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A new economics approach to
modelling policies to achieve global
2020 targets for climate stabilisation
Terry Barker a , Annela Anger a , Unnada Chewpreecha b & Hector
Pollitt b
a Cambridge Centre for Climate Change Mitigation Research
(4CMR), Department of Land Economy, University of Cambridge,
Cambridge, CB3 9PE, UK
b Cambridge Econometrics Ltd, Covent Garden, Cambridge, CB1
2HT, UK
Available online: 01 Mar 2012
To cite this article: Terry Barker, Annela Anger, Unnada Chewpreecha & Hector Pollitt (2012):
A new economics approach to modelling policies to achieve global 2020 targets for climate
stabilisation, International Review of Applied Economics, 26:2, 205-221
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A new economics approach to modelling policies to achieve global
2020 targets for climate stabilisation
Terry Barker
a
*, Annela Anger
a
, Unnada Chewpreecha
b
and Hector Pollitt
b
a
Cambridge Centre for Climate Change Mitigation Research (4CMR), Department of Land
Economy, University of Cambridge, Cambridge, CB3 9PE, UK;
b
Cambridge Econometrics
Ltd, Covent Garden, Cambridge, CB1 2HT, UK
(Received 31 May 2011; final version received 7 October 2011)
This paper explores a Post Keynesian, ‘new economics’approach to climate
policy, assessing the opportunities for investment in accelerated decarbonisation
of the global economy to 2020 following the Great Recession of 2008–2009.
The risks associated with business-as-usual growth in greenhouse gas (GHG)
concentrations in the atmosphere suggest that avoiding dangerous climate
change will require that the world’s energy-economy system is transformed
through switching to low-carbon technologies and lifestyles. Governments have
agreed a target to hold the increase in temperatures above pre-industrial levels
to at most 2°C and have offered reductions by 2020 in GHG emissions or the
carbon-intensity of GDP. The effects of policies proposed to achieve pathways
to 2020 towards this target are assessed using E3MG, an Energy-Environment-
Economy (E3) Model at the Global level. E3MG is an annual simulation econo-
metric model, estimated for 20 world regions over 1972–2006 adopting a new
economics approach. Additional low-GHG investment of some 0.7% of GDP,
with carbon pricing and other policies, is sufficient to achieve a pathway consis-
tent with a medium chance of achieving the long-term target. GDP is above ref-
erence levels because decarbonisation reduces world oil prices and increases
investment. Employment is some 0.9% above reference levels by 2020 and pub-
lic finances are almost unaffected.
Keywords: climate change mitigation; green new deal; energy-environment-
economy (E3) modelling; post-2012 policies; World Energy Outlook
1. A new economics approach to climate change mitigation
1.1. Introduction
This paper explores the effects on the global economy of climate policies designed
to achieve interim targets for GHG mitigation implied by the long-term target
agreed in the Copenhagen Accord, 2009, and confirmed in the Cancun Agree-
ments, 2010. The approach to policy analysis is Post Keynesian in that the fiscal
stimulus from investment to mitigate climate change is allowed to reduce unem-
ployment in both the short and long runs. The approach and modelling adopts the
following features that are emerging in the ‘new economics’literature: a rejection
of general equilibrium as a condition for modelling economic systems, economic
*Corresponding author. Email: tsb1@cam.ac.uk
International Review of Applied Economics
Vol. 26, No. 2, March 2012, 205–221
ISSN 0269-2171 print/ISSN 1465-3486 online
Ó2011 Taylor & Francis
http://dx.doi.org/10.1080/02692171.2011.631901
http://www.tandfonline.com
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growth which is demand-led and supply constrained, and simulation of economies
as they develop in their historical and geographical institutional contexts. The stim-
ulus packages implemented by governments in 2009 and 2010 following the onset
of the Great Recession are the starting points for a wider and longer programme
of investment to decarbonise the global economy. We use a global ‘new econom-
ics’, Post Keynesian model with estimated energy demand equations to suggest
how policy portfolios and strategies can be developed to generate ‘green growth’
while simultaneously reducing greenhouse gas emissions at the rates deemed nec-
essary to achieve the climate targets. The focus of the paper is on the initial phase
of the decarbonisation of the global economy, i.e. the effects of long-term policies
on outcomes to 2020. One reason is that 2020 has become important for such pol-
icies, as the target year chosen for the reductions in GHG emissions and carbon
intensity of economies in the Cancun Agreement. Another reason is that the period
is one of recovery after the Great Recession. The need for fiscal stimulus gives the
opportunity to re-orientate economies towards green growth at low cost or even
with benefit.
1.2. The new economics approach
In the literature, much of the macroeconomic analysis of policies for climate change
mitigation (IPCC 2007) has been undertaken with traditional approaches to under-
standing the economy. Typically long-run growth has been assumed to be deter-
mined from the supply-side with economies in full-employment equilibrium. The
growth rates then depend on those of labour supply and exogenous technological
change. There is no allowance for demand-side effects or the possibility of unem-
ployment being lower in the long term. The models have assumed representative
agents, with no room for a variety of responses.
