Environmental Policy, Full-Employment Models, and Employment: A Critical Analysis

This paper assesses the use of full-employment computable-general equilibrium (CGE) models to evaluate labor-market effects of environmental policy. Specifically, it compares a full-employment model to two alternatives: a Balistreri model that introduces unemployment through an endogenous wage premium and a search-CGE model that uses a search-and-matching friction to introduce unemployment (extending Hafstead and Williams). We find that some key results are robust across the three models, such as the reallocation of labor across sectors in response to a carbon tax, but that small differences for each industry add up to larger differences across models at the aggregate level. Applying a full-time-equivalent assumption to the full-employment model seriously overestimates the economy-wide net change in jobs (by a factor of more than 2.4 for a carbon tax with revenues returned lump sum and by a factor of almost 2.7 when carbon tax revenue reduces payroll taxes) relative to the search-CGE model.