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Production Functions for Climate Policy Modeling: An Empirical Analysis

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  • Edwin van der Werf

Abstract

Quantitative models for climate policy modeling differ in the production structure used and in the sizes of the elasticities of substitution. The empirical foundation for both is generally lacking. This paper estimates the parameters of two-level CES production functions with capital, labour and energy as inputs, and is the first to systematically compare all nesting structures. Using industry-level data from 12 OECD countries, we find that the nesting structure where capital and labour are combined first, fits the data best, but for most countries and industries we cannot reject that all three inputs can be put into one single nest. These two nesting structures are used by most climate models. However, while several climate policy models use a Cobb-Douglas function for (part of the) production function, we reject elasticities equal to one, in favour of considerably smaller values. Finally we find evidence for factor-specific technological change. With lower elasticities and with factor-specific technological change, some climate policy models may find a bigger effect of endogenous technological change on mitigating the costs of climate policy.

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1316.

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Length: 30 pages
Date of creation: Mar 2007
Date of revision:
Handle: RePEc:kie:kieliw:1316

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Keywords: Climate policy; input substitution; technological change;

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  1. Chang, Kuo-Ping, 1994. "Capital-energy substitution and the multi-level CES production function," Energy Economics, Elsevier, Elsevier, vol. 16(1), pages 22-26, January.
  2. Popp, David, 2004. "ENTICE: endogenous technological change in the DICE model of global warming," Journal of Environmental Economics and Management, Elsevier, vol. 48(1), pages 742-768, July.
  3. Manne, Alan & Mendelsohn, Robert & Richels, Richard, 1995. "MERGE : A model for evaluating regional and global effects of GHG reduction policies," Energy Policy, Elsevier, Elsevier, vol. 23(1), pages 17-34, January.
  4. Daron Acemoglu, 2003. "Labor- And Capital-Augmenting Technical Change," Journal of the European Economic Association, MIT Press, MIT Press, vol. 1(1), pages 1-37, 03.
  5. Edenhofer, Ottmar & Bauer, Nico & Kriegler, Elmar, 2005. "The impact of technological change on climate protection and welfare: Insights from the model MIND," Ecological Economics, Elsevier, Elsevier, vol. 54(2-3), pages 277-292, August.
  6. Jacoby, Henry D. & Reilly, John M. & McFarland, James R. & Paltsev, Sergey, 2006. "Technology and technical change in the MIT EPPA model," Energy Economics, Elsevier, Elsevier, vol. 28(5-6), pages 610-631, November.
  7. Valentina Bosetti & Carlo Carraro & Marzio Galeotti & Emanuele Massetti & Massimo Tavoni, 2006. "WITCH. A World Induced Technical Change Hybrid Model," Working Papers 2006_46, Department of Economics, University of Venice "Ca' Foscari".
  8. van Soest, Daan P. & List, John A. & Jeppesen, Tim, 2006. "Shadow prices, environmental stringency, and international competitiveness," European Economic Review, Elsevier, Elsevier, vol. 50(5), pages 1151-1167, July.
  9. Jean-Marc Burniaux & John P. Martin & Giuseppe Nicoletti & Joaquim Oliveira Martins, 1992. "GREEN a Multi-Sector, Multi-Region General Equilibrium Model for Quantifying the Costs of Curbing CO2 Emissions: A Technical Manual," OECD Economics Department Working Papers, OECD Publishing 116, OECD Publishing.
  10. Prywes, Menahem, 1986. "A nested CES approach to capital-energy substitution," Energy Economics, Elsevier, Elsevier, vol. 8(1), pages 22-28, January.
  11. Goulder, Lawrence H. & Schneider, Stephen H., 1999. "Induced technological change and the attractiveness of CO2 abatement policies," Resource and Energy Economics, Elsevier, Elsevier, vol. 21(3-4), pages 211-253, August.
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