CGE model of pollution abatement processes for assessing the economic effects of environmental policy

Economic Modelling 1995 12 (1) 53-59

CGE model of pollution abatement processes for assessing the economic effects of environmental policy Deborah Vaughn Nestor and Carl A Pasurka Jr

We use a computable general equilibrium (CGE) model to investigate the impacts of environmental regulations on the German economy. Our assessment differs from most previous CGE studies of environmental policy in that our model is based on a dataset in which the specific inputs used for pollution abatement processes are in input-output matrix form. This allows us to model pollution abatement processes more accurately. We use the model to compare the impacts of environmental policy to the impacts of tariffs, non-tariff barriers (NTBs) and production subsidies. At a minimum, the impacts of environmental programs on the German economy are comparable to these other distortionary government policies. Depending upon the source of capital stock for complying with environmental regulation, the economic impacts may be substantially larger than those observedfor other economic policies. Keywords:Computable general equilibrium; Pollution abatement; German economy

As in most industrialized nations, pollution control became a central focus of government policy for Germany beginning in the 1970s. In addition, the regulatory and environmentalist communities often view Germany as a progressive country regarding pollution control, having, for example, some of the strictest ambient air quality standards in the world. The available data on international pollution control expenditures supports that perception, to some degree. According to data collected by the Organization for Economic Cooperation and Development (OECD [14]), Germany ranked ahead of all other countries for which data were collected, having pollution control ]1 I

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Till

I I

I I

The authors are with the Economic Analysis and Research Branch, US Environmental Protection Agency (2127), 401 M Street, SW, Washington, DC 20460, USA. The authors thank Glenn Harrison for assistancewith the MPS/GE program, Doug Nyhus and Carsten Stahmer for assistance with data, and an anonymous refereefor helpfulcomments. Any errors, opinions, and conclusions are the authors' and should not be attributed to the US Environmental Protection Agency.An earlier version of this paper was presented at the 4th CGE Modeling Conference in Waterloo, Ontario (October 1992). Final manuscript received20 May 1994. 0264-9993/95/010053-07 © 1995 Butterworth-Heinemann Ltd

expenditures ranging from about 5% higher than the USA to 85% higher than Norway in 1985.1 The prominence of environmental programs in Germany has logically raised concerns regarding their effects on the economy. In this study, we use a computable general equilibrium (CGE) model to investigate the impacts of environmental regulations on the German economy. We chose a CGE approach because of its advantages over a partial equilibrium analysis of environmental policy. In particular, the C G E framework captures interrelationships among economic sectors and accounts for the repercussionary effects of policy. A number of previous studies have acknowledged this important advantage. Our analysis is similar to these previous studies in that we focus on costs and make no attempt to assess the benefits of environmental regulation. However, our assessment differs from previous work in one important regard. Our model is based on a dataset in which the specific inputs used for pollution abatement processes are in input-output matrix form. This allows us to model pollution 1This is the most recent year for which cross-country data are available. 53

CGE model of pollution abatement processes: D V Nestor and C A Pasurka Jr

abatement processes more accurately than most previous CGE analyses of environmental regulation. Furthermore, we model environmental regulation as command and control since, in a retrospective sense, this has been the predominant approach to environmental policy. Thus, we focus on assessing the size of the actual economic impacts rather than on the choice of policy instruments or the efficiency gains from switching to incentive based policy. 2 The analysis is conducted by comparing the impacts of environmental policy with the impacts of other economic policies in Germany, namely tariffs, nontariff barriers (NTBs) and production subsidies. We compare the welfare change for the representative household in Germany (measured as Hicksian equivalent variation) associated with a 1% increase in environmental control costs to the welfare change for a 1% increase in tariffs and NTBs and a 1% reduction in production subsidies. These comparisons give an indication of the relative magnitude of the effects, and hence, the relative importance of environmental control costs to the German economy. This analysis indicates that concerns regarding the economic impacts of environmental regulation are justified. At a minimum, the impacts of environmental programs on the German economy are comparable to these other distortionary government policies. Depending upon the source of capital stock for complying with environmental regulation, the economic impacts may be substantially larger than those observed for other economic policies. The remainder of this study is organized as follows. The next section outlines the basic CGE model of the Germany economy; our approach to modelling the technology of pollution abatement is then detailed, followed by a discussion of data sources and the calibration of the model. A section then compares the effects of environmental policy with other economic policies undertaken in the German economy. This comparison shows that environmental policy has effects that are relatively large. Finally, all results and conclusions are summarized.

