A computable general equilibrium analysis of the relative price sensitivity required to induce rebound effects in response to an improvement in energy efficiency in the UK economy

In recent years there has been extensive debate in the energy economics and policy literature on the likely impacts of improvements in energy efficiency. This debate has focussed on the notion of rebound effects. Rebound effects occur when improvements in energy efficiency actually stimulate the direct and indirect demand for energy in production and/or consumption. This phenomenon occurs through the impact of the increased efficiency on the effective, or implicit, price of energy. If demand is stimulated in this way, the anticipated reduction in energy use, and the consequent environmental benefits, will be partially or possibly even more than wholly (in the case of ‘backfire’ effects) offset. A recent report published by the UK House of Lords identifies rebound effects as a plausible explanation as to why recent improvements in energy efficiency in the UK have not translated to reductions in energy demand at the macroeconomic level, but calls for empirical investigation of the factors that govern the extent of such effects. Undoubtedly the single most important conclusion of recent analysis in the UK, led by the UK Energy Research Centre (UKERC) is that the extent of rebound and backfire effects is always and everywhere an empirical issue. It is simply not possible to determine the degree of rebound and backfire from theoretical considerations alone, notwithstanding the claims of some contributors to the debate. In particular, theoretical analysis cannot rule out backfire. Nor, strictly, can theoretical considerations alone rule out the other limiting case, of zero rebound, that a narrow engineering approach would imply. In this paper we use a computable general equilibrium (CGE) framework to investigate the conditions under which rebound effects may occur in the Scottish regional and UK national economies. Previous work has suggested that rebound effects will occur even where key elasticities of substitution in production are set close to zero. Here, we carry out a systematic sensitivity analysis, where we gradually introduce relative price sensitivity into the system, focusing in particular on elasticities of substitution in production and trade parameters, in order to determine conditions under which rebound effects become a likely outcome. We find that, while there is positive pressure for rebound effects even where (direct and indirect) demand for energy is very price inelastic, this may be partially or wholly offset by negative income and disinvestment effects, which also occur in response to falling energy prices.

The added value from adopting a CGE approach to analyse changes in environmental trade balances

The application of multi-region environmental input-output (IO) analysis to the problem of accounting for emissions generation (and/or resource use) under different accounting principles has become increasingly common in the ecological and environmental economics literature in particular, with applications at the international and interregional subnational level. However, while environmental IO analysis is invaluable in accounting for pollution flows in the single time period that the accounts relate to, it is limited when the focus is on modelling the impacts of any marginal change in activity. This is because a conventional demand-driven IO model assumes an entirely passive supply-side in the economy (i.e. all supply is infinitely elastic) and is further restricted by the assumption of universal Leontief (fixed proportions) technology implied by the use of the A and multiplier matrices. Where analysis of marginal changes in activity is required, extension from an IO accounting framework to a more flexible interregional computable general equilibrium (CGE) approach, where behavioural relationships can be modelled in a more realistic and theory-consistent manner, is appropriate. Our argument is illustrated by comparing the results of introducing a positive demand stimulus in the UK economy using IO and CGE interregional models of Scotland and the rest of the UK. In the case of the latter, we demonstrate how more theory consistent modelling of both demand and supply side behaviour at the regional and national levels effect model results, including the impact on the interregional CO2 ‘trade balance’.

Do Productivity Improvements Move Us Along the Environmental Kuznets Curve?

The Environmental Kuznets Curve (EKC) hypothesis focuses on the argument that rising prosperity will eventually be accompanied by falling pollution levels as a result of one or more of three factors: (1) structural change in the economy; (2) demand for environmental quality increasing at a more-than-proportional rate; (3) technological progress. Here, we focus on the third of these. In particular, energy efficiency is commonly regarded as a key element of climate policy in terms of achieving reductions in economy-wide CO2 emissions over time. However, a growing literature suggests that improvements in energy efficiency will lead to rebound (or backfire) effects that partially (or wholly) offset energy savings from efficiency improvements. Where efficiency improvements are aimed at the production side of the economy, the net impact of increased efficiency in any input to production will depend on the combination and relative strength of substitution, output/competitiveness, composition and income effects that occur in response to changes in effective and actual factor prices, as well as on the structure of the economy in question, including which sectors are targeted with the efficiency improvement. In this paper we consider whether increasing labour productivity will have a more beneficial, or more predictable, impact on CO2/GDP ratios than improvements in energy efficiency. We do this by using CGE models of the Scottish regional and UK national economies to analyse the impacts of a simple 5% exogenous (and costless) increase in energy or labour augmenting technological progress.

How do improvements in labour productivity in the Scottish economy affect the UK position on the Environmental Kuznets Curve?

The research reported here is an output of Karen Turner’s ESRC Climate Change Leadership Fellow project (Grant reference RES-066-27-0029). However, this research builds on previous work funded by the ESRC on modelling the economic and environmental impacts of technological improvement (Grant reference: RES-061-25-0010) and by the EPSRC through the SuperGen Marine Energy Research Consortium on accounting for and modeling environmental indicators (Grant reference: EP/E040136/1).

An interregional input-output analysis of the pollution content of trade flows and environmental trade balances between five states in the US Mid-West

In this paper we attempt an empirical application of the multi-region input-output (MRIO) method in order to enumerate the pollution content of interregional trade flows between five Mid-West regions/states in the US –Illinois, Indiana, Iowa, Michigan and Wisconsin – and the rest of the US. This allows us to analyse some very important issues in terms of the nature and significance of interregional environmental spillovers within the US Mid-West and the existence of pollution ‘trade balances’ between states. Our results raise questions in terms of the extent to which authorities at State level can control local emissions where they are limited in the way some emissions can be controlled, particularly with respect to changes in demand elsewhere in the Mid-West and US. This implies a need for policy co-ordination between national and state level authorities in the US to meet emissions reductions targets. The existence of an environmental trade balances between states also raises issues in terms of net losses/gains in terms of pollutants as a result of interregional trade within the US and whether, if certain activities can be carried out using less polluting technology in one region relative to others, it is better for the US as a whole if this type of relationship exists.

