Our Common Future Under Climate Change

International Scientific Conference 7-10 JULY 2015 Paris, France

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Thursday 9 July - 15:00-16:30 UPMC Jussieu - ROOM 307 - Block 24/34

4405 - On the macroeconomic opportunity of climate policy

Parallel Session

Chair(s): C. Jaeger (Global Climate forum, Berlin, Germany), C. Carraro (FEEM, Milan, Italy)

Lead Convener(s): S. Wolf (Global Climate Forum, Berlin, Germany), I. Alloisio (ICCG FEEM, Venice, Italy)

Convener(s): C. Gavard (ICCG Fondazione Eni Enrico Mattei and International Center for Climate Governance, Venice, Italy)

15:00

Introduction

C. Carraro (International Center for Climate Governance (ICCG), Ca’ Foscari University of Venice, Venice, Italy)

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Introduction
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15:05

Why finance ministers might favor carbon taxes, even if they do not believe in climate change

O. Edenhofer (Potsdam Institute for Climate Impact Research, Potsdam, Germany), M. Franks, (Potsdam Institute for Climate Impact Research (PIK), Potsdam, Germany), K. Lessmann (Potsdam Institute for Climate Impact Research, Potsdam, Germany)

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Why finance ministers might favor carbon taxes, even if they do not believe in climate change

O. Edenhofer (1) ; M. Franks, (2) ; K. Lessmann (3)
(1) Potsdam Institute for Climate Impact Research, Potsdam, Germany; (2) Potsdam Institute for Climate Impact Research (PIK), Potsdam, Germany; (3) Potsdam Institute for Climate Impact Research, Sustainable solutions, Potsdam, Germany

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The economic forces of globalization constrain democratic governments increasingly. According to Dani Rodrik, we cannot have democracy, national sovereignty, and hyperglobalization at the same time (Rodrik, 2011)[1]. Hyperglobalization impinges on democratic choices within sovereign nations by giving rise to corporate tax competition, which “restricts a nation’s ability to choose the tax structure that best reflects its needs and preferences” (ibid., p. 193). Declining corporate tax rates, complemented by a rising share of labor taxes, give evidence of the resulting race-to-the-bottom.

            The fact that this race-to-the-bottom impedes a government’s ability to raise sufficient funds has far reaching consequences. Funds are required, e.g., not only for health care or education, but also for productive public infrastructure, which is important for both efficiency and equity. Accordingly, an emerging consensus in the empirical literature suggests that these stocks are underfinanced. This raises the question how to reduce exposure to tax competition and generate funds to finance essential public goods.

            We identify taxes on the use of carbon resources as a superior alternative to capital taxes. Even though fossil resources are also traded internationally, there is an asymmetry in efficiency between capital and resources as tax base. While ownership of fossil resources gives rise to a rent, capital does not. Taxes on either factor cause an interregional reallocation by driving economic activity out of countries with relatively high tax rates. The carbon tax has the advantage, though, of capturing part of the resource rent. Governments can use the appropriated rent for productivity enhancing infrastructure investments, which in turn attracts investments in domestic capital stocks.

            Further, it turns out that a carbon tax may not only have fiscal benefits. When the motivation to tax the use of fossil resources is based exclusively on fiscal needs, then resource exporters react by reducing both the rate (a timing effect) and the cumulative amount of resource extraction (a volume effect). Thus, carbon taxes do not cause a green paradox in this situation, but can be part of an effective green tax reform. Governments may not take climate externalities into account, as modeled in our paper. In that case, timing and volume effects per se do not affect decisions about fiscal policy. Nevertheless, these observed effects show that a unilateral tax reform which introduces a carbon tax also has beneficial environmental implications.

            Our contribution is thus twofold. First, we bridge the gap between horizontal fiscal federalism, in particular the tax competition literature on the one hand, and the economics of exhaustible resources on the other. Using a numerical general equilibrium model we compute optimal tax portfolios and precisely assess their opportunity costs. To our knowledge, our model is the first to combine the following key features. We implement a decentralized market economy with several representative agents and strategically interacting governments. The tax instruments, which governments use to finance productive infrastructure stocks, are determined endogenously for both cooperative and non-cooperative behavior in the Nash equilibrium. Capital and fossil resources are traded on international markets. Finally, we include the intertemporal dynamics of capital accumulation and resource extraction (based on the respective models of Frank P. Ramsey and Harold Hotelling). Second, we shed light on the supply side dynamics of fossil resource extraction. So far, most of the research on the conditions under which a green paradox occurs has used partial equilibrium analysis. Only recently has this strand of literature been extended to general equilibrium. Now, we take even one step further. Our model allows strategic interactions between fossil fuel selling and buying countries, as well as among the governments of buying countries themselves.

            We conclude that even when governments do not intend to address climate change, they still have an incentive to implement a carbon tax to improve their fiscal policy. Then, the carbon tax nevertheless helps mitigating the adverse effects of climate change. It is thus not only the environmental ministers who should favor carbon taxes, but also the ministers of finance.

