Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation

ECOLEC-05682; No of Pages 8 Ecological Economics xxx (2016) xxx–xxx

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Methodological and Ideological Options

Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation Bernd Meyer a,⁎, Gerd Ahlert b a b

University of Osnabrück and GWS, 49080 Osnabrück, Heinrichstr. 30, Germany GWS, 49080, Osnabrück, Heinrichstr. 30, Germany

a r t i c l e

i n f o

Article history: Received 17 February 2017 Received in revised form 11 May 2017 Accepted 13 June 2017 Available online xxxx Keywords: Integrated Assessment Modeling CGE Models Macro-econometric models Neoclassical theory Keynesian theory

a b s t r a c t Economic-Environmental Models are deeply disaggregated macro-economic systems, which are used in economic environmental studies to explain the emissions of pollutions and the extraction of resources. Concerning the economic base two approaches can be differentiated – the neoclassical and the Keynesian paradigm. Models based on the neoclassical paradigm are depicting equilibrium of perfectly competitive markets, whereas the models based on the Keynesian paradigm have been developed from a critical position vis-a-vis neoclassical theory stressing the importance of market imperfections. The paper at hand shows in its theoretical part that this fundamental difference to a large extent is responsible for differences in modeling results concerning the impact of policy instruments on the economy and the environment. Furthermore the two paradigms prefer different ways of parameterization which has consequences for the empirical validation of the models, the construction of the references and the effects of environmental policy. The paper at hand further shows that the theoretical arguments allow explaining the totally different and partly opposite results of concrete policy simulations in the POLFREE project, where the large scale economic environmental models EXIOMOD (neoclassical) and GINFORS (Keynesian) have been used. © 2016 Elsevier B.V. All rights reserved.

1. Introduction The dependency of emissions and extractions of resources from the economic development can only be understood on the basis of models with a deep industry and/or product-specific disaggregation of the economy, which allows identifying the environmentally important consumption, investment and production activities in their relation to the entire economy. So input-output modeling is essential for environmental studies. But the open static Leontief model is too simple. A system is needed which has all this and in addition endogenizes final demand and factor demand for labor and capital. As every textbook on input-output economics shows, these extensions have all been done, but these models describe a linear world with constant input coefficients and constant consumption and investment ratios, in which prices and volumes are independent from each other. How to implement economically acting agents in such a framework? Johansen (1960) gave the answer in the neoclassical tradition: He developed a model, in which households maximize their utility subject to their budget constraint. Industries decide on inputs minimizing costs subject to production function constraints. Investors allocate capital to industries to maximize their profits. This model is the first in the long ⁎ Corresponding author. E-mail addresses: [email protected] (B. Meyer), [email protected] (G. Ahlert).

tradition of neoclassical input-output modeling, which is discussed in the literature as computable general equilibrium models (CGE). Almon (1967) and Barker and Lecomber (1967) were the first to integrate the input-output approach in a macro-econometric (ME) framework based on Keynesian theory. Both types of disaggregated macroeconomic models have been used in the last 50 years for the evaluation of policies in complex application fields relating to economic-environmental questions. The models used in economic-environmental applications became huge, because the questions to be answered need a global, but also a deep country, sector, resource and pollutant perspective with all its interrelations. The systems are called E3 models because they show the interdependences between the Economy, Energy and the Environment. This allows using them for policy assessment. The central question is what impact a policy has on sustainability which means that economic, social and environmental indicators have to be explained by the models. The big success of the neoclassical revolution in the 70s and 80s pushed the development of CGE models. Today these are the typical “work horses” of economic-environmental studies. Böhringer and Löschel (2006) give an overview of the state of art. They show that the main representatives of this class fulfill all requirements relating to economic indicators, but have deficits in regard to environmental and social indicators, which can be reduced linking the models to specific natural science and social models. The same experience has been made in the

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Please cite this article as: Meyer, B., Ahlert, G., Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation, Ecol. Econ. (2016), http://dx.doi.org/10.1016/j.ecolecon.2017.06.017

