World Simulations with GEM-E3

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1 World Simulations with 1 Introduction The implementation of the Kyoto protocol would imply the emissions of Annex B countries to be collectively reduced by 5% in relatively to their 1990 level, whereas no emission limits are implied for developing (non-annex-b) countries. In addition, the Annex B countries have to meet individual emission targets for relatively to their 1990 emissions. The Kyoto protocol allows for flexibility in reducing emissions. The countries could meet their targets not only through emission reduction measures within their territory but also through emission reduction in other countries. To do so the Kyoto protocol envisages three types of flexibility instruments: Trading of emission permits between the Annex B countries Joint Implementation projects in Annex B countries Clean Development mechanisms involving projects with partners in Annex B and in non-annex B countries. In addition, the Kyoto protocol has set the above targets for the basket of greenhouse gases without setting individual targets by gas type. Among these greenhouse gases, carbon dioxide from fossil energy combustion represents about 80% of total greenhouse gas emissions. Table 1 : Summary of Annex B targets under the Kyoto Protocol Target GHG Emission Index for relatively to 1990 (=100) for OECD or to 1995 (=100) for Eastern European and Former Soviet Union countries Australia 108 European Union 92 Switzerland 92 Norway 101 Iceland 110 Eastern European countries Former Soviet Union (Russia and Ukraine) 92 to 94 (roughly) 100 (roughly) Canada 94 USA 93 Japan 94 Page 1

2 The analysis with the current GEME3 World model aimed at evaluating the importance of emission trading as a means of reducing the overall costs for complying with the Kyoto protocol. The objective was also, and probably primarily, to test the current model structure and evaluate the model properties in stylised cases for which analysis with CGE models has been already published in the bibliography. Serving for model testing purposes, the exercise as presented here must be considered as very preliminary and has not the ambition to address the Kyoto implementation policy issues. The scenarios analysed with GEME3 World are hypothetical cases of CO2 emission trading and the results should not be used, at this stage, for policy analysis. 2 Design of Scenarios The current version of the GEME3 World model does not represent greenhouse gases other than carbon dioxide related to fossil energy combustion. So the analysis is limited to energyrelated CO2, which however represents the bulk of greenhouse gas emission and has systemwide effects through energy. The analysis starts from a baseline scenario for the world economy constructed with the model (see previous section). In this scenario there are no emission constraints. The policy scenarios involve reduction constraints on emission of carbon dioxide imposed at an annual basis, starting from 2000 and increasing gradually so as to reach the magnitude set at the Kyoto protocol in The emission reduction constraints continue to increase beyond 2010 so as to comply, as much as possible, with the IPCC requirement regarding sustainability of greenhouse gas concentration in the very long run. Therefore, since CO2 emissions tend to increase also beyond 2010, even if Kyoto objectives are met in 2010, the reduction constraints become more and more stringent over time. In summary, the global objective for the World involves reducing emissions in 2010 by 6% from baseline (still increasing emissions by more than 30% from 1990). It is further requested accelerating the effort beyond 2010 so as not to exceed emissions higher by 45% to 50% in 2020 and 2030 relatively to the level of Instead the baseline projection would lead to emissions higher in 2020 by 65% and in 2030 by 100% from the level of The following table shows the emission index for the baseline (relatively to 1990) and the allowed emissions under the Kyoto protocol and the extrapolated Kyoto (termed Kyoto forever) as assumed for the GEME-E3 scenarios. Page 2