 

15:17

Modelling the macroeconomic opportunity of climate policy

S. Wolf (Global Climate Forum, Berlin, Germany), F. Schuetze, (Global Climate Forum, Berlin, Germany), C. Jaeger (Global Climate Forum, Berlin, Germany)

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Modelling the macroeconomic opportunity of climate policy

S. Wolf (1) ; F. Schuetze, (1) ; C. Jaeger (1)
(1) Global Climate Forum, Berlin, Germany

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Economic policy analysis modelling has largely depicted climate change mitigation as a drag on economic development. In contrast, concepts as green growth or green economy and results of recent studies, such as the New Climate Economy Report, suggest that reducing emissions need not slow down but may benefit the economy.

The possibility of protecting climate while enhancing economic development deserves to be carefully researched; economic models constitute an important tool for doing so. Unfortunately, this possibility is beyond the horizon of the marginal analysis conducted with many conventional climate policy analysis models. Rooted in the general equilibrium framework, these models mostly find economic costs of mitigation when optimizing in the vicinity of a "business as usual" equilibrium.

A survey of models that can represent economic benefits from climate change mitigation reveals a large spectrum of approaches for going beyond this standard modelling setup. At the more conventional end of the spectrum, the literature provides theoretical model extensions, for example to address external effects, that open up the possibility of positive economic effects from climate policy. Computational models further away from the general equilibrium and optimization approach, such as system dynamics models or a macroeconometric model for climate policy analysis, can be viewed as the other end of the spectrum. Within the general equilibrium framework, but outside common modelling practice, several studies conceptualize the current fossil-fuel based economy and a low carbon economy as different equilibria of the economic system. For example, inframarginal economics generalizes the marginal analysis approach by considering different structures of specialization and division of labour. By modelling structural change to the division of labour that is triggered by mitigation policy, the possibility of green growth can be represented and analysed.  Similarly, an analysis of a virtuous circle of expectations, investment and learning-by-doing has shown that investment oriented climate policy can induce a shift to a new growth path with lower emissions but higher growth and employment.

This contribution focuses on the question how climate policy can facilitate a recoordination of investors' expectations so as to induce a transition to a green growth equilibrium and how this can be modelled.

15:29

Climate change and adaptation. A new opportunity for public debt relief?

C. Carraro (FEEM, Milan, Italy), E. Delpiazzo (CMCC, Venice, Italy), F. Bosello (University of Milan, FEEM, and CMCC, Milan, Italy)

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Climate change and adaptation. A new opportunity for public debt relief?

C. Carraro (1) ; E. Delpiazzo (2) ; F. Bosello (3)
(1) FEEM, Climate change and sustainable development, Milan, Italy; (2) CMCC, Venice, Italy; (3) University of Milan, FEEM, and CMCC, Dep. of economics, Milan, Italy

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Notwithstanding a consolidated and vast literature on the possibility to conjugate development and environmental protection, a view still rooted in the policy domains considers the environment as a luxury good less important than social goals like growth or employment. This is epitomized by the climate change challenge. On the one hand the trade-off development/ GHG mitigation is at the heart of the difficulty to involve developing countries in an international agreement on emission reduction. On the other hand, especially in a background of a financial crisis along with high levels of indebtedness and aging population, high unemployment levels and the need for fiscal outlays for unemployment compensation or welfare benefits, climate change policies seem to appear as something which would not be regarded as an urgent policy also in many European countries. In fact, in a situation where public budgets are overstretched due to economic crisis, there is an increasing need to understand the implications of climate change impacts, climate change mitigation and adaptation policies on the fiscal side.

This is particularly true for those countries which experienced growing levels of deficit and debt in the last decades, and especially for adaptation that typically implies an increase in expenditure coming from the public sector. In this context, cuts in public expenses to reduce the gap between revenues and expenditures might appear to be the winning strategy, however there are also impacts to cope with whose timing and magnitude are uncertain as uncertain are their fiscal effects. Policy intervention may lead to an inefficient result with negative ramifications for the economy if adaptation measures are either too paltry or too ambitious. Different options also have different implications for fiscal costs and government revenues.

We tackle these issues using a recursive-dynamic Computable General Equilibrium (CGE) model: the Intertemporal Computable Equilibrium System (ICES) model, enriched with a more realistic description of the government sector both on the revenue and the expenditure side. The relations between debt sustainability and climate change are analyzed both in their short-term and long-term dimensions.

More specifically: firstly, we assess the “direct” or “first round” effects of climate change on the public budget through changes in total tax revenues induced by impacts on production, consumption patterns and trade structure. This also originates indirect fiscal costs (or second round effects) as it impacts governments’ fiscal capacity.

