The Really Important Reason Why Cutting Carbon Emissions Might Improve Britain’s Economy

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The city of London in the United Kingdom.

Staying on course to meet its climate goals will leave Britain with a slightly bigger economy and more jobs, according to an analysis released Wednesday.

But what’s particularly striking about the paper is it found those improvements would come from the first-order changes the economy would have to make to decarbonize. Plenty of other studies have found that cutting greenhouse gas (GHG) emissions will leave economies better off. But usually it’s because of second-order effects — avoided damage from climate change, or health benefits from reduced air pollution — that offset economic drag caused by the first-order changes. The assumption that cutting carbon itself will damage the economy is widely held in both economics and politics, and contributes to a lot of hesitation to aggressively confront climate change.

Some background: Britain has legally committed itself to cutting its GHG emissions 80 percent below their 1990 levels by 2050. To that end, the government established a set of four interim emission-cutting goals, the last of which would end in 2027. So Cambridge Econometrics decided to model how the British economy would change by 2030 if all four targets were met, versus a scenario in which the latter three targets were missed.

Wednesday’s paper “The Economics of Climate Change Policy” was the result. It found that:

  • While cutting emissions would drive production down in some industries (like refining and gas production), it would ramp up in other sectors (like manufacturing and service jobs). That would leave the British economy in 2030 1.1 percent larger on net, and with 190,000 extra jobs.
  • Electricity bills would go up, as would some product prices in the economy. But energy demand would also go down thanks to increased efficiency. Meanwhile, other changes to the economy to get off carbon would drive up wages for certain classes of workers, leaving the average British household £565 richer ($916.22 in American dollars) in 2030. Moreover, that improvement would not be distributed evenly through the economy, and workers coming out of unemployment or underemployment would see the biggest gains.
  • Britain’s demand for oil and natural gas would be cut 30 and 55 percent, respectively, thus reducing its annual imports and reliance on foreign sources for both.

Those net benefits also hold, though they get smaller, if fossil fuels actually remain cheaper longer than the projections Cambridge Econometrics relied on.

But the big issue is the study’s use of what it calls “econometric-based simulation” models rather than Computable General Equilibrium (CGE) models. In plain English, Cambridge Econometrics built their model by sifting through historical data going back to 1970, and then designed their equations to mimic how the economy has actually behaved in the past. By contrast, CGE models rely on a priori economic theories that markets are always optimizing efficiencies and that everyone who wants to be employed is already employed — i.e. that markets are always trending towards “equilibrium.” So the CGE approach comes with an inbuilt bias: if markets are already efficient, then by definition efforts to cut carbon emissions can only hurt economic and job growth. But under the assumptions of the simulation model, markets are not always efficient, so cutting emissions may be harmful in some instances but beneficial in others. Sometimes there can be “win-win” outcomes where both environmental sustainability and economic performance can be improved at once.

“In our view,” Cambridge Econometrics said in the paper, “these model features make simulation models more suitable for this type of analysis than CGE models.”

As The Carbon Brief pointed out, this divide — the theory that markets optimize efficiency and resource use versus the theory that markets can be irrational and prone to failure — is one of the central long-running divides in the economics profession. And CGE models are actually quite widespread. For example, they underlie most of the projections made by the Intergovernmental Panel On Climate Change, which already tends to low-ball its estimates of future climate change damage.

Now, projections relying on CGE models still often shake out in favor of aggressive action to curb clime change. Sometimes, while the CGE calculations show efforts to lower carbon emissions will slow economic growth some, the consequences of unabated climate change ultimately cause far more damage. Or the economic costs of the emissions cuts are vastly outweighed by the economic benefits of cutting air pollutants that exacerbate cardiovascular diseases and other ailments — that makes workers healthier, which makes them more productive, which boosts the economy back up. In other cases, intertwined policy choices — like using the revenue from a carbon tax to reduce other taxes elsewhere, or to cut everyone a reimbursement check — serve to offset the economic drag from the carbon reductions themselves.

What makes the Cambridge Econometrics analysis significant is that it finds the improvements before any of those additional factors are calculated in. Rather than second-order climate, health, or policy benefits of cutting carbon emissions, it’s the first-order restructuring of the economy itself to get those cuts that delivers the improved results. That’s a fairly new finding, and one that drives home how tricky modeling economies can be.

As with all models of the economy, there are plenty of caveats. The study didn’t include the health benefits of cutting pollution, which would improve the results of emissions reductions further. It assumes Britain is the only country that changes its emissions, which is highly unlikely, and could cut in either direction depending on how competitive the country remains vis-a-vis its neighbors. The analysis also assumes the learning rate for renewable technological improvement is the same under both scenarios, though it would almost certainly be higher under the more aggressive emission reductions.

Finally, it assumes emission reductions are made through the most efficient means. That’s a fair guess, given Britain will be working with Europe’s cap-and-trade system — and cap-and-trade tends to drive businesses to find the most cost-effective emission cuts — but it’s still an assumption.

But ultimately those caveats are all over the place, cutting both ways, and thus probably cancel each other out.