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Economic Modeling of Contemporary Global Policy Issues: Trade Liberalization and Environmental Policy. Warwick J McKibbin ANU Centre for Applied Macroeconomic Analysis (CAMA) and Lowy Institute for International Policy And The Brookings Institution. ANU POGO 8027 March 15, 2005. - PowerPoint PPT Presentation
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Economic Modeling of Contemporary Global Policy Issues:
Trade Liberalization and Environmental Policy
Warwick J McKibbinANU Centre for Applied Macroeconomic Analysis (CAMA)
and Lowy Institute for International Policy
And The Brookings Institution
ANU POGO 8027 March 15, 2005
Background papers are available from:
WWW.SENSIBLEPOLICY.COM
Or
WWW.GCUBED.COM
Overview
Part I• Thinking about the Uncertain Future
The need for a framework• What are models?• How to Use them• Economy Wide and Global Economic Models
Key Features Strengths and Weaknesses
• A peek inside a new generation of models (dynamic intertemporal general equilibrium models)
Overview
Part II• Using Dynamic Intertemporal General Equilibrium Models for
Scenario Analysis and Policy Design Dynamics of Trade Liberalization Sensible Climate Change Policy
Use of Models in Policy Evaluation
The world is an uncertain place Models are useful for
• Forecasting• Policy evaluation• Scenario analysis
Use of Scenarios
The most effective way to undertake scenario analysis is with an internally consistent and empirically relevant framework
We have developed a series of global economic models with many countries and many sectors based on new developments in intertemporal economics
The models form the analytical and empirical basis for designing alternative scenarios
Use of Scenarios
Ask the question• What are the likely consequences of the Iraq War?
Design the scenarios that give different insights to the question• Examine history (Gulf War I, Afghanistan, Vietnam, Korea)
Wars always cost more than expected Costs are more than the fiscal outlays
• Shocks to Government spending for the war (US,Aust,UK) Government spending for the peace (Europe/Japan) Increased global risk
Impose the shocks in a consistent framework (a model) Interpret the results Assess the key sensitivities that drive the results
Do people expect it to be temporary or more permanent?
Scenario Examples www.economicscenarios.com
The Aftermath of the Sept 11 Terrorist Attacks What if Japan Adopted a Sensible Macroeconomic Policy? The Consequences of WorldCom and Enron Collapses The War with Iraq: the compounding Effects of Oil Prices, Budgetary
Costs and Uncertainty The SARS Outbreak: How Bad can It Get? Exploding Fiscal Deficits in the United States: Implication for the World
Economy What if China Revalues Its Currency China: The Implications of Policy Tightening Oil Price Scenarios and the Global Economy The United States Current Account Deficit and World Markets
What is an Empirical Economic Model?
A set of equations embodying the history of theoretical and empirical economic knowledge
Key bits• identities• behavioural equations• exogenous inputs
How to Use Economic Models
Very carefully!
Can get both quantitative estimates and new insights on complex issues
What Features are Important in a Model?
Does the model explain anything we observe today or in the recent past (VALIDATION)? ;
Is the model continually reviewed by experts who actually use it; is it published in the refereed academic literature; is a full listing of all equations available on request; and is it generally open to evaluation by others?;
What Features are Important in a Model?
Is the private market willing to purchase the model for the value it provides? ;
Do the model results pass the test of common sense?; Are the mechanisms in the model transparent to other
trained economists?
Types of Economic Models
Input Output Models• Examples:
United Nations Global models developed by Wassily Leontieff, Faye Duchin
Types of Economic Models
Input/output models Computable general equilibrium (CGE) models Old style macro-econometric models Modern macro-econometric models Dynamic intertemporal general equilibrium models
• New Keynesian macro models Micro-simulation models/ artificial life models
Types of Economic Models
Input Output Models• Trace the flow of resources between sectors;• Little role for relative price changes or substitution of inputs or
consumption bundles;• Tend to be static;• No allowance for capital accumulation or international financial
flows;• Ignore the role of money and asset prices;
Types of Economic Models
Computable General Equilibrium Models (CGE)• Examples:
Domestic– ORANI model, Monash Model– Murphy 303
Multi-Country– MEGABARE, GIGABARE, GTEM– GTAP World Trade Model– Michigan World Trade Model
Types of Economic Models
Computable General Equilibrium Models (CGE)• Derived from microeconomic optimization theory;• Considerable attention to individual behavior;• Relatively easy to understand results given theoretical structure;• Inadequate macroeconomic behavior;• Tend to be comparative static or recursive dynamic;
Types of Economic Models
Computable General Equilibrium Models (CGE) Inadequate treatment of intertemporal saving and investment
decisions, capital accumulation, financial capital flows; Ignore the role of money and asset prices; Rarely validated with actual experience either econometrically or
through forecasting or shock replication.
