Dynamic CGE Modelling for Analyzing Environmental Policies

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/

2. 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

3. Part I: Model description

4. 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

5. 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

6. 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

7. 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

8. 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

9. 120 Sustainability Current Short-term Technical estimate pollution level policy target potential 100 80 Cumulative abatement costs (in % of maximum) 60 40 Data abatement costs PAS curve 20 0 0 20 40 60 80 100 120 Emissions (in % of current level) From MAC to PAS

10. 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

11. Output 0 Environmental Production Services Y 0 PAS ID KL Capital Intermediate Labour Abatement Pollution permits -unabatable part Pollution permits -abatable part deliveries Structure of the production function

12. Part II: Calibration

13. 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

14. 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

15. 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)

16. Policy impulse for Acidification

17. Part III: Main results

18. Impact on GDP

19. Impact on GDP

20. 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

21. 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 Grouped sectoral results

22. Emission reductions (year 2030)

23. Technically abatable emissions

24. Gross environmental expenditures in the NEPP2030 scenario with the base specification of 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

25. Part IV: Final remarks

26. 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

27. Equivalent variation Base specification -5.8 GHG emission policy -7.4 Endogenous innovation -3.2 Labour tax recycling -5.6 Multilateral policy -11.7 High technical potential Smog formation -4.1 Impact of model variants on welfare

28. 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)

29. 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