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application of the Keynesian model GINFORS that has been linked to the vegetation model LPJmL (Beringer et al., 2011) and the material model WORLD (Sverdrup et al., 2012). Fifty years of development created not only extensions in the environmental dimension of economically pure models of the two paradigms. Market imperfections have been added to neoclassical models generating models with a hybrid economic base. A prominent example is GEM-E3 (Capros et al., 2013). A classification of these hybrid models may be a useful task, but it is not the aim of the paper at hand. Pure Keynesian E3 models on a global scale are only E3ME (Pollitt et al., 2015) and GINFORS3 (Meyer et al., 2015). The general principles underlying both models are the same (Pollitt and Mercure, 2017). Further it has to be mentioned that the paper at hand is not a critical assessment of CGE and macro-econometric modeling. This work has been done by Grassini (2007), Serban Scrieciu (2007), and others. We are interested in the question which influence the central assumption about the market structure has on the properties of the models when they are used as instruments for policy assessment. What does it mean – all other structures equal – for the economic results of policy simulations whether a model assumes perfect or imperfect markets? Similar questions have already been answered for other fields of application: Capros et al. (1990) compared simulation results for the impacts of general macro-economic policies with a neoclassical and a Keynesian macro model of the Greek economy. Roson (2006) analyzed theoretically the impacts of single market imperfections on the solution of a neoclassical CGE model and compared simulation results for the effects of agricultural trade liberalization generated with the neoclassical GTAP model and another version of the model modified by market imperfections. Both studies came to the result that market imperfections have a very strong influence on the effects of policy simulations. Furthermore, we want to discuss which effects are combined with the different methods of parameterization that are preferred by the two modeling paradigms. The neoclassical paradigm is clear: All agents act on perfect markets, producers maximize their profits facing a substitutional production function, and consumers maximize their utility constrained by income. But what is the Keynesian paradigm? This is not the place to open a debate on neo, new and post Keynesianism. The only Keynesian global economic environmental models E3ME (Pollitt et al., 2015) and GINFORS (Meyer et al., 2015) are based on a modeling approach that is close to the paradigm, which Eichner and Kregel (1975) called the Post Keynesian theory. In chapter 2 we give an overview of the different theoretical modeling approaches for the labor, capital and goods markets, which we want to summarize under this heading. With this theoretical background we compare in chapter 3 the impact of typical classes of environmental policy measures on the economy and the environment in the two paradigms. Furthermore, we want to analyze in chapter 4 which consequences are associated with the different concepts of parametrization that are preferred in both communities. After the theoretical discussion we compare in chapter 5 the results of the application of the neoclassical model EXIOMOD 2.0 (Hu et al., 2015) and the Keynesian model GINFORS3 (Meyer et al., 2015) in the project POLFREE. Both large scale E3 models are very close to their paradigms. The identical simulations of a big number of climate and resource policy instruments generate very different and partly opposite results, which can be explained by the different theoretical structures and the parameterization of the models. Some conclusions in chapter 6 close the paper. 2. The Keynesian Paradigm Keynes (1936) criticized classical theory indicating that the labor market and the capital market are imperfect. The wage rate has not the flexibility to equilibrate the labor market and the incomplete information of lenders and borrowers of capital does not guarantee that

savings determine investment as neoclassical theory claims. With these corrections, Keynes was able to show that equilibrium in the circular flow of income could coexist together with permanent unemployment. Neokeynesian theory uses micro foundations for these two imperfections and adds stickiness of goods prices so that in this approach, all markets fail to work as neoclassical theory presumes it. 2.1. Labor Market A theory is needed that shows that the real wage rate can be permanently above the market clearing rate. A simple explanation for such a situation could be a strong power of unions in the sector and country in question. In the wage bargaining process the expected productivity development of the industry in question and the inflation rate are the arguments to find the nominal wage rate for the contract, which holds for a certain period. This is the Phillips Curve approach in the interpretation of Samuelson and Solow (1960). The resulting real wage rate is not related to the market clearing rate. Of course, strong unions are not to be found in all industries and countries. What pushes producers to pay voluntarily more than the market clearing rate? The answer is that it must pay for the producers. The efficiency wage theory (Stiglitz, 1976) shows that the higher wage rate raises the efforts of employees and reduces labor turnover. Each firm hires employees until the real wage rate equals the marginal productivity of labor. Yellen (1984) gives an overview of several variants of this theory. 2.2. Capital Market and Macroeconomic Closure The neoclassical equilibrium in the labor market determines the real wage rate and fixes labor demand to the level of labor supply. The capital stock is given from the investment of preceding periods and depreciation. Having the inputs of labor and capital the output is given by the production function and cannot be influenced from the demand side of the economy. This means that in the neoclassical framework we are not free in modeling demand. Sen (1963) concluded that so called “closure rules” have to be mentioned, if inconsistencies between supply and demand shall be avoided. Rattsö (1982) stressed the importance of this question for policy evaluation which is discussed in the literature as the “macroeconomic closure” problem. The inconsistency problem can be solved either if investment is determined by savings or if savings are determined by investment. In the first case Sen (1963) speaks of a “neoclassical closure”, in the other case of a “Johansen closure”. In the second case we are still in a neoclassical surrounding with cleared labor market and insofar a fixed supply. Here a rise of investment induces a rise of savings, which means a reduction of consumption, which leaves total demand unchanged. In the case of the neoclassical closure a rise of savings means a reduction of consumption and induces a rise of investment compensating the fall of consumption. It is used in growth theory and in far by most CGE models. It can be interpreted as the reduced form of a perfect capital market, where all savings are supplied and transformed into investment. The interest rate equilibrates the market: A rise of savings reduces the interest rate and raises investment. In an open economy the current account of international trade has to be taken into account additionally, which complicates the analysis requiring further closure rules in relation to exchange rate regimes (Taylor and Lysy, 1979, Dewatripont and Michel, 1987). Sen (1963) defined the “Keynesian closure” allowing for an independent investment function, in combination with an imperfect labor market with unemployment, where labor demand is explained by a flexible real wage rate. In other words: In a Keynesian model with unemployment the neoclassical property of a fixed production in the short run does not exist. The nominal wage rate is fixed in the short run by contracts, but a change of the GDP price moves the real wage rate and

