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Trade balance, 1973 dollars:
Impact on Economic 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 associated with pollution control investment will result in a higher growth rate and hence a higher level of employment. Our results support this analysis for the period 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 a result, we have a somewhat variegated picture of an incremental pattern of real growth over the forecast period. During the early years—1974 through 1976-real GNP is higher than the baseline solution and hence unemployment is lower. However, in 1977 and succeeeding 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 perturbed 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 utilization reduces the size of markups in several industries. Thus for the 1980–82 period the shortfall in real GNP averages only 0.7%, and in 1982 the perturbed real GNP has virtually returned to the baseline level. Impact on Investment
Turning to the major components of investment, we find that constant dollar purchases of producers durable goods are up 7.0% 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 difference declines to 0.8% in 1977 and -3.3% in 1979 before returning almost to zero. Nonresidential construction increases 13% in 1975 and 5% in 19 but reaches a maximum negative decrement of -8.3% in 1980. These decrements are due entirely to higher costs and a lower level of economic activity, since incremental pollution 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 addition stimulation exercises in which we returned housing to its baseline level. We found that stimulating the housing industry simply resulted in reducing the amount of funds available to the remaining borrowing sectors, particulary fixed business investment, and hence had relatively little short-run effect on 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 factor is offset in part by fluctuations in economic activity. Hence in 1975, when both prices and domestic output are 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 of 4.2% in 1978; this corresponds to about 500,000 cars. 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 a combination of factors which include changes in relative prices, disposable income, the rate of unemployment, and credit conditions. Gasoline prices are explicitly included but other operations and maintenance costs are 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 412% higher in 1976 but then decline sharply to a maximum decrement of 6% in 1979. After 1979, as with other macroeconomic variables, the difference between the perturbed and the baseline solution return toward zero, the difference being only 1.6% in 1982. No measure for "constant dollar" corporate 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% (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 follows much the same pattern as constantdollar GNP, with the peak positive difference of 2.4% being recorded in 1975 and the peak negative difference of 2.0% occurring in 1979. The projected levels and differences in interest rates depend, of course, upon monetary policy. Sensitivity Analyses
We now consider the results of alternative simulation analyses which tested changes in the underlying assumptions about the condition of the economy 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 be 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 GNP are also similar in nature although the timing pattern is somewhat different. The increase in producers durable equipment and nonresidential 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 412% 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.
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 Chase cyclical economic base case) shows price rises about one-fourth less than in the original analysis. Because prices rise less, the maximum decrement in real GNP which occurs in 1979 is less 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
4 The cost estimates underlving this analysis were based on the April 1973 implementation schedule announced by the administrator of EPA in April 1973 and therefore do not take account of subsequent modifications of this schedule which will reduce these costs.
by only two-thirds as much and the other disturbances 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 were seriously understated. This analysis showed the wholesale price index rising over one-fourth more by 1982 than the standard case, and the implicit GNP deflator by one-sixth, but the CPI by less than one-twelfth. These appear to be paradoxical results in that the increase in prices is smaller than the additional increase in expenditures. However, this is because the economy, and therefore the Chase macroeconomic model, contain many nonlinear and dynamic effects. These nonlinearities 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 GNP in 1977 is over twice as large, and in 1978 it is two-thirds larger. Thus the higher than proportional price increases lead, as might well be expected, to higher than proportional declines in real production and increases in unemployment; thus increases in wage rates in future years are lower than the standard analysis, hence eventually leading to some mitigating factors affecting prices.
In the fourth sensitivity analysis the timing pattern of expenditures was evened out and in some cases extended beyond 1982 in order to test the impacts of extending implementation deadlines. As expected, phasing in the expenditures more evenly until 1982 does reduce the overall rate of price increase. In 1982, the WPI is one-third lower, the implicit GNP 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 nonresidential 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 macroeconomic picture.
The figures supplied by EPA/CEQ on pollution control expenditures for the period 1973 to 1982 will have a noticeable but modest effect on the overall economy. During this ten-year period, prices will average approximately 0.2% 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 0.3% more, the implicit GNP deflator increases an average of 0.4% more, and the WPI increases an average of 0.8% more per year. The maximum difference of 1.9% for 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 in turn results in a rate of 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 investment, while prices are only some 2% higher.
We also experimented with various alternative assumptions concerning the underlying economic scenario and the level and timing of expenditures. The 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 raise the incremental change in prices about two-fifths in the peak years and would also have a greater negative effect on real growth and employment. Finally, 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.
Mr. Powers. I notice in the footnote in the study that you have there from the Department of Commerce that excluded from these billiondollar totals are any agricultural expenditures. It is footnote 1 that notes that that data is not contained. Is there any data on agricultural expenditures contained in the Chase/EPA study?
Mr. BRANDS. Yes, there is. We include in that both the investment and the additional operating costs associated with such things as dairies, feedlots, and other agriculutral enterprises which are covered by our regulations.
Apparently, the Department of Commerce, in their sampling, did not include agricultural enterprises.
Mr. Powers. Do you have any idea at this time as to what the investment will have to be by the agricultural sector of the economy?
Mr. Brands. I can roughly estimate that, again from this same report. Apparently, we have different numbering. I have an earlier version, 1 guess.
With respect to dairies, we indicate that the total investment required for the 1977 deadline is something like $275 million. If we add to that the feedlots, the total is an additional $40 million, so that is a little over $300 million. And I believe those are the principal agricultural activities affected by our regulations, although there are some costs associated with cane sugar and some seafoods, if you wanted to include those activities. But, primarily, it is the first activities. So we are talking about investment costs of a little over $300 million.
Mrs. FENWICK. Could you give me the figures again? Dairies arewhat?
Mr. BRANDS. Dairies are about $275 million and feedlots about $40 million. These are the aggregate investment capital expenditure dollars associated with those two activities.
Mr. POWERS. Solely restricted to pollution control equipment ? Mr. BRANDS. Yes; that is correct. Mrs. FENWICK. I have one more question. I am sorry, Mr. Chairman. What clause in the law makes it possible that your permit should be a protection against a citizens suit? How do you know it is and what clause in the law makes that possible, do you know?
Mr. AGEE. Section 505 governs the scope of citizens suits.
Mr. Suti. I am just a little bit puzzled about the figure of $40 million for feedlots and $275 million for dairies. I can see that it would be more costly for dairies, because to start with there are more dairies that are subject to rules and regulations, and with 691 feedlots now feeding 55 percent of the Nation's cattle, I suppose they are large, they would have a large facility involved and it would be a cheaper cost per animal. Is there any other explanation for that?
Mr. BRANDS. Well, I have before me some data, which indicates in the case of dairies we show something close to 5.000 dairies. Now, let me make one point: The dairies category it is really milk processing as opposed to a dairy farmer. A dairy farmer falls in the category of feedlots. So we show something like 4,800 dairies, and $275 million is associated with that.
Mr. SMITH. You mean the $10 million covers both cattle feeding and dairy production?
Vr. BRANDS. Yes. Your dairy farmers; that is correct. It is not associated with milk processing.