Model of the German economy To assess the effects of environmental regulation, we first specify a CGE model of the Germany economy.

2Several studies have explored issues pertaining to the relative efficiency of policy instruments. Bergman [2] investigates the impacts of environmental policy while allowing for tradable permits. Boyd and Uri [3] compare a command and control approach to an emissions tax, while Conrad and Schr6der I-4] compare several policy alternatives for reducing CO 2 emissions. Ballard and Medema 1-1] investigate the implications of replacing traditional taxes with Pigouvian taxes on externalities.

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Table 1. Classification of model sectors. Sector number 1

2 3 4 5 6 7 8 9 10 11 12 13

14

Description Agricultural, forestry and fishing products Electricity, gas, water, mining products Chemicals, chemical products Petroleum products Plastic and non-metallic products Basic metal products Machinery (except electrical), transport equipment Electrical machinery, fabricated metal products, nec Textiles, leather, wood, paper and products Food, beverages, tobacco Construction Trade, transport and communication services Other market services except environmental protection services Non-market services except environmental protection services

Our model is a fairly standard CGE model and we discuss it only briefly. 3 The model is a static CGE model of an open economy. The US input-output (I-O) table is scaled to represent foreign trade with the rest of the world (ROW). This allows us to model the Germany economy as having some effect on ROW prices (ie Germany is not a small country). We use the standard Armington assumption that imports are imperfect substitutes in both production and consumption. Following Schfifer and Stahmer [17] the German economy is comprised of 14 producing sectors, an external environmental protection sector, a household sector, government, and a foreign sector. All markets operate under conditions of perfect competition. Table 1 lists the producing sectors of the German economy in our model. We assume labor is mobile across industries but immobile across regions while capital is mobile across industries as well as between Germany and the ROW. Given income from the sale of capital and labor, households choose a consumption bundle consisting of foreign and domestically produced output from the 14 industries and maximize utility subject to a budget constraint. Production in the German and ROW economy is represented as a hierarchy of CES production functions. At the top of the hierarchy, firms combine value-added and a composite intermediate good according to a CES production technology. In an underlying level, capital and labor are combined in a CES production function to form value-added. Similarly, composite intermediate inputs are formed first by combining domestic and foreign goods of the same type in a CES production function and second, by combining domestic-imported composites in a 3The details of the formal model are provided in an appendix available upon request from the authors.

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C G E model o f pollution abatement processes: D V Nestor and C A Pasurka Jr

CES production function. Given wages, the rental price of capital, and intermediate factor prices, firms maximize profits subject to the production function. Each industry, of course, is able to purchase all the labor, capital, and intermediate inputs it needs at market prices. Finally, the German government collects taxes and tariffs and pays the resulting revenues to households as transfer payments. The government sector also has an important role regarding the provision of environmental protection services, which we describe in the next section.

Pollution abatement processes One advantage to our evaluation of German environmental programs lies in the modeling of pollution abatement processes. Because we have data on the exact inputs used by German industries for environmental protection, we are able to explicitly model pollution abatement technology. This contrasts to previous models of environmental regulation, which due to data limitations, have relied on simplifying, more restrictive assumptions.* Sch/ifer and Stahmer [17] have adjusted the 1980 I ~ ) table for the Federal Republic of Germany to isolate inputs to environmental protection activities. They (SS) identify three types of environmental protection activities in the Germany economy: external, internal, and fixed capital formation for environmental protection. Within the SS framework, external environmental protection activities are represented as separate rows and columns in an I-O matrix. External environmental protection activities include, for example, the services of solid waste disposal and sewage treatment. Internal environmental protection activities are ancillary activities (analogous to administration or research and development) and are measured by the inputs purchased for and combined as pollution abatement activity by the polluting industry. Internal environmental protection activities are not separated from the main activities of an establishment, and in the I-O framework are accounted for by separating out that portion of total inputs used by polluting industries for pollution abatement. The category fixed capital formation (or investment) for environmental protection represents the accumulation of fixed assets *For example, Jorgenson and Wilcoxen [11,12] assume that an industry's production function for environmental protection directly mirrors its output production function (see Wilcoxen [18] p 35). Hazilla and Kopp [10] invoke a similar assumption. More recently, Ballard and Medema I-1] assume that pollution abatement activities involve only purchases of capital and labor. Boyd and Uri [3] model the installation of emission control devices at electric utilities as simply an increase in the price of electricity. Conrad and Schrrder [4], in contrast, explicitly model pollution abatement, but focus only on the German state of Baden-Wiirttemberg.

