GHG Mitigation Policies and Employment: A CGE Analysis with Wage Rigidity and Application to Canada

GHG Mitigation Policies and Employment S53

Canadian PubliC PoliCy – analyse de Politiques, vol. xxxix, suPPlement/numéro sPéCial 2 2013

GHG Mitigation Policies and Employment: A CGE Analysis with Wage Rigidity and Application to Canadayazid dissouDepartment of Economics University of Ottawa, Ontarioqian sunDepartment of Economics University of Ottawa, Ontario

Dans cet article, nous évaluons, grâce à un modèle d’équilibre général, les effets d’une politique d’atténuation des impacts des GES en présence de rigidités du marché du travail. Nous analysons l’impact de la réduc-tion d’émissions de CO2 dans le cadre d’un système de plafonnement et d’échange de droits d’émission ainsi que les implications de différentes possibilités de recyclage des recettes. Nos résultats indiquent que cette politique a un effet négatif sur l’emploi et le bien-être quand les recettes des permis sont recyclées en tant que dividendes sociaux forfaitaires aux ménages. Utiliser les recettes du carbone pour réduire les cotisations sociales donne de meilleurs résultats, puisque les avantages sont plus importants que les coûts de la réduction elle-même. De plus, utiliser les recettes des permis pour réduire les cotisations sociales uniquement des travailleurs peu spécialisés est l’option la plus avantageuse.

Mots clés : atténuation des impacts des GES, permis échangeable d’émission de carbone, rigidités du marché du travail, bénéfices liés à l’emploi, modèle d’équilibre général calculable

We use a general equilibrium framework to assess the impact of carbon mitigation policies in the presence of labour market rigidities. We analyze the impact of reducing CO2 emissions in a cap-and-trade system and the implications of different revenue-recycling options. Our results suggest that the policy has a negative impact on employment and welfare when permit revenues are recycled as lump-sum transfers to house-holds. Using the carbon proceeds to reduce payroll tax achieves better outcomes, as the benefits outweigh the pure abatement cost. Moreover, using permit revenues to reduce payroll tax of low-skill workers alone represents the best option.

Keywords: GHG mitigation, carbon permit, labour market rigidity, employment dividends, computable general equilibrium models

S54 Yazid Dissou and Qian Sun


introduCtion

While there is a growing consensus on the need to curb anthropogenic greenhouse

gases (GHGs) using market-based policy instru-ments, there are also deep concerns over the costs of stringent environmental policies relating to competitiveness and employment. For example, the implementation of stringent carbon mitigation poli-cies could lead to a shift of labour resources away from polluting industries and towards those that are less pollution-intensive. Still, in the real world, this resource reallocation from one sector to another does not always occur smoothly within an economy. Several jobs could be lost in the process due to the presence of rigidities in the labour market. Hence, in political debates, stringent carbon policies are often portrayed as “job destructing” policies.

Labour market rigidities are usually defined as constraints that prevent labour supply, whether skilled or unskilled, to be allocated optimally and immediately. The reasons behind the sub-optimal reallocation of employment include search costs associated with seeking alternative employment, and minimum-wage laws, among many others. Using partial-equilibrium econometric models, some studies have assessed the impact of environmental policies on employment in the United States. For example, using rich longitudinal data for the United States, Walker (2011) finds that more stringent en-vironmental regulations brought about by the Clean Air Act amendment in 1990 have led to a decline in employment growth rates within the affected sec-tors. Another US study by Deschênes (2011) uses data from 1976 to 2007 to estimate the effects of variations in electricity prices on full-time equiva-lent (FTE) employment. This study finds that a 4 percent increase in the price of electricity leads to a 0.6 percent reduction in FTE employment in the short-run.

It is widely recognized that partial-equilibrium models cannot provide a thorough assessment of

the employment implications involved in using revenue generated by carbon mitigation policies to mitigate the costs of abatement. Yet, the possibil-ity of using these revenues has surfaced in Europe, where unemployment is high. There have also been fierce discussions on the possibility of mitigating the labour market incidence of environmental poli-cies, as illustrated by the controversial debate over the existence of a double dividend. According to the double-dividend hypothesis, although carbon policies could have a negative impact on economic activities, benefits arise from a cleaner environment, which is the first dividend. The second dividend occurs if revenues from carbon taxes are properly targeted to reducing existing distortionary labour taxes.1 Despite considerable efforts, there is still no consensus among researchers about the existence, as well as the magnitude of the double dividend. Studies, such as those of Bento and Jacobsen (2007), Manresa and Sancho (2005), and Parry and Bento (2000) offer support for the existence of the double dividend. In contrast, several other studies, for ex-ample, Bovenberg, Goulder, and Jacobsen (2008); Goulder et al. (1999); Parry, Williams, and Goulder (1998); and Williams (2002), do not find any sup-port for its existence. One of the potential sources of disagreement in the findings of these studies is related to the modelling of the labour market. Most models used in these studies ignore some important characteristics of the labour market: namely, that the labour market features heterogeneity among workers, and most importantly, is characterized by wage rigidity, which, in turn, creates unemployment. Moreover, the scope for employment dividends and welfare dividends depends upon these features of labour markets. Most theoretical and empirical pa-pers indicate that labour market imperfections may increase the size of employment effects and, at the same time, enhance the scope for a double dividend on employment. Therefore, modelling realistic features of labour markets is a useful undertaking.