Please cite this article as: Meyer, B., Ahlert, G., Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation, Ecol. Econ. (2016), http://dx.doi.org/10.1016/j.ecolecon.2017.06.017

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the explanation of price rigidities in all markets. In these theories firms behave all “rationally”; an alternative “explanation” of seeming price rigidities is that firm's managers act according to certain rules of thumb, for example, those that entail a mark-up over average costs.” The recommendation of Stiglitz is very helpful, since the macro-econometric models applied in economic-environmental research are typically multi-country/multi-industry models with thousands of prices that have to be explained. Insofar it would be a huge task to identify which of the more sophisticated approaches can be identified in which industry and country. Further, it is clear that the variables needed to estimate more sophisticated approaches are not available in such a context. If price rigidity is given with mark-up pricing then prices are not equilibrium prices and production is determined by the prices set and demand reacting to them. A determination of production via a production function is then inconsistent. Either the price is determined by market clearing and supply is determined by the production function (neoclassical case), or the price is set by the supplier and production is given by the clearing of the market (Keynesian case).

this pushes employment and production. Insofar the neoclassical consistency problem for supply and demand of GDP does not exist, and investment can be independent from savings, even though it has to match savings in the solution, which is of course the result of the interplay of all variables. So the term “Keynesian closure” is misleading since a Keynesian model does not require a closure rule because supply and demand are fully flexible and are determined interdependently in the equilibrium of the circular flow of income. So the rise of investment in one sector of the economy does not mean – as in neoclassical theory – that a crowding out of investment in other sectors has to follow, because a positive multiplier-accelerator process is induced that raises GDP and savings, which implicitly means that money is rising endogenously (Pollitt and Mercure, 2017). These considerations show that neoclassical models have the wellknown property of the dominance of the supply side of the economy, whereas fully developed Keynesian models depict a well-balanced interdependency of both market sides. Therefore, it is not true that in Keynesian models the demand side dominates. Demand side models are only the simple multiplier models, which we better should call “Incomplete Keynesian Models”. How is investment demand explained in Keynesian models? Optimal capital input facing a substitutive technology is given, if the capital output ratio – the relation between the capital stock and the expected capacity output – depends on the relative user cost of capital, which is influenced by the interest rate. Investment demand is net investment – the change in the stock of capital plus the replacement of losses in the capital stock. This specification is not complete, because the imperfections of the capital market are not taken into account. Greenwald and Stiglitz (1987) argue that suppliers of capital in special situations may not accept the amount of capital demand because of risk considerations, which may induce credit rationing. They do not try to clear the market via rising interest rates fearing that increasing interest rates might reduce the return to the supplier of capital either because the mix of applicants changes adversely or because they expect that borrowers are induced to realize riskier actions. Greenwald and Stiglitz (1987) further argue that also borrowers could behave in a way that restricts the investment decisions because they see risks that they do not want to bear. Such effects can be incorporated in our specification of the investment demand function with very pessimistic expectations for capacity output. In any case, investment demand in Keynesian models is somehow modeled in an accelerator approach linking the level of sectoral investment to the change of output of that sector giving the system dynamic properties allowing for a cyclical development of the economy but also introducing stability problems which has already been shown by Hicks (1950). Further the interest rate is a determinant of investment influencing the user cost of capital. From here the money market gets importance.

The impact of environmental policy on the economy and the environment is part of the debate on the rebound effect, which has been summarized by Sorrell (2007) and with a focus on CGE models by Allan et al. (2007). The aim of our paper in this context is a very specific one: We are only interested in the differences between both modeling paradigms in this respect. This means for example that the decisions of private consumption are not in the focus, because the modeling of this part of the economy is very similar in both paradigms in the sense that consumption structures are dependent from income and relative prices.

