Environmental Input-Output Analysis: Application to Portugal

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1 UNIVERSIDADE TÉCNICA DE LISBOA INSTITUTO SUPERIOR TÉCNICO Environmental Input-Output Analysis: Application to Portugal Marta Alexandra Sousa e Silva (Licenciada) Dissertação para a obtenção do Grau de Mestre em Engenharia e Gestão de Tecnologia Presidente: Doutor Manuel Frederico Tojal de Valsassina Heitor Instituto Superior Técnico Universidade Técnica de Lisboa Vogais: Doutor Eduardo Anselmo Moreira Fernandes de Castro Universidade de Aveiro Doutor Paulo Manuel Cadete Ferrão Instituto Superior Técnico Universidade Técnica de Lisboa Doutor Pedro Filipe Teixeira da Conceição Instituto Superior Técnico Universidade Técnica de Lisboa Julho 2001

2 Resumo A crescente consciência ambiental demonstrada pelos cidadãos Europeus no que respeita à qualidade do meio ambiente e a determinação da Comissão Europeia em desenvolver políticas ambientais eficazes, incentiva o uso de novas metodologias de avaliação dos impactes ambientais decorrentes das actividades económicas. Esta tese contribui para este objectivo, sendo analisada a extensão dos quadros input-output das Contas Nacionais, de forma a incluir impactes ambientais. Neste contexto, a metodologia de input-output ambiental é aplicada ao cálculo dos gases com efeito de estufa em Portugal, decorrentes de um certo aumento da procura final em alguns sectores de actividade económica. As estimativas realizadas para 2010, com base em cenários de desenvolvimento estabelecidos por entidades públicas, demonstram claramente que, na ausência de medidas de carácter político, Portugal irá exceder largamente o limite imposto pelo Protocolo de Quioto, de não ultrapassar os níveis das emissões de 1990 de gases com efeito de estufa em mais de 27%. No decorrer da tese são discutidas algumas medidas políticas cuja implementação pode contribuir para diminuir a emissão de gases com efeito de estufa. Palavras Chave: Análise input-output, análise input-output ambiental, avaliação ambiental, emissão de gases com efeito de estufa, mudanças climáticas. i

3 Resumo Alargado A crescente consciência ambiental demonstrada pelos cidadãos europeus no que respeita à qualidade do meio ambiente e a determinação da Comissão Europeia em desenvolver políticas ambientais credíveis e eficazes, incentiva o uso de novas metodologias de avaliação dos impactes ambientais que decorram, em particular, das actividades económicas. Esta tese contribui para este objectivo, sendo analisada a extensão dos quadros input-output das Contas Nacionais, de forma a incluir impactes ambientais. O uso de tabelas input-output permite utilizar dados publicados por entidades oficiais, sendo, desta forma, um método pouco oneroso e fidedigno. O uso destes modelos é muito vantajoso na medida em que permite ter em conta toda a cadeia de valor (incluindo fornecedores indirectos), permitindo incluir a totalidade de inputs para um processo, evitando deste modo recorrer a fronteiras arbitrárias, nem sempre as mais indicadas para a análise que se pretende, permitindo desta forma uma análise mais precisa e detalhada. Nos anos mais recentes a análise input-output, outrora realizada somente para fins de análise económica, tem sido aplicada para avaliar e contabilizar fluxos de energia, poluição ambiental, produção de resíduos, ou o emprego associado à produção industrial, assim como outros tipos de problemas ambientais. O método usado nesta tese segue a abordagem desenvolvida pelo grupo de investigação Green Design Initiative da Universidade de Carnegie Mellon nos Estados Unidos da América, o qual foi denominado Economic Input Output Life Cycle Assessment (EIO-LCA). Esta abordagem permite estimar as emissões ambientais associadas com a variação da procura final, através da multiplicação das mudanças introduzidas nessa procura pelos níveis médios de poluição, consumo de energia, ou outro tipo de dano ambiental. Neste contexto, a metodologia de input-output ambiental é aplicada ao cálculo dos gases com efeito de estufa em Portugal, decorrentes do aumento da procura final em alguns sectores de actividade económica. As estimativas realizadas para o ano de 2010 foram desenvolvidas com base em cenários de desenvolvimento estabelecidos por entidades públicas e seguindo o método EIO-LCA. Os resultados desta análise demonstram claramente que, na ausência de medidas de carácter ii

4 político e segundo as projecções consideradas, Portugal irá exceder largamente o limite imposto pelo Protocolo de Quioto, de não ultrapassar em 27% os níveis das emissões de gases com efeito de estufa verificados em Estes resultados traduzem-se na forte necessidade de implementação a curto prazo de medidas políticas por forma a reverter esta tendência. As implicações políticas e as diferentes abordagens possíveis são discutidas no decorrer da tese, focando essencialmente o sector energético e o sector dos transportes por serem aqueles que contribuem mais fortemente para as emissões de gases com efeito de estufa. Palavras Chave: Análise input-output, análise input-output ambiental, avaliação ambiental, emissão de gases com efeito de estufa, mudanças climáticas. iii

5 Abstract The growing environmental awareness of the European citizens and the European Commission commitment in developing wider policies on environment require new methodologies for assessing the environmental impacts of the economic activities. This thesis contributes to this purpose, by extending the well-established input-output analysis based on the National Accounting System to include environmental impacts and provides the application of this method to Portugal. The Environmental Input-Output methodology is used to estimate greenhouse gas emissions in Portugal based on a publicly available forecast for the growth of different Portuguese economic sectors. The results obtained for 2010 clearly demonstrate that if no policy action is taken, Portugal will largely surpass the emission target of 27% increase, comparatively to the 1990 s levels, agreed in Kyoto. Effective policy measures to be taken in the short range to revert this tendency are discussed in this thesis. Key words: Input-output analysis, environmental input-output analysis, environmental assessment, greenhouse gas emissions, climate change. iv

6 ACKNOWLEDGMENTS First of all, I would like to thank the Center for Innovation, Technology and Policy Research (IN+) for providing me with fund and all the facilities to carry out this Master thesis, and particularly to Prof. Manuel Heitor for inviting me to work at this Center as a research student. I would like to specially thank my outstanding supervisor, Prof. Paulo Ferrão, for all the technical and human support during the last year. I thank for all the encouragement and guidance when I felt confused, and for all the inspiration and motivation to face this challenge. Particular thanks goes also to my family, friends and Master colleagues and especially to Pedro, for all the patience, love and support. Their support was chief in the execution of this Master thesis. I also would like to thank Jorge Nhambiu the enriching discussions, inputs and ideas to this work. A final and special thanks goes to FORDESI, SA for all the time flexibility and motivation that allowed the conclusion of this work. v

7 List of Contents 1 INTRODUCTION Motivation and Objectives Dissertation Organisation and Contribution INPUT-OUTPUT ANALYSIS Input-Output Analysis Historical Overview Input-Output Fundamentals Structure of an Input-Output Model The Transaction Table Technical Coefficients Table Interdependence Coefficients Matrix Use of Input-Output Analysis to Trace Environmental Discharges Economic Input-Output Analysis: The Portuguese Case Study The Portuguese Input-Output Tables Evolution of the Portuguese Economy ( ) Environmental Input-Output Analysis: The Portuguese Case Study Global Warming Theoretical Overview Political Overview International Actions The Kyoto Protocol Prospective Analysis for Greenhouse Gas Emissions in Portugal Portuguese Greenhouse Gas Emissions Economic Development Scenarios for Portugal Application of the Environmental Input-Output methodology to Portugal. Prospective GHGs emissions for Discussion and Main Conclusions Discussion Compliance Mechanisms Transportation sector Energy sectors Other Measures Conclusions...87 vi

8 List of Figures Figure 1 - Input-Output System Schema Figure 2 Portuguese input-output transaction table (1995) Figure 3 Portuguese technical coefficients table (1995) Figure 4 Portuguese interdependence coefficients matrix (1995) Figure 5 Principal supply components (at constant prices of 1995) Figure 6 Total output by economic sector in 1990 and 1995 (prices of 1995) Figure 7 Total output variation between 1990 and 1995 (prices of 1995) Figure 8 Contribution of Agriculture, Industry and Services sectors to national gross value-added Figure 9 Contribution of Services sectors to national gross value-added Figure 10 Contribution of Agriculture, Sylviculture and Fishing sectors to national gross value-added Figure 11 Contribution of the Industry sectors to national gross value-added Figure 12 Variation in the Portuguese technical coefficients Figure 13 Technical coefficient change in the Cooking Oil and Food Fats from 1990 to Figure 14 Technical coefficients change in the Fishing sector between 1990 and Figure 15 Technical coefficients change in the Land Transport sector between 1990 and Figure 16 Technical coefficients change in the Maritime and Air Transportation sector between 1990 and Figure 17- Solar radiation interaction with the surface of the earth Figure 18 Atmospheric carbon dioxide concentration and temperature change Figure 19 Solar activity versus climate Figure 20 CO 2 concentration Figure 21 Global average temperature Figure 22 - Global average temperature Figure 23 International institutional context of climate change Figure 24 Economic sectors that contribute the most for National Global Warming Potential Figure 25 Energy consumption in Portugal by economic sector Figure 26 National passenger transportation in vii

9 List of Tables Table 1 Input-output transactions table Table 2 Portuguese economic sectors Table 3 - Share of GDP per Sector in European Countries in Table 4 Reduction target of GHGs emissions for Portugal Table 5 Portuguese greenhouse gas emissions by economic sector in Table 6 Global warming potential of different gases Table 7 Greenhouse gases emissions in Portugal (1990 and 1995) and the consequent GWP Table 8 Annual growing patterns by economic sector for Portugal Table 9 Economic sectors included in the National Energetic Plan (DGE) and in the National Accounts (INE) Table 10 Total growth by economic sector for Portugal Table 11 Increase in greenhouse gas emissions forecasted for 2010, according with scenario A Table 12 Increase in greenhouse gas emissions forecasted for 2010, according with scenario B Table 13 Total greenhouse gas emissions forecasted for 2010 in Portugal, according with scenario A Table 14 Total greenhouse gas emissions forecasted for 2010 in Portugal, according with scenario B Table 15 Comparison between the GWP increase estimated for 2010 and the levels agreed in Kyoto viii

10 1 INTRODUCTION 1.1 Motivation and Objectives The growing concern of the European citizens for the quality of the environment and the European Commission commitment in developing wider policies on the environment increases the need for an environmental information system, which helps to measure progress towards a sustainable society. In this context, decision-makers in industry and government need tools and methodologies to pro-actively identify sustainable options, optimised as to environmental, social and economic aspects. Current Life Cycle Assessment (LCA) methods, frequently used with the purpose of accounting environmental impacts of products and services, have vast limitations namely in terms of excessive cost, choosing an appropriate problem boundary, availability of data from each industry, which is associated, directly or indirectly, to the product/service analysed. Conversely, matrix representation allows using publicly available, standard data sources, such as the national sector-based economic input-output tables, constituting a low-cost and coherent approach to environmental accounting, if additional information emissions and use of natural resources are added and detailed results are not required. The use of input-output models is advantageous since they take into account the entire supply chain for a product (including indirect suppliers), allowing tracing the full range of inputs to a process, thus avoiding arbitrary analysis boundary decisions. The ever greater need for disaggregated and analytically flexible tools, demands the fruitful use of matrices of sector interdependence with their powerful store of information. The fundamental interest of the input-output approach is the elaboration and the development of methodologies whose final purpose is the application to contemporary policy. Input-Output (I-O) models represent forms of simulation analysis with a relatively long history, tracing their conceptual underpinnings to the mid-1700 s in France, where it is generally accepted that mathematical economics first got its start. In fact, input-output models can be thought of as formalisation of concepts set forth many years earlier by the French economist François Quesnay. However, this framework is only known as input-output analysis after the work developed by Wassily Leontief in the late 1930s for which he received the Nobel Prize in Economic Science in The availability of high-speed digital computers has made input-output a very useful tool and one of the most widely applied methods in economics nowadays. For example, United Nations has promoted input-output as 1

11 a practical planning tool for less-developed countries and has sponsored a standardised system of economic accounts for developing input-output models. According to Leontief, economic input-output analysis is a method of systematically quantifying the mutual interrelationships among the various sectors of a complex economic system. In practical terms, the economic system to which it is applied may be as large as a nation or even the entire world economy, or as small as the economy of a metropolitan area or even a single enterprise. In all instances the approach is essentially the same. The structure of each sector s production process is represented by an appropriately defined vector of structural coefficients that describes in quantitative terms the relationship between the inputs it absorbs and the outputs it produces. The interdependence among the various sectors of a given economy is described by a set of linear equations expressing the balances between the total input and the aggregate output of each commodity and service produced and used in the course of one or several periods of time. Input-Output analysis provides a robust and relatively easily understood analytical technique providing businesses, state and local governments, economic and resource planners, policy makers, and academicians the means to more completely understand and evaluate the extensive economic interactions and financial linkages that typically characterise economies nowadays. Through the application of input-output analysis, private and public sectors have the means to better assess the widespread impacts and repercussions of their business decisions and public policy actions and make more informed decisions based on established direct and indirect economic linkages and impacts among the various industry sectors. In fact, the great virtue of input-output analysis is that it surfaces the indirect internal transactions of an economic system and brings them into the reckoning of economic theory. Within each sector there is a relatively invariable connection between the inputs it draws from other sectors and its contribution to the total output of the economy (Leontief, 1986). In recent years the input-output framework has been extended to deal more explicitly with topics as interregional flows of products and accounting for energy consumption, environmental pollution, and employment associated with industrial production. Indeed, these models are highly flexible and can be used to address a number of economic, resource, and even environmental impacts, namely in terms of the effects of economic growth on air and water pollution, energy consumption, traffic congestion, waste disposal and other environmental burdens. In fact, any input factor that can be quantified in terms of a given level of an industry s output, for example pollution, or infrastructure requirements, may be promptly incorporated into the I-O modelling process. 2

12 The method used in this work follows the approach of the Carnegie Mellon University s Green Design Initiative, the so-called Economic Input Output Life Cycle Assessment (EIO- LCA). This method allows to forecast the direct economic changes associated with certain choices. An economic input-output table is then used to estimate both direct and indirect changes in output throughout the entire economy, for each sector. Finally, the environmental discharges associated with the changes are evaluated by multiplying the output changes by the average level of a pollutant, electricity use or any other type of environmental burden. Hence, this vector of additional discharges characterises the overall environmental impact caused by a specific variation of final demand. This thesis extends the EIO-LCA methodology to Portugal, where publicly available data is used to demonstrate the usefulness of the methodology in analysing the environmental impacts originated by the national economic activity, taking into account the greenhouse gas (GHG) emissions specified in the Kyoto Protocol. The main reason for choosing the greenhouse gases as a research topic is the importance attached to greenhouse gas emissions by the European Union and their impact on global warming and climate change. Indeed, climate change is widely recognised as a serious potential threat to the world s environment, since it is expected to have wide-spread consequences, including sea-level rise and possible flooding of low-lying areas; melting of glaciers and sea ice; changes in rainfall patterns with implications for floods and drought; and more climatic extremes (especially high temperatures). These effects have major impacts on ecosystems, health, water resources and key economic sectors, such as agriculture. There is increasing evidence that greenhouse gas emissions from human activities are causing an enhanced greenhouse effect. The dominant human activity or driving force for climate change is fossil-fuel combustion, due to its carbon dioxide emissions. Other activities that also contribute to GHGs emissions are agriculture, land use changes, i.e. deforestation, waste disposal to landfills and industrial processes such as cement production, refrigeration, foam blowing and solvent use. At the Third Conference of the Parties of the United Nations Framework Convention on Climate Change (UNFCCC) held in Kyoto in December 1997, several developed countries agreed on various commitments aiming the reduction of GHGs (Kyoto Protocol). Namely, to reduce the 1990 levels of carbon dioxide, methane, nitrous oxide, HFCs, PFCs and sulphur hexafluoride emissions by an overall of 5% in This reduction will be expressed in carbon dioxide equivalents using global warming potentials with a 100-year time horizon. In the Kyoto Protocol it is stipulated that the European Union member states as a group will have to reduce greenhouse gas emissions by 8% between , taking 1990 emissions level as a reference. Portugal has been allowed to increase 27% its emissions, according to the burden share agreement. However, due to the high rates of growth occurred in the last few 3

13 years, active policies must be conducted to reduce the greenhouse gas emissions to appropriate levels. With the strong belief that this Protocol is essential as a step forward on the actual tendencies of climate change and that the actions to be developed under what was established in the Protocol are vital for future generations, this work intends to contribute to this objective, mainly by providing a methodology to better assess the real GHGs production in Portugal and to evaluate the trends towards the future. Actually, in order for a country to take actions in agreement with the Kyoto Protocol, it must develop methodologies to increase the knowledge base about the GHGs emissions within the whole economy and, particularly, in the sectors that most contribute to this increase. The purpose of this thesis is make use of this new methodology to evaluate greenhouse gas emissions, or other kind of environmental burden, enabling governments to better access the amount of greenhouse gases released, their origins and, as a consequence, a solid basis to establish policy actions to promote the sustainable development. 1.2 Dissertation Organisation and Contribution The present dissertation discusses the use of environmental input-output analysis methodology to assess and estimate environmental burdens, with special emphasis on the evaluation of greenhouse gas emissions in Portugal. In chapter 2, the input-output analysis methodology is described as well as its extended application in order to include environmental discharges. In chapter 3, the input-output framework is applied to Portugal, allowing the analysis of the data characterising the evolution of the National economy between 1990 and 1995 in different economic sectors. In chapter 4, the extended environmental input-output methodology is applied to calculate future emissions of greenhouse gases in Portugal. The case study aims to estimate the potential greenhouse gas emissions in Portugal by 2010, in order to assess the National compliance with the established in the Kyoto Protocol. Chapter 5, is focused on general policy considerations to help the mitigation of the greenhouse gas emissions and alleviate the effect of global warming. A discussion about the best way to respect and accomplish the levels of compliance agreed in Kyoto is also provided. This chapter concludes with the main contribution of this thesis, which is focused on the development of a valuable new methodology to assess, in a systematic and structured way, 4

14 any category of environmental impact. Additionally, it is suggested its further development and dissemination as a standard framework to calculate environmental burdens associated with economic activity. 5

15 2 INPUT-OUTPUT ANALYSIS 2.1 Input-Output Analysis Historical Overview Input-Output models can trace its earliest documented beginnings to 1758 when the French economist, François Quesnay, published the Tableau Economique showing a diagrammatic representation of the process of tracing sales and expenditures through an economic system, in a systematic way. This first recorded effort attempted merely to trace the economic transactions involved in the production of a single commodity a loaf of bread from the growing of the wheat, to the milling, baking, distribution, and sales to the final consumer. As simple as this process might seem, when combined with the economic behaviour and interactions of other economic sectors, directly and indirectly involved in this activity, one can quickly perceive the complexities associated with tracing even a simple economy transaction. Nevertheless, this first effort demonstrated the practical usefulness in being able to describe inter-industry linkages. The lack of sophisticated and comprehensive data compilation at that time, as well as the inability to effectively deal with the resultant complex mathematical relationships inherent in this form of analysis, precluded a more extensive incorporation of other commodities and other industrial sectors of the economy. Nonetheless, the far-reaching possibilities for economic input-output analysis were visibly demonstrated. The next major effort in this area was performed more than a century after by another French economist, Léon Walras, who, in the 1870 s, developed a general equilibrium model, which attempted to solve simultaneously the demand and supply conditions of all economic sectors. In this work, Walras employed a set of production coefficients that linked the quantities of factors required to produce a unit of a particular product to levels of total production of that product. Walras examined both the interdependence of producing industries and what each producing sector needed from the other supplying industries (the linkages) to produce a unit of a finished good. Though, Walras general equilibrium model was assumed as a theoretical one due to both the impressive computational demands as well as the model s wide-ranging data needs, which could not be entirely fulfilled. Due to difficulties namely in terms of growing modelling system s complexity, lack of comprehensive data sources and difficulties in manipulating the vast amounts of information, the potential usefulness of this form of inter-industry analysis could not be entirely recognised at that time. Nevertheless, this effort represented a significant extension of I-O analysis to an entire economic system, and not just the coverage of a single product or a single economic 6

16 sector. It was only when Professor Wassily W. Leontief, from the Harvard University, presented an input-output system of the United States economy and developed a more rigorous analytical framework that the use of these techniques gained popularity and practical application. Leontief presented in 1936 the theoretical framework and U.S. tables for 1919 and 1929 in a book called The structure of the American Economy , followed by his first book on the input-output structure of the U.S. economy, in This book was revised in 1951 in an enlarged and expanded edition that presented the U.S. input-output table for Leontief was interested in identifying the industrial interdependence within the American economy and in developing a mathematical model within which all linkages could be stated and estimated statistically. Leontief s work was made possible mainly through the simplification of Walras earlier general equilibrium model such that the model s equations could now be estimated empirically, that is, by using more readily available published data. In fact, his model is an approximation of the Walrasian model, with several important simplifications that allowed a theory of general equilibrium to be put in practice. Since this original work, the input-output technique has become the most popular inter-industry model around the world, for which he received the Nobel Prize in Economic Science in Currently, the availability of detailed and extensive business and economic data, the widespread use of powerful computer systems, the availability of sophisticated software programs, and the fact that input-output model represents little more than a matrix (algebraic) manipulation of a specific economy s transactions table of relevant industry data, make this form of analysis far more widely accepted and used and more easily adapted and extended to the full spectrum of economic systems, from national to regional, state and county, and even city levels. Nowadays, input-output analysis has become extremely important to all the highly industrialised countries in what concerns economic planning and decision-making, because it allows tracing the flow (direct and indirect) of goods and services through and between different industries. In fact, the use of input-output models has some main advantages that make them particularly well suite to analyse structural change and economic transactions, such as:!"comprehensive and consistent data. Input-output tables encompass all the formal economic activities that occur in an economy. Usually, a considerable amount of data sources are used to ensure the completeness and internal consistency of the data, resulting, probably, in the single most comprehensive and complete source for economic data for most countries. In this context, input-output tables frequently play a fundamental role in structuring the national accounts, meaning that the data is systematically checked for their accuracy, and that the tables are intrinsically linked with many of the traditional indicators 7

17 of economic performance such as production and GDP. In fact, as economic structures, industry concentrations, technologies, product mixes and sources of inputs continually change, the I-O model s transaction table must be continually updated and refined in order to incorporate the behaviour of a dynamic economic system. Nonetheless, the requirement for detailed and comprehensive data can be also a limitation of the model since it may not always be readily available through published, or secondary data sources. In reality, each major industry sector must be extensively analysed regarding the nature of its production mix, specific industry sources of inputs, and industry sectors to which sales are made. Some major features of the input-output analysis are discussed in the following paragraphs:!"an economy is analysed as an interconnected system of industries that directly and indirectly affect one another, tracing structural changes back through industrial interconnections. Input-output techniques trace all the linkages and connections among all industries within an economy. Thus, when analysing an economy s reaction to changes in the market place or in the final demand, this type of analysis has the ability to capture the indirect effects of that change. In sum, it permits the disentanglement and accurate measurement of the indirect effects.!"identify the sources of change as well as the direction and magnitude of the change. Changes in output can be linked with underlying changes in factors such as exports, imports, final demand as well as technology. This methodology permits a consistent estimation of the relative importance of these factors in creating output and employment growth. In sum, it provides economic projections and forecasts giving the means to better predict changes in industrial output resulting from changes in demand.!"resource input requirements. Determining for example demands for energy, water, timber and building products, land, minerals, and other natural resources arising from changes in the demand for a certain product.!"environmental impacts. Determining for instance the changes in the levels of air and water pollution, traffic congestion, energy consumption, and other similar factors due to changes in the final output. However, the input-output framework has also some limitations. Those limitations, according to the OECD document, Structural Change and Industrial Performance (1998), are:!"input-output analysis assumes constant returns to scale. The model assumes that the same relative mix of inputs will be used by an industry to create output regardless the quantity produced. This fact has some implications, such as: 8

18 !"Technical coefficients are assumed to be constant. The amount of each input necessary to produce one unit of certain output is assumed to be constant. Hence, the amount of input purchased by a sector is determined exclusively based on the level of output desired; no consideration is made to price effects, changes in technology or economies of scale.!"consequently, input-output analysis assumes linear production functions. The input-output process assumes that if the output level of an industry changes, the input requirements will have to change in a proportional way. For instance, if the output is doubled, inputs will also need to be doubled. In cases where innovative technology allows either input substitution or greater efficiencies in the use of inputs, impacts to supplying industry sectors may be seriously misrepresented by thoroughly adhering to the assumption of linearity.!"each product within an industry is assumed to be the same. There is no substitution between inputs. The output of each sector is produced with a unique set of inputs.!"there are no resources constrains. Supply is assumed infinite and perfectly elastic.!"local resources are efficiently employed. There is no underemployment of resources.!"actuality of input-output data. There is a long time lag between the collection of data and the availability of the input-output tables. In fact, input-output tables provide a snapshot of the complete economy and all of its industrial interconnections at a specific point in time. The required data covers only a specific period of time and therefore may fail to capture longer-term trends and changes in economic relationships of an evolving economic system. 2.2 Input-Output Fundamentals Structure of an Input-Output Model The basic Leontief input-output model is generally constructed from observed economic data for a specific geographic region (nation, state, county, etc.), concerning the activity of a group of industries that both produce goods (outputs) and consume goods from other industries (inputs) in the process of producing each industry s own output interindustry consumption. The data required to fulfil the input-output model consists in flows of products from each of the producing sectors to each of the purchasing sectors. These interindustry flows (or intersectoral) are measured for a particular time period (usually a year) and in monetary terms. 9

19 Basically, an input-output model consists of three basic tables, which are analysed in the following sections: the transaction or flow table, the technical coefficients table and the direct requirements table The Transaction Table The fundamental information with which one deals in input-output analysis concerns the flows of products from each industrial or service sector considered as a producer to each of the sectors considered as consumers. This basic information, from which an input-output model is developed, is contained in an interindustry transactions table - the central core of the input-output analysis -, which is not merely a device for displaying or storing information but is above all an analytical tool. The transaction table describes the flow of goods and services (in value) between all the individual sectors of a national economy over a stated period of time. In order to achieve this, one needs to know what amount of output of a particular sector can be purchased for one monetary unit at prices that prevailed during the interval of time, which the table was constructed (Leontief, 1986). While the physical measure is probably a better reflection of one sector s use of another sector s product, there are enormous measurement problems when sectors actually sell more than one good. Therefore, although in principle intersectoral flows can be thought of as being measured in physical units, in practice most input-output tables are constructed in value terms. Although its application is simple, the construction of an input-output transaction table is a highly complex and laborious operation. The first step, and one that has little appeal to the theoretical imagination, is the gathering and ordering of an immense volume of quantitative information. The kinds of surveys needed to collect input-output data for an economy can be expensive and very time consuming, resulting in tables of input-output coefficients that are old before they are born. Given the inevitable lag between the accumulation and the collation of data for any given year, the input-output table will always be a historical document (Leontief, 1986). In this context, for practical purposes the original figures in the table must be regarded as a base, subject to refinement and correction according with subsequent trends. The entries in the transactions table can be named x ij where i is the sector from which the flow comes and j is the sector to where it goes. The row entries in a transaction table describe the way in which the total sales or each sector are allocated over the remaining sectors in the economy and the column entries describe the inputs or purchases side of each sector in relation to all other sectors. Since each figure in any horizontal row is also a figure in a 10

20 vertical column, the output of each sector is shown to be an input in some other. These interindustry exchanges of goods constitute the shaded portion of table 1. The additional columns, labelled Final Demand, record the sales to the households, government and foreign trade. As a matter of fact, each producing sector within the economy has certain amount of output that may be used within the sector, sold as inputs to other producing sectors or sold for final demand to consumers. For example, electricity is sold to other sectors as input to production (an interindustry transaction) and also to consumers (a final demand sale). Usually the demand of these external units is generally determined by considerations that are relatively unrelated to the amount being produced in each of the units. When all purchases or expenditures by sector are considered, total sector output is exactly equal to sector outlay. Such a table may be developed in as fine or as coarse detail as the available data permit and the purpose requires. PRODUCERS Agriculture Mining Construction Manufacturing Trade Transportation Services Other Personal Consumption Expenditures Gross Private Domestic Investment FINAL DEMAND Net Exports of Goods and Services Government Purchases of Goods and Services Agriculture Mining PRODUCERS Construction Manufacturing Trade Transportation Services VALUE ADDED Other Employees Owners of Business and Capital Government Employee compensation Profit: type income and capital consumption allowances Indirect business taxes Table 1 Input-output transactions table Source: U.S. Department of Commerce, Bureau of Economic Analysis Thus, if the economy is divided into n sectors, and if we denote by X i the total output (production) of sector i and by Y i the total demand for sector i s product, we may write X i = x i1 + x i2 + + x ii + +x in +Y i (1) 11

21 The x terms on the right-hand side of equation 1, represent the interindustry sales by sector i, thus the entire right-hand side is the sum of all sector i s interindustry sales and its sales to the final demand, representing the distribution of sector i s output. Therefore, for each of the n sectors there will be: X 1 = x 11 + x x 1i + +x 1n +Y 1 X 2 = x 21 + x x 2i + +x 2n +Y 2.. (2). X i = x i1 + x i2 + + x ii + +x in +Y i. X n = x n1 + x n2 + + x ni + +x nn +Y n The x elements represent the sales to sector i, meaning i s purchases of the products of the various producing sectors in the country. Clearly beside the interindustry purchases or inputs to production, a sector also pays for other items, such as labour and capital, and uses other inputs as well, such as inventoried items. All of these inputs are termed the value added in sector i. In addition, imported goods may also be purchased as inputs by sector i Technical Coefficients Table The transaction table provides an interesting and useful snapshot of the structure of an economy, however is only descriptive of the current situation and thus not very useful for economic analysis. In order to use input-output techniques analytically to examine how production in each sector will change in response to a certain change in the final demand it is necessary to use the technical coefficients table. The technical coefficients show the value of inputs purchased from all sectors in the economy per monetary unit of output in a particular sector, in other words, they show the production function for each productive sector. For instance, for a given sector A, technical coefficients represent the value of purchases from each sector in the economy that must be made by the sector A in order for it to produce one monetary unit worth of output. Therefore, technical coefficients can be derived by dividing all entries in each sector s column by the total outlay of that sector. If, from the transaction table, x ij symbolise the value of sales from sector i to sector j and x j the total output of sector j, the technical coefficients (described by the symbol a ij ) for each sector are calculated using the following equation: 12

22 a ij = x ij / x j (3) A complete set of the input coefficients of all sectors of a given economy arranged in the format of a rectangular table is called the structural matrix or technical coefficients matrix of that economy. A table of technical coefficients for the entire economy gives us, in as much detail as we require a quantitatively determined picture of the internal structure of the system. In order to compare the structural properties of two economies, or the structural characteristics of the same economy at two different points of time, one only needs to compare two technical coefficient matrices. The only difficulty that may arise in doing such a comparison might be caused by the incompatibility of the sectoral breakdown in terms of which the two tables were originally compiled (Leontief, 1986). With this table for the economy as a whole, it is possible to calculate the secondary demand on the output of the industries that supply a specific industry s suppliers and so on through successive outputs until the effect of the final demand has been traced (Leontief, 1986). The effect of an event at any point is transmitted to the rest of the economy step by step via the chain of transactions that links the whole system together Interdependence Coefficients Matrix The interdependence coefficients matrix is the most important of the three input-output matrices for economic analysis purposes. The coefficients or elements of this matrix measure the total (direct and indirect) output required of all sectors in order for any particular sector to make a sale of one monetary unit to final demand. In other words, it measures the total impact of a change in final demand in a given sector on the output of all other sectors of the economy after all successive rounds of output increases have been recorded. The next paragraph discusses its algebraic formulation. In a broad way, the commodity flow balance, takes the form: x + m = Ax + F = Ax + f C + f G + f I + f V + f E (4) where the left side, x + m, represents the total supply of commodities by sector and the right side represents the total demand for commodities, and: 13

23 x n-vector, total output by sector; m n-vector, imports by sector; A n n matrix, technical coefficient matrix; the element ij in the matrix shows how much of sector i s output is used as input by sector j per unit of output; F n-vector, total final consumption by sector; f C private consumption by sector, includes households and private non profit institutions; f G public consumption; f I gross fixed capital formation by sector of production (investment); f V changes in inventories plus statistical error; f E exports. The previous equation allows determining the total output produced in the whole economy given the levels of total final demand for commodities (private and public consumption, exports, etc.). As it was stated before, the interindustry relationships among sectors was defined as a ij = x ij /X j. This expression can be rearranged to read x ij = a ij. X j, meaning that the level of sales from sector i to sector j depends upon the level of output in sector j (X j ) and the technical coefficient of input requirements of sector j from sector i (a ij ). Being, F, the final demand vector, which contains the monetary changes in each sector s final demand; A, the technical coefficients matrix and X a vector representing the overall changes in output by sector, in an economy with only three producing sector, for instance, the transactions of the producing sectors may be written as a set of simultaneous equations: x 11 + x 12 + x 13 + F 1 = X 1 x 21 + x 22 + x 23 + F 2 = X 2 (5) x 31 + x 32 + x 33 + F 3 = X 3 where, x ij sales from sector i to sector j F i sales from sector i to final demand X i total output of sector i 14

24 Substituting equation x ij = a ij. X j into equation 5 and rearranging the equations for the producing sector (i = 1,, 3), a 11 X 1 + a 12 X 2 + a 13 X 3 + F 1 = X 1 a 21 X 1 + a 22 X 2 + a 23 X 3 + F 2 = X 2 (6) a 31 X 1 + a 32 X 2 + a 33 X 3 + F 3 = X 3 The previous equation disclose the interdependence of each sector on all others because it shows that the level of output in any sector is dependent on the level of output in the other sectors, on the input requirements of each sector and on the level of its final demand. Assuming the final demand (F i ) as exogenous to the producing sectors: X 1 a 11 X 1 a 12 X 2 a 13 X 3 = F 1 -a 12 X 2 + X 2 a 22 X 2 a 33 X 3 = F 2 (7) -a 31 X 1 + a 32 X 2 + X 3 a 33 X 3 = F 3 or, (1 a 11 )X 1 a 12 X 2 a 13 X 3 = F 1 -a 21 X 1 + (1 a 22 )X 2 a 23 X 3 = F 2 (8) -a 31 X 1 a 32 X 2 + (1 a 33 )X 3 = F 3 The system can be simplified displaying it in a matrix notation, X X X (1 a = a a ) a (1 a a ) a a (1 a 33 ) 1 F1 F 2 F 3 or: (I A)X = F (9) The solution that expresses each sector s output (X) as a function of final demand (F) might be found by the following manipulation. Pre-multiplying by (I A) -1 gives: 15

25 X = (I A) -1 F (10) The previous equation is the solution equation to the input-output system though which we can find the levels of output from all sectors required to support specified levels of final demands in all sectors. The (I A) -1 is called the inverse Leontief matrix or matrix of interdependence coefficients and the elements of this matrix measure the direct and indirect output levels from each producing sector of the economy required to satisfy given levels of final demand. The matrix (I-A) -1 is also referred as the multiplier matrix as it shows the direct and indirect requirements of input-output per unit of sectoral final demand. From such viewpoint equation (10) can be seen as the result of an iterative process that shows the progressive adjustments of output to final demand and input requirements, meaning it can be expanded to the infinite series of intersector transactions: X = (I + A + A 2 + A A n-1 ) F (11) The first component on the right-hand side of equation 11 shows the direct outputs requirements to meet the final demand vector (F). The second component shows the direct output requirements satisfying, in the second round, the intermediate demand vector, AF, needed for the production of vector F in the previous round; the third component shows the direct output requirement for the intermediate consumption, A 2 F, required for the production of vector AF in the previous round, and so on until the process decays and the sum of the series converges to the multiplier matrix (I-A) -1. It is important to notice that equation 10 provides the total output (X) needed to satisfy a certain increase or decrease in the final demand F, being useful to examine how production will change in response to a certain change (variation) in the final demand. If one needs to determine the value of total output produced in the whole economy derived from the real value of final demand, and not only its variation, will have to use equation 4. The model presented above consists in the input-output static model, a cross-section in time, where changes in the economy over periods of time are measured by comparing before and after pictures. 16

