On the Effect of Greenhouse Gas Abatement in Japanese Economy: an Overlapping Generations Approach

1. On the Effect of Greenhouse Gas Abatement in Japanese Economy: an Overlapping Generations Approach Shimasawa Manabu Akita University March 2006

2. Slide2 Background • Goal of the project: the model analysis using Japanese NAMEA. • Key future in this paper: multi-sector, life-cycle agents. • Focus is on intergenerational equity of the greenhouse gas abatement policy.

3. Slide3 Background • The policy aimed at mitigating the problems of climate change has very long time horizon. • The greenhouse gas emission abatement policy has twofold aspects: - (i) the effects to present various industries and macro economy - (ii) the intergenerational equity problem

4. Slide4 Background • In Japan many researchers used simulation model in order to quantify the effect of greenhouse gas abatement policy. - MARIA (Prof.Mori Tokyo university of Science) - AIM model (NIES) - GAMES (Prof.Goto Univ. of Tokyo ) • But they focused only one aspect, i.e., “the effects to present various industries and macro economy .”

5. Slide5 Background • This paper presents a multi-sector overlapping generations (OLG) model that captures important characteristics of Japanese economy and industrial structure in order to explore the intergenerational effects of the CO2 emissions abatement policy.

6. Slide6 Background • A number of papers written after the seminal study by Auerbach and Kotlikoff (1987) have examined the impacts of policy changes on the intergenerational equity by using computable general equilibrium models with the overlapping generations. - Now, A-K type OLG model has been typical tool in order to investigate the impacts of policy changes on intergenerational redistribution.

7. Slide7 Background • Why we use NOT infinitely-lived agent (ILA) model BUT overlapping generations (OLG) model ? • We believe that the OLG framework has several advantages compared to the ILA model from the following reasons.

8. Slide8 Why OLG? - (i) to investigate distributional effects between generations of greenhouse gas abatement . - (ii) Schelling (1995) pointed out that using the ILA model in the context of environmental problems involves a fallacy of composition on the intergenerational fairness.

9. Slide9 Structure of Presentation • Background to Project and this paper • Overview of the Model • Simulation Analysis • Comparative Analysis • Main Conclusions

10. Slide10 The Model • We use Rasmussen Model(2003) with Japanese SAM. • The model assumes - overlapping generations - perfect foresight households - eight sectors and nine goods - benchmark year 2000

11. Slide11 The Model - calibrated to a 2000 SAM describing the Japanese economy - perfect competition - no uncertainty - infinite supply & demand elasticities for exports and imports to and from the world market

12. Slide12 The Model - endogenous labor supply - The effects of greenhouse gas reduction are evaluated by considering the effects of an emissions tax that limits CO2 emissions by an amount roughly conforming to that required by the Kyoto protocol Tobias N. Rasmussen (2003) “Modeling the economics of greenhouse gas abatement: An overlapping generations perspective” Review of Economic Dynamics

13. Slide13 The Model • 8 sectors (1) Iron and Steel (2) Chemical products (3) Petroleum refining & coal prod. (4) Electric utilities (5) Gas utilities (6) Energy intensive industries (7) Other manufacturing industries (8) Other industries

14. Slide14 The Model • 9 goods (1) Iron and Steel (2) Chemical products (3) Petroleum refining & coal prod. (4) Electric utilities (5) Gas utilities (6) Energy intensive industries (7) Other manufacturing industries (8) Other industries (9) Non-comp imports

15. Slide15 The Model • Production - production activities are modeled by the nested constant elasticity of substitution (CES) and Leontief functions

16. Slide16 The Model • Each sector produces multiple goods and all goods are traded on the world market. • Armington specification is adopted to account for the simultaneous presence of imports and exports. • Energy enters production and final demand in the form of a composite of the 5 energy goods.

17. Slide17 The Model • Output in non-fossil-fuel production sector Tobias N. Rasmussen (2003) “Modeling the economics of greenhouse gas abatement: An overlapping generations perspective” Review of Economic Dynamics

18. Slide18 The Model • Output in fossil-fuel production sector Tobias N. Rasmussen (2003) “Modeling the economics of greenhouse gas abatement: An overlapping generations perspective” Review of Economic Dynamics

19. Slide19 The Model • Commodity trade Tobias N. Rasmussen (2003) “Modeling the economics of greenhouse gas abatement: An overlapping generations perspective” Review of Economic Dynamics

20. Slide20 The Model • Energy for production and final demand Tobias N. Rasmussen (2003) “Modeling the economics of greenhouse gas abatement: An overlapping generations perspective” Review of Economic Dynamics

21. Slide21 The Model • Household - each generation enters the model (at age 20) and die (at age 80) at the end of year g + N (N=59). - each generation chooses consumption and leisure to maximize his/her intertemporal utility.

22. Slide22 The Model c: consumption, ll: leisure, ρ: discount rate, ε: the inverse of intertemporal elasticity of substitution, φ: weight on consumption, σ: the inverse of the elasticity of substitution between consumption and leisure, e: age-related productivity profile, ω: time endowment in efficiency units, pC: the price index for composite goods, transfer: a lump sum transfer.

23. Slide23 The Model • Household demand structure Tobias N. Rasmussen (2003) “Modeling the economics of greenhouse gas abatement: An overlapping generations perspective” Review of Economic Dynamics

24. Slide24 The Model • Model Closure - (i) Trade balance X: export, M: import, CAS: current account surplus at bench year, γ: effective growth rate

25. Slide25 The Model • (ii) government budget balance τL: labor tax, L: aggregate labor, τK: interest rate tax, r: interest rate, K: aggregate capital stock, τhK: commodity tax in sector h, phK: output prices in sector h,Yh: output in sector h, τjM: import tax of goods j, pjF: import prices of goods j,G2000: government expenditure level at bench year, GDEF2000: government deficit level at bench year.

26. Slide26 The Model • Dynamic Equilibrium Condition YR: capital income at bench year, δ: depression rate, I: investment expenditure at bench year.

27. Slide27 Simulation • CO2 emission

28. Slide28 Simulation • Tax on CO2 emission (thousand yen/metric ton of carbon)

29. Slide29 Simulation • Consumption level (% change from baseline)

30. Slide30 Simulation • Equivalent variation by generations (% change from baseline)

31. Slide31 ILA model

32. Slide32 Comparative Analysis • Consumption level (% change from baseline)

33. Slide33 Comparative Analysis • Equivalent variation by generations (% change from baseline)

34. Slide34 Main Conclusions • The cost of greenhouse gas emission abatement policy is distributed between generations unequally; small for current generations, large for future generations. • - in the OLG setup, each generation maximizes ONLY his/her own utility, NOT his/her descendants’. - the reduction cost of CO2 abatement would rise rapidly, because we need to consume more fossil fuel in the process economy evolve under the constant technical level.