2.3. Goods Markets

3.1. Taxes on Environmentally Harmful Goods

Akerloff and Yellen (1985) discuss the reaction of a firm supplying under monopolistic competition, which faces the reduction of demand of the total industry moving the demand function of the firm to the left. Profit maximization would require a reduction of the price until the marginal revenues and marginal costs again equilibrate. Akerloff and Yellen (1985) argue that the losses may be very small so that already small costs of the price change itself (menu costs) can outweigh the advantage of the price change. Romer (1993) discusses four effects that influence this incentive. Blinder (1994) presents 12 different micro foundations for sticky prices and discusses the result of an empirical study testing their evidence. Stiglitz (1984, p. 355) concludes in a paper with micro economic arguments favoring price stickiness: “I suspect that some of these theories may provide a better description of some markets, others of other markets; there is no compelling reason to believe a single theory provides

Taxes on the demand for environmentally harmful goods can be laid on intermediate and final goods. For industries producing these goods the primary effect of taxation is in both paradigms that their demand curve will shift to the left. The higher the price elasticity in absolute terms the stronger is this primary effect. In the neoclassical case this means for the initial producer price a reduction of demand, which generates a gap between supply and demand inducing a fall of the producer price. So a rebound effect is given: the reduction of demand by the tax is at least partly compensated by the rise of demand induced by the fall of the producer price. The higher in absolute terms the price elasticity of demand is, the stronger will be the rebound effect. The economic effect is clearly negative since demand and production is less than in the initial equilibrium. Also in the Keynesian case the shift of the demand curve to the left creates for the initial producer price a gap between supply and demand.

3. Consequences for the Impact of Environmental Policy These short theoretical considerations allow drawing some first rough consequences for the impact of environmental policies. Of course there are a big number of economic instruments, regulations and information instruments, which we can't check all. We choose the following groups of instruments that are typical for “top down” environmental policies implemented by the government: ▪ Taxation of environmentally “harmful” goods ▪ Environmental tax reform with taxes on the demand for environmentally harmful goods, with two variants: – the additional tax revenue is used to reduce taxes for other goods, – the additional tax revenue is used to reduce social security contributions ▪ Subsidies for investment in resource efficient technologies,

Please cite this article as: Meyer, B., Ahlert, G., Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation, Ecol. Econ. (2016), http://dx.doi.org/10.1016/j.ecolecon.2017.06.017

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But this causes now a reduction of production. The existence of fixed costs will raise unit costs, which induces a higher producer price and a further reduction of demand and production. So there is no rebound effect, the opposite is the case: The higher producer price supports the reduction of demand that primarily was induced by the tax. As in the neoclassical case the economic effects will be negative since production and demand are lower than before the taxation. The demand side effects of the taxation of final and intermediate products on the environment are in the Keynesian case more efficient than in the neoclassical case, whereas the economic effects are similar. The taxation of intermediate demand additionally has a primary effect on the supply side in industries, which use these intermediate products: In the neoclassical case a rise of production costs shifts the supply curve to the left, which raises the producer price and reduces demand and production. In the Keynesian case the tax raises unit costs and thus the producer price, which reduces also demand and production. Since these effects are very similar in both paradigms we can neglect them in the further discussion. 3.2. Environmental Tax Reform: Additional Tax Revenue is Used to Reduce Taxes for Other Goods If in the neoclassical case an environmental tax reform is introduced in the sense that the additional tax revenue is used to diminish the tax for the other products, the demand curves for them will shift to the right. Prices, demand and production for these products will rise. In the Keynesian case the rising demand and production will reduce unit costs of these products and thus lower the prices. In both paradigms there will be a tendency that rising and falling prices will more or less equilibrate, which means that also secondary economic effects will in total be small. The concrete result depends of course from the parameters of the models. But the reduction of the pressure on the environment will be weaker in the neoclassical paradigm, because we still have the rebound effect generated by the prices for the harmful goods. 3.3. Environmental Tax Reform: Additional Tax Revenue is Used to Reduce Social Security Contributions If the environmental tax reform is introduced in the sense that the additional tax revenue is used for a reduction of social security payments of the employees, the neoclassical paradigm reacts on the labor market with a shift of the labor supply curve to the right. A new equilibrium is found with a lower real wage rate and a higher employment. Via the production functions higher production, income and consumption is generated. This will compensate more or less the negative effect on GDP which is induced by the taxation. In the Keynesian case the reduction of social security payments raises directly the disposable income of households and thus consumption demand and GDP. On the other side the taxation of the environmentally harmful goods will reduce GDP. Both effects may more or less compensate each other. 3.4. Subsidies for Investment in Resource Efficient Technologies Programs for the promotion of investment in resource efficient technologies can have very different structures: Examples are subsidies for the investment in resource efficiency of buildings or feed in tariffs for investment in renewable energies. Let us assume that the direct effects of such a program on investment are the same in the neoclassical and the Keynesian case. In the neoclassical case the rise of investment demand for a certain technology will induce crowding out for other investments since total investment is determined by total savings in the capital market equilibrium. The structure of total investment will change, but not its amount. The goods markets will also be affected depending from the goods structure of investment. Some goods prices will fall, others will rise.

