Economic impacts

The main tool to analyse the economic impacts of the transition to a low-carbon energy system was NEWAGE (National European World Applied General Equilibrium). NEWAGE is a Computable General Equilibrium (CGE) model that divides the World in 18 regions, being 9 of them inside the EU, 18 production sectors and 4 production factors. The model presents a disaggregated electricity generation sector, with 18 different technologies.

Being a macroeconomic model enables NEWAGE to capture the interaction between different sectors of the economy. One of the main outputs, for example, is how a carbon tax can influence sectoral production by increased energy costs, or how consumers react to price changes of energy goods. Ultimately, NEWAGE is capable of indicating how the Gross Domestic Product (GDP) of a country or region is likely to increase or decrease for a given policy.

Under the scope of the REEEM integrated framework, the main modelling activities performed were the coupling of NEWAGE with TIMES-PanEU and the disaggregation of the households’ sectors in NEWAGE into 5 representative household groups. For the former, the main steps were:

  1. Calibration of NEWAGE over a Reference pathway;
  2. Definition of parameters to be transferred from TIMES Pan-EU to NEWAGE and vice-versa: a. From TIMES-PanEU to NEWAGE: i. Sectoral emissions (calibration) ii. Electricity generation by technology (coupling process) b. From NEWAGE to TIMES-PanEU: i. Sectoral production (coupling process) ii. GDP (coupling process)
  3. Interface for data transferring between the two models;
  4. Iterative coupling between the two models.

Although not in the scope of the REEEM project, the Reference pathway (RF) was added to the coupling process between NEWAGE and TIME-PanEU for a couple of reasons. First, NEWAGE does not produce predictions, but does pathway analysis, so the Reference pathway is used as a starting point, from which the counterfactual pathways (three REEEM pathways and one extra, PA-EU) are compared to. In order to create this pathway, we chose the EU Reference Scenario 2016, which contained GDP, emissions and population projections until 2050 and calibrated NEWAGE to be able to generate similar results when running under the Reference pathway configuration. Additionally, in the framework of the model coupling, TIMES-PanEU was also calibrated according to the Reference pathway in order to ensure that both models had compatible assumptions regarding technology development and ensured the convergence between them.

With the coupling, two objectives were reached. First, NEWAGE was made capable of assimilating the detailed technology information contained in TIMES-PanEU and, second, TIMES-PanEU was able to respond to energy demand shifts caused by changes on sectoral production levels.

The households’ disaggregation had the objective of gaining deeper understanding on the impacts of carbon taxation on groups of different incomes, shedding light on potential winners and losers of the energy transition. Important results from this analysis are the share of income dedicated to energy goods per household group and its effects on energy poverty.

The analysis of economic impacts covers the CL, LS and PA pathways. A sensitivity was also created, assuming fulfilment of the Paris Agreement merely by the EU and not the rest of the world (PA-EU). A summary of the key characteristics of the analysed pathways is given in Table 4. For the analysis, the qualitative assumptions on global effort towards decarbonisation reported in the description of the pathways (Section 2.4) are turned into quantitative inputs for NEWAGE. In the CA and LS pathways it is assumed that the EU28 has a target to decrease its CO2 emissions by 80% until 2050, compared to 1990 levels, while the global push to climate change mitigation is assumed to be driven by some regions/countries. In the PA pathway, the EU28 has a target to decrease its CO2 emissions by 95% until 2050, compared to 1990 levels, where an indistinct global push is assumed instead. For the special case of PA-EU pathway, the 95% target is kept, but the rest of the world follows the same emission targets as in Coalitions for a low carbon path and Local solutions. Further information on the economic impacts derived from the REEEM analysis can be found in deliverable D3.3a – Focus report on economic impacts and D3.3b – Policy brief. More details on the assumptions regarding emission trajectories outside the EU are given in Appendix A.

Key pathway assumptions for the economic impacts analysis

Table 4. Key pathway assumptions for the economic impacts analysis.

Country index for the current study

Table 5. Country index for the current study.

Main insights

Message 14: Robust GDP growth is expected to continue under stringent decarbonisation objectives, although at slightly lower rates

On a broader level (i.e. without looking into winners and losers), the EU economy will continue to grow under the transition to a low carbon pattern. As illustrated in Figure 15a, GDP rises at a steady pace very decade, reaching a total of 55-72% in 2050 compared to 2011 levels. However, economic growth could be slowed in the cases where the highest decarbonisation effort is pursued, as shown in Figure 15b.

GDP growth
2015202020252030203520402045205000.450.91.351.8GDP (2011=1)

Figure 15. a) Relative growth compared to 2011; b) Difference to Reference Scenario.

Compared to 2011, on a European level, the LS pathway delivered lower GDP growth by the year 2040 in comparison to other pathways, indicating that taxing consumers, transportation and services is the least efficient of the presented strategies. The cause relies in that services comprehend more than 70% of European economic activity. and the European consumers are the main target of goods produced within the EU. Consequently, an uneven carbon taxation policy, as in the LS pathway where a few sectors have to undergo a higher emission reduction, decreases European GDP growth by imposing a high burden on consumers and, thus, decreasing their consumption of locally produced goods. However, in the last 10 years of the analysis, the lowest GDP growth is recorded in the PA pathway. This can be attributed to the more ambitious targets set, which require more drastic measures that appear to have a negative impact on the economy. Nevertheless, even when examining the worst case, the maximum relative difference to the CL pathway is around 6%, which is not dramatic considering the fact that there is a global action towards the Paris Agreement’s goal and, thus, other regions will also experience lower GDP growth . Finally, it is important to keep in mind that factors such as technology or demography which, so far in the future as 2050, are governed by a high level of uncertainty, could potentially have an even greater impact on the economy than decarbonisation.