In this paper we approach the economics of climate change mitigation using the
new economics outlined by Barker (2008, 2011) and represented in E3MG, an
Energy-Environment-Economy Model at the Global level (Barker et al. 2006;
Barker and Scrieciu 2010).
1
A brief summary of the approach is given here.
In contrast with traditional models, economic growth is demand-driven and supply-
constrained, with no assumption of the economy being in full-employment equilib-
rium. The world economy is treated as an open system of interacting economies
with different levels of unemployment and financial imbalances. In order to imple-
ment the institutional aspect of new economics, namely that economic activity is
highly specific to location and timing, the model is disaggregated into 20 world
regions and 41 industrial sectors in each region. Although there are regional macro-
economic variables derived by aggregation, such as GDP, and global variables, such
as the world oil price, many economic activities, such as output, investment,
employment, exports and imports, and associated prices, are treated at the industrial
or product level. The assumption is that each industry has its own institutional rules
and procedures. The model is further disaggregated in its treatment of consumers’
and government expenditures, in energy demand and supply, and in emissions of
pollutants into the atmosphere.
A crucial Post Keynesian feature of the model is that it represents observed
behaviour. It is a simulation econometric model based on annual data from
1970–2006 and input–output data for the year 2000. The economic data are
organized around the Social Accounting Matrix with supply-demand balances for
206 T. Barker et al.
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20 regions and 41 products. The model includes 22 sets of stochastic equations
estimated with short- and long-term components by instrumental variables for
aggregate consumption, consumers’expenditure shares, investment, employment,
exports, imports, prices and wage rates, energy demands, fuel shares, and labour
participation rates. Population, exchange rates and interest rates, government
spending, tax and other fiscal policies, and the availability of natural resources
are taken as exogenous. E3MG is a non-equilibrium model with an open struc-
ture such that labour, foreign exchange and public financial markets are not
necessarily closed.
In this approach, fiscal policy is paramount in managing the economy, with
monetary policy responsible for maintaining financial stability, interest rates and
exchange rates. In the modelling, industrial output is determined as the sum of
intermediate demands from other industries and the final demands of households,
government, investment and net international trade. Employment is derived from
output, allowing for varying returns to scale across industries and over time. The
estimated equations show that, in the long run, employment rises less than output
in most industries, i.e. there are economies of scale and specialisation. Employment
can increase through changes in industrial structure with economic growth, so that
employment-intensive sectors such as health and education increase relative to man-
ufacturing or through fiscal policy changing the level or structure of demand over
time. Unemployment is the difference between employment and participation in the
working population. Participation in turn depends on the level of unemployment
(the ‘discouraged worker effect’with higher unemployment). There is an extensive
dynamic treatment of prices, wages and costs and the effect of changes in relative
prices on the real economy, making the model much more complex than the Leon-
tief input–output model. Prices depend on unit costs, expected world inflation repre-
sented by world oil prices, and the ratio of actual to expected output, with
exchange rates, taxes and subsidies affecting costs. The industrial wage equations
for each sector are based on a theory of real wage bargaining, allowing for levels
of unemployment, consumer price inflation and wage rates in other sectors and
other countries. Since the equations are estimated from historical data for each
sector in each region, the prices and wage rates vary by sector as to how much
costs are passed on to prices.
The model is based upon a Post Keynesian economic view of the long-run. In
other words, in modelling long-run economic growth and technological change we
have adopted the ‘history’approach of cumulative causation and demand-led
growth (Kaldor 1957, 1972, 1985; Setterfield 2002), focusing on gross investment
(Scott 1989) and trade, and incorporating technological progress in gross investment
enhanced by R&D expenditures. Other Post Keynesian features of the model (see
Holt 2007, for a discussion of such features) include: varying returns to scale (that
are derived from estimation), non-equilibrium, not assuming full employment, vary-
ing degrees of competition, and the feature that industries act as social groups and
not as a group of individual firms (i.e. no optimisation is assumed but bounded
rationality is implied). The grouping of countries and regions has been based on
political criteria, the main one being the division into Annex 1 regions and others.
At the global level, accounting conventions are imposed so that the expenditure
components of GDP add up to total GDP and total exports equal total imports at a
sectoral level allowing for imbalances in the data.
