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4. A Stylised Look at Transition Costs: Associated with the ETS

Our objective here is to examine the extent to which a general equilibrium approach can provide insights about the transition costs, particularly with respect to employment, that might arise as the economy adjusts to a carbon price.

Our point of comparison is the previous Scenario 5, specified as:

  • A price on carbon of $25/tonne CO 2 in an emissions trading scheme covering all emissions from all industries (including methane and nitrous oxides emissions from agriculture), with no free allocation of emissions rights.

Here we examine two scenarios, Scenarios 10 and 11, that are analogously specified to Scenario 5 except that the previous factor market closure rules of fixed total employment and fixed total capital stock are relaxed. The real wage rate and the cost of capital are fixed at the BAU levels. Essentially this imposes greater price rigidity on the economy, forcing more of the adjustment to a carbon price onto the level of employment and aggregate investment. This is intended to be more representative of a short run situation.

In Scenario 10 the real exchange rate is free to vary. With higher domestic prices caused by the ETS the real exchange rate can be expected to rise. In Scenario 11 the real exchange rate is prevented from appreciating by endogenising the balance of trade.

Note that neither Scenario 10 nor Scenario 11 allows the cost of the offshore emission units to be financed by borrowing and thus cause a deterioration in the current account.

It is stressed that these scenarios are intended to present a guide to the short term transition costs that might arise under the ETS – after relative industry competitiveness has been affected by the carbon price, but before resources have moved between industries. In this sense the scenario is a stylised representation of adjustment costs. It is certainly not intended to be an alternative picture of the economy in 2025 to that presented in Scenario 5. 12

Table 7 shows the macroeconomic results and Tables 8-10 show the changes in employment by industry and region.

Private consumption falls by 3.4% in Scenario 10, a direct result of the decline in industry competitiveness. Household tax rates increase in order to restore fiscal balance following the potential decline in tax revenue and increase in expenditure on unemployment benefits.

Higher domestic prices with an unchanged nominal exchange rate implies an increase in the real exchange rate. Once the nominal exchange rate falls, or alternatively domestic (factor) prices fall, the real exchange rate will decline and the macroeconomic picture will eventually look like Scenario 5.

Table 7: Macroeconomic Results

 

BAU

Scenario 5

ETS $25/tonne. No free allocation.

50 Mt International allowance

Scenario 10

As in 5 with fixed factor prices, endogenous real exchange rate

Scenario 11

As in 5 with fixed factor prices and fixed real exchange rate

Emission units required to be purchased off shore (p.a)

 

57.0Mt

54.5Mt

55.1Mt

Private Consumption

 

-0.7%

-3.4%

-4.7%

Exports

 

0.1%

-2.7%

-0.6%

Imports

 

-0.8%

-2.5%

-3.4%

GDP

 

-0.0%

-2.9%

-2.5%

GDP in world prices

 

-0.4%

-1.6%

-2.5%

Real wage rate

 

-0.7%

0.0%*

0.0%*

Mean household tax rate

 

-2.3%

7.2%

8.1%

Real exchange rate

 

-0.4%

1.4%

0.0%

Terms of Trade

 

0.3%

1.6%

0.6%

Employment

 

0.0%* 

-2.6%

-2.3%

CO2 emissions (Gg)

52368

-5.3%

-8.0%

-7.6%

Agriculture CH4 & N2O

63513

-3.0%

-5.1%

-4.4%

 

115881

-4.0%

-6.4%

-5.8%

International transport

4299

-5.5%

-8.8%

-6.4%

Emissions by NZ

111582

-4.0%

-6.3%

-5.8%

Comparing Scenario 11 with Scenario 10, there is small lift in overall activity as measured by real GDP. Employment declines by 2.3% (46,700 FTE) compared to 2.6% in Scenario 10.

However, when GDP is expressed in world prices it falls by more than in Scenario 10. The lower exchange rate, while boosting exports (0.6% lower than BAU compared to 2.7% in Scenario 10), does so by reducing the international purchasing power of the New Zealand dollar. The volume of goods and services produced in New Zealand rises, but the value of those goods and services expressed in world prices falls. Private consumption falls by 4.7% in Scenario 11 compared to 3.4% in Scenario 10.