Real GDP will not be affected. The capital stock will be more resource efficient, which reduces the pressure on the environment. In the Keynesian case the additional investment demand induces a positive multiplier/accelerator effect, which pushes real GDP and employment. Higher income creates higher savings which allows equilibrating the capital market. Nevertheless there may be substitution effects which reduce investment in other sectors, but the strength of this is open depending on the parameters of the model. The expansion of the entire economy creates a rebound effect: resource extractions and emissions rise, which at least partly compensates the effects introduced by the higher resource efficiency of the capital stock. Finally, concerning the impact of subsidies for investments in resource efficiency are in the Keynesian case better concerning the performance of the economy than in the neoclassical case, but the impact on the environment is less successful. With regard to the before mentioned environmental tax reforms we expect in both paradigms only very weak effects on GDP, but the effects on the environment will be different: In the Keynesian case the rise of the producer's price will support the primary effect of taxation on the purchaser's price, in the neoclassical case the fall of the producer's price creates the opposite. The strength of this rebound effect depends on the price elasticity of demand. Therefore the method of parameterization plays an important role for the results, which will be discussed in the next chapter. 4. Implications of Different Procedures of Parameterization The broad acceptance of neoclassical theory allowed using an easy method of parameterization, which more or less became standard in neoclassical modeling: Assumptions are made on the elasticities of the equations and the intercepts are calibrated by the consistent information of one data point. Only several authors of the “Computable General Equilibrium” (CGE) community like Jorgenson prefer the econometric parameterization. An early example is Hudson and Jorgenson (1974). Jorgenson (1984) gives a detailed analysis of the advantages of econometric parameterization for CGE models. In the case of the Keynesian paradigm the modeling of bounded rationality and imperfect markets is much more open than that of perfect competition and stresses the problem of the selection between competing specifications. Therefore authors of models close to the Keynesian paradigm often prefer the econometric parameter estimation, which is, of course, arduous, but gives the model an empirical underpinning. These models are also called “macro-econometric models”. In assessing the implications of specific policy measures a reference solution of the model is compared with an alternative solution, in which one or more variables have been shocked against their values in the reference. The deviations between both simulations give all direct and indirect effects of the shock. Especially in economic environmental simulations the challenges for policy formulation are given for the future, since it is clear that the restructuring of the economy to meet ambitious targets needs decades. Here the reference is a forecast with the model with policy parameters that exclude the policy in question in terms of business-as-usual. It is rather unlikely that a calibrated system produces a plausible long run forecast (Dixon and Rimmer, 2012). Therefore pathways either for GDP or for factor productivities are taken from exogenous sources and the model is calibrated to that pathway. This procedure seems to be acceptable, if the analysis is done to evaluate single policy instruments. Typically, the policy impacts are measured as percentage deviations from the reference. Therefore, the levels of the variables of the reference are of minor interest. The argument is: If the reference is wrong, this failure is also contained in the alternative scenario. Since policy evaluation is interested only in the differences between both scenarios the failure will in most cases be eliminated. But if the user of the model wants to know the levels of emissions, extractions, GDP and employment, for a future in which a certain policy is not introduced, this procedure does not work. In this case, the

Please cite this article as: Meyer, B., Ahlert, G., Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation, Ecol. Econ. (2016), http://dx.doi.org/10.1016/j.ecolecon.2017.06.017

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exogenous construction of a reference is very problematic, because the policy implications of the business-as-usual do not enter the forecast. Dixon and Rimmer (2012) argue that these applications become more important and they recommend improving the forecasting qualities of CGE models. Econometric models are adjusted to a longer period and insofar have the chance to meet the driving forces of the long run economic-environmental development, which allows using them for forecasting purposes and therefore for the calculation of the reference. An example is the use of the model GINFORS in the POLFREE project (Meyer et al., 2015). On the other side in many studies also with Keynesian models the user of the model wants to compare the results with other studies and expects that the references have to be calibrated to exogenously given developments from other studies. Calibration of parameters is not only a problem, if forecasts are needed. It also critically affects the results of alternative simulations which are used to identify the impacts of policy measures (Boys and Florax, 2007, Arndt et al., 2002, McKitrick, 1998). Hertel et al. (2007) criticize the common practice to take elasticities from the literature: Modelers often take point estimates of the parameters ignoring the quality of the estimation. Further estimates taken from other researchers typically employ different levels of aggregation. These and further arguments prevail Hertel et al. (2007) to estimate at least those parameters econometrically, which are of importance for the questions that have to be answered by the results of the model simulations. 5. Comparison of the Simulation Results of EXIOMOD and GINFORS in the POLFREE Project 5.1. The Models EXIOMOD 2.0 and GINFORS3 Both models are global multiregional input-output models with links to detailed energy, resource and land use. Both models have a deep country, product and sector group, energy carrier and resource disaggregation and a macroeconomic closure. Both models have a bilateral international trade system for each of the product groups with price dependent trade shares and import ratios. In both models all components of final demand are endogenous and the structure of final demand is depending in both models from relative prices. GINFORS3 explains further the structure of intermediate demand by relative prices, whereas EXIOMOD 2.0 has constant structures for intermediate demand. In both models the inputs of labor and capital are explained by substitutional technologies. This structure allows both models to calculate not only the direct resource use of a country induced by domestic production; for both models it is possible to show also the indirect flows of resources that are hidden in the imported final and intermediate goods. These calculations are based on the endogenous production structures of the delivering countries. But the models differ in two dimensions: EXIOMOD 2.0 is a typical neoclassical CGE model with perfect markets whereas GINFORS3 is a typical Keynesian model with imperfections on the labor, capital and goods markets. The second dimension is the type of parameterization: The parameterization of EXIOMOD 2.0 has been done by calibration using the EXIOBASE data. GINFORS3 is based on the WIOD time series of international make and use tables and environmental data, which allows estimating all parameters of the model econometrically. More detailed descriptions of the models are given by Hu et al., 2015 (for EXIOMOD) and Meyer et al., 2015 (for GINFORS3); earlier versions of GINFORS are documented in Meyer and Lutz (2007) and in Lutz et al. (2010). 5.2. The POLFREE Project The central research question of the POLFREE project (POLFREE.eu) was, how to reach the environmental targets of the vision for Europe

