A change in relative prices caused by the imposition of a carbon tax might affect economic development by making existing capital equipment uneconomic, thereby bringing forward its scrapping date. This could be a major potential source of adjustment costs related to the tax.
One would expect that the least disruptive imposition of a carbon tax would be one introduced initially at a low level, with modest annual increases over a substantial, pre-announced period of time. This would allow responses to the tax to be synchronized with normal investment schedules. If a carbon tax were introduced in this gradual, expected way, it is doubtful whether experience gained in response to the energy price shocks of the 1970s would provide a reliable guide to the economy's response. As explained in Chapter 1, elasticities derived from these responses should therefore be treated with caution when applied to this different situation.
Ingham et al. (1992) have developed a vintage model of the UK manufacturing sector which allows firms to change their machines' energy-output ratio according to relative factor prices, both between different machine vintages and with existing machines. Technical change is thus at least partly endogenized. The model further allows the energy-output ratio to depend on the rate of growth of output.
Ingham et al. (1992:128-9) then identify, for UK manufacturing, the separate contribution to the decline in the energy-output ratio of relative factor prices, output and an exogenous component of technical progress. They conclude that in the period 1971-80 energy prices, which increased markedly, played the dominant role in reducing the energy-output ratio. Although they stress the tentative nature of their result, at the least it suggests what might have been expected from theory, namely that investment and innovation in the achievement of energy efficiency would increase with the price of fossil energy. This casts doubt on other models' treatment of energy efficiency as autonomous and unaffected by the imposition of the carbon tax.
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