A relatively recent study by Fæhn, Gómez-Plana, and Kverndokk (2009) uses a computable general



equilibrium (CGE) model with some of the fore-going labour market imperfections to find that the implementation of a carbon policy does not aggravate unemployment if it is accompanied by revenue-recycling schemes. These authors find that using the proceeds from permit sales to reduce payroll taxes for skilled labour generates a higher employment dividend than returning the proceeds to households as lump-sum transfers, or using the proceeds to reduce the payroll taxes of unskilled workers only. Another study by Chateau, Saint-Martin, and Manfredi (2011) assesses the impacts of carbon policies on gross domestic product (GDP) and employment by con-sidering labour market imperfections in the form of short-run, ad hoc rigidities in wage adjustment. The authors find that carbon policies are more costly in the presence of labour market imperfections. None-theless, the negative effects of those policies can be offset with an appropriate revenue-recycling scheme that reduces wage taxes. Finally, Guivarch et al. (2011) emphasize the crucial role of labour market imperfections in cost analyses of climate policies. Using a dynamic, recursive energy-economy model, they find that achieving emissions reductions at a reasonable macroeconomic cost would require the adoption of parallel policies in the labour market to reduce the existing distortions.

In Canada, several studies have been conducted to assess the potential impact of carbon mitigation policies. Bohringer and Rutherford (2010), Dissou (2005), Rivers (2010), and Wigle (2001) are some examples, among several others. Unfortunately, none of these previous studies has explicitly intro-duced labour market rigidities in their analyses. Rather, their analyses have relied on the assumption of a perfectly flexible labour market. While the modelling approach developed by these studies pro-vides a good starting point for assessing the overall economic cost of carbon mitigation policies, it is clearly inadequate for portraying a more realistic picture of the potential impact of these policies on unemployment, which is a noticeable feature of the Canadian economy.

This study attempts to fill this gap by developing a static CGE model with labour market rigidity of the Canadian economy in order to analyze the po-tential economic implications for employment of reducing carbon dioxide emissions. Moreover, we consider heterogeneity in the composition of the labour market by considering two types of workers: high-skilled and low-skilled. We are not aware of any similar model for the Canadian economy. We focus exclusively on carbon dioxide emissions and consider the use of tradable permits as policy instru-ments to reduce emissions. Furthermore, we analyze the effects of different revenue-recycling options.

As there is no active cap-and-trade policy in Can-ada, the simulations discussed in this study cannot be linked to the potential outcomes of any existing policy in this country. Our simulations are rather meant to derive some insights on the potential im-plications of carbon mitigation policies in Canada. Still, the lessons learnt from this analysis could be useful in the design of environment policies. The rest of the paper is structured as follows: the second section presents the main structure and features of the CGE model; the third explains data and calibra-tion; the fourth provides an analysis of numerical results; and the fifth and final section concludes.

the model

OverviewThis section provides a summary description of the model. We use a static, multisector general equilibrium model of Canada, with perfect competitive markets in the presence of labour market rigidity. We study the potential impacts of alternative carbon permit revenue-recycling schemes. The model builds heavily on a previous contribution to the literature on CGE modelling of climate change policy by Dissou (2005). The main addition in this study is the introduction of real-wage rigidity in the labour market and the con-sideration of two types of workers: low-skilled and high-skilled. The latter receive different wage rates.



Wage rigidity is modelled using a wage curve. The introduction of real-wage rigidity makes it pos-sible to account for the presence of unemployment. As the real-wage rates of both types of workers are rigid, the level of employment is always uniquely determined by firms, through labour demand. In order to focus exclusively on the impact of the abatement policy on employment (and hence on un-employment), while removing the impact of changes in the unemployment rate due to changes in labour supply, we assume that labour supply is exogenous.