Economic Modelling 1995 Volume 12 Number 1

Table 2. Schiifer--Staluner representation of environmental protection activities in the German economy. Input-output matrix adjusted for environmental protection activities X + X EP

X~n+.

y + yEe

q + qee

X~.+ ii

X~,,+ 1..+ l~

v~.+ .

q~.+ .

V + pEP

p(n+ ii

q, +q,Ee

q~+l)

Externalization of internal environmental protection activities

x

x,.+.+.W.

y + yEe

q + qee

X~+ t~+ X ,EP+ vEP

X~+ I~+ ,

r,.+,,

ExT+Er~ +q(n+ 1)

V

V(,,+ll

q,+q,rl"

EP EX..+E v EP

+qln+ 11

for environmental protection and corresponds to gross private domestic investment in the I-O format. As an example, the purchase of a scrubber represents the accumulation of capital for air pollution abatement. For illustrative purposes, the three categories of environmental protection activities are now described in the context of the I-O accounting framework. In the first part of Table 2, the entries depicted by the column vector X(,+t) represent the value of the products purchased as intermediate inputs from other sectors in the economy for performing external environmental protection activities. The corresponding row vector X~,+ t} represents the value of the external environmental protection activities that other industries purchase for use as an intermediate input. The entry X{,÷x}{,÷t) is the amount of external environmental protection activities purchased by the external environmental protection sector. In the first part of Table 2 the internal environmental protection activities appear as an adjustment to the n x n matrix of non-environmental intermediate inputs, X, and the 1 x n vector representing non-environmental valueadded, V. This adjustment is reflected by X ~r and V re, respectively. Finally, investment environmental protection activities are embodied in final demand, depicted by the nx 1 vector ire. y, of course, represents the n x 1 vector of non-environmental final demand. The row vector q,re represents the total costs of pollution abatement while the corresponding column vector qee represents total demand (intermediate and final) for inputs used in pollution abatement processes. As Schfifer and Stahmer note, the presentation of 55

C G E model o f pollution abatement processes: D V Nestor and C A Pasurka Jr

environmental protection activities illustrated in this way is cumbersome. To simplify the presentation of environmental protection activities in the I-O tables, Sch/ifer and Stahmer propose externalizing internal environmental protection activities. The second part of Table 2 provides a schematic representation of the externalization procedure. The process involves transfering the inputs associated with environmental protection to the column in the I-O table that represents external environmental protection activities. X,eP,is the n x 1 column vector in which each element is the row sum of the matrix X Ee, and Xe,e is the 1 x n row vector in which each element is the column sum of the matrix X Ee. Reading down column (n+ 1) in Table 2 gives the value of each intermediate and primary input used in pollution abatement activity in the economy. As shown by row (n + 1), the inputs used for internal EP activities in each sector are aggregated with purchases of external environmental protection activities. The individual entries in row (n+l) become total operation and maintenance costs for environmental protection undertaken by business sectors. For purposes of modelling the impacts of environmental regulation, we follow the convention developed by Sch/ifer and Stahmer (1989) and externalize environmental protection expenditures. Next, we assume that the technology to abate pollution is separate and distinct from the technology to produce economic goods or services. This is equivalent to assuming that emission controls are end of the pipe. 5 Conceptually, we model environmental regulation as being performed by an environmental agency (Gova). Gov a collects abatement expenditures as environmental production taxes and uses the revenues to hire the intermediate inputs and primary factors needed to provide environmental protection activities. 6 The cost of the inputs used in pollution abatement constitutes the environmental production tax. Stated formally, the environmental tax rate for sector j (t~) is