Types of Models
Old Style Macroeconometric Models • Examples
Domestic– NIF Treasury Model– Reserve Bank Models I & II
International– Data Resources Inc (DRI)– Warton
Types of Models
Old Style Macroeconometric Models • Rely on correlations in time series data based on aggregate
economic theory;• Reasonably good for short term forecasting (tend to be quarterly)• Difficult to understand results because of lack of theoretical
structure;• Unclear long run properties;
Types of Models
Modern Macroeconometric Models • Examples
Domestic– Murphy model 2– Access Economics– Treasury TRYM model
International– IMF Multimod– Oxford Econometric Forecasting (OEF)– GEM model of LBS/ NIESR
Types of Models
Modern Macroeconometric Models • More tightly specified theory• Rational Expectations in some markets• short run data consistency with long run theoretical properties• tend to be quarterly
Types of Models
Dynamic Intertemporal GE Models• Examples
The MSG2 Multi-Country Model » (McKibbin & Sachs)
The GCUBED Multi-Country Model» (McKibbin & Wilcoxen)
– GCUBED Environment– GCUBED (Asia Pacific)– GCUBED (Agriculture)– The MSG3 Multi-Country Model
Types of Models
Dynamic Intertemporal GE Models• integrates the key features of the other types of models• mix of econometric estimation and calibration• annual frequency• problem with large degree of dis-aggregation because of complexity
of the numerical algorithms needs
Types of Models
New Keynesian Models (also called Dynamic Stochastic General Equilibrium models (DSGE)) • Since the publication of the Obstfeld and Rogoff textbook on
International Economics, macro modellers have discovered intertemporal models Sticky prices Mix of optimizing and rule of thumb agents Imperfect competition
Types of Models
Others• Micro Simulation Models (NATSEM)• Artificial Life Models (Sante Fe Institute, Brookings Institution)
Inside one class of models
Dynamic Intertemporal General Equilibrium Models
Overall model development strategy
Funding is both through research grants and private consulting Hub and spoke approach to coordinating a global research project
• The model is managed/developed in the core research team in Australia and Texas
• Users (researchers/ governments/ financial investors) in different countries feed back to the core group both their own developments of the model as well as funding the core for new developments. All of which which we are able to incorporate into the model over time
Features of DIGE models
Dynamic Intertemporal General Equilibrium Multi-Country Multi-sectoral Econometric Macroeconomic
The MSG2 Multi-country model
McKibbin and Sachs
Development and Subscription Funding
– McKibbin Software Group Inc– US Congressional Budget Office– The Brookings Institution– US Department of Commerce– US Government– United Nations– World Bank– Australian Treasury– Centre for International Economics– Nomura Research Institute– Daewoo Research Institute (Korea)– Warwick Modeling Bureau– Many Academic Colleagues
The MSG2 Model Countries
United States - Taiwan Japan - Malaysia Germany - Indonesia France - Thailand Canada - India United Kingdom -Philippines Italy - Hong Kong Austria - Singapore Australia - Korea New Zealand China
The MSG2 Model 1 Sector in each country macroeconomic focus International capital and trade flows Forward looking expectations by some agents Rigidities in physical capital formation but highly mobile
financial capital Unemployment is labour markets due to institutional factors
The G-Cubed Model
McKibbin & Wilcoxen
Development and Subscription Funding
• Major Funding The Brookings Institution United States Environmental Protection Agency United States National Science Foundation McKibbin Software Group Inc
• Minor Funding through consultancies United Nations Australian Dept of Environment New Zealand Department of Commerce Canadian Dept of Finance
The G-Cubed Model
• Countries United States Japan Australia New Zealand Canada Rest of OECD Brazil Rest of Latin America China Eastern Europe and Former Soviet Union Oil Exporting Developing Countries Other non Oil Exporting Developing Countries
The G-Cubed Model• Sectors
– Electric Utilities– Gas Utilities– Petroleum Refining– Coal Mining– Crude Oil and Gas Extraction– Other Mining– Agriculture, Fishing and Hunting– Forestry and Wood Products– Durable Manufacturing– Non Durable Manufacturing– Transportation– Services
The G-Cubed (Asia Pacific) Model
Countries United States Japan Australia New Zealand Rest of the OECD Korea Thailand Indonesia China Malaysia Singapore Taiwan Hong Kong Philippines India Oil Exporting Developing Countries Eastern Europe and the former Soviet Union Other Developing Countries
