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Model Documentation - GEM-E3

Corresponding documentation
Previous versions
Model information
Model link
Institution Institute of Communication And Computer Systems (ICCS), Greece,
Solution concept General equilibrium (closed economy)
Solution method Optimization

The GEM-E3 environment module addresses the following GHGs: CO2, CH4, N2O, HFCs, PFs and SF6. In the model these emissions are linked to the activity level of the relevant sectors. This link is presented in the following table. Data on GHG emissions are extracted from the UNFCCC database and estimates for process related GHG MACCs are taken from "Global mitigation of non-CO2 GHG" EPA report (2006), and IIASA database.

Table 12: GHG emission sources and link with GEM-E3 activities

GHGs Sources GEM-E3 activity % in total GHG emissions of Annex I (2005) GWP
CO2 Burning of fossil fuels Coal, Oil, Gas 0.785 1
CO2 Cement production Non-metallic minerals 0.04 1
CH4 Waste management, Gas and Coal mining, Oil, Animals Coal, Oil, Gas, Agriculture, Public services 0.12 24
N2O Burning of fossil fuels, Transport, Production of adipic and nitric acid (nylon), Fertilizers Coal, Oil, Gas, Transport, Chemical products, Agriculture 0.057 310
HFC CFC substitute,Production of HCFC-22, refrigerators Chemical products, Equipment goods 0.0119 2000
PFC Production of aluminium, semiconductors Ferrous and non ferrous metals, Equipment goods 0.002 6800
SF6 Magnesium production, power distribution, Production of aluminium Power supply, Ferrous and non ferrous metals 0.002 22200

There are three mechanisms of emission reduction explicitly specified in the GEM-E3 model:

• End-of-pipe abatement (where appropriate technologies are available): End-of-pipe abatement technologies are formulated explicitly by bottom-up derived abatement cost functions that differ between sectors, durable goods, pollutants and between countries. The marginal costs of abatement are increasing functions of the degree of abatement. These costs differ between sectors and countries according to the country- or sector-specific abatement efforts already done. End-of-pipe abatement technologies refer only to non-CO2 emissions.

• Substitution between fuels and/or between energy and non-energy inputs: In the case of substitution of fuels, as the production of the sectors is specified in nested CES-functions, there is (at least for a substitution elasticity greater than zero) some flexibility on the decision of intermediates. The input demand is linked to the relative prices of these inputs. Hence, if there is an extra cost on energy inputs, there will be a shift in the intermediate demand away from “expensive” energy inputs towards less costly inputs. A politically imposed cost on emissions therefore drives substitution towards less emission intensive inputs, e.g. from coal to gas or from energy to materials, labour or capital.

• Emission reduction due to a decrease of production and/or consumption: in a general system that covers the interdependency of agent’s decision, imposing an environmental constraint (through standards, taxes or other instruments) causes additional costs to production (which is linked to the costs of substitution or abatement installation). An increasing selling price decreases demand of these goods even if this demand is inelastic to price changes (which are usually not the case) due to budget constraints. This lowers production and accordingly the demand for intermediates. Hence, there is an emission reduction due to a demand driven decline in production.

The dual formulation of the GEM-E3 model eases the incorporation of changes in economic behaviour due to emission or energy based environmental policy instruments. The costs of environmental policy requirements are added to the input (and consumption) prices. Intermediate demand is derived from the unit cost function which takes these extra costs into account. Similarly the demand of households for consumption categories is derived from the expenditure function, which is the dual of the utility function. Hence, the additional policy constraint is easily reflected in prices and volumes.

The model takes into account the trans-boundary effects of emissions through transport coefficients, relating the emissions in one country to the deposition/ concentration in the other countries. For secondary pollutants as tropospheric ozone, it implies considering the relation between the emissions of primary pollutants (NOx emissions and VOC emissions for ozone) and the level of concentration of the secondary pollutants (ozone).

Damage estimates are computed for each country and for the EU-15 as a whole, making the distinction between global warming, health damages and others. The figures for damage per unit of emission, deposition or concentration and per person and their valuation are based on the ExternE project results.

GHGs reduction policies

In GEM-E3 a GHG reduction policy can be implemented either through exogenous tax enforcement (thereby the level of the exogenous tax is given in advance but the level of emission reductions is unknown and is endogenously estimated), or through an exogenous implementation of an emission cap, namely an endogenous tax enforcement (thereby the level of the tax is originally unknown and endogenously estimated in order to achieve a specific emission reduction target). The estimation of the endogenous tax level ensues as the clearing price of demand and supply for emission permits. The available permits for the club are calculated and allocated according to the reduction target relative to emissions in 2005, set on a country or on a regional level.

According to the environmental policy under analysis, GEM-E3 features a selective activation of equations and respective variables that enable the appropriate simulation of policies. In this way, detailed alternative policies can be assessed as regards, for example, the allocation of emission allowances, the participation of country clusters in common emission reduction clubs, the recycling of government revenues from the sale of emission allowances and other detailed policy features. The activation of the appropriate equations is undertaken by means of specified “switch” parameters.

One method of permit allocation is the supply of free allowances through grandfathering (allocation of permits based on base year emissions) or other type of sectoral distribution. In the GEM-E3 this simulation allows for transfer of the value of emission permits to the firms and/or households by a respective reduction of the production cost or increase of the capital income for firms and by a transfer of value from the government to households.

The case of “hot air” permit supply is treated specifically in GEM-E3 model. If there is “hot air” permit supply, i.e. larger permit supply than actual baseline emissions, then half of the respective value is transferred from the government to the household (lump-sum transfer) and the rest is transferred from the government to the world. In this way, the government has no additional revenues due to “hot air” permit supply.

Recycling options

In microeconomic theory, the distortionary effect of taxes in the economy can be reduced by the recycling of revenues occurring from a second tax (carbon permits) with growth-enhancing effects on the longer-run. Such efficiency gains could lead to the double dividend effect if addressed optimally. A simple application of this “efficiency value” of the carbon permits is the “employment dividend” according to which the distortions created by taxes on labour can be reduced. The economic impacts of climate policies rely on the choice of the revenue recycling options.

In the GEM-E3 model, the following recycling options can be implemented:

• Lump-sum transfer to the household income

• Reduction of the social security contribution of employees

• Direct taxation reduction for households: Government revenues are redistributed back to households by lowering income taxes

• Tax cut for firms: Government revenues are used to reduce firms' costs by lowering indirect taxes

• Revenues from permit sales are used to reduce VAT rate for all goods to stimulate households final consumption

• Revenues from permit sales are used to subsidy private R&D.