+plsX15j

e G p~Xij+w L je + r K je

tj--e-- Li=I

A

exI

ext

tje - P15X15j pjX j

j = 1..... 14

where X ~ ) is industry j's purchases from the consolidated environmental protection sector (ie an environmental protection sector with all pollution abatement expenditures externalized). Further, Gov a has a utility function for the activity of collecting environmental 'taxes' which has no relationship to the rest of the economy. Equivalently, environmental protection activities represent nonproductive uses for intermediate inputs and primary factors. This assumption allows us to avoid measuring and modeling the benefits of environmental regulation (eg improvements in human health). As is the case for the capital and labor used to produce economic goods and services, capital and labor employed in environmental protection activities are owned by the representative household in Germany (HGer). Also, there is a lump-sum transfer for H aer to Gov ~ equal to the value of environmental protection services consumed as part of final demand. The collection of this revenue, of course, allows Gov a to employ capital, labor and intermediate inputs for the purpose of producing environmental protection services consumed as final demand. Further, it insures that all income is spent in the base case equilibrium. Because we have assumed that provision of environmental protection activities represents nonproductive employment of resources, households do not derive utility from these activities. This occurs since environmental quality/damage is not incorporated into the representative household's utility function.

Data, calibration and selection of elasticities j = 1..... 14

pjXj

where X.tJ ~. is the quantity of intermediate input i used for pollution abatement by industry j, p~ is the price of input i, L~ is the amount of labor used by sector j in internal environmental protection activities, K~ is 5This is a reasonable assumption since, in 1980, the year of the data for which we calibrate the model, 76% of all pollution abatement expenditures were for end of the pipe technologies (Leipert and Simonis [13] p 304). 6 This tax should not be confused with a Pigouvian tax on emissions. In our model, pollution abatement expenditues increase production costs and this cost increase is modelled as a tax.

56

the amount of capital used by sector j in internal environmental protection activities, X l s j is the amount of external environmental protection activities used by industry j, w~ is the German wage rate, r is the price of capital, and pjXj is gross output for sector j. In terms of externalized internal environmental protection activities,

We calibrate the model of pollution abatement activities in the German economy using 1980 data. Because pollution abatement activities are assumed to be end of the pipe, we calibrate the production functions for all sectors in the model using only those inputs used in the production of economic goods and services. 7 In order to model production technology as CES, we need a variety of elasticities. Elasticities of primary factor substitution and elasticities between domestic 7 The sources for data as well as data construction techniques are detailed in an appendix available upon request from the authors.

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C G E model o f pollution abatement processes: D V Nestor and C A Pasurka Jr

Table 3. Elasticities of substitution (standard errors in parentheses).

Sector 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Between capital and labor

Between domestic and imported goods

Germany

ROW

Germany

ROW

0.9450 (0.0407) 0.4256 (0.1050) 1.009 (0.0268) 0.2930 (0.1016) 0.9717 (0.0820) 0.9110 (0.2411) 1.202 (0.0910) 0.9808 (0.0267) 0.9044 (0.1036) 0.9205 (0.0519) 3.125 (0.817) 1.487 (0.4311) 3.125 (0.817) 1.988 (0.477)

0.9450 (0.0407) 0.4256 (0.1050) 1.009 (0.0268) 0.2930 (0.1016) 0.9717 (0.0820) 0.9110 (0.2411) 1.203 (0.0972) 0.9808 (0.0267) 0.9509 (0.1015) 0.9344 (0.0456) 3.125 (0.817) 1.463 (0.442) 3.125 (0.817) 1.988 (0.477)

2.00

2.00

0.65

0.59

2.00

2.00

0.34

0.34

0.72

0.66

0.80

0.86

2.66

3.65

1.30

1.30

2.00

2.50

1.40

1.40

2.00

2.00

2.00

2.00

2.00

2.00

2.00

2.00

and imported goods were constructed on the basis of the elasticities presented in Harrison et al [9]. These are presented in Table 3. Following Harrison et al [8], we set the elasticity of substitution among the composite intermediate inputs at 2 and the elasticity of substitution between the composite intermediate input and the composite value-added at 1.