As noted in the previous chapter, the ‘Kyoto shock’ of purchasing emission units offshore leads to a reduction in economic welfare. This reduction is worse if factor prices are inflexible as with a fixed nominal exchange rate the real exchange rate appreciates (Scenario 10). Letting the nominal exchange rate fall in order to prevent the real exchange rate from appreciating (Scenario 11) helps the export sector and GDP (a little), but at the cost of lower private consumption. If consumption is the preferred welfare metric, there is no benefit in having a flexible nominal exchange rate as long as factor prices, and real wage rates in particular, are inflexible.

In other words, while there is no escaping the welfare loss caused by having to buy emission rights on the world market, the cost can be minimised by allowing relative prices to adjust and by resources being able to readily move between industries according to the new profile of relative competitiveness – favouring less carbon intensive industries. Rigid factor prices prevents this adjustment and thus worsens the welfare cost.

In Scenario 10 the fall in employment of 2.6% represents about 52,000 FTE, with about 46,700 FTE in Scenario 11. These figures should be seen as a guide to the temporary loss of employment that could occur during the transition phase. Table 8 shows the distribution of the change in employment by industry, comparing Scenarios 5, 10 and 11 with the BAU. For example, in Scenario 5 employment in Horticulture is 0.2% or 40 FTE below the BAU figure, but Scenario 10 indicates that in the short term employment in Horticulture could fall by as much as 4.1% or 1040 FTE. In Scenario 11 the fall is less than half that amount.

In scenario 10 the industries that face the greatest percentage decreases in employment are coal mining (9.2%); oil and gas extraction and exploration (8.3%); basic metal manufacturing (6.5%) and petroleum (6.1%). In absolute terms the greatest decreases in employment are in wholesale and retail trade (11,240); legal, accounting and other business services (3,490); personal and other services, waste disposal and sewerage (2,790); and accommodation, cafes and restaurants (2,140).

Simply pro-rating the industry changes in employment (in Scenario 10) across regions based on the current region by industry composition of employment (Table 9), reveals that the largest absolute falls are in Auckland City (8,405), Christchurch City (4,873), Manukau City (3,433) and Wellington City (3,028), but the largest percentage reductions are in Waimate and Southland, both at -1%.

It is useful to put these employment effects into perspective. Table 10 shows that the changes estimated in Scenario 10, expressed relative to actual regional employment for the year ended 2006 (not relative to BAU), are generally much smaller than occurred historically, especially between 1986 and 1991.

A 2003 report on the effects of import tariff reform13 found that while there were noticeable impacts on certain industries (footwear and clothing) there was little evidence of a consistent relationship between tariff changes and changes in industry employment. Essentially the employment effects of tariff reform could not be distinguished from other factors that simultaneously affected employment at the time, such as the terms of trade and monetary policy. Nevertheless the data also suggested that a few industries and/or communities could be adversely affected with the tariff changes then projected.

Carrol et al (2002)14 found that on average over the 1994-2001 period around 285,000 (18%) jobs are created and 249,000 (15%) jobs destroyed in the New Zealand labour market each year, although these numbers may be biased upwards by changes in company ownership and mergers.

Table 8: Changes in Industry Employment

 

Scenario 5

Scenario 10

Scenario 11

No.

%

No.

%

No.