3 Table 2: Targets for the GEME3 Scenarios Emissions of CO 2 Index in 1990 North America EU-15 Eastern Europe Former Soviet Union Japan Australia & NZ Total Annex B Rest of the World Total World 1990 Baseline Allowed % Kyotoforever Kyoto change Baseline Target from Target baseline Allowed % change from baseline Baseline Kyotoforever Target Allowed % change from baseline Table 2 shows that if the Annex B countries were requested to reduce emissions domestically the necessary reduction effort, relatively to the baseline, would be considerably high, in particular beyond Former Soviet Union countries do not need to reduce emissions from their baseline levels in 2010 and However as they grow, hence increase fuel use and emissions, they are likely to emit more than their target in 2030, therefore they have to reduce in 2030 relatively to their baseline projection. It is also assumed that the non-annex B countries do not need to reduce emissions domestically. Under emission trading regimes, however, the Annex B countries may undertake less emission reduction domestically, although reducing emissions collectively at the desired level. Two trading regimes are assumed: one grouping the Annex B countries only, letting the developing countries entirely unconstrained, and one grouping the whole World in which case the developing countries participate in the collective emission reduction effort. Of course the latter case is completely hypothetical and does not correspond to Kyoto protocol provisions. In summary, the GEME3 World model quantified three scenarios of emission reduction: No Trading: all Annex B countries undertake emission reduction domestically and separately to each other according to the targets shown in Table 2. Annex B Trading: the group within Annex B establish an emission permit trading system based on a grandfathering initial allocation of permits (base year is 1995) and face a collective Annex B emission reduction target, as shown in the Annex B line of Table 2. World Trading: all countries establish an emission permit trading system also based on 1995 grandfathering and face a global emission reduction target, as shown in the World line of Table 2. It is also assumed that all economic agents in a country participating in trading or acting domestically also participate in a sort of country-specific emission trading system. They all (production sectors and households) may purchase or sell permits so as to obtain least cost at equalised marginal abatement cost. The model formulation of the trading system has important economic implications. It is assumed that any net rent obtained by the firms in trading permits is directly reflected to their product selling prices allowing the consumers to benefit in case of positive rents. It is also Page 3

4 assumed that if at the country level the total rents from permit selling is positive, the government improves public finance deficit or surplus by using the net corresponding revenues. The country under such a situation does not get direct benefits because the countrylevel interest rates are kept exogenous and invariant across the scenarios. On the contrary, if households are net buyers of permits their income allocated to consumption is affected, and the volume of consumption is reduced. One could formulate other regimes, as for example the case of allowing governments to redistribute to households (in the form of income subsidy) any positive rent from permits obtained at the country level. This would allow the reestablishment of private income. However this regime has not been analysed in the current GEME3 exercises. The GEME3 World model used for the emission reduction exercises incorporates endogenous bilateral trade at the World level. Therefore, even if a country does not participate in the emission reduction effort, it will bear indirect effects and burdens from all countries trading internationally. The reason is that reallocation of domestic resources in the industrialised world to meet emission constraint may change international market prices, i.e. terms of trade. The aim of using the GEME3 World model is also to analyse the different kinds of influences of Kyoto protocol on world trading. This analysis also considers that the required changes in the energy system will depend very much on the degree of flexibility that will occur in the implementation processes of the Kyoto Protocol. 3 Overview of GEME3 Results 3.1 General mechanism As a consequence of an emission ceiling the production sectors and the consumers perceive higher cost of using fossil fuels, costs that are proportional to their carbon content. The perceived marginal cost reflects the shadow value of the emission ceiling. These perceived costs do not entail transfer payments for the producers and consumers. However, they act as if these costs would to be really paid. Therefore they undergo changes in their production and consumption structure, substituting fossil energy by non-fossil energy and generally nonenergy or less-energy intensive commodities. These changes are propagated throughout the economy and influence demand and supply in all markets for commodities. Substitution in consumption and production is not perfect, therefore both production and consumption become less efficient than in baseline equilibrium, so producers see higher overall costs and consumers lose in welfare. So even if there are no additional direct payments for fossil fuels, production costs hence commodity prices rise as a consequence of emission ceilings. The relative competitiveness of production sectors and countries change. The sectors and countries depending more than others on fossil fuels will obtain lower market shares in trade. Consequently capital will be re-allocated. As capital is perfectly mobile, investment will be more attractive in sectors and countries that obtain relatively higher growth potential in the new distribution. Foreign trade also changes accordingly. In addition, as fossil fuels are generally substituted, the countries exporting fossil fuels tend to suffer more than importers of energy. The latter will partly compensate their losses by gaining, through international trade, higher terms of trade as compared to exporters. Page 4