G-Cubed (Asia Pacific)
• Sectors Energy Mining Agriculture Durable Manufacturing Non-Durable Manufacturing Services
The G-Cubed (Agriculture) Model
G-Cubed (Agriculture)• Countries
– United States– Japan– Australia– EU12– Canada– Mexico– ROECD– China & Hong Kong– ASEAN– Taiwan– Korea– ROW
G-Cubed (Agriculture)
• Sectors Food grains (rice and wheat) Feed grains Non-grain crops Livestock and its products Processed food Forest and Fishery Mining Energy Textile and Clothing Other non-durable consumer goods Durable consumer goods Services
Agents and Markets
AGENTS MARKETS Households Goods & Services Firms Factors of Production Governments Money
Bond Equity
Foreign Exchange
Key Features
the demand and supply side of the major economies are explicitly modelled ;
demand and supply equations are based on a combination of intertemporal optimizing behavior and liquidity constrained behavior;
Households
• 2 types A) maximize an intertemporal utility function consisting of all
goods and services produced domestically and overseas, subject to an intertemporal budget constraint that the present value of consumption is bounded by the present value of after tax income from all sources
B)Base aggregate consumption expenditure on an optimal rule of thumb with current consumption of each good allocated so as to maximize contemporaneous utility
Firms• 2 types
A) Maximise their share market value (the present value of the future stream of dividends) subject to production technology, a cost of adjustment model of capital and taking prices as given. They base their calculation on a summary of the future measured by Tobin’s Q.
B)Base aggregate investment expenditure on an optimal rule of thumb with investment equal to cash flow after paying for variable factors of production
Apart from physical capital other factors of production are flexible
– Labor, energy and imported intermediates in MSG2 – Labor, energy, materials, resources in GCUBED
Governments
Governments provide public goods that enter into the utility functions on households (additively seperable) and transfer payments;
In MSG2 governments provide infrastructure that enters into the production function of firms with increasing returns
They collect a wide variety of taxes on income of firms households, imports, sales.
Governments are subject to the intertemporal budget constraint that the present value of spending and transfers is bounded by the present value of future tax collections.
Countries
Countries are collections of individual firms, households and governments that trade goods and services as well as financial assets;
Labor is immobile between countries but mobile within countries;
Financial capital is mobile within and between countries;
Physical capital is sector and country specific at any point in time and subject to adjustment costs over time.
Role of Money
Money is required for transactions between all agents. There is a technology that combines money with produced goods and services and the combined product is what is available in the market.
The supply of money is determined by the a central bank in each economy in conjunction with assumptions about the exchange rate regime.
Financial Markets
Financial markets exist for– Money– Government Bonds– Equity– Foreign Assets– Foreign Exchange
Each financial asset represents a claim over real resources– Money over purchasing power– Bonds are claims over future tax collections– Equity is a claim over the future dividend stream of a firm– Foreign assets are claims over the future exports of the
debtor country
Goods and Services Markets
Households, Firms and Governments trade goods and services and price for each is assumed to clear the markets at an annual frequency
Factor Markets
• Labor Markets Nominal wages are set by different institutional
structures in each country; Given the nominal wage and the market prices
for goods and services firms higher labor until the real wage in each sector equals the marginal product of labor;
Aggregate unemployment can result although over time it is assumed that unemployment tends to force the nominal wage towards the labor market clearing level.
Factor Markets
• Capital
once installed physical capital is costly to move;
Capital produces a flow of services for firms that have installed a capital stock through investment decisions in the past;
Investment is subject to rising marginal costs of installation and depreciation over time.
