Chapter 24 CGE Modeling of Environmental Policy and Resource Management

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Computable general equilibrium (CGE) modeling is an attempt to use general equilibrium theory as a tool for analysis of resource allocation and income distribution issues in market economies. Since the beginning of the 1990s, CGE modeling has been widely used for analysis of environmental policy and natural resource management issues. The purpose of this chapter is to review this branch of CGE modeling.

Most existing CGE models are static, but as faster computers and more efficient software have become available, an increasing number of environmental CGE models are dynamic. In addition to the static–dynamic dimension, it is useful to distinguish between single-country, multi-country and global models. Some environmental CGE models are primarily focused on the external effects of production and consumption, while others are designed to elucidate various issues related to the management of natural resources.

However, most existing CGE models are focused on externalities, primarily emissions of greenhouse gases. Global “externality” CGE models have been used to estimate the social cost of complying with the Kyoto Protocol, while single-country models, among many other things, have been used for evaluation of the efficiency of emission taxes and other environmental policy instruments.

CGE modeling currently is both a field for specialists and an almost standard part of the toolbox of economists concerned with policy-oriented research. A major reason for the widespread use of CGE modeling probably is that a CGE model is an ideal bridge between economic theory and applied policy research. The “bridge” perspective, however, suggests that CGE modeling is a way of using rather than testing economic theory. Yet carefully designed and estimated CGE models have a lot to say about real world economies.

Introduction

General equilibrium theory is a formalization of the simple but fundamental observation that markets in real world economies are mutually interdependent. Theoretical general equilibrium analyses have provided important insights about factors and mechanisms that determine relative prices and the allocation of resources within and between market economies. As witnessed by, for instance, Debreu (1959) general equilibrium theory has reached a very high level of rigor and elegance. However, most contributions to general equilibrium theory have focused on the allocation of private goods and privately owned resources. The prime exception is Mäler (1974) who, inspired by Ayres and Kneese (1969), extended the general equilibrium framework to encompass externalities and environmental resources with public goods characteristics.

Computable general equilibrium (CGE)1 modeling is an attempt to use general equilibrium theory as an operational tool in empirically oriented analyses of resource allocation and income distribution issues in market economies. The first CGE model was presented in Johansen (1960), and with the development of fast computers and suitable software a large number of CGE models has been developed and used for policy analysis. The applications include analyses of major tax reforms, changes in trade policy regimes, economic integration, agricultural policies and energy policies. A number of CGE models have been designed to elucidate various policy issues in developing countries.2

Since the beginning of the 1990s CGE modeling has also become a widely used tool for analysis of environmental policy and natural resource management issues. The purpose of this chapter is to review this branch of CGE modeling. The aim is to elucidate the modeling approaches adopted and the policy and resource management issues dealt with in “environmental” CGE models. In addition some specific problems in environmental CGE modeling will be discussed. A number of specific models will be referred to, but the chapter is far from an exhaustive survey of all CGE models intended for environmental resource management or policy analysis.3

The exposition is organized in the following way. In the ensuing section the distinguishing features, and the potential usefulness, of CGE models are briefly discussed. Section 3 is devoted to a short summary of the history of CGE modeling. In Section 4 some general modeling issues in relation to environmental CGE models are discussed. In Section 5 global models are discussed, while Section 6 is devoted to regional multi-country models. Then single-country models are discussed in Sections 7 and 8, while some concluding remarks on environmental CGE modeling are made in Section 9.

Section snippets

What is a CGE model – and what is it good for?

There is no precise definition of a CGE model, but whenever this particular label is used the model in question tends to have certain specific features. A very basic one is that it is a multi-sector model based on real world data of one or several national economies. However, while general equilibrium theory is concerned with the interactions of large numbers of individual households and firms most CGE models are rather aggregated. Thus, in a typical CGE model there is only one or possibly a

The history of CGE modeling9

The current literature on CGE modeling and economic analyses based on CGE models is vast. It has developed from three quite distinct origins, each one associated with the contributions of a particular author. The three authors are Leif Johansen, Herbert Scarf and Dale W. Jorgenson. In this section I will briefly discuss their contributions and how they have influenced the development of CGE modeling. I will also briefly comment on the impact of increasingly efficient computers and software on

Some general issues in environmental CGE modeling

Most environmental CGE models are designed to elucidate various aspects of climate change or, in some cases, acid rain policies. To a large extent, climate change and acid rain problems are caused by emissions from the combustion of fossil fuels. In both cases, the environmental damage depends on the accumulated stock rather than the current flow of pollutants. Moreover, the stocks of the pollutants in question accumulate slowly so there is a considerable time lag, particularly, in the case of

Global “externality” CGE models

During the 1990s, a number of global CGE models intended for analysis of climate change policies were developed and used for policy analysis. The major field of application has been evaluations of various aspects of the Kyoto Protocol, i.e. the (not yet ratified) agreement to reduce the emissions of carbon dioxide and other greenhouse gases. In fact, the commitments by industrial countries under the Kyoto Protocol seem to be the primary reason that so many global environmental CGE models were

Regional multi-country “externality” CGE models

A model in this category typically covers a region, such as the European Union, and consists of sub-models of each one of the countries within that region. From an environmental policy point of view, regional models are suitable for analyses of regional environmental problems, such as acid rain. Regional multi-country CGE models are also used for analyses of policy proposals that imply coordination of the national policies within the region. One example is analyses of the implications of the

Single-country “externality” CGE models

A large number of single-country environmental CGE models were developed during the 1990s. Most were designed to elucidate environmental problems or policies that are specific to the country in question. The most commonly studied environmental problem is emissions to air that contribute to climate change or acid rain. Thus most single-country environmental CGE models can be characterized as “externality” CGE models. However, there are also a few single-country models that can be classified as

CGE models of resource depletion and management

As developing countries tend to be more dependent on natural resources than industrialized high-income countries, CGE models focused on natural resource management issues are typically models of developing countries. However, the “externality” type of environmental CGE models completely dominates the field. In fact, very few models are focused on natural resource and management and policy issues.

Devarajan (1988) surveys the issues that have to be dealt with in a CGE model of a developing

Concluding remarks

In terms of the number of models and studies based on these models, CGE modeling has expanded very significantly, particularly during the 1990s. Currently CGE modeling is both a field for specialized research, and an almost standard part of the toolbox of economists concerned with policy-oriented research. A major reason for the widespread use of CGE modeling probably is that a CGE model is an ideal bridge between economic theory and applied policy research. The “bridge” perspective, however,

Acknowledgements

Financial support from the National Swedish Energy Administration, as well as research assistance by Martin Hill and Charlotte Nilsson, is gratefully acknowledged. The author is grateful for comments by Eirik Amundsen, Martin Hill and the editors of the Handbook on an earlier version, but is solely responsible for all remaining errors and mistakes.

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