Canada is considered as a small, open economy that produces and consumes tradable, as well as non-tradable goods. In addition to the rest of the world and the government, the model distinguishes two main domestic agents: firms and households. All agents operate in a competitive environment and consider prices as given. Moreover, because of the static nature of the model, we assume that capital is internationally immobile, but can move from one sector to another in the country.

Since the model focuses on combustion carbon dioxide emissions, it only tracks CO2 emissions stemming from the use of fossil fuels. To account for the differences in the emissions intensities of existing fossil fuels, the model considers six types of fossil products: coal, natural gas, motor gasoline, diesel, liquid petroleum gases, and “other refined petroleum and coal products.” Moreover, to take into consideration the observed heterogeneity in sectoral emissions intensity, as well as the sectoral differences in factor intensity, the model provides a disaggregation of the production sector into 38 industries. In what follows, we present a thumbnail discussion on the main characteristics of the model that will help the reader put the simulation results in proper perspective.

FirmsThe production sector is disaggregated into 38 industries that produce 42 composite commodities sold on the domestic or the export market. The representative firm in each industry uses a linear

homogeneous technology to combine labour, capital, energy, and non-energy inputs to produce output. Gross output is a constant elasticity of substitution (CES) aggregate of the composite of intermediate inputs and the composite of value added and energy. The latter is a CES aggregate of unskilled labour and the composite of capital, energy, and high-skill labour. The latter composite is a CES function of the index of total energy and the composite of cap-ital and high-skilled workers. A CES aggregator is used to combine capital and high-skilled workers. The rationale for not including the two types of labour in the same nest derives from the empirical evidence provided by Böhringer, Boeters, and Feil (2005), who suggest that low-skilled workers are poor substitutes for capital.

The index of total energy is formed by combin-ing electricity and the aggregate of stationary fossil energy inputs using a CES aggregator. The aggre-gate stationary fossil fuel input is derived from the combination of coal, natural gas, and a composite of refined petroleum products, using a CES aggregator function. The composite of refined petroleum prod-ucts is a combination of various refined petroleum products (such as liquid petroleum gases) using a Cobb-Douglas (C-D) function. Natural gas is a fixed-proportion combination of natural gas per se and gas pipelines. Besides, the composite of intermediate inputs is a CES composite of a C-D aggregate of mo-tive fuels (i.e., gasoline and diesel), on the one hand; and of a fixed proportion (Leontief) combination of all the other material inputs, on the other.

We assume that both types of labour, including physical capital, are mobile across sectors. The objective of the representative firm is to maximize profits and to determine the optimal levels of input uses. At the margin, each input will be used up to the point where its marginal product is equal to its price. Firms sell their output in the domestic and foreign markets. We use the traditional product dif-ferentiation (Armington) assumption and assume a costly transformation of the product destined to one market to the other.



HouseholdsThe representative household is the owner of the capital stock that is rented to firms. Its labour supply of the two types of workers is fixed. In addition to the salaries and return to capital paid by the firm, the representative household receives transfers from the government and the rest of the world. It pays income taxes to the government. It has preferences over the goods and services sold in the country.

Akin to the specification of firm technology, the household’s preference structure depicts several substitution possibilities among goods, especially between energy and non-energy goods, and also among energy goods themselves. Its utility is a CES function of the index of energy goods and the index of the other good. The aggregate of energy goods is another CES function of electricity and the index of fossil fuels. The latter is a CES function of coal, natural gas, and refined petroleum products. The composite of refined petroleum products is a C-D index of liquid petroleum gas and other refined petroleum products. The index of other goods is a CES function of the CES aggregate of motive fuels and the composite of non-energy goods. Finally, the maximization of the utility function subject to the budget constraint makes it possible to determine the optimal composition of the consumer basket.

Government and Other Components of Domestic DemandThere is only one (consolidated) government in the model. It collects direct taxes on primary-factor returns, and indirect taxes on domestic and inter-national transactions. It consumes goods in fixed quantities and enacts transfers to households and the rest of the world. Its balance is kept fixed to the one observed in the benchmark equilibrium, and the transfers to households are used as the equilibrating variables to achieve that objective. The domestic total demand of each commodity is the sum of all demands (by households, government, and firms) for consumption, intermediate and investment uses. The demand for each good for investment purposes is a fixed share of total investment expenditures. The

latter is funded by total saving, which is the sum of household, firm, government, and foreign savings.

Finally, we assume that imports of each com-modity are imperfect substitutes for their domestic counterparts produced by local firms. Using the traditional Armington assumption, we determine the optimal composition of total demand for each com-modity in terms of imports and domestic demand.

