology improvements,
3) changes in the composition of production and consumption, which also involves changes in
international trade and thus pollution leakages, and
4) changes in environmental policy.
Two scenarios are constructed in order to carry out this decomposition. The climate policy scenario
represents a projection of emissions to air, which takes into account various exogenous variables
decisive of the general economic development for the next 20 years, including a possible conjecture of
endogenous climate policy changes. The reference scenario leaves out climate policy changes, in
order to isolate effects of the general economic development. We analyze this scenario to obtain first
1
PM includes PM 2,5 and PM10 .
4
order approximations of the scale, composition and technology components determining total emission
changes. The differences between the two scenarios, in terms of average annual percentage growth,
constitute the first order approximation to the simulated, isolated effect of the climate policy.
1) Scale effects
Due to general growth factors like productivity progress, labor force changes and improved world
market conditions, GDP and consumption grow steadily over time. This scaling up of aggregate
production and consumption increases emissions over time, given constant emissions per
GDP/consumption unit. A crucial question in the EKC literature is whether positive environmental
effects of changes in composition, technology and policy are sufficient to counteract these scale effect
on emissions.
2) Technological change effects
One theory in support of EKC is based on the role of technological change. In our projections,
technological change is, first, represented by the increasing total factor productivity, implying that
inter alia polluting inputs are more efficiently used. Secondly, the composition of energy production
based on hydropower and gas power, respectively, is endogenously changing in the model dependent
on profitability calculations. Thirdly, some changes in emission coefficients that are expected to be
realized in the near future are built in as assumptions. Finally, energy and material intensities change
due to factor substitution. We identify the effect of these technology changes. They do, however,
constitute only a fraction of potential innovations that may occur within the next two decades. We
have not yet accounted for technology shifts in response to the conjectures concerning altered policy.
We also regard it beyond the scope of this paper to take into account effects of endogenous technology
growth mechanisms and future innovations with characters and costs not yet possible to identify.
3) Composition effects and leakages
Our disaggregated model provides very detailed information on the changes in industrial patterns, as
well as the composition of consumption. This provides the opportunity to isolate the effects of
structural changes on emissions. Explanations of EKC include the hypothesis that rising income
beyond a certain level correlates with stronger emphasis on non- or low-polluting activities, like
production and consumption of services.
Linked to this hypothesis is the assumption that a cleaner production pattern partly originates from
altered comparative advantages in favor of cleaner products. The shift towards less pollutive activities
that takes place, may imply that consumption becomes more reliant on imported goods and thus on
emissions abroad. In order to conclude on the net leakage effects, we study the changes in import and
export shares, and combine our results concerning import and export changes with emission
5
coefficients that apply to our trade partners, in order to conclude on pollution leakages of CO2 (carbon
leakages), the greenhouse gases NH4 and N2O, as well as SO2, NOX, CO and NMVOC.
4) Policy effects
Through a shift analysis on the CGE model, we may isolate effects of tighter environmental policy, in
order to investigate the EKC hypothesis of changing political preferences.. There are three design
options. One is to treat environmental policy as an exogenous decision variable. Another is to
exogenously allow for a maximum emission limit, and deduce the necessary policy action, for instance
by means of environmental taxes. A third approach is to treat policy as endogenously determined by
the welfare level of the inhabitants. The latter is most neatly adapted to the EKC hypothesis.
Nevertheless, very few applied model studies have tested the implications of such mechanisms. Jansen
(2001) reports effects on emissions of suspended particulates from trade liberalization by means of a
static, applied CGE model with endogenous abatement policy. In order to obtain a more complete
picture of the EKC mechanisms, we aim to treat climate policy as endogenously determined by the
welfare level of the consumers. We explore the implications of applying an endogenous policy rule as
explored in Jansen (2001) in case of climate policy.
In the context of EKC, one could imagine similar rules simultaneously applied to all environmental
problems. We choose climate policy as the case in this study of Norway, as many of the other
emission problems have diminished markedly over the last few decades. Previous econometric results
when it comes to EKC curves for CO2 are mixed. Results concerning a possible turning point of the
emission curves suggest that it appears at very high income levels, varying between about the level of
Norwegian GDP/cap today (40 000 Euros in 2000) and several millions Euros (see e.g. Holtz-Eakin
and Selden 1995 or Lucas 1996).
Econometric representations of the relationship between emissions and per capita income usually use a
functional form that is quadratic or cubic in GDP per capita (Y), either linear or logarithmic, and with a
trend term, T. Cross sectional analyses also include land specific variables, such as population density
and temperature (for an overview of such studies, see e.g. Agras and Chapman 1999). For our time
series data of CO2 for Norway over the years 1949-2000, we have used the following model:
(1)
ln CO 2,t     1 ln Yt   2 (ln Yt ) 2   3 (ln Yt ) 3   4Tt  et
The results of this regression show a concave relationship between income and emissions of CO2 with
statistically significant estimates.2 The projections imply that emissions will continue to grow, with a
falling rate. In our simulations, we use this model to account for a climate policy that is endogenously
determined by income per capita. In order to model a comprehensive climate policy approach, we
6
assume that this model applies to emissions of all climate gases. The difference between the two
simulated paths with and without an endogenous climate tax makes up the contribution of abatement
policy. The inferred climate policy may assume different forms. We model it as a uniform tax rate
applied to all the six climate gases included in the Kyoto protocol.