Factor Markets
• Energy and Materials in GCUBED Firms purchase the output of other sectors as
inputs in production; Total demand for the materials and energy sectors
is final demand plus demand for intermediate inputs in each sector;
In contrast to standard CGE models (which assume Leontieff fixed coefficients between intermediate inputs and value added ) there is a CES production technology which allows substitution of capital, labor energy and materials in production.
Recent Applications
Global Demographic Change (Japanese Govt, IMF) Economics of Infectious Diseases (WHO) Global trade policy (WTO) Macroeconomic imbalances Climate Change Policy
Part II
Trade Liberalization in a Dynamic Setting
by
Warwick J. McKibbin
Goals of the Paper
Explore the dynamic adjustment to a new WTO Round of Trade Liberalization from 2000 to 2010
Explore how this helps Asia Crisis economies relative to a direct transfer of foreign Aid from OECD economies
Explore the impact of incorporating an empirical model of endogenous total factor productivity growth ( Chand (1999))
The Asia Pacific G-Cubed Model
Dynamic, Intertemporal, General Equilibrium Multi-Country Multi-sectoral Macroeconomic Econometric Keynesian short run with unemployment Mix of rational & rule of thumb behavior
See WWW.GCUBED.COM
Key dynamic features
annual frequency physical capital is accumulation is endogenous but subject
to adjustment costs forward looking agents in goods, factor and financial
markets full accounting of stock flow relations combination of intertemporal optimization by agents plus
liquidity constraints sticky nominal wages
Some Important Issues
Trade, capital flows and adjustments in domestic financial markets are central to global adjustment to shocks;
Agents arbitrage between different assets within countries and across countries - taking into account the adjustment costs of changing the physical capital stock in each sector.
What are Financial Assets?
Each financial asset represents a claim over real resources • Money over purchasing power • Bonds are claims over future tax collections• Equity is a claim over the future dividend stream of a firm • Foreign assets are a claim over the future exports of the debtor
country
Asset values embody expectations of future real activities
The Simulations
A New Millenium Round
In 2000, it is announced that existing tariffs will be reduced by 1/3 from 2000 to 2010 in most countries
Tariffs on goods trade are based on the GTAP4 database (see Table 3a)
For services it is assumed there is a cost reduction based on work by Centre for International Economics (see Table 3b)
Figure 1: Impact of a new WTO Round on Real GDP (OECD Economies)
-0.1
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 2: Impact of a new WTO Round on Real GDP (non OECD)
-0.5
0
0.5
1
1.5
2
2.5
3
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Figure 3: Impact of a new WTO Round on Real Consumption (OECD Economies)
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 4: Impact of a new WTO Round on Real Consumption (non OECD)
-2
-1
0
1
2
3
4
5
6
7
8
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Figure 5: Impact of a new WTO Round on Real Exports (OECD Economies)
-0.5
0
0.5
1
1.5
2
2.5
3
3.5
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 6: Impact of a new WTO Round on Real Exports (non OECD)
-6
-4
-2
0
2
4
6
8
10
12
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Figure 7: Impact of a new WTO Round on Trade Balances (OECD Economies)
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% b
as
eli
ne
GD
P d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 8: Impact of a new WTO Round on Trade Balances (non OECD)
-4
-3
-2
-1
0
1
2
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% b
as
eli
ne
GD
P d
ev
iati
on
fro
m b
as
eli
ne
Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Figure 9: Impact of a new WTO Round on Real Effective Exchange Rates (OECD Economies)
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 10: Impact of a new WTO Round on Real Effective Exchange Rates (non OECD)
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
3
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Figure 11: Impact of a new WTO Round on Employment (OECD Economies)
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
0.6
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 12: Impact of a new WTO Round on Employment (non OECD)
-1
-0.5
0
0.5
1
1.5
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne
Indonesia
Malaysia
Philippines
Thailand
China
India
Taiwan
Hong Kong
Figure 13: Impact of a new WTO Round on Real Interest Rates (OECD Economies)
-0.06
-0.04
-0.02
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% p
oin
t d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 14: Impact of a new WTO Round on Real Interest Rates (non OECD)
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Summary
Largest gains to countries liberalizing most short run losses outweighed by long run gains trade impacts /exchange rate adjustments tend to be the
