M.H. Babiker r Energy Economics 23 2001 121᎐139 129
3. Results
3.1. Parameters and policy scenarios The essential parameters and elasticities used in the model are summarized in
Table 1. The carbon emissions limit in OECD is set according to the Kyoto Agreement, and is assumed to take effect starting from year 2005 on.
4
To assess the impact of capital controls on carbon leakage in the presence of an OECD
abatement policy, we implement a scenario in which all regions, except OECD, are constrained in the international capital market. According to this scenario each
non-OECD region is subject to global capital restrictions that its BOP deficit must
Ž not exceed its baseline trajectory throughout the model horizon. The baseline or
. the Business as Usual, BaU is in turn defined as the situation where there is no
carbon abatement anywhere. A natural way of modeling capital controls and financial repression is by treating
Ž them as implicit taxes Giovannini and de Melo, 1993; Alm and Buckley, 1997;
. Manne and Stephan, 1997 . Provided the absence of financial instruments and
government deficits in our model, BOP controls are equivalent to current account Ž
controls. Therefore, the capital controls are modeled as endogenous taxes or .
equivalently, foreign exchange premiums on international merchandise trade subject to the constraint that the net current account deficits should not exceed
their target levels in the scenario.
3.2. Numerical results ᎏ central case Ž
D M
. In the central case the Armington elasticities and
are, respectively, 8 Ž .
Ž . and 16, the utility discount rate is 5, and the crude oil supply elasticity is
1. Fig. 1 shows the implications of carbon Policies on regional BOP deficits with
and without capital flow constraints. Fig. 1a displays the magnitudes of the BAU projected exogenous capital flows in present-value dollars. It is clear that the oil
Ž .
exporting countries OEX are the major suppliers of international capital and that Ž
. OECD and the dynamic Asian economies DAS are the major demanders. It is
Ž .
also evident that all other regions, except the rest of the world ROW and the Ž
. dynamic South American economies DSM , are net borrowers in the international
capital market. In disposable income terms, these flows amount to 0.7 in OECD, 1.3 in FSU, 1.9 in CHN, 15 in OEX, 0.5 in DSM, 5.5 in DAS, and 1 in
ROW for the year 2000. Fig. 1b shows how the regional BOP deficits might evolve over time in the absence of capital controls if OECD were to adopt the carbon
abatement policy. Fig. 1b suggests significant capital outflows from OECD to the other regions during the first 15 years of the horizon. In particular OECD appears
to move from a major importer of international capital to a major exporter,
4
We estimate the carbon limit implied by Kyoto to 92.75 of the 1992 OECD emissions level.
M.H. Babiker r Energy Economics 23 2001 121᎐139 130
Table 1 A summary of the model’s parameters
Parameter Description
Value Comments
Low Medium
High
t r
The transformation elasticity
1 2
᎐ 1 for fossil fuels
2 for non-fossil fuels
E
Substitution between energy and
0.25 0.35
0.5 Increases gradually
t
non-energy in intermediate and from the short run to
final demand sectors the long run
O
Substitution between the oil᎐gas
᎐ 0.5
᎐ Non-fossil fuel
composite and coal in production production only
D
Armington substitution between
᎐ 2
᎐ Energy goods
domestic and imports 4
8 16
Non-energy goods
M
Armington substitution across
᎐ 4
᎐ Energy goods
imports 8
16 32
Non-energy goods
Fossil fuels supply elasticities 1
5 Crude oil
F r
᎐ 0.5
᎐ Coal
᎐ 1
᎐ Natural gas
G Labor supply growth rate
᎐ 2.5
᎐ Uniform growth case
᎐ 2.5
3.5 Different growth case:
2.5 for OECD and 3.5 for non-OECD
␦ The depreciation rate of capital
᎐ 7
᎐ Uniform across regions
stock
Investment own-period ᎐
0.4 ᎐
Uniform across regions maturation rate
The utility discount rate
0.03 0.05
0.07 Uniform across
regions
The coefficient of relative risk ᎐
2 ᎐
Uniform across Ž
. aversion CRRA
regions
whereas both DSM and ROW are now net importers of capital. In contrast, Fig. 1c shows how the regional BOP deficits might evolve in the presence of global
restrictions on capital mobility. It is clear from Fig. 1c that international capital flights are virtually sterilized in the first two decades during which the BOP
constraints are binding.
Next we investigate the patterns of global and regional leakage rates under the regime of capital flows vs. the regime of capital controls.