Impacts of environmental policy: a comparison to other economic policies To compare the effects of environmental regulation to the effects of other economic policies in Germany, we solve the model for six counterfactual equilibria, each representing an incremental change in policy. In addition to environmental programs, tariffs, non-tariff barriers (NTBs) and production subsidies are examined. The six counterfactual scenarios represent: (1) a 1% increase in tariffs; (2) a 1% increase in NTBs; (3) a 1% increase in total trade barriers (tariffs plus NTBs); (4) a 1% reduction in production subsidies; (5) a 1% increase in environmental control costs under the assumption of full crowding out; and (6) a 1% increase in environmental control costs under the assumption of no crowding out. Under full crowding out, it is assumed than the capital stock needed to comply with environmental regulations is completely drawn from productive capital stock. In contrast, the no crowding Economic Modelling 1995 Volume 12 Number 1

Table 4. Rates for tariffs, NTBe, production subsidies and environmental control costs.

Sector

Tariff rates ~

NTBs ~

Production subsidies b

Environmental control costs b

1 2 3 4 5 6 7 8 9 10 11 12 13 14

4.70 0.00 8.00 1.80 4.10 4.60 6.20 8.30 5.80 11.20 0.00 0.00 0.00 0.00

3.60 0.00 0.00 0.00 0.20 8.20 3.00 1.00 2.60 4.50 0.00 0.00 0.00 0.00

1.20 0.20 0.01 0.02 0.01 0.03 0.02 0.02 0.03 0.07 0.19 0.15 0.01 0.01

0.00 1.09 2.16 0.65 0.69 0.69 0.24 0.32 0.47 0.40 0.13 0.06 1.26 0.00

a Percentage of the value of imports. b Percentage of gross industry output. Source: Tariff rates and NTBs are for 1987 (post-Tokyo Round) and are derived from Saxonhouse and Stern [16]. NTBs are ad valorem equivalents. Production subsidies levels are for 1980 and are derived from Dicke et al [5]. Environmental control costs are reported in and taken directly from Schfifer and Stahmer [17].

out scenario assumes that environmental regulations result in no drawing down of productive capital stock. Examination of the no crowding out versus the full crowding out assumption allows us to gauge the importance of the source of capital stock for pollution abatement to the model results, a Table 4 provides the level of tarrifs, NTBs, production subsidies, and environmental control costs as a percentage of total production costs in the German economy. These values serve as the reference points for computing one percent policy changes for each counterfactual scenario. We calculate the welfare change (measured as Hicksian equivalent variation, EV) for the representative household in Germany for each counterfactual scenario. To make these welfare changes comparable across policies, we normalize by dividing by the associated changes in revenues (eg for tariffs) or expenditures (eg for production subsidies and environmental programs). We also examine the sensitivity of the results to the specified values for the elasticities, applying the procedures developed in Harrison and Vinod [7-1 and following the example presented in Harrison, Rutherford and Tarr [8]. 9 In essence, the sensitivity analysis involves executing a set of 1000 Monte Carlo simulations. In these simulations, the elasticities are systematically perturbed from their 8 Under full crowding out, the capital stock remains constant from the base case to the counterfactual scenarios. Under no crowding out the German endowment of capital is increased by 1% of the capital stock required for environmental protection activities in the base case. This approximates the level of capital stock needed to comply with the increment in environmental regulations. 9 We solve the GE model using MPS/GE (see Rutherford [15]) and perform sensitivity analysis using MPSS (see Harrison [6]).

57

CGE model of pollution abatement processes: D V Nestor and C ,4 Pasurka Jr Table 5. Equivalent variation (EV) as a proportion of revenue/expenditure associated with an incremental change in various policies. Policy

Point estimate

Mean

Standard error

Minimum

Maximum

Tariff Increase Increase in NTBs Increase in tariffs+ NTBS Decrease in production subsidies Increase in environmental control costs (1)a Increase in environmental control costs (2)b

1.126 0.499 1.624 0.071 -0.887 -0.473

0.501 0.515 0.505 0.071 -0.883 -0.481

0.015 0.014 0.014 0.004 0.008 0.005

0.47 ! 0.487 0.478 0.055 -0.909 -0.501

0.534 0.548 0.536 0.082 -0.865 -0.466

Increase in environmental control costs (1)= full crowding out. b Increase in environmental control costs (2)= no crowding out.