It would be of high interest to coherently study the cases with and without a multinational climate
policy agreement and compare the effects in overall emissions and, in particular, the extent of
emission leakages. While this is an interesting topic for future research, we restrict this particular
study to unilateral actions. Unilateral actions in the field of greenhouse gas abatement may be
motivated by a desire to stand out as good examples and be at the front in climate policy development.
The final objective of abatement policy is of course much more ambitious. The challenge is to
counteract the ongoing climate changes. This will only be realizable within a broad international
context. One reason for studying unilateral actions in the EKC context is that observations on CO2
abatement efforts until date have not been influenced by international agreements on climate policy,
and available empirical results on the relation between growth and climate policy are thus interpreted
as indicative for what we can expect of unilateral actions. Though there are difficulties with
interpreting the correlations in the data3, we do regard the deduced policy actions as a best guess of the
national climate policy in the near future, conditioned on the possible case of no ratified Kyoto
Agreement.4 The case of a Kyoto ratification would more fruitfully be approached by restricting the
total Kyoto gas emissions exogenously to the commitments made in the negotiations, and deduce the
necessary policy measures. Several studies of this kind are already made, both in global, regional and
national studies. For Norway, see e.g. Norwegian Ministry of the Environment (2001) and Strøm
(2001).
2.2
The model
The applied CGE model of the Norwegian economy, MSG6, is an integrated economy and emission
model, designed for studies of economic and environmental impacts of climate policy. A more
detailed description, with references, is provided in Fæhn and Holmøy (2000). The model specifies 60
commodities and 40 industries, classified with particular respect to capturing important substitution
possibilities with environmental implications. The model is dynamic, based on rational agents with
2
The results show the following relation: lnCO2,t=-709.5+176.2lnYt+14.6(lnYt)2+0.4(lnYt)3+0.01Tt. All coefficients, except
for 4, are significant on a 0.03 percent level.
3
As an international agreement has been on the agenda for many years, the observed actions may of course have been
influenced by anticipations of an agreement to be established. We find it difficult to correct the estimates for this, however.
So far, EKC studies of CO2 have not corrected for actions abroad, a factor that ex ante have an ambiguous effect: It could
stimulate to follow, in order to be able to reach a common goal, or the temptation of free-riding could be dominating.
4
In Norwegian Ministry of the Environment (2001), where the Government states its future climate policy intentions, this
scenario is not concretised in much detail.
7
intertemporal behavior and perfect foresight. This opens for interesting endogenous trade dynamics,
which will have implications for the pollution leakage effects. Since the Norwegian economy is small,
and the exchange rate is normalized to unity, all agents face exogenous world prices and real interest
rates. While financial capital is, thus, perfectly mobile across borders, real capital and labor are
assumed immobile. Policy variables like trade policy, subsidies and tax rates, as well as government
spending, are exogenous. The model may be adapted to endogenously determine the climate policy, as
a function of per capital GDP, a formulation we make use of in this study. An exogenous public
budget constraint is satisfied through endogenous lump-sum transfers. Parameters are estimated, or
calibrated on the basis of the 1995 Norwegian National Accounts and relevant micro-econometric
studies.
Household behavior
Consumption and savings are derived from standard welfare-maximizing behavior over an infinite
horizon of one representative, price-taking household. External effects, and in particular repercussions
from the environment to the utility of the household, are not modeled explicitly. The modeling of
endogenous policy is nevertheless based on reasoning of this kind; increased income stimulates
demand for environmental quality and thus policy. The intratemporal household decision can be
solved by a stepwise budgeting procedure due to a nested CES structure of the utility function (see
Appendix, Figure A1), where the goods in each aggregate are imperfect substitutes. The classification
of consumption goods distinguishes between activities with different pollution profiles and reflects
relevant substitution possibilities. Most of the emissions from households are due to heating and
transport. In the heating process the dirty energy carriers fossil fuels and wood can be substituted by
electricity, which is more or less based on clean hydropower (see section on the energy market below).
Own transport is based on polluting petrol and diesel. Four substitutable public alternatives are
specified, transport by road, sea, air and rail/tramway, all with individual emission intensities.
Consumption of most material goods generates solid waste for deposition, which in turn emits
Methane. Emission coefficients are not calculated for public consumption.