5 Under a pollution permit regime, the initial allocation of permits plays an important role and influences the new distribution. If for any reason (for example the base year situation in a grandfathering system) a country is endowed with relatively high number of permits, it might be favoured under the emission ceiling as compared to other countries endowed with fewer permits. Generally at any moment a producer and consumer will compare the marginal abatement cost entailed by his substitution possibilities with the prevailing permit price. Therefore at the equilibrium, all marginal abatement costs and the permit prices will be equal to each other within the group of traders. A country being a net seller of permits in this situation will obtain net revenue from abroad. An important issue regards the use of such revenue. If for example this can serve to lower financial needs and relax the capital market, then interest rates might drop in this country, relatively to others, and attract investment further allowing for growth and higher competitiveness. This however will imply more emissions, hence higher abatement costs, a factor that limits the possibility for selling permits. A country not participating in the emission reduction effort, hence in emission trading, starts from a competitive advantage and will obtain a higher market share. However, it will also suffer from higher import prices from countries that do emission reduction. To maintain welfare the non-participating country will have to export and therefore face deteriorating terms of trade. The trade partners will also demand less because their growth is slowing down as a result of their emission reduction effort. The combined effect of these mechanisms might be positive or negative for economic growth of the non-participating countries. 3.2 Implications of the no trading case. In this case each Annex B country has to meet an individual target. Within each country the emission reduction effort is allocated to sectors and households at least cost. The results of the model confirm the above-described mechanism. As a result of imperfect substitution of fossil fuels, there is a general rise of commodity prices, first in the Annex B countries having to reduce emissions then to all countries as the effects propagate through international trade. At the world level prices increase by about 1.3% in 2010, but his rise is higher for countries that face higher difficulty in reaching their targets, like Japan (+3%) and some of the EU member-states (+2%). Higher prices in these countries influence their main trade partners, as for example is the case of China and East Asia that even though not participating in the emission reduction effort they see their prices rising as a consequence of Japanese price rise. A differential increase of prices has several consequences. Countries with higher price increases will export less and import more, therefore their domestic supply will fall. Investment and employment tend to decrease consequently. On the other hand, as the use of energy entails high costs in these countries, non-energy and non-material production factor, like investment and employment, will be demanded more than in other countries. The case of Japan is illustrative. Because substitution mechanisms dominate the effects from diminishing domestic activity, investment and employment are found to change positively in the emission reduction case. Keeping up employment also helps maintaining real wages hence private income and domestic consumption. This acts as a moderator on GDP losses a mechanism. Similarly, depending on the situation of the main trade partners, which can be also illustrated by observing that terms of trade also improve in these cases. Page 5

6 Countries like China, India, Latin America and East Asia do not participate in the emission reduction effort but bear the effects of higher import prices leading to higher domestic prices. Their relative position in international trade improves allowing them to moderate the negative effects and limit the losses in terms of GDP. Countries that export fossil fuels even if not participating in the emission reduction effort bear high consequences. This is the case of North Africa & Middle East, and the case of Former Soviet Union. The modelling results show that generally the spillover effects are high. The consequences on developing countries are important. The effects on world GDP in 2010 also is significant (loss of 1.3% or about 500 billion $). Two sorts of countries bear GDP losses higher than the average: some of those participating in the emission reduction effort and all those that export fossil fuels. Investment (-0.3%) is less affected than GDP, since through perfect capital mobility it also serves for substituting fossil energy. Employment (-0.04%) is also less affected than GDP, but households see higher than GDP fall of their real income (-1.5%). Energy consumption decreases by about 7.7% which is less than the overall fall of carbon dioxide emissions (-11.25%). Since the no trade case is less efficient in economic terms than trading of emissions, the relative higher drop of production activity and consumption leads to higher emission reduction than expected at the world level. Of course the bulk of reduction is undertaken in the Annex B countries (98.9%). The non Annex B countries face higher reduction of their GDP than the reduction of energy and carbon dioxide emissions, which means that both their energy and carbon intensity deteriorate. The marginal abatement costs (in other words the national permit prices) are generally high (239 $/tnc in average) and unequal across the Annex B countries. In 2010, the highest marginal costs are observed for the Nordic EU and Japan, and the lowest for North America. Eastern European countries face a very small marginal cost but for Former Soviet Union the emission constraint is not binding (therefore the marginal cost is zero). Despite this the indirect economic implications on these countries are significant, especially for Russia who is an exporter of fossil fuels. Beyond 2010 the emission reduction effort intensifies while emission trading is not permitted. The economic consequences are considerable leading to about 10% drop of world GDP in Cumulatively over a period of 30 years the world economy is avoiding the emission of about 130 billion of tons of CO2 at a cumulative (non discounted) GDP loss of the order of 35 trillion $ or a one year s loss of world GDP. The marginal abatement costs are also excessively high in 2030 reaching about 1500 $/tnc in average. It should be mentioned that the model version used for this exercise does not allow for endogenous technology progress. Such high abatement costs are likely to induce acceleration of technology progress, in particular in the energy field, leading to lower marginal costs. 3.3 Implications of Annex B Trading Annex B trading implies facing a collective emission ceiling. Given that the no trading exercise revealed high marginal cost differences among the Annex B countries, it is logical to expect significant cost savings from trading in the Annex B group. Page 6

