Rob Dellink — Modelling the costs of environmental policy 1

Dynamic CGE Modelling

for Analyzing Environmental Policies

Ekko van Ierland and Rob Dellink

Ekko.vanIerland@wur.nl Rob.Dellink@wur.nl

or: www.enr.wur.nl/uk/staff/dellink/

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Set-up of the presentation

Aim: assessing the costs of Dutch environmental policy by developing a dynamic AGE model with special attention to pollution and abatement (DEAN)

Introduction

Overview of the model

Data and policy scenarios

Main results

Concluding remarks

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Part I:

Model description

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Overview of the DEAN model

Multi-sector dynamic Applied General Equilibrium model

– perfect-foresight behaviour: Ramsey-type model

Environmental module: pollution and abatement– pollution and abatement are present in the benchmark

No impact from environment to economy– no amenity value of environmental quality– no damages from environment on economy– no efficiency analysis, just cost-effectiveness

Model specified in GAMS / MPSGE & available on website

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Specification of economic activity Multi-sector Applied General Equilibrium model

– description of the national economy– producers: profit maximisation under perfect competition– consumers: utility maximisation under budget balance & LES structure– equilibrium on all markets (Walras’ Law)– individual agents are price takers; no money illusion

International trade– small open economy– domestic and foreign goods are imperfect substitutes (Armington)– no international co-ordination of environmental policy

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Specification of economic growth Dynamic model

– perfect-foresight behaviour: Ramsey-type model with finite horizon– exogenous increase in labour supply– endogenous accumulation of capital and greenhouse gasses

Comparison of dynamic behaviour in Chapter 3– comparative-static specification– recursive-dynamic specification– perfect-foresight speciciation– comparison uses small version of the model

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Specification of pollution

Environmental themes– individual pollutants aggregated using ‘theme equivalents’– interactions within theme fully taken into account

Polluters need pollution (permits) for their activities– necessary input of production process / utility formation– tradable permit system implemented in the benchmark– autonomous pollution efficiency improvements

Government auctions pollution permits – environmental policy implemented as restriction of number

of permits– revenues are recycled lumpsum to private households

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Specification of abatement

Using bottom-up technical abatement information– costs and effects of end-of-pipe and process-integrated options: discrete modelling of all available options is practically infeasible– measures ordered by increasing marginal abatement costs– technical potential: in the short run not all pollution can be abated– ‘spending effects’: inputs in Abatement production function

Endogenous choice between (i) paying for pollution permits or (ii) investing in abatement or (iii) reducing activity level

Estimation of “Pollution - Abatement Substitution” (PAS) curves: limited substitution between pollution and abatement

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From MAC to PAS

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Emissions (in % of current level)

Cu

mu

lati

ve a

bate

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t costs

(in

% o

f m

axim

um

)

Data abatement costs

PAS curve

Technical potential

Current pollution level

Sustainabilityestimate

Short-termpolicy target

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Abatement as an economic good Abatement modelled like ‘normal’ production

sector– abatement goods are demanded by all polluters (on a perfect market)– decisions on ratio between pollution and abatement are reversible

The ‘Abatement sector’ production function– nested CES production function– labour, capital and produced goods are inputs in abatement sector production function (the ‘spending effects’)– changes in input costs leads to changes in marginal abatement costs (mainly changes in labour productivity)

Autonomous pollution efficiency improvements

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Structure of the production functionOutput

Environmental Services

0

Production

Intermediate deliveries

LabourCapital

KL

Y

ID

Pollution permits -unabatab

le part

Abatement

0

PAS

Pollution permits -abatable

part

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Part II:

Calibration

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Calibration of the model

Environmental themes– Climate change, Acidification, Eutrophication, Smog

formation, Dispersion of fine dust, Desiccation, Soil contamination

Benchmark projection– model calibrated to the Netherlands, accounting matrix

for 1990– balanced growth of 2% per year – theme-specific autonomous pollution efficiency

improvements– 27 production sectors– 1 representative consumer for all private households– 1 government sector: existing distortionary taxes

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Data sources

Description of initial situation in 1990– Social Accounting Matrix: Statistics Netherlands (National

accounts)– emissions: Statistics Netherlands / RIVM– abatement cost curves: own compilation based on various

sources, including RIVM and ICARUS

Growth rates– own calculations based on data for 1995 and 2000

Parameters– elasticities: extended Keller model / SNI-AGE model– other parameters: existing literature

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Policy scenarios

Policy scenario NEPP2030– emission targets for 2030 based on NEPP4 (+expert

judgements):Climate -50%; Acid. -85%; Eutroph. -75%; Smog -85%; PM10 -90%

– linear path to target from 2000 - 2030– stabilisation of emissions from 2030 onwards

Policy scenario Delay– targets for 2030 postponed to 2040

Policy scenario NEPP2010– additional targets for 2010 based on NEPP3 (+expert

judgements)

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Policy impulse for Acidification

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Benchmark projection NEPP2030 Delay NEPP2010

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Benchmark projection NEPP2030 Delay NEPP2010

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Benchmark projection NEPP2030 Delay NEPP2010

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Benchmark projection NEPP2030 Delay NEPP2010

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Part III:

Main results

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Impact on GDP

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without environmental policy

with environmental policy

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with environmental policy

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Impact on GDP

-12.0

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NEPP2030 Delay NEPP2010-12.0

-10.0

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-4.0

-2.0

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NEPP2030 Delay NEPP2010

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Sectoral results

Indirect effects are important– most dirty sectors not necessarily most heavily impacted

Impacts on production sectors very diverse– in long run large reductions in energy sectors and heavy industry– small reductions (or even small increases) in services sectors– combination of shift and shrink

Impacts on consumption more evenly spread– impacts depend crucially on environmental policy abroad– in short run increase in consumption

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Grouped sectoral results

Sectoral effects of NEPP2030 policy

1990 2010 2030 2050

Private consumption Agriculture 0.44 -0.08 -6.88 -9.30

Private consumption Industry 0.89 0.91 -8.80 -12.05

Private consumption Services 1.06 1.34 -3.23 -8.57

Sectoral production Agriculture -1.09 -7.46 -32.64 -34.58

Sectoral production Industry -0.60 -3.25 -35.05 -30.64

Sectoral production Services 0.09 -0.64 0.49 -3.74

Sectoral production Abatement services-0.03 4.23 16.59 15.81

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Emission reductions (year 2030)

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Climate change Acidification Eutrophication Smog formation Fine dust

Emissions before policy Economic restructuring Technical measures

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Climate change Acidification Eutrophication Smog formation Fine dust

Remaining emissions Technical measures Economic restructuring

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Climate change Acidification Eutrophication Smog formation Fine dust

Emissions after policy Economic restructuring Technical measures

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Technically abatable emissions

-100

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Climate change Acidification Eutrophication Smog formation Fine dust

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Gross environmental expenditures in the NEPP2030 scenario with the base specificationof DEAN (undiscounted values in billion Euro)

1990 2010 2030 2050

Climate change 0.55 1.64 2.52 6.07

Acidification 0.16 0.42 5.60 6.58

Eutrophication 0.11 0.23 0.36 0.54

Smog formation 0.07 0.25 100.96 107.54

Fine particles to air 0.01 0.02 0.65 0.82

Desiccation 0.25 0.37 0.37 0.64

Soil contamination 8.77 13.04 13.15 22.42

Total environmental expenditures 9.92 15.98 123.62 144.62

in percentage of GDP 4% 5% 26% 21%

Gross environmental expenditures

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Part IV:

Final remarks

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Sensitivity analysis

Specification of technical potential– results highly sensitive to technical potential Smog formation– higher technical potential means lower costs and more abatement

Specification of PAS-elasticity– small impact, as all VOC measures will be implemented anyway– higher elasticity means lower costs and less abatement expenditure

Specification of endogenous environmental innovation

– endogenous innovation (read: learning by doing) is likely to occur– any excessive economic costs of environmental policy can be prevented

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Impact of model variants on welfare

Equivalent variationBase specification -5.8GHG emission policy -7.4Endogenous innovation -3.2Labour tax recycling -5.6Multilateral policy -11.7

High technical potential Smog formation -4.1

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Future research / room for improvement Better modelling of energy carriers and fuel switch

options– linking emissions of GHGs to input of energy where appropriate– top-down modelling of fuel switch options– ay suggestions on modelling national climate policy?

Add more empirical details on abatement options– sectoral specification of potential options (if possible)– differentiate production function abatement sector– improve modelling of negative cost options

Add feedback effects from environment to economy (benefits)

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Conclusions Major (bottom-up) characteristics of abatement

options can be integrated in a (top-down) CGE framework

Macro-economic impact ‘modest’ 10 percent / 5 years delay / 80 bn Euro net / 145 bn Euro gross

Environmental policy creates both threats and opportunities for production sectors

Technical measures and economic restructuring are both essential

Interactions between environmental problems have substantial influence on results