The Macroeconomics of Fighting Climate Change

Macroeconomic Policy and Financial Markets master project by Astrid Esparza Sánchez, Benedikt J. F. Höcherl, and Wei Liam Yap ’21

Photo by Nicholas Doherty on Unsplash

The full title of this project is “The Macroeconomics of Fighting Climate Change: Estimating the Impact of Carbon Taxes, Public and Private R&D Investment in Low-Carbon Technologies on the Scandinavian Economy.”

Editor’s note: This post is part of a series showcasing BSE master projects. The project is a required component of all Master’s programs at the Barcelona School of Economics.

Abstract

The worldwide lockdowns and slowdown of the global economy in the past two years induced a significant overall decrease in CO2 emissions by 8.8% – the largest observed decrease since World War II. In that sense, COVID-19 emphasized the important trade-off between the emissions reductions necessary to fight climate change and economic welfare, which also constitutes a major political stumbling block to introducing policies aimed at halting climate change in normal times.

In order to further our understanding of this trade-off, we evaluate the macroeconomic impact of three policies that are commonly regarded as crucial to meeting national emissions targets:

  • Carbon taxes
  • Public Investment in low-carbon R&D
  • Private Investment in the R&D of low-carbon technologies, proxied by the number of patents for environmentally friendly applications 

In our paper, we develop a novel approach to identifying the long-term impact of these policies using an Structural Vector Autoregression (SVAR) model. We use a Blanchard-Quah long-run identification scheme and a Cholesky short-run identification respectively to  recover a one-standard deviation shock of carbon tax and low-carbon R&D, and investigate their impact on the evolution of GDP, employment and CO2 emissions. In an extension, we include both public and private low-carbon R&D in an SVAR to uncover how public and low-carbon R&D incentivize and complement each other.

Conclusions

We evaluate the effect of carbon taxes, public low-carbon R&D and private low-carbon R&D on GDP, employment and CO2 emissions in Finland, Norway, Denmark and Sweden. We find that carbon taxes do not significantly affect GDP and employment in the long run, but we also do not observe a significant reduction in CO2 emissions. Our results might be shaped by the fact that the first carbon taxes were introduced in 1990 and consequently data is still relatively limited.

Furthermore, our results indicate a significant negative effect of public and private low-carbon R&D on emissions in Denmark and Finland. However, the effect on GDP and employment is ambiguous and depends on the individual country. 

To the best of our knowledge, this is a first empirical indication of the relevance of R&D into low-carbon technologies in reducing CO2 emissions in Northern Europe. 

The implications of our result can fruitfully contribute to the debate about the adequate policy instruments for fighting climate change on at least three dimensions:

  • We find no evidence supporting the political concern that carbon taxes might negatively impact jobs and growth.
  • We provide evidence for the effectiveness of low-carbon R&D – public and private – in reducing CO2 emissions. However, country specific crowding in and crowding out effects of public and private investment in low-carbon technologies should be taken into account when deciding for example on appropriate innovation policies.
  • Our paper underlines the idea that revenues from carbon taxes might potentially be employed for financing low-carbon R&D which in turn could spur long-run, emission free economic growth.

In any case, as for the planet time is of the essence, the Economics profession should focus ever more efforts on understanding the macroeconomics of climate change.

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About the BSE Master’s Program in Macroeconomic Policy and Financial Markets

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