Endogenizing the Cap in a Cap-and-Trade System: Assessing the Agreement on EU ETS Phase 4 (with Ulrik R. Beck) [Environmental and Resource Economics (2020)]

Abstract: In early 2018, a reform of the world’s largest functioning greenhouse gas emissions cap-and-trade system, the EU Emissions Trading System (ETS), was formally approved. The reform changes the main principles of the system by endogenizing the previously fixed emissions cap. We show that the effective emissions cap is now affected by the allowance demand and therefore not set directly by EU policymakers. One consequence of this is that national policies that reduce allowance demand can reduce long-run cumulative emissions, which is not possible in a standard cap-and-trade system. Using a newly developed dynamic model of the EU ETS, we show that policies reducing allowance demand can have substantial effects on cumulative emissions. Our model simulations also suggest that the reform reduces aggregate emissions in both the short and long run, but the long-run impact is substantially larger. Yet, the reform has a small impact on the currently large allowance surplus.


Comment on B. Carlén and B. Kriström: Are Climate Policies in the Nordic Countries Cost-Effective? In: L. Calmfors and J. Hassler, editors, Nordic Economic Policy Review 2019: Climate Policies in the Nordics. p. 148-151. Nordic Council of Ministers, 2019.


Working Papers

Directed Technical Change, Environmental Sustainability, and Population Growth

Abstract: Population growth has two potentially counteracting effects on pollution emissions:(i) more people implies more production and thereby more emissions, and (ii) more people implies a larger research capacity which might reduce the emission intensity of production, depending on the direction of research. This paper investigates how to achieve a given climate goal in the presence of these two effects. A growth model featuring both directed technical change and population growth is developed. The model allows for simultaneous research in polluting and non-polluting technologies. Both analytical and numerical results indicate that population growth is a burden on the environment, even when all research efforts are directed toward non-polluting technologies. Thus research subsidies alone cannot ensure environmental sustainability. Instead, the analysis shows that environmental sustainability requires pollution taxes and/or population control policies.

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Carbon Leakage in a Small Open Economy: The Importance of International Climate Policies

Abstract: A substantial literature investigates leakage effects for large countries and climate coalitions. However, little is known about carbon leakage effects for a small open economy within a climate coalition. To fill this gap, we incorporate international climate policies relevant for a small open EU economy into the general equilibrium model GTAP-E. We focus our analysis on Denmark, but we show that our framework can be employed on any EU economy. We find substantial leakage associated with an economy-wide CO2e tax. This result is strongly affected by EU climate policies. We also present sector-specific leakage rates and find large sectoral differences.

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Optimal Unilateral Climate Policy with Carbon Leakage at the Extensive and the Intensive Margin (with Peter Birch Sørensen)

Abstract: We analyse the optimal climate policy design in an open economy where the government is committed to a target for reduction of domestic CO2 emissions but where it is also concerned about carbon leakage. We highlight the importance of distinguishing between leakage at the extensive margin where firms relocate to a foreign country to avoid the domestic carbon tax, and leakage at the intensive margin where domestic firms lose world market shares to foreign competitors due to the tax. Assuming that the government cannot implement border carbon adjustments, we show that the optimal allocation can still be implemented through a set of instruments that includes taxes on emissions and on final consumption goods differentiated according to their marginal effects on foreign emissions, an output subsidy as well as a lump-sum location subsidy to leakage-exposed firms, subsidies to carbon capture, taxes on domestic energy use and on domestic production of fossil fuels, and a subsidy to domestic production of green energy. Simulation experiments indicate that the social welfare gain from implementing the optimal leakage-adjusted tax-subsidy scheme rather than a single uniform emissions tax could amount to 0.5 percent of national income. A location subsidy aimed at reducing leakage at the extensive margin contributes to reducing the welfare loss from leakage.

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Optimal Energy Taxes and Subsidies under a Cost-Effective Unilateral Climate Policy: Addressing Carbon Leakage (with Peter Birch Sørensen) [Under Review]

Abstract: We analyze how a country pursuing a unilateral climate policy may contribute to a reduction in global CO2 emissions in a cost-effective way. To do so its system of energy taxes and subsidies must account for leakage of emissions from the domestic to the foreign economy. We focus on leakage occurring via international trade in electricity and via shifts between domestic and foreign production of other goods. The optimal tax-subsidy scheme is based on an intuitive principle: Impose a uniform carbon tax on all additions to global emissions caused by changes in domestic production and consumption of energy, including additions to emissions occurring via shifts in international trade. Emissions from the sector exposed to foreign competition should be taxed at reduced rates to avoid excessive carbon leakage, and a part of the carbon tax on electricity should be levied at the consumer rather than the producer level to ensure taxation of the carbon content of imported electricity. Producers of renewables-based electricity should receive a subsidy to internalize their contribution to the reduction of global emissions. In other sectors emissions should be taxed at a uniform rate corresponding to the marginal social cost of meeting the target for emissions reduction. Simulations calibrated to data for the Danish economy suggest that redesigning energy taxes and subsidies to account for carbon leakage can generate a welfare gain.

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Testing R&D-Based Endogenous Growth Models

Abstract: This paper examines U.S. productivity growth through the lens of R&D-based growth models. A general R&D-based model, nesting different model varieties, is developed. In contrast to previous analyses, the present study includes productivity gains from both horizontal and vertical innovation. A novel cointegrating relationship is derived from the theoretical model, and different R&D-based growth models are tested using the cointegrating relationship and data for the period 1953-2018. The results provide evidence against the widely-used fully endogenous variety and support for the semi-endogenous variety and a model of less-than-exponential growth. These findings shed new light on the recent debate on productivity growth. A robust finding is the presence of fishing-out effects in knowledge production, implying that it becomes increasingly harder to achieve productivity-enhancing innovations as technologies become more advanced. Forecasts suggest that the U.S. productivity growth slowdown continues over the coming decades.

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Directed Technical Change and Economic Growth Effects of Environmental Policy [currently rewriting]

Abstract: A Schumpeterian growth model is developed to investigate how environmental policy affects economic growth when environmental policy also affects the direction of technical change. In contrast to previous models, production and pollution abatement technologies are embodied in separate intermediate good types. A set of stylized facts related to pollution emission, environmental policy, and pollution abatement expenditures is presented, and it is shown that the developed model is consistent with these stylized facts. It is shown analytically that a tightening of the environmental policy unambiguously directs research efforts toward pollution abatement technologies and away from production technologies. This directed technical change reduces economic growth and pollution emission growth. Simulation results indicate that even large environmental policy reforms have small economic growth effects. However, these economic growth effects have relatively large welfare effects which suggest that static models and exogenous growth models leave out an important welfare effect of environmental policy.

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Paying indulgences for your climate sins

Abstract: This paper develops a simple economic model to characterize the optimal investment path associated with a long-run climate target like carbon neutrality by 2050. Introducing a short-run emission target increases the cost of reaching the long-run emission target if it pushes short-run mitigation investments above the optimal level associated with the long-run target. In this case, it may be cost-effective to employ a flexibility mechanism (like international emissions trading) that relaxes the short-run emission target by reducing greenhouse gas emissions in foreign economies. The developed model highlights the main mechanisms at work, and it is shown under which conditions it is cost-effective to employ a flexibility mechanism. In addition, the analysis shows how cost-benefit analyses focusing only on a short-run emission target exaggerate the cost-reducing potential of flexibility mechanisms. Finally, the analysis provides illustrative calculations and discusses how the results relate to current climate policies.

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