opposite in the short run relative to the medium run (role of intertemporal budget constraints)
Direct Aid to Asia Crisis Countries
Aid Simulation Indonesia, Korea, Thailand and Philippines receive a direct
transfer from the OECD economies such that:• The transfer declines by 10% per year after 2000• Receiving countries are no worse off in terms of the present value of
consumption than under the trade liberalization simulation.• Donor countries donate in proportion to their share of GDP in the
donor total
Figure 15: Impact of Foreign Aid on Real GDP (OECD Economies)
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
ROECD
Figure 16: Impact of Foreign Aid on Real GDP (non OECD plus Korea)
-0.5
0
0.5
1
1.5
2
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Korea
Figure 17: Impact of Foreign Aid on Real Consumption (OECD Economies)
-0.4
-0.35
-0.3
-0.25
-0.2
-0.15
-0.1
-0.05
01999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
ROECD
Figure 18: Impact of Foreign Aid on Real Consumption (non OECD plus Korea)
-4
-2
0
2
4
6
8
10
12
14
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Korea
Summary
Income transfer causes adjustment through the balance of payments
consumption of receiving countries rise consumption of donating countries fall trade liberalization is a better way to help crisis economies
Total factor productivity growth in manufacturing endogenous to the change
in tariffs (following the econometric results of
Satish Chand (1999)
Figure 19: Impact with Endogenous Productivity on Real GDP (OECD Economies)
-0.5
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
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m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 20: Impact with Endogenous Productivity on Real GDP (non OECD)
0
2
4
6
8
10
12
14
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Figure 21: Impact with Endogenous Productivity on Real Consumption (OECD Economies)
-0.5
0
0.5
1
1.5
2
2.5
3
3.5
4
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
e
USA
Japan
Australia
Korea
ROECD
Figure 22: Impact with Endogenous Productivity on Real Consumption (non OECD)
-5
0
5
10
15
20
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
% d
ev
iati
on
fro
m b
as
eli
ne Indonesia
Malaysia
Philippines
Singapore
Thailand
China
India
Taiwan
Hong Kong
Summary
Making TFP growth endogenous to changes in tariff rates increases the gains from liberalization
But also accentuates the adjustment process through the balance of payments in the short run
Conclusion
Dynamics in the sense used in this paper adds a richer story to trade liberalization
In particular there are many problems - noticeable to policy makers in the real world - which need to be understood
Many short term results (over a decade) are the opposite of the long term neoclassical results that come from conventional CGE models.
Sensible Climate Policy
See “Uncertainty and Climate Change: The Challenge for Policy” Zillman, McKibbin and Kellow
www.assa.edu.au
Based on the book:
McKibbin W.J and P.J. Wilcoxen (2002) Climate Change Policy after Kyoto: A
Blueprint for a Realistic Approach
The Brookings Institution
www.notwrong.com
Overview
What is the climate change policy issue?• Managing Uncertainty in a sustainable way
Features of a Sustainable System What Has Been Done so far?
• The UN Framework Convention on Climate Change• The Kyoto Protocol
Fatal Problems with the Kyoto Protocol? An Alternative Approach: The McKibbin Wilcoxen Blueprint? Where to go from here?
We need to distinguish between two separate questions:
• Should the world take action against the threat of climate change?
• Should the world implement the Kyoto Protocol?
What is Climate policy about ?
• We know that carbon concentrations in the atmosphere have risen 30% since the industrial revolution.
• We know the science of the greenhouse effect.
Uncertainty is everywhere :Uncertainty is everywhere :
• UncertaintyUncertainty about link between carbon dioxide emissions and the timing and magnitude of climate change
• UncertaintyUncertainty about costs and benefits of climate change • UncertaintyUncertainty about costs and benefits of abatement
• UncertaintyUncertainty about the policy responses
Figure 2.1: Global Carbon Dioxide Emissions, 1751-1998
0
1000
2000
3000
4000
5000
6000
7000
1750 1770 1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990
Year
Some Illustrations of the uncertainties
Figure 2.7: Global Temperature Record, Vostok Ice Core Data
-12
-10
-8
-6
-4
-2
0
2
4
050,000100,000150,000200,000250,000300,000350,000400,000450,000
Years Before Present
Dif
fere
nce in
Mean
Tem
pera
ture
, C
Figure 2.6: Emissions of Carbon Under IPCC Scenario A1B
7.1
15.9
26.6
22.9
17.9
7.1
12.1
18.718.0
13.4
7.1
9.6
13.013.5
16.4
0.0
5.0
10.0
15.0
20.0
25.0
30.0
1980 2000 2020 2040 2060 2080 2100 2120
Year
Gig
ato
ns o
f C
arb
on
(G
t)
AIM
ASF
IMAGE
MARIA
MESSAGE
MiniCAM
What should be done given uncertainty?