benchmark values, as presented in Table 3. We allow the elasticities of primary factor substitution to assume five values within a normal distribution (note that Table 3 presents standard errors for the elasticities of substitution between the primary factors). In addition, we allow the elasticity of substitution between the composite intermediate input and the composite value-added to assume the values of either 0.0, 0.5, or 1.0.1° For each of the 1000 perturbations, a counterfactual solution is generated and the estimated welfare changes are tabulated as a probability distribution. This procedure of calculating 1000 counterfactuals is followed for all six scenarios. Table 5 presents the results. The column titled point estimate gives the welfare changes obtained when the substitution elasticities are set at the benchmark values and 1 for the composite intermediate input and value-added components. The remaining columns provide the sensitivity analysis results. These results highlight the importance of conducting sensitivity analysis of CGE results. More specifically, the point estimates for E V for the tariff and the tariff plus NTBs counterfactual scenarios fall outside the range of values indicated by the minimum and maximum of the sensitivity analysis. This suggests that the results obtained with the benchmark specification for the substitution elasticities are not representative for the tariff and tariff plus NTBs policy simulations. For the NTBs, production subsidies, and both environmental policy scenarios, however, the point estimates fall within the range indicated by the sensitivity analysis. This suggest that the results for these four policy scenarios are robust with regard to the various values for the elasticities. Note that EV>O over the full range of results, or welfare increases for the representative household in Germany, when tariffs and NTBs are increased and production subsidies are decreased. The increase in welfare associated with an incremental increase in tariffs, NTBs, and total trade barriers is expected since Germany is modelled as a large country, having some 10 These assumptions follow the convention of Harrison et al [8].

58

influence over world prices (ie we are observing a terms of trade effect). In contrast, an incremental increase in the stringency environmental regulations results in a welfare loss (ie EV<0). This is also expected because pollution abatement expenditures decrease consumption activities for the representative household. Furthermore, benefits are not incorporated into the model. If the benefits were explicitly incorporated, then it is possible that welfare would rise with an increase in the stringency of environmental regulations. It is useful to focus on relative magnitudes as opposed to direction for the changes. This gives a frame of reference and allows us to gauge whether the effects of environmental policy are large or small in comparison to other policies. In addition, we conduct the comparison on the basis of the sensitivity analysis results since the benchmark results for the tariff and the tariff plus NTBs scenarios are not representative. The model estimates that for each DM of pollution abatement expenditure, the representative consumer in Germany would be willing to pay between 47 and 91 pfennigs to avoid the decrease in welfare. As expected, the lower bound represents the case of no crowding out while the upper bound represents full crowding out. For the other policies, EV>O and the results are interpreted as the maximum amount that the representative consumer would be willing to pay to see a DMI increase in tariffs, NTBS, and total trade barriers, or a DM 1 decrease in production subsidies. The range is 47-53 pfennigs for tariffs, 49-55 pfennigs for NTBs, 48-54 pfennigs for total trade barriers and 6-8 pfennigs for production subsidies. Thus, the marginal welfare change associated with environmental programs is larger than the change associated with production subsidies and is comparable to tariffs, NTBs, and total trade barriers. Depending upon the source of the capital stock, the effect of environmental policy is potentially larger than the effect of all of the policies examined. These results suggest that when the benefits of environmental regulation are ignored, the reduction in welfare for the representative household in Germany is potentially large. An additional interpretation is that the next increEconomic Modellin9 1995 Volume 12 Number 1

CGE model of pollution abatement processes: D V Nestor and C A Pasurka Jr

ment in environmental regulation must yield benefits that range between 47-91 pfennigs per deutschmark of pollution abatement expenditure to be welfare improving for the representative household in Germany, The result that an additional deutschmark of pollution abatement expenditure needs to yield benefits of less than DM1 is not surprising. The reason is that expenditures on pollution abatement do not shift the representative household's utility function directly, but reduce it indirectly through the effects on production costs, and thus, sector prices. This result is interesting from a policy standpoint as it illustrates that choosing environmental programs on the basis of a marginal benefits equals marginal costs criteria may be inappropriate.

