Intergenerational Discounting and Market Rate of Return in OLG version of RICE Model

Transcription

1 Intergenerational Discounting and Market Rate of Return in OLG version of RICE Model Oleg Lugovoy (EDF, RANE) Andrey Polbin (RANE) IEW 2013

2 Outline Brief introduction to IAM and motivation of current research Description of the OLG model Key results of the model Conclusions and further dimensions of research

3 Integrated Assessment Modeling Economic block Gross output Damages from climate change Abatement costs where µ [0,1] t - emissions control rates Output net of damages and costs Climate block Carbon cycle Temperature Emissions Radiative forcing Y =A K L γr 1-γR RT, RT, RT, RT, AT AT 2 ( ( ) ) -1 Ω = 1+π T +π T RT, 1, R T 2 T Λ =θ μ θ 2 RT, 1, RT, RT, Y =(1- Λ )Ω Y =C +K -(1-δ )K net RT, RT, RT, RT, RT, RT, +1 R T AT UP LO M T=(M T,M T,M T )' AT LO T T=(T T,T T )' { 2 ( ) 2 ( 1750 )} E =σ (1-μ )Y +E Land T RT, RT, RT, R R F=η log M -log M +F AT AT EX T T T

4 Integrated Assessment Modeling Regional welfare: These parameters determine the real interest rates W R 1 θ 1 C RT, = N t t T (1 + ρ) 1 θ ρ where is the social discount rate, θ is the elasticity of marginal utility consumption. Social planner problem: W = ϕ W SP R R R max R where ϕ is the weight of the region in the social welfare function. The widely used approach to constraction SW is Negishi weighting.

5 Integrated Assessment Modeling There is an international debate on an appropriate discounting in climate-economy modeling. Nordhaus among others calibrates the pure rate for social time preferences to 1.5% per year, and elasticity of marginal utility of consumption equals to 2 to reproduce observable returns on capital. As a result, the optimal emissions reductions follow a policy ramp in which policies involve modest rates of emissions reductions in the near term, followed by sharp reductions in the medium and long terms. Critique: the use of high time discount rates is inconsistent with classical utilitarianism, which holds that equal weights should be attached to the welfare of present and future generations (Arrow, Broome, Cline, Ramsey).

6 Integrated Assessment Modeling Stern among others calibrates the pure rate of time preferences equals to 0.1 percent per year and the inverse of the inter-temporal elasticity of substitution equals to 1 (logarithmic utility function) and concludes about the need for extreme immediate actions in reduction emissions of GHG. Critique: the use of high time discount rates is inconsistent with observable market returns on capital, saving rates, capital-output ratios (Dasgupta, Nordhaus, Wietzman)

7 Integrated Assessment Modeling In this study: we introduce overlapping generations in RICE model and consider competitive equilibrium OLG framework provides two discount rates for investments in physical capital and analyzing climate policy

8 Model structure Households Firms Climate block Governments

9 Model structure: households Each adult individual lives seven periods of ten years, works first five periods and then retires We don t consider bequest and pension system in this simple framework Individuals make savings over the first five periods of life to ensure consumption in old age.

10 Model structure: households A newborn generation's problem consists of maximizing an intertemporal utility function: U RT, G 1 1 θ CRGT,, + G = G= 1 1 ˆ + ρ 1 θ Individual rate of time preferences subject to lifetime income: С + lend = W + (1 + r ) lend RT,, G RT, + 1, G+ 1 RT,, G RT, RT,, G where lend RT,, G are the assets of individual of age group g at the beginning of period t, is the labor earnings W RT,, G

11 Model structure: firms and governments Firms maximize profits π = Y - w L - R K - > max net K RT, RT, RT, T RT, T The welfare function of the government in the each region is the sum of discounted utilities of all generations, as measured from the moment of birth: 1 W = Pop T TG, = 1U (1 + ρ) T T Social discount rate

12 Calibration and numerical results Most of the parameters are the same as in the paper: Ortiz et al., DICER: a tool for analyzing climate policies. Energy Economics 33(S1), S42-S49. Eight regions We fix the inverse of the inter-temporal elasticity of substitution to 2, then we chose the value for the pure rate of time preferences equal to 2.5 to ensure that returns on capital compatible with ILA version of the model

