8. The joint effects of energy prices and carbon taxes in the French manufacturing sector

The chapter is a summary of “The joint effects of energy prices and carbon taxes on environmental and economic performance: Evidence from the French manufacturing sector” (2020[4]) by D. Dussaux, published as OECD Environment Working Paper No. 154.

Among market-based environmental policy instruments, energy taxes are a common tool to incentivise reductions in energy use and thus ultimately in carbon emissions (Jacobsen, 2015[1]). While these market-based instruments are associated with lower abatement costs compared to regulatory instruments (Holland, 2012[2]) and do not interfere with consumption choices (Gayer and Viscusi, 2013[3]), they do impose real costs on consumers. Because energy taxation increases production costs, policy makers fear negative consequences for firms in terms of a reduction of output or employment from these policies.

In 2013, France introduced a carbon tax. After a gradual phase-in, the carbon tax amounted to EUR 44.6 per tonne of carbon since 2019 (Figure 8.1. ). Evaluating the environmental and economic impacts of this large-scale policy instrument is crucial to understand actual firm-level responses to this policy.

There are several reasons why firms’ reactions to changes in energy prices are likely to differ according to the firm’s size. First, large firms are more efficient than small firms not only because of economies of scale but also because they can incur the fixed cost required for energy efficiency investments. Therefore, smaller firms have more room for energy-efficiency gains than larger firms, which might not be able to reduce energy use without cutting output and thus lowering employment. Similarly, larger firms might have greater capacity to offshore or outsource part of their production in response to changes in energy prices, while small and medium-sized firms might be driven out of the market. This could imply that large firms are more affected by higher energy prices in terms of employment or output. Last but not least, small surviving firms might be able to capture the market share of other small firms that exit the market because of the energy cost increase. However, whether and by how much the effects may differ according to the size of firms remains an empirical question.

The study summarised here contributes to the literature investigating the direct effects of higher energy prices on energy use as well as to the literature evaluating joint outcomes of environmental policies more broadly. The previous literature investigating the relationship between energy prices and energy use has found non-negligible fuel and electricity price elasticities, especially in the long run (Houthakker, 1951[5]; Taylor, 1975[6]; Bohi and Zimmerman, 1984[7]; Al-Sahlawi, 1989[8]; Espey, 1996[9]; Brons et al., 2008[10]; Havranek, Irsova and Janda, 2012[11]; Labandeira, Labeaga and Lopez-Otero, 2017[12]).

This study adds to this literature by investigating the way in which firms actually reduce their energy consumption, i.e. through fuel switching, input substitution or investment in pollution abatement technologies. The literature investigating economic and environmental outcomes of changes in environmental policies (Greenstone, List and Syverson, 2012[13]; Walker, 2013[14]; Martin, de Preux and Wagner, 2014[15]; Wagner et al., 2018[16]; Flues and Lutz, 2015[17]; Gerster, 2015[18]; Petrick and Wagner, 2014[19]) finds a reduction in the use of energy inputs and thus in carbon emissions in response to tighter environmental policies, but is ambiguous regarding the effect on economic outcomes.

Firm and sector heterogeneity is often not investigated in detail and the economic outcomes considered vary across studies. The most relevant paper to the study at hand also investigates the impact of energy prices on employment and environmental performance in the French manufacturing sector for the years 1997 to 2010 (Marin and Vona, 2017[20]), but focuses only on surviving plants. Marin and Vona (2017[20]) find that a 10% increase in energy prices is related to a reduction of 6% in energy consumption, an 11% reduction in CO2 emissions and a decrease in employment by 2.6% with a small impact on wages and productivity. The study by Marin and Vona (2017) is based on plant-level data and does not investigate firm-level responses such as real output, investment and patenting activity.

The study summarised in this chapter offers one of the first comprehensive, causal analyses of the effect of energy taxes by combining a firm-level with an industry-level analysis. Using a unique dataset of 8 000 French manufacturing firms from 2001 to 2016, an instrumental variable approach is used to provide a causal analysis. The study investigates multiple economic outcomes, namely output, employment, investment in terms of pollution abatement capital expenditure, and patent applications. In addition, firm-level heterogeneity is explored in terms of the energy-intensity and the size of firms. The industry-level analysis complements the firm-level analysis by taking into account reallocation effects between firms.

