The David Suzuki Foundation and the Pembina Institute recently sponsored a study that concludes that the economic effects of a significant reduction in greenhouse gas emissions would be relatively small. Since its release, any number of journalists have dutifully cut-and-pasted bits from the summary report into their commentaries. But it never seemed to occur to them to ask how these results could be reconciled with what had already been written on the subject.
In an op-ed, Jack Mintz took the time to read the technical report (1 Mb pdf):
The good
news: The Canadian government target to reduce emissions by 20% from
2006 levels by 2020 is doable and relatively painless for Canada as a
whole. The study estimates that Canada’s GDP would decline only 1.4% by
2020, shaving Canada’s annual economic growth rate by a bit over the
coming decade.The bad news: The target would involve a large
transfer of wealth from Alberta and Saskatchewan to the rest of Canada,
creating a major nation-splitting transfer program. Ontario and
Manitoba would gain GDP while Alberta’s GDP would fall by 7%…
It's not clear that the study's sponsors would view that second bit as bad news. But Jack points out a fatal flaw in the assumptions that drive this result:
The most incredible and
naïve assumption in the Pembina-Suzuki paper is that Canada’s aggregate
capital stock is fixed and therefore stays in Canada. By punishing
energy investments, it assumes, interest rates and the cost of capital
will fall, causing manufacturing and service industries to boom by
investing heavily in non-residential structures and machinery.This
zero-sum thinking has it backwards. Since Canadian capital markets are
integrated with global markets, capital would shift to other parts of
the world where investors would earn higher returns. In plain English,
interest rates and the cost of capital in Canada, which is determined
by international markets, can’t fall.Therefore, carbon policies
that impede investment in the energy industry will not lead to a shift
of capital to other sectors of the Canadian economy. Instead capital
would flee to countries like China and India.
My first reaction to those paragraphs was to say to myself "That can't be right; no economist would build those assumptions about the capital stock into a model of the long-term effects of climate change policy." But no, Jack got it right. Here's what the study says on pp 10-11:
R-GEEM, as a static CGE model with fixed and flexible capital, operates with the assumption that Canadian savings will support a given amount of capital investment between 2010 and 2020, to both replace worn out stock and make new investments. In the case of 2020, using Informetrica’s economic forecast, the total capital stock available is $510 billion. Table 13 details how this capital is allocated in the BAU and policy scenarios in 2020. The new, flexible portion of this is free to migrate to whichever sectors and regions in the country that offer the highest returns. No net foreign capital is assumed to be available, i.e. all investment must be funded in the long run from Canadian sources. Table 14 illustrates the change in capital investment under the policy scenarios. Of note is that $12–15 billion less is invested in Alberta, and is instead invested in other regions, mainly Ontario and Québec. However, the total amount of capital investment does not change, which reflects the assumptions of the model.
After reading that, there's really no point in continuing on with the other 90 pages. To begin with, static (are there any other kind?) CGE models shouldn't be used for policy projections with a 10-year horizon; such an analysis requires a dynamic model to trace out the evolution of the capital stock as investment levels vary.
More fundamentally, this is a classic example of assuming a can opener. The debate about the long-run economic effects of climate change policy revolves around how reducing greenhouse gases will affect the productive capacity of the economy as a whole. If you assume a priori that the capital stock is fixed, you're pretty much guaranteed to find that the effects on long-run capacity output are nil.
Worthwhile Canadian Initiative 
Ah jeez. Is that your point? That I’m part of some media conspiracy?
You can’t be. I never saw you at any of the meetings.
“eastern bastards will be freezing in the dark while the Republic of Alberta prospers”
Juvenile. Next they’ll be threatening to hold their breath.
Stephen – not sure what jvfm is insinuating, but he makes one good point – the generic strategy to get Albertans to oppose something is to call it the next NEP. Regardless of the issue, they immediately turn off their brains and reach for their pitchforks and lynch ropes.
The Alberta-loses-everyone-else-wins scenario is built into the assumptions of the CGE modeling exercise. What is far more likely is that we’ll all pay the price. And it’s important to be honest about it.
Funny, if you chop up every part of the world into 1000 pieces proportional to their CO2 emissions, they all account for just 0.10% of global emissions and can thus safely continue to as usual. Right, Don?
Re natural gas prices, and cost structure, as I was saying:
http://watch.bnn.ca/commodities/december-2009/commodities-december-17-2009/#clip247527
Stephen, sorry to pester you further, but a q arising from Jack Mintz’s rebuttal in the NP of yesterday.
He wrote:
To assume that aggregate capital is fixed in the Canadian economy over the next decade is far-fetched. John is correct that if other countries pursue similar policies as Canada, the world cost of capital will likely fall, including Canada’s. But that is not what is modeled by the TD-sponsored study. It looks at harsher policies compared to the U.S., China and other large economies, thus resulting in a capital outflow from Canada.
http://network.nationalpost.com/np/blogs/fpcomment/archive/2009/12/16/canada-should-lead-climate-fight.aspx
Now, on page 4 of the TD study, it states:
The analysis shows that the carbon charge and complementary polices chosen are not sufficient alone to meet the targets. Their effect under two scenarios was tested: one where the OECD countries impose policies as stringent as Canada (OECD acts together – “OAT”), and one where Canada goes significantly further than its OECD trading partners (Canada goes further – “CGF”). To make up the difference between the target and domestic emissions reductions, purchases of international emissions permits are necessary in both scenarios.
So, it seems to me that Mintz is taking issue with the unreasonable assumption that the total capital invested in Canada ($510.1 B, table 13, pg 11) remains constant under both OAT and CGF. Ok, I can agree with that, and I assume that was your point as well. So throw out the more unlikely CGF case.
But the more likely scenario OAT (one where the OECD countries impose policies as stringent as Canada – OECD acts together) it would seem to me still stands. Or is it your position that the OAT case is also tainted? And isn’t this the more likely scenario, assuming Copenhagen is successful?
More likely than CGF, perhaps, but there’s still no reason to impose it a priori. At best, if all OECD countries had the same structure, then there wouldn’t be any inter-country reallocations of capital. But there’s still a way to go before you can assert that global (and hence national) capital stocks would remain constant.
If Canada is relatively harder hit – and I don’t think there’s any doubt about this point – than even that story has to be set aside.
k, thanks. Sorry if my comments were interpreted as implying anything about motives on your part. Not intended, but I can see how they might have been interpreted as such.
Cheers