Some proposals:• Do nothing
Problem may be small, avoiding it may be expensive (what if the problem is large and avoiding it is cheap?)
• Do something drasticProblem may be enormous, avoiding it may be cheap (what if the problem is small and avoiding it is expensive?)
A prudent policy would avoid extremes• Reduce emissions where possible at low cost
Features of a Sustainable System
• Extensive - all major carbon emitters need to participate
• Implementable in key countries• Equitable - across a range of dimensions• Efficient - minimum economic cost• Flexible - need to adjust as new information is
revealed• Low cost of implementation/administration• Must establish clear property rights over a long period of time to
provide the right incentives for all involved households, industry, governments
• Should be in all participants interest to commit current and future participants within each country involved
What has been Done so far?
The UN Framework Convention on Climate Change
Negotiated at the Earth Summit in 1992 in Rio Set Goals (not targets)
• “preventing dangerous anthropogenic interference with the Earth’s climate system”
• Annex I countries (industrial countries) were to adopt policies to “aim” to reduce their emissions
• Entered into force in March 1994
Set in process a series of meetings of the “Conference of the Parties” (COP)
The Kyoto Protocol
Protocol to the 1992 UN framework Convention on Climate Change, negotiated at COP3 in 1997
Annex 1 countries agreed to reduce emissions of 6 greenhouse gases to 5.2% below 1990 levels on average between 2008 and 2012
No commitments for Developing Countries (countries such as China ratify but have no targets!)
Some flexibility allowed through • permit trading• clean development mechanism (CDM)• joint implementation
The Kyoto Protocol
legally binding if 55 countries accounting for 55% of developed country emissions ratify
USA and Australia have rejected Massive dilution of the original targets to encourage
countries such as Japan, Canada, NZ and Russia to ratify Russia is the key country that will determine if the Protocol
enters into force – Russia has put the ratification legislation to the Duma
Kyoto-style Permit Trading Emission permits are issued equal to the Annex 1 target Each country receives an allocation of permits Countries/firms
• buy permits if they wish to increase emissions • sell permits if they wish to reduce emissions
Trading allows original country targets to be tightened or relaxed depending on the costs• Abatement differs across countries depending on costs of
abatement relative to the price of permits• The permit price will be determined by demand and supply and will
equal the cost of preventing the emission of an additional unit of carbon
Advantages of Kyoto trading
Global target is met but differential country response allowed through the market
Cost of removing an additional unit of carbon is equal everywhere (efficient)
Compensation (across countries and within countries) can be built into the initial permit allocation
A fundamental problem with targets and timetables
What is the correct target for each country and the world? What is the optimal period?
• targets impose unknown cost for given outcome for emissions
permit trading gives greater flexibility across countries but no flexibility in total
Problems With Kyoto Approach
Problems With Kyoto Approach
If costs are low we miss the opportunity to cut emissions quickly (in total) because we have a fixed target
If costs are high we might create severe problems that would destroy the commitment to Kyoto
Permit trading more widely implemented could cause economic and political problems with large wealth transfers between economies and large fluctuations in trade balances and real exchange rate
Some historical examples• Dutch Disease – e.g. North Sea Oil Discovery in 1970s• Keynes classic “transfer problem” related to German Reparations
after WWI
Problems With Kyoto Approach
If one large country reneges the permit system would likely collapse since the price depends on all countries supply and demand
This requires a very strong monitoring and enforcement mechanism in all participating countries.
If developing countries participate in permit trading the price of carbon would be the same as in industrial countries – why would they want this structural shock even with payments for permits?