M.H. Babiker r Energy Economics 23 2001 121᎐139 131
Ž . Ž
. Fig. 1. Carbon tax, BOP deficits and capital flows: a baseline BOP deficits BAU ᎏ no carbon tax ;
Ž . Ž .
b BOP deficits: capital flows; and c BOP deficits: capital controls.
M.H. Babiker r Energy Economics 23 2001 121᎐139 132
Fig. 2. Capital flows and global carbon leakage.
Fig. 2 depicts the global carbon leakage profiles under these two regimes. In both regimes the leakage rate is high at the beginning of the horizon, but declines
gradually to reach a level of 10 by the end of the horizon. Such a time profile of leakage may be explained by the fact that the unilateral emissions cut in OECD
puts a downward pressure on the international crude-oil price in the early periods and thereby induces non-OECD regions to become more energy intensive. How-
ever, the strength of this pressure declines as the backstop technologies start to kick in gradually after year 2020. Compared to other studies, our average leakage
rate of 14 for the capital flows case is 2 higher than that reported in Babiker
Ž .
and Rutherford 1998 for the static version of the model, and 3 higher than that Ž
. reported in OECD 1992 for a similar parameterization of an EU unilateral
abatement initiative. With the capital controls in effect, in spite of the tightness of Ž
. the restrictions, Fig. 2 indicates that in absolute terms the global leakage rate is
at most only 1 lower than that in the case of capital flows. Furthermore, the figure shows a virtually complete convergence to the no-controls leakage profile by
year 2025. Hence, the upshot of Fig. 2 is the result that the global leakage profile is largely unaffected by the restrictions on capital flows.
Then, are the magnitudes and time profiles of the regional leakage rates affected by the presence of capital controls? The answer is provided in Fig. 3, where the
time profiles of regional leakage rates under the two regimes are depicted in Fig. 3a,b, respectively. Overall, the plots reveal only small downward shifts in leakage
M.H. Babiker r Energy Economics 23 2001 121᎐139 133
Ž . Ž .
Fig. 3. Capital flows and regional leakage rates: a regional leakage rates: capital flows; and b regional leakage rates: capital controls.
M.H. Babiker r Energy Economics 23 2001 121᎐139 134
profiles from their unrestricted levels during the first two decades. Indeed, without a careful look, it may be even hard to discern the differences between the two
plots. Therefore, not only the global leakage profile but also the regional leakage profiles are largely unaffected by the presence of capital controls.
Next we ask whether our result of the ineffectiveness of capital controls on carbon leakage is in fact dictated by the parameter values used in the central case.
The following subsection addresses this question. We shall see that this result holds regardless of the particular assumptions on the trade structure, the oil supply
elasticity, the utility discount rate, and the pattern of regional growth rates.
3.3. Sensiti
¨
ity analysis In assessing the sensitivity of the relationship between leakage and capital flows
to the alternative model parameters, we limit our focus to the global leakage rate. To ensure comparability across the different cases and the different parameter
values, we turn off the backstop technologies in all the sensitivity simulations. In relation to carbon leakage, the three crucial parameters in the model are the utility
discount rate, the two Armington elasticities, and the crude-oil supply elasticity. The utility discount rate affects the consumption profiles and the rates of return to
capital accumulation. By moving resources from consumption to investment, a low discount rate is likely to reduce the global leakage rate whereas a high discount
rate is likely to increase it. The Armington elasticities determine the scope for trade-induced carbon leakage: the higher the elasticities the more homogenous are
the traded goods and the greater the scope for leakage. The crude-oil supply elasticity determines the extent to which the international crude oil price falls in
response to the OECD carbon abatement policy. The lower the supply elasticity the greater the downward pressure on the international crude oil price and the
greater the scope for carbon leakage. Three experiments, one on each of these parameters, are included in the sensitivity exercise. In each experiment the global
leakage rate is computed for a low value and a high value of the particular parameter in both capital-flows regimes. For the Armington elasticities the low
values are 4 and 8 and the high values are 16 and 32, for the utility discount rate the low value is 3 and the high value is 7, and for the crude-oil supply elasticity
the low value is 0 and the high value is 5. In addition a fourth experiment is included to test the sensitivity of the result on leakage to the differences in
regional growth rates. In this experiment, we relax our baseline assumption that both OECD and non-OECD regions grow at the same rate. Since differences in
growth rates may affect leakage rates through altering the regional fossil fuel consumption profiles, it is possible that our result on the effect of capital restric-
tions on leakage may no longer hold. To test this conjecture, we calibrate the model on a new baseline with 2.5 growth rate in OECD and 3.5 growth rate in
all other regions.