7 The basic mechanism is of course similar to that described above. However the magnitude of all effects is significantly smaller as compared to the no trading case. The cost savings and the moderation of the indirect negative effects on production and consumption lead at a global level to lower emission reduction (-6% in 2010 from baseline) than in the no trading case (- 11.5%). The avoidance of GDP loss is more than proportional: the loss of global GDP under Annex B trading is 0.4% instead of 1.3% in the no trading case. Similar are the effects on all macroeconomic aggregates. The effects are more equally distributed across the Annex B countries and the spillover effects on developing countries are also smaller as compared to the no trade case. The only exception is Former Soviet Union who bears relatively higher costs. This is related to the fact that Former Soviet Union has to decrease emissions domestically (from baseline) under Annex B trading, as facing the marginal abatement cost collectively applied to the Annex B group. Former Soviet Union of course is the main seller of permits and gets high revenues from this. But the model as it stands now limits the effects of these high revenues only to the improvement of public finance deficit (which shows a spectacular surplus under Annex B trading). Should the Former Soviet Union benefits from such surplus to lower for example interest rates, the macroeconomic effects would be different. In addition, as in this country firms sell permits, domestic prices fall. Exports do increase but the terms of trade strongly deteriorate. As the model stands now, workers will see higher real wages and some them will refrain from supplying labour to the labour market pushing downwards real wages. Households are net buyers of permits therefore some of their income is spent to buy permits. To re-establish their private income households need to further accept lower real wages and keep up employment, hence private income and consumption lower. If the government was recycling the positive revenues to subsidy households revenue, then private income and consumption would be maintained, if not increased, allowing for higher domestic activity and GDP for Former Soviet Union. The conclusion is that the mechanism of the model concerning recycling of revenues in case of selling permits has to be revised in the model. Annex B trading implies a more than four times drop of the marginal abatement cost, which approaches in $/tnC for Annex B as a whole. The marginal abatement costs increase beyond 2010, as the emission reduction effort intensifies. The macroeconomic implications for the long-run are still considerable (-6.6% loss of global GDP in 2030). The relative gains from trading as compared to no trading diminish over time since the so-called hot air also decreases in magnitude within the Annex B group. 3.4 Implications of World Trading This scenario explores the hypothetical case of establishing a pollution permit market at the world level. This implies that the developing countries participate in the collective effort of reducing emissions, an assumption that is not provided in the Kyoto protocol. It is also assumed that the Annex B countries do not compensate the developing countries for the incurring costs from participating in the emission reduction effort. The results of the model show a general gain of economic efficiency and a lowering of negative effects, as compared to the other emission reduction scenarios. At the global level, world trading leads to moderate GDP loss in 2010 (-0.24% instead of 0.4% for Annex B Page 7

8 trading case). The general rise of prices is also limited (0.33%) although CO2 emissions are globally reduced as much as in the Annex B trading case. An important change from previous scenarios is that the necessary improvement of energy intensity (which entails relatively high costs through substitution) is much lower than in the other scenarios while the carbon intensity (through changes in the fuel mix) plays a more important role. This of course is related to the fact that developing countries use relatively more coal than developed ones, so by participating in the collective effort they allow for cheaper emission reduction mostly by means of fuel mix changes. China and India generally face slightly higher GDP losses than in the case of Annex B trading. This has consequences on their employment and on global employment which is significantly more affected than in other scenarios. However, the new allocation corresponds to higher sectoral investment, as compared to the other cases. The exporters of fossil fuels generally suffer less under world trading. Former Soviet Union is also less affected. However it still sells permits allowing for lower prices and more exports. However the limitations of the revenue recycling mechanisms as represented in the current version of the model explain also in the case the loss of GDP for Former Soviet Union. Under world trading of emissions about 60% of emission reduction is undertaken in the Annex B countries and 40% in the developing countries. This of course reveals that there is great scope for undertaking emission reduction in the developing world. Over the period of , the cumulative gain (in terms of avoided GDP loss) is of the order of 200 billion $ which of course can be considered as a fund sufficient to partly compensate the developing countries for their emission reduction efforts. In that sense, the results show great scope for intensifying the clean development mechanisms provided for under the Kyoto protocol, if of course this is possible from an institutional point of view. The marginal abatement cost for 2010 halves from its value under Annex B trading, becoming 26$/tnC. In addition the long-run macroeconomic implications from intensifying the reduction effort beyond 2010 are considerably smaller in case of world trading. For example, the marginal abatement cost in 2030 becomes 195$/tnC under world trading, while it was higher equal to1000 $/tnc and even higher in the other emission reduction cases. Under world trading, it will possible to avoid the emission of 100 billion tons of CO2 over a period of 30 years at a cumulative non-discounted loss of 9 trillion $ over the same period, which represents on fourth of one year world GDP. The following tables and figures summarise the results of the model and compares the three scenarios. Page 8