Labour Market RigidityThe existence of involuntary unemployment in equi-librium can only be rationalized by the presence of real-wage rigidities that prevent wages from falling to their market-clearing level. Several theories have been developed to explain wage rigidity. Boeters and Savard (2011) provide an excellent review of some of the theories that have been implemented in a CGE framework. Among the theories developed to explain wage rigidity, three categories are worth mentioning: the search and matching theory by Pissarides (1990), the efficiency wages theory by Shapiro and Stiglitz (1984), and the collective wage bargaining theory by McDonald and Solow (1981). We have elected to use the most common framework found in the literature, which is the wage curve introduced by Blanchflower and Oswald (1995). The wage curve depicts the empirically stable and nega-tive relationship that has been observed between the real-wage rate and the unemployment rate. In particular, we use the following specification:

W, PC , and u are the actual wage rate, consump-tion price index, and unemployment rate; , , and are the benchmark values of the respective variables; the superscript k denotes skill type (hs: high-skill; ls: low-skill); and β is the elasticity par-ameter. Since firms are always on the labour demand curve, the level of employment is always determined by them. Given the current ongoing wage rate in the market, which is determined by the wage curve,



labour supply might be in excess of demand; hence there is a possibility of unemployment.

Equilibrium Conditions and Closure RulesIn all markets but the labour market, prices adjust to bring about equilibrium between demand and sup-ply. Hence, in the markets of domestic goods and of physical capital, domestic prices and the rental rate of capital adjust to equilibrate demand and supply. In contrast, because of wage rigidity, the demand for each category of workers is not necessarily equal to their supply. The level of unemployment is endogenous.

Finally, we close the model, by fixing foreign savings (the current account balance) and by let-ting the real exchange rate adjust to bring about an external equilibrium. The model numeraire is the nominal exchange rate.

data, Calibration, and numeriCal solution

We calibrate the model using the 2007 benchmark data of national accounts, input-output tables, and employment and sectoral CO2 emissions data by fossil fuel type for Canada. Our benchmark data of national accounts, input-output tables, and em-ployment are developed and published by Statistics Canada (see Table 1 for the labour market charac-teristics in the benchmark situation). Emissions data can be found in the Canadian Government’s 2012 Submission to the United Nations Framework Convention on Climate Change (UNFCCC) (En-vironment Canada 2012). We believe these data, which are the most recent before the onset of the global recession in 2008, should be able to provide a good approximation of the steady state equilibrium.

Using these data, we construct a social accounting matrix (SAM), which distinguishes 38 industries and 42 commodities, including non-competitive imports. To reproduce the initial equilibrium, we determine

the values of some behavioural parameters and some non-observable variables by using, on the one hand, observed data and first order conditions of the household and the firm optimization problem, and on the other hand, the values of other behavioural parameters, basically elasticity parameters, estimated empirically or theoretically, that are found in the lit-erature. The calibration procedure and the numerical solution strategy used in this study follow the standard rules found in most static CGE models. We solve the model numerically using its analytic formulation with the software GAMS (General Algebraic Modelling Systems) and the solver Conopt.

simulations

In all simulations, we consider a cap-and-trade sys-tem where CO2 emissions are reduced by 20 percent in comparison to the benchmark, and where all emitters are required to buy emissions permits. Our choice of a cap-and-trade system is guided by the desire to keep the level of emissions constant across all simulations to allow for the possibility of welfare

Table 1Benchmark Situation (2007) of Unemployment and Wage Rates by Skill Category

Unemployment Rates

Low-skill workers 8.70%High-skill workers 5.05%Total economy 6.60%

Shares in Unemployment

Low-skill workers 56%High-skill workers 44%Total economy 100%

Ratio of wage rate of high-skill/low-skill workers 1.63

Source: Statistics Canada (2006).



comparison. The cost of the permits increases the user price of fossil fuel. We consider four alternative methods of recycling the permit revenue:

Simulation 1: revenue is recycled as a lump-sum transfer to households.

Simulation 2: revenue is used to reduce payroll tax rates on skilled labour alone.

Simulation 3: revenue is used to reduce payroll tax rates of unskilled labour alone.

Simulation 4: revenue is used to reduce payroll tax rates of both types of labour.

We do not consider a simulation on changing cor-porate income tax as has been considered in some jurisdictions in Canada, since the current static framework is not appropriate for dealing with the adjustment in physical capital that it will involve.

We assess the effects on employment and welfare. In addition to reporting the employment effects, we define employment dividends in terms of reductions in the unemployment rate. This definition accounts for changes in both types of labour demands. We exam-ine the possible welfare dividends by calculating the welfare gains exclusive of any environmental effects.

