Saturday, June 7, 2014

Regulating CO2 emissions and firm competitiveness

EPA announced this week the Clean Power Plan to reduce carbon emissions of coal fired power plants by 30% by 2030 (relative to 2005 levels).  It has created a lot of discussion with environmental groups praising it as an overdue step and some business pointing to the cost of such regulation.

One thing to note is that EPA was smart enough in giving states a lot of flexibility in meeting the 30% reduction.  In general, more flexibility should allow regulated plants to meet the goal in the most cost effective way. Max Auffhammer called this the Yoga Theorem, i.e., the "less flexible you are, the more you will suffer," which I can personally relate to (you don't want to see me stretch).

Most of the research we have talked about on this blog has estimated the effects of increasing temperatures that are caused by elevated CO2 levels (or other greenhouse gases like methane). Having spent so much time on the benefit side of greenhouse gas regulation (avoided damages), it might be interesting to look at some research on the cost side of such regulation. As any student of econ 101 remembers, in the optimum one should balance the costs of regulation against the benefits.

Making a factor of production (coal) more expensive will have two effects: first, there will be a shift away from coal, which will be especially felt in regions that rely on coal production (e.g., West Virginia).  While electricity generation has been shifting from coal to natural gas even before the regulation was implemented, the regulation will likely accelerate this transition. So there will be losers compared to the stays quo (one could also argue that coal has an unfair advantage in the status quo as it imposes a sizable unpriced externality, which makes a factor of production artificially cheap).

The best research on the cost of environmental regulation is a recent paper by Reed Walker, where he compares wages of individuals that work in industries in a county that are subject to tougher regulation under a the revised ozone standard compared to workers who work in the same county in industries that are not covered by the more stringent regulation. The combined loss in wages are sizable (5 billion in present discounted value), but order(s) of magnitude lower than the estimated benefits.  The largest cost incur to people that used to work in firms that are subject to tougher regulation and loose their jobs - once they find a new job wages tend to be lower for up to eight years.  Workers who stay at regulated firms see no drop in wages.

Second, regulating coal will make production that uses electricity (pretty much all production) more expensive as electricity prizes might rise as a result of the regulation.  How big is this second effect? We have some evidence from Europe, where the European Trading System (ETS) created a market for carbon credits.  Similar to the EPA regulation that only covers coal-fired power plants, ETS only covered a subset of firms.  This offers some nice way for researchers to compare regulated and unregulated firms.

Sebastian Petrick and Ulrich Wagner have a great new paper that uses firm-level data from firms in Germany and compares what happens to firms that are regulated under ETS by matching them to comparable firms that were not regulated.  Not surprisingly, regulated firms reduce emissions by 20% more than unregulated firms (the regulation is effective), but there seems to be no reduction in competitiveness of regulated firm, i.e., they find no reduction in employment, gross output, or exports.

In summary, my best guess is that the carbon regulation will have very little effect on overall competitiveness or employment in the US as a whole, but will be felt in some regions that heavily rely on coal.

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