The Macroeconomic Impacts
of Federal Pollution Control Programs
-------
11532
The Macroeconomic Impacts
of Federal Pollution Control Programs
by
Chase Econometric Associates, Inc.
Bala Cynwyd, Pennsylvania
undertaken for
The Council on Environmental Quality
The Environmental Protection Agency
January 1975
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TABLE OF CONTENTS
Introduction 1
Principal Conclusions 1
Impact on Inflation 1
Impact on Economic Growth 2
Impact on Unemployment 2
Investment 2
Pollution Abatement Costs 3
Methodology and Assumptions 3
Operation of Model 7
Results of Analysis g
Impact on Prices 9
Impact on Economic Growth 9
Impact on Investment 13
Impact on Foreign Trade 13
Other Economic Impacts 13
Sensitivity Analyses 14
Conclusion 16
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FOREWORD
This analysis of the macroeconomic impact of pollution
control expenditures was sponsored by CEQ and EPA as part
of a continuing effort to assess the impact of environmental
programs on the economy. Further studies on this issue are
expected to be released this year.
The analysis is based upon CEQ/EPA estimates of "incre-
mental abatement costs" associated with current Federal air
and water pollution control legislation. These costs are
defined as the public and private expenditures expected to
be made as a result of Federal environmental legislation
which would not have been made in the absence of this legis-
lation. The methodology and data sources used in estimating
these costs are described in the fifth annual report of the
CEQ.*
The cost estimates are primarily based on the
assumption that the deadlines and standards established in
the Clean Air Act (as amended) and the Federal Water Pollution
Control Act (as amended) will be achieved. They, therefore,
show a significant peaking prior to 1978. There is some
evidence that these deadlines will not all be met, and that
some expenditures will be delayed beyond 1978. In this case
the macroeconomic effects of the programs would likely be
less than projected in these analyses.
However, the cost estimates do not fully include the
costs associated with meeting the 1983 standards established
by the 1972 amendments to the Federal Water Pollution Control
Act, and therefore, the actual macroeconomic impacts at the
end of the decade 1973-82 may be greater than projected. It
should also be noted that the initial computer runs for this
study were made in the fall of 1974 and hence some of the
baseline forecasts do not completely reflect subsequent
changes in economic conditions.
Further macroeconomic analyses of this type are expected
to be undertaken in the future as the abatement cost estimates
are changed.
Edwin H. Clark, CEQ
Roy N. Gamse, EPA
January 1975
*The Council on Environmental Quality, Environmental Quality
1974 (U.S. novernment Printing Office, 1974), Appendix 1 to
Chapter 2.
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conometrics
INTRODUCTION
This study represents an updating and continuation of the work done in
previous years by Chase Econometrics for the Environmental Protection Agency
(EPA) and the Council on Environmental Quality (CEO) in assessing the macro-
economic impact of Federal environmental programs.1 The analysis uses abate-
ment cost estimates for the period 1973-1982 supplied by EPA and CEQ for air
and water pollution abatement; these figures are given in Table 1. The
estimates include capital investment, annualized capital costs, and operating
and maintenance costs for each of the years in the period of analysis, and are
disaggregated by two-digit industry. The cost estimates are consistent with
the "incremental abatement costs" estimates published in the CEQ 1974 annual
report.
The analysis was performed using the Chase Econometrics macroeconomic
and input/output models, which are linked together into a single solution
algorithm. The Chase model system thus allows analysis of both the impacts
that different industries have on one another and on the interaction between
pollution control expenditures and general economic factors such as the rate
of growth, inflation, unemployment, and financial markets.
Most of the analysis is based upon the EPA/CEQ estimated level and timing
of costs superimposed on a general cyclical economic scenario taken from a
recent Chase Econometrics ten-year forecast. The impacts of the pollution con-
trol expenditures are estimated by comparing the economic forecasts including
these expenditures with a forecast which is similar in every respect except
that it excludes such additional environmental expenditures. It should be
noted, however, that the inclusion of these expenditures involves several
sets of adjustments to the model, which are discussed in greater detail in
the Methodology and Assumptions section. However, an additional 11 simulations
were also calculated using different cost estimates, alternative assumptions
about the underlying economic scenario, the level of expenditures, and their.
timing over the ten-year period. These alternative scenarios are discussed
in more detail later in this report.
PRINCIPAL CONCLUSIONS
Impact on Inflation
By 1978, when the bulk of the incremental investment in the industrial
sector is complete, the wholesale price index will be 3.0% higher, the implicit
GNP deflator will be 1.9% higher, and the consumer price index will be 1.2%
higher than would have been the case in the absence of pollution control expen-
ditures. These correspond to an average annual rate of increase of 0.6% for
the WPI, 0.4% for the GNP deflator, and 0.24% for the CPI over this period.
The Economic Impacts of Meeting Exhaust Emission Standards, 1971-1980,
October, 1971; The Economic Impact of Pollution Control Upon the General
Economy, October, 1972; The Economic Impact of Pollution Control: Macro-
economic and Industry Reports, July. 1973.
-------
conometrics
In the latter half of the 1973-1982 decade the effect on prices is reduced.
liy l<)82 the cumulative nricc different 1:1 Is arc only 2.'\%, 0.9%, and 0.2°i. This
reduction in the price differentials results from a substantial reduction in
investment and, in part, to the incremental slowdown in the economy. Thus, when
averaged over the decade, the WPI increases (}.2"« more, the GNP deflator 0.1%
more, and tho CP1 0.021 more with pollution control expenditures.
The largest single-year increments occur in 1976. when the WPI rises 1.8%
more and the riNP deflator 0.91. more because of pollution control expenditures.
Por the CPI. the largest single-year differential is in 1977, when it rises
O.c»?i more than it otherwise would have.
Impact on Lcononic Growth
The stimulus of increased expenditures on pollution control growth in the
early years of the decade is projected to raise the rate of economic growth
above what it would have otherwise been through 1976. The maximum differential
in the rate of growth occurs in 1975, when constant dollar GNP will be 1.6%
higher with pollution control expenditures. In the latter half of the decade,
however, low levels of pollution control investment combined with a higher rate
of inflation leads to slower economic growth. By 1979 real GNP is projected to
be J.0"« below the baseline forecast. This difference gradually diminishes and
by 1982 the real GNP ends up virtually the same in both forecasts.
Impact on Unemployment
In keeping with the pattern of overall economic growth, the unemployment
rate is (i.4°o lower in 1975 and O.Vi lower in 1976 than it otherwise would have
been. However, it gradually rises to a level of 0.4% above the baseline fore-
cast by 1979. The difference gradually decreases and returns almost to zero
by 1982.
Investment
The cost estimates provided by EPA/CEQ show incremental pollution control
investments amounting to approximately 5% of total plant and equipment expendi-
tures through 1976. This investment is estimated to result in somewhat lower
levels of other types of investment, the substitution taking place approximately
at .-> r;itc of $0.40 reduction in all other private investment for every $1.00 of
investment in pollution control plant and equipment." However, the housing
sector usually accounts for the majority of the reduced investment because of
its greater sensitivity to the cost and availability of borrowed funds. This
impact dcncnds very much on the particular fiscal and monetary policy being
pursued by the government. The combined effects of slower economic growth,
greater credit stringency, and the increased cost of capital reduce annual
investment in plant and equipment some 4.8% below the baseline level in 1979;
this difference declines to 2.5*j by 1982. Housing starts decline by as much
as 15.3". in 1978, although this difference disappears by the end of the fore-
cast period.
This result is based on a number of simulations performed with the Chase
Econometrics macro model under different assumptions about underlying econo-
mic conditions.
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-3-
cohometrics
POLLUTION ABATEMENT COSTS
The cost estimates used in this analysis arc consistent with the most
recent CI~Q estimates of "incremental abatement costs" beinj- published in its
li)7<1 annual report. The CLQ defines "incremental" abatement costs as expendi-
tures made to satisfy the requirements of Federal environmental legislation
beyond what would have been spent for pollution control in the absence of this
legislation. Some industries arc shown to have negative investment for air
pollution in the years following 1978, which means that the firms in those
industries would h.ivc undertaken certain investment for pollution control in
any case, but did so sooner because of I-'cderal legislation.
The cost estimates, which arc predominantly based upon cost estimator
provided in the 1974 edition of The Cost of Clean Air and the 1975 edition
of The Economics of Clean Water, arc summarized in Table 1. Those figures
were made available to Chase Econometrics for 15 two-digit industries in the
manufacturing sector, utilities, and public sector investment. Very small
expenditures which were also given for agriculture and mining were combined
into the appropriate manufacturing category. These figures were given on an
annual b.isis for the years 1975 to 1982 and were separated into expenditures
for .iir pollution and water pollution abatement. The estimates included
investment cost, annual operation and maintenance costs, and total annual costs.
Annual costs include depreciation, interest charges, and operating and mainten-
ance expenditures. In addition, figures were supplied for the cost of meeting
mobile source emission standards for automobiles.
In addition to the basic analysis using the cost estimates summarized in
Table 1, four other sensitivity analyses were run using different assumptions
about the level or timing of costs. The first of these assumed that, on the
average, capital investment would be 2()9« less than estimated, but that opera-
ting and maintenance costs would be 1 5°<> higher. This adjustment was made to
reflect the impact of an increased emphasis on process changes rather th.m
cnd-of-thc-pipe treatment for pollution abatement. The EPA/CEQ cost estimates
(predominantly) assume "end-of-thc-pipc" treatment.
The second cost sensitivity scenario assumed that all costs were increased
by 25"o in order to estimate the likely macrocconoimc impact if the 1IPA/CKQ
estimates were significantly understated. The third cost sensitivity scenario
involved an "evening out" of costs over the ten-year period -- and a delay of
some costs beyond the period -- in order to determine the impact of a delay in
implementing the current compliance dates. Finally, because of the sharp drop
in housing starts in some years, we returned the level of housing activity to
its baseline level in order to determine what the effect of this policy might
be when applied in conjunction with the pollution control expenditures.
METHODOLOGY AND ASSUMPTIONS
The baseline values for the overall economic scenario arc taken from the
Chase Econometrics long-term macroeconomic outlook. In this forecast we predict
a continuation of the recession throughout 1974 and a rise in the rate of unem-
ployment continuing into 1975. After that, the economy gradually returns to a
4V«> rate of unemployment in 1978 and remains at that level through 1980. This
baseline projects another small business cycle from 1980 to 1983, but the unem-
ployment rate returns to 4%°* by 1985. The indicated growth rate for real GNP
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TABLE 1
ESTIMATED INCRI.MF.NTAL POLI UTION CONTROL EXPENDITURES, 1973-1982
Air Pollution
Abatement Costs
1973-77
Investment Annual
1188
0
0
130
285
565
icts 0
0
195
2479
946
0
0
0
0
5786
8861
1314
15965
ols 10900
577
0
0
195
306
560
0
0
290
1424
1237
0
0
0
0
4589
10575
1701
16865
21150
Water Pollution
Abatement Costs
1973-77
Investment Annual
1448
417
545
974
1340
966
214
126
616
749
286
482
376
306
238
9083
1925
17900
28908
1665
48(.
964
760
860
702
399
143
231
257
224
253
210
145
103
7402
754
7990
16146
Air Pol Kit ion
Abatement Costs
1978-82
Investment Annual
-5h
0
0
-6
-14
-27
0
0
-9
-118
-45
0
0
0
0
-275
1867
407
1999
20370
504
0
0
227
338
611
0
0
336
1338
1412
0
0
0
0
4766
17440
2702
24908
53280
Water Pol hit ion
Abatement Costs
1978-82
Investment Annual
119
34
45
80
110
79
18
10
51
61
24
40
31
25
20
747
2476
-3150
75
2485
726
1466
1105
1228
1014
608
214
305
321
340
352
295
200
140
10797
2319
10868
23984
Food 6 Kindred Products
Textiles
Lumber
Paper 6 Paper Products
Chemicals
Petroleum
Rubber & Misc. Plastic Products
Leather
Stone, Clay 5 Glass
Iron & Steel
Primary Nonferrous Metals
Fabricated Metals
Nonelectrical Machinery
Electrical Machinery
Transportation Equipment
Total Industrial
Utilicies c
Public
Total Fixed Source
Mobile Source emission controls
a
includes feedlots and grain handling
includes coal cleaning and natural gas production
includes residential/commercial/industrial heating
All figures are in millions of 1973 dollars.
The definitions of investment and annual costs arc given on page 3.
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-5-
Sohometrics
averages 4.0% for the period 1975-1980 and 3.7?0 for the period 1981-1983.
The rate of inflation as measured by the consumer price index averages 6.5%
from 1975 to 1980 and 5.2% from 1981 to 1983.
Other major factors of the baseline forecast include the assumption that
both the Federal and state and local government budgets will remain approxi-
mately in balance over the coming decade, with an average annual surplus of
$3 billion over this period. The personal savings rate will average approxi-
mately 7^% for the period, representing an increase from the postwar average
of 6'i?o; this will be due primarily to a higher average rate of inflation.
New car sales will increase from a low level of 9.1 million units in 1974
to 11.2 million in 1976 and then rise slowly from that point to 12.8 million
units in 1983. Housing starts will rebound from a low level of 1.4 million
units this year to 1.9 million units in 1976 and will remain at approximately
this level for the rest of the decade, but will not surpass the figure of
2.05 million starts recorded in 1973. Short-term interest rates will decline
from present peak levels, but long-term interest rates will continue to rise
and will average approximately 11% over the decade.
An alternative scenario, called the "full employment baseline" is not
vastly different from the cyclical baseline. The EPA/CEQ provided guidelines
to Chase Econometrics which stated that the real growth rate should average
4.6% per year for the 1975-80 period and 3.2% per year for the 1981-83 period.
Furtnermore, it was stipulated that the unemployment rate should average 5.4%
in 1975 and 3.9% in both 1980 and 1983. We have maintained these conventions
jn solving for the baseline full employment scenario. As we move to higher
rates of employment, the rate of price increase is slightly larger. Thus the
consumer price index increases at a 6.7% annual rate during the forecast period,
compared to a 6.01 increase in the baseline forecast. Similarly, the implicit
C".NP deflator rises at 6.5% instead of 5.8%, and the wholesale price index rises
;it 5.8°; instead of 5.0%. The model has been adjusted so that real GNP rises
at .m average rate of 4.1% compared to 3.9% in the cyclical baseline case.
Other variables arc not significantly affected; the personal savings rate
remains around 74% and housing starts average just under 2 million units per
year, although new passenger car sales rise about 1% a year faster.
We now consider the major steps which were taken to enter the GPA pollution
cost figures into the Chase Econometrics industry and macro models. These can
be briefly summarized as follows:
1) Enter the estimated investment costs for each industry into the
model as an addition to the year by year demand for plant and
equipment investment. These adjustments have two effects:
(a) they are added directly to the investment functions in the
model (see (7) below), and (b) they increase the asset base on
which firms must earn the normal rate of return, hence resulting
in higher prices.
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nometrics
2) [Enter the annual operation and maintenance costs and interest
costs on pollution control investments into the model as an
increase in each industry's production costs.
3) Apply "markup" factors to the increase in production costs,
including capital depreciation, interest charges, and operation
and maintenance, to determine the increase in prices. The markup
factors, which represent the proportion of increased costs passed
along as higher prices, have already been calculated on an indus-
try by industry basis in the Chase Econometrics industrial models.
The markups in general range from 0.8 to 1.0. A. markup factor of
1.0 indicates that the average firm in the industry will be able
to just recover all the increased costs through product prices.
4) Calculate the effect which these price increases will have on all
industries. The previous step calculated only the direct effect
of pollution controls on prices; that is, the amount that the price
of steel (e.g.) rises because the steel industry invests in pollu-
tion control plant and equipment. However, we must also consider
the effects which an increase in steel will have on machinery, autos,
and other steel-using industries. In other words, we must measure
the indirect as well as the direct effects of the price increases
in each industry.
5) Convert the price increases by final demand categories to price
increases by aggregate demand categories. We use a reverse bridge
matrix to go from the 40 categories of final demand to the aggre-
gate demand components contained in the Chase Econometrics macro
model.
6) Translate the price increases which come from the input-output
table and the bridge matrix -- as given in (5) above -- into actual
ex post price changes by using the markup factors at the macro level.
Until this has been accomplished we do not yet know what changes in
final product prices will be, since the cost increases may not be
fully passed along. Thus we use the markup factors at the final
demand level (consumption, investment, and exports) to determine
what the price rise will be before taking into account interactive
and dynamic factors. These markup factors range from 0.8 to 1.1.
7) Adjust for changes in fixed business investment due to pollution
control expenditures. Since more investment will be needed, the
constant terms in the investment functions should be raised accord-
ingly. However, we adjust the rental cost of capital upward by the
percentage of investment for pollution control because it will now
take more investment to produce a given amount of output. Hence
the required rate of return on investment for capacity expansion
will have to increase to offset the zero financial return on the
pollution control investments.
8) Labor productivity was adjusted downward through a decrease in
capital stock to reflect the fact that the additional capital
expenditures for pollution control do not increase output/manhour.
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Sbhometrics
9) The index of industrial production was increased to represent
the manufacture of auto emission control devices.
10) The consumption of transportation services was increased because
of higher operating and maintenance costs due to the catalytic
converters and other pollution control devices.
11) Corporate profits were adjusted downward to tnkc into account
the added costs of pollution control. The existing profit
functions would show an increase in profits if prices rose and
unit labor costs, raw material prices, interest rates, output,
and capacity utilization all stayed at the same level.
12) The amount of financing undertaken by the Federal government
increased, reflecting higher government debt because of increased
spending in the public sector, and the amount of bond financing
was also increased by the amount necessary to keep the debt/equity
ratio constant.
A final round of price and output changes were then obtained by solving
the complete Chase macroeconomic model, taking into account the interactive
and dynamic factors.
OPERATION OF MODEL
We now consider the interactive and dynamic features of the macroeconomic
model. The additional plant and equipment expenditures for pollution control
will reduce the amount of investment in the private sector undertaken for other
purposes. Part of this effect has already been included by raising the value of
the rental cost of capital term.3 However, several other factors need to be taken
into account. First, an increase in nominal investment will place greater pressure
on the capital markets, thus increasing interest rates and lowering other invest-
ment. Second, the increased investment demand will cause an increase in the costs
of construction materials, labor, and equipment which results in some decline in
constant dollar investment for a given level of output and financial variables.
Third, .1 significant substitution exists between residential and nonrcsitlenti.nl
construction. This substitution works through changes in three variables: credit
nva i l.ihi 11 ty, the cost of construction, and the availability of labor. Since
housing is more sensitive than other construction to all three of these variables,
it suffers the greatc'st decline when other sectors of investment increase. The
average elasticity of substitution between pollution control expenditures and
other fixed investment is approximately 0.4, .is has already been mentioned. This
value can reach even larger values during periods of overfull employment and strin-
gent monetary policy, although it does not in these simulations.
3 I»K (r+6) (1-uz-k)
"The rental cost of capital is defined as ~j-. r where
P = supply price of capital goods z = depreciation factor
r - cost of borrowed funds J = '"vestment tax credit rate
r , P.. = wholesale price index
6 = depreciation rate W r
u = marginal statuatory tax rate .
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conometrics
It should he mentioned that a higher rate of inflation leads to a slower
rate of growth in the economy for a number of other reasons. The most impor-
tant link: a rise in the rate of inflation increases the savings rate and
hence reduces consumption. According to the permanent income hypothesis, the
marginal propensity to consume is lower for variable incomes than it is for
fixed incomes. Yet clearly inflation penalizes those on fixed incomes at the
expense of those on variable incomes. During inflation the decline in consump-
tion by those on fixed incomes is not nearly matched by the increase in con-
sumption by those on variable incomes -- even if we assume that income changes
are the same -- and thus the savings rate rises. This is one of the important
endogenous relationships in the macro model, and works through the income dis-
tribution and relative price terms in the consumption function. In addition
there is a relative decline in durable purchases which is not balanced by the
slightly higher spending on services.
The other channels by which a rise in prices lowers real output are more
straightforward and require only brief commentary. First, for a given nominal
money supply, higher prices must lead to a lower real money supply and hence
an increase in interest rates unless there has been a specific offsetting
shift in the liquidity preference function; this leads to the effects on invest-
ment which have already been discussed. Second, an increase in domestic prices
for a given level of foreign prices leads to a deterioration in the net foreign
balance in constant prices, although if the sum of the price elasticities of
exports and imports is less than unity, the balance in nominal terms may increase.
Third, a government budget which is fixed in current dollars buys fewer goods and
services and generates less employment if prices increase. If the government
attempts to retain its real purchasing power, it can do so only by creating
ndditional money, which will in turn raise prices, or by borrowing additional
funds, which will raise interest rates. We have chosen to assume that this
latter route is operative, as indicated in our earlier discussion of constant
adjustments.
All of these linkages reinforce the result that a rise in costs and prices
will reduce aggregate demand and raise unemployment. As soon as this happens,
however, secondary effects which act in the opposite direction begin to surface.
A rise in unemployment will result in a lower level of wage increases in follow-
ing years. Thus unit labor costs and prices will not rise as much for a given
increase in productivity. In addition, the lower level of capacity utilization
leads to lower markup factors. When these events begin to increase in impor-
tance, the rate of price increase starts to diminish. The decline in real
GNP and employment, which was originally caused by higher prices, also begins
to slacken. As this continues, prices and real GNP tend to return toward the
level which would have occurred if the additional costs had not been added.
Under a fairly wide variety of assumptions it is likely that the economy will
eventually return to the level of output and employment which would have
occurred in the absence of expenditures for pollution control, although prices
will remain somewhat higher because of a lower level of productivity.
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bonometrics
RESULTS OF AN'\LYSIS
Impact on Prices
The economic effects of pollution control expenditures are found to be
rather modest. By 1978 the implicit f.NP deflator is only 1.9% above the base-
line case, the wholesale price index is only 3.0%, and the consumer price
index only 1.2% above their baselines. The biggest price effect occurs in
1976, when the GNP deflator with pollution control costs rises 0.9% more than
in the baseline scenario, and in 1977, when it rises 0.6% more. The difference
in all other years is much less. Similarly, the wholesale price index rises
an additional 1.9% in 1976 because of pollution control expenditures. This is
the largest annual increase for any of the macroeconomic price indicators.
The fact that some price increase does occur is no surprise, since it is
.issumcd that pollution control expenditures do not increase output per unit of
labor or capital. The increased aggregate demand caused by the pollution con-
trol expenditures with no compensating increase in aggregate production inevi-
tably results in higher prices. The amount of inflation will depend upon how
much "slack" there is in the economy. At "full employment", the price increases
caused by the additional demand could be very significant, while a sluggish
economy will result in less increase. Even with a sluggish ecnnomv. however,
there will be some price increase as firms pass on higher production costs in
the form of higher prices, and as resources are competed away from other sectors
to the production and installation of pollution control equipment.
Impact on^ jjconomic Growth
There has been a considerable amount of disagreement about whether pollution
control expenditures on balance increase or diminish the rate of real growth and
employment. Some economists have argued that the additional expenditures asso-
ciated with pollution control investment will result in a higher growth rate and
hence .j higher level of employment. Our results support this analysis for the
pcrioil before 1977. However, they also reveal that pollution controls contribute
to the negative effect of higher inflation on real growth after 1977. This latter
effect works through several different channels, which have already been described
in the previous section.
As .1 result, we have a somewhat variegated picture of an incremental pattern
ol" real growth over the forecast period. During the early years -- 1974 through
l()7(i -- real GNP is higher than the baseline solution and hence unemployment is
lower. However, in 1977 and succeeding years the picture is reversed. First,
less new investment is being added in 1977 and subsequent years. Second, the
additional price increases resulting from the environmental expenditures set in
motion forces that lead to a slower rate of real growth causing real GNP to be
lower and unemployment higher in the perturbed solution in the years 1977 through
1982. The greatest decrement in real growth is reached in 1979, when the per-
turbed real GNP is 2.0% below the baseline solution.
After 1979, countervailing forces come into place. The lower rate of growth
leads to a higher rate of unemployment, which in turn leads to smaller increases
in wage rates, unit labor costs and prices. In addition, a decline in capacity
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TABLE II
1974
1975
1976
1977
1978
1979
1980
1981
1982
Gross National Product, Current Dollars
Baseline projection
With pollution control costs
% Difference
Gross National Product, 1973 Dollars
Baseline projection
With pollution control costs
% Difference
Implicit GNP Deflator. 1973 = 100
Baseline projection
With pollution control costs
% Difference
-fonsumer Price Index, 1973 = 100
Baseline projection
With pollution control costs
% Difference
Wholesale Price Index. 1975 = 100
Baseline projection
With pollution control costs
% Difference
Unemployment Rate, Percent
Baseline projection
With pollution control costs
% Difference
Fixed Investment in Producers Durable
Equipment, 1973 Dollars
Baseline projection
With pollution control costs
% Difference
1405.1
1413.8
.62
1279.5
1286.9
.58
109.8
109.8
.00
110.9
111.0
.09
121.0
121.1
.08
5.2
5.1
-1.92
91.4
93.8
2.63
1557.9
1586.8
1.86
1303.1
1323.4
1.56
119.5
119.9
.33
120.5
121.0
.41
135.5
136.3
.96
5.5
5.1
-7.27
95.7
102.4
7.00
1738.9
1779.1
2.31
1364.0
1379.0
1.10
127.5
129.0
1.18
128.6
129.4
.62
142.2
146.2
2.81
5.3
5.0
-5.66
102.8
107.4
4.47
1931.2
1962.0
1.59
1435.2
1432.5
-.19
134.5
136.9
1.78
136.4
138.0
1.17
148.7
153.5
3.23
4.8
4.8
.00
109.3
110.2
.82
2149.6
2157.7
.38
1514.0
1491.8
-1.47
141.9
144.6
1.90
144.6
146.4
1.24
155.8
160.5
3.02
4.4
4.6
4.S5
116.7
114.4
-1.97
2354.0
2344.5
-.40
1570.6
1539.3
-1.99
149.8
152.3
1.67
152.9
154.6
1.11
162.7
167.0
2.64
4.4
4.8
9.09
121.8
117.7
-3.37
2555.8
2550.7
-.20
1619.1
1594.9
-1.49
157.8
159.9
1.33
161.3
162.5
.74
169 . 1
173.2
2.42
4.5
4.8
6.67
126.4
123.0
-2.69
2762.7
2775.8
.47
1664.3
1654.7
-.58
166.0
167.7
1.02
169.9
170.6
.41
175.2
179.4
2.40
4.7
4.8
2.13
130.4
129.0
-1.07
3008.9
3030.9
.73
1726.2
1723.4
-.16
174.3
175.8
.86
178.6
179.0
.22
181.5
185.8
2.37
4.6
4.7
2.17
135.9
135.4
-.37
o
I
-------
IAHI.I II (cort'd)
Fixed Investment in Nor.rcsidential
Structures, 1975 Dollars
Baseline projection
Ivith pollution control costs
?o Difference
Housing Starts, Millions of Units
Baseline projection
With pollution control costs
°6 fHffcience
Percentage Growth Rate of GNP, 1975 Dollar
Baseline projection
With pollution control costs
Difference
Percentage Growth Rate of CP1
Baseline projection
With pollution control costs
Difference
Consumption of Other Durables , 1973 Dollars
Baseline projection
With pollution control costs
% Difference
52.fi
5 2
1 o.l
1 .">
5.13
-1.2
-.6
.6
10.9
11.0
. 1
8.9
8.7
?.25
49.3
49.4
.20
75.1
75.2
.13
51. 1
57. 7
12.02
1 . 40
1 ~(1
-5 ~9
1.8
2.8
1.0
8.7
9.0
.3
6.0
5.0
-16.67
55.0
55.3
.55
75.9
76.9
1.32
52.7
58.8
11 57
1 S8
1 6b
-11 .70
4.7
4.2
-.5
6.8
7.2
.4
6.0
5.6
-6.67
59.4
58.8
-1.03
79.1
80.3
1.52
1976 197" 1978
55.5 57.5
58.5 55.9
5.05 -2.78
1 05 2.05
-15.03 -15.27
5.2
3.9
-1.3
6.0
6.4
5.5
4.1
-1.4
0.0
6.1
.1
1979
58. 3
53.8
-7.72
2.00
1.82
-9.on
3.7
3.2
-.5
5.8
5.6
-.2
1980
1981
19S2
Trade Balance, 1973 Dollars
Baseline projection
With pollution control
% Difference
Consumption of Autos and
Baseline projection
With pollution control
% Difference
costs
Parts, 1973 Dollars
costs
8.9
8.7
-?.25
49.3
49.4
.20
6.0
5.0
-16.67
55.0
55.3
.55
6.0
5.6
-6.67
59.4
58.8
-1.03
7.4
7.3
-1.35
61.8
60.4
-2.27
9.1
8.8
-3.30
62.3
59.7
-4.17
11.1
10.5
-5.41
61.7
59.2
-4.05
J2.5
11.7
-6.40
61.3
59.7
-2.61
13.S
13.0
-5 .
61
61
80
.6
.0
97
4 7
14.0
-4.7o
62.5
62.0
-.80
82.4
83.2
.97
86.3
86.2
-.12
89.5
88.4
-1.23
60.1
55.1
S.32
1.91
1.87
2.ng
3.1
3.6
. 5
5 . 3
5.1
-.4
J2.5
11.7
6.40
61.3
59.7
2.61
91.9
91.0
-.98
63.8
59.6
-6.58
1 82
86
1 20
2.8
3 . 7
.9
5 . i
5.0
-.3
13.8
13.0
-5.80
61.6
61.0
-.97
94.4
94.2
-.21
68.1
63.5
-6. "5
l.SS
1 92
2 1 -
j .
-I 2
. 5
5. 1
1.9
^
4 7
14.0
-4.?o
62.5
62.0
-.80
97.4
97.6
.21
-------
TABLE II (cont'd)
1974
1975
1976
1977
1978
1979
1980
1981
1982
Consumption of Nondurables, 1973 Dollar^
Baseline projection
With pollution control costs
% Difference
Consumption of Services, 1973 Dollars
Baseline projection
With pollution control costs
% Difference
Disposable Personal Income^ Current Dol
Baseline projection
With pollution control costs
% Difference
Corporate Profits Before Taxes , Current
Baseline projection
With pollution control costs
% Difference
Corporate Profits After Taxes , Current
Baseline projection
With pollution control costs
- %-Difference
Aa Corporate Bond Rate for New Issues
Baseline projection
With pollution control costs
% Difference
353.7
334.4
.21
356.5
337.3
.24
lars
985.0
988.8
.39
Dollars
142.2
145.3
2.18
Dollars
86.1
88. 0
2.21
9.58
9.70
1.25
337.3
340.1
.83
340.5
343.8
.97
1089.4
1104.2
1.36
137.1
146.8
7.08
78.6
84.4
7.38
10.59
11.29
6.61
354.2
357.7
.99
352.7'
357.0
1.22
1211.4
1236.0
2.03
158.3
165.3
4.42
90.8
95.0
4.63
10.97
11.85
8.02
370.7
372.7
.54
370.4
373.4
.81
1345.8
1370.3
1.82
181.8
179.1
1.49
103.4
101.8
-1.55
11.47
12.47
8.72
385.7
384.8
-.23
393.2
393.0
-.05
1488.4
1503.8
1.03
209.2
198.0
-5.35
121.0
114.2
-5.62
10.97
11.77
7.29
397.8
394.8
-.75
411.4
407.9
-.85
1629.7
1633.0
.20
227.8
213.8
-6.15
133.0
124.7
-6.24
11.01
11.44
3.91
408.7
405.9
-.69
425.3
421.1
-.99
1772.7
1772.3
-.02
247.7
236.6
-4.48
145.6
139.0
-4.53
11.03
11.23
1.81
419.5
418.4
-.26
437.3
456.0
-.30
1920.8
1925.1
.22
267.1
261.4
-2.13
158.0
154.5
-2.22
10.97
11.16
1.73
Index of Industrial Production, 1973 = 100
Baseline projection
With pollution control costs
% Difference
100.3
101.2
.90
103.6
106.1
2.41
109.7
111.7
1.82
115.2
115.6
.35
120.9
119.4
-1.24
124.6
122.1
-2.01
127.9
126.1
-1.41
131.0
130.5
-.38
432.0
432.1
.02
450.5
452.2
.38
2088.4
2095.0
.32
294.9
290.1
-1.63
175.4
172.5
-1.65
10.87
11.18
2.85
135.6
135.6
.00
-------
-13-
utilization reduces the size of markups in several industries. Thus for the
1980-82 period the shortfall in real TiNP averages only 0.7%, and in 1982 the
perturbed real GNP has virtually returned to the baseline level.
Impact on Investment
Turning to the maior components of investment, we find that constant
dollar purchases of producers durable Roods are up 7.0°o in 1975, but most of
this increase represents investment in pollution control equipment. Thereafter,
there is a relative reduction in pollution control expenditures, and the differ-
ence declines to Q.S* in 1977 and -3.3% in 1979 before returning almost to zero.
Nonresidcntial construction increases 13% in 197S and 5% in 1977, but reaches a
maximum negative decrement of -8.396 in 1980. These decrements are due entirely
to higher costs and a lower level of economic activity, since incremental pollu-
tion control investment in total remains positive throughout the decade.
Housing starts are hard hit and decline by 5.8% in 1975, 11.7% in 1976,
and 15% in both 1977 and 1978. After that the difference narrows and they are
only 9% below the baseline solution by 1982. The impact on housing, of course,
depends very much on the particular monetary and fiscal policies being pursued
by the Federal government. The government, for instance, could take steps
directly to aid the housing market. To determine the impact of such a policy on
prices and GNP growth, we calculated additional simulation exercises in which we
rctumod housing to-its baseline level. We found that stimulating the housing
industry simply resulted in reducing the amount of funds available to the remain-
ing borrowing sectors, particularly fixed business investment, and hence had
relatively little short-run effect or. the overall macroeconomic picture.
Impact on Foreign Trade
The foreign trade balance in 1973 dollars declines slightly in all years of
the simulation period, unlike other components of income and production which
start with positive increments but then become negative around 1978. The major
cause of this is the increased level of prices over the entire period. This fac-
tor is offset in part by fluctuations in economic activity. Hence in 1975, when
both prices and domestic output arc higher, the decrement, is largest; higher
prices reduce U. S. competitiveness in international markets, while higher output
increases U. S. imports. In later years the factors work in opposite directions.
Prices are still higher, but a lower level of output reduces the demand for imports.
On balance, however, the price effects always outweigh the income effects.
Other Economic Impacts
The major components of consumption follow the pattern which might be expected.
All sectors show an increase in 1974 and 1975 and a decrease for -the period 1978-
1981. Auto sales are relatively harder hit because of the mobile source emission
controls and decline by a peak amount of 4.2% in 1978; this corresponds to about
500,000 cars.4 They also remain below the baseline solution in 1982 when all
other major components of consumption show slight positive increments. The change
in auto sales is due to .-i combination of factors which include changes in relative
4
The cost estimates underlying this analysis were based on the April 1973 imple-
mentation schedule announced by the administrator of I:PA in April 1973 and there-
fore do not take account of subsequent modifica.tions of this schedule which will
reduce these costs.
-------
-14-
Sbhometrics
i
prices, disposable income, the rate of unemployment, and credit conditions.
Gasoline prices are explicitly included but other operations and maintenance
costs arc not included in the new car equation.
Disposable personal income (DPI) in current dollars is slightly above the
baseline solution in all years except 1980. In constant dollars, it follows
the general pattern of other economic variables; it is higher through 1977,
lower for 1978 through 1981, and slightly positive in 1982. The actual
changes in constant dollars can be calculated by subtracting the percentage
changes in the CPI from the percentage changes in DPI. Corporate profits
fluctuate much more on both a pretax and after-tax basis. They rise 7% higher
in 1975 and 44% higher in 1976 but then decline sharply to a maximum decrement
of 6% in 1979. After 1979, as with other macroeconomic variables, the differ-
ence between the perturbed and the baseline solution return toward zero, the
difference being only 1.6% in 1982. No measure for "constant dollar" corpor-
ate profits is given, since this term is not easily defined.
In the financial markets, the Aa corporate bond rate for new issues is
above the baseline solution throughout the simulation period. It is higher
by 0.7"0 (or a 6.6% increase) in 1975; the difference continues to widen to
1977, where the gap is a full 100 basis points (or an 8.7% increase). After
that it diminishes somewhat but still remains 0.3% higher (or a 2.9% increase)
by 1982. Finally, the index of industrial production ^ollows much the same
pattern as constant-dollar CNP, with the peak oositive difference of 2.4%
being recorded in 1975 and the peak negative di^erence of 2.0°* occurring in
1979. The projected levels and differences in interest rates depend, of course,
upon monetary policy.
Sensitivity Analyses
Ko now consider the results of alternative simulation analyses which
tested changes in the underlying assumptions about the condition of the
cconom\ or about the level or timing of pollution abatement expenditures.
First, we summarize the changes that occur when we superimpose the expected
levels of pollution control costs on the "full employment" baseline. As
would he expected under this scenario, the price increases are slightly
larger although the differences are modest. For example, by 1982 we find
that the wholesale price index has increased by about three-fifths, the
implicit GNP deflator by about two-fifths, and the CPI by about one-fifth
more than with the Chase cyclical economic scenario used in the earlier
analyses. The declines in real r,NP are also similar in nature although the
timing pattern is somewhat different. The increase in producers durable
equipment and nonresidcntial construction and the decline in housing starts
all follow the same pattern.
The impacts under the "cyclical" and "full employment" cases are similar
primarily because there is relatively little difference between the two
economic scenarios. In particular, the cyclical scenario assumes that the
unemployment rate averages approximately 4.5% whereas in the full employment
scenario this rate moves from 44% to 3.9% in 1980 and remains at that level.
It is clear that somewhat greater differences would have been observed if
we had run a true recession scenario with the unemployment rate as high as 6%.
However, the alternative runs at full employment do indicate that the rise in
prices, while somewhat greater, is not of major importance, although the
difference is more significant for the WPI than for the CPI or GNP deflator.
-------
-15-
hometrics
For the second sensitivity analysis, the assumed abatement costs were
adjusted by reducing investment costs by 10"« and increasing O&M costs by an
average of 15%. The purpose of this scenario was to test the impacts of
increased emphasis upon process change rather than end-of-the-pipe treatment
as an abatement strategy. This scenario (with the'Chnsc cyclical economic
base case) shows price rises about one-fourth less than in the original
analysis. Because prices rise loss, the maximum decrement in real GNP which
occurs in 1979 is les«- than two-thirds as great as in the original analysis.
By 1982 the change in consumer prices is only one-tenth less, but for the GNP
deflator it is one-fifth less, and the wholesale price index one-third less.
The housing market declines by only two-thirds as much and the other distur-
bances to the baseline growth pattern are similarly restrained.
The third sensitivity analysis involved increasing all costs by 25% in
order to test the impacts which could be expected in case the EPA/CEQ estimates
ucre seriously understated. This analysis showed the wholesale price index
rising over one-fourth more by 1982 than the standard case, and the implicit
f.\P deflator by one-sixth, but the CPT by less than one-twelfth. These appear
to be paradoxical results in that the increase in prices is smaller than the
.idditional increase in expenditures. However, this is because the economy,
and therefore the Chase nacroccononic model, contain many nonlinear and dynamic
effects. These nonlincarities are evident in the changes in prices and output
for earlier years. For example, in 1975 the incremental change in the wholesale
price index is two-fifths above the standard, and in 1976 the difference is
about one-third. These larger than proportional price increases lead to a
sharper than proportional decline in real output. For example, the decline in
CNP in 1977 is over twice :is large, and in 1978 it is two-thirds larger. Thus
the higher than proportional price increases lead, as night uol1 be expected,
to higher than proportional declines in real product ion and increases in unem-
ployment; thus increases in wage rates in future yc.irs are lower than the stan-
dard analysis, hence eventually leading to some mitigating factors affecting
price*..
In the fourth sensitivity analysis the timing pattern of expenditures was
evened out ,md in some cases extended beyond 1982 in order to test the impacts
of extending implementation deadlines. As expected, phasing in the expendi-
tures more evenly until 1982 does reduce the overall rate of price increase.
In 1982, the WPI js one-third lower, the implicit fiNP deflator is one-fifth
lower than in the standard run, while the small increment in the CPI is not
affected. The maximum decrement in GNP, which also occurs in 1979, is only
about half as large, while the increase in the unemployment rate is only half
as great. The decline in housing starts and in producers durable equipment
purchases and nonresident i :il construction expenditures is only about half as
much. Thus timing patterns are quite important; stretching out the expenditures
reduces the effect on output and prices by almost half.
It could be argued that the very substantial decline in housing is not
indicative of what would actually happen in the economy, since the government
could take steps to aid the housing market. Thus in our last sensitivity
analysis, we tested this possibility by returning housing to its baseline
level in order to determine whether the effect, in real growth and prices
would be substantially different. However, we found that this was not. the
case. Adding funds to the housing market through action by the Federal
government, and its agencies simply resulted in reducing the amount of funds
available to the capital goods sector and hence had relatively little effect
on the overall macroeconomu picture.
-------
-16-
hometrics
CONCLUSION
'Ihe figures supplied by EPA/CEQ on pollution control expenditures for
the period 197.3 to 1982 will nave a noticeable but modest effect on the
overall economy. During this .ten-year period, prices will average approxi-
mately 0.2°u a year higher than they would have in the absence of these
expenditures', although in the early part of that period (1974-1977) the
CPI increases an average of G.3°s rr.ore, the implicit GNP deflator increases
.in average of 0.4% more, and the WPI increases an average of 0.8T> more per
vear. The maximum difference of 1,9% -cor prices is reached in 1976. These
higher prices eventually result in a somewhat lower growth rate of GNP, with
the maximum decrement of 2% reached in 1979, which ivs turn results in a rate
>f unemployment which is 0.4% higher. However, the differences gradually
diminish so that by 1982 real growth and employment are at virtually the same
levels which would have occurred in the absence of pollution control invest-
ment, while prices are only some 2% higher.
We also experimented with various alternative assumptions concerning
i lie underlying economic scenario and the level and timing of expenditures.
I he increase in prices would be about two-fifths higher if the economy were
operating at full employment throughout this period; however, this, does not
appear TO be a near-term problem. An increase in expenditures of 25% would
r:« i se the incremental change in prices about two-fifths in the peak years
iind woijld also have a greater negative effect on real growth and employment.
l;iiially, a stretching out of expenditures to level peak year purchases would
reduce the economic effects on output and prices by as much as one-half.
------- |