Balance or Synergies between Environment and Economy—A Note on Model Structures
2. Material and Methods
3. A Spectrum of Modelling Approaches
3.1. The Most Common Approach for Modelling Climate Policy
3.2. Mechanisms that Lead to Lower Cost (or Even Net Benefit) Estimates
- The external effect of emissions: Greenhouse gas emissions from production (e.g., of electricity) constitute a negative externality: producers of emissions do not take into account the effect these have on later generations through climate change. According to standard economic theory, externalities lead to suboptimal economic equilibria; in particular, activities related to a negative externality are generally overprovided. This implies that a Pareto improvement should be possible by internalizing the externality (see, e.g., , Chapter 11). Foley  presents a theoretical model to show that both present and future generations can be better off with mitigation if the current generation compensates its increased investment in mitigation technology by reducing conventional investment, rather than reducing consumption. This is because, according to the standard model logic, utility increases with consumption, and thus a reduction in consumption would imply a sacrifice.See also [17,18,19] on this issue: Rezai and colleagues argue that the business-as-usual scenario commonly chosen as a reference is problematic. In the BAU case (an equilibrium of the economy with an externality), agents ignore the effects of their emissions. The competitive equilibrium diverges from the optimum because social costs of emitting are not taken into account. In the optimal case, agents are aware of these costs and choose the appropriate levels of mitigation. What is usually considered as BAU in the literature is labelled a “constrained optimal path” by Rezai and colleagues: agents know about the negative consequences of their emissions, but are constrained to “no mitigation”. Their only means to avoid emissions is to accumulate less capital, which will then result in less production and therefore less emissions. The choice by current generations to invest less results in the corresponding choice to consume more, meaning that, compared with the mitigation scenario, consumption is higher in this scenario.
- Climate change damages: Mitigation cost estimates should ideally be derived from a business-as-usual case, with accurate climate change damage estimates and a mitigation scenario where these damages can be reduced or avoided. However, as such damage estimates are difficult or even impossible to obtain given long time scales and immense uncertainty, the mitigation scenario is often compared to a BAU scenario without damages caused by climate change. It is obvious that the mitigation scenario fares less well in the latter comparison, such that costs rather than benefits are more likely to be found. This point closely relates to the previous one. In both cases, future climate damages play a role. The perspective is a little different, though: accounting for an externality, the BAU case should not be assumed optimal. When accounting for climate damages, one can theoretically consider an optimal BAU scenario that can be expected to lead to a worse result with the inclusion of climate change damages than without, and may therefore also have a worse result than a mitigation scenario that avoids these damages (see [20,21] and references therein for a short sketch of the issue and available literature).
- Environment and natural resources: The environment and natural resources are often modelled only insofar as they are influenced by the economic system, but not explicitly as factors that, in turn, influence the economy. Introducing direct or indirect effects of the impact of the environment on economic activity may bring to light additional positive effects of environmental policy on the economic system [22,23,24]. Not only may the state of the environment itself be valued (in modelling terms, the state of the environment is an input to the utility function), increased environmental quality may also benefit the economic system—for example, if the positive effects of an improved environment on health lead to higher labour productivity . For natural resources, the UNEP Green Economy Report provides examples of how environmental policy can lead to economic (among other) benefits : Under business–as–usual, natural resource depletion and high energy costs lead to falling long–term growth rates, whereas natural resource use is mostly decoupled from economic growth for scenarios with additional green investments.
- Effects of environmental policy: Other than throught the enhancement of environmental quality that then influences the economic system, environmental policy itself can influence the economy positively or negatively [22,23,25]. Positive influences may occur by increasing market efficiency (correcting market failures, influencing behaviours, e.g., for energy efficiency), through a stimulus effect (green investments, e.g., for infrastructure) or via an innovation effect (driving investments into R&D and innovation).
- Green investments take effect via different mechanisms in different sectors. While in the primary sectors (agriculture, fishing, forests, and water) investments in natural capital are directed towards restoring and maintaining ecosystem services as well as making management more sustainable and equitable, for secondary sectors such as energy, transport, and manufacturing, investments target opportunities for saving energy and resources .
