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4. Simulation results: costly requirements on households to reduce energy use

The next scenario we attempt to simulate focuses on the labour market effects of costly requirements on households to reduce their energy use. At present the AMOSENVI model cannot be used to simulate policies aimed at changing household energy consumption behaviour. However, it can be used to examine the likely knock-on effects of reductions in household income that are likely to occur as a result. Our simulation strategy in explained in Technical Appendix 4. In short, we simulate the economy-wide impacts of a reduction in household income (on the assumption that this may accompany/result from policy actions requiring households to reduce their energy use).

Such an approach is consistent with a mandatory requirement for households to purchase costly technologies that may reduce their energy use. There will be system-wide labour market consequences of the implied reduction in household income. The reduction in household income will lead to workers bargaining for an increased nominal wage, which will in turn reduce the competitiveness of Scottish economic activity. We would also expect there to be migration effects as, in AMOSENVI, net migration is driven by real wage and unemployment rate differentials between Scotland and the rest of the UK. A lower real (take-home) wage may induce out-migration from Scotland.

Our main result (which is qualitatively robust to sensitivity analysis) is that a reduction in real household income will lead to a reduction in the level of CO2 emissions in the Scottish economy (up to 1.81% in the long-run for a 1% decrease in real household income), and also to the CO2 intensity of Scottish Production (-0.19% where real income falls by 1%), but this is at the cost of a contraction in GDP (-1.63% in the 1% scenario). This result is qualitatively only sensitive to how we specify the labour market. However, halting the decline in GDP requires a very restrictive (and most likely quite unrealistic), specification of the Scottish labour market.

Let us examine our central case scenario more carefully. As with previous simulations, results should be interpreted as being variations away from what would have happened to economic activity and environmental impacts but for the policy that reduced household income. Table 4.1 shows the aggregate results for economic, energy and environmental from such a policy in the long-run. The long-run here is a conceptual time period over which labour and capital stocks have fully adjusted to new equilibrium levels. In AMOSENVI with migration possible, this is consistent with a time period over which the real wage and unemployment rate have been restored to their initial equilibrium values, and the capital rental rate is equalised across all sectors in the economy.

Table 4.1: Short- and long-run impacts on aggregate economic, energy and environmental indicators under a 1% decrease in household income, bargaining labour market, % changes from base year

Table 4.1 shows that the initial decrease in household income leads to a 0.35% fall in the real wage in the short run ( i.e. while capital and labour stocks are fixed). (Private) consumption is down by 0.80%, and overall GDP is lower by 0.23%. Under a bargaining labour market specification with migration from and to Scotland possible, as is used here, we would expect that this would lead to outmigration. While population is fixed in the short-run, over the long run outmigration should act to restore the real wage differential between Scotland and the rest of the UK.

Figure 4.1: Long-run impact on sectoral output and employment, % changes from base year

By the long-run, GDP is 1.63% lower, and while real wages have risen back to their pre-shock levels, nominal wages are 1.33% higher and the CPI is higher. This has a damaging impact on employment and exports. The sectoral pattern of changes in output and employment is shown in Figure 4.1. Sectors that are labour intensive and export intensive suffer particularly badly, as (before tax) wages are higher and higher prices damage the competitiveness of output. Due to their export intensity, the energy sectors (with the exception of Oil) suffer the greatest long-run declines in output and employment. Sectors such as Communications, Finance and Business (which incorporates a number of the key sectors identified in the Government Economic Strategy), Transport and Distribution also suffer declines in output of more than 2% in the long run, along with Water and Construction.

The environmental consequences of this policy are lower emissions in both the short and long-run, and the decreases in CO ₂ emissions are greater than the falls in GDP. The CO ₂ intensity of production thus decreases. The time path of the changes in GDP, CO ₂ emissions and the sustainable prosperity measure are shown in Figure 4.2. The simulation is run over 150 periods in order that a long-run equilibrium is reached, although most of the adjustment to the long-run has occurred by period 120. The CO ₂ intensity of production falls immediately and is lower again in the long-run, but does not decrease monotonically before reaching its long-run equilibrium.

Figure 4.2: GDP, CO ₂ emissions and CO ₂ intensity of production following a 1% decrease in household income, bargaining labour market, % changes from base

Energy demand (both electrical and non-electrical energy demands) is lower in the short- and long-run compared to the base year, with greater reductions in the long-run. The GDP/energy indicators show positive movements in sustainability, i.e. increasing GDP per unit of energy. Positive changes in this variable show greater economic output per unit of energy, and, despite total GDP being lower - both electrical and non-electrical energy use shows a greater decline. The profile of adjustment between the short-run and long-run equilibrium path for electrical and non-electrical energy demands - along with GDP and the GDP/energy indicators - is shown in Figure 4.3.

Figure 4.3: GDP, electrical energy and non-electrical energy demands following a 1% decrease in household income, bargaining labour market, % changes from base

Our sensitivity analysis of around this scenario suggests that the key driver of these results is out-migration from Scotland, due Scottish real (take-home) wages declining relative to those in the rest of the UK. Table 4.2 below shows that the effect of 'turning off' migration to examine the difference this makes to our results.

Table 4.2: Percentage changes in long-run for aggregate economic, energy and environmental indicators under 1% decrease in household income with and without migration, bargaining labour market, % change from base

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