Market Structure and Producer Behavior
All firms in the private business sector are run by managers who maximize the net present value of the
cash flow to owners. A list of the industry classification in the model is provided in Table A1 in the
Appendix. Commodities produced by primary industries are assumed to be homogenous and traded in
perfectly competitive markets. Domestic markets for manufacturing goods and services, which
constitute the main part of the economy, are described by monopolistic competition among firms. The
model captures that output and input in an industry may change both because of changes at the firm
level and as a result of entry or exit of firms. The model includes a rough description of productivity
8
differentials between firms within the same industry causing firms to differ in size and profitability. As
in most models in the CGE tradition, all goods, services and factors are perfectly mobile across
industries within the economy, and supply equals demand in all markets in all periods.
In all industries the demand for input factors is derived from a nested structure of linearly
homogeneous CES-functions (see Appendix, Figure A2). Emissions from firms are dependent on the
composition of energy use for stationary purposes, which is determined by the relative prices of the
sources fuel and electricity, respectively. Transport services are partly provided internally, with
associated emissions from use of petrol and diesel, and partly outsourced. Industries differ
significantly with respect to the extent to which transport services can be profitably purchased from
one of the commercial transport sectors. As for consumption, the use of several input factors involves
solid waste generation.
Import and export
In the case of services and manufactured goods, imported products are considered as close, but
imperfect substitutes for the corresponding differentiated products supplied domestically. It is assumed
that both Norwegian and foreign consumers consider Electricity, Crude Oil and Natural Gas, as well
as commodities produced by the primary industries Agriculture, Forestry and Fisheries, as
homogenous. The domestic prices of these commodities are equal to the corresponding import prices,
and the model determines net imports as the residual between domestic production and domestic
demand.
Producers of manufactured goods and tradable services allocate their output between the domestic and
the foreign market, which are assumed to be segregated. It is assumed costly to change the
composition of these deliveries. This aspect of the technology is captured by assuming that output is a
Constant-Elasticity-of-Transformation function of deliveries to the export market and deliveries to the
domestic market. World prices of exports are exogenously determined in the world markets.
The energy market
The energy market is especially important in studies of the links between economic and environmental
effects. It has therefore been given a relatively detailed treatment in the model. On the demand side
particularly large amounts of energy are needed to generate power on oil platforms, because the
efficiency of this process is very low. Extraction and Transport of Crude Oil and Gas is a large and
heavily regulated sector in the Norwegian economy, and its activity is exogenous in the model. The
exposition above summarizes how households and firms may change their demand for electricity and
fuels in response to changes in relative prices and households' real income.
9
On the macro level, changes in industry structure may contribute significantly to the price sensitivity
of energy demand. By its disaggregated structure, the model captures many interesting composition
effects. The separation of transport and communication into six sectors, Post and Telecommunications,
Railway and Tramway Transport, Air Transport, Road Transport, Coastal and Inland Water
Transport, and Ocean Transport, is one example in this respect. Another is the specification of the
three extremely electricity-intensive industries Manufacture of Metals, Manufacture of Industrial
Chemicals and Manufacture of Pulp and Paper. These industries are also substantial polluters in terms
of dirty industrial processes.
On the supply side the model specifies three potential sources of electricity supply. First, hydropower
is produced domestically with virtually no emissions to air. This sector is characterized by large
irreversible investments, and capacity expansion is limited by sharply decreasing returns to scale. In
this study the production of hydropower is exogenously controlled in accordance with recent practice
and intentions expressed by the government. As a potential second domestic source, the model
specifies the technology of gas combustion for electricity production, which would involve national
emissions to air of several gases - see section on the modeling of emissions below. The production of
gas power is determined in the model according to standard investment behavior.
The third source of electricity is import from the Nordic market. In 1998, 3 per cent of the total
Norwegian electricity consumption was covered by net imports. The electricity price is determined by
conditions in the Nordic electricity market, which again determine electricity net imports as the
residual between domestic production and consumption. In order to satisfactorily get a grip on Nordic
circumstances, we have simulated a model for the Nordic electricity market (Johnsen, 1998) in
iterations with our scenarios.
The modeling of emissions
The model calculates emissions of 12 air pollutants. Table 1 provides an overview of the specified air
pollutants reported in this study, and their sources. The description of household and firm behavior
above outlines the most important activities in terms of discharges of pollutive gases. The calculations
of emissions are based on exogenous coefficients for each source in each sector (Strøm, 2000). The
coefficients are generally linked to economic variables in the model. For example, stationary emission
from combustion in an industry is linked to the input of fuel, whereas mobile emission from road
transport is linked to the input of petrol and diesel. Several process emissions are linked to the input of
intermediates.
10
Table 1: Air pollutants and important sources in MSG-6.
