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GP Report Summary

Project ID: 269788
Funded under: FP7-IDEAS-ERC
Country: Netherlands

Final Report Summary - GP (COMBATING CLIMATE CHANGE: Political economy of Green Paradoxes)

The Green Paradox is the phenomenon that second-best climate change policies can have counterproductive effects. For example, a subsidy on clean energy from renewable resources (solar, wind) will decrease the price at which this energy is supplied. But if the price continues to exceed the cost of fossil fuel extraction all available stocks will be depleted, and the price decrease will enhance the extraction from non-renewable resources, such as oil, that cause CO2 emissions. Hence, instead of delaying extraction the policy enhances initial extraction and emissions. In the design of environmental policy this supply side effect is insufficiently taken into account.
The principal aim of the project was to critically investigate the Green Paradox and to come up with sound policy recommendations. Contributions were made on the theory side as well on the more empirical side. This summary cannot do justice to total output of the project. Just a few highlights can be mentioned.
One of the main challenges of climate change policies is to prevent all non-renewable fossil fuel stocks from being depleted. It has been shown that with stock-dependent extraction costs this goal can be achieved better than with constant per unit extraction costs. In the absence of carbon taxation, second-best policies such as a subsidy on renewables may make fossil fuel stocks too expensive to extract. If the price elasticity of supply is much larger than that of demand for fossil fuel, the negative adverse welfare effects resulting from accelerated global warming will be dominated by the positive welfare effects resulting from locking up more carbon in the crust of the earth in the long run. Second-best climate policies can thus be productive despite Green Paradoxes, albeit less so than first-best climate policies. We have established that they are particularly productive if policy makers can commit to pre-announced time paths of future climate policies.
The incidence of the Green Paradox can also be relaxed in a general equilibrium setting, where, contrary to what is usually assumed, the interest rate is not given, but determined within the model. We have also paid attention to the different impacts of policies in less developed versus developed countries. Another issue that was studied is the interaction between countries, or regions. Examples are the strategic interaction between the suppliers of fossil fuel and regions that mainly use fossil fuel or the interaction between countries that actively implement a climate change policy and countries that do not. In such situations not only intertemporal leakage but also spatial leakage may occur. Recently, as announced in the original proposal, more attention has been paid to imperfect competition on the market for fossil fuel.

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