As lump-sum transfers are by definition non-distortionary, Simulation 1 is useful for identifying the pure effects of introducing a cap on carbon emissions (the pure abatement effects). By compar-ing the other recycling policies to Simulation 1, we are able to isolate the contributions of the different recycling schemes (the recycling effects). In addi-tion, a comparison between Simulations 2, 3, and 4 provides us with some insights on the trade-off between welfare and employment dividends. The detailed analyses are presented in the subsections below. Subsequently, we present the results of our sensitivity analysis, where we investigate the sensi-tivity of our results to model characteristics and

parameter assumptions. In what follows, we focus more of our attention on the aggregate impacts at the expense of sectoral details.

Simulation 1: Lump-Sum RecyclingIn Simulation 1, with neutral recycling effects, the introduction of carbon-emissions permits has some real effects on the economy. Focusing on employment effects, we present the move to the new equilibrium by explaining the main direct impacts and repercussions on the labour markets.

In this simulation, emissions are reduced by 20 percent in comparison to the benchmark situation, and the proceeds of the carbon permits are returned to the households. In this new carbon-constrained economy, all users of fossil fuels are required to buy permits whose price jumps by $31.3 compared to the base case. The direct effect of the permit cost is to increase the user prices of fossil fuels that contribute to a fall in their demand. As a consequence, the supply of fossil fuels decreases, along with their imports. An-other interesting implication of higher fossil energy prices is a rise in production costs for all industries. The magnitude of the increase in production costs depends on the energy intensity of each industry. Energy-intensive industries are the most affected, and their producer prices climb the most, in comparison to those in non-energy-intensive industries.

As a consequence, both the demand for energy-intensive goods and their supply fall. This general fall in the level of economic activity exerts downward pressure on the remuneration of all production factors, especially of primary factors, i.e., capital and labour. The rental rate of capital falls by 2.4 percent and the nominal wage rates of low- and high-skilled workers fall by 0.61 percent and 0.73 percent, respectively, de-spite the presence of rigidity. Total employment levels of low- and high-skilled workers fall by, respectively, 0.41 percent and 0.29 percent. This leads to an increase in the unemployment rates of both types of workers, by 0.37 and 0.28 percentage points for, respectively, low- and high-skilled workers.



The relatively small magnitudes of the changes in employment should not be surprising. Indeed, even though energy-producing and energy-intensive industries lose more workers than the others, the aggregate impact of these changes on total employ-ment should not be large, since these industries are mostly capital-intensive. In other words, as energy-producing and energy-intensive industries use relatively less workers than capital, it must be the case that their contraction sheds more capital than labour. Hence, in general, and from a theoretical perspective, their contraction should not have a sig-nificant impact on total employment in this economy characterized by wage rigidity. The negative impact of the carbon mitigation policy should, rather, be sought in the use or in the return of physical capital.

Besides, it is interesting to observe that total employment of high-skilled workers falls less than that of low-skilled workers, despite a larger decrease in the wage rate of the former. This has largely to do with the relative importance of high-skilled workers in this new carbon-constrained environment. Indeed, as firms reduce their use of energy, they directly sub-stitute it with the index of capital and high-skilled workers; hence the relative advantage given to the demand for high-skilled workers, which falls less in comparison to the demand for low-skilled work-ers. Nevertheless, labour income of high-skilled households falls as much as that of low-skilled households, which points to the neutrality of carbon pricing in relation to labour force skills in the case when permit revenue is returned to households as a lump-sum transfer.

The combined effects of the fall in the wage rates and in the aggregate levels of employment of both types of workers reduce household disposable income (earned) by 0.26 percent and lower total consumption slightly by 0.03 percent. It is import-ant to note that the low magnitude of the fall in household consumption is attributable to permit- revenue recycling, which enables households to counteract the fall in their earned income. Taking into consideration the change in price, household

welfare measured as equivalent variation, expressed as a percentage of total consumption, falls by 0.05 percent. Finally, the decline in the employment levels of both types of workers contributes to the fall in aggregate output; thus GDP at market prices decreases by 0.3 percent.

Simulation 2: Recycling Permit Revenue through Reduced Payroll Tax Rates on High-Skilled LabourIn this simulation, we assess the implications of recycling carbon permits toward the reduction of payroll taxes of skilled labour. When the carbon pro-ceeds are used in that perspective, the payroll tax rate on high-skilled labour is reduced by 2.2 percentage points, which drives down the labour cost of high-skilled workers. As a consequence, firms increase their use of high-skilled workers by 0.53 percent in comparison to the benchmark situation. This corres-ponds to an increase of 0.82 percent in comparison to the previous simulation with lump-sum transfers. The increase in the demand for high-skilled workers pushes up their wage rate, which rises by 0.83 per-cent.2 The unemployment rate of high-skilled labour decreases by 0.50 percentage points, in comparison to the benchmark situation.