International Review of Applied Economics 207
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2. Climate change mitigation after the Great Recession
2.1. Proposals for a ‘Green New Deal’
As the financial crisis of 2008 progressed and governments responded by consider-
ing Keynesian reflationary policies to prevent economic collapse, a literature devel-
oped in proposing a ‘Green New Deal’for the recovery packages. The first
proposal was by a group largely consisting of UK environmental policy activists
and published by the New Economics Foundation (2008). The group examined the
emerging financial, energy and climate crises and proposed a coherent set of poli-
cies, aimed at UK policy makers, to solve them. A less ambitious set of proposals
was aimed at US policymakers by Pollin et al. (2008). As the financial crisis deep-
ened with the bankruptcy of the Lehman bank in September 2008 and the subse-
quent fall in world trade and output, the need for coordinated global action
became apparent. Proposals for a green stimulus package were formulated in the
period leading to the London G20 summit in April 2009 (Barbier 2009; UNEP
2009a; Edenhofer and Stern 2009; Bowen at al. 2009). Barbier’s (2009) report was
commissioned by the UN Environment Programme (UNEP) and called for 1% of
GDP in the stimulus packages to be used for green investments in low-carbon
electricity supply, energy efficiency, transport and water infrastructure. The poten-
tial for an alternative greener economy to reduce the effects of high oil prices on
oil-importing economies was explored by Pollitt and Junankar (2009). The UNEP
has followed up the first proposal in a later report (UNEP 2009b) involving green
investments of 2% of global GDP (UNEP 2011), and Barbier went on to consoli-
date his work into a review of progress (Barbier 2010a) and a book (Barbier
2010b).
2.2. Policies to restore the global economy to sustainable growth
Many governments recognised the benefits of combining economic recovery with
improvements to the environment. The overall green stimulus announced in 2009
was some $436 billion out of $2796billion (Edenhofer and Stern 2009), but these
totals are of direct government spending spread over two or more years (2009–
2010 for China, over ten years for the US) so the annual amounts will be half or
less. They also cover a wide range of environmental policies as well as climate
change mitigation. Much of the spending is on energy efficiency improvements, but
without a carbon price there may be substantial rebound effects, maybe as high as
50% (Barker, Dagoumas, and Rubin 2009). The rebound comes as the users of
energy take some of the benefits of the increased efficiency in the form of more
energy services, such as more comfort or more travel, so offsetting the hoped-for
reduction in energy use and hence greenhouse gas emissions. This rebound effect
seems likely to be stronger in developing countries, where consumption of energy
in the home is well below saturation levels.
The scale of the green spending compares with the target of 1% of GDP for the
low-carbon economy and sustainable transport called for by the UNEP report
(Barbier 2009). This translates to some $656 billion pa globally, $138 billion for the
US, $144 billion for the EU and $71 billion for China, using 2007 estimates of
global GDP. The estimated spend by China of $110 billion a year over 2009–2010
is well above the 1%, but the other estimates, at least for the major economies, fall
far short of the 1% target.
208 T. Barker et al.
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2.3. Economic recovery and climate change mitigation following the Great
Recession
The collapse of the global investment banks led to reductions in lending and hence
industrial output, trade, personal incomes and household expenditures, and then in
turn to reductions in energy use and in greenhouse gas emissions. However, the
global levels of CO
2
emissions from energy use were almost unchanged from 2008
to 2009 (US EIA 2010) because the reductions in the USA and other economies
leading the recession were offset by increases in China and other developing coun-
tries. China had already become the largest country emitter of CO
2
in 2007. The
Great Recession led to USA emissions falling by 7.0% in 2009, but the recovery
led to China’s emissions rising by 13.3% in 2009 (US EIA 2010).
The long-term effect of the crisis has been to accelerate the shift of production
and emissions to developing countries, especially China, so that it has become even
more obvious that policies for decarbonisation must be adopted worldwide for cli-
mate change targets to be achieved. There is recognition of the importance for
China of reducing polluting emissions in the official announcements of the Twelfth
5-year Plan, 2010–2015, adopted in 2011, which aims to raise non-fossil sources to
20% of total energy by 2015.
The overall picture is that greenhouse gas emissions have resumed an upward
trend after the recession and that, without further substantial action to promote a
long-term green recovery, the targets of the Copenhagen Accord of 2009 and the
Cancun Agreement of December 2010 will not be reached. Countries have made
commitments to reduce by 2020 their GHG emissions or the CO
2
-intensity of their
economies, but there remains a potential ‘emissions gap’between the reduction
required for the 2°C target and the likely outcome of these commitments.
2.4. Pathways to 2020 to reach climate targets
The United Nations Environment Programme has compiled an expert analysis of
this emissions gap (UNEP 2010). It is based on recent literature using Integrated
Assessment Models presenting GHG emissions over the twenty-first century (‘GHG
pathways’) to achieve the 2°C target by 2100. The timing of the emissions of the
different GHGs is important because each has its own characteristic lifetime in the
atmosphere and it is the accumulated concentrations of GHGs that affect global
warming. Some 27 pathways are covered, divided into those that give a medium
chance of achieving the target (50 to 66%) and those that give a likely chance (bet-
ter than 66%). Each of these sets of pathways is further divided into those that do
and do not assume substantial adoption of technologies that remove CO
2
from the
air so that net emissions from energy use and industrial processes are negative after
2060. The main such technology is combustion for electricity generation with bio-
mass and with capture and storage of the resulting CO
2
emissions. All imply a peak
of emissions between 2010 and 2020. Table 1 summarises the target levels for glo-
bal GHG emissions by 2020.
These global emissions are compared with the projections for 2020 estimated
without including the agreements reached in Cancun and with different combina-
tions of assumptions about the conditionality of the pledges to reduce emissions
and about how lenient or strict the unresolved accounting rules will be interpreted.