Summary and conclusions We have applied a CGE model to investigate the impacts of environmental regulations on the German economy. The primary advantage of our assessment lies in the modeling of pollution abatement processes. Because we have data on the exact inputs used by German industries for environmental protection, we are able to model pollution abatement processes more accurately than most previous CGE assessments of environmental regulation. Further, our results highlight the importance of conducting sensitivity analysis of CGE results. The results are of interest from a policy perspective. At a minimum, the impacts of environmental programs on the German economy are comparable to other distortionary government policies. This result is highly sensitive to assumptions regarding the source of capital stock for complying with environmental regulation, which indicates the need for empirical investigation of the impacts of environmental regulation on a nation's productive capital stock. This result also indicates that concerns regarding the economic impacts of environmental policy are valid, since the impacts are similar in magnitude to other economic policies which are often controversial. Another important insight is that an additional deutschmark of pollution abatement expenditure needs to yield benefits of less than DM1. This illustrates the dangers of conducting benefit-cost analysis of environmental policy in a partial equilibrium framework, where the choice to regulate is typically guided by the marginal benefits equals marginal costs rule.

References 1 Ballard, Charles L and Medema, Steven G 'The marginal efficiency effects of taxes and subsidies in the presence of externalities: a computational general equilibrium approach' Journal of Public Economics

Ecomm~ic Modelling 1995 Volume 12 Number I

.... 1 ~ 3 5~ 199,-216 2 Bergman, Lars 'General equilibrium effects of environmental policy: a CGE modeling approach' Environmental and Resource Economics 1991 1 (1) 43-61 3 Boyd, Royd and Uri, Noel 'The cost of improving quality of the environment' Journal of Policy Modeling 1991 13 (1) 115-140 4 Conrad, Klaus and Schr6der, Michael 'Choosing policy instruments using general equilibrium models' Journal of Policy Modelin 9 1993 15 (5, 6) 521-543 5 Dicke, Hugo, Donges, Juergen B, Gerken, Egbert and Kirkpatrick, Grant 'The economic effects of agricultural policy in West Germany' Welwirtschaftliches Archiv 1988 124 (2) 301-321 6 Harrison, Glenn The Sensitivity Analysis of Applied General Equilibrium Models with MPSS: User's Guide unpublished manuscript, Department of Economics, University of South Carolina (1990) 7 Harrison, Glenn and Vinod, D H 'The sensitivity analysis of applied general equilibrium models: completely randomized factorial designs' The Review of Economics and Statistics 1992 74 (2) 357-362 8 Harrison, Glenn, Rutherford, Thomas F and Tarr, David G Piecemeal Trade Reform in Partially Liberalized Economies: An Evaluation for Turkey Working Paper No WPS 951, Country Economics Department, The World Bank (1992) 9 Harrison, G W, Rutherford, T F and Wooton, I 'An empirical database for a general equilibrium model of the European communities' Empirical Economics 1991 16 (1) 95-120 10 Hazilla, Michael and Kopp, Raymond 'Social cost of environmental quality regulations: a general equilibrium analysis' Journal of Political Economy 1990 98 (4) 853-873 11 Jorgenson, Dale W and Wilcoxen, Peter 'Environmental regulation and US economic growth' RAND Journal of Economics 1990 21 (2) 314-340 12 Jorgenson, Dale W and Wilcoxen, Peter 'Intertemporal general equilibrium modeling of US environmental regulation' Journal of Policy Modeling 1990 12 (4) 715-744 13 Leipert, Christian and Simonis, Udo Ernst 'Environmental damage-environmental expenditure 1: statistical evidence on the Federal Republic of Germany' The Environmentalist 1990 10 (4) 301-309 14 Organization for Economic Cooperation and Development (OECD) Pollution Control and Abatement Expenditure in OECD Countries: A Statistical Compendium OECD Environment Monographs No 38 (1990) 15 Rutherford, Thomas F General Equilibrium Modelling with MPS/GE unpublished manuscript, Department of Economics, University of Western Ontario (1989) 16 Saxonhouse, Gary R and Stern, Robert M 'An analytic survey of formal and informal barriers to international trade and investment in the United States, Canada, and Japan' in Stern, Robert M (ed) Trade and Investment Relations among the United States, Canada and Japan University of Chicago Press, Chicago (1989) 17 Sch~ifer, Dieter and Stahmer, Carsten 'Input-output model for the analysis of environmental protection activities' Economic Systems Research 1989 1 (2)203-228 18 Wilcoxen,Peter The Effects of Environmental Regulation and Energy Prices on US Economic Per[ormance PhD dissertation, Harvard University (1988) 59