Final Report Summary - CLIPOL&TECH (How does climate policy affect the pace and direction of technical change? Theory and applications in a general equilibrium framework.) The CliPolTech (how does climate policy affect technical change: theory and applications in a general equilibrium framework) project has resulted in development of new theoretical and empirical models and insights. The research focussed particularly on the consequences of capital-embodiment of energy and other relevant technologies. These are often neglected in theoretical and even in many empirical models. The first part of the project focussed on identifying and clarifying the role of obsolescence costs when research and development (R&D) efforts are directed at improving clean or dirty technologies embodied in capital goods. This is in contrast to other models – most notably, that of Acemoglu et al. (2012) – in which clean and dirty technologies are disembodied. In the model developed here, technical change is modelled as being ‘investment-specific’, following Krusell (1998). The first consequence of capital-embodiment of clean and dirty technologies is that profit-driven R&D efforts depend not on the levels of clean and dirty production, but on the levels of clean and dirty investment. The second consequence is that changes in the relative rate of progress in clean versus dirty technologies has a perverse effect on the attractiveness of investments in the respective technologies in the shorter term. It is shown theoretically how these obsolescence effects depend on rates of technical progress and of depreciation. We also show that the structure of first-best policies is analogous to that in AABH: they involve a subsidy to clean R&D coupled with taxes on dirty output (the latter being equivalent to a carbon tax). Targeted subsidies for clean investments are not optimal in this setting, although they nevertheless provide a complementary or alternative policy instrument. The effects of technological embodiment are quantified using calibrated numerical implementations of this model and of a model in which technologies are disembodied, but that is otherwise identical. These simulations show that the obsolescence effects can play a dynamic role that is qualitatively important in the context of avoiding dangerous climate change. With a rapid increase in the pace of embodied clean technical progress and/or a sudden decrease in the pace of dirty technical progress, obsolescence costs could make it economically optimal to decrease clean and increase dirty investments for quite some time. Clean investments only take off once the acceleration in R&D has yielded sufficient progress to outweigh the obsolescence effects. The second part of the project involved drawing on the insights developed in the theoretical part and attempting to apply these in the context of an existing large-scale computable general equilibrium (CGE) model: FEEM’s Intertemporal Computable Equilibrium System model (ICES). The recursive dynamic structure of ICES is unsuited to studying the role of obsolescence costs. However, it was possible to develop the model to study the dynamics of accumulation of heterogeneous capital. A modified version of ICES referred to as ICES-K was developed in which installed capital is sector-specific and is moreover characterised by sector-specific deprecation rates. This takes into account to some different capital-embodied technologies used in different energy and non-energy sectors. For example, wind turbines have normal lifespans of 20-30 years while the lifespans of coal-fired power plants are at least twice that long. Particularly in the context of energy technologies, complete immobility of capital between sectors seems a more realistic approximation than the previous assumption of unrestricted capital mobility. However, the most innovate aspect of ICES-K was the modelling of (exogenously specified) technical as being investment-specific. This is a pragmatic solution to the problem of modelling progress in capital-embodied technologies in a multisector general equilibrium framework. Through numerical simulations, the effects of modelling technical change as being investment-specific or disembodied were assessed. It was concluded that under relevant, but very specific and somewhat optimistic conditions, the two approaches to modelling exogenous technical change could give very similar results. However, theoretical analysis suggests that the investment-specific approach is warranted in principle, it has no obvious disadvantage over the conventional approach and it is likely to yield different results when applied under less restrictive conditions. The research conducted in CliPolTech will primarily benefit other researchers studying climate mitigation from a theoretical perspective, as well as the integrated assessment modelling community who are studying mitigation from an empirical modelling perspective. The direct beneficiaries of the work on ICES-K are the FEEM CGE modelling group and their many national and international collaborators. The work on clean and dirty capital-embodied technologies has also influenced ongoing research in another EU project, PATHWAYS, in which Dr Lennox is now involved. References:Acemoglu, D., Aghion, P., Bursztyn, L. & Hemous, D., 2012. The Environment and Directed Technical Change. American Economic Review, 102(1), pp.131–166.Krusell, P., 1998. Investment-Specific R&D and the Decline in the Relative Price of Capital. Journal of Economic Growth, 141(June), pp.131–141.Nordhaus, W. & Sztorc, P., 2013. DICE 2013: Introduction and User’s Manual, New Haven, CT.