Pollutant
Important sources
MSG-6 sector in parenthesis
Kyoto gases
Carbon Dioxide (CO2)
Methane (CH4)
Nitrous Oxide (N2O)
Perflourocarbons (PFKs)
Sulphur Hexafluoroides (SF6)
Hydrofluorocarbons (HFKs)
Other pollutants
Sulphur Dioxide (SO2)
Combustion of fossil fuels (Several), reducing agents
(Manufacture of Metals)
Livestock, manure management (Agriculture), landfills,
production and use of fossil fuels and fuel wood
(Several)
Fertilising (Agriculture), fertiliser production
(Manufacture of Industrial chemicals), road traffic
(Road Transport)
Aluminium production (Manufacture of Metals)
Magnesium production (Manufacture of Metals)
Cooling fluids (Several)
Combustion (Several), process emissions
(Manufacture of Metals)
Nitrogen Oxides (NOx)
Combustion (Several)
Carbon Monoxide (CO)
Combustion (Several)
Non-Methane Volatile Organic Compounds (NMVOCs) Oil and gas-related activities, road traffic, solvents (Oil
Refining, Road Transport, Households)
Suspended Particulates (PM2,5 and PM10)
Road traffic (Households, Agriculture, Road
Transport), fuel wood (Households)
Source: Statistics Norway (1999a, Box 4.1).
3
RESULTS
3.1
Economic projections
The reference scenario
The reference scenario represents a projection of the general economic development for the next 20
years. It is conditioned on constant economic policy variables, at the levels of 19955, including
constant climate policy. In 1995, the climate policy consisted in a differentiated carbon tax system see Table 2, both with respect to different kinds of fossil fuels and with respect to industries. Carbon
taxes applied both to final consumption of fossil fuels and when used as input in production,
regardless of whether they were used as energy or as reducing agents in industrial processes. Other
greenhouse gas emissions were not taxed. Both scenarios start with 1995 as a base year, and
exogenous estimates are developed until 2020. Long run projections reported in the study are the
steady-state results based on the exogenous estimates of 2020, i.e. results of the 2020 state-of-the-art
after all intertemporal general equilibrium adjustments are emptied out. Based on this interpretation,
long run and 2020 are used synonymously in the following text. Most exogenous estimates, apart from
the policy variables, are in line with long-term projections in The Norwegian Ministry of Finance
(2001).
11
Table 2: Carbon taxation in the reference scenario. NOK * per tonne CO2.
Fuels
Gasoline
Light fuel oils, diesel
Heavy fuel oils
Coal for energy purposes
Coke for energy purposes
Coal and coke for processing (Ferro alloys-, carbide- and aluminium industry)
Gas (land-based use not covered by the petroleum tax legislation)
397.00
173.20
148.00
189.40
144.00
0.00
0.00
North Sea petroleum extraction
Oil extraction
Natural gas extraction
335.10
381.00
Industries with reduced rates:
Wood processing industry, herring flour industry
Light fuel oils, transport oils (petrol, diesel etc.)
Heavy fuel oils
86.60
74.10
Industries with exemptions
Air transport
Foreign carriage by sea
Domestic goods traffic by sea
Inshore fishing
Fishing and catching in foreign waters
Cement and leca production
0.00
0.00
0.00
0.00
0.00
0.00
*
1 Euro = 7.90 NOK
Source: Statistics Norway
The main exogenous driving forces behind the general economic development in our scenarios are
population and labor force forecasts, productivity growth estimates, the development in Norwegian oil
and gas values, as well as changes in international market conditions. The implemented total
population forecast corresponds to the medium population projection by Statistics Norway (1999b).
As for most European countries, the growth in total employment will be low the next 20 years
compared to previous periods (on average 0.5 percent annually) due to an ageing population. TFP
growth rates in the private sector are exogenously set to 1 percent annually; the corresponding rates in
the public sector are 0.5. International prices are assumed to grow steadily. Norway's income is
heavily dependent on natural resources; share of real GDP from oil and gas exploitation was 13.0
percent in 1995 and has been increasing. Also the real prices of oil and gas increased markedly before
the turn of the century. For the subsequent 20 years, we base calculations on constant real oil and gas
prices, while the relative importance of the offshore activities gradually declines to a GDP share of 4.2
percent in 2020. However, the former natural resource wealth will to a large extent be turned into
financial assets, assuring Norway a substantial currency income flow also in the future. The return
flow is based on a 4 percent international real interest rate.
5
The only policy variables that are changing along the path is public consumption, which increase by 0.9 percent annually on
average, and unit taxes, which are price index regulated.
12
All these growth factors imply a steadily increasing labor demand in the reference scenario, reflected
by wage rate adjustments upwards in order to maintain the labor market equilibrium. The
simultaneous determination of the wage rate and consumption also obeys the long-term current
account restrictions consistent with the intertemporal budget constraint (i.e. financial wealth is not
allowed to explode). In average annual terms, the private consumption increases by 4.2 percent, while
the wage rate increases by 3.7 percent. The user prices of capital increase less than wages, causing a
decrease in the overall labor to capital ratio. Annual capital accumulation increases 2.0 percent yearly
on average. In the land-based industries, GDP growth projections are 2.5 percent annually on average.