The conditionality comes from countries promising to take more stringent action
depending on the actions of other countries. The accounting rules relate to the
International Review of Applied Economics 209
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treatment of surplus credits under the Kyoto Protocol and of emissions from land
use and land use change (LULUC) in Annex 1 countries (UNEP 2010, 33–36 gives
more details). The outcomes under the different assumptions are summarised from
nine studies in Table 2. It is clear from the median results that even the higher
reductions from conditional pledges and strict rules imply an emission gap when
compared with the emissions for 2020 for the 2°C target from Table 1. The gap is
some 4 to 8 GtCO
2
-eq for the medium chance of achieving the target.
The UNEP report does not assess the policies and measures that may be
required to close the emissions gap. This paper uses a modelling approach,
described in the next section, to assess the policies and measures proposed by the
International Energy Agency (IEA) in its World Energy Outlook 2010 (IEA WEO
2010) as an interpretation of what is needed to put world GHG emissions by 2020
on a pathway to achieve the long-term climate targets, although the IEA has chosen
2150 as the date for eventual stabilisation rather than the 2100, which we have
chosen for our 2°C target scenario described below.
3. Modelling the effects of climate policies
The effects of climate policies are investigated here using the model described in
Section 1.2 above, E3MG, a sectoral dynamic macroeconomic model of the global
Table 1. Target GHG emissions levels for 2020 from integrated assessment models.
2°C pathways Number of
Pathways
2020 total emission levels (GtCO
2-
eq)
Median 20th–80th percentile range
‘Likely’chance (greater than 66%) of staying below 2°C during twenty-first century
Without negative CO
2
emissions
from energy and industry
231 28to34
With negative CO
2
emissions
from energy and industry
744 44to44
‘Medium’chance (50 to 66%) of staying below 2°C during twenty-first century
Without negative CO
2
emissions
from energy and industry
944 42to45
With negative CO
2
emissions from
energy and industry
945 42to46
Source: UNEP (2010, 29)
Table 2. Ranges of agreed GHG emissions levels for 2020 from Copenhagen Accord from
nine studies.
Pledges Accounting rules
2020 total emission levels (GtCO
2-
eq)
Median 20th–80th percentile range
None (business as usual) none 55.5 54.3 to 59.9
Unconditional lenient 53.0 51.8 to 57.1
Unconditional strict 51.9 50.3 to 55.1
Conditional lenient 51.4 48.8 to 53.0
Conditional strict 49.0 46.7 to 50.9
Source: UNEP (2010, 29).
210 T. Barker et al.
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economy, which has been designed to assess options for climate and energy policies
and to allow for energy-environment-economy (E3) interactions. It is organised
around production sectors, which enables a more accurate representation of the
effects of policies than is common in most macroeconomic modelling approaches.
In addition, the structure and underlying assumptions of E3MG, as described in
Section 1.2, differ from that of the more commonly applied Computable General
Equilibrium (CGE) approach, for example as represented in the GEM-E3 model
(Capros et al. 2010; Van Regemorter 2005). A comparison between approaches is
made in Jansen and Klaassen (2000). The model addresses the issues of energy
security and climate stabilisation both in the medium and long terms, with particular
emphasis on dynamics, uncertainty and the design and use of economic instruments,
such as emission allowance trading schemes. It is disaggregated, with 20 world
regions, 41 production sectors, 12 energy carriers, 19 energy users, 28 energy tech-
nologies and 14 atmospheric emissions, with comparable detail for the rest of the
real economy. The model also represents a novel long-term economic modelling
approach in the treatment of technological change, since it is based on cross-section
and time-series data analysis of the global system 1973–2006 (in the version used
for this paper) using formal econometric techniques, and thus provides a different
perspective on the costs of climate stabilisation compared with traditional equilib-
rium models.
Energy demand is derived from industrial output, consumers’income and trade,
as well as relative prices and technological progress. The fuels supplying the energy
are estimated by fuel share equations and the mix of fuels demanded is used to
change the input–output coefficients and consumer shares for fuel use. Technologi-
cal progress is measured by accumulated investment enhanced by R&D spending.
Prices and wage rates are dependent on unit labour and other input costs, tax, sub-
sidy and exchange rates and exchange rates and utilisation of capacity.
Earlier papers using the model have focused on the role of induced and acceler-
ated technological change in policies to decarbonise the global economy (Barker
et al. 2006) and on achieving very stringent targets for reducing GHG emissions in
the long run (Barker and Scrieciu 2010). For this paper, we focus on an investment
programme for decarbonisation over the years to 2020 designed to achieve the tar-
gets of GHG reduction agreed at the UNFCCC meeting in Cancun in 2010. A size-
able component of the investment is in low-carbon electricity capacity induced by a
variety of policies, which we have made exogenous, relying on WEO 2010 for the
estimates of the scale of energy saving and investment required. This capacity is
imposed within the energy technology model incorporated in E3MG. The imple-
mentation of different policies through time, such as incentives, regulation, and rev-
enue recycling allow low or non-carbon options to meet a larger part of global
energy demand. The model includes 28 representative energy technologies,
described by 21 technology characteristics, so the WEO estimates can be incorpo-
rated in some detail. The economy-wide effects are captured in E3MG through the
interactions between the different sectors in the model, without assuming that
resources are used at full economic efficiency.
