CPF_AssessingUSClimatePolicyOptions

Competitiveness Impacts of Carbon Dioxide Pricing Policies on Manufacturing

Richard D. Morgenstern, Joseph E. Aldy, Evan M. Herrnstadt, Mun Ho, and William A. Pizer

Summary

In the debate over the design of mandatory federal climate change policy, the potential for adverse impacts on the competitiveness of U.S. industry, on domestic jobs, and on the nation's balance of trade consistently emerges as a key concern. This issue brief explores how production across individual manufacturing industries could be affected by a unilateral policy that establishes a price on carbon dioxide (CO2) emissions. (Issue Brief #8 examines possible policy responses to address these impacts.) Our review of existing analyses and new research¹ on the topic of climate policy and U.S. competitiveness yields a number of observations:

Competitiveness Impacts of Carbon Dioxide Pricing Policies on Manufacturing

The impact of a CO2 price on the competitiveness of different industries is fundamentally tied to the energy (and more specifically, carbon) intensity of those industries, and the degree to which firms can pass costs on to the consumers of their products. The answer to the latter question hinges on the extent to which consumers can substitute other, lower-carbon products and/or turn to imports.
Industry-level studies of competitiveness tend to focus on the energy-price impacts of a specific CO2 policy. They typically do not consider what level of carbon price would be required to meet a particular emissions-reduction target or how overall program stringency is coupled with decisions about offsets and/or a safety valve. Studies of competitiveness impacts typically also ignore "general equilibrium" effects, such as the possibility that shifting from coal to natural gas for power generation could drive up natural gas prices and have additional effects on the competitiveness of natural gas users.
Energy costs in most manufacturing industries (broadly defined at the two-digit classification level) are less than 2 percent of total costs. However, energy costs are more than 3 percent of total costs in a number of energy-intensive manufacturing industries such as refining, nonmetal mineral products, primary metals, and paper and printing. For these more energy-intensive industries, total production costs rise by roughly 1 percent to 2.5 percent for each $10 increment in the per-ton price associated with CO2 emissions (with less being known about the impacts of larger CO2 prices). Also, cost impacts can be considerably greater within more narrowly defined industrial categories.
Recent case studies in the European Union (EU) found more substantial impacts in some industries when narrower industry classifications were used and process emissions were also considered. Specifically, a $10-per-ton CO2 price led to a 6 percent increase in total costs for steel production using basic oxygen furnace (BOF) technology; for cement, production costs increased by 13 percent. With free allowance allocation and some ability to increase prices, however, researchers have found that adverse impacts on industry can be reduced substantially. Using simple demand models, one study found that output in most industries declined less than 1 percent - and by at most 2 percent in the most strongly affected industries - for a $10-per-ton CO2 price with 95 percent free allocation.
More generally, cost increases can be translated into impacts on production, profitability, and employment using either an explicit model of domestic demand and international trade behavior, or empirical evidence from past cost increases.
Using an economic model of U.S. industrial production, demand, and international trade, Morgenstern et al. generally find adverse effects of less than 1 percent when estimating the reduction in industrial production due to a $10-per-ton CO2 charge. The exceptions are motor vehicle manufacturing (1.0 percent), chemicals and plastics (1.0 percent), and primary metals (1.5 percent). These estimates represent near-term effects - that is, impacts over the first several years after a carbon price is introduced - before producers and users begin adjusting technology and operations to the new CO2-policy regime. Longer-term effects could be larger or smaller.
Using an empirical analysis of historical data on energy prices and industry output across five countries, Aldy and Pizer find somewhat larger impacts. While a $10-per-ton CO2 charge is estimated to reduce industrial production by less than 1 percent in most cases - consistent with the results of the Morgenstern et al. study - considerably larger effects are found in some industries, notably non-ferrous metals (3.0 percent), iron and steel (6.0 percent), fabricated metals (1.8 percent), and machinery (3.9 percent).
Impacts on domestic industries will generally be lower if it is assumed that key trading partners also implement comparable CO2 prices or that border tax adjustments or other import regulations are used to address the CO2 content of imported (and exported) goods. Analysis by Aldy and Pizer suggests that such assumptions reduce the estimated impact on domestic production among energy-intensive manufacturing industries by perhaps 50 percent.
Various current proposals for a mandatory U.S. cap-and-trade program to limit greenhouse gas (GHG) emissions would give free allowances to different industries to help address economic burdens from a CO2 pricing policy.
Calculations based on results from Morgenstern et al. suggest that for most industries where energy is more than 1 percent of total costs, giving away free allowances equal to around 15 percent of a firm's emissions from fossil-fuel and electricity use would be sufficient to address adverse impacts on shareholder value. This number varies widely, however, across different industries. As with earlier calculations, narrower industry classifications can produce much higher estimates of the free allocation necessary to address lost shareholder value.

1. Results of this work are forthcoming in two RFF discussion papers, one by J. Aldy and W. Pizer, and another by Morgenstern, Ho, and Shih. This issue brief does not consider competitiveness impacts arising from the regulation of non-co2 gases; see Issue Brief #13 for some discussion.