In per capita terms, GDP grows by 1.6 percent as a yearly average. The per capita growth in
consumption averages 3.7 percent.
Behind the total GDP changes, substantial structural changes take place. One main effect is that
offshore activities fall by 2.4 percent in annual terms, and this affects offshore, as well as land-based,
production of goods and services associated to oil and gas exploitation (transport, piping, oil platform
construction etc.). Housing is the sector with the highest growth. The annual value added from housing
grows by 5.1 percent on average. This is the value of the flow of housing services resulting from
housing investments. This housing boom implies an increasing value added in the construction
industry of 3.4 percent from 1995 to 2010; the growth slows down in the long run. This investment
dynamics is a result of the forward-looking behavior of the agents. Capital prices increase along the
path, in accordance with the import prices and the wage rates. This means that capital gains are high
by investing in the near future.
Shifts in consumption and input patterns are to a large extent explained by relative price changes.
Fossil fuel falls somewhat in price relative to electricity, implying a substitution of fuel-based
activities for use of electricity. Electricity is totally hydropower-based in the first part of the period,
while gas power production takes place from 2002, in accordance with the relative development of
prices and long-term marginal costs in the sector (see Table 3). Hydropower production is set to its
factual levels until 2001, and from then grows steadily the next 20 years, by an average annual rate of
0.5 percent.
Non-polluting long-distant transport gradually looses market shares to polluting air and sea transport.
Prices of services increase more than goods prices, both because services tend to be labor intensive,
and because the import shares are low. As already discussed, the growth in the user cost of housing is
relatively low. For consumption, these relative price changes, along with income growth, imply that
expenditure shares increase for cars, housing and furniture, leisure equipment, clothing, some income
elastic services, as well as tourism abroad.
13
Table 3: Electricity production based on hydropower and on gaspower in the reference scenario
(GWH).
Year
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Hydropower
120650
112670
113001
113333
113666
118100
118602
119105
119611
120119
120600
121695
122799
123914
125039
126200
126786
127375
127966
128560
129157
129757
130359
130965
131573
132200
Gaspower
0
0
0
0
0
0
0
250
318
403
469
595
756
960
1219
1549
1967
2498
3172
4029
5117
6498
8253
10481
13310
16904
The climate policy scenario
The climate policy scenario is built on the same exogenous assumptions as in the reference scenario,
except from the carbon tax system, which is replaced by a conjectured endogenous relation between
climate policy and economic growth per capita, as described in section 2.1. Thus, we capture the
effects of the interplay between the general economic development and the endogenous climate policy,
which is a two-way relationship. The simulations indicate that the marginal greenhouse gas tax rate
will increase from NOK 167 (in real 1995 terms) (21 Euros) in 2000, to NOK 505 (64 Euros) as an
average in the Kyoto period 2008 to 2012. It ends up at NOK 829 (105 Euros) in 2020, which is
considerably higher than the constant real taxes in the reference scenario (see Table 2), in spite of an
extended tax base. For a comparison, the Norwegian Ministry of the Environment 2001 indicates an
estimated cost of fulfilling the Kyoto commitments by means of national measures of NOK 11
billions. Previous estimates by the Ministry were much lower and amounted to NOK 6 billions,
corresponding to a uniform carbon tax of NOK 350 in 2010. Thus, NOK 505, which we obtain for the
Kyoto period seems to be in the vicinity of what is needed to obtain the committed green house gas
14
reductions by the years 2008 to 2012, unless an international emission quota regime is established.
Estimates of quota prices in case of a Kyoto quota mechanism vary between 50 and 200 NOK.
The climate policy, in turn, affects the economic activity. In the long run, total GDP falls by 1.7
percent, while the GDP fall is 1.8 percent in the land-based part of the economy (exclusive of oil and
gas exploitation and international shipping). The first part of the scenario does, however, deviate less
from the reference scenario, rendering the average annual growth rate 0.06 percentage points lower
than in the reference scenario. Long-run aggregate consumption falls by 0.8 percent; again the fall is
lower in the early periods (before 2010). All in all, the shift implies only a 0.01 percentage points
lower annual average growth rate when effects of climate policy is accounted for.
Though aggregate effects on the annual growth rates of introducing climate policy are minor,
interesting composition effects have implications for the emissions of polluting gases. In consumption,
the emphasis is shifted even more towards services, while the investments in durables (houses and
cars) and use of cars and heating oils fall in relative terms. The latter effect is also significant for
firms. Price impulses from the tax rates are the main explanation. Production of electricity is based on
hydropower, only, as the tax of CO2 emissions render investments in gaspower plants unprofitable.