26 Dynamics is introduced by taking into consideration the investment behaviour and so stating explicitly the rules for passing through one single period to the following. Equation 10 would then become the well-known Leontief dynamic system: X(t) = Ax (t) + B (x(t+1) x(t)) + F*(t) (12) Where vector F*(t) represents the final demand vector after the new capital requirements have been taken out and matrix B, i(t)=k(t+1)-k(t)=b (x(t+1)-x(t)), is the capital coefficients matrix, showing the new capital requirements for the input-output sectors for one unit change in the output vector. The dynamic models of the economy are much closer to the actual processes of economics, however it requires for stocks as well as flow of goods, for inventories of goods in process and in finished form, for capital equipment, for buildings, and for dwellings and household stocks of durable consumer goods. The dynamic input-output analysis requires more advanced mathematical methods for instance, instead of ordinary linear equations it leads to systems of linear differential equations. Among the questions the dynamic system should make it possible to answer, one could mention the determination of the changing pattern of outputs and inventories or investments and capacities that would attend a given pattern of growth in final demand projected over a five or ten-year period (Leontief, 1986). Due to more advanced mathematical methods required, the huge amount of actual data necessary and the level of analysis and objectives desired for this work, it will be used the static method described above instead of a dynamic approach. 2.3 Use of Input-Output Analysis to Trace Environmental Discharges The complexity of the interaction between human activities (through economic goods) and environmental systems has long been recognised. It is often argued that policy analysts do not sufficiently consider this complexity in their evaluation of policy options for environmental regulations. In a world of perfect information and efficient markets, the need for environmental policies would not exist since all scarce resources, including the environment, would be allocated based upon their scarcity. However, such is not the case and throughout the world, political institutions are faced with the task of correcting market failures associated with the use (or abuse) of the environment. 17

27 In this context, to develop the appropriate policy responses to prevent the various types and consequences of pollution, or other environmental burdens, requires the input of a vast array of expertise, a clear description of the current situation and accurate mechanisms to evaluate different options, focusing the desired output results. In this section a useful methodology to support policy making, providing the endpoints necessary as inputs into policy models, is described. It is intuitive that effective environmental decision-making requires, among other things, information about the consequences of alternative designs, available materials, manufacturing processes, product use pasterns and disposal. One of the most well known and common tools to provide this type of information is Life-Cycle Assessment (LCA) methodology (Ferrão, 1998). This methodology attempt to quantify the environmental implications of alternative products and processes tracing pollution discharges and resources use through the chain of producers and consumers. It involves quantification of the environmental burdens (inventory analysis), estimation of the impacts of these burdens on humans and nature (impact analysis), and identification of areas where improvements are possible (improvement analysis) (Horvath and Hendrickson, 1998). As defined by ISO , Life-cycle Analysis (LCA) is a technique for assessing the environmental aspects and potential impacts associated with a product by compiling an inventory of environmentally relevant inputs and outputs of a system, evaluating the potential environmental impacts associated with those inputs and outputs and interpreting the results of the inventory and impact phases in relation to the objectives of the study. Life-cycle analysis seeks to characterise the direct and indirect impacts of a product or process from raw material extraction through product disposal, looking systematically at the environmental effects of various stages of a product s life cycle: the materials extraction stage, the manufacturing/production stage, the use phase, and the ultimate disposal phase (or end-oflife). In short, it attempts to measure the cradle-to-grave environmental impacts of a product. One of the most widely used tools for performing life cycle analysis is that advocated by the Society for Environmental Toxicology and Chemistry (SETAC) and the U.S. Environmental Protection Agency (EPA). The SETAC-EPA approach divides each product into individual process flows, and tries to quantify their environmental effects during its life cycle. Existing studies differ in the number of environmental effects quantified, and in the scope of the analysis, which is determined by where the boundary of the analysis is drawn. 1 In (http://www.iso.ch/) 18

28 Despite the useful aspects and the need of conducing LCA, several numbers of limitations to the LCA methodology have been pointed out in the literature, such as:!"as several different variants of assessment methods are currently in use, it is difficult to compare the results of different LCAs (Behrendt, Jasch, Peneda and Weenen, 1997). Moreover, equally credible analyses can produce qualitatively different results, so the results of any particular life-cycle analysis cannot be defended scientifically (Lave, Cobas-Flores, Hendrickson and McMichael, 1995).!"The availability of data is not usually sufficient and its quality varies widely (Behrendt, Jasch, Peneda and Weenen, 1997). Meaning that, there is lack of comprehensive data for LCA and the data quality is not uniformly high (Lave, Cobas-Flores, Hendrickson and McMichael, 1995).!"LCA always involves simplifications and, because not all required data are available, some information will unavoidably be off a qualitative nature (Behrendt, Jasch, Peneda and Weenen, 1997).!"The scope of a LCA analysis is limited (simplified) by drawing an ad hoc system boundary that excludes all but a few upstream and downstream processes. Defining system boundaries for LCA is arbitrary and controversial, considering each industry is dependent, directly or indirectly, on all other industries (Fiksel, 1996). The interdependent and interactive nature of the modern economy means that a narrow focus can ignore important effects and lead to qualitatively incorrect conclusions. In fact, the indirect effects of increased production of a commodity typically are larger than the direct effects. According to a study performed by Lave, Cobas-Flores, Hendrickson and McMichael (1995) comparing paper cups versus plastic cups, the SETAC-LCA discharge estimates are less than one-half of the total discharges, considering all interdependencies. In fact, the indirect economic effects of an initial order are large, generally more than twice that of the direct effect, concluding that they cannot be neglected in the analysis without seriously underestimating the total discharges. Therefore, analysts should be extremely cautious in making such assumptions as environmental impacts can vary significantly from process to process and from industry to industry.!"the process model analysis is expensive and time consuming because inputs and environmental burdens have to be either empirically gathered or obtained from literature (if available) (Hendrickson, Horvath, Joshi, Klausner, Lave and McMichael, 1998). LCA is data intensive and thus expensive to conduct (Fiksel, 1996). Moreover, it is slow for application in the design process (Lave, Cobas-Flores, Hendrickson and McMichael, 1995). 19

29 !"LCA does not account for other, non-environmental aspects of product quality and cost (Fiksel, 1996).!"LCA cannot capture the dynamics of changing markets and technologies (Fiksel, 1996).!"Modelling a new product or process is difficult and expensive (Lave, Cobas-Flores, Hendrickson and McMichael, 1995). Regarding all these limitations (especially in what concerns the definition of system boundaries) we can easily conclude that to examine the economy-wide environmental implications of a design or product, a model must capture all the economic interdependencies. A model entitled Economic Input-Output-Based Life Cycle Assessment (EIO-LCA) was developed by a group of researchers in Carnegie Mellon University s Green Design Initiative. The EIO-LCA is basically an extension of the input-output analysis described previously, enabling to quantify all the direct and indirect interrelationships among industry sectors of an economic system and their respective environmental burdens. EIO-LCA complements the economic input-output analysis by linking economic data with resource use (such as energy, ore and fertiliser consumption) and/or environmental impact categories (such as greenhouse gas emissions, toxic discharges, ozone depletion potential, hazardous or non-hazardous waste). In the EIO-LCA method, the economic input-output method (equation 10) is augmented with data vectors indicating environmental impacts per unit of output: E i =R i X=R i (I-A) -1 F (13) R = R (1 a11) 0 a21 R 33 a31 a (1 a a ) a a (1 a 33 ) 1 F1 F 2 F 3 Where E i represents the vector of total environmental effects of category i, R i is a matrix of discharges of type i, per monetary unit of sector s output. Environmental impacts can be estimated either for all effects or just for direct supplier impacts: E D =RY=R(I+D)F (14) 20

30 Where E D represents the direct discharges and Y represents the direct economic changes. Using this methodology brings several major advantages, regarding the inventory of environmental discharges, comparing to LCA. This type of analysis is transparent since the method is based on publicly available data, making it cheaper and more efficient to apply than the conventional LCA. An EIO-LCA analysis can be accomplished in a few hours without additional data, once the input-output matrix has been filled out. Furthermore, a comprehensive model of the entire economy is used, so that analysts do not need to draw arbitrary boundaries, ensuring that the full range of direct and indirect effects and their environmental consequences are taken into account. Indeed, one of the main advantages of economic input-output analysis is that it explicitly accounts for all of the direct and indirect inputs to producing a product or service by using the input-output matrices of a national economy. Indirect and feedback relationships among the different processes and economic sectors can be included directly. In summary, within this method the direct economic changes associated with a certain choice are forecast. An economic input-output table is then used to estimate both direct and indirect changes in output throughout the entire economy, for each sector. Finally, the environmental discharges associated with the changes can be assessed by multiplying the output changes by the average level of a pollutant, electricity use or any other type of environmental burden. Hence, this vector of additional discharges characterises the overall environmental impact caused by a specific variation of final demand. Notwithstanding the obvious advantages foreseen for this methodology comparing with the LCA approach, it has also some limitations that ought to be considered, such as:!"the current sectors level of disaggregation may be insufficient for the desired level of analysis, since environmental effects of the entire product mix are considered in the model, thereby leading to potential errors from aggregation (Lave, Cobas-Flores, Hendrickson and McMichael, 1995 and Hendrickson, Horvath, Joshi and Lave, 1998).!"As input-output models include sectors of the economy rather than simple processes, one of the limitations is that the sectors may be too heterogeneous to correctly reflect particular processes (Hendrickson, Horvath, Joshi and Lave, 1998).!"It is difficult to differentiate product types and processes used within any particular industry (Cobas, Hendrickson, Lave and McMichael, 1995).!"The model can be used to reflect fabrication of a product or process but not the environmental impacts arising from use or disposal (Hendrickson, Horvath, Joshi and 21

31 Lave, 1998). Nor the environmental impacts of exports and imports of goods included in the model (Lave Cobas-Flores, Hendrickson and McMichael, 1995).!"The results of input-output models are most accurate when changes in output are relatively small. As changes increase or as new technology is introduced, the model results are likely to be less good approximations of what the economy would deliver (Lave, Cobas-Flores, Hendrickson and McMichael, 1995).!"The input-output matrix employed, in principle could be estimated for any geographic region, but the data gathering and estimation cost might be prohibitive (Lave, Cobas- Flores, Hendrickson and McMichael, 1995). Although there are limitations this method provides a strong and advantageous methodology to access any type of environmental burdens caused by a certain level of production increase or decrease since it uses reliable economic data. The only major limitation might be the quality and quantity of the environmental data available for each one of the economic sectors. The better and more accurate is the data used, the more benefits and reliable conclusions we can take from the model, and more precisely we can use the results to fundament policy actions. 22

32 3 ECONOMIC INPUT-OUTPUT ANALYSIS: THE PORTUGUESE CASE STUDY 3.1 The Portuguese Input-Output Tables Many countries, including Portugal, collect and publish an input-output table for their economies. These tables are used to calculate the additional resources, such as intermediate and final products required for increases in the final demand for specific sectors of the country s economy. In this section the Portuguese input-output tables will be presented, as well as its usefulness in terms of the analysis they allow to perform. Additionally it will be presented a macro analysis of the evolution of the Portuguese economy based on the input-output framework. The growing integration and interdependency of the national economies impose the need of international comparison of the statistical information among different countries, especially in what concerns the national accounts. In the European context this need is even more stressed. Indeed, the national accounts perform, nowadays, an important role in what concerns the economic, monetary and fiscal policy of the European Union, namely in:!"self community resources: - Determination of the total amount of resources based on the Gross National Product (GNP); - The contribution of the member states to the value added tax (VAT) is affected by the National Accounts;!"The decision of the structural funds make use of the regionalised data of the National Accounts;!"The protocol relative to the excessive debits that is annexed to the European Union Treaty uses as reference values the ones determined in the input-output table;!"the contributions of the national Central Banks to the European Monetary Institute are based on the GDP and total population, defined by the National Accounts. Thus, gathering statistical economical data and organising it into an input-output transactions table is crucial either for internal economic analysis purposes or for international comparisons. 23

33 Economic sectors are defined by the agency that gathers the information about the country s economy that assigns a name and a number to each economic sector. In Portugal the national economic input-output tables are compiled by the National Statistics Institute ( Instituto Nacional de Estatística INE) of the Ministry of Planning, for 49 economic sectors. Until 1976, the INE performed the input-output table following the OECD approach. In 1979 the national input-output tables started to be completed according to the European System of National and Regional Accounts (ESA) 2 nd edition (1978). However, the National accounts will soon consider 150 economic sectors, according with the new European nomenclature ESA2000. Nevertheless, the most recent Portuguese transaction table publicly available at the moment dates back to 1995 and includes sectors. Each one of the 49 sectors has a code, known as CAE (Economic Activity Classification) code (Table 2). A new transaction table for 1998 will be released soon, but is still not available. Therefore, the 1995 transactions table is the latest available table one can focus on to make the necessary calculations (Annex 1). The inputs and outputs of this transaction table are stated in 1995 PTE. 24

34 Sectors Denomination 01 Agriculture & hunting 02 Sylviculture & forestry 03 Fishing 04 Coal mining 05 Petroleum Mining and Refinery 06 Electricity, gas and water 07 Metallic mineral mining 08 Non metallic minerals mining 09 Porcelain, faience, etc. 10 Glass and glass articles 11 Other building materials 12 Chemical products 13 Metallic products 14 Non-electrical machinery 15 Machinery, apparatus, etc. 16 Transport vehicles and equipment 17 Slaughter & meat processing 18 Dairy products 19 Conservation of fish and other related products 20 Cooking oil and food fats 21 Cereals & leguminous processing 22 Other food processing 23 Beverages industry 24 Tobacco industry 25 Textile & clothing industry 26 Tanning & leather industries 27 Wood & cork industries 28 Paper, graphics arts & publications 29 Rubber products & articles of plastic material 30 Other manufacturing industries 31 Construction 32 Restoring & repair 33 Wholesale & retail trade 34 Restaurants & hotels 35 Land transport & inland waterways transport 36 Maritime & air transport 37 Transportation-related services 38 Communications 39 Financial services 40 Insurance services 41 House renting 42 Services rendered for companies 43 Commercial services of education & research 44 Commercial services of health& veterinary 45 Other commercial services 46 Non-commercial services of Public Administration 47 Non-commercial services of education & research 48 Non-commercial services of health & veterinary 49 Other non-commercial services 50 Virtual sector Table 2 Portuguese economic sectors. Source: INE,

35 According with ESA (1978), the institutional units, whose operations are described by the National Accounts are denominated resident units. The resident units are those that have a core of interest in the national economic territory. The economic territory considered in the National Accounts encompasses:!"geographical continental territory and the Autonomous Regions of Azores and Madeira, excluding parts of the territory used by foreigner public administrations, European community institutions or other international institutions ruled by international treaties or agreements between States;!"National air space, territorial waters and part of the continental platform located in international waters;!"the territories located in foreigner countries used by the Portuguese public administration by means of international agreements or agreements between States (embassies and Portuguese consulates);!"the mineral deposits located in international waters, outside the continental platform, that are explored by resident units in the territory, as defined previously. ESA defines the resident units in a country as follows:!"productive, financial, insurance and redistributing units;!"consuming units;!"land and building owners (exclusively to operations related to this activity). The production represents the result of the economic activity of each resident unit, which composes the production of goods and services in a certain period of time. The production is evaluated at factory prices and therefore includes all the taxes related to production free from deduction and can be divided into:!" Production of goods;!" Production of commercial services, except financial ones;!" Production attributed to financial services. Production of goods include: production of new goods for commercial trade, production of goods for interconsumption, production of agricultural and alimentary goods to be auto 26

36 consumed by the families, production for one s own account of fixed capital goods and all the production that the producing units give to their employees as a way of remuneration. Production of commercial services includes all the services that can be trade in the market, and that are produced in units, which profits arise from their production. The non-commercial production embraces the domestic services produced by the families for their own profit and the collective services that are provided for the community or for groups of families in a free or almost free way. The intermediate consumption is the value of all goods and commercial services consumed in a certain period of time in order to produce other goods and services. This type of consumption is evaluated by the acquisition price. The final consumption is the value of goods and services used for private satisfaction, being evaluated also by the acquisition price. Therefore, this type of consumption includes the final consumption of families (or private consumption) and the collective consumption of the public and private administration. The gross formation of fixed capital represents the value of durable goods, designed for non-military purposes, acquired by the resident production units to be used for more than a year in their production process, augmented by the value of services incorporated in the fixed capital goods. The change in stocks represents the difference between the input and output in stocks, in a certain period of time of every goods that are not included in the fixed capital. By convention, it is assumed that the families and public and private administration consume immediately all the goods they buy, with exception of those that constitute strategic stocks. The exports of goods and services:!"exports of goods include all the goods that that freely or not leave definitively the country economic territory, with destination to the rest of the world.!"exports of services include all the services (transports, insurance, etc.) provided by resident units to non-resident units. Imports of goods and services:!"imports of goods include all the goods that, freely or not, enter definitively the Portuguese economic territory from the rest of the world.!"imports of services include all the services (transports, insurance, etc.) provided by the non-resident units to the resident units. 27

37 Similarly to other countries the Portuguese input-output table encompasses six elements:!"domestic intermediate consumption;!"imported goods;!"domestically-sourced investment goods;!"sub-matrices of final demand vectors for expenditures on both domestic and foreign products;!"the sub-matrix of value-added sectors. Therefore, the national input-output table format can be schematised in the next figure (Figure 1): Transactions Table Private Exp. Govenment Exp. GFCF Change in stocks Exports Gross Output Imports Compensation of employees VALUE ADDED Operating Surplus Depreciation of Capital Net indirect taxes Total Inputs Figure 1 - Input-Output System Schema. Source: Based on OECD (1998). Observing the national input-output transactions table (Annex 1) one can see that it isn t a square matrix, having an additional sector (sector 50). This is explained by the fact that in the Portuguese table, the production imputed to the financial and banking sector (sector 39) is measured, conventionally, through the difference between the income/revenue received by the credit institutions, except the ones providing from the application of their own funds, and the amount of interests paid to their creditors. This production is totally reserved for the intermediate consumption of a fictitious sector (sector 50), whose production is null, thus having a negative gross value added (GVA). As it was mentioned before, the Portuguese most recently available transactions table, at the moment of this study, dates back to 1995 (Annex 1) and analysing it (Figure 2) one can 28

38 conclude (by noting the principal diagonal of the picture below) that, in average, the major contribution to each sectors output is done by the sector itself. Therefore, in order to produce for final demand each sector has to use as input its own production Figure 2 Portuguese input-output transaction table (1995). Values in 10 6 PTE Source: INE, Input-output tables 1990 and From the transaction table, is possible to determine the technical coefficients table following the equation 3. The technical coefficients table (Figure 3) provide the production function of the producing sectors as it quantifies the inputs coming from each one of the other producing sectors that one certain sector need to produce one monetary unit of output. For instance, for the Agriculture and Hunting sector (sector 1) to produce one PTE of output, requires an input PTE from the sector itself, 0.1 PTE from the Petroleum sector (sector 5), 0.37 PTE from the Other Food Processing sector (sector 22), and the remain 0.3 PTE from the rest of the economic sectors. 29

39 Figure 3 Portuguese technical coefficients table (1995). The interdependence coefficients matrix, or the inverse Leontief matrix - (I-A) -1 - measure the direct and indirect output levels from each producing sector of the economy required to satisfy given levels of final demand. Observing a representation of this matrix for Portugal one can see, as expected, that the petroleum and electricity sectors (sector 5 and 6) contribute highly on inputs to the others sectors. In fact, economic growth is arguably the most important driver of energy demand, since all production is strongly dependent on energy consumption (Figure 4). Figure 4 Portuguese interdependence coefficients matrix (1995). 30

40 3.2 Evolution of the Portuguese Economy ( ) The analysis here performed is based on the reference years of 1990 and The year of 1995 was chosen for obvious reasons, since it is the most recent year for which the transaction table for Portugal is available. The choice of 1990 was made to evaluate structural changes in the Portuguese economy for a five-year period, and mainly because it is the reference year established in the Kyoto Protocol. As the emissions of GHGs are strongly correlated with the energy use, and energy consumption is associated with economic development, it is useful, at this stage, to understand the evolution of the Portuguese economy between 1990 and 1995, in order to better foresee the economic evolution in the years to come. In the period between 1990 and 1995, the behaviour of the relevant macroeconomic indicators, such as those represented in figure 5, show an almost constant trend for an increasing of the private consumption and a growing decrease verified in the Portuguese economy since 1990, with a special incidence in PTE Private Consumption Imports of goods and services Exports of goods and services GFFC Figure 5 Principal supply components (at constant prices of 1995). Source: INE, Input-output tables from 1990 to

41 In the second trimester of 1994, the economic recovery began, which increased in 1995 (Seixas, 2000). The analysis of the national input-output tables contributes to assess the evolution of the Portuguese economic structure and performance over a specific period of time. As it is illustrated in the figures 6 and 7, which contain data obtained from the national input-output tables, there was a general increase in the total output of the Portuguese economy between 1990 and 1995, and almost all the sectors verified an increase in their production, with the important exceptions of Agriculture and Hunting, Petroleum, Chemical, Non-electrical Machinery and the Textile sectors, as represented in figure 7. Agriculture & hunting Sylviculture & fo restry Fishing Coalmining Petroleum Electricity,gas and water Metallic mineralmining Non metallic minerals mining Porcelain,faience,etc. Glass O ther building m aterials C hem icalproducts Metallic products Non-electricalm achinery M achinery,apparatus,etc. Transport vehicles and equipment Slaughter & m eat processing Dairy products C onservation of fish Cooking oiland fo o d fats C ereals & legum inous processing O ther food processing B everages industry Tobacco ind ustry Textile & clothing Tanning & leather Wood & cork Paper,graphics arts & publications Rubber & plastic materials Other m anufacturing industries C o nstruction R estoring & rep air Wholesale & retailtrad e R estaurants & hotels Land transp o rt & inland w aterw ays transp o rt Maritime & air transport T ransp o rtatio n-related services Communications Financialservices Insurance services House renting Services rendered for com panies Commercialservices of E&R Commercialservices of health& veterinary O ther commercialservices Non-commercialservices of PA Non-commercialservices of E&R Non-commercialservices of health & O ther non-com m ercialservices PTE Figure 6 Total output by economic sector in 1990 and 1995 (prices of 1995). Source: INE, Input-output tables 1990 and

42 (10 6 PTE) Figure 7 Total output variation between 1990 and 1995 (prices of 1995). Source: INE, Input-output tables 1990 and The contributions of the main economic sectors to the national output did not observe significant changes between 1990 and 1995, as represented in figure 8, but the increase of the services sector contribution to the gross value-added (GVA) is worth mentioning. 33

43 Agriculture & hunting, sylviculture and fishing 4.3% 6.7% Industry 40.2% 38.4% Services 53.1% 57.3% Figure 8 Contribution of Agriculture, Industry and Services sectors to national gross value-added (% of GVA). Source: INE, Input-output tables, 1990 and This is particularly important as the Services sectors are contributing with more than 50% to the GVA structure, followed by the Industry sectors. There is a widely held belief, which asserts that services offer more opportunities for growth than manufacturing product-based industries (P. Castello and A. Soria, 1997). There is no doubt that the role of services has increased substantially in contemporary economies, in terms of their output, employment, and importance as inputs to other sectors. In most European Union member states nowadays, service activities provide around twothirds of all jobs and GDP due to the dynamic innovative capacity of many newly emerging service sectors (EIMS, 1998), as it can be seen in the table below. 34

44 Country % of GDP derived from: Agriculture Industry Services Luxembourg Belgium Denmark Austria Germany France Netherlands Italy UK Sweden Finland Ireland Spain Portugal Greece Source: EUROSTAT, Table 3 - Share of GDP per Sector in European Countries in Portugal follows these European tendencies towards increasing economic contribution of services, either technological and knowledge intensive services or with no technological knowledge associated (traditional professional services). The services that have higher contribution for GVA are the Wholesale and Retail Trade sector, the Financial Services sector and the Services Rendered for Companies sector, although the first two sectors are decreasing their contribution, if we compare 1990 with 1995 (Figure 9). 2 In (Oliveira, 1998) 35

45 Wholesale & retail trade Restaurants & hotels Land transport & inland waterways transport Maritime & air transport Transportation-related services Communications Financial services Insurance services House renting Services rendered for companies Commercial services of education & research Commercial services of health& veterinary Other commercial services Non-commercial services of Public Administration Non-commercial services of education & research Non-commercial services of health & veterinary Other non-commercial services Figure 9 Contribution of Services sectors to national gross value-added (% of GVA). Source: INE, Input-output tables, 1990 and The reduction of the weight of Agriculture, Sylviculture and Fishing as quantified in figure 10 can be justified by the Portuguese adhesion to the European Union, due to the production targets established in the Common Agricultural Policy (Banco de Portugal, 1994, 1996) 3. 3 In (Seixas, 2000). 36

46 Agriculture & hunting Sylviculture & forestry Fishing Figure 10 Contribution of Agriculture, Sylviculture and Fishing sectors to national gross value-added (% of GVA). Source: INE, Input-output tables, 1990 and On the other hand, the analysis of figure 11 shows that the industry sectors that provide the major contributions for GVA in Portugal are the Utility sector, Textile and Clothing sector and the Construction sector. Coal mining Petroleum Mining and Refinery Electricity, gas and water Metallic mineral mining Non metallic minerals mining Porcelain, faience, etc. Glass and glass articles Other building materials Chemical products Metallic products Non-electrical machinery Machinery, apparatus, etc. Transport vehicles and equipment Slaughter & meat processing Dairy products Conservation of fish and other related products Cooking oil and food fats Cereals & leguminous processing Other food processing Beverages industry Tobacco industry Textile & clothing industry Tanning & leather industries Wood & cork industries Paper, graphics arts & publications Rubber products & articles of plastic material Other manufacturing industries Construction Restoring & repair Figure 11 Contribution of the Industry sectors to national gross value-added Source: INE, Input-output tables, 1990 and

47 Input-output tables can also be used to assess technological change, although this is a very complex topic that is related to a wide range of other economic and social phenomena, with inventive and innovative activities involving a variety of phenomena, which are difficult to conceptualise and measure in simple models (Archibugi and Michie, 1998). Each sector industry has its own cooking recipe, which is determined mainly by technology. Technology in a real economy changes slowly over the periods of time usually involved in economic forecasting and planning (Leontief, 1986). Therefore, it is generally assumed constancy in technical coefficients in the short-run. In fact, this is one of the assumptions of input-output analysis that the technical coefficients can be assumed constant over a short period of time. The perception of the changes in input structure of the industry, due to changes in prices or technology, can be achieved through comparing different years technical coefficients matrices. Since a column vector of input coefficients represents the technological structure of each sector of the economy, technological change can be described concisely as a change in the magnitudes of the elements of these vectors. Figure 12, quantifies the change in the technical coefficients of the Portuguese economy between 1990 and Figure 12 Variation in the Portuguese technical coefficients