%

HFRG

-40

-0.2%

-1040

-4.1%

-510

-2.0%

MLVC

-140

-2.1%

-360

-5.5%

-270

-4.1%

SHBF

-720

-2.4%

-1460

-4.8%

-1260

-4.1%

DAIF

-900

-2.2%

-1690

-4.1%

-1430

-3.5%

OAGR

-470

-1.8%

-1270

-4.9%

-1000

-3.9%

LOGG

90

0.8%

-320

-2.9%

-160

-1.5%

FISH

0

0.0%

-110

-3.7%

-80

-2.7%

COAL

-60

-5.5%

-100

-9.2%

-80

-7.3%

OILG

-10

-4.2%

-20

-8.3%

-10

-4.2%

OMIN

-20

-1.0%

-100

-5.1%

-70

-3.5%

MEAT

-180

-1.3%

-520

-3.7%

-400

-2.8%

DAIR

-20

-0.2%

-190

-2.2%

-130

-1.5%

OFOD

-30

-0.1%

-910

-3.6%

-680

-2.7%

TEXT

-210

-2.7%

-520

-6.7%

-400

-5.2%

CLTH

40

0.4%

-340

-3.6%

-190

-2.0%

FOOT

30

2.7%

-20

-1.8%

0

0.0%

LEAT

-110

-4.4%

-190

-7.6%

-140

-5.6%

WOOD

300

1.0%

-710

-2.4%

-320

-1.1%

PAPR

70

1.1%

-220

-3.3%

-110

-1.7%

PPRM

120

0.5%

-840

-3.4%

-600

-2.5%

PETR

-50

-3.4%

-90

-6.1%

-100

-6.8%

CHEM

10

0.1%

-320

-3.5%

-190

-2.1%

RBPL

40

0.5%

-270

-3.2%

-150

-1.8%

NMMP

-20

-0.3%

-290

-3.8%

-250

-3.3%

BASM

-110

-2.0%

-360

-6.5%

-220

-4.0%

FABM

140

0.9%

-640

-4.0%

-310

-2.0%

MACH

720

1.4%

-1280

-2.5%

-440

-0.9%

OMFG

210

1.1%

-490

-2.5%

-240

-1.2%

EGEN

-60

-2.8%

-110

-5.2%

-100

-4.7%

EDIS

-90

-0.8%

-370

-3.2%

-350

-3.0%

GASS

-20

-1.8%

-50

-4.4%

-40

-3.5%

WATS

-10

-0.3%

-110

-3.5%

-120

-3.8%

BLDG

190

0.1%

-4880

-2.6%

-5580

-3.0%

TRDE

-450

-0.1%

-11240

-3.0%

-10970

-2.9%

ACCR

400

0.5%

-2140

-2.5%

-1410

-1.7%

ROAD

-150

-0.3%

-1490

-3.3%

-1330

-2.9%

WRAI

40

0.4%

-300

-2.9%

-190

-1.8%

AIRS

500

1.2%

-1210

-2.8%

-390

-0.9%

COMM

-20

-0.2%

-360

-2.8%

-330

-2.5%

FIIN

-150

-0.2%

-2160

-3.4%

-2380

-3.8%

OPRS

-10

0.0%

-1540

-3.1%

-1570

-3.2%

SCIT

-10

0.0%

-640

-2.6%

-560

-2.3%

COMP

0

0.0%

-330

-2.8%

-310

-2.7%

LAOB

280

0.2%

-3490

-3.1%

-2770

-2.4%

GOVD

-40

0.0%

-380

-0.3%

-530

-0.4%

SCHL

580

0.4%

-1060

-0.8%

-1030

-0.7%

OEDU

310

0.7%

-290

-0.7%

-140

-0.3%

HOSP

0

0.0%

-810

-1.0%

-1310

-1.6%

OHLT

-10

0.0%

-500

-1.1%

-680

-1.5%

MPRT

60

0.1%

-1410

-3.0%

-1440

-3.1%

PERS

-130

-0.1%

-2790

-2.9%

-3410

-3.5%

TOTAL

-120

0.0%

-52350

-2.6%

-46700

-2.3%

Table 9: Employment Changes by Region(Scenario 10 v Scenario 5)

 

 

 

 

Scenario 10

Scenario 5

 

% of yr to

 

% of yr to

No.

Sep-06

No.

