Climate policy and economic dynamics : The role of substitution and technological change

The main objective of this thesis is to study the dynamic effects of a cap on carbon dioxide emissions on the economy. Questions that will be answered include: What is the effect of the emission cap on the optimal use of fossil fuels like coal, oil and gas? To what extent will emissions of greenhouse gases be shifted from countries subject to the Kyoto Protocol to countries that did not ratify this treaty? What is the role of carbon-saving technological change in this? Is announcement of climate policy, such that the economy has time to prepare, always a good thing to do? This thesis shows that taking into account the dynamic aspects of climate policy may reverse the conclusions found in static models. Taking into account that fossil fuels are non-renewable resources, it is shown that it might be optimal to substitute from cleaner towards more polluting fuels, and that announcement of climate policy might actually induce an increase in emissions in the period between the policy’s announcement and its implementation. A more positive conclusion, from the perspective of the proponents of climate policy, is that the current quantitative literature seems to overestimate the degree of carbon leakage (the increase in emissions by countries without climate policy, in response to the emission reduction by countries subject to a cap on emissions), as this literature does not take into account the effect that climate policy has on technological change. Furthermore, the role that technological change plays in mitigating the costs of climate policy might be underestimated in the literature, as the production functions of some models do not match with what we find empirically.