48 In fact, figure 12 identifies the sectors for which major technological or production changes occurred between 1990 and For instance, figure 13 shows that the Cooking Oil and Food Fats sector needed, in 1995, higher percentage of inputs from Agriculture & Hunting sector when compared to 1990 (71%). On the other hand, it became less dependent of the Chemicals sector compared with 1990 (-28%) Agriculture Chemical Products Other Figure 13 Technical coefficient change in the Cooking Oil and Food Fats from 1990 to The Fishing sector, to produce the same output, required more inputs from the Other Food Processing sector (1044%) and Transportation Related Services sector (467%), in 1995, than in 1990 (Figure 14). One curiosity is that the Fishing sector in 1995 was less dependent on the Petroleum sector (-47%) than it was five years before and this may be associated with the fact that the fisheries were done closer to the coast, or due to a productivity increase Petroleum Other food processing Transportation-related services Other Figure 14 Technical coefficients change in the Fishing sector between 1990 and

49 The sectors of Land Transport and Inland Waterways Transport, and Maritime and Air Transport required in 1995 more inputs from the Services Rendered for Companies sector (to produce one unit of output), respectively more 128% and 102%, than they used to in 1990 (Figures 15 and 16). This shows a change in the production structure of the Portuguese economy, contradicting the theory that the technical coefficients remain almost the same over a short period of time Petroleum Transport vehicles and equipment Land transport Services rendered for companies Other Figure 15 Technical coefficients change in the Land Transport sector between 1990 and Petroleum Maritime and air transport Transportation-related services Services rendered for companies Other Figure 16 Technical coefficients change in the Maritime and Air Transportation sector between 1990 and

50 The main evidence we can take from this level of analysis is that the Portuguese economy is oriented towards services, as the industrial sectors are becoming more dependent of the services sector. 41

51 4 ENVIRONMENTAL INPUT-OUTPUT ANALYSIS: THE PORTUGUESE CASE STUDY The state of the environment is currently a major world-wide concern. Pollution, in particular, is perceived as a serious threat mainly in the industrialised countries, where quality of life is synonymous of growth in material output. Meanwhile, environmental degradation has become a serious factor to take in consideration when defining the economic development and the alleviation of poverty in the developing world. The growing evidence of environmental problems is due to a combination of factors. Over the last three decades the environmental impact of human activities has grown considerably on account of the increase in economic activity, population and per capita consumption. This section focuses on the greenhouse gas (GHG) emissions as a case study since they contribute to one of the most serious environmental problems the world faces nowadays - the climate change. Although the role of GHGs in climate change is not unanimous among some scientific experts the reality is that the average global temperature is increasing at a quick rate and almost all Nations are concerned about this issue and willing to take political actions to revert this tendency. Many countries are now making efforts to stabilise greenhouse gas emissions at 1990 levels. In this context, emissions inventories represent a critical first step towards the development of policies and strategies to mitigate greenhouse gas emissions. Once the emissions of various GHGs have been inventoried and assigned to specific economic activities, policy makers may identify and assess various options for reducing those emissions. This study propose the use of input-output analysis methodology to calculate the expected increase in the GHGs in the coming years, comparing the results with the levels agreed in the Kyoto Protocol. This thesis is aimed at demonstrating that this methodology is a powerful and advantageous tool to assess the changes of any type of environmental burden generated by a change in the final demand and to provide useful inputs for decision-making. In fact, the use of the input-output framework has the major advantage of considering all the direct and indirect economic effects and avoiding the settlement of arbitrary boundaries. The GHGs evaluation for year 2010 will contribute to evaluate the position of Portugal when compared to the targets agreed by the European Union in Kyoto. To achieve these proposes the next sections start by reviewing some concepts about the GHGs, their consequences to the global warming, and the international political context and background concerning this matter. Subsequently, the greenhouse gas emissions in Portugal will be characterised, for the reference years of 1990 and 1995 and the consequent Global 42

52 Warming Potential (GWP). Based on this information, the emissions for 2010 will be estimated based on a certain forecast of change in the final demand and compared to what was established in the Kyoto Protocol, for Portugal. The methodology presented in this work is a trade-off between the need for reliable results and the data limitations, concerning the GHGs emissions. 4.1 Global Warming Theoretical Overview Solar radiation interacts with the surface of the earth in several ways. Some portion of this energy is reflected back into space by the earth's atmosphere, another portion is dispersed and scattered by the molecules in the atmosphere and a large portion penetrates through the earth's atmosphere to reach the surface of the earth. The radiation reaching the earth's surface is largely absorbed resulting in any atmospheric warming. Figure 17- Solar radiation interaction with the surface of the earth. Source: "Energy Futures", a publication of the Natural Resources Defence Council and Uncommon Sense, Inc. (http://www.nrdc.org) 43

53 Much of this absorbed energy is re-radiated in longer infrared wavelengths. As it leaves the earth, it interacts with the atmosphere. Some of this re-radiated energy escapes to space, but much of this re-radiated energy is reflected back to the earth's surface by molecules in the earth's atmosphere. This reflected energy further warms the surface of the earth. The molecules responsible for this phenomenon are called greenhouse gases. These gases act like the glass in a greenhouse, trapping re-radiated energy and they are essential for humankind because they act as a surrounding shield that enables the terrestrial surface to be around 30ºC warmer than it would be. Greenhouse gases include water vapour (H 2 O), carbon dioxide (CO 2 ), methane (CH 4 ), nitrous oxide (N 2 O), ozone (O 3 ) and several classes of halocarbons that contain fluoride, chlorine, and bromine. Human activity has modified the equilibrium of these atmospheric gases. Increasing the concentration of these gases in the atmosphere increases the atmosphere's ability to block the escape of infrared radiation. Therefore, increasing the concentration of greenhouse gases can have dramatic effects on climate and significant repercussions upon the world around us. Climates suitable for human existence do not exist simply above some minimum threshold level of greenhouse gas concentration, rather they exist within a finite window - a limited range of greenhouse gas concentrations that makes life as we know it possible. Several literature states that if the GHGs emissions continue to increase at the same rate they used to, the CO 2 atmospheric levels will duplicate in this century comparatively with the preindustrial levels and others are even more pessimistic predicting that if no action is taken the GHGs concentration will triplicate around year According to the IPCC report (IPCC, 1995) there will be an increase in the global warming of 1-3.5ºC in the next 100 years, and consequently an increase in the sea level of around 15-95cm (Seixas, 1999). Carbon dioxide is considered the principal greenhouse gas. Stabilisation at 1990 levels in year 2000 would have required a 20 per cent reduction in global carbon dioxide emissions relative to a business-as-usual scenario (Chisholm, Moran and Zeitsch 4 ). According to the 1990 scientific assessment by the Inter-governmental Panel on Climate Change, stabilisation of the carbon dioxide concentrations in the atmosphere at present days level would require reductions in annual emissions from human sources of more than 60 per cent. 4 in (Oates, 1996) 44

54 In this context, it is clear that any action to stabilise carbon dioxide concentrations will involve large-scale changes in production processes, consumer behaviour and international trade. Some existing studies strongly connect the temperature change with the increase of CO 2 concentration in the atmosphere. Through the study of ancient ice cores from Antarctica both the concentration of carbon dioxide in the atmosphere and Global Mean Annual Temperature can be determined for the past 160 thousand years of the earth's history. By examining the graph of Global Mean Annual Temperature and Atmospheric Carbon Dioxide Concentration over this time period (Figure 18), it seems quite evident that the two levels are related. Figure 18 Atmospheric carbon dioxide concentration and temperature change. Source: The White House Initiative on Global Climate Change (Barnola et al). However, some solar scientists disagree with this theory and argue that the global warming might be caused, wholly or in part, by a periodic but small increase in the Sun s energy output rather than by the increase in the concentration of greenhouse gases in the atmosphere. In fact, an increase of just 0.2% in the solar output could have the same effect as doubling the carbon dioxide in the Earth s atmosphere (Stanford Solar Center). Actually, many scientists have observed correlations between the solar magnetic activity, which is reflected in the sunspot frequency, and the climate parameters at the earth (Figure 19). 45

55 Figure 19 Solar activity versus climate. Source: Friis-Christensen, E., and K. Lassen, "Length of the solar cycle: An indicator of solar activity closely associated with climate," Science, 254, , 1991 (http://solar-center.stanford.edu/sun-on-earth/test.html). The solid dots curve illustrates the solar activity, which is generally increasing through an interval of 100 years. Within the same interval the Earth s average temperature as indicated by the empty dots curve has increased by approximately 0.7ºC. Nevertheless, one can also observe that the concentration of carbon dioxide in the atmosphere and the mean annual global temperature have been increasing since the end of the last ice age approximately 10,000 years ago (Figures 20 and 21). Figure 20 CO 2 concentration. Source: The White House Initiative on Global Climate Change (Neftel et al & Keeling). 46

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