Sep-06

01

Northland

Far North

-555

-2.6%

-19

-0.1%

   

Kaipara

-203

-3.2%

-33

-0.5%

   

Whangarei

-872

-2.6%

-18

-0.1%

01 Total

 

-1630

-2.7%

-70

-0.1%

02

Auckland

Auckland City

-8421

-2.4%

383

0.1%

   

Franklin

-578

-3.1%

-48

-0.3%

   

Manukau City

-3423

-2.6%

311

0.2%

   

North Shore City

-2221

-2.4%

97

0.1%

   

Papakura

-491

-2.6%

22

0.1%

   

Rodney

-654

-2.6%

13

0.1%

   

Waitakere City

-1276

-2.5%

55

0.1%

02 Total

 

-17064

-2.5%

834

0.1%

03

Waikato

Hamilton City

-1892

-2.3%

87

0.1%

   

Hauraki

-165

-3.0%

-25

-0.4%

   

Matamata-Piako

-450

-3.1%

-83

-0.6%

   

Otorohanga

-142

-3.3%

-37

-0.9%

   

South Waikato

-310

-3.1%

-2

0.0%

   

Taupo

-460

-2.8%

-11

-0.1%

   

Thames-Coromandel

-296

-2.7%

-2

0.0%

   

Waikato

-485

-3.4%

-102

-0.7%

   

Waipa

-523

-2.9%

-50

-0.3%

   

Waitomo

-174

-3.2%

-39

-0.7%

03 Total

 

-4897

-2.7%

-263

-0.1%

04

Bay of Plenty

Kawerau

-102

-3.0%

26

0.7%

   

Opotiki

-94

-2.9%

-14

-0.4%

   

Rotorua

-874

-2.5%

17

0.0%

   

Tauranga City

-1320

-2.5%

41

0.1%

   

Western Bay of Plenty

-436

-3.2%

-62

-0.4%

   

Whakatane

-340

-2.6%

-19

-0.1%

04 Total

 

-3165

-2.6%

-11

0.0%

05

Gisborne

Gisborne

-539

-2.7%

-34

-0.2%

05 Total

 

-539

-2.7%

-34

-0.2%

06

Hawke's Bay

Central Hawke's Bay

-187

-3.1%

-47

-0.8%

   

Hastings

-988

-2.7%

-49

-0.1%

   

Napier City

-659

-2.5%

28

0.1%

   

Wairoa

-96

-2.8%

-21

-0.6%

06 Total

 

-1930

-2.6%

-89

-0.1%

07

Taranaki

New Plymouth

-885

-2.5%

-17

0.0%

   

South Taranaki

-392

-3.0%

-86

-0.7%

   

Stratford

-101

-3.1%

-19

-0.6%

07 Total

 

-1378

-2.7%

-122

-0.2%

08

Manawatu-Wanganui

Horowhenua

-301

-3.0%

-26

-0.3%

   

Manawatu

-251

-2.8%

-34

-0.4%

   

Palmerston North City

-1060

-2.1%

55

0.1%

   

Rangitikei

-216

-3.3%

-50

-0.8%

   

Ruapehu

-189

-2.8%

-27

-0.4%

   

Tararua

-264

-3.4%

-68

-0.9%

   

Wanganui

-471

-2.5%

-14

-0.1%

08 Total

 

-2752

-2.5%

-163

-0.1%

09

Wellington

Carterton

-90

-3.2%

-6

-0.2%

   

Kapiti Coast

-309

-2.4%

10

0.1%

   

Lower Hutt City

-1198

-2.5%

45

0.1%

   

Masterton

-277

-2.5%

-13

-0.1%

   

Porirua City

-336

-2.1%

21

0.1%

   

South Wairarapa

-112

-3.4%

-21

-0.6%

   

Upper Hutt City

-263

-2.2%

16

0.1%

   

Wellington City

-3015

-2.1%

89

0.1%

09 Total

 

-5600

-2.2%

141

0.1%

12

West Coast

Buller

-131

-3.4%

-26

-0.7%

   

Grey

-200

-2.7%

-12

-0.2%

   

Westland

-104

-2.7%

-3

-0.1%

12 Total

 

-435

-2.9%

-41

-0.3%

13

Canterbury

Ashburton

-510

-3.4%

-96

-0.6%

   

Banks Peninsula

-85

-2.9%

3

0.1%

   

Chatham Islands

-12

-3.3%

-1

-0.4%

   

Christchurch City

-4881

-2.4%

245

0.1%

   

Hurunui

-154

-3.6%

-38

-0.9%

   