PA-EU and PA have similar GDP development until 2035. However, in years 2045 and 2050 PA-EU has much higher GDP development than PA. This is due to the fact that under the PA pathway it is expected that there will be lower economic activity in the other regions of the world due to higher expenditure on climate protection. Furthermore, GDP development under the PA-EU, despite having a higher decrease of European CO2 emissions than the CL and LS pathways, still has a higher development than these pathways because of its carbon taxation scheme, as described in Table 4, which shares the burden more evenly among the players of the economy. Although these results might seem negative for the PA pathway, it is important to remember that until 2040, the PA pathway had GDP development very similar to the other pathways and only diverged on the last two-time steps. Considering that these time steps are over 25 years in the future, there is enough time to prepare and adapt for this pathway.

Message 15: Different sectors may grow at a different pace

The analysis shows that the contribution of every sector to the economic growth will increase. In other words, as shown in Figure 16, the Gross Value Added (GVA) of every sector is expected to increase, though at different rates. The chemical industry for example, seems to record the lowest growth potential. The reason is that industries like this and the non-ferrous metals are sectors focused on the European market. Thus, they grow according to the EU’s own economic growth and, in addition, the European chemical sector has been stagnant for the last 10 years, so a 20% growth can be still considered positive. Since those sectors are oriented towards the internal EU market, we can expect that their growth trend follows that of the EU, considering that they keep their market share. However, with new competition entering the EU, it is plausible that they record relative losses. In other words, their growth is expected to be hindered by foreign competition. On the other hand, sectors that are more export oriented, such as that of non-metallic minerals are expected to record higher economic growth due to the higher economic growth potential outside the EU.

Competitiveness index (GVA) development Figure 16. Competitiveness index (GVA) development.

Variations by pathway

When looking into industrial production in the EU, the results indicate that for the PA pathway, sectors which are strongly oriented to exports, such as vehicles and machinery, have a lower GVA in 2050 compared to the other pathways, due to lower economic activity in the rest of the world.

In some sectors, the Reference pathway shows lower growth compared to the other pathways (e.g. iron and steel), while in others higher growth. This can be attributed to the fact that since they are export oriented, the higher the (relative to the EU) economic growth outside the EU, the more they benefit.

Vehicle, machinery and rest of industry are sectors that are not energy intensive. Therefore, they do not suffer in the CL, LS and PA-EU pathway, but are quite export oriented, so they are negatively affected in the PA pathway, because economic activity in other regions decreases. As for chemicals, non-ferrous metals and the paper sector which are energy intensive and more oriented for internal consumption, they follow the overall European economic tendency.

Message 16: Uneven GDP growth occurs across Member States

With very few exceptions, every other country/region will see a lower rate of economic growth in a decarbonisation pathway compared to the Reference pathway, although strong overall growth. Figure 17 shows that the economy of Germany and Northern Europe will be affected the least from decarbonisation, compared to all other regions. This can be explained by the fact that those countries currently record a relatively low per capita emission rate and have already decarbonised their systems significantly compared to 1990. Therefore, the remaining burden for them is consequently lower.

GDP difference relative to RF pathway for the European Regions in NEWAGE Figure 17. GDP difference relative to RF pathway for the European Regions in NEWAGE.

Variations by pathway

In the CL pathway where decarbonisation targets are lower in particular regions, Poland and the South and Eastern European countries are affected less than the rest in terms of economic growth. On the other hand, the fulfilment of the Paris Agreement will have more severe effects on almost every region, with Italy, Poland, Spain and Portugal impacted the most. In the case of Italy, its economy is still recovering from the last crisis and is vulnerable against such policies, while Poland is economic dependent of its coal reserves and Portugal and Spain have both increased their emissions compared to 1990 levels, meaning they have to undertake higher emission reduction than the other western European countries.

Message 17: Effects on different income groups

From the analysis on distinct income groups, as shown in Figure 18, results demonstrate that the richest 20% of population in the EU will be able to afford a higher share of their total consumption of energy goods on carbon tax and, thus, consume a higher share of fossil fuels. In this case we consider energy goods not only as electricity, gas, coal and oil products, but also as the corresponding carbon taxation of each pathway, represented by the dotted columns. Additionally, while columns “PA taxation” and “LS taxation” are straight forward regarding the pathway they represent, column “ESD” represents the taxation for the Effort Sharing Decision which has a price in this case because it was modelled as a cap-and-trade policy with national targets.

Consumption of specific EG in the EU-28 according to income level Figure 18: Consumption of specific EG in the EU-28 according to income level (hh1 are the 20% poorest households and hh5 are the 20% richest households). Source: Authors.

The results on income development among different income groups were also analysed in order to find effects on income inequality as a response to environmental policies. Assuming that revenues from CO₂ certificates are payed back to households in the same proportion as government payments are made today among quintiles, there is a potential that they can be used as a tool to decrease income inequalities, as gross income grows more for lowest income quintile than highest in 2050, the year when carbon price reaches its peak, especially for pathways PA-EU and PA, while in the RF pathway the opposite is true for all years analysed.

Development of gross income for the 20% poorest households (hh1) and 20% richest households (hh5) Figure 19: Development of gross income for the 20% poorest households (hh1) and 20% richest households (hh5). Source: Authors.