CGE models for climate policy simulation: Some critical thoughts Satoshi Kojima Director, Economy and Environment Group Director, Economy and Environment Group Institute for Global Environmental Strategies (IGES) Climate Policy Simulation Tool (CPST) Brainstorming Meeting 15-16 July 2010, Shangri-La Hotel, Bangkok, Thailand I nstitute for G lobal E nvironmental S trategies Outline I t Introduction : necessity of critical examination of limitations d ti it f iti l i ti f li it ti Scope of CGE application 2 types of policy impacts 2 types of policy impacts Difficulty in long-run assessment Discounting problems Policy cost issues (e.g. abatement costs) Coping with uncertainty Policy planning and policy implementation Conclusions 2 I nstitute for G lobal E nvironmental S trategies
CGE b CGE-based climate policy simulation? d li li i l i ? CGE b CGE-based climate policy simulation may play a central role in CPST. d li t li i l ti l t l l i CPST Economic impacts of climate change and climate change policy through inter- sectoral linkages are important. Both major consequences and drivers of environmental and social impacts. Multi-regional CGE seems suitable to assess international impacts of domestic policies as well as impacts of international policy coordination. po c es as e as pacts o te at o a po cy coo d at o To explore such possibility, need to critically examine following limitations: Scope of CGE application p pp Difficulty in long-run assessment Policy cost issues (e.g. abatement costs) Coping with uncertainty 3 I nstitute for G lobal E nvironmental S trategies Scope of CGE application: 2 types of climate policy impacts Direct policy impacts Direct policy impacts Impacts caused by implementation of climate policies itself: e.g. influence of carbon pricing on market conditions, air pollution mitigation assessment, etc. Mitigation (or adaptation) impacts Impacts of climate change mitigation (or adaptation) induced by climate policies: e g impacts of more stable food production impacts of less flood impacts of e.g. impacts of more stable food production, impacts of less flood, impacts of less damages from extreme climate conditions, etc. They have different characteristics. y Time-lag: Direct policy impacts can be generated in much shorter period than mitigation/adaptation impacts. Uncertainty: Mitigation/adaptation impacts depend on climate change severity and Uncertainty: Mitigation/adaptation impacts depend on climate change severity and they are associated with much higher uncertainty than direct policy impacts. Climate change dependence: Direct policy impacts matter regardless of actual climate change events. li t h t 4 I nstitute for G lobal E nvironmental S trategies
P li Policy implications i li i Ends and m eans of policy Ends and m eans of policy Mitigation/adaptation impacts are originally ends of climate policies. However, assessing these impacts are very difficult due to time scale and high uncertainty. g p y g y Direct policy impacts are originally means (or by- products) of climate policies, but easier to assess. In practice, more justifiable and robust policy ends. Potential m agnitude of im pacts Mitigation/adaptation impacts are potentially huge as potential damage of catastrophic climate change is immense (c.f. the Stern Review). But due to high t t hi li t h i i ( f th St R i ) B t d t hi h uncertainty not necessarily convincing to justify policy. 5 I nstitute for G lobal E nvironmental S trategies R Recommended scope of CGE analysis d d f CGE l i Miti Mitigation impacts for target setting ti i t f t t tti Mitigation impacts might not be suitable subject of quantitative assessment for cost-benefit analysis (CBA). Rather, better to reflect them to target setting y ( ) g g through political process. Inclusion of mitigation impacts in CBA causes controversy. Impacts of adaptation policies need to be addressed by scientific models, e.g. f f hydrological models, ecological models, etc. → These will be done outside CGE analysis → These will be done outside CGE analysis Direct policy impacts for demonstrating policy benefits Direct policy impacts are free from controversy over high uncertainty in climate ect po cy pacts a e ee o co t o e sy o e g u ce ta ty c ate science. Once demonstrating net benefits of climate policy based on these impacts, policy justification is robust. → This is suitable for CGE analysis 6 I nstitute for G lobal E nvironmental S trategies
H How to reflect abatement costs in CGE? fl b i CGE? Importance of abatement costs I t f b t t t Key driver of economic impacts. Sector specific and country specific abatement costs are crucial information to Sector-specific and country-specific abatement costs are crucial information to analyse impacts of climate policies on competitiveness. Difficulty in estimating abatement costs Difficulty in estimating abatement costs Bottom-up approach estimates expenditures of sector for abatement actions. But these expenditures are not necessarily “costs” for an economy (could be resource reallocation). Top-down approach tries to capture abatement costs for an economy as loss of productivity (e.g. GDP per input) as a result of abatement activities. Many CGE d ti it ( GDP i t) lt f b t t ti iti M CGE studies employ this approach. 7 I nstitute for G lobal E nvironmental S trategies Abatement costs in CGE studies Ab i CGE di CGE b CGE-base estimation merely reflect mitigation mechanisms reflected by the ti ti l fl t iti ti h i fl t d b th models. Mainly substitution effects due to price change (e.g. carbon pricing). y p g ( g p g) Many studies do not estimate sector-specific and country-specific abatement costs, which are key to analyse competitiveness issues. Challenges to reflect sector specific abatement costs Ideally, abatement costs will be modelled as additional inputs (intermediate inputs such as equipments, or factor inputs such as labour and capital) for inputs such as equipments or factor inputs such as labour and capital) for abatement activities with reduced productivity as these inputs do not directly contribute to production. In practice such simulation is difficult as these variables are endogenous In practice, such simulation is difficult as these variables are endogenous variables. Compromise may be just reducing corresponding productivity parameters. 8 I nstitute for G lobal E nvironmental S trategies
CGE models and long-run environmental problems CGE d l d l i l bl Is CGE analysis relevant for long-run? I CGE l i l t f l ? Model parameters (technology parameters, behavioral parameters such as preference of commodities) may change for long-run. Economic conditions, social structures may drastically change beyond our expectation. Better to restrict short or mid term (say 10 Better to restrict short- or mid-term (say, 10 – 20 years). 20 years) How to reflect long-run environmental impacts like climate change? Rely on scientific results (e g climate model) to set policy targets for simulation Rely on scientific results (e.g. climate model) to set policy targets for simulation. For example, setting a 20% GHG emission reduction by 2020, considering the potential climate change for long-run. CGE model can provide potential impacts of policies to achieve given targets CGE model can provide potential impacts of policies to achieve given targets. Using CGE models for long-run cost-benefit analysis cannot avoid “discounting” problems discounting problems. 9 I nstitute for G lobal E nvironmental S trategies Di Discounting problems i bl Long-run cost-benefit analysis faces discounting problems: Normative vs. Long run cost benefit analysis faces discounting problems: “Normative vs Positive” For long-run, setting significant discount rate results in ignoring future events. Example: 100 years consequences: 1%/year -> 37%, 5%/year -> 0.8%! Some argue low discounting rate to avoid ignorance of future (Normative discounting) g) Some argue empirical observation indicates quite high discounting (5 – 10%), and setting unrealistic low discounting rate is irrelevant. Kojima (2006) argues that normative and positive rates are different and they can coexist. 10 I nstitute for G lobal E nvironmental S trategies
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