3.2
Emission projections
The reference projection provides the isolated effects on emissions of the development in exogenous
variables determinant to the general economic development. These effects on emissions may be split
into the isolated effect of an upscaling of aggregate economic activity (scale effect), effects of changed
technology along the path (technology effect), and altered patterns of activity (composition effect). We
also split effects into changes in the adaptation of firms on the one side, and (not input-output
adjusted) changes in consumption activities on the other. See Table 1 for an overview of the sources of
different pollution components.
Scale effects
The average annual emission growth due to the upscaling of private consumption, i.e. irrespective of
compositional changes, is 4.17 percent, while the GDP growth indicates a scale effect from industrial
activities of 2.12 percent. These are identical to the growth rates of consumption and GDP,
respectively, as emissions are, by assumption, produced according to constant returns to scale.
Technology effects
Based on information from Norwegian Pollution Control Unit (SFT) and Statistics Norway, we have
accounted for expected changes in unit emission intensities due to technological adjustments.
15
Technology effects on the emissions form households are first of all due to new and less polluting
vintages of cars, which will gradually enter the markets and reduce emission coefficients for several
gases (CO, NOx, SO2 and PM). For greenhouse gas emissions the technology effects are positive,
though minor. They arise from a substitution of the greenhouse gas HFC for Kaliumflourcarbons
(KFC) in refrigerators and air-condition equipment, motivated by that KFC is harmful to the ozone
layer.
Emissions from firms are also influenced by these technology adjustments, In addition, some firms
have announced commitments to cleaner technical solutions, and we have let these influence the
technical emission coefficients in manufacture of metals, industrial chemicals and mineral and
chemical products. Endogenous factor substitution within firms is also classified as technology effects,
as is effects from the gradual introduction of gas-based power plants (see Table 3). Technology
changes influence all emission components from industries negatively; particularly the emissions per
unit of SO2, CO and PM fall drastically along the path. These reductions are first of all explained by
new car vintages, which imply cleaner input of transportation services in all industries. There are also
some positive contributions, mainly due to the gradual expansion of the gas power sector and to a
substitution towards fossil fuel (for energy and reducing agents) and fuel-based inputs (polluting
transport).
Composition effects
We first turn to the composition effects that result from changed consumption patterns within
households. For SO2, CO and PM we find that composition effects on household emissions moderate
the scale effect, in accordance with the composition argument explaining EKC (see Table 4).
Expenditure shares increase for cars, housing and furniture, leisure equipment, clothing, some income
elastic services, as well as tourism abroad. This happens at the relative expense of energy use, which
mainly explains the reductions when comes to SO2, CO and PM. Composition effects when comes to
NOx are positive, mainly due to a relative increase in use of cars. Non-polluting transport gradually
looses market shares to polluting transportation, inter alia consumers' use of own cars. This is also the
main positive contribution from composition effects in case of greenhouse gases. The relative increase
in use of own cars explains app. 70 percent of the composition effect for greenhouse gases.
In emissions from firms, changes in the industrial structure make up the composition effect. When
emissions of Kyoto gases, NOX and most markedly NMVOC, fall in response to structural changes,
this reflects first of all the gradual downscaling of the offshore activities. NMVOC emissions are
related to oil and gas activities like exploitation, refining and tanking.
16
Table 4: Average annual growth in emissions decomposed into (1) scale, (2) technology, (3)
composition, and (4) endogenous policy effects.
Emission changes from households,
Emission changes from firms, contribution
Changes in
contribution from:
from:
total emissions
(1)
(2)
(3)
(4)
Scale Techno-
Compo-
Policy
logy
sition
effects
effects
effects
effects
(1)
Total
(2)
(3)
Scale Techno- Compoeffects
logy
effects
sition
(4)
policy Total
effects
effects
Kyoto gases
4.17
0.02
0.21
-0.25
4.20
2.12
-0.82
-0.55
Sulphur Dioxide
4.17
-0.11
-1.44
-0.47
2.15
2.12
-3.36
Nitrogen Oxides
4.17
-5.41
0.32
-0.30
-1.22
2.12
Carbon Monoxide
4.17
-3.56
-0.20
-0.39
0.02
NMVOC
4.17
-3.51
0.48
-0.23
Particulate Matter
4.17
-0.13
-1.97
0.54
-0.06
0.70
1.33
0.89
-0.16 -0.51
-0.38
-1.12
-1.36
-0.10 -0.46
-0.55
2.12
-3.96
0.13
0.00 -1.71
-0.42
0.91
2.12
-0.25
-3.23
-0.12 -1.48
-0.87
1.53
2.12
-3.86
0.20
-0.11 -1.65
0.70
Endogenous climate policy effects
The difference between the two simulated paths with and without an endogenous development of the
uniform greenhouse gas tax rate, makes up the contribution of abatement policy. We find that the
reductions in emissions caused by policy action first of all take place in the households. This is not a
result of reduced overall consumption, which only accounts for 0.01 percentage points of these
reductions. Neither is technology progress in the wake of climate taxes accounted for. Thus an altered
pattern of consumption explains the relatively strong response we find in the household emissions
from the tax adjustments. The emphasis is shifted even more towards service consumption, while
investments and use of cars, housing, and heating oils, fall in relative terms.