13 Solution concept: Nash equilibrium For demonstration of the discounting issue we consider Nash equilibrium solution. Government in each region sets regional emission control rate maximizing own social welfare treating emission control rates of the other regions as a given Two policy scenarios: social discount rate equals to 1.5% per year and 0% per year

14 Regional emission control rates Emission control rates USA discount=1.5% USA discount=0% OECD1 discount=1.5% OECD1 discount=0% CHINA discount=1.5% CHINA discount=0% INDIA discount=1.5% INDIA discount=0% T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

15 Regional emission control rates Emission control rates OECD2 discount=1.5% OECD2 discount=0% FOREST discount=1.5% FOREST discount=0% FSU_EE discount=1.5% FSU_EE discount=0% ROW discount=1.5% ROW discount=0% T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

16 Regional emissions of industrial GHG. 3.5 GHG emissions 3 billions ton per year USA discount=1.5% USA discount=0% OECD1 discount=1.5% OECD1 discount=0% CHINA discount=1.5% CHINA discount=0% INDIA discount=1.5% INDIA discount=0% T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

17 Regional emissions of industrial GHG. GHG emissions billions ton per year OECD2 discount=1.5% OECD2 discount=0% FOREST discount=1.5% FOREST discount=0% FSU_EE discount=1.5% FSU_EE discount=0% ROW discount=1.5% ROW discount=0% 0 T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

18 Global mean temperature change degrees Celsius discount=1.5% discount=0% 1 0 T1 T2 T3 T4 T5 T6 T7 T8 T9 T10 T11 T12 T13 T14 T15 T16 T17 T18 T19 T20

19 Real returns on capital 8 Real returns on capital 7 % per year USA discount=1.5% USA discount=0% OECD1 discount=1.5% OECD1 discount=0% CHINA discount=1.5% CHINA discount=0% INDIA discount=1.5% INDIA discount=0% 1 0 T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

20 Real returns on capital 12 Real returns on capital 10 % per year OECD2 discount=1.5% OECD2 discount=0% FOREST discount=1.5% FOREST discount=0% FSU_EE discount=1.5% FSU_EE discount=0% ROW discount=1.5% ROW discount=0% 0 T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

21 Capital-output ratio Capital-output ratio USA discount=1.5% USA discount=0% OECD1 discount=1.5% OECD1 discount=0% CHINA discount=1.5% CHINA discount=0% INDIA discount=1.5% INDIA discount=0% T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

22 Capital-output ratio 2.9 Capital-output ratio OECD2 discount=1.5% OECD2 discount=0% FOREST discount=1.5% FOREST discount=0% FSU_EE discount=1.5% FSU_EE discount=0% ROW discount=1.5% ROW discount=0% T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

23 Solution concept: grand coalition Global social planner sets emission control rates maximizing social welfare function: W = ϕ W SP R R R max R We set weights ϕ = 1 and add condition of equalization of marginal abatement costs Two policy scenarios: grand coalition vs Nash equilibrium. Social discount rate equals to per 0% per year

24 Emission control rates in grand coalition Emission control rates USA coalition USA Nash OECD1 coalition OECD1 Nash CHINA coalition CHINA Nash INDIA coalition INDIA Nash T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

25 Emission control rates in grand coalition Emission control rates OECD2 coalition OECD2 Nash FOREST coalition FOREST Nash FSU_EE coalition FSU_EE Nash ROW coalition ROW Nash T1 T3 T5 T7 T9 T11 T13 T15 T17 T19

26 Global mean temperature change in grand coalition degrees Celsius Coalition Nash 1 T1 T2 T3 T4 T5 T6 T7 T8 T9 0 T10 T11 T12 T13 T14 T15 T16 T17 T18 T19 T20

27 Welfare gains of different generations from grand coalition Welfare gains 30 percent of consumption USA OECD1 CHINA INDIA OECD2 FOREST FSU_EE ROW T(-6) T(-4) T(-2) T1 T3 T5 T7 T9 T11 T13 T15 T17 T19 period of birth

28 Conclusions OLG framework provides two discount rates for investments in physical capital and analyzing climate policy It is possible to rationalize more radical emissions reduction side by side with observable market returns on capital Regional and OLG specification of the model allows to investigate regional-specific policies and to analyze welfare gains and losses of different generations in different regions in comparison to alternative policies Further research: game-theoretic solution of coalitions formation

29 Thank you for your attention! Oleg Lugovoy Andrey Polbin