An indication can be given of the properties of the model by calculating the fis-
cal multiplier, assuming that the extra investment spending is funded by govern-
ments. The global fiscal multiplier in E3MG is 1.6, i.e. GDP increases by 1.6 times
the amount of the increase in investment, assuming no response in interest rates or
exchange rates. This compares with the estimates from other models presented by
International Review of Applied Economics 211
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the IMF to the G20 London meeting of 0.5 to 1.8 for capital spending (Spilimbergo,
Symansky, and Schindler 2009). Within this range, estimates from global models
tend to be higher than those from national models, since at the global level all extra
imports become other country’s extra exports.
4. Description of climate mitigation policies and scenarios
4.1. Scenarios for decarbonisation and recovery and the Cancun Agreement
The modelling undertaken in this study required the specification of scenarios to
reflect the set of policies for GHG mitigation. The baseline or ‘current policies’sce-
nario is intended to represent the outcome for the global economy 2013–2020 of
adopting current policies, but without the extra efforts promised in the Cancun
Agreement
2
to reduce GHG emissions by 2020. This scenario is mainly based on
the IEA’s current policies scenario using our model to provide a fully dynamic solu-
tion over the period, with results calibrated to match those in (IEA WEO 2010).
This reference case is compared with two scenarios that include policies to increase
investment and reduce GHG emissions. The ‘Cancun scenario’includes the policies
for reducing GHG emissions assumed in the IEA’s 450 scenario (IEA WEO 2010),
which can be interpreted as the outcome of the Cancun Agreement at the high end
of the range of commitments to reduce emissions. The ‘2°C target scenario’
assumes a strengthening of these commitments to reach a level of emissions by
2020, which is 15% lower than those in the Cancun scenario. This further reduction
is required to give a medium (50 to 66%) chance of achieving climate stabilisation
at 2°C as summarised in Table 3. The higher level of investment is designed to
accelerate recovery towards full employment in those economies most affected by
the Great Recession. In both policy scenarios, the CDM (Clean Development Mech-
anism) plays a role in transferring funding to developing countries for climate
change mitigation.
The difference between the two policy scenarios and the baseline gives estimates
of the impact of these policies on the global economy. The policy cases include car-
bon prices introduced through an emission trading scheme in OECD countries,
extended to China in the Cancun scenario (see CCICED 2009, for a discussion of
policies for a low-carbon China). These schemes assume that all allowances are
freely allocated to industry and that the extra costs are passed on as higher final
product and electricity prices.
Within each scenario, the effects of the relevant policy measures are introduced
into the model on an annual basis. The assumptions used in the modelling for
carbon and oil prices are shown in Table 4. A critical feature of the baseline
scenario is that world oil prices rise substantially as a result of limited supplies in
the face of increasing demand. When world oil demand is reduced in the policy
scenarios, world oil prices rise at a slower rate, although still increasing by 55%
over 2010–2020 in real terms (compared with 88% in the baseline). Note that we
have assumed that OPEC restricts output to maintain the oil price when oil demand
falls below that of the Cancun scenario.
4.2. Additional investment and regulation
The required additional annual investment for the post-2012 period, 2013–2020, is
presented for 2020 in Table 5, based on the IEA’s 450 scenario (IEA WEO 2010,
212 T. Barker et al.
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Table 4. Carbon and oil prices in the modelling scenarios.
The Baseline Scenario assumptions 2005 2010 2015 2020
EU ETS allowance price (2009$/tCO
2
) 2722 2630
OECD (excl. EU) ETS allowance price (2009$/tCO
2
)0000
Crude oil price (2009$/bbl) 54 75 108 141
The Cancun Scenario assumptions 2005 2010 2015 2020
EU ETS allowance price (2009$/tCO
2
) 2722 3145
OECD (excl. EU) ETS allowance price (2009$/tCO
2
)002045
Crude oil price (2009$/bbl) 54 75 101 116
The 2°C Target Scenario 2005 2010 2015 2020
EU ETS allowance price (2009$/tCO
2
) 2722 3145
OECD (excl. EU) and China ETS allowance price (2009$/tCO
2
)0 0 2045
Crude oil price (2009$/bbl) assumption 54 75 101 116
Sources: IEA WEO (2010) and E3MG.
Table 3. Some details of the E3MG scenarios.
