Canada: Wrestling with Climate Change

Kyoto Is Uncommonly Popular…

For a big issue that has been tackled by Canada's politicians, climate change is unusually popular. Indeed, none of the big four structural changes to Canada's economy listed above was popular in the public opinion polls, and some—such as the GST—were outright hated. The reason the governments of the day pressed on with these unpopular adjustments was because they were seen as good for the economy by key policy makers. To some extent, politicians took the risk that these changes would turn out to have public support by the next election. Indeed, public opinion has been brought on side eventually after the positive impacts became apparent and dire predictions of doom failed to come to pass.

The popularity of the climate change issue virtually guarantees that it will remain at or near the top of political agendas for years, even decades, to come. This is especially true for minority governments hanging on to power by their fingernails. Judging from the massive failure to live up to obligations of the Kyoto protocol so far, meeting lower-emissions targets will not get any easier in the future. This will provide opposition parties with plenty of ammunition to criticize the incumbent government for playing a role in missing the targets.

…But Difficulties Are Not fully Appreciated

Unfortunately, difficulties related to achieving substantial progress on climate change are not fully appreciated by the public. The then-Liberal federal government signed the Kyoto protocol in 1998, committing Canada to cut greenhouse gas emissions 6% below the 1990 level by 2012. The available data for 2004 show that emissions had risen 27% since 1990. If Canada were on the path to meet Kyoto targets, emissions should have been 4% below the 1990 level in 2004. A simple regression analysis suggests that unless something drastic happens to the structure of the economy, Canada's greenhouse gas emissions will grow at six-tenths the pace of economic growth, reaching 40% above the 1990 level by 2012 and 90% above by 2035.

A cold-turkey imposition of lower emission targets on all economic agents could wreak havoc in the economy, causing double-digit unemployment and most likely a return to fiscal deficits. The pain would be sharpened by the fact that some of our key trade partners and competitors—especially the United States, China, and India—are outside the Kyoto protocol.

Baseline Assumptions

As the debate on climate change continues, Global Insight has stuck to the basics in the long-term economic forecast for Canada. We continue to expect slower growth due to a population slowdown. Productivity growth is expected to be an increasingly important driver of the economy.

Whatever combination of emissions trading, caps, and green taxes future governments design, they are assumed to have a neutral influence on potential GDP growth. Judging from the historical record, this raises the risk that emissions will continue to grow. This is especially true if, as anticipated, energy prices remain high and drive the expansion of the oil sands. Also judging from the track record, federal governments will be able to move from one set of missed targets to another without incurring too much of a political price. Even so, the major polluters will spend more on clean-air technologies and consumers will have to pay more for cleaner energy. Over the long term, the availability and application of clean-air technologies may cause emissions to stabilize or perhaps even decline without affecting measured GDP growth. This is the eventual outcome that the baseline scenario assumes the federal government wants to achieve over the long haul.

Even in this benign scenario, however, there will be wide-ranging implications for all players in the economy. Businesses in industries that account for most of the emissions will either invest more in clean technologies or move to countries with less stringent environmental standards. Those businesses that have to stay in order to exploit Canada's natural resources, most notably oil sands, may have to pay the price in the form of lower profitability in order to remain viable. Consumers will have their choices restricted to more expensive, but more environmentally friendly, technologies, such as hybrid vehicles, and cleaner sources of energy. Meanwhile, the task of keeping track of who is emitting what, and how much, will keep governments busy at the cost of taxpayers' money.

The winners, naturally, will be businesses analyzing, designing, and selling clean-air technologies. As much as it is held in suspicion by the public due to a few isolated accidents in the past, this means a boost for nuclear energy, as well as for hydro. Solar and wind power, and other alternative energy sources, will also be exploited more intensively.

Risks Tilted to the Downside

In Global Insight's opinion, the risks to economic growth stemming from actions on the environment are tilted to the downside. It cannot be overemphasized that here we mean the risks to GDP growth as currently measured. Cleaner air would, of course, lead to a healthier population and a more pleasant environment. Any time there is a structural adjustment in the economy, the process of moving resources from old to new activities invariably involves learning new things. This in turn implies that a lot of capital and labor that was previously employed in highly productive endeavors will have to adjust to become productive somewhere else, with a temporary negative hit to productivity growth.

In addition to the adjustments in the private sector, there will be also a process of learning on the job by governments and regulators. Some mishaps will be inevitable. Unless the cost of such inevitable mistakes is counterbalanced by lucky technological breakthroughs, measured economic growth would be weaker than projected in the baseline.