Stiftelsen Frischsenteret for samfunnsøkonomisk forskning Ragnar Frisch Centre for Economic Research Climate Agreements and Technology Policy Rolf Golombek Lavutslippsutvalget March 6th 2006

Frischsenteret Emission reductions - principles Two main questions –How much to reduce emissions? Radical abatement is possible, but very costly – worthwhile? Costs vs. benefits –For given emission target; how to obtain cost effectiveness? Choice of instruments/policies Technology important –Abatement costs depend on technology –Instruments affect prices, profits and thus R&D

Frischsenteret Is the answer more and better technnology? –Technology development requires resources, which have have opportunity costs How much to spend on R&D? What type of R&D? General answer: Benefits vs. costs to determine R&D –Most knowledge is imported: Technology level in Norway depends on R&D in other countries through technology spillovers Own choices of abatement should also depend on choices taken by other countries –GHG: Total emissions matters –International environmental agreements

Frischsenteret Outline of talk Constraints on own choices –International climate agreement Types of international climate agreement –First-best (no constraints on instruments) –Second-best (constraints on instruments) Ranking of second-best agreements –Price of carbon, technology subsidy, technology level

Frischsenteret Constraints on own choices – international climate agreements Total emissions among signatories may be given (quota agreement) –Domestic actions may have no impact on total emissions among the signatories –If Norway has a radical abatement target: Throw, not sell, quotas; economic loss Have pushed up prices on permits May other signatories demand redistribution of quotas? (No) Instruments might be given by the agreement (e.g. tax agreement) –If Norway has a radical abatement target: Increase the imposed tax (or stricter standards)

Frischsenteret Constraints on own choices – international climate agreements Technology agreement – definiton? –Agreement on R&D subsidy or R&D level and/or technology standards –If Norway has a radical abatement target: No problem (except own costs)

Frischsenteret International climate agreements Different climate agreements will have different prices on carbon and different R&D policies Costs for Norway will differ across types of agreement Can we rank the prices and subsidies? Need a point of reference; –Total emissions –Second-best agreements

Frischsenteret International climate agreements – basic results When technology is given (standard model) –Quota and tax agreement equivalent –The market supports efficient solution When technology is not given – technology depends on R&D in all countries through technology spillovers –Quota agreement dominates tax agreeemnt –The market does not support efficient solution

Frischsenteret What makes technology change – standard economic theory Economists are simple (or simle minded?) Technology level tomorrow= Technolog level today (predetermined)+ investment today –Takes time to change technology level Investment by private firms determined by profitability –Present and future prices, costs, subsidies, taxes –Regulations, patents, standards and market structue (”winner takes all”?) Modifications –Technology spillovers; you learn from others not only own R&D expenditures matters –Own learning may also depend on own skills Learn more if your skills are high

Frischsenteret International climate agreements – externalities Emissions of GHGs –Harmful effects for all countries ( too much emissions in a free market ) –Use a carbon tax to obtain efficiency R&D investments –Positive spillovers to all other firms ( too litttle R&D in a free market ) –Stimulate (subsidize) R&D investments to obtain efficiency Standard economic theory –Two externalities require two instruments to obtain efficiency (first- best outcome) –First-best agreement: Use a carbon tax and R&D policy (R&D subsidy) No R&D policy elements in Kyoto agreement Assume: –International agreements have no R&D policy elements –R&D policy determined by individual countries –Second-best agreements

Frischsenteret Second best international climate agreements –framework Two types of agreements –Quota or tax Three levels of decisions –Group of all countries Maximizes global welfare Determines quota allocations or common carbon tax –Each country Maximizes own welfare Determines R&D subsidy (technology policy) –Each firm Maximizes own profits Determines abatement and R&D investments R&D is increasing in R&D subsidy and price of carbon

Frischsenteret Second best international climate agreements – quota vs. tax Quota and tax agreement: Each country neglects that own R&D are beneficial for other countries –National R&D subsidies too low –First-best outcome is not reached Tax agreement: –Imposed common tax exceeds the country’s desired tax rate (= marginal damage costs) –Incentive to decrease abatement, accomplished through reduced R&D subsidy – Quota agreement better than tax agreement

Frischsenteret Second best international climate agreements – ranking R&D subsidy First-best >Quota=No Agreement>Tax Price of carbon Quota>First-best>Tax>No Agreement Technology level –Depends on price of carbon and R&D subsidy –Quota>No Agreement>Tax –If international spillovers are ”small”: First- best>Quota

Frischsenteret Non-second best int. climate agreements – Common level of emissions Ranking of technology level –Quota>Tax

Frischsenteret Main results Emissions are man made; possible to reduce emissions, but abatement is costly and beneficial Climate policy in Norway depends on type of international climate agreement Price of carbon, R&D subsidy and technology level differ across types of agreements Costs of reaching a climate target in Norway depends on whether there is an int. climate agreement and type of agreeement