The results show that there are strong environmental co-benefits to climate policy in terms of reduced
emissions of a variety of local and regional pollutants. Actually, the fall in Kyoto gas emissions is
relatively small compared to other emissions. This reflects the need for an integrated approach in the
assessment of climate policy, which takes into considerations overall environmental impacts.
This point also applies to emissions from firms, though the effects on emissions are not that strong.
The scale effect is somewhat stronger than in case of consumption and contributes to a 0.06
percentage point reduction. Thus, the net composition and technology effects are weakly negative for
almost all the gases.
17
Leakage effects
In the scenario that accounts for all the components that determine emissions, we find that
international trade changes considerably along the path. There are high export surpluses in the first
part of the simulation period, while the situation turns to high import surpluses in the long run. First,
this reflects a gradual downscaling of oil export and more relative reliance on income flows of foreign
currency from financial assets. Gross export increases by 0.38 on average, veiling a growth rate of
0.84 percent in the first 15 years, and of -0.3 percent in the last part from 2010 to 2020. Secondly, it is
explained by the dynamics of import, which goes in the opposite direction. This is a consequence of a
gradual price decrease of imports relative to domestic prices, the latter increasing substantially along
with wages and greenhouse gas taxes. The increasing import shares are of course partly reliant on the
fact that we study unilateral policy efforts.
Along with this development of international trade, the pollution leakage problems will, in net terms,
increase markedly over the years. For most gases, the unit emissions in Norwegian production are
markedly lower than for our trade partners. Table 5 shows the weighted macro emission factor for our
trade partners. These factors are emissions per GDP for each country, weighted with their respective
share of Norwegian import, and divided by the Norwegian emissions per unit GDP. The factors for
each emission, zz, FACTORzz, are computed as follows:
(2)
IMPi Ezzi
IMP GDPi
FACTORzz 
Ezz Norway
GDPNorway
where IMPi is Norwegian import from country i, IMP is total Norwegian import, Ezzs is emission of
pollution zz and GDPs is gross domestic product, s= i, Norway, where i refers to foreign country i. The
computations are done for 1995. The emission database is UNFCCC (2002) and the data source for
GDP is United Nations (2002).
Table 5: Macro emission factors for Norwegian trade partners.
Emission (zz)
CO2
CH4
N2O
CO
SO2
NOx
NMVOC
FACTORzz
2.24
2.18
1.72
1.57
9.82
1.03
0.72
As we see from Table 5, the emissions per GDP unit are significantly lower in Norway than for our
trade partners. For SO2, the emissions per unit GDP for our trade partners are almost 10 times higher.
18
This reflects the 80 percent decrease in Norwegian emissions over the two last decades, which is a
result of sulphur taxes and other political regulations. The macro emission factor for climate gas
emissions is about the double of the Norwegian. To a large extent this is explained by aggregate
energy-mix differences. Norwegian energy production is relatively independent on fossil fuel.
NMVOC emissions, however, are lower than in Norway, because of substantial Norwegian oil loading
activities.
The factors indicate that the computed growth in Norwegian net import underestimates the associated
leakage problem, as emissions associated with import deliveries are relatively high compared to those
of Norwegian domestic deliveries. It is, however, not justifiable to draw sharp conclusion on this
basis. First, composition effects must be taken into account, which would require a detailed account of
emission intensities per production unit of the different industries and countries. Secondly, the
possible projections of unit emission changes in the near future must be taken more carefully into
consideration. The conclusion above relies on the assumption that progress abroad in environmental
technology and policy will not be much faster than in Norway. According to the EKC hypotheses,
each country will follow its own emission abatement path for each different pollutant, dependent on
their welfare development.
4
CONCLUSIONS
Based on these projections, one may be relatively optimistic with respect to the environmental
development for the local pollutants NMVOC, NOX, CO, and SO2 in the wake of further economic
growth. Despite an average yearly growth in per capita GDP of 1.58 percent, the total emissions of
these pollutants decrease by 0.87 percent, 0.55 percent, 0.42 percent and 0.38 percent, respectively.
The endogenous policy mechanisms are associated with particular uncertainty, and should be
interpreted as an illustration of one of many possible policy developments. The induced policy effects
are not decisive for the signs of the total emission changes. NMVOC reductions are first of all a result
of the downscaling of oil and gas exploitation. Technology changes dominate the reductions in the
latter three.