Environmental Degradation and the Limits to LOV

We show how consumers’ environmental concerns may limit ‘love of variety’ (LOV) and be reflected in consumers decisions. We investigate how the impact of environmental degradation on LOV influences demand and optimal product variety, and how a pollution tax on firms might be used to improve upon the market outcome and increase welfare.

Global Warming And Extreme Events: Rethinking The Timing And Intensity Of Environmental Policy

The possibility of low-probability extreme events has reignited the debate over the optimal intensity and timing of climate policy. In this paper we therefore contribute to the literature by assessing the implications of low-probability extreme events on environmental policy in a continuous-time real options model with “tail risk”. In a nutshell, our results indicate the importance of tail risk and call for foresighted pre-emptive climate policies.

First-and second-best allocations under economic and environmental uncertainty

This paper uses a micro-founded DSGE model to compare second-best optimal environmental policy and the resulting allocation to first-best allocation. The focus is on the source and size of uncertainty, and how this affects optimal choices and the inferiority of second best vis-à-vis first best.

Minu, Startu and all that:- Pitfalls in estimating the sensitivity of a worker’s wage to aggregate unemployment

In this paper we show that the inclusion of unemployment-tenure interaction variates in Mincer wage equations is subject to serious pitfalls. These variates were designed to test whether or not the sensitivity to the business cycle of a worker’s wage varies according to her tenure. We show that three canonical variates used in the literature - the minimum unemployment rate during a worker’s time at the firm(min u), the unemployment rate at the start of her tenure(Su) and the current unemployment rate interacted with a new hire dummy(δu) - can all be significant and "correctly" signed even when each worker in the firm receives the same wage, regardless of tenure (equal treatment). In matched data the problem can be resolved by the inclusion in the panel of firm-year interaction dummies. In unmatched data where this is not possible, we propose a solution for min u and Su based on Solon, Barsky and Parker’s(1994) two step method. This method is sub-optimal because it ignores a large amount of cross tenure variation in average wages and is only valid when the scaled covariances of firm wages and firm employment are acyclical. Unfortunately δu cannot be identified in unmatched data because a differential wage response to unemployment of new hires and incumbents will appear under both equal treatment and unequal treatment.

The Effects of Experience on Preference Uncertainty: Theory and Empirics for Public and Quasi-Public Environmental Goods

This paper develop and estimates a model of demand estimation for environmental public goods which allows for consumers to learn about their preferences through consumption experiences. We develop a theoretical model of Bayesian updating, perform comparative statics over the model, and show how the theoretical model can be consistently incorporated into a reduced form econometric model. We then estimate the model using data collected for two environmental goods. We find that the predictions of the theoretical exercise that additional experience makes consumers more certain over their preferences in both mean and variance are supported in each case.

Consumer Behaviour in a Social Context: Implications for Environmental Policy

In this paper we summarise some of our recent work on consumer behaviour, drawing on recent developments in behavioural economics, in which consumers are embedded in a social context, so their behaviour is shaped by their interactions with other consumers. For the purpose of this paper we also allow consumption to cause environmental damage. Analysing the social context of consumption naturally lends itself to the use of game theoretic tools, and indicates that we seek to develop links between economics and sociology rather than economics and psychology, which has been the more predominant field for work in behavioural economics. We shall be concerned with three sets of issues: conspicuous consumption, consumption norms and altruistic behaviour. Our aim is to show that building links between sociological and economic approaches to the study of consumer behaviour can lead to significant and surprising implications for conventional economic policy prescriptions, especially with respect to environmental policy.

Moral Behaviour, Altruism and Environmental Policy

Free‐riding is often associated with self‐interested behaviour. However if there is a global mixed pollutant, free‐riding will arise if individuals calculate that their emissions are negligible relative to the total, so total emissions and hence any damage that they and others suffer will be unaffected by whatever consumption choice they make. In this context consumer behaviour and the optimal environmental tax are independent of the degree of altruism. For behaviour to change, individuals need to make their decisions in a different way. We propose a new theory of moral behaviour whereby individuals recognise that they will be worse off by not acting in their own self‐interest, and balance this cost off against the hypothetical moral value of adopting a Kantian form of behaviour, that is by calculating the consequences of their action by asking what would happen if everyone else acted in the same way as they did. We show that: (a) if individuals behave this way, then altruism matters and the greater the degree of altruism the more individuals cut back their consumption of a ’dirty’ good; (b) nevertheless the optimal environmental tax is exactly the same as that emerging from classical analysis where individuals act in self‐interested fashion.

Estimating the Impact on Efficiency of the Adoption of a Voluntary Environmental Standard: An Empirical Study of the Global Copper Mining Industry

This paper uses data on the world's copper mining industry to measure the impact on efficiency of the adoption of the ISO 14001 environmental standard. Anecdotal and case study literature suggests that firms are motivated to adopt this standard so as to achieve greater efficiency through changes in operating procedures and processes. Using plant level panel data from 1992-2007 on most of the world's industrial copper mines, the study uses stochastic frontier methods to investigate the effects of ISO adoption. The variety of models used in this study find that adoption either tends to improve efficiency or has no impact on efficiency, but no evidence is found that ISO adoption decreases efficiency.