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till 2050, and how these targets can simultaneously be met and which socio-economic impacts will be induced: • • • •

CO2 emissions reduction by 80% compared with 1990, raw material consumption 5 tons per capita, reduction of the cropland footprint by 30% compared with 2005, water exploitation index below 20% in all EU countries.

The answers are given by an integrated assessment modeling exercise, in which the economic environmental models GINFORS and EXIOMOD have been linked with the vegetation model LPJmL (Beringer et al., 2011). The modeling work is embedded in a scenario framework (Jäger et al., 2017, also this special issue) which defines in addition to the EU targets the cooperation in the other countries of the world and allocates plausible policy mixes (Wilts, 2017, also this special issue) to different assumptions on governance (Milligan and O'Keeffe, 2017, also this special issue). The reference of the GINFORS simulations is a business-as-usual projection assuming for the EU that the already implemented climate policy is maintained and that no activities to reduce material extractions are taken, and that in the Non-EU countries no environmental policy action at all will be implemented. The reference for the EXIOMOD model is calibrated on the CEPII EconMap v2.2 data (Fouré et al., 2012; Fouré et al., 2013). Therefore, the macroeconomic development of the reference is exogenous for the model. Insofar it is not a business-as-usual forecast of the model itself and the results cannot be interpreted as such. In the EXIOMOD Reference Scenario the GDP of EU27 is growing over the period 2015 to 2050 with an average annual growth rate of 1.4%, whereas this rate for the GINFORS Reference Scenario is just 0.9%. This means that EXIOMOD calculates for the year 2050 a 20% higher GDP of EU27 than GINFORS, but at the same time CO2 emissions are in EXIOMOD about 20% lower than in GINFORS. Obviously the exogenously in EXIOMOD implemented efficiency trends are much stronger than the endogenously working determinants of GINFORS. In the case of GINFORS positive contributions to growth are especially coming from the global competitiveness of the European industries whereas in EXIOMOD the total opposite can be observed: the external balance reduces growth and main contributions are coming from private and public consumption. Three alternative scenarios with different governance and international cooperation assumptions have been assumed: ▪ ‘Global Cooperation’ – All countries co-operate through international agreements and harmonized economic and regulatory policy instruments to pursue decarbonisation and a resource-efficient global economy. ▪ ‘EU Goes Ahead’ – The EU pursues the development of a low-carbon, resource-efficient economy unilaterally, through strong EU-level economic and regulatory policy instruments instituted by Member States. Non- EU countries only install a moderate low carbon policy. ▪ ‘Civil Society Leads’ – Main difference to “EU Goes Ahead”: in the EU civil society, NGOs and businesses drive resource-efficiency through voluntary changes in preferences and behavior. Policies are introduced to facilitate such changes.

It is not the aim of this paper to give an overview of results for the total project. This is done for the GINFORS application by Distelkamp and Meyer (2017, also this special issue) in this journal and Meyer et al. (2015) and for the EXIOMOD results by Hu et al. (2015). The aim of this paper is trying to mirror the influence of the different modeling paradigms in the simulation results. Of course this assumes that the policy mixes are identical, which is in reality only approximatively the case, because models are different in their ability to implement concrete

Please cite this article as: Meyer, B., Ahlert, G., Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation, Ecol. Econ. (2016), http://dx.doi.org/10.1016/j.ecolecon.2017.06.017

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policy measures. In the case of scenario “Global Cooperation” the policy mixes are almost identical, in the other scenarios there are some more differences. Therefore we choose the results of “Global Cooperation” for the comparison.