Fig. 4 reports the sensitivity results of the four experiments. Fig. 4a shows the sensitivity of global leakage to the value of the utility discount rate in the case of
Ž .
Ž .
capital flows CF vs. the case of capital controls CC . We see that, in absolute
M.H. Babiker r Energy Economics 23 2001 121᎐139 135
terms, the maximum difference between the CF and the CC leakage profiles is only approximately 0.8 for either value of the discount rate. Hence, our basic result is
invariant to the value of the utility discount rate. Fig. 4b depicts the CF and the CC global leakage profiles for the low and the
high oil-supply elasticities. As is apparent from the graphs, the maximum discrep- ancy between the FC and the CC leakage trajectories is approximately 1.5 for the
low elasticity and approximately 1 for the high elasticity value. In addition, for both elasticity values, the two leakage profiles appear to converge to the same
trajectory by year 2030. This suggests that the crude-oil supply elasticity has no leverage on the relationship between carbon leakage and capital flows and there-
fore does not alter our basic result.
Fig. 4c reports the sensitivity story for the Armington elasticities. The maximum discrepancy between the CF and the CC leakage profiles is approximately 1
percentage point for the high elasticity values, and approximately 0.5 percentage points for the low elasticity ones. Furthermore, for both elasticity values the global
leakage rates converge to the same trajectory by year 2035. Hence, we may conclude that the relationship between leakage and capital flows is largely invari-
ant to the degree of homogeneity among the traded goods.
Finally, Fig. 4d shows, for the CF and the CC regimes, the global leakage profiles under the baseline assumption that non-OECD regions grow at a higher rate than
OECD. Not surprisingly, Fig. 4d indicates that the magnitude of the maximum divergence between the CF and the CC leakage profiles is only approximately 1.
Hence the result that carbon leakage is largely unaffected by the presence of restrictions on capital flows seems to be quite robust.
3.4. Some intuition At first this result may appear to be counter intuitive. The general intuition
would have it that carbon restrictions increase the costs of production and lower the rate of return to capital accumulation in OECD. This would cause capital to
outflow into non-OECD regions where investment rates would boom and as a result fossil fuel consumption profiles and hence leakage rates would also boom.
This intuition would mean that constraints in the international capital markets would stop these investment flows and cause leakage rates to fall drastically from
their otherwise unconstrained levels.
This reasoning misses at least three important points. First, the source of carbon leakage is not capital flows but mainly the movement of regional terms of trade
that follows the OECD abatement action. The presence of restrictions on capital flows does not reduce this initial effect and therefore does not affect the competi-
tive incentives that lead to the carbon leakage in the first place. Second, in a world with forward-looking optimizing agents, domestic regional savings will adjust and
undo any capital flow constraints without much effect on consumption profiles. An increase in investment rates funded by capital inflows merely imply a present
liability of high saving rates to maintain these high investment rates, as well as a future liability of repaying the debt plus the accrued interest. Therefore, these
M.H. Babiker r Energy Economics 23 2001 121᎐139 136
Ž . Fig. 4. Global leakage and capital flows: sensitivity to model parameters: a sensitivity to the discount
Ž .
Ž . Ž
. rate no backstop ; and b sensitivity to oil supply elasticity no backstop .
M.H. Babiker r Energy Economics 23 2001 121᎐139 137
Fig. 4.
M.H. Babiker r Energy Economics 23 2001 121᎐139 138
capital inflows do not represent any direct real increase in national purchasing power and accordingly the regional consumption profiles and hence the regional
emissions profiles should not be much affected by their presence. Third, to the extent that the non-OECD consumption profiles were actually constrained by the
presence of restrictions on international capital mobility, it is the non-fossil rather than the fossil fuel profiles that would mostly likely to bear the effect. This is
simply because the presence of carbon constraint in OECD lowers the relative prices of fossil fuels in non-OECD. In effect, these arguments suggest that leakage
is a self-financed process and does not really require any capital flows.
The irrelevance of capital flows to the issue of climate-change policies was also Ž
. found by Manne and Stephan 1997 in a somewhat different context. They have
looked at the determination of the optimal greenhouse gas abatement in a North᎐South Integrated Assessment model. With a ‘descriptive’ view of the world,
they have shown an invariant result that the Pareto-optimal amount of greenhouse abatement is virtually independent of the restrictions on capital flows. Though
their result mainly relates to the optimal spilt of investment between physical and environmental capital rather than to the consumption-saving decision, it has the
same implication to the current climate-change integrated-assessment models as ours to the current climate-change impact-assessment models. Both results imply
that the presence of restrictions on capital flows does not significantly alter the results obtained from these models.
4. Conclusion
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