And while CGE models do a good job of capturing the downside risks of energy and climate policy on U.S. employment, they fall short in capturing the upside potential, particularly in the following five areas:
Investment: While CGE models forecast jobs lost from higher energy prices, they don’t accurately assess jobs created from the increase in investment likely to occur in the United States from pricing carbon. The input-output tables used in CGE modeling indicate the amount of investment, labor, and fossil fuels required by each industry to produce one dollar. These ratios are derived from economy-wide averages in whatever reference year is used in the model. So when policy raises energy prices and households and businesses improve efficiency in response, overall energy consumption falls and energy sector investment falls right along with it. This works okay for fossil fuel production like mining coal and pumping oil, but misses most of the story when it comes to power generation, particularly in the United States.
Continuing along business as usual for the United States means continuing to operate coal-fired power plants built decades ago for power generation. Pricing carbon would mean replacing these plants with natural gas, renewable energy, or nuclear power or retrofitting them for carbon capture and sequestration. That all requires far more investment than maintaining the existing coal-fired power fleet, even if overall electricity demand falls moderately from efficiency improvements. Most CGE models are too aggregated to capture this turnover in the capital stock. And given the scale of power sector transformation required to meet the policy goals outlined in draft U.S. legislation, the amount of additional investment demand would be significant.
- Timing: Now the economically astute reader may point out that it’s all fine and good to argue that pricing carbon will produce an increase in investment in power generation, but that investment needs to come from somewhere — and if the economy is at full employment a surge of investment demand will cause inflation. Both points are correct. But the economy is far from full employment, and the Energy Information Administration doesn’t see us getting back there until 2020. That means that if an energy and climate bill that prices carbon were passed today, for the first decade of the program the United States could see a significant uptick in clean energy investment without robbing other industries of workers or capital.
- Market failures: In general, CGE models assume investment automatically flows to its most productive uses, i.e., that there are no imperfections in the market. Yet the energy sector is awash with market failures, primarily in the area of energy efficiency. Last year, the World Business Council on Sustainable Development, United Technologies Corporation, LaFarge Cement, and 12 other corporate leaders published an exhaustive catalogue of energy efficiency investments in the buildings sector that would provide an above-average rate of return but are not exploited because of a range of barriers, from principal-agent problems in commercial real estate to lack of access to capital for residential efficiency improvements. Working with this group I assessed the potential economic benefits of removing these barriers, and they are significant. A U.S. energy and climate bill with a combination of building codes, appliance incentives, higher energy prices, public education, and financing mechanisms would unlock these highly profitable efficiency investments and produce employment gains not captured in the studies reviewed by the CBO.
- Export competitiveness: CGE models are good at assessing the impact on incumbent industries from pricing carbon but struggle to forecast the emergence of new industries in response to that carbon price. So while a loss of jobs in energy-intensive manufacturing from higher energy prices is analyzed in the three studies reviewed by the CBO — the potential increase in U.S. competitiveness in clean energy technology abroad from boosting demand at home isn’t captured.
- Knowledge-spillover: Finally, long-term economic growth depends largely on how fast a country develops technologically. Pricing carbon will force companies to innovate, whether by developing technologies that deliver energy or changing process and production methods to use energy more efficiently. This innovation will result in spillover effects that lower prices and increase production in other sectors. The question is whether the spillover effects from clean energy technology are greater than under the status quo. This is an important question that CGE models don’t address.
The bottom line
Despite the shortcomings of CGE models in assessing the employment impact of energy and climate policy listed above, there’s not much in the way of alternatives. The problem is not the studies selected by the CBO (the Brookings and RFF reports are nonpartisan, independent, and academically rigorous studies) but the omission of serious discussion of the limitations of CGE modeling in predicting employment outcomes, limitations the authors of the underlying studies themselves would readily acknowledge. There is certainly no shortage of recent reports that, though weak or incomplete, overstate the potential jobs gains from pricing carbon. But the methodological approach of the studies included in the CBO report arguably overstates potential job losses. Hopefully in the months ahead the CBO will conduct its own analysis and provide the Congress with a more balanced picture.