E3MG Scenario Baseline Cancun scenario 2°C target scenario
Description Current policies 450ppmv CO
2
-eq
by 2150
medium chance (50
to 66%) of reaching
2°C target in 21st C
Source WEO 2010 WEO 2010 this paper
Emissions Trading
Scheme
EU only from 2005 EU from 2005 EU from 2005
Other OECD from
2013
Other OECD from
2013
China from 2013
Carbon price 2020
(2009$/tCO
2
)
30 45 45
Annual additional
investment into
low-carbon
technologies
2013–2020 (2009
$bn pa)
n/a 395 474
Other policies No new climate
change mitigation and
energy policies in
addition to those
formally adopted by
mid-2010
Removal of fossil
fuel subsidies in
net-oil-importers by
2020
Removal of fossil
fuel subsidies in net-
oil-importers by
2020
Clean Development
Mechanism used to
fund extra investment
in least developed
countries
Clean Development
Mechanism used to
fund extra investment
in least developed
countries
International Review of Applied Economics 213
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Figures 13.14 and 13.15, p. 401). The scale of the additional investment is some
0.6% of world GDP. The investment is assumed for every year from 2013–2020
and is related to the various policies and measures assumed for the different
countries and regions. The investment is associated with additional regulation
requiring gradually more stringent standards for lower carbon intensity in power
generation, buildings and vehicles. The investment is assumed to be funded by
increases in the price of electricity or the costs of buildings and vehicles. For the
2°C target scenario, the investment numbers are 20% higher at about $500 billion
(2009 prices) or 0.7% of world GDP in 2013. This additional investment is funded
through increases in the prices of electricity and the costs of buildings and vehicles.
5. Results
5.1. The reference case
The growth rates for five key indicators in the baseline are shown in Table 6. As
described in the previous section, these are produced using the E3MG model and
are calibrated to be broadly consistent with the current policies case in the IEA’s
publication (IEA WEO 2010), also taking into account the most recent data. The
figures take into account the impact of the economic crisis.
Table 5. Projected annual global additional investment costs by 2020 for the Cancun
scenario (billion 2009US$).
Power generation Industry Transport Buildings Biofuels Total
United States 0.0 6.8 24.8 27.4 2.3 61.3
European Union 24.1 7.5 33.2 19.9 3.1 87.7
Japan 4.4 3.9 12.4 9.0 0.1 29.8
Other OECD+ 2.9 4.8 14.8 12.4 1.0 36.0
Russia 0.0 0.8 4.6 2.6 0.1 8.1
China 18.9 9.4 24.6 23.0 0.3 76.2
India 2.4 1.7 10.3 4.6 0.1 19.0
Middle East 3.3 4.3 6.1 7.7 0.6 22.0
Other non-OECD 1.2 8.8 28.5 14.1 1.9 54.5
World 57.2 47.9 159.4 120.7 9.4 394.6
Source: IEA WEO (2010)
Note: the additional investment is included each year 2013–2020 at about 0.6% of global GDP and the
table shows the 2020 values.
Table 6. Average annual world growth of key macroeconomic variables, baseline, % pa.
2000–2010 2010–2015 2015–2020
CO
2
Emissions 1.4 2.5 3.6
Final Energy Demand 1.9 1.5 1.7
GDP 2.4 3.6 2.9
Price index consumers’expenditure 3.3 2.6 2.5
Employment 1.0 1.2 1.1
Source: E3MG 2.4, 4CMR, Cambridge Econometrics, IEA.
Note: The projections are not forecasts. The significant figures given in this and later tables should not
be taken to indicate reliability.
214 T. Barker et al.
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5.2. Results from the Cancun and 2°C target scenarios
Figure 1 shows the percentage difference from the reference case of global CO
2
emissions in the scenarios. The chart shows global energy-related CO
2
emissions to
be 10% and 15% lower, for the Cancun and 2°C target scenarios respectively,
compared with the baseline in 2020. Energy demand, measured as final energy con-
sumption, falls by a similar amount. These reductions represent the combined effect
of the large investment programmes and carbon pricing (including removal of exist-
ing subsidies) in the scenarios. On the other hand, the lower global energy prices
encourage higher levels of consumption and emissions. The estimated effect is to
reduce global GHG emissions from 52 GtCO
2
-eq in the reference case to 47
GtCO
2
-eq in the Cancun scenario. Strengthened policies are required to reach 45
GtCO
2
-eq to give a medium chance of achieving the 2°C target over the 21st cen-
tury (Table 1).
Figure 2 shows the impact of the measures on global GDP, as a percentage dif-
ference from the reference case (i.e. comparing the results including climate policy
to those based on current policy).
The results show that the economic impacts are generally small but positive,
with the effects increasing over time. This is due to (1) large increases in invest-
ment in new technologies, (2) induced technological change arising from the trading
scheme leading to additional investment in the electricity sector and (3) the assumed
lower world oil prices in the policy scenarios meaning that the wealth flowing to
oil-producing countries is reduced (as these countries have higher savings rates,
reducing the transfer has a net positive effect on the global economy). The effect of
the additional investment alone is that world GDP is about 0.9% higher by 2020.
The technological change induced by the higher carbon price leads to lower
investment prices and higher investment in the model results as described in Barker
Figure 1. World CO
2
emissions, percentage difference from reference case.
Sources: E3MG, Cambridge Econometrics.