Table 1 The policy mix in the scenario Global Cooperation of the POLFREE project. Policy field Climate policy

5.3. Comparison of Results for the Scenario Global Cooperation The comparison of results is based on Distelkamp et al. (2015).a Further the descriptions of results for GINFORS (Meyer et al., 2015, Distelkamp and Meyer, 2017) and for EXIOMOD (Hu et al., 2015) have been used. A set of about 30 different policy instruments (information, economic and regulation instruments) have been allocated to the scenario “Global Cooperation”. Table 1 gives an overview of the main instruments for the different policy fields. In the case of GINFORS this policy mix allowed to reach more or less the above mentioned targets. For EXIOMOD 2.0 the procedure did not converge. Very strong rebound effects occurred and the authors speak about conflicts between the targets (Hu et al., 2015, pp. 24). Only with additional assumptions for an autonomous rise of resource productivity, which were not part of the common policy mix, EXIOMOD could reach the environmental targets (Hu et al., 2015, p. 46). These assumptions are: Autonomous technological progress creating resource efficiency improvement in the range of 0.4–1.5% per year (crop yield 0.4%; material productivity 0.7% and energy efficiency 1.5%). Table 2 shows the targets and the simulation results for both models in the year 2050. For EXIOMOD the results of the simulation including the additional technical progress assumptions are depicted. For CO2 emissions a reduction of 72.5% is demanded (1.1 against 4.0 in 2010) compared with actual levels, which both models nearly reach. Also raw material consumption (RMC) has with a reduction of about 60% compared with actual levels (5.0 against 12.2) an ambitious target, which is met by GINFORS and nearly also by EXIOMOD. The cropland footprint target is reached by GINFORS with 0.27 ha per capita (2010: 0.31). For EXIOMOD this indicator is not calculated. The water exploitation target is only for some southern countries of EU27 a problem. In the average the target is easily met by both models. The EXIOMOD results for the pure policy mix excluding the exogenous technical change assumptions have not been published. But a rough estimation – given the additional growth rates for resource productivities over a 35 years period from 2015 to 2050 – shows that CO2 emissions in 2050 would have been calculated 68% and raw material consumption 24% higher than depicted in Table 2. The core of the policy mix of the POLFREE scenarios “Global Cooperation” is a broad environmental tax reform charging environmentally harmful goods and inputs and – in the simulations with EXIOMOD – discharging labor reducing social security contributions (Hu et al., 2015, p. 24). In the GINFORS simulations the additional tax revenue is used to reduce taxes on goods with low resource and carbon intensity. In both model applications this is combined with regulations and subsidies for investments in resource efficient technologies. EXIOMOD 2.0 assumes for intermediate products a price elasticity of zero. This means that for these products the taxation has no primary effect, which excludes a very important channel for an impact on the environment. Further the taxation of final demand creates strong rebound effects, because the assumed price elasticities are very high: For private consumption the assumed price elasticities are −1. Even stronger rebound effects are created by international trade, since import ratios and trade shares have a price elasticity of −5. In the GINFORS3 case the taxation of demand for environmentally harmful goods has no rebound effects. In the contrary the direct consequence of taxation – the reduction of demand and production – creates a The authors are one member of each of the modeling teams and the responsible leader of the modeling work package of the project.

Decoupling of economic development and the use of minerals Sustainable agricultural land and water use

Environmental tax reform

Main instruments ▪ Upstream carbon tax, ▪ Regulation of the share of renewable energies, ▪ Regulation and subsidies favoring e-mobility and investments in the energy efficiency of buildings. ▪ Upstream tax for minerals ▪ Regulation for recycling, ▪ Public innovation fund for material efficiency. ▪ Regulation of water abstraction for agriculture, ▪ Information programs to avoid food waste and yield gaps, ▪ Tax on meat consumption. ▪ Tax revenues are used for the reduction of taxes on goods with low carbon and resource contents.

higher unit costs and prices, which supports the primary effect. Further the price elasticities for intermediate demand are negative, which means that taxation has also a direct negative demand effect for them. The environmental tax reform now is used for the reduction of taxes for the goods with low resource and carbon intensity. Rising demand and production will reduce unit costs of these products and thus lower the prices. There will be a tendency that rising and falling prices will in total more or less equilibrate, which means that also secondary economic effects will in total be small. Summarizing we find that the differences in paradigm explain, why EXIOMOD by far does not meet the environmental targets and why with nearly the same policy mix this is possible with GINFORS. The economic results are also quite different (Distelkamp et al., 2015): The structural change towards a resource efficient economy induces strong investment, which in the case of GINFORS – at least partly – is additional investment. This induces in all countries a multiplier/accelerator process which pushes income and demand and reaches all components of final demand. Of course in those countries which supply fossil fuels and other resources, demand is strictly reduced by the global environmental tax reform and the investments in resource efficiency, and for those countries the net effect on GDP is negative. For Russia the deviation of real GDP from the reference in the year 2050 is − 27.7%, for Brazil − 16.5%, but for global GDP the deviation is + 5.2% and for Germany +9.0%. In the EU27 (including UK and excluding Croatia) the multiplier/accelerator process raises total investment by 17.0%, private consumption by 3.2%, public consumption by 8.7% (Table 3). The exports of EU27 rise by 6.2, which is equivalent to the effect on global GDP, whereas the deviation of imports (+5.4%) indicates a reduction of the import ratio in the EU27 (GDP: + 7.9%), which is consistent with the reduction the imported inputs of fossil fuels and other resources. In the case of EXIOMOD the investments in resource efficient technologies also take place, but crowding out of other investments avoids that total investment can rise. GDP is more or less unaffected, which

