For a number of reasons, there is an increasing interest in developing macroeconomic and industrial models to include energy demand and supply. In particular such studies are motivated by the call for reductions in greenhouse gas emissions resulting from fossil fuel combustion. Such models might prove useful, for example, in determining the economic impacts of achieving specific emission reduction targets. An appropriate model might also be used to determine the interaction between energy prices and emission levels, and thereby provide a useful tool for the analysis of fiscal policy measures (such as a carbon or energy tax) aimed at reducing greenhouse gas emissions.
However, in the course of the development of such modelling approaches it has become apparent that different kinds of models exhibit significantly different degrees of optimism about achieving given reductions. Macro-economic models have tended to predict the need for very high carbon taxes, implying the possibility of significant macroeconomic disruption if desired greenhouse gas emission reduction targets are to be met. For example, Capros et al. (1990) estimated that tax rates in the European Union in excess of 200 per cent, with a tax rate on coal of almost 600 per cent, would still fail to meet the Toronto target of 20 per cent emissions reduction over 1987 levels. Ingham and Ulph (1990) estimated that tax rates of 123-277 per cent would be required in the UK manufacturing sector. Barker and Lewney (1991) required incremental tax rates reaching 350 per cent on coal in 2005 in order to achieve the Toronto target.
The magnitude of the taxes required to achieve a given reduction is a reflection of the responsiveness of consumers to changes in the price of energy. As such these results are hardly surprising, given that historically determined price elasticities of demand for energy are rather low. For instance, Barker and Lewney (1991) used a price elasticity of demand for electricity of -0.4; long-term elasticities of around -0.3 (varying between different sectors and fuel types) are cited by Barker (1992, 1993b), the UK Department of Trade and Industry (DEn 1989a; Hodgson and Miller 1992) and Gregory et al. (1991). On the basis of these low price elasticities, macroeconomic models have often suggested that significant price changes, and associated economic dislocation, are required to meet environmental objectives.
On the other hand, 'bottom-up' engineering analyses of the technological characteristics of energy consumption in different sectors indicate that considerable potential exists for reductions in the greenhouse gas emissions associated with energy consumption, in particular by the implementation of 'demand-side' energy efficiency measures (DEn 1984, 1988, 1990a, b) as well as fuel substitution. Analysis of these technological options suggests moreover that much of this potential is economically cost effective now, even at current fuel prices, and that more of it becomes economic, given relatively small fuel price increases (Jackson 1989, 1991; Jackson and Roberts 1989; Mills et al. 1991). Figure 10.1 illustrates the results of an analysis of technological options for reducing emissions of greenhouse gases into the atmosphere. Several
Figure 10.1 Cost-effectiveness of different CO2 emission abatement options (by the year 2005; 10 per cent assumed discount rate)
of these options—in particular those associated with energy efficiency improvements—incur economic savings when assessed on a marginal cost basis at a common discount rate of 10 per cent.
In Figure 10.2, a carbon tax has been included in the energy price (Jackson 1992). The magnitude of this tax was chosen to reflect the level of tax deemed necessary according to one of the macroeconomic models (Barker and Lewney 1991) in order to achieve the Toronto target (20 per cent reduction over current levels) by the year 2005. But the results of this microeconomic analysis seem to suggest that such a tax would result in economically viable reductions significantly in excess of those required for a 20 per cent reduction in emissions.
Thus, it is apparent that low energy price elasticities can coexist with unrealized opportunities for improvements in energy efficiency. This has profound repercussions for the interpretation of both macroeconomic models and engineering models of energy demand. If energy efficiency improvements are really economic, why are they not already being implemented? Why is a carbon tax or an energy tax required at all? And why, if there are economic gains to be made by reducing energy consumption through improved energy efficiency, have macroeconomic analyses tended to suggest that reducing greenhouse gas emissions could be both costly and disruptive (Nordhaus 1990; Manne and Richels 1992)?
The answers to such questions rest, in part, with an understanding of the different methodological approaches used by the models and the questions that they are attempting to answer. On the one hand, macroeconomic models take the structural characteristics of the economy as given and, as such, are not able to capture the impact of changes in that structure. On the other hand, engineering models tend to adopt an assumption of 'socially optimal' economic decision-making, and therefore fail to reflect the exigencies of actual market behaviour. Thus, although both approaches provide valuable insights into the potential for, and means of, realizing significant gains in understanding energy consumption, the respective insights of the two approaches should be regarded in the light of their methodological foundations when they are used to evaluate appropriate policy interventions.
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