Anthropogenic climate change in a descriptive growth model

This paper studies the effects of global warming in a descriptive model of endogenous growth. It is assumed that deviations from the pre-industrial global surface temperature negatively affect aggregate output. The paper studies the effects of varying the tax rate and of different abatement activities on the emission of greenhouse gases and on the growth rate. We study both effects for the long run balanced growth rate and for the growth rate of GDP on the transition path. Using simulations, it is demonstrated that higher abatement activities may both reduce greenhouse gas emissions and lead to higher growth. Further, the second-best abatement share is computed and the corresponding growth rate as well as the social optimum. Forthcoming in: Environment and Development Economics ∗I thank Peter Flaschel and Norbert Schütt as well as three referees for valuable comments which help to improve the paper. Non-Technical Summary This paper presents a simple descriptive growth model where production leads to emissions of greenhouse gases (GHGs) which raise the average surface temperature of the earth. The increase in the average surface temperature, for its part, negatively affects aggregate production. The model assumes that disposable GDP, i.e. GDP after taxes, is used for investment, for consumption and for abatement. Consumption is assumed to be a certain share of disposable GDP and the government can fix how much resources must be spent for abatement in the economy. Further, it is assumed that investment goes along with positive externalities which build up a stock of knowledge capital. This brings about constant returns to scale in the aggregate per capita production function and generates positive per capita growth in the long run. The paper, then, studies how variations in the tax rate and in the abatement share affect economic growth in this economy. This is done for both the model on the transition path and for the economy on the balanced growth path (BGP). Simulations demonstrate that a tax policy leading to less GHG emissions may also raise both the balanced growth and the growth rate of GDP on the transition path (win-win situation). This outcome crucially depends on the damage caused by the temperature increase. However, such a win-win situation can be obtained for damages which are considered as realistic. In a next step, a specialization of the model is presented which gives the so-called AK model of endogenous growth. For this economy the second-best solution is computed as well as the social optimum. It turns out that both for the second-best solution and for the social optimum countries with a more polluting technology should have higher abatement shares compared to countries with a less polluting technology. Nevertheless, GHG emissions are smaller in countries with less polluting technologies. This holds because the higher abatement share cannot compensate for the less clean production technology.