Working Paper

Environmental Policy, Full-Employment Models, and Employment: A Critical Analysis

Apr 26, 2018 | Marc Hafstead, Roberton C. Williams III, Yunguang Chen

Summary

Full-employment models are often used to predict the labor-market effects of environmental policy. Here, we compare these predictions to those from a new model that incorporates key labor market details, including unemployment and job search.

Key Findings

  • Full-employment models, which are commonly used to evaluate policy, fail to capture key aspects of the labor market such as unemployment, job search, and the distinction between the number of workers and hours per worker.
  • We develop a new search-CGE model, a multisector CGE extension of the model in Hafstead and Williams (2018), and compare its results for a carbon tax (as a sample policy) to those from an otherwise-identical full-employment model.
  • The estimated change in total quantity of labor and the general pattern of job changes across sectors are very similar between the two models.
  • The full-employment model overestimates the change in the number of jobs by a factor of 2.5 or more.
  • Our estimates suggest that a carbon tax has little effect on employment. In the search-CGE model, a $40 carbon tax with lump-sum rebates reduces total jobs by 0.3 percent, and job losses are far smaller still if revenues are used to cut labor taxes.

Abstract

This paper assesses the use of full-employment computable-general equilibrium (CGE) models to predict the labor-market effects of environmental policy. Specifically, it compares the predictions of a standard full-employment CGE model with those of a new search-CGE model with labor-search frictions and resulting unemployment (but that is otherwise identical to the full-employment model). The search-CGE captures key labor market details, including a distinction between the extensive margin of labor demand (the number of employees) and the intensive margin (the number of hours each employee works). We find that some key results are robust across the two models, such as the reallocation of labor across sectors in response to a carbon tax and the overall change in total labor demand. However, the full-employment model seriously overestimates the economy-wide net change in the number of jobs (by a factor of more than 2.5 for a carbon tax with revenues returned lump-sum to households, and by a factor of almost 3.5 when carbon tax revenues are used to reduce payroll taxes).