9 Table 3 : Comparison of GDP effects for the three emission reduction scenarios Change of GDP from baseline in % No Trade AnnexB Trading Full World Trading WORLD Australia Japan East Asia China India North America Latin America Nordic EU Germany UK Rest of EU Other Europe Eastern Europe F. Soviet Union N. Africa & ME Africa Rest of World Table 4 : Comparison of CO 2 emission reduction for the three scenarios Change of CO2 from baseline in % No Trade AnnexB Trading Full World Trading WORLD Australia Japan East Asia China India North America Latin America Nordic EU Germany UK Rest of EU Other Europe Eastern Europe F. Soviet Union N. Africa & ME Africa Rest of World Page 9

10 Table 5 : Comparison of pollution permit prices for the three emission reduction scenarios Price of Pollution Permits in $/tc No Trade AnnexB Trading Full World Trading WORLD Australia Japan East Asia China India North America Latin America Nordic EU Germany UK Rest of EU Other Europe Eastern Europe F. Soviet Union N. Africa & ME Africa Rest of World Figure 1 : Pollution permit prices Price of Pollution Permits in No Trading AnnexB Trading World Trading WORLD Australia Japan East Asia China India North America Latin America Nordic EU Germany UK Rest of EU Other Europe Eastern Europe F. Soviet Union N. Africa & ME Africa Rest of World Page 10

11 4 Tables with Summary Results from GEME3 World model 4.1 No trading case Scenario: No trade Case model Results for World % change from baseline Gross Domestic Product Employment Private Investment Private Consumption Domestic Demand Intra World trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate CO NOX SO VOC PM Page 11

12 No Trade Scenario % change from baseline World AUZ JAP EAS CHI IND NAM LAM NEU Gross Domestic Product in Employment Private Investment Private Consumption Domestic Demand Exports in volume Imports in volume Intra World Trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate Current account as % of GDP (diff.) Terms of Trade CO2 Emissions No Trade Scenario % change from baseline GEU BEU REU OEU CEA FSU NAF AFR ROW Gross Domestic Product in Employment Private Investment Private Consumption Domestic Demand Exports in volume Imports in volume Intra World Trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate Current account as % of GDP (diff.) Terms of Trade CO2 Emissions No Trade Scenario Results for the World Domestic Production Investment Exports Imports % change from baseline 2010 Long-term 2010 Long-term Agriculture Coal Oil Gas Electricity Ferrous and non ferrous metals Chemical Products Other energy intensive Electronic Equipment Transport equipment Other Equipment Goods Other Manufacturing products Construction Food Industry Trade and Transport Textile Industry Other Market Services Non Market Services Page 12

13 No Trade Scenario Percent change of CO2 Emissions from baseline scenario % change from baseline Australia, New Zeland Japan Dynamic East Asia China India and rest of Asia North America Latin America EU Nordic countries EU Germany EU Unit. Kingdom EU rest of Member-states Other Europe OECD Central European Associates Former Soviet Union Middle East and North Africa Rest of Africa Rest of the World World World: Effects from No Trading % changes from Baseline Gross Domestic Product Employment Private Investment Domestic Demand Private Consumption Page 13

14 World: Effects from No Trading 0.00 % changes from Baseline CO2 Energy consumption in volume 4.2 Annex B trading case Scenario: Annex B Trading Case model Results for World % change from baseline Gross Domestic Product Employment Private Investment Private Consumption Domestic Demand Intra World trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate CO NOX SO VOC PM Page 14