Problems With Kyoto Approach
Carbon taxes Subsidies to technologies Mandatory targets for renewables
Alternatives to permit trading?
A carbon tax:
A fixed price for carbon with revenue going to the government
Emission outcome is unknown but the cost of carbon is known with certainty
Problems• Tax payments are enormous• If optimal reduction is 20% of emissions, firms must pay tax on 80%
of original output.
• Very unpopular with industry and politicians!
Subsidies for the Best Technology ?
Clean Coal? Renewables? Problem is that the solution will be technological
but are governments the best placed to pick the winners?• The subsidies will likely go to those with the greatest
lobbying power
Mandatory Targets for renewable energy
Evidence is that this is a high cost approach Targets and timetables approach yet again
Other options?
Reform coal markets (see Anderson and McKibbin (1998)
Address direct problem such as black carbon in developing countries
Black Carbon
Important issue particularly in developing countries• Significant short run climate impacts• Significant health impacts• Significant negative impacts on agriculture productivity
Major issue in China
Features
Released when carbonaceous fuels incompletely combust Hard to measure China is 17% of global emissions Mostly emitted by burning of raw coal, coal briquettes and
bio-fuels in the residential sector
Sources of Black Carbon in China
Residential83%
Industry7%
Power1%
Transport - diesel3%
Transport - other0%
Field Combustion6%
Source: Table 2 page 7 of Streets (2004)
Are there any other alternatives?
Need a policy with best features of permits, taxes and subsidies
Like a tax:• Should guarantee that costs won’t be excessive
Like permits:• Should avoid huge transfers to the government
Like subsidies:• it should encourage the search for technological solutions
Importantly it should make property rights clear over a long period and provide incentives for industry,households and governments to reduce emissions at low cost
The Blueprint (a hybrid policy) Each participating country would:
• Require that producers of energy within their borders have an annual emission permit for each ton of carbon embodied in their energy produced and sold domestically or imported
• Issue perpetual emissions permits equal to a specified fraction of a base period emissions.
• Be allowed to sell additional annual permits to firms within its borders at a stipulated price ($P per ton of carbon), where $P could be $US10 per ton of Carbon ($US2.72 per ton of CO2).
• Create domestic markets in the perpetual and annual permits
PerpetualPermit
Looking at the policy in more detail:
Allows one unit of emission per year for a long period
Distributed once at enactment Can be leased or sold within a country Quantity can set by treaty: QT
Price will be set by the market
AnnualPermit
Allows one unit for one year Sold by government as demanded Price set by treaty: PT
Supply of each type of permit (for use in a given year)
$
SS
QP
Annual permits for sale
PT
Perpetual permits for lease
SL $
QP QT
Overall supply of permits (for use in a given year)
S
$
QP
PT
QT
If abatement is easy:
MAC rise slowly Low D for permits P below threshold No annual permits Hit target QT
S
$
Q Permits
D P
PT
QT
Revenue to permit owners
If abatement is difficult:
MAC rises rapidly High D for permits P at threshold PT
Annual permits used Emissions exceed QT
S
$
Q Permits
D
P, PT
QT
QA
Revenue to permit owners
Revenue to government
Key Points
Each system is run within a country using that country’s own imperfect monitoring and enforcement mechanisms and its own legal and accounting systems
No international trade in the assets • only domestic markets• Short run efficiency guaranteed by a common price• Long run efficiency driven by structural change
Incentives for all actors are internalized within countries
Developing Countries ...
Negotiate a perpetual permit allocation that is larger than current emissions
Price of annual emission permits zero in the short run because more permits than needed
Price of perpetual emission permits will be non zero giving important signals for investment projects
Over time the permit price in countries will equalize as developing countries “ability to pay rises”
Example from
“ Climate Change Policy For India”
Figure 6: Stylized Annual Permit Price
0
20
40
60
80
100
120
140
160
2003
2007
2011
2015
2019
2023
2027
2031
2035
2039
2043
2047
2051
2055
2059
2063
2067
2071
2075
2079
2083
2087
2091
2095
2099
$US
200
2
Annex B
India
Figure 7: Stylized Value of Perpetual Permits(Assuming r=5%)
0
500
1000
1500
2000
2500
3000
2003
2007
2011
2015
2019
2023
2027
2031
2035
2039
2043
2047
2051
2055
2059
2063
2067
2071
2075
2079
2083
2087
2091
2095
2099
$US
200
2
Annex B
India
Developing Countries ...
