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View the documentAppendix to part 3 examining the macroeconomic effects of curbing CO2 emissions with the Project LINK world econometric model

8. Macroeconomic costs and other side-effects of reducing CO2 emissions

Akihiro Amano

1. Introduction

More than 150 nations signed the Framework Convention on Climate Change in June 1992 at Rio de Janeiro, revealing their determination to start coping with the global warming issue. Although the agreements were not as aggressive as had been expected in advance, the extensive guiding principles brought together in Agenda 21 represent a big step forward. One clear message is that more use is to be made of economic measures to combat global warming and other environmental problems. The question we now face is to decide the extent to which we should apply these measures with respect to the abatement of carbon dioxide and other greenhouse gas emissions. The nations that agreed to the Convention have not yet decided about it explicitly except for some environmentally advanced Northern European countries.

In this paper I shall first discuss, in section 2, the magnitudes of the macroeconomic costs of limiting carbon dioxide emissions. By comparing the results of the OECD global model comparison project and those of Japanese studies, I shall point up the importance of understanding the model structures behind these simulation experiments. Besides the macroeconomic costs, economic measures such as carbon taxes (and to a large extent other market-oriented measures as well) will have other side-effects both domestically and internationally. In section 3, some of these problems will also be addressed.

Assessment of mitigation costs alone cannot determine the optimum scale of measures against global warming. Recently, there have been interesting discussions concerning the size of optimal carbon taxes. In section 4, I shall attempt to discern the factors affecting the size of carbon taxes in the optimal abatement path, or the social costs of carbon emissions. Section 5 closes the paper with a summary and conclusions.

2. The macroeconomic costs of reducing CO2 emissions

When the OECD convened an international workshop in 1991 to compare the simulation results of representative global models on cost estimates of limiting carbon dioxide emissions, one of the objectives was to investigate the reasons such diverse figures had been obtained. Intensive comparative studies of six global models of greenhouse gas emissions culminated in a number of OECD working papers and Economic Studies articles, and many important findings explaining the determinants of macroeconomic costs have been obtained. (See Dean, 1993, for a survey of the workshop.)

Table 8.1 is constructed from the simulation results of four dynamic, long-term models: the Manne-Richels model (MR), Rutherford's Carbon Rights Trade Model (CRTM), the Edmonds-Reilly model (ER), and the OECD GREEN model (GREEN). The figures in the table have been derived from the simulation results involving CO2 abatement in terms of a 2 per cent reduction in annual rates of increase compared with the business-as-usual scenarios.

The left-hand panel of table 8.1 reports the ratio of percentage reductions in real GDP to those in CO2 emissions (i.e. percentage GDP losses caused by a one percentage point reduction in CO2 e missions relative to the baseline), and the right-hand panel reports the ratio of carbon tax rates (measured in dollars per ton carbon) to percentage reductions in CO2 emissions (i.e. the amount of carbon taxes required to achieve a 1 per cent reduction in CO2 emissions).

Because these simulation exercises were performed on the same set of exogenous assumptions and on the same method of perturbing the systems, the results turned out to be fairly similar, especially for developed countries. There are a couple of notable differences, however. The Edmonds Reilly model reports relatively larger impacts in the longer term, because backstop technologies do not play a large role compared with other models. The Rutherford model, on the other hand, reports smaller effects, because this model allows for opportunities to trade energy-intensive products and carbon emission rights. Noting these special cases, however, we may say that a 1 per cent reduction in carbon emissions generally requires a 0.02-0.05 per cent decrease in GDP in developed countries. The corresponding carbon tax rates are around US$2-10 per ton carbon (tC).

Table 8.1 The macroeconomic costs of CO2 emission reduction


Percentage reduction in GDPa

Carbon taxes (US$/tC)b

Year

United States

Other OECD

Former USSR

China

Other regions

United States

Other OECD

Former USSR

China

Other regions

MR











2000

0.05

0.03

0.10

0.11

0.18

7

7

11

12

12

2020

0.05

0.03

0.07

0.06

0.11

8

5

7

6

9

2100

0.04

0.02

0.06

0.06

0.06

2

2

9

2

2

CRTM











2000

0.01

0.00

0.04

0.04

0.13

10

9

9

9

12

2020

0.03

0.01

0.03

0.04

0.06

7

5

7

7

9

2100

0.03

0.02

0.05

0.04

0.05

2

2

9

1

2

ER











2000

0.03

0.03

0.03

0.05

0.05

4

6

3

3

6

2020

0.04

0.04

0.02

0.06

0.05

8

8

2

4

10

2100

0.10

0.05

0.04

0.07

0.06

31

14

8

8

23

GREEN











2000

0.02

0.02

0.02

0.02

0.06

7

9

1

1

5

2020

0.03

0.03

0.04

0.02

0.09

5

5

2

1

4

2050

0.02

0.02

0.05

0.02

0.06

5

4

3

1

5

Source: Dean and Hoeller (1992).

