1 Modeling the Economic System and the Environment: An Overview on Different Approaches and a Presentation of the RICE96 Model Francesco Bosello Trieste 20 May 2003

2 A bit of historical perspective Beginning of 70s first economic-environmental models, mainly defining the amount of GHGs produced by the economic system. Small number of parameters, defined according to expert quantitative and qualitative assessments Toronto Climate Conference stated the need to reduce GHGs emissions the 20% respect to 1988 levels. Boom of economic-environmental modeling trying to assess costs and feasibility of the policy. (I/O, CGE, Macro-econometric models). Still no representation of the environmental system. Beginning of 90s Integrated Assessment Models (IAMs) trying to balance environmental and economic part (simplified representation of the functioning of the environmental system added). Present trend: large models trying to melt Global Circulation Models, environmental impact models and economic models.

3 Environmental system Socio-Economic System Climate change and variability Extreme events Air, Water, Land quality and availability Sea level rise Envir. impacts Changes in emissions and land cover Changes in Water, Land, Air, Capital, Labour stock and productivity Change in Production and consumption patterns Econ. impacts Vulnerability Policies Mitigation Adaptation Envir. pressures Econ. pressures

4 Issues in environmental-economic modelling Uncertainty Irreversibility: Non linearity and discontinuity in environmental phenomena (e.g. bio-diversity loss) and in economic phenomena (investments with high sunk cost and long payback periods). Technical progress: determines the damage that the economic system causes to the environment and the capacity to sustain and correct the damage identify and model determinants TC. International dimension (geographical scale): Transboundary phenomena due to environmental (e.g. global warming, acid rains) and economic (trade mechanisms and factor mobility) characteristics leakage + free riding. Welfare: Measuring utility, discounting, time scale.

5 Some criteria for classification Integrated Assessment Models

6 Integrated Assessment (IA) IA is a process aimed at combining, interpreting and communicating knowledge from diverse scientific fields in order to tackle an environmental problem comprehensively by stressing its cause-effect links in their entirety. Any economic model with one (or more) environmental module is called “Integrated”. It is possible to distinguish: Soft-links vs. Hard-link models. Optimisation model (best i.e. welfare or utility maximising or cost minimising strategies) vs. policy evaluation model (if-then analysis). Recent trend: different complex modules working in integration.

7 The RICE Model Basic version: RICE96 (Nordhaus and Yang, American Economic Review, (1996)); Previous version DICE (‘91), updates RICE98, (Nordhaus and Boyer, 1999), RICE99 (Nordhaus and Boyer, 2000). One of the most popular IAMs in circulation: Well documented. Free access to the code. Widely used (see e.g. Manne, 1996; Gjerde et al., 1998; Heykmans and Tulkens, 1998; Bosello, Buchner, Carraro Raggi, 2001). Relative simplicity (model core 12 equations).

8 Model features (1) Fully Integrated Assessment Model - two-way relationship economic-environmental system modelled via interaction of an economic block with an environmental block - (production produces emissions increasing temperature, temperature decrease production through environmental damages) World divided in 6 macro regions (USA, Japan, Europe, China, Former Soviet Union and Rest of the World). Intertemporal optimisation model (suitable for optimisation and policy optimisation exercises): a planner maximises discounted utility derived from consumption deciding how much to invest and how much to abate. Strategic interactions among players can be modelled (co- operation vs. non co-operative or partially co-operative solutions can be analysed).

9 Model features (2) Production function combines capital and labour to produce output. Green technical progress (lowering the emission intensity per unit of output), technical progress (increasing the amount of output per unit of inputs) and labour force evolution are exogenous. Environmental part converting emission in temperature increase is governed by a reduced form of the Schneider- Thompson climate model.

10 RICE Economic Block Constraint: law of motion of capital Potential Production Link: from potential production to net production Net Production: considers costs and benefits of climate control Allocation of output Emissions: link with the envir. part Objective function

11 Calculating Temperature RICE96 ENVIRONMENTAL BLOCK Evolution of CO2 stock: M(T+1) = 590+ATRET*SUM(N,E(N,T))+(1-DELTAM)*(M(T)-590); Radiative forcing: FORC(T) = 4.1*(LOG(M(T)/590)/LOG(2))+FORCOTH(T); Evolution of Atmospheric Temperature: TE(T+1) = TE(T)+C1*(FORC(T)-LAM*TE(T)-C3*(TE(T)-TL(T))); Evolution of Oceanic Temperature: TL(T+1) = TL(T)+C4*(TE(T)-TL(T)); Exogenous Component Of Radiative Forcing: FORCOTH(T) = (0.85/10)*(T-1); Notes ATRET: Atmospheric Retention M(T):Co2 concentration LAM: climate feedback factor DELTAM: removal rate of carbon C1,C3, C4: Feedback factors ocean atmosphere

12 Major shortcomings No international trade: the only link among regions is the climate externality. No sectoral disaggregation (one sector/one good model). Technical progress is exogenous (FEEM developed a version with endogenous - R&D driven - technological progress). The equilibrium is “open loop”, not possible for agents to revise their strategies. Naive climate representation (only global mean temperature considered).