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Summary

This paper presents a general equilibrium analysis of a number of possible policies that would meet New Zealand’s emissions obligations, both under the Kyoto first commitment period 2008-12 (CP1) and under some plausible international agreement in 2025.

A general equilibrium model takes into account the main inter-dependencies in the economy, such as flows of goods from one industry to another and the passing on of changes in costs in one industry into prices and hence the costs of other industries. It is not a macroeconomic forecasting model. For this reason in all scenarios the total amount of employment and investment in the economy is held constant, with pressure in labour and capital markets being absorbed in the prices of these inputs. This ensures that the economy-wide effects of different policies can be attributed to changes in allocative efficiency and changes in international competitiveness, not to changes in the volume of factor inputs.

For the Kyoto first commitment period the cost to aggregate economic welfare of introducing policies to meet New Zealand’s obligations is likely to be less than 0.3% for a range of welfare indicators. If the carbon price is around $25/tonne there is no significant difference between the government purchasing all required emission units from offshore (financed by higher income taxes) without any domestic carbon price, or having an explicit carbon price as part of an emissions trading scheme. This applies even if major emitters that are exposed to international competition receive some free allocation and if agricultural emissions are exempt.

In the longer term, however, an explicit domestic carbon price is clearly a better option than having government responsible for all emissions with no carbon price, as some abatement is cheaper to undertake domestically than purchasing emission units offshore.

Even at around $25/tonne, the probable greater stringency of international obligations means that the cost of meeting those obligations by 2025 is much higher than during CP1. At $100/tonne, private consumption is 2.2% below what it would otherwise be in 2025. At current prices, but allowing for growth in real income between now and 2025, this corresponds to about $800 per person in 2025. Putting this into perspective, however, the overall increment in private consumption between now and 2025 is expected to be around $12,900 per capita. In terms of growth rates the $800 reduces the growth rate from 2.4% pa to 2.3% pa.

As might be expected these results are sensitive to what is assumed about New Zealand’s obligations in 2025. Reducing our allowable emissions by 30 Mt CO2e increases the welfare cost of meeting our obligations by over 50%.

In 2025 relative to ‘business as usual’, the largest reductions in industrial output occur in oil refining, electricity production, meat processing and dairy processing. It is doubtful, however, whether any of these industries would incur absolute reductions in output relative to the present.
Part 1 of the paper explores a number of policy scenarios for CP1, while Part 2 examines scenarios in 2025. The two main differences between these periods are the amount of emissions to which New Zealand is likely to be entitled, and the exclusion/inclusion of methane and nitrous oxide emissions in an emissions trading scheme. Part 3 looks at a number of sensitivity tests around the 2025 scenarios.

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