In contrast, total employment of low-skilled work-ers falls by 0.13 percent, which is less important than the result observed in the previous simulation. Their unemployment rate increases by 0.12 percentage points in comparison to the benchmark case. Still, the rise in low-skilled labour unemployment rate is more than offset by the fall in the unemployment rate of high-skilled labour; this explains the aggregate 0.38 percent decrease in unemployment. Total employ-ment rises by 0.40 percent, which is 1.10 percentage points higher than in the previous case. Household disposable income increases by 0.28 percent, without the carbon proceeds. It ensues that household con-sumption increases by 0.54 percent and the measure of household welfare change is 0.52 percent. Com-pared to the earlier scenario, the recycling scheme in this simulation translates into a recycling effect of a 0.57 percentage-point increase in welfare.



Three mechanisms underlie the upward pressure on employment. First, the reduced payroll tax fuels an increase in the use of more high-skilled workers in comparison to low-skilled labour. The second mechanism is that the reduced cost of high-skilled labour lowers the total cost of value added and energy, and thus the output price of each firm. This increases firms’ market shares and stimulates their demand for both types of labour at the aggregate level. We observe that this effect halves the number of industries that reduce their demand for high-skilled labour, in comparison to Simulation 1. This suggests that the recycling of carbon-permit pro-ceeds towards high-skilled labour benefits all labour categories. Since the employment level is higher than in the benchmark situation, aggregate output increases. Real GDP at market prices rises by 0.12 percent in comparison to the benchmark situation.

Simulation 3: Recycling through Reduced Payroll Tax Rates on Low-Skilled LabourIn this simulation, the proceeds of carbon permits are used to reduce the payroll taxes of low-skilled workers. The same mechanisms involved in the previous simulation are still observed. The main difference is reflected in the magnitudes of the changes. As in the previous simulation, the wage rate of low-skilled labour increases by 2.21 percent, and their total employment rises by 1.98 percent. Consequently, the unemployment rate of low-skilled labour decreases by 1.8 percentage points. In contrast, the wage rate of high-skilled workers decreases by 0.08 percent, and their unemployment rate increases slightly by 0.04 percentage points. Total real household disposable income increases by 0.48 percent, which allows households to ex-perience a higher level of real consumption and to enjoy a higher level of welfare (+0.64 percent) in comparison to the benchmark situation. As total employment rises, aggregate output increases, and GDP at market prices rises by 0.22 percent.

It is interesting to note that the magnitudes of the positive changes are larger in this simulation in comparison to the previous one. The impact on

unemployment, consumption, and GDP are larger when the proceeds from carbon permits are used to reduce the payroll taxes of low-skilled labour, rather than of high-skilled labour. This finding can be partly explained by the magnitude of the reduction in payroll taxes, which is induced by the recyc-ling method. In this simulation, the payroll taxes of low-skilled labour have been reduced by 5.65 percent, in contrast to only 2.2 percent in the pre-vious simulation. Our results confirm the findings of other studies (e.g., Drèze and Malinvaud 1994), which suggest that targeting low-skilled labour (as opposed to high-skilled labour) in the recycling of permit revenue increases employment dividends.

Simulaton 4: Recycling through Reduced Payroll Tax Rates on All Types of LabourIn this simulation, permit revenue is used to reduce payroll taxes of both types of labour. As shown in Table 2, the employment levels of both types of workers increase and their unemployment levels fall by 0.36 percent and 0.44 percent, respectively, for high- and low-skilled workers. As total labour income increases, households are able to increase their consumption (+0.59 percent) and to enjoy higher welfare (+0.57 percent). Obviously, the magnitudes of the welfare and the employment dividend generated by the recycling scheme in this simulation lie within the range of those obtained in Simulations 2 and 3. Overall, our findings suggest that targeting both labour types is better than target-ing high-skilled labour alone.

Sensitivity AnalysesWe performed some sensitivity analyses related to the values of behavioural parameters that could influence the results. We ran the same four simu-lations with a higher unemployment elasticity of the wage curve. We also ran the same simulations with high values of elasticities between, on the one hand, low-skilled labour and the composite of capital, energy, and high-skill labour and, on the other hand, between high-skilled labour and capital. Table 3 presents the results of these sensi-tivity analyses.