a. The percentage change in GDP relative to the business-as-usual scenario for a 1 per cent reduction in CO2 emissions, also relative to the business-as-usual scenario.

b. Carbon faxes required for a 1 per cent reduction in CO2 emissions relative to the business-as-usual scenario.

Table 8.2 Carbon tax simulations of Japanese models

Model

Final year

Percentage reduction in GNP

Carbon taxes ($/tC)

Goto

2030

0.02

3

Ban

2000

0.05

6

Mori

2020

0.22

17

Yamaji

2005

0.23

19

Ito

2010

0.29

17

Yamazaki

2010

0.41

19

Source: Amano (1992a,b).

For non-OECD countries the results are somewhat diverse, but I can make two observations. First, all models show relatively larger output effects in these countries, especially in the "rest of the world" region, which includes energy-exporting countries. Secondly, carbon taxes for the former USSR and China are fairly low in the GREEN and Edmonds Reilly models, because these models take into account the subsidized, low domestic energy prices in these countries.

Table 8.2 presents the results of similar simulation studies conducted in Japan. I report this additional information because it clearly shows that the objectives of model-building and the methods of simulation experiments can both influence the results substantially. The figures in table 8.2 are constructed in the same way as those in table 8.1.

We can distinguish two groups in this table. The first group (the Goto and Ban models) obtained comparable results to those of table 8.1 with respect to both GDP/GNP reductions and carbon taxes. The results of the second group, however, are surprisingly similar to each other, but they are much larger than other estimates in either table 8.2 or table 8.1.

Three reasons can explain these differences. First, the models in the second group have been developed by combining econometric forecasting models of the demand-determined type with some form of energy model, and most of them have usually been used for projection and simulation exercises. The role expected of such models is to make precise short- to medium-term projections and not to draw a clear picture of the distant future. On the other hand, computable general equilibrium (CGE) models can generally treat the long-run responses more explicitly and adequately with smoother adjustments in various sectors. As the above results indicate, the long-run and short-run responses captured by these two sets of models can give rise to notable differences.

The second reason for the difference is that short-run models involve temporary deviations from full employment resulting from higher energy prices, which are absent in CGE models by assumption. Of course, this does not mean that short-run adjustment problems are unimportant. There are, however, regular anti-cyclical measures in the policy arsenal, and these measures should be and will be integrated in the policy package at the level of actual implementation.

The third point relates to the treatment of tax revenue. In general equilibrium models, carbon tax revenue is usually recycled to the public to make the carbon tax revenue neutral. However, this is not true for the second group of models in table 8.2; the results reported in the table were based on an assumption of no change in public sector behaviour. This assumption, combined with the demand-determined type of macroeconometric model, can lead to a large decline in output with the imposition of carbon taxes.

These considerations suggest that policy simulation results should be presented and interpreted with care. Analysts try to identify the effects of some factors by isolating the disturbance as far as possible. But the way of isolating an event depends a great deal on how that factor is modelled. Therefore, the results of such simulations must be presented and interpreted with a clear understanding of the model structure.

In fact, actual policies may not be implemented as suggested by the model simulations we have just seen. Assignment of the same percentage reduction in emissions to all countries is not an efficient way of formulating a global or an international policy. An efficient policy would require that the rate of carbon tax be the same for all countries. The way in which tax revenue is recycled may vary from one country to another, reflecting differing public deficits. To say the same thing from a different angle, real policy simulations should be based on combinations of policy measures with realistic policy responses to expected unfavourable side-effects. Ordinary "policy simulations" are often not carried out in this way.