The empirical analysis comprises two parts, a firm-level and an industry-level analysis. The firm-level analysis identifies firms’ responses to exogenous changes in energy prices by relying on the use of the fixed-weight energy price index by Sato et al. (2019[21]) as an instrumental variable for average energy costs. Using fixed instead of average weights helps to avoid endogeneity issues associated with firms potentially being able to affect energy demand and energy prices simultaneously. Moreover, these energy prices are measured at the industry-level and can therefore be assumed to be exogenous at the firm-level. This is not the case at the industry-level, making this analysis rely on stronger assumptions than the firm-level analysis. The strong advantage of the industry-level analysis is, however, that it is able to analyse between-firm adjustments, for example, through new firms entering the market as it is not restricted to surviving firms. The comprehensive employment data covers the whole population of French firms, thus allowing to calculate job destruction and job creation metrics, following Davis and Haltiwanger (1992[22]).

The following model is estimated at the firm-level for several outcome variables, using a fixed-effects, two-stage least squares estimator:

yit=β0+β1Costit-1+β2Xit-1+μi+γt+εit 

where yit is an outcome variable of firm i at time t (i.e. energy use, number of workers, real output, etc.). Cost is the log of average energy cost measured by the ratio between energy expenditure (electricity and other energy carriers) and the purchased quantity in tonnes of oil equivalent. X is a vector of firm-level control variables, including a dummy equal to 1 when the firm is subject to the European Union Emissions Trading System and the average age of the firm’s plant. These control variables are lagged by one year in order to account for the time lag firms need to adjust to new energy prices. μi are firm fixed effects, γt are year dummies and εit is the remaining error term. In order to test for heterogeneous effects across firm size, two interaction terms are added to the model, differentiating the effect by firm size and energy intensity. The average energy cost is interacted with (i) a dummy variable equal to 1, if the firm has less than 250 employees in the first year it is observed, and (ii) a continuous variable indicating the energy use per employee of the firm in the first year it is observed.

The empirical model at the industry level differs slightly from the firm-level model, with the following equation being estimated:

ykt=α0+βFEPIkt-1+λt+γk+εkt 

where ykt is a job flow metric in industry k at time t (i.e. job creation rate, job destruction rate, net change in jobs), FEPIkt-1 is the lagged fixed-weight energy price index (used as an instrument for average energy cost in the firm-level analysis), λt are time fixed effects, γk are sector fixed effects, and εkt is the remaining error term.

The dataset used in this study covers 8 000 firms in the French manufacturing sector over the period 2001 to 2016. The dataset combines several databases which are managed by the French Statistical Office (INSEE): Data on energy consumption and expenditure comes from the EACEI (Enquête Annuelle sur les Consommations d’Énergie dans l’Industrie) survey, financial data from FARE (Fichier approché des résultats d’Esane) and FICUS (Fichier de comptabilité unifié dans SUSE), patent data from the PATSTAT database maintained by the European Patent Office, and pollution abatement investment data from the Antipol survey. The emission data are calculated based on the energy consumption from the EACEI survey and CO2 emission factors from the French Environment and Energy Management Agency (ADEME). As these data are available at the plant level but the data on economic outcomes are available at the firm level, the emission data are aggregated at the firm level, ensuring that only observations are used where all plants belonging to a firm are available in the data. The dataset used for the analysis on investment, built from the Antipol survey, is smaller than the firm-level dataset for the other economic outcomes.

The results of the study show an average reduction of energy and fossil fuel use, as well as a reduction in CO2 emissions and workers in response to higher energy prices (Table 8.1). A 10% increase in energy costs leads to a decrease of 5.9% in energy use and a reduction of fossil fuel use of 6.5%. The reduction in CO2 emissions is estimated to be 9.2% and the number of workers declines by 2.2%.

In addition, no statistically significant effect is found for real output and investment. Investigating the channels through which firms react to changing energy prices shows that the energy-intensity is reduced by 5.2% in response to an increase of energy prices by 10%. There is also some statistical evidence that labour, material and capital decrease significantly less than energy use when energy prices rise, suggesting that firms reduce their energy-intensity by substituting energy by other inputs (for detailed results see Dussaux (2020[4])). The reduction in the CO2 intensity is found to come from substituting fossil fuel use by electricity use.

It is important to note that these reductions estimated at the firm level correspond to a situation where only the energy price of the firm varies. In reality, when the price of a fuel increases in responses to an energy tax, all firms experience a change in their relative energy cost. Energy-intensive firms experience larger energy cost increases than energy-efficient firms. This relative change can lead to market share reallocations between firms. Therefore, it is not possible to extrapolate the effect of a change in the energy price at the aggregate manufacturing level simply by multiplying the estimated effect by the number of firms in a given sector. Consequently, the study also includes an analysis at the industry level that incorporates between-firm reallocations.