15 Annex B Trading Scenario % change from baseline World AUZ JAP EAS CHI IND NAM LAM NEU Gross Domestic Product in Employment Private Investment Private Consumption Domestic Demand Exports in volume Imports in volume Intra World Trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate Current account as % of GDP (diff.) Terms of Trade CO2 Emissions Annex B Trading Scenario % change from baseline GEU BEU REU OEU CEA FSU NAF AFR ROW Gross Domestic Product in Employment Private Investment Private Consumption Domestic Demand Exports in volume Imports in volume Intra World Trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate Current account as % of GDP (diff.) Terms of Trade CO2 Emissions Annex B Trading Scenario Results for the World Domestic Production Investment Exports Imports % change from baseline 2010 Long-term 2010 Long-term Agriculture Coal Oil Gas Electricity Ferrous and non ferrous metals Chemical Products Other energy intensive Electronic Equipment Transport equipment Other Equipment Goods Other Manufacturing products Construction Food Industry Trade and Transport Textile Industry Other Market Services Non Market Services Page 15

16 Annex B Trading Scenario Percent change of CO2 Emissions from baseline scenario % change from baseline Australia, New Zeland Japan Dynamic East Asia China India and rest of Asia North America Latin America EU Nordic countries EU Germany EU Unit. Kingdom EU rest of Member-states Other Europe OECD Central European Associates Former Soviet Union Middle East and North Africa Rest of Africa Rest of the World World World: Effects from Annex B Trading % changes from Baseline Gross Domestic Product Employment Private Investment Domestic Demand Private Consumption Page 16

17 World: Effects from Annex B Trading 0.00 % changes from Baseline CO2 Energy consumption in volume 4.3 World trading case Scenario: Full World trade Case model Results for World % change from baseline Gross Domestic Product Employment Private Investment Private Consumption Domestic Demand Intra World trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate CO NOX SO VOC PM Page 17

18 Full World Trade Scenario % change from baseline World AUZ JAP EAS CHI IND NAM LAM NEU Gross Domestic Product in Employment Private Investment Private Consumption Domestic Demand Exports in volume Imports in volume Intra World Trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate Current account as % of GDP (diff.) Terms of Trade CO2 Emissions Full World Trade Scenario % change from baseline GEU BEU REU OEU CEA FSU NAF AFR ROW Gross Domestic Product in Employment Private Investment Private Consumption Domestic Demand Exports in volume Imports in volume Intra World Trade Energy consumption in volume Consumers' price index GDP deflator in factor prices Nominal Wage rate Real wage rate Current account as % of GDP (diff.) Terms of Trade CO2 Emissions Full World Trade Scenario Results for the World Domestic Production Investment Exports Imports % change from baseline 2010 Long-term 2010 Long-term Agriculture Coal Oil Gas Electricity Ferrous and non ferrous metals Chemical Products Other energy intensive Electronic Equipment Transport equipment Other Equipment Goods Other Manufacturing products Construction Food Industry Trade and Transport Textile Industry Other Market Services Non Market Services Page 18

19 Full World Trade Scenario Percent change of CO2 Emissions from baseline scenario % change from baseline Australia, New Zeland Japan Dynamic East Asia China India and rest of Asia North America Latin America EU Nordic countries EU Germany EU Unit. Kingdom EU rest of Member-states Other Europe OECD Central European Associates Former Soviet Union Middle East and North Africa Rest of Africa Rest of the World World World: Effects from Full World Trading % changes from Baseline Gross Domestic Product Employment Private Investment Domestic Demand Private Consumption Page 19

20 World: Effects from Full World Trading 0.00 % changes from Baseline CO2 Energy consumption in volume 5 Conclusions from World simulations The scenarios with the world version of aimed at analysing the macroeconomic implications of carbon dioxide emission reduction under different emission trading regimes. The analysis showed clear benefits from trading, as compared to a no trading case. The economic efficiency is highly improved. The analyses also showed that the spillover effects on developing countries from Annex B countries undertaking emission reduction are significant. In particular, fossil fuel exporting countries are negatively affected. The role of international trading under the new equilibrium corresponding to a less carbon-emitting world is considerable. World level trading of emissions is even more efficient at a global scale than Annex B trading. However, some of the developing countries bear consequences that are higher than in the case of Annex B trading. The analysis identified great scope for intensifying the clean development mechanism and the Annex B trading as provided for in the Kyoto protocol. The analysis has several limitations and needs to be extended and improved. A major difficulty with the model, as it stands at present, regards the representation of effects from endogenously redistributing the revenues from selling permits in case a country is a net seller of permits. This is of particular interest to study the effects on the Former Soviet Union countries in case of emission trading. Page 20

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