Carbon motivated regional trade arrangements: Analytics and simulations

doi:10.1016/j.econmod.2011.08.016

Economic Modelling

Volume 28, Issue 6, November 2011, Pages 2783-2792

https://doi.org/10.1016/j.econmod.2011.08.016 Get rights and content

Abstract

This paper presents both analytics and numerical simulation results relevant to proposals for carbon motivated regional trade agreements summarized in Dong and Whalley (2010). Unlike traditional regional trade agreements, by lowing tariffs on participant's low carbon emission goods and setting penalties on outsiders to force them to join such agreements, carbon motivated regional trade agreements reflect an effective merging of trade and climate change regimes, and are rising in profile as part of the post 2012 Copenhagen UNFCC negotiation. By adding country energy extraction cost functions, we develop a multi-region general equilibrium structure with endogenously determined energy supply. We calibrate our model to business as usual scenarios for the period 2006–2036. Our results show that carbon motivated regional agreements can reduce global emissions, but the effect is very small and even with penalty mechanisms used, the effects are still small. This supports the basic idea in our previous policy paper that trade policy is likely to be a relatively minor consideration in climate change containment.

Highlights

► We present analytics and numerical simulation results of proposals for carbon RTAs. ► We develop a multi-region GE structure with endogenously determined energy supply. ► Carbon RTAs may reduce global carbon emissions, while the effects are small. ► Most carbon RTAs are welfare improving. ► Trade policy is likely to be a minor consideration in climate change containment.

Introduction

This paper presents both analytics and numerical simulation results relevant to recent debate on carbon motivated regional trade agreements (see Chatham House, 2007, Dong and Whalley, 2010). Proposals which circulate include explicitly lowering or eliminating tariffs among parties to a regional agreement on low carbon intensive goods and products used in low carbon technologies, border adjustments on trade with parties outside the area based on differential emission content of goods, and the use of trade sanctions against countries outside the area to enforce compliance with emission reduction targets set for them. Such proposals reflect an effective merging of trade and climate change regimes, and are rising in profile as part of the post 2012 Copenhagen UNFCC negotiations (see Walsh and Whalley, 2008 and Lockwood and Whalley, 2010). Here we discuss carbon motivated regional agreements in terms similar to customs union and regional trade agreements based literature (see Viner, 1950).

We note that agreements with lower within-region barriers on low carbon intensive products need not reduce emissions globally if emission intensities of production differ sharply within and inside the region. This reflects the differential impact of trade creation and trade diversion on emissions. We also note that unlike conventional customs union literature the welfare effects of a regional agreement now also include welfare impacts on climate change from emission changes.

We use a multi-region general equilibrium structure in which countries produce commodities of varying emission intensities using substitutable fossil fuel based energy and non-energy inputs. Commodities are differentiated by country of origin following Armington (1969). Preferences are defined over both consumption of goods and climate change, with lower utility from higher global temperature change.

Unlike in conventional trade models in which there is a fixed endowment of factor inputs for each country, here we model energy supply globally as integrated with a single global market and price, and there being a supply function for each country reflecting increasing extraction costs. We do not separately differentiate between fossil and non fossil fuels, but in a further model extension we could do so. We model the extraction cost function in constant elasticity form to yield a specification consistent with alternative values of the supply elasticity of energy. We then treat emissions in each country as fixed coefficient in energy use, and in this way incorporate endogeneity of emission levels. Global emission levels can thus rise or fall under any given regional trade agreement. This differs from other equilibrium structures (see OECD, 1993; Bhattacharyya, 1996; and Wing, 2004) in which the energy endowment is fixed (perfectly inelastic supply).

We next turn to numerical simulation, and using a number of data sources construct a benchmark global equilibrium data set based on data for 2006. This covers production, consumption and trade for each of a number of regions (US, EU, China, ROW) which we then project forward using 2004–2006 average growth rates for the period 2006–2036. In our static equilibrium model we thus treat the 30-year period 2006–2036 as a single period. The data set also contains estimates of energy use by sector and emissions for 2006 which are growth rate projected forward for period 2006–2036. We calibrate our model to this data set using literature based estimates of key elasticities.

Results from our analysis support the conjecture made verbally in our previous policy paper (see Dong and Whalley, 2010) that carbon motivated trade policies such as carbon free trade areas can only have a relatively small role in reducing carbon emissions. Carbon motivated regional agreements may increase world welfare, but the effects on participating countries may be negative or positive, when with penalties, the effect of carbon motivated trade policies on carbon emissions is still small. Though the carbon motivated regional agreements will have larger effects with emissions of high and low emission intensities countries involved, the effects are still small.

Section snippets

Literature review

Discussion of both the form and impact of carbon free trade agreements is related to the long studied customs union issue originally analyzed by Viner (1950). Viner, the initiator of subsequent customs union literature, pointed out that regional trade agreements do not necessarily result in gains to members, even though bilateral tariffs are eliminated by the agreement. He developed what later became known as the trade creation — trade diversion approach to regional trade agreements to help

Data and parameterization

We build a model compatible benchmark general equilibrium data set which we use in calibration. Our base case assumes a single 30-year period, forward projecting a business as usual scenario for trade, production, and consumption data (as well as energy use) for a 2 good (energy/non energy intensive), 2 factor (energy inputs, other inputs) structure for 4 regions (China, US, EU, ROW). We forward project 2006 data using 2004–2006 average growth rates, for the period 2006–2036.

In Table 1-1 GDP

Model experiments and results for carbon motivated regional trade agreements

We have used our calibrated model to simulate the impacts of carbon motivated regional trade agreements on emissions and welfare. Following Dong and Whalley (2010), we analyze the first type of carbon motivated regional agreement (lower tariffs on low carbon intensive goods) and the third types of carbon motivated regional agreements (added penalties on third parties). Results are presented in Table 3-1, Table 3-2, Table 4, Table 5, Table 6-1, Table 6-2, Table 7, Table 8.

These experiments

Concluding remarks

We build on an earlier policy piece by Dong and Whalley (2010) and develop a multi-region general equilibrium model calibrated to a single period data set reflecting a business as usual scenario between 2006 and 2036. We use this to evaluate the impacts of both carbon motivated free trade agreements and customs unions on trade, emissions and welfare. Our results confirm the widely held view that as a mechanism for reducing carbon emissions trade policy would seem to only offer quantitatively

Acknowledgments

We are grateful to the Center for International Governance Innovation (CIGI), and the Academic Development Fund of the University of Western Ontario, and the Ontario Research Fund for financial support. Yan Dong acknowledge the financial support from Minister of Human Resources and Social Security of China for the Scientific Research Starting Foundation for Returned Overseas Chinese Scholars.

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Carbon motivated regional trade arrangements: Analytics and simulations

Abstract

Highlights

Introduction

Section snippets

Literature review

Data and parameterization

Model experiments and results for carbon motivated regional trade agreements

Concluding remarks

Acknowledgments

Energy Economics

Energy Economics

Journal of International Economics

Journal of International Economics

A theory of demand for products distinguished by place of production

International trade and the negotiability of global climate change agreements

Changing Climates: Interdependencies on Energy and Climate Security for China and Europe

Carbon, trade policy, and carbon free trade areas

The World Economy

GTAP 7 Data Base Documentation — Chapter 14: Behavioral Parameters

SALTER: a general equilibrium model of the world economy

The general theory of second best

The Review of Economic Studies