Table 2 Global Cooperation: the environmental targets and simulation results of EXIOMOD and GINFORS in the year 2050 for EU 27. Source: Distelkamp et al., 2015. Target

CO2 emissions in megatons RMC in tons per capita Crop land footprint in ha per capita Water exploitation index in percent

1.1 5.0 0.35 20.0

Simulation results GINFORS

EXIOMOD

1.3 4.4 0.27 9.6

1.2 5.3 n.a. 13.0

Please cite this article as: Meyer, B., Ahlert, G., Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation, Ecol. Econ. (2016), http://dx.doi.org/10.1016/j.ecolecon.2017.06.017

B. Meyer, G. Ahlert / Ecological Economics xxx (2016) xxx–xxx Table 3 Comparison of macroeconomic results for the scenario Global Cooperation. Source: Distelkamp et al., 2015. GDP in constant prices and its components in EU27 Deviations from the reference in the year 2050 in percent

GDP Household consumption Public consumption Investments Exports Imports

GINFORS

EXIOMOD

+7.9 +3.2 +8.7 +17.0 +6.2 +5.4

−0.6 +1.1 −2.1 −1.3 −0.3 +2.0

means that the environmental tax reform just balances the negative economic effects combined with the taxation of resource consumption. Of course – similar to Table 2 – Table 3 contains only the total effects of the policy mix and the additional technical progress assumptions for resource productivities. If those would not have been used the firms would have had higher costs shifting the supply curves to the left. This generates higher prices and lower production. So for the EXIOMOD simulation GDP and its components would have been lower than depicted in Table 3. Or in other words: without these additional productivity gains the economic performance would be worse, which would even raise the positive difference between the economic performance of the GINFORS and the EXIOMOD simulation. 6. Conclusions Environmental tax reforms which charge goods with high carbon and resource contents and reduce taxation of other goods or reduce social security contributions are central parts in the literature of environmental policy. A prominent position in the discussed policy mixes is mostly also given to programs for the promotion of investments in resource efficient technologies. Our knowledge about the impacts of these instruments on the economy, the social system and the environment is based on the results of simulations with highly complex models, which distinguish often drastically producing uncertainty for the users of the modeling results. The paper at hand analyses whether the fact that the economic hearts of these models are designed closer to the neoclassical or the Keynesian paradigm of modeling plays a role to explain these differences. In a theoretical investigation that compares the policy impacts of the mentioned instruments on the economy and the environment in a perfect neoclassical economy with that in a Keynesian world with market imperfections the paper comes to the conclusion: The promotion of investments in resource efficiency creates in the Keynesian case a multiplier/accelerator process, which pushes the economic development, whereas in the neoclassical case the determination of total investment by total savings induces crowding out of other investments leaving the economy without a major impulse. On the other side in the Keynesian case the positive effect on the economy means for the environment a rebound effect. For the environmental tax reforms we expect in both paradigms only very weak effects on GDP, but the effects on the environment will be different: in the Keynesian case the rise of the producer's price will support the primary effect of taxation on the purchaser's price, in the neoclassical case the fall of the producer's price creates the opposite. The strength of this rebound effect depends on the price elasticity of demand. Therefore the method of parameterization plays an important role for the results. Win-win results with positive effects for the environment and the economy are possible only for Keynesian models. Further it can be expected that the impacts on the environment will be stronger in the applications of Keynesian models. The theoretical considerations explain the differences in concrete simulation results with the models EXIOMOD 2.0 (neoclassical) and

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GINFORS3 (Keynesian) in the POLFREE project. With the same policy mix the neoclassical model failed reaching the ambitious environmental targets and the effects on the economy were negligible. The Keynesian model met the ambitious environmental targets and simultaneously created positive effects on GDP and employment. The comparison of simulation results further showed the importance of the methods of parameterization for the policy impact analysis and the meaning of the reference in neoclassical models. Unrealistic parameter assumptions (too high price elasticities) may create very strong rebound effects and do not allow to forecast a reference with the model. On the other side too low price elasticities may prevent primary effects of economic instruments. We understand these results as a confirmation of leading authors of CGE modeling, who argue for a better empirical underpinning of CGE models (Hertel et al., 2007 and Dixon and Rimmer, 2012). 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Please cite this article as: Meyer, B., Ahlert, G., Imperfect Markets and the Properties of Macro-economic-environmental Models as Tools for Policy Evaluation, Ecol. Econ. (2016), http://dx.doi.org/10.1016/j.ecolecon.2017.06.017