The greenhouse gas emissions seem to be a far more difficult challenge, even with the perspective of a
small, rich country with a restricted objective of contributing to a fair share of the global combat
against climate change by means of national policy reforms. The upscaling of consumption, as well as
production, is not sufficiently counteracted by environmentally beneficial changes in technology,
climate policy and structural changes, and total emission growth in annual terms reaches a rate of 1.33
percent. This rate is nevertheless lower than growth in GDP/cap of 1.58 percent. A retarding emission
growth of greenhouse gases is compatible with EKC findings for high-income countries, though a
19
turning point is far from reached in these simulations. The greenhouse gas emissions are first of all
driven upwards by the emission changes from households, which perform a growth rate of 4.20
percent as an annual average. This finds place along with an increase in consumption per capita of
3.68 percent.
Such unilateral policy efforts might be motivated by a wish to front climate policies and appear as
good examples. The actual objective of abatement policy and climate technology progress is of course
much more ambitious. The challenge is to counteract the ongoing climate changes, which are partly
man-made. The literature on global greenhouse emissions, international climate policy agreements,
abatement costs, and burden sharing, is extensive. This study has no intentions to address these
questions, which must be addressed in a global context. A natural and interesting extension of this
country study would be to assess the effects on domestic and leaked emissions of joining a multilateral
climate policy effort, e.g. the Kyoto Agreement. In this context, comparative advantage effects would
be of less importance, and another important channel for leakages would probably be topical, namely
leakages through quota purchases.
This analysis illustrates and supports the need for broadening up the perspective in studies of climate
policy in two other respects: First, assessments of climate policy should apply an integrated approach,
which takes into considerations overall environmental impacts. We find strong environmental cobenefits of climate policy in terms of reduced emissions of local and regional pollutants. Secondly,
this study points to the need for including counteracting, as well as reinforcing, leakage effects in the
overall assessment. We conclude that emissions of greenhouse gases, as well as of locally and
regionally harmful gases, are leaking out in the long run, as a result of the economic mechanisms that
we have taken into account. Our computations indicate that not only will the local environment
improve at the expense of other countries, but the emissions abroad will increase more than the
domestic reduction.
Though the question of emission leakages is qualitatively analysed in our study, it deserves a more
detailed and quantifiable approach. This will be a natural direction to continue in our further research.
Another way to progress is to include a broader spectrum of technology mechanisms. First of all, one
could open for possible, persistent technological change mechanisms, either driven by productivity
growth through learning by doing, or driven by research and development (R&D). The characteristics
of such mechanisms in relation to technology shifts of the kind we already account for, are that they
may have increasing returns-to-scale effects, so that the more we learn or perform R&D, the more
effective will further learning and R&D become.
20
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22
Appendix:
Figure A1: The preference structure of the household in MSG-6
Welfare (discounted utility)
Utility in year t
Leisure year t
Consumption year t
Housing
Other Consumption
Furniture and
Durables
Gross
rents
Food
Heatin
g
Electric Goods
Fuel
Beverages
and Tobacco
Electric Appliances
Transport
Private Transport
User Costs
Other Goods
Communication
Electricity
Petrol/Diesel and
Maintanance
Clothes and
Footwear
Post and Telecommunications
Public Transport
Road
Sea
Air
23
Rail/
Tramway
Health
Expendit
ures
Purchases Abroad
Other Services
Figure A2: The separable structure of production structure of the firms in MSG-6.
G ro ss p ro d uc tio n
Va ria b le Inp ut
Mo d ifie d Va lue Ad d e d
Ma n-ho urs a nd Me c ha nise d se rvic e s
Ma n-ho urs
Me c ha nise d se rvic e s
Ele c tric ity
Co m m o d ity inp uts
Tra nsp o rt
No n-p o lluting tra nsp o rt
Ene rg y
Ma c hine ry
Struc ture s
Ow n tra nsp o rt
Fo ssil Fue l
Pe tro l a nd Die se l
24
Po lluting tra nsp o rt
Co m m e rc ia l tra nsp o rt
Tra nsp o rt e q uip m e nt
Table A1: Industries in the model.
Manufacture of Metals
Manufacture of Industrial Chemicals
Fish Farming
Manufacture of Pulp and Paper
Manufacture of Dairy and Meat Products
Preserving and Processing of Fish
Dwelling Services
Air Transport
Coastal and Inland Water Transport
Wholesale and Retail Trade
Fisheries
Extraction and Transport of Crude Oil and Gas
Oil and Gas Exploration
Defence
Government Education, Central
Government Education, Local
Government Health Care, Central
Government Health Care, Local
Other Government Services, Central
Other Government Services, Local
Water Supply and Sanitary Services
Land Transport
Ocean Transport
Construction
Printing and Publishing
Manufacture of Wood and Wood Products
Railway and Tramway Transport
Other Private Services
Finance and Insurance
Post and Telecommunications
Manufacture of Other Consumption Goods2)
Forestry
Textile and Clothing Industry
Production of Electricity
Manufacture of Oil Platforms
Oil Refining
Agriculture
Manufacture of Hardware and Machinery
Manufacture of Chemical and Mineral Products
Shipbuilding
25