- Technical change: The representation of technical change in models as exogenous, endogenous, or as induced by policy, and its implications for the assessment of mitigation costs has been widely discussed in the literature (see, [20,26] for summaries and references therein for the literature). Let us emphasize here the mechanisms of learning–by–doing (e.g., [27,28]), and directed technical change : Investment not only increases production via the direct effect of capital accumulation, but also via an indirect effect on producivity. Investments in green technologies can, therefore, increase technical change in green sectors, helping them to catch up with conventional technologies.
- Positive externalities from additional investment: There also is a positive externality involved in knowledge accumulation, and, hence, in technical change: Benefits of increasing productivity not only accrue to the investors themselves. If the social benefits of investment are not taken into consideration by single investors, as is often the case, market outcomes generally underprovide investment. Large investments are needed for decarbonizing the economy, and investment levels are currently low in most OECD countries. Hence, triggering additional investment (be it public, private, or a combination of these) is a mechanism that can make green growth feasible (e.g., [5,30]). In combination with other mechanisms, investment-oriented climate policy presents a green growth opportunity .
- Irrational behaviour and imperfect information: The behaviour of individual agents is represented as optimization under perfect foresight in general equilibrium style models. The inherent assumption in optimization approaches—that the reference scenario achieves the economic optimum—implies the assumption that all investment opportunities with a positive return are known and realized in the optimal scenario. Hence, following this model logic, there are no untapped investment opportunities, and any additional investments will be made at a net cost. If agents in a model may not know all investment opportunities, or if they behave suboptimally, negative cost options may result.
- Negative cost options: The literature indicates that a considerable amount of investments into GHG emission reductions can be realized at net negative costs (i.e., net benefits) . Especially energy–efficiency investments, such as building insulation, lighting, air–conditioning, and more fuel–efficient vehicles, are reported as net negative abatement cost options. Increasing efficiency is, as mentioned above, recognized as one mechanism through which environmental policy can have positive economic effects .
- Financial market inefficiencies are another issue related to investments. The general equilibrium framework does not have money; prices are relative prices. Since all resources are optimally employed by assumption in the BAU case, as mentioned above, there are no untapped financial resources for additional investments, nor are there positive investment opportunities that are not funded in these models. When such inefficiencies are included in a model together with net negative cost investment opportunities, positive macroeconomic effects of mitigation measures can be found, as has been shown in [33,34,35].
- Expectation dynamics: Not only the individual behaviour of agents matters, but also their interaction in networks. The general equilibrium framework dispenses with these networks by construction: the market as a single central point for the exchange of goods makes networks between agents unnecessary. When solving a system of equations for those prices that balance aggregate supply and demand, the question of who trades with whom is never asked. Representing both the imperfect foresight of real-world agents via expectations and the fact that agents interact and may influence each other—considering the dynamics of expectations in networks of agents—is another mechanism that (in combination with other mechanisms) may lead to positive economic effects of climate policy [31,36].
3.3. Model Structures that Lead to Lower Cost (or Even Net Benefit) Estimates
5. Conclusions and Outlook
Conflicts of Interest
business as usual
gross domestic product
computable general equilibrium
United Nations Environment Programme
research and development
Organisation for Economic Co-operation and Development
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Wolf, S.; Schütze, F.; Jaeger, C.C. Balance or Synergies between Environment and Economy—A Note on Model Structures. Sustainability 2016, 8, 761. https://doi.org/10.3390/su8080761
Wolf S, Schütze F, Jaeger CC. Balance or Synergies between Environment and Economy—A Note on Model Structures. Sustainability. 2016; 8(8):761. https://doi.org/10.3390/su8080761Chicago/Turabian Style
Wolf, Sarah, Franziska Schütze, and Carlo C. Jaeger. 2016. "Balance or Synergies between Environment and Economy—A Note on Model Structures" Sustainability 8, no. 8: 761. https://doi.org/10.3390/su8080761