3. Some side-effects of reducing CO2 emissions

The kind of consideration mentioned at the end of the last section provokes discussion concerning the various side-effects of economic measures to mitigate global warming (such as carbon taxes), including the regressive distributional effects within a country and undesirable effects upon international competitiveness when other countries do not adopt similar measures. There is some empirical evidence to support the first point (see, e.g., Poterba, 1991, and Smith, 1993), but these authors also indicate that there are policy instruments that can offset the socially undesirable distributional consequences of carbon taxes.

The question of international competitiveness seems to involve at least three points. First, when the external costs associated with carbon emissions are internalized, changes in the relative cost structure may lead to alterations in the pattern of the international division of labour. If an international carbon tax scheme is adopted with a uniform tax rate, then an efficient international division of labour will not be distorted, although ordinary short-term adjustment problems will accompany any change in comparative cost structures. Rather, international resource allocation will be improved because the price structure now reflects social costs rather than mere private costs. However, if only a subset of countries participate in this scheme, or if the tax rates vary substantially among countries, then "trade-diversion effects" may result. The supply sources of carbon-intensive goods may shift from more efficient and more benign-to-the-environment countries to less efficient and less benign-to-the-environment countries. In such circumstances, exemption from carbon taxes may be justified. It should be noted, however, that this argument applies only to those industries that suffer from the trade diversion, not to all industries suffering from a loss of international competitiveness.

In this connection, Hoeller and Wallin (1991) show that there exist fairly large differences in implicit carbon tax rates among major OECD countries, and Burniaux et al. (1992) subjoin that the differences are even wider if we consider the world economy as a whole. World energy and carbon uses would be made much more efficient if these distortions could be eliminated.

Secondly, when carbon taxes are introduced in some countries to the extent that world energy prices are depressed, then energy consumption or carbon emissions in other countries not participating in the carbon tax scheme will increase, and this tends to lessen the initial reduction in carbon emissions. This effect, combined with the offsetting influence resulting from trade-diversion effects mentioned above, is called "carbon leakages." Rutherford (1992) reported that the leakage effects are fairly large, especially when carbon limitation becomes very stringent. According to his model simulation, when OECD countries alone attempt to reduce the annual rate of increase in carbon emissions by 3 per cent, the leakage rate, i.e. the proportion of unilateral abatement effects that are offset by the expansion of carbon emissions in non-participating countries, will approach 100 per cent (see Rutherford, 1992). If this conclusion is correct, then any international unilateral action that might affect international energy prices should involve some arrangements to minimize such carbon leakage effects.

On the other hand, simulation analyses performed by the OECD GREEN model suggest that the carbon emission stabilization scheme unilaterally adopted by the OECD countries will lead to carbon leakages of only 2.5 per cent (see Burniaux et al., 1992, and Nicoletti and Oliveira-Martins, 1992). On the average for the period 1990-2050 the greatest reduction in the production of energy-intensive sectors occurs in Japan (- 2.6 per cent) and the smallest reduction in the United States (-0.4 per cent). These results are in sharp contrast to those of Rutherford.

Manne (1993) also examined the extent of carbon leakages with a global model incorporating international trade in crude oil, natural gas, energy-intensive products, and tradable emission permits. According to his simulation results, carbon leakages through the channel of oil trade seem unimportant except perhaps in the initial period. However, international trade in energy-intensive products creates a broad conduit for carbon leakages. The leakage rate starts from around 20 per cent in 2000, increasing to a level slightly above 30 per cent in 2050. Trade in natural gas also raises the leakage ratio in the medium term, but it tends to moderate the leakage in the longer run as world natural gas prices are capped at the backstop level. The overall results seem to fall between Rutherford and the GREEN model results.

Even with these leakage effects, however Manne concludes that unilateral carbon limitations by the OECD nations would be effective in that they could reduce global emissions for some time. At the same time, he also stresses the finding that, beyond 2020 or so, emissions from non-OECD countries will become quite important. These two major conclusions seem to suggest that carbon leakages are at most a medium-term issue, if relevant at all. In the longer teen, many energy-intensive activities will move to the non-OECD region anyway, irrespective of the introduction of carbon taxes in OECD countries, and emission reductions in the non-OECD region will become a central issue. Effective arrangements to contain the vast increase in emissions expected from this region will become imperative under most plausible scenarios.

All three models mentioned above aggregate industries into energy-intensive and energy-non-intensive sectors, but a more disaggregated approach would be needed to verify the results. Quantitative studies of the impacts of carbon taxes upon more disaggregated sectors, such as Jorgenson et al. (1992) for the United States and Kuroda and Shimpo (1992) for Japan, have shown that output responses brought about by the imposition of carbon taxes will be concentrated in a rather small number of energy-related industries such as coal mining, crude oil, electric utilities, gas utilities, and refining. The effects on energy-intensive manufacturing sectors such as iron and steel and paper and pulp products, however, are not as marked as in the energy industries. Therefore, the distinction between energy-intensive and energy-non-intensive sectors does not really indicate the uneven distribution of sectoral impacts upon output. Of course, aggregation does not affect the size of the total impact upon carbon dioxide emissions, so that the implications of simulation results concerning carbon leakages will remain unaffected. However, the distinction masks the differential burden of adjustments among industries which should somehow be taken into account in formulating an appropriate policy package.

Another interesting study applies the GREEN model. Oliveira-Martins et al. (1992) examined the effects of tax exemption of energy-intensive industries, in order to see if such measures can protect these industries from a loss of international competitiveness. Their results show, quite interestingly, that the effects of tax exemption are almost negligible in terms both of leakage rates and of changes in sectoral output. It appears that it is not the loss of competitiveness due to the imposition of the tax but a contraction in the market in question that hits these particular industries.

The third question related to the international competitiveness issue concerns the effects of changes in the terms of trade caused by an international carbon tax scheme. As discussed in relation to the second problem, the international application of carbon taxes, be they unilateral or worldwide, would most probably lead to changes in the international terms of trade of carbon energies in favour of energy-importing countries and against energy-exporting countries, implying large-scale international income transfers. There are not many global models that examine this question, but the OECD GREEN model has shown that the terms of trade effects upon real incomes are of non-negligible magnitudes (see Burniaux et al., 1992). In international negotiations to apply economic measures to mitigate global warming, due consideration will have to be given to this issue.

4. The social costs of CO2 emissions

One of the important questions remaining unresolved in the discussion of how to cope with the global warming issue is the extent of the desirable, or socially optimal, strategy to reduce greenhouse gases. On the one hand, the group of scientists associated with the Intergovernmental Panel on Climate Change (IPCC) confirmed their earlier recommendation that in order to stabilize climatic change it would be necessary to reduce the current level of emissions of CO2 by 60 per cent (IPCC, 1992). On the other hand, William Nordhaus has been maintaining in a series of papers that climatic stabilization or even emission stabilization is far from optimal from the socioeconomic viewpoint, and that the socially optimal abatement path is much closer to the uncontrolled path (Nordhaus, 1990a,b, 1992a,b). According to his view, percentage rates of reduction of greenhouse gases along the optimal path will be as low as 10 per cent in around 2000 and 14 per cent in around 2100. The levels of carbon taxes will also be moderate along the optimal path, ranging from about US$6/tC in 2000 to a little above US$20/tC in 2100.

William Cline (1992), on the other hand, considers that a more aggressive policy of stabilizing current CO2 emissions at an annual rate of 4 billion tons of carbon (GtC) would be justified if (a) future benefits are given higher weights by means of a lower social rate of time discount, and if (b) the risk-averse stances of policy makers are taken into account. Although Cline's conclusions are not based on an optimization model, they are derived from a detailed global cost benefit analysis. If we reconstruct his cost-benefit model, we can calculate the carbon taxes required for the aggressive policy to obtain US$50/tC in 2013, US$100/tC in 2020, US$200/tC in 2025, and US$250/tC in 2054 and after. These rates are much higher than those of Nordhaus.

At an OECD/IEA international conference, Fankhauser and Pearce (1993) reported that their estimates of the social costs of CO2 emissions, measured as the discounted sum of future incremental damages, are US$20/tC in 1991 -2000, US$23/tC in 2001-2010, US$25/tC in 2011-2020, and US$28/tC in 2021-2030. These estimates fall between those of Nordhaus and Cline, although Fankhauser and Pearce did not present estimates beyond 2030.

In this section I shall examine the factors affecting the magnitude of the shadow prices or social costs of carbon dioxide emissions by means of a small economy-climate model of the Nordhaus type (see the appendix at the end of the chapter for a brief description of the model).

I first performed simulation experiments in order to substantiate the wide differences between Nordhaus's results and those assuming stabilization of CO2 emissions or of temperature rise. The first five columns of tables 8.3-8.7 present cases where (a) a 3 per cent annual social discount rate is used, as in Nordhaus's analysis, except for Case O' as will be explained below, (b) the IPCC's central estimate of 3°C is used for the climate sensitivity parameter (i.e. the temperature increase at the benchmark condition of doubling carbon dioxide concentration in the atmosphere relative to the pre-industrial level), and (c) the damage function is such that the damage parameter (i.e. the percentage reduction in world GDP at the benchmark climate of 2 x CO2) is 1 per cent and the function is quadratic.

In these simulations, world output is influenced by climate change through the damage function, which reflects both the macroeconomic costs of emission control and the damage arising from a temperature increase (or the benefits of preventing temperature increase through emission control). The "Uncontrolled" case, however, refers to a situation where these cost-benefit interactions between climate and the economy are completely neglected. In what follows I shall call this the "Business as Usual" (BaU) case.

As expected, the characteristics of Case O are very similar to those of Nordhaus. Optimal percentage reductions in carbon emissions start from 7 per cent in 2000 and remain below 20 per cent all the time. Carbon taxes are also low, starting from US$5/tC and rising to US$13/tC in 21)50 and to US$25/tC in 2100. Reflecting such low emission control. the pattern of temperature rise is very similar to that of the BaU scenario. In other words, a large-scale reduction in CO2 emissions would not be optimal, and the optimal control path under these conditions almost implies the maintenance of the status quo as far as global warming is concerned.

Table 8.3 Percentage reductions in CO2 emissions


Case

Year

U

O

O'

E

T

LT

MT

HT

LL

HH

2000

-

7

23

20

29

19

23

32

14

48

2010

-

7

25

32

34

20

25

34

15

52

2020

-

8

25

45

40

20

25

35

15

54

2050

-

8

26

55

60

20

26

37

14

59

2100

-

12

33

76

92

22

33

46

16

79

2150

-

15

37

86

92

23

37

53

17

95

2200

-

18

36

92

94

21

36

52

17

100

U:

Uncontrolled

O:

Optimization (3% discount)

O:

Optimization (0.5% discount)

E:

Emission stabilization

T:

Temperature rise stabilization

LT:

Low temperature rise

MT:

Medium temperature rise

HT:

High temperature rise

LL:

Low damage, etc.

HH:

High damage, etc.

Table 8.4 Carbon taxes (US$/tC)


Case

Year

U

O

O'

E

T

LT

MT

HT

LL

HH

2000

-

5

60

46

94

41

60

117

23

263

2010

-

7

76

130

146

50

76

149

27

344

2020

8

89

280

219

56

89

174

30

415


2050

-

13

129

571

697

72

129

254

36

672

2100

-

25

200

1,116

1,704

91

200

401

47

1,214

2150

-

42

255

1,474

1,712

96

255

526

55

1,830

2200

-

58

244

1,700

1,777

64

244

514

52

2,268

Table 8.5 Carbon emissions (GtC)


Case

Year

U

O

O'

E

T

LT

MT

HT

LL

HH

2000

7.6

7.0

6.1

6.0

5.4

6.4

6.1

5.4

6.6

4.2

2010

8.9

8.2

7.3

6.0

5.8

7.7

7.3

6.3

7.7

4.2

2020

11.0

10.2

9.0

6.0

6.6

9.7

9.0

7.8

9.0

6.1

2050

16.6

12.5

11.1

6.0

5.2

12.1

11.1

9.4

9.4

7.9

2100

26.2

23.0

19.3

6.0

1.9

22.5

19.3

15.3

12.1

10.7

2150

47.2

39.4

32.3

6.0

3.3

39.9

32.3

23.8

16.0

5.5

2200

82.9

65.8

56.6

6.0

4.7

71.3

56.6

41.3

28.2

0.2

Table 8.6 Temperature rise (°C)


Case

Year

U

O

O'

E

T

LT

MT

HT

LL

HH

2000

1.1

1.1

1.1

1.1

1.1

0.6

1.1

1.7

0.6

1.7

2050

1.5

1.4

1.4

1.3

1.3

0.7

1.4

2.0

0.7

1.9

2100

2.4

2.3

2.1

1.6

1.5

1.1

2.1

2.9

1.0

2.6

2150

3.8

3.6

3.3

1.9

1.5

1.8

3.3

4.3

1.4

3.5

2200

5.7

5.2

4.7

2.2

1.5

2.6

4.7

6.1

1.8

3.9

Table 8.7 Percentage change in world GDP relative to "business-as-usual" scenario


Case

Year

U

O

O'

E

T

LT

MT

HT

LL

HH

2000

-

-0.2

-0.4

-0.4

-0.6

-0.4

-0.4

-0.9

-0.3

- 1.6

2050

-

-0.4

-0.9

-2.9

-3.3

-0.7

-0.9

- 1.7

-0.5

-3.3

2100

-

-0.8

-1.5

-5.8

-9.3

-1.2

-1.5

-2.9

-0.8

-6.2

2150

-

-2.0

2.6

-7.9

- 9.0

-1.9

-2.6

-4.7

1.3

-10.1

2200

-

-3.7

-4.2

-9.3

-7.5

-2.8

-4.2

-7.0

-1.7

-12.0

The contrasting assumptions often adopted in the mitigation scenarios are cases of stabilizing emissions or temperature increases. In Case E, the annual level of CO2 emissions is stabilized at the 1990 level, and, in Case T. the temperature rise from the pre-industrial level is constrained below or equal to 1.5°C. The required emission reductions in these two cases are, of course, substantial. The carbon taxes required in Case E, for instance, are US$46/tC in 2000, US$130/tC in 2010, US$280/tC in 2020, and so on; and in Case T they are somewhat higher in the near term and register US$697/tC in 2050 and US$1,704/tC in 2100. The rate of reduction in world GDP in 2100 is a mere 0.8 per cent in Case O, but it is much higher in Cases E and T (5.8 per cent and 9.3 per cent, respectively).

Against the view that deems continuing global warming optimal, there can be a criticism that it discriminates against future generations. Indeed, Cline argues that the application of a 3 per cent discount rate is inappropriate. On the basis of the facts that the elasticity of marginal utility of consumption is around 1.5 and that the long-term rate of growth of per capita income is roughly 1 per cent per annum, he considers that the annual rate of social time discount should be around 1.5 per cent. He also points out that, if a logarithmic utility function is used, the elasticity of marginal utility with respect to consumption is unity so that consumption growth at an annual rate of 1 per cent implies built-in discounting of 1 per cent per annum.

Case O' in tables 8.3-8.7 reports the results where only the rate of time discount is changed, from 3 per cent per annum to 0.5 per cent per annum, all other conditions being kept unchanged as in Case O. It can be seen that both the rates of emission reduction and carbon taxes are higher now, although the rates of emission reduction hardly exceed 40 per cent even in the 22nd century. Moreover, the time profile of temperature rise does not change very much. When the rate of social discount is lowered, a larger weight is given to the utility from future consumption. Therefore, when optimization involves savings-investment decisions, as in the present model, this change tends to induce larger investments and hence larger future output and CO2 emissions. On the other hand, the lower discount rate also attaches a larger weight to future damage, so that it raises rates of emission reduction in the nearer term. Because these two opposing forces cancel each other out, the two scenarios look very similar as far as physical conditions are concerned. This means that lowering the discount rate can explain only a part of the differences between the Nordhaus and Cline results.

Let us now turn to the remaining five cases of tables 8.3-8.7. In these cases, I set the rate of discount at 0.5 per cent per annum. The first three cases distinguish climate sensitivity and the extent of damage from global warming as follows:

LT - low climate sensitivity parameter (1.5°C) and low damage parameter (1 per cent with the degree of non-linearity 1.3);

MT - medium climate sensitivity parameter (3.0°C) and medium damage parameter (1 per cent with the degree of non-linearity 2.0);

HT - high climate sensitivity parameter (4.5°C) and high damage parameter (2 per cent with the degree of non-linearity 3.0).

The central case, MT, is identical to Case O'. Comparing the results for these three cases, we can observe that climate and damage parameters can change the nature of optimal time paths substantially. Emission reduction rates and carbon taxes are higher in Case HT than in Case MT, with smaller emissions but larger temperature increases and larger output reductions in Case HT. The reverse holds for Case LT. However, none of the three cases would satisfy those who prefer stabilizing emissions or temperature rise. The temperature increases in 2200 lie in the range of 2.6-6.1°C, which is much higher than in Cases E and T.