International Review of Applied Economics 215
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et al. (2008). The effect of decarbonisation on world oil prices, point (3) above, is
sufficient in itself according to our modelling to increase world GDP by 1.2% by
2020. This effect is also observed in the IMF general-equilibrium modelling of
higher oil prices on GDP (IMF 2011, chapter 3), although not as pronounced. These
positive effects are enough to counter the costs associated with higher energy prices
(e.g. through carbon pricing) and the costs associated with the investment.
Perhaps unexpectedly, overall price levels are below baseline in both the Cancun
and 2°C target scenarios, with the world rate of consumer price inflation being
some 2.5% pa in the baseline reduced to 2.2% pa in the scenarios. This is despite
the very large investment costs and higher carbon prices, and is due to the lower
world oil price assumptions (see Table 4) which outweigh the inflationary effects
from such policies. In essence, production is moving away from tight oil supplies,
reducing inflationary pressures in the world oil market and towards construction,
where unemployed resources are available without increasing prices, and low-GHG
equipment, such as wind turbines and solar panels, produced under increasing
returns to scale. One important reason for this shift is the composition of the poli-
cies and measures. The price policies are based on emissions trading, which is
restricted mainly to electricity production. There is no increase in taxation on trans-
port assumed for major economies. The energy-saving regulations have more rela-
tive effect on transport, so that oil demand falls below baseline. The reduction in
oil demand then reduces the inflation in world oil prices, offsetting some of the
effects of the regulations on increased efficiency of vehicles. The lower oil-price
inflation acts directly on unit costs and indirectly as an expectations signal in the
model, reducing inflation in many sectors. Although the prices of the energy sector
rise, apart from transport, those of other sectors fall because increases in aggregate
demand can be accommodated without increases in unit labour costs in the
conditions of unemployment persisting through the period.
Figure 2. World GDP, percentage difference from reference case.
Sources: E3MG, Cambridge Econometrics.
216 T. Barker et al.
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Overall, there is a 2.5% reduction below baseline on average in world prices by
2020, although it is noted that electricity prices increase. Although these effects are
quite small when spread across the whole period up to 2020, they could have a
particular impact on low-income groups (which typically spend a larger share of
income on energy for heating); this could be positive or negative and should be
assessed further.
Employment is also expected to increase in the scenarios. There are two reasons
for this:
a general increase in economic activity creates additional jobs
a shift in relative prices means that labour replaces energy as an input to
production.
Unemployment is lower as a result.
In terms of the main components of GDP, the scenarios represent a shift from
household expenditure to long-term investment (the global trade balance is by defi-
nition unchanged, and we assume that government consumption does not change).
Table 7 (see below) shows the impacts on GDP in three broad regional groupings;
each group benefits overall, although the largest changes are seen in OECD+. The
reason this group of countries benefits the most is that most of its economies do
not rely on fossil fuel production for a substantial contribution to output.
Generally, the sectors that benefit are those that produce investment goods
(construction, engineering, metal goods), mainly at the expense of energy sectors
(i.e. there is a shift from energy to capital as inputs to production). The pattern in
employment is similar, although it should be noted that the investment sectors are
much larger employers than the energy-extraction and processing industries.
The countries that benefit will therefore be the ones that specialise in producing
investment goods while the ones that lose out will be those that export energy
goods. For example, under current production patterns, Germany is one of the main
beneficiaries in the scenarios, while OPEC sees a net reduction in GDP due to
lower global consumption of oil at lower prices.
Table 7. CO
2
and macroeconomic variables as % difference from the baseline by 2020.
Scenario OECD+
Other major
economies
*
Other
countries World
CO
2
emissions (%) Cancun 10.0 8.8 17.0 10.8
CO
2
emissions (%) 2°C target 12.5 16.4 17.4 15.6
Final Energy Demand (%) Cancun 9.1 9.9 28.3 13.2
Final Energy Demand (%) 2°C target 10.0 21.4 29.1 18.3
GDP (%) Cancun 2.4 0.5 2.0 2.0
GDP (%) 2°C target 2.5 0.2 2.0 2.0
Price index consumers’
expenditure (%)
Cancun 2.9 1.2 2.8 2.8
Price index consumers’
expenditure (%)
2°C target 2.8 1.0 2.4 2.7
Employment (%) Cancun 0.9 0.8 0.9 0.8
Employment (%) 2°C target 0.9 0.9 0.9 0.9
Notes: OECD+: all OECD and non-OECD EU countries.
*Other major economies: Brazil, China, the Middle East, Russia but not South Africa. This is because
South Africa falls under the ‘rest of world’region within E3MG.
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In the 2°C target scenario, the economic outcomes are not markedly different
from those for the Cancun scenario. GDP is slightly lower for China than in the
Cancun scenario as China faces higher domestic prices from introducing an emis-
sion trading scheme without recycling the possible revenues from auctioned allow-
ances. This smaller impact can be seen in Table 7 in the GDP results for Other
Major Economies, which includes China. GDP in other regions benefits slightly
from higher investment in the 2°C target scenario. Despite world GDP being
unchanged, employment impacts are more positive in the 2°C target scenario than
the Cancun scenario due to further increasing demand for biofuel-products, which
are more labour intensive than the traditional fossil fuels extraction.