Tabl

e 2Eff

ects

on Se

lecte

d Var

iables

in D

iffer

ent S

imul

atio

ns: P

erce

ntag

e Dev

iatio

ns fr

om B

ench

mar

k

a:

Pure

Abat

emen

t Effe

ctsb:

Recy

cling

Effec

tsc:

Tota

l Effe

cts

%

Chan

ge fr

om Be

nchm

ark

% Ch

ange

from

Sim

ulat

ion 1

% Ch

ange

from

Benc

hmar

k

Sim

ulat

ion 1

Simul

ation

2Sim

ulat

ion 3

Simul

ation

4Sim

ulat

ion 2

Simul

ation

3Sim

ulat

ion 4

Unem

ploy

men

t rat

e ( h

igh-

skill)

0.28

–0.78

–0.24

–0.64

–0.50

0.04

–0.36

Unem

ploy

men

t rat

e (lo

w-sk

ill)0.3

7–0

.25–2

.17–0

.810.1

2–1

.80–0

.44

Unem

ploy

men

t rat

e (ag

greg

ate)

0.65

–1.03

–2.41

–1.45

–0.38

–1.76

–0.80

Welf

are

–0.05

0.57

0.69

0.62

0.52

0.64

0.57

Nom

inal

wage

rate

(hig

h-sk

ill)–0

.731.5

60.5

21.2

80.8

3–0

.220.5

5

Nom

. wag

e rat

e (lo

w-sk

ill)–0

.610.2

52.8

20.9

4–0

.362.2

10.3

3

Subs

idy r

ate

2.2

05.6

01.6

02.2

05.6

01.6

0

Capi

tal r

ent

–2.42

0.42

0.53

0.46

–2.00

–1.89

–1.96

Hous

ehol

d lab

our i

ncom

e (hi

gh-sk

ill)

–1.02

2.39

0.76

1.95

1.37

–0.26

0.93

Hous

ehol

d lab

our i

ncom

e (lo

w-sk

ill)–1

.020.5

35.2

51.8

3–0

.494.2

30.8

1

Hous

ehol

d ca

pita

l inco

me

–2.42

0.42

0.53

0.46

–2.00

–1.89

–1.96

Price

of c

arbo

n pe

rmit

($)

31.33

0.49

0.62

0.54

31.81

31.94

31.86

GDP a

t mar

ket p

rices

–0.30

0.42

0.52

0.46

0.12

0.22

0.16

Note

s: Sim

ulat

ion

1 con

sider

s a lu

mp-

sum

tran

sfer o

f per

mit

reve

nue t

o ho

useh

olds

. Sim

ulat

ion

2 con

sider

s rec

yclin

g th

e per

mit

reve

nue t

hrou

gh re

duce

d pa

yrol

l tax

rate

s on

high

-skill

labou

r. Sim

ulat

ion

3 con

sider

s rec

yclin

g th

roug

h re

duce

d pa

yrol

l tax

rate

s on

low-

skill

labou

r. Sim

ulat

ion

4 con

sider

s rec

yclin

g th

roug

h re

duce

d pa

yrol

l tax

rate

s on

all la

bour

. GD

P = g

ross

dom

estic

pro

duct

.So

urce

: Aut

hors’

calcu

latio

ns.



Tabl

e 3Se

nsiti

vity A

nalys

is—Eff

ects

on Se

lecte

d Var

iables

in D

iffer

ent S

chem

es: P

erce

ntag

e Dev

iatio

ns fr

om B

ench

mar

k

Hi

gh W

age E

lastic

ityHi

gh El

astic

ity of

Subs

titut

ion be

twee

n Lo

w-Sk

ill La

bour

and t

he In

dex o

f Ca

pita

l-Ene

rgy a

nd H

igh-

Skill

Labo

ur

High

Elas

ticity

of Su

bstit

ution

betw

een

High

-Skil

l Lab

our a

nd Ca

pita

l

Sim

ulat

ion 2

Simul

ation

3Sim

ulat

ion 4

Simul

ation

2Sim

ulat

ion 3

Simul

ation

4Sim

ulat

ion 2

Simul

ation

3Sim

ulat

ion 4

Unem

ploy

men

t rat

e (hi

gh-sk

ill)–0

.140.0

4–0

.09–0

.520.1

3–0

.35–0

.460.1

7–0

.29

Unem

ploy

men

t rat

e (lo

w-sk

ill)0.0

9–0

.66–0

.130.2

2–2

.34–0

.560.1

2–1

.78–0

.44

Unem

ploy

men

t rat

e (ag

greg

ate)

