STRATEGