The Unassuming Economist

There are conflicting claims about whether emissions growth and GDP growth have decoupled. My presentation today shows that some of this debate is due to a failure to distinguish cycles from trends: there is an Environmental Okun’s Law (a cyclical relationship between emissions and GDP) which often obscures the Environmental Kuznets Curve (the trend relationship between emissions and GDP).

My ongoing work casts relationships between emissions and economic growth in much simpler terms than is typically done in the climate change literature. My co-authors and I use the trend and cycle decomposition that is familiar to most economists, particularly macroeconomists. We then show that the cyclical relationship between emissions and real GDP—akin to an Okun’s Law, in the terminology of macroeconomists—obscures the trend relationship—the Kuznets Curve that is the focus of many papers in the climate change literature. Once the cyclical relationship is stripped away, the trends do show some evidence of decoupling in the richer nations, particularly in Europe.

We then apply the framework to take into account the effects of international trade. That is, we distinguish between production-based and consumption-based emissions. This makes a big difference to the results. Specifically, the evidence for decoupling among the top emitting countries gets much weaker, including for many countries in Europe.

From an IMF report:

There exists a strong positive long-run relationship between real GDP per capita and the real value of hydrocarbons production in Latin American and Caribbean (LAC) oil and gas producers. Panel co-integration analysis for the period 1980–2014 suggests that a 100 percent increase in the value of oil and gas production increases the level of GDP by 14 percent on average. The relationship is particularly pronounced in Trinidad and Tobago and Venezuela while for Bolivia it is close to the LAC average. Between 2000 and 2014, the real value of oil and gas production per capita in Bolivia increased by about 370 percent, while real GDP per capita increased by 43 percent. The developments in Bolivia over the recent boom period are thus very close to what one would have expected based on this general relationship.

At the provincial level in Bolivia, real GDP per capita in the main gas producing region (Tarija), increased nearly 150 percent during the boom in the 2000s. The huge gas fields discovered in Bolivia in the late 1990s are located in the southern province of Tarija, which now produces about 70 percent of all Bolivian gas. The massive growth in the extractive sector and the related fiscal windfall (with Tarija receiving more revenues than all other 8 provinces combined in 2014) does not seem to have produced important spillovers to other sectors. The only sector besides the oil and gas one which grew substantially more in Tarija than in the rest of Bolivia was construction.

The gas boom and associated fiscal windfall reduced poverty in producing municipalities. Data from the 2001 and 2012 population censuses indicates that the large gas discoveries were associated with significant reductions in poverty of around 10 percentage points (as measured by population without access to basic necessities) in directly affected municipalities. Gas producing municipalities also experienced a very large increase in public sector employment (more than 1 standard deviation) as well as important increases in construction and manufacturing employment. In municipalities with mining—which is more labor intensive but generated a smaller fiscal windfall—a larger reallocation of labor away from agriculture, a positive migration effect, but a smaller reduction in poverty was observed.

A DSGE model calibrated for Bolivia shows consistent results.

Commodity Boom:

The 2 percent increase in potential growth observed during the period 2006–14 (chart) is explained mostly by the commodity price boom increasing profitability in the energy and agricultural sectors, and government revenues. This allowed for more infrastructure investment, improving private sector productivity. The increase in the urban labor supply due to rural to urban migration and the substantial increase in the fraction of skilled individuals in this urban labor force helped the industrial sector to expand and take advantage of the increased private sector productivity.

In terms of distributional implications, the increase in the urban labor supply and its average skill level led to higher incomes in urban areas. These factors also reduced the skills premium, accounting for about 1/3 of the observed decline in inequality (chart). In addition, higher agricultural demand and a larger increase in productivity in agriculture (the sector with lower initial average productivity) reduces inter-sectoral inequality with the urban sector. This accounts for another 1/3 of the observed decrease in inequality. Higher government revenues allowed for a substantial expansion in social programs, which account for the remainder of the observed decline in inequality.

Commodity Bust

Model simulations suggest that the bust could reduce mediumterm potential growth by about 1½ percentage points. The forces at play are somewhat symmetric to the boom. First, the direct impact of lower commodity prices accounts for slightly more than half of the expected decline, with the rest explained by a combination of general equilibrium effects. Policies that increase fiscal space to support infrastructure investment and enhance the efficiency of such investment can halve the impact of the bust on growth.

Regarding the distributional implications, lower agricultural export prices affect large farmers more than smaller ones, and hence reduces the rural Gini. The urban Gini increases as private sector wages decline more than public sector ones, and civil servants are relatively well paid. The national Gini also rises given the increase in inter-sectoral inequality (chart). The economic slowdown triggered by the bust in energy and commodity prices also lowers incomes across the board. This reduces the pace of poverty reduction. Better targeting cash-transfers can go a long way to mitigate inequality this impact.

An IMF paper notes: “Since at least 2001, Mexico’s federal government has hedged the near-term fiscal impact of declines in oil prices through put options. Using a structural model calibrated to the Mexican economy, we quantify the overall benefits of this long-standing policy. Compared to a self-insurance alternative, we find welfare gains from hedging through put options equivalent to a permanent increase in consumption of 0.4 percent. These gains arise mostly from a reduction in sovereign spreads and to a lesser extent from smoothing income volatility. In terms of design, expanding the program to cover domestic fuel sales could yield further gains once gasoline and diesel markets are liberalized. Relying more on liquid instruments—such as options on the Brent—is an avenue worth exploring to ensure the program remains cost effective.”. Read the paper.

From iMFdirect:

While oil prices have stabilized somewhat in recent months, there are good reasons to believe they won’t return to the high levels that preceded their historic collapse two years ago. For one thing, shale oil production has permanently added to supply at lower prices. For another, demand will be curtailed by slower growth in emerging markets and global efforts to cut down on carbon emissions. It all adds up to a “new normal” for oil.

The “new” oil supply

Shale has been a game changer. Unexpectedly strong shale-oil production of 5 million barrels per day contributed to the global supply glut. That, along with the surprising decision by the Organization of the Petroleum Exporting Countries (OPEC) to keep production unchanged, contributed to the oil price collapse that started in June 2014.

Although the price collapse led to a massive cut in oil investment, production was slow to respond, keeping supply in excess. What’s more, the resilience of shale production to lower prices again surprised market participants, leading to even lower prices in 2015. Shale drillers significantly cut costs by improving efficiency, allowing major players to avoid bankruptcy. While reduced investment is expected to result in lower production by non-OPEC countries in 2016, production still exceeds consumption. Many experts expect oil markets to balance in 2017, albeit with high level of inventory (Chart 1). That said, there is uncertainty regarding supply, especially regarding the cost associated with extraction as well as production from so-called shale “fracklog”—drilled but uncompleted wells. The latter can add to production flows in a matter of weeks and hence considerably change the dynamics of production compared to conventional oil—that features long lead times between investment and production.

Against that backdrop, OPEC countries and Russia have been increasing output, and Iran’s return to markets has added even more supply. (While OPEC members have recently agreed to cut production, that agreement is yet to be finalized.) There are other factors at play. Recent data suggest that shale-oil production may be once again more resilient than expected. And the anticipation of an OPEC production cut in cooperation with other exporters has boosted prices to the level that will further stimulate output by many shale producers.

Continue reading here.

A new IMF working paper by Sebastian Acevedo studies the economic costs of hurricanes in the Caribbean by constructing a novel dataset that combines a detailed record of tropical cyclones’ characteristics with reported damages. Acevedo estimates the relation between hurricane wind speeds and damages in the Caribbean; finding that the elasticity of damages to GDP ratio with respect to maximum wind speeds is three in the case of landfalls. The data show that hurricane damages are considerably underreported, particularly in the 1950s and 1960s, with average damages potentially being three times as large as the reported average of 1.6 percent of GDP per year. He document and show that hurricanes that do not make landfall also have considerable negative impacts on the Caribbean economies. Finally, he estimate that the average annual hurricane damages in the Caribbean will increase between 22 and 77 percent by the year 2100, in a global warming scenario of high CO2 concentrations and high global temperatures.