Will developing countries ever agree?• Depends on who is expected to get the valuable assets
called permits• Will they ever agree to Kyoto style interventions?
Advantages of the Blueprint policy
Guarantees that compliance costs would not be too high• Passes the test that Kyoto fails
Can be justified on cost-benefit grounds• Current knowledge about climate risks justifies slowing emissions at
low cost
Advantages of the Blueprint policy
Avoids huge transfers to the government• Each government can decide how to hand out perpetual permits but
once these property rights are distributed they are not revisited (like land contracts)
• Permits act as transition relief for industries (and affected workers) and will reduce opposition
• Also, easy for industry to understand -- like grandfathering
Reduces emissions wherever cost-effective• Prudent: eliminates emissions where possible below a fixed price
More advantages ...
Maintains national sovereignty• Important for US and developing country participation
Incorporates an explicit mechanism for developing country commitments with no short term costs but clear incentives for future investment in less carbon intensive activities
Provides a futures market (perpetual permit market)• Allows individual risk management
More advantages ...
No direct international transfers of wealth• Trading is national, rather than international• Less disruptive to exchange rates and foreign aid
budgets
Gives incentives for early action• Perpetual permits could be distributed now, even without
a treaty!• The private sector is already doing this but property
rights unclear
More advantages ...
Built-in incentives to monitor and enforce• Annual permits generate government revenue• Owners of perpetual permits do not want permit prices to
erode
Credible• Less draconian so more likely to be enforced into the
future
Still more advantages ...
Relatively easy to modify as information arrives• Can raise or lower the world price as risks become better
known
Easy to add countries over time• Does not require re-negotiation of treaty• New countries don’t hurt existing permit owners
Creates a future market in carbon (the perpetual permit market)• Gives a long term price signal but with a fixed short term cost
An Illustration of how Uncertainty impacts on the costs
of Kyoto versus Blueprint
Suppose Russia grows at 1% per year faster from 2000 to 2012 than our baseline forecast (4.4% rather than 3.3%)
What is the cost of Kyoto versus the Blueprint under the baseline scenario versus the alternative scenario of higher Russian growth?
Both Kyoto and the Blueprint assume non participation by developing countries even though the Blueprint has a clear mechanism for getting developing country participation!
The G-Cubed Model• Countries
United States Japan Australia New Zealand Canada Europe Rest of OECD Brazil Rest of Latin America China India Eastern Europe and Former Soviet Union Oil Exporting Developing Countries Other non Oil Exporting Developing Countries
The G-Cubed Model• Sectors
– Electric Utilities– Gas Utilities– Petroleum Refining– Coal Mining– Crude Oil and Gas Extraction– Other Mining– Agriculture, Fishing and Hunting– Forestry and Wood Products– Durable Manufacturing– Non Durable Manufacturing– Transportation– Services
Figure 1: Cumulative World Carbon Emissions1999-2015
100000
110000
120000
130000
Unconstrained Kyoto Blueprint
mmt of carbon
BAU Russian growth High Russian growth
Europe
-1.6
-1.2
-0.8
-0.4
0.0
1999 2004 2009 2014 2019 2024
OPEC
-2.8
-2.4
-2.0
-1.6
-1.2
-0.8
-0.4
0.0
1999 2004 2009 2014 2019 2024
Strong Russian Growth - BlueprintMod Russian Growth - Blueprint
Strong Russian Growth - KyotoMod Russian Growth - Kyoto x
Change in GNP:
Change in GNP under KyotoAlternative Russian Growth Assumptions
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025
US Japan
Europe Australia
Russia China
LDC OPEC
% pts
GNP under MWAlternative Russian Growth Assumptions
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025
US Japan
Europe Australia
Russia China
LDC OPEC
% pts
Where to go from here?
The current approach as embodied in the Kyoto protocol does not deal with uncertainty and is not sustainable
The Blueprint dominates in terms of• the extent of emissions reductions; • risk management; • sustainability.
The Blueprint can be implemented within countries and is consistent with moving towards Kyoto if a country ever wanted to.• Just have the government pull out of the annual permit market and
allow these asset to be traded internationally