Analysing potential heterogeneous effects shows that firm responses to increasing energy prices differ significantly according to their initial size and energy-intensity (see Dussaux (2020[4]), for detailed estimation results). Energy-intensive firms react more negatively to higher energy costs in terms of both environmental and economic performance likely because the same energy cost increase penalises these firms more. Small, medium-sized and large firms react differently in terms of both environmental and economic performance. The larger the firm, the more it improves its environmental performance in response to higher energy cost. In terms of economic outcomes, large firms reduce their output by 2.6%, while medium-sized firms do not change their output. Surprisingly, small firms increase their output by 1.4%. The responses in terms of employment also differ greatly. A 10% increase in energy cost does not affect employment of small firms, but reduces it by 2.6% for medium-sized firms and by 5.5% for large firms. Allowing for heterogeneous effects at the sector level shows that firms do not reduce their CO2 emissions or the number of employees in every sector (Figure 8.2). There are large differences between industries. 79% of the sectors experience a statistically significant reduction in CO2, 26% reduce employment, 53% reduce CO2 emissions but not employment, and no sector reduces employment, but not CO2 emissions in response to higher energy prices. The largest reduction in CO2 emissions is found for the beverages, wood products and wearing apparel sectors (Figure 8.2, Panel A). For employment, the largest changes are found in the basic metal, plastic and food products sectors (Figure 8.2, Panel B).

The industry-level analysis shows no statistically significant effects of rising energy prices on job destruction, job creation or net employment (see Dussaux (2020[4]), for estimation results). The difference compared to the results from the firm-level analysis is explained by the different sample of firms covered: The firm-level analysis only covers surviving firms while the industry-level accounts for new firms as well as firms exiting the market. An additional analysis of the study finds evidence for the hypothesis that an output reallocation between firms induced by changes in the energy price leads to a reallocation of workers between firms, especially from large energy-intensive firms to energy-efficient SMEs. The negative effect on surviving firms found at the micro level is thus offset by worker reallocation towards energy-efficient firms. This implies that while there is no average effect at the industry level in terms of employment, workers are reallocated within industries and thereby might face adjustment costs.

The results are robust to many robustness checks, including using different lags of the main explanatory variables and investigating contemporaneous as well as dynamic effects of energy price variation.

The results of the study show that climate policies, which increase energy costs, are effective in terms of carbon emission reductions but also have some small economic effects in terms of employment reallocation. Regarding the environmental effects, the firm-level analysis shows that a 10% increase in energy prices results in a decline in energy use by 6% and a reduction in carbon emissions by 9%. For the economic effects, the study finds that employment can decline for mid-sized and large firms. However, small enterprises, who stay in the market after energy prices rise, do not reduce their employment. The accompanying industry-level analysis shows that at the industry level, the total number of jobs is unaffected. This is due to two opposing effects: On the one hand, employment declines in large and energy-intensive firms and on the other hand, employment rises in energy-efficient firms (including new firms entering the market) as output is reallocated. The overall contribution of changes in energy prices to changes in employment is, however, small: changes in energy prices only triggered the reallocation of 0.25% of total manufacturing employment over the period 2005-16. In comparison, over this period, energy prices rose by 80% and manufacturing employment declined by 26%. In other words, 99% of employment reallocations within the manufacturing sector is due to factors other than changes in the energy price. These effects are, however, heterogeneous across sectors with the beverages, basic metals and wood products sectors having the largest worker reallocation caused by changes in energy prices.

The results of the analysis regarding reductions in carbon emissions are only based on the firm-level analysis, implying that the effect is only driven by surviving firms. Due to data limitations, an industry-level analysis of effects of increased energy cost on carbon emissions, similar to the analysis conducted for employment, is not possible. However, a net negative effect at the industry-level in terms of carbon emissions can be expected as the effect on surviving firms in the firm-level analysis is negative and because output reallocation is directed towards more energy-efficient firms in the sectors.

Two important policy-relevant conclusions can be drawn from the analysis. First, tighter environmental policies, in the form of higher energy prices, can lead to employment reallocations between firms and industries. While some sectors are affected more than others, complementary labour market policies could help to absorb redistributive implications and reduce the costs for laid-off workers. Second, carbon taxes reduce carbon emissions significantly. As shown in Chapter 1, the carbon tax applied on the French manufacturing sector since 2014, which gradually increased the cost per tonne of CO2 emission to EUR 45 in 2019 (corresponding to a 5.4% increase in energy prices), decreased carbon emissions by 5% (3.6 Mt of CO2) with no statistically significant impact on aggregate employment. These two factors imply that there is scope for tighter unilateral environmental policies in order to achieve global climate goals and suggest that accompanying labour market policies could potentially reduce the economic impacts of these policies.

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