In the last two columns of tables 8.3-8.7, I take up two extreme cases: for Case LL I assigned the lowest parameter values for climate sensitivity and output damage as well as for the rates of population growth, and similarly for Case HH I assigned the highest set of parameter values. I can point out two interesting similarities. First, Case LL has many points in common with Case O. This means that the application of rather high time discount rates is tantamount to assuming the most favourable global climate conditions in many important aspects: low temperature increases, little damage, less severe non-linearity of damage, and low rates of population growth. Second, Case HH, in turn, has many similarities with Cases E and T. CO2 emissions are severely controlled by high carbon taxes, resulting in fairly large output losses in the long run. However, there is one important difference: even with such severe emission controls global warming will not be mitigated in Case HH as sufficiently as in cases E and T.

One might think that if the expected damage caused by global warming were much more substantial, then further stringent emission controls would lessen global warming. Thus, I considered two higher-damage scenarios in table 8.8: one with a higher degree of non-linearity of the damage function (power 3.5) and the other with an even higher damage parameter (4 per cent of world output at 2 x CO2). In both cases carbon tax rates in 2100 are in the range of US$1.200-$1,500/tC, and rates of emission reduction in 2200 become 100 per cent. Indeed, in the case where damage is 4 per cent, the extent of temperature rise becomes lower than that in Case HT or HH. However, it is still larger than those of Cases E and T. Thus we must conclude that, even enlarging the size of the damage parameter by twice the most pessimistic estimate and making other assumptions most amenable to substantial damage, we cannot obtain optimal abatement paths that would justify immediate emission stabilization at about current levels. It appears that we need some other sort of social valuation function that incorporates much broader non-market values, or that takes a more serious view of uncertain, catastrophic situations in the distant future.

Table 8.8 Two high-damage scenarios


Emission reduction (%)

Carbon tax (US$/tC)

Emissions (GtC)

Temperature rise (°C)

Year

Power 3.5

Damage 4%

Power 3.5

Damage 4%

Power 3.5

Damage 4%

Power 3.5

Damage 4%

2000

47

56

257

357

4.2

3.5

1.7

1.7

2010

52

60

338

461

4.9

4.0

1.7

1.7

2020

54

62

409

551

6.2

5.0

1.7

1.7

2050

59

67

671

868

7.9

6.3

1.9

1.8

2100

79

86

1,235

1,467

10.3

6.9

2.6

2.3

2150

96

100

1,874

2,075

4.4

0.1

3.5

2.8

2200

100

100

2,365

2,572

0.2

0.2

3.8

2.7

As I mentioned at the beginning of this section, Fankhauser and Pearce arrived at the conclusion that the social costs of carbon emissions for the period 1990-2030 are in the range of US$20-30/tC. I shall conclude this section by summarizing my own estimates in table 8.9. It is clear that Case O. which attempts to reproduce the Nordhausian situation, does not seem to be normal when we apply the discount rate of 0.5 per cent per annum. My MT scenario gives slightly higher estimates than those of Fankhauser and Pearce, but it should be noted that these numbers are only for a relatively short period. My Case MT shows that the estimates would rise as we move further into the future, and will approach US$200/tC by 2100.

I add one more simulation in table 8.9 within brackets. This case is based on exactly the same assumptions as Case MT, but the terminal year is 2250 rather than 2300. Thus, shortening the time-horizon tends to reduce the social costs of carbon emissions. Since the problem of global warming arises from stock externality, higher discounting of the future will make the social costs smaller. By shortening the time-horizon, we simply discount the events beyond the time-horizon by an infinite discount rate. We must therefore take a fairly long view in evaluating the social costs of greenhouse gas emissions.

Table 8.9 The social costs of carbon emissions (US$/tC)

Scenario

2000

2010

2020

2030

Optimization à la Nordhaus

5

7

8

11

Emission stabilization

48

130

280

375

Stabilization of temperature rise

94

146

219

331

Low temperature rise

41

50

56

62

Medium temperature rise

60

76

89

103

(With shorter time horizon

54

69

80

92)

High temperature rise

117

149

174

201

Low population growth, etc.

23

27

30

32

High population growth, etc.