Kaikoura

-53

-2.9%

-5

-0.3%

   

Mackenzie

-64

-3.3%

-11

-0.5%

   

Selwyn

-351

-2.8%

-64

-0.5%

   

Timaru

-584

-2.7%

-41

-0.2%

   

Waimakariri

-299

-2.8%

-7

-0.1%

   

Waimate

-101

-3.9%

-26

-1.0%

13 Total

 

-7094

-2.6%

-41

0.0%

14

Otago

Central Otago

-280

-3.0%

-23

-0.3%

   

Clutha

-270

-3.3%

-63

-0.8%

   

Dunedin City

-1357

-2.3%

61

0.1%

   

Queenstown-Lakes

-428

-2.6%

20

0.1%

   

Waitaki

-250

-2.8%

-32

-0.4%

14 Total

 

-2586

-2.5%

-37

0.0%

15

Southland

Gore

-197

-2.9%

-36

-0.5%

   

Invercargill City

-655

-2.5%

-7

0.0%

   

Southland

-560

-3.6%

-161

-1.0%

15 Total

 

-1412

-2.9%

-204

-0.4%

16

Tasman

Tasman

-598

-3.0%

-13

-0.1%

16 Total

 

-598

-3.0%

-13

-0.1%

17

Nelson

Nelson City

-613

-2.3%

27

0.1%

17 Total

 

-613

-2.3%

27

0.1%

18

Marlborough

Marlborough

-636

-2.8%

-23

-0.1%

18 Total

 

-636

-2.8%

-23

-0.1%

Grand Total

 

-52330

-2.5%

-110

0.0%

Source: LEED and Business Demography

Table 10: Employment Changes by Region(Scenario 10 v Historical)

 

