Skip to main content.

Part 1. The Kyoto First Commitment Period

The analysis takes a snapshot of 2011/12 as being representative of the first Commitment Period (CP1) under Kyoto, while allowing enough time for the transitory effects of policy changes to have largely disappeared. A ‘business as usual’ (BAU) scenario is developed which represents a picture of the economy and emissions without any carbon charges. The BAU is not necessarily the most likely forecast of what the economy might look like. Rather it is intended to be a plausible projection of the economy that can constitute a frame of reference against which other scenarios may be compared. The BAU does not take into account any of the possible climate change related costs associated with adopting this scenario, such as trade barriers that might arise from non-participation in global efforts against climate change.

The model is then ‘shocked’ with a number of scenarios:

  • Scenario 1 – An international carbon price of NZ$25/tonne1 with the government purchasing emission units on the world market to cover New Zealand’s excess emissions. The cost of the permits is financed by higher personal income taxes. (Note that this does not necessarily mean that tax rates will be higher than they are currently, only that they are higher than in the BAU scenario)
  • Scenario 2 – A price on carbon of $25/tonne CO2 in an emissions trading scheme covering all emissions from energy and industrial processes, with free allocation of permits covering around 90% of 2005 emissions for major emitters excluding electricity generators. Emissions of methane and nitrous oxides from agriculture are exempt. Any remaining excess emissions are covered as in Scenario 1.
  • Scenario 3 – As in Scenario 2 with a higher price of $50/tonne of CO2.

Note that although these scenarios are run as ‘shocks’ relative to the BAU, it is implicitly assumed that the various policies are implemented early enough for the economy to reallocate labour and investment in response to new price signals.

In all scenarios the following are held constant at BAU levels:

  1. Total employment, wage rates endogenous.
  2. Total capital stock, user costs of capital endogenous.
  3. Balance of payments as proportion of GDP, real exchange rate endogenous.
  4. Fiscal surplus, personal income tax rates endogenous.

The first two macroeconomic closure rules imply that the overall level of resource use in the economy is not dependent on climate change policy. Other closure rules are possible. For example instead of fixed employment, wage rates could be fixed at BAU levels. This implies, however, that the long run level of total employment is driven more by the price of carbon and energy than by the forces of labour supply and demand – an unlikely state of affairs.

The third rule ensures that the costs of meeting New Zealand’s emission obligations are not met simply by borrowing more offshore, as this is not sustainable. Relaxing this constraint would mean that in the long term New Zealand could run a larger external deficit than it other wise would – not a view likely to be shared by foreign lenders and investors.

The fourth rule prevents the results from being confounded by issues around the optimal size of government. An increase in government revenue from a carbon tax or auctioned emission permits is not a reason for enlarging government as proportion of GDP. However, other closure rules such as revenue recycling via lower corporate taxes or debt repayment would also meet this objective. Raising spending on say health, would not. If it is believed that government should be larger, then this scenario should be investigated in its own right; it is unlikely that a carbon charge is the most efficient way of doing this.

The following model limitations should be noted:

  • Aggregation bias – All industries in the model represent aggregations of companies, products and processes, but even with over 50 industries, aggregation bias remains. For example we cannot distinguish between the production of fertilizer and hydrogen in the Chemicals industry.
  • Lumpiness in production – The model assumes that small increments and decrements in production are possible. For industries that are dominated by a single plant dependent on economies of scale this could be unrealistic, especially with respect to increments in output. However, under a carbon charge increases in output from such industries are unlikely.
  • Pricing – Being an ‘equilibrium’ model, unless specifically altered, industries must price their output at the average cost of production. There are no long run economies of scale so marginal costs equal average costs.
  • Costs of Resource Re-Allocation – The model is an “equilibrium” model. It looks at the situation after resources have been reallocated in response to changes in relative prices and changes in policy. It does not measure transition costs. Hence short term costs to the economy may be under-stated, although by a relatively small amount in a macro-economic sense, if the economy is close to capacity.

Apart from GHG emissions, we do not present the results in levels. Rather they are expressed as percentage changes in real dollar amounts relative to BAU. This reflects the strength of the model being in comparative scenario analysis, rather than in forecasting levels of economic activity. However, results in absolute levels (real 1995/96 prices) are available on request.

With regard to Forestry, all model runs for 2012 are on a like-for-like basis. That is, government is assumed to hold credits and liabilities for both post 1989 and pre 1990 forests, so valid comparisons can be drawn between the scenarios. In particular:

  • Post 1989 Forests – No estimate has been made on the macro-economic effect of devolving sink credits and liabilities in this modelling. Devolving sink credits, to the degree this will occur (as it is voluntary), represents a wealth transfer within the economy and would reduce the revenue that the model has available for tax recycling. Importantly, the number of units that need to be purchased offshore by New Zealand, over time, would not change. However, to the extent that liabilities on harvest of forests are reduced as a result of devolution of credits and liabilities, the macroeconomic impact of the decision to devolve sink credits and liabilities will be positive.
  • Pre 1990 Forests – The act of devolving deforestation liabilities could see significant emission reductions over the first commitment period which would reduce the need to purchase emission units offshore. These emission reductions have not been taken into account in this modelling. However, they would work to further reduce the macroeconomic impacts under the ETS.

1 The lowest price of emission used in this report is $25/tonne. It was thought that using lower prices would not be useful as many of the metrics could end up being rounded to zero.

[ |