263

344

415

497

High damage: power 3.5

257

338

409

493

High damage: damage parameter 4%

357

461

551

655

5. Summary and conclusions

In this paper I first examined the magnitudes of the macroeconomic costs of carbon emission reductions based upon the OECD project of global model comparisons. I found that a 1 per cent reduction in carbon emissions generally requires a 0.02-0.05 per cent decline in GDP in developed countries, and that corresponding carbon tax rates are around US$2-10/tC.

I also showed that many Japanese research results had found much larger macroeconomic costs, because these models are fairly short term in scope involving demand-determined output responses. Also, the treatment of tax revenue is different. These findings suggest that interpretation of simulation results should be based upon clear understanding of the nature of the model.

Economic measures to limit carbon dioxide emissions, such as carbon taxes, usually have some side-effects as well. There is some empirical evidence that carbon taxes would have regressive distributional implications, but there seem to exist appropriate instruments to accommodate these undesirable domestic side-effects.

International side-effects need careful distinction. Any change in the structure of comparative advantage induced by an efficient, international scheme to internalize the external costs of carbon emissions should not be counteracted. Sectoral adjustment problems should be handled as in many other cases of changing environments. Carbon leakages resulting from trade diversion and from changes in international energy prices can theoretically be large enough to negate the initial effort of limiting carbon emissions, but the available evidence seems to suggest that unilateral action by OECD countries, for example, will still be largely effective. Finally, due consideration should be given to the possibility of an international scheme to limit carbon emissions causing large-scale international redistribution of income against fossil-fuel-exporting countries.

In contrast to the macroeconomic cost estimates based upon some sort of stabilization objectives for the emission or atmospheric concentration of greenhouse gases, the optimal response approach suggested by William Nordhaus has led to the conclusion that optimal abatement paths are much closer to the business-as-usual scenario path than to stabilization paths. The questions of the appropriate rate of time discount and of proper estimates of damage from global warming do not seem to resolve the wide gap between the optimization approach and the stabilization approach It appears that we need to investigate further if we are to broaden our scope of non-market values and take a more serious view of uncertain, catastrophic situations in the distant future.

Appendix: A simple Nordhaus-type model of climate and the world economy

This appendix gives a short summary of a simple Nordhaus-type model of climate and the world economy to evaluate optimal emission control paths under various alternative assumptions. The model consists of the following 12 equations:

1.



2.


3.


4.


5.


6.


7.


8.


9.


10.


11.


12.

Variable and parameter names and parameter values as well as initial conditions are as given below.

Variables

At:

production technology factor

ACt:

atmospheric stock of carbon dioxide

Ct:

consumption

Et:

carbon dioxide emissions

GDPt:

gross domestic product

gA

annual growth rate of A

ga

annual rate of change in a

at:

emission factor

mt

emission control variable

Ft

damage factor

It

investment

Kt

capital stock

Lt

population

Tt

temperature rise



equilibrium temperature rise

U

discounted sum of consumption utility

dK

capital depreciation rate

dM

fraction of CO2 transferred to deep ocean

Parameters

a:

percentage loss of world GDP due to GHG abatement

b:

percentage loss of world GDP due to global warming damage

ACP

pre-industrial level of atmospheric stock of carbon dioxide

N

time horizon



temperature rise at the benchmark

b

feedback parameter

q

power of the damage function

g1,g2

coefficients in the damage function

k

fraction of CO2 remaining in the atmosphere

l

adjustment coefficient

p

share of capital

r

social discount rate

Parameter values and initial conditions

a = 1%
ACP = 580(GtC)
AC0 = 750(GtC)



b = 1% or 2%
E0 = 6.003 (GtC)
gA = 0.85% p.a.
ga = -1.0% p.a.
GDP0 = 25.8 (tril. $)


a0 = E0/GDP0
g1 = a/100/0.53


dK = 0.05
dM = 0.002
q = 1.3, 2.0, or 3.0
k = 0.5
l = 0.2
K0 = 70.32 (tril. $)
L0 = 5.292 (bil.)
N = 2300
p = 0.25
r = 0.005 or 0.03

Acknowledgements

The author thanks Kenji Yamaji of the University of Tokyo and Tsuneyuki Morita of the National Institute of Environmental Studies for helpful comments and valuable suggestions. Of course, the author is solely responsible for any remaining errors.

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