Then, we introduce the possibility of adaptation expenditures to reduce the climate change impacts. We explore adaptation long-run effects on fiscal capacity and fiscal flexibility under different assumptions of financing. Could there be room for issuing more debt (adaptation bonds) to cover climate adaptation expenditure inducing anyway in the long term a decrease in the debt/GDP ratios exploiting adaptation effects on avoided future damages? Even though possible, would it be more efficient and growth enhancing to support adaptation expenditure with revenues from other, e.g. carbon-energy, taxes? What are the different crowding out effects on public/private investment?

It can be established, that climate change has introduced a new aspect into the structure of public finances both in expenditure and in revenue side. In the context of the current multi-year crisis, public finances in the EU are strained, and thus the fiscal consequences of climate change are important to estimate and the worst case scenarios need to be avoided. From few case studies in literature, it is evident that the fiscal consequences are not negligible. However, there has not yet been any study that satisfactorily addresses the way climate change and adaptation affect the state budget, and particularly its stability, in a general equilibrium framework.

15:41

Managing Climate Change Risks and Vulnerabilities: A Microfinance and Climate Finance Perspective

R. Martin (Seeds of Opportunity, Blantyre, Malawi)

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Managing Climate Change Risks and Vulnerabilities: A Microfinance and Climate Finance Perspective

D. Chirambo (1)
(1) Seeds of Opportunity, Blantyre, Malawi

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Climate change touches upon a myriad of inter-related and multi-dimensional aspects of societies, economies and the environment. From an African perspective, climate change may be considered as a phenomenon that may seriously hamper the continent’s future development and pose as an additional impediment to sustainable development. Since climate change impacts are anticipated to vary across countries and localities with some geographic regions being anticipated to suffer more from climate change than others due to variations in national capacities, it can be argued that the poorest and most vulnerable groups and countries will likely be the most affected, consequently increasing world inequality.

 

Even though different countries have various models and approaches for climate change risk assessments and management, it is widely believed that in-order to reduce the impacts of climate change on various countries, and to ensure that international consensus and policies for climate change mitigation, adaptation and financing can be achieved, the post 2015 development agendas should increase funding towards climate change initiatives most notably in developing countries and promote mechanisms for raising the capacity for effective climate change management in Least Developed Countries (LDCs), including focusing on women, youth and local and marginalised communities

 

To date, most climate financing modalities and projects in Africa have had limited or no effect in terms of poverty alleviation and sustainable development due to a lack of emphasis on strengthening the participation of marginalised groups, and the continent’s adaptation deficit as caused by a lack of institutional, financial or technological capacity to adapt effectively  to climate change. In addition to this, even though climate financing for mitigation and adaptation should be addressed with the same priority, research has shown that the implementation of climate finance modalities are highly construed towards mitigation efforts whereby 91% of climate finance flows are for mitigation efforts, 7% for adaptation efforts and  2% for activities with both mitigation and adaptation objectives.  Cumulatively, these issues suggest that most communities in Africa could be becoming more vulnerable to the impacts of climate change.

 

Recent research shows that almost three-quarters of climate finance flows are invested with the expectation of earning commercial returns, hence signifying the need for innovative climate financing models that provide win-win situations for funders and recipients, as well as the world at large as the risks and consequences attributed to climate change can be minimised. In-order to determine the opportunities that exist in enhancing the capacities and opportunities for microfinance for climate change mitigation and adaptation initiatives, and disaster risks and management, this paper expounds the Microfinance-Climate Finance Framework that was shortlisted for the 2014/2015 UNDP MDG Carbon Climate Finance Innovation Award. Using this framework, it is possible to highlight the challenges and opportunities that microfinance institutions could have in the mobilisation of funds and resources from various types of funders, and redistribution of funds and resources to various types of recipients. This paper concludes that fostering international and domestic policies that encourage remittances and financial inclusion may be an effective strategy to encourage microfinance based climate change management funding.

15:53

Carbon Tax, Pensions and Deficits

E. Combet (Centre International de Recherche sur l'Environnement et le Développement (CIRED), Nogent-sur-Marne, France)

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Carbon Tax, Pensions and Deficits

E. Combet (1)
(1) Centre International de Recherche sur l'Environnement et le Développement (CIRED), Nogent-sur-Marne, France

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This paper aims to draw attention on the consequences of the prevailing intellectual compartmentalization between 'energy and climate', on the one hand, and 'the viability of social security systems', on the other. We take the methodological venture of building a general equilibrium model to analyse jointly these issues. The model is applied to France and projected to a future horizon (2020). It ensures consistency by linking together 1) a description of the future constraints on energy and demand, and 2) a partial forecasting scenario of the pension system. First, we analyse two types of archetypical reforms that use one instrument to meet one objective. The first type recourses to one of the present instruments of the pension system (social security contributions on wage income, age of retirement). The second type absorbs the deficits of the pension system by preempting revenues generated by the climate policy (here a carbon tax). After examining the limitations of those single-instrument/single-objective policies, we provide an example of a multi-objective policy package that enables the limitations to be removed. In so doing, we present a way of exploring potential synergies between long term development goals.

16:05

Discussion

C. Jaeger (Global Climate forum, Berlin, Germany)

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Discussion
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