The effect of the climate policies on government financial balances is mixed,
with several competing factors. Impacts that might reduce levels of government
debt include:
cutting of fuel subsidies
a general increase in economic activity and employment, boosting tax
receipts.
However, there are some impacts that may lead to an increase in government defi-
cits:
loss of revenue from fuel excise duties
loss of revenue from energy extraction (e.g. in OPEC).
In the post-crisis world, much attention is being paid to government balances, with
austerity plans now in place across much of Europe, and the Republicans in the US
focusing on reducing the level of government debt. The complexity of national tax
systems (and links to national oil companies) means it is difficult to produce a
robust estimate of the impacts of the policies on government balances. Table 8
gives a rough estimate; the figures take into account the removal of subsidies and
loss of earnings from excise duties, but also the indirect effects on the main direct
taxes, social contributions and VAT revenues. It is assumed in the scenarios that
government consumption and social transfers are unchanged in real terms beyond
the reductions due to loss of earnings at state oil companies.
Table 8. Effects of policy scenarios on government balances as difference from baseline.
Scenario OECD+
Other major
economies
*
Other
countries World
Government net revenues
($bn, nominal)
Cancun 57 131 19 207
Government net revenues
($bn, nominal)
2°C target 97 113 26 236
Government net revenues
(% GDP, nominal)
Cancun 0.10 0.59 0.11 0.22
Government net revenues
(% GDP, nominal)
2°C target 0.17 0.52 0.15 0.25
Notes: OECD+: all OECD and non-OECD EU countries.
*Other major economies: Brazil, China, the Middle East, Russia but not South Africa. This is because
South Africa falls under the ‘rest of world’region within E3MG.
218 T. Barker et al.
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Overall, the results from the E3MG model suggest that enacting a broad set of
climate policies could lead to a small improvement in government financial bal-
ances in the period up to 2020 (see Table 8), particularly in the Other major econo-
mies. In the OECD, the measures would lead to quite substantial reductions in
revenues from fuel excise duties (particularly in European countries where these
have high rates) but this is outweighed by higher receipts of income and corpora-
tion taxes and VAT, related to the higher rates of economic growth. In developing
countries there is also a positive effect via the removal of fuel subsidies, although
this is reduced by the lower oil revenues for the oil exporters. In the 2°C target
scenario, Other major economies have a slightly lower increase in net revenues as a
result of emission trading being introduced in China. These changes are shown
before any transfers of funds from OECD to developing countries to fund the
additional low-GHG investment projects.
6. Conclusions
This paper has adopted the conventional approach to modelling climate change mit-
igation by setting aside the primary benefit of reduced long-term impacts from glo-
bal warming and the co-benefits of reduced air pollution and the like. Instead, the
focus is on macroeconomic and GHG effects over the period to 2020 following the
Great Recession and subsequent high unemployment in OECD economies. We have
used a ‘new economics’model to assess the effects of the policies in the Cancun
scenario prepared for the G20 by the International Energy Agency (IEA WEO
2010).
Five conclusions can be drawn from this research.
(1) The IEA’s 450 scenario does not appear to be sufficiently strong to have a
reasonable chance of achieving the 2°C target over the twenty-first century.
We find that an extra 20% of the investment assumed by the IEA and an
emission trading scheme in China brought forward from 2021 to 2013 will
give a medium chance (50–66%) of achieving the target. Much stronger
policies will be needed to give a likely (greater than 66%) chance.
(2) Some form of carbon pricing is needed for economic efficiency and to offset
any rebound effect from energy efficiency policies alone. The rise in prices
for fossil-fuel electricity is critical in providing incentives for installation of
low-GHG technologies and saving of electricity by households and business.
(3) The reduction in oil prices following reduced demand for oil in the Cancun
policy scenario is an important contribution to the increased economic activ-
ity in oil-importing countries and as an offset to the effects from carbon price
increases and the removal of fossil-fuel subsidies.
(4) Additional employment from policies for decarbonisation is concentrated in
the construction, agriculture and forestry sectors, because manufacturing is
much less employment-intensive.
(5) There could be small but beneficial effects to the global economy from
implementing the policies designed to limit temperature change to 2°C, with
employment over 0.9% higher than the reference level by 2020. The effect is
excluded from traditional equilibrium models of policies dominating the liter-
ature, but evident with a demand-led approach to growth, which allows for
the additional investment to utilise resources that would otherwise be unem-
International Review of Applied Economics 219
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ployed. Not unexpectedly, there are both winners and losers in the scenarios.
In particular, sectors and countries that specialise in the production of invest-
ment goods stand to benefit, while energy sectors and the OPEC members
would lose out from reduced demand for energy.
Acknowledgement
The support of the Three Guineas Trust, one of the Sainsbury Family Trusts, is gratefully
acknowledged in funding this work.
Notes
1. This section gives a very brief description of the model. Further details are in http://
sites.google.com/site/4cmrhome/home/our-research/e3mg and http://www.e3mgmodel.
com.
2. http://cancun.unfccc.int/.
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