The final impact of the shock on employment will depend on the following three factors:

# **I.** **<u>The size of the shock, determined by current energy prices and fuel mix</u>**

The extent to which the introduction of carbon regulation will affect employment is closely related to prevailing energy prices in individual countries. The ECA region inherited from the Soviet era a highly subsided energy system.<sup>4</sup> Since the collapse of central-planning in the 1990s, transition economies embarked on a large scale energy market reform program, including energy tariffs reform. Many countries, especially the new EU member states and the Balkans, have significantly increased fuel prices. However, in the medium to long run, all ECA countries are likely to face continued upward pressure on electricity prices. The EU and EU accession countries will have to conform to EU climate policies. In these countries, energy prices will need to rise to internalize environmental costs and to achieve the EU20-20-20 goal.

In CIS countries, there is still a large gap between cost-recovery price and prevailing energy prices. Governments need to remove electricity subsidies to maintain fiscal stability. Finally, demand for electricity is expected to increase at an annual rate of 3.1 percent between 2005 and 2010 in ECA.<sup>5</sup> Since much of the supply capacity is old and needs to be retired or rehabilitated, enormous amount of capital investment is needed to keep up the supply. The estimated investment amounts to US$3.3 trillion, including US$1.5 trillion for primary energy development and US$1.5 trillion for the power infrastructure.<sup>6</sup> To fully meet the capital needs, tariffs would have to rise to cover the costs.

# **II.** **<u>The vulnerability of the economy to energy price increases</u>**

Countries have different economic and employment structures; since an introduction (increase) in the price of carbon is an actual change in relative prices, some industries will be more affected than others. In particular energy producers or energy-intensive industries will be most hardly hit. To the extent that a country’s output depends heavily on these energy-intensive industries and has a large share of its employment in these sectors, countries will be highly vulnerable to an energy price shock. In addition, countries that have a large share of employment in otherwise clean industries but that rely to some extent on energy-intensive ones (as inputs), will also be affected. We measure the exposure of an economy to energy price shocks by the share of energy-intensive industries in value added, the share of energyintensive industries in employment and combine these with .the estimated energy price increase after regulation.<sup>7</sup> Using the UN sectoral classification, we consider the following sectors as energy-intensive: mining, quarrying, utilities, transport (air and land), and manufacturing.<sup>8</sup> Most of these sectors are already

> 4 In 1991, of all non-OECD subsidies to fossil fuels (including electricity), totaling $270-$330 billion, roughly two-thirds were in ECA. In 1991, subsidies in the former Soviet Union states amounted to 10-13 percent of GDP. (Myers and Kent, 2001) 5 World Bank (2010)

> 6 _Ibid._

> 7 Due to the lack of data, we do not systematically measure employment in “clean” industries depending on their reliance on dirty inputs.

> 8 It is worthwhile to note that we will be displaying results in this paper for overall manufacturing, although we also performed the same analysis for the and energy-intensive branches of the manufacturing sector, namely, iron and steel, chemical and petrochemical, non-metallic minerals (such as glass, ceramic, cement etc.), and paper and pulp. These are the top four energy consuming branches, accounting more than half of the total manufacturing energy use in ECA (Zhang, 2012). To see the results

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