–0.05

–0.62

–0.22

–0.29

–2.21

–0.91

–0.34

–1.61

–0.73

Welf

are

0.29

0.36

0.31

0.49

0.78

0.60

0.45

0.46

0.47

Nom

inal

wage

rate

(hig

h-sk

ill)1.1

9–0

.600.6

91.0

8–0

.260.7

20.7

3–0

.470.4

0

Nom

inal

wage

rate

(low-

skill)

–0.70

3.84

0.55

–0.47

3.02

0.47

–0.36

2.16

0.32

Subs

idy r

ate

2.19

5.53

1.59

2.19

5.50

1.59

2.20

5.53

1.59

Capi

tal r

ent

–2.16

–2.11

–2.15

–1.98

–2.01

–1.98

–1.91

–1.64

–1.82

Hous

ehol

d lab

our i

ncom

e (hi

gh-sk

ill)

1.33

–0.65

0.79

1.42

–0.56

0.89

1.22

–0.65

0.71

Hous

ehol

d lab

our i

ncom

e (lo

w-sk

ill)–0

.794.5

90.7

0–0

.715.6

71.0

8–0

.494.1

50.8

0

Hous

ehol

d ca

pita

l inco

me

–2.16

–2.11

–2.15

–1.98

–2.01

–1.98

–1.91

–1.64

–1.82

Price

of c

arbo

n pe

rmit

($)

31.62

31.69

31.64

31.65

31.81

31.71

31.66

31.52

31.64

GDP a

t mar

ket p

rices

–0.05

0.01

–0.03

0.11

0.28

0.18

0.10

0.15

0.12

Note

s: Sim

ulat

ion

1 con

sider

s a lu

mp-

sum

tran

sfer o

f per

mit

reve

nue t

o ho

useh

olds

. Sim

ulat

ion

2 con

sider

s rec

yclin

g th

e per

mit

reve

nue t

hrou

gh re

duce

d pa

yrol

l tax

rate

s on

high

-skill

labou

r. Sim

ulat

ion

3 con

sider

s rec

yclin

g th

roug

h re

duce

d pa

yrol

l tax

rate

s on

low-

skill

labou

r. Sim

ulat

ion

4 con

sider

s rec

yclin

g th

roug

h re

duce

d pa

yrol

l tax

rate

s on

all la

bour

. GD

P = g

ross

dom

estic

pro

duct

.So

urce

: Aut

hors’

calcu

latio

ns.



The results suggest that higher labour market rigidity leads to a stronger negative effect on the economy in terms of welfare. The welfare dividends from all recycling schemes are pared by higher wage rigidity. Nonetheless, the ranking of the recycling methods is not altered by the magnitude of the wage rigidity.

The results in Table 3 suggest that the substitut-ability of high-skilled labour has a stronger effect on the abatement cost than the substitutability of low-skilled labour. However, the substitution elasticities of labour do not fundamentally alter the ranking of recycling schemes.

ConClusions

In this paper, we have assessed the employment implications of carbon mitigation policies in the presence of wage rigidity with an application to Canada. We have used a CGE model to assess the welfare and employment dividends of reducing car-bon dioxide (CO2) through a cap-and-trade system. We have considered several options for recycling permit revenues—either through lump-sum transfers to households or through a reduction in payroll taxes.

Our simulation results suggest that the use of permit revenue to reduce payroll taxes is better than a direct transfer of that revenue to households. The former option has a positive effect on the employ-ment level and makes it possible for households to enjoy higher welfare. Our results also show that different recycling schemes have varied potentials for reducing unemployment rates. The potential for increasing employment is most promising when the revenue is used for reducing the payroll taxes of low-skilled workers alone. This result has the most welcome distributional impact, since it can simultaneously enhance employment and narrow the income gap between the two categories of workers.

We have also found strong welfare effects aris-ing from different recycling schemes, as the gains

from revenue recycling are more than enough to offset the welfare cost of a carbon-pricing system. In general, our results are quite robust, and our ranking of recycling schemes does not appear to be sensitive to the choice of key behavioural param-eters. Nevertheless, we would like to mention that the positive effects observed on real GDP might not occur in a dynamic context if capital is allowed to move from the country.

Notes

We would like to thank Faisal Arif, Selma Didic, Tatsiana Yakautsava, and Muhammad Shahid Siddiqui for com-ments and discussions; also an anonymous referee for suggestions. We acknowledge financial support from a grant on Canadian environmental issues by the Can-adian Social Sciences and Humanities Research Council (SSHRC).

1 See Schöb (2005) for an interesting review of the theoretical issues related to the double-dividend hypothesis.

2 This is the wage rate received by the workers.

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GHG Mitigation Policies and Employment: A CGE Analysis with Wage Rigidity and Application to Canada

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