Abstract
The energy system and the economy are inextricably intertwined. Whilst this interdependence is, of course, widely recognized, it has not featured prominently in assessing the likely impact of economic policies. In principle, fiscal policies are likely to have an influence on key elements of the energy system, the neglect of which may lead to inefficiencies in the design of appropriate energy and economic policies. The importance of this in practice depends on the strength of the spillover effects from fiscal policy instruments to energy policy goals. This is the focus of this chapter. We employ a multi-sectoral computable general equilibrium approach for the United Kingdom that allows us to track the impact of key fiscal policy interventions on goals of economic and energy policies. We explore whether it is possible to stimulate the economy through fiscal policy without generating an adverse impact on the energy system. Overall, our results suggest that it is unlikely that an increase in current public spending or a fall in the income tax rate will generate a simultaneous increase in GDP and fall in emissions in the United Kingdom context. Nonetheless, there are undoubted differential spillover effects on key components of the energy system from tax and public spending interventions that may prove capable of being exploited through the coordination of fiscal and energy policies. Even if it seems doubtful that fiscal policies would be formulated with a view to improved coordination with energy policies, policymakers can benefit from knowledge of the likely direction and scale of fiscal spillover effects to key elements of the energy system, since this reveals, for example, the extent of any energy policy adjustment that would be required to maintain a given level of emissions.
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- 1.
In effect, this is “as if” the United Kingdom is operating in a “liquidity trap”.
- 2.
Clearly, some expenditure classified as current would be expected to have supply side effects, e.g. spending on education provision via its impact on human capital. We return to this in due course.
- 3.
Labour demand could rise with an increase in real wages because an increase in the real wage could increase household income and consumption demand. However, in comparatively “small” (as a proportion of total world trade), open economy like the United Kingdom we expect competitiveness effects to dominate income effects.
- 4.
In the short run, the rightward shift is more limited, because of capacity constraints. However, capital rental rates will increase, spurring sectors to invest leading to increased capacity and a higher demand for labour in the long run.
- 5.
An efficiency wage explanation is also available. Additionally, we separately explore the consequences of adopting a wage curve that relates the pre-tax wage to the unemployment rate. (See the subsequent discussion of the social wage case.)
- 6.
The employment rate is one minus the unemployment rate.
- 7.
In the context of a multi-sectoral model, the link is not inevitable given the importance of changes in the composition of economic activity as well as its level.
- 8.
In general, net in-migration could generate such a response without incurring any capacity constraint. However, given language barriers and movement costs this seems unlikely to be of sufficient scale in practice to motivate the FRW case for the United Kingdom, even in the long run.
- 9.
In a multi-sectoral context demand disturbances generate results that are effectively those of an augmented input–output system in the long run (McGregor et al. 1996). However, the same is not true of supply disturbances, as we shall see.
- 10.
Partridge and Rickman (2010) give a brief discussion.
- 11.
Labour supply can adjust through natural population change, but we abstract from long-term demographic change throughout for simplicity. However, ELS effectively precludes net-inmigration in response to an increase in the real wage, a restriction that seems inappropriate for the United Kingdom as long as it remains a member of the EU and therefore is subject to freedom of movement.
- 12.
Ross et al. (2018b) give a list of the 30 sectors. Emonts-Holley et al. (2014) give a detailed description of the methods employed to construct the SAM which is available for download at: https://doi.org/10.15129/bf6809d0-4849-4fd7-a283-916b5e765950
- 13.
Many conventional models treat the labour supply decision as a labour/leisure trade-off, in which context GDP would be an inappropriate indicator of welfare. Here the real-wage decision reflects bargaining behaviour and implies the presence of involuntary unemployment even in long-run equilibrium. The UK Government tends to focus, rightly or wrongly, on GDP and employment as the main macroeconomic indicators. (Unemployment always figures large, and negatively, in studies of well-being.)
- 14.
In all the model closures here, a government expenditure shock is always accompanied by a non-positive change in exports net of imports so that some emissions are shifted abroad and therefore no longer count in the UK’s territorial emissions.
- 15.
Investment is driven by the gap between rental rates and the user cost of capital. The depreciation rate is fixed as is the world interest rate.
- 16.
In the long run, the percentage change in the capital stock equals that of investment.
- 17.
- 18.
The model here operates as an extended IO with endogenous household consumption and investment, where the household consumption coefficients have been reduced.
- 19.
The qualitative results are broadly similar across other closures.
- 20.
As noted previously, energy policies directed at decarbonization are in place. For example, a 1.75% fall in emissions in the electricity generation sector would offset the emissions arising here from the reduction in income tax.
- 21.
- 22.
Note that this result reflects compositional changes (rather than incentives).
- 23.
Note that the reduction in economic activity is even greater than in the comparable simulation in Table 8.2. This is because the tax take actually falls here, so that reduced public expenditure adds to the contractionary effects.
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Acknowledgements
This research was undertaken as part of the research programme of the UK Energy Research Centre, supported by the UK Research Councils under EPSRC award EP/L024756/1. We are very grateful to John R. Madden for extensive helpful comments on an earlier draft.
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Ross, A.G. et al. (2020). The Economic Impacts of UK Fiscal Policies and Their Spillover Effects on the Energy System. In: Madden, J., Shibusawa, H., Higano, Y. (eds) Environmental Economics and Computable General Equilibrium Analysis. New Frontiers in Regional Science: Asian Perspectives, vol 41. Springer, Singapore. https://doi.org/10.1007/978-981-15-3970-1_8
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