Weekly Hours Worked

Employment

Territorial Local Authority (TLA) area

86-91

91-96

96-01

Scenario 10

Far North District

-15.1%

17.3%

6.6%

-2.6%

Whangarei District

-21.4%

13.4%

5.0%

-2.6%

Kaipara District

-16.4%

9.9%

4.2%

-3.2%

Rodney District

10.8%

31.8%

15.1%

-2.6%

North Shore City

-0.4%

16.5%

7.4%

-2.4%

Waitakere City

-2.1%

18.3%

6.7%

-2.5%

Auckland City

-7.5%

20.8%

10.0%

-2.4%

Manukau City

-8.4%

19.0%

10.7%

-2.6%

Papakura District

-3.2%

12.7%

2.9%

-2.6%

Franklin District

5.9%

19.6%

8.9%

-3.1%

Thames-Coromandel District

1.0%

20.1%

9.4%

-2.7%

Hauraki District

-9.7%

5.3%

2.4%

-3.0%

Waikato District

-11.2%

10.4%

7.6%

-3.4%

Matamata-Piako District

-7.6%

5.0%

-1.4%

-3.1%

Hamilton City

-5.1%

14.5%

6.9%

-2.3%

Waipa District

-2.6%

14.1%

7.7%

-2.9%

Otorohanga District

-10.3%

11.9%

-2.3%

-3.3%

South Waikato District

-20.2%

-7.9%

-1.1%

-3.1%

Waitomo District

-15.8%

7.3%

5.9%

-3.2%

Taupo District

-6.4%

16.2%

5.3%

-2.8%

Western Bay Of Plenty District

0.0%

21.6%

12.7%

-3.2%

Tauranga District

-2.2%

24.4%

19.3%

-2.5%

Rotorua District

-13.3%

14.4%

0.7%

-2.5%

Whakatane District

-12.9%

8.1%

4.5%

-2.6%

Kawerau District

-20.6%

-10.8%

-16.9%

-3.0%

Opotiki District

-18.2%

10.9%

6.7%

-2.9%

Gisborne District

-20.7%

10.4%

1.4%

-2.7%

Wairoa District

-18.5%

3.3%

-0.7%

-2.8%

Hastings District

-8.0%

11.2%

3.9%

-2.7%

Napier City

-13.2%

14.0%

4.3%

-2.5%

Central Hawke's Bay District

-9.0%

16.7%

6.2%

-3.1%

New Plymouth District

-12.4%

6.3%

-2.7%

-2.5%

Stratford District

-18.1%

6.2%

0.8%

-3.1%

South Taranaki District

-14.0%

4.0%

0.1%

-3.0%

Ruapehu District

-23.1%

4.8%

-12.8%

-2.8%

Wanganui District

-13.6%

5.7%

2.3%

-2.5%

Rangitikei District

-15.4%

5.9%

-4.7%

-3.3%

Manawatu District

-1.7%

8.4%

2.0%

-2.8%

Palmerston North City

-5.0%

10.5%

1.1%

-2.1%

Tararua District

-9.6%

2.7%

-0.5%

-3.4%

Horowhenua District

-10.5%

4.1%

2.2%

-3.0%

Kapiti Coast District

10.8%

12.2%

15.4%

-2.4%

Porirua City

-10.9%

1.7%

10.4%

-2.1%

Upper Hutt City

-7.1%

-0.6%

1.7%

-2.2%

Lower Hutt City

-9.9%

4.0%

2.7%

-2.5%

Wellington City

-5.3%

9.8%

5.9%

-2.1%

Masterton District

-11.3%

9.5%

4.6%

-2.5%

Carterton District

-7.1%

5.5%

11.8%

-3.2%

South Wairarapa District

-7.3%

1.6%

12.0%

-3.4%

Tasman District

-2.0%

21.0%

11.3%

-3.0%

Nelson City

-5.5%

19.4%

4.2%

-2.3%

Marlborough District

-0.4%

21.3%

8.1%

-2.8%

Kaikoura District

-13.3%

22.8%

8.3%

-2.9%

Buller District

-15.4%

7.3%

-3.1%

-3.4%

Grey District

-17.2%

10.8%

2.0%

-2.7%

Westland District

-8.7%

9.8%

0.3%

-2.7%

Hurunui District

-4.3%

14.8%

11.1%

-3.6%

Waimakariri District

11.0%

27.5%

16.2%

-2.8%

Christchurch City

-7.0%

15.6%

5.6%

-2.4%

Banks Peninsula District

-7.9%

18.2%

9.0%

-2.9%

Selwyn District

2.9%

16.3%

21.2%

-2.8%

Ashburton District

-6.4%

15.1%

8.5%

-3.4%

Timaru District

-12.4%

12.1%

3.0%

-2.7%

Mackenzie District

-18.9%

26.9%

-1.3%

-3.3%

Waimate District

-10.7%

11.7%

1.0%

-3.9%

Chatham Islands District

-23.2%

3.2%

1.9%

-3.3%

Waitaki District

-8.5%

8.4%

-2.4%

-2.8%

Central Otago District

-13.7%

6.0%

3.3%

-3.0%

Queenstown-Lakes District

10.6%

63.6%

19.5%

-2.6%

Dunedin City

-10.7%

9.9%

1.0%

-2.3%

Clutha District

-10.2%

6.7%

5.9%

-3.3%

Southland District

-10.5%

8.6%

3.9%

-3.6%

Gore District

-9.4%

10.0%

1.4%

-2.9%

Invercargill City

-13.1%

6.1%

-5.3%

-2.5%

NEC

       

Total, New Zealand

-7.6%

13.9%

6.2%

-2.5%


12 Ordinarily the ‘putty-clay’ model applies to investment. Capital stock (clay) in one industry cannot move into another industry, but replacement investment for depreciated capital must compete with all other new (putty) investment. For Scenarios 10 and 11 an additional constraint is imposed, namely that no industry can increase its capital stock above the BAU level by more than the implied increment in growth that occurs between 2007 and the 2012 BAU. This effectively tells the model that it can reallocate only 5 years worth of the type of investment that is currently expected, rather than 18 (from 2007 to 2025) years worth. Note that this is an imprecise calculation as no official capital stock data exists for 2007.

13 Infometrics (2003), Review of Import Tariffs beyond 2005, report to Ministry of Economic Development.

14 Carroll, N; Hyslop, D; Maré, D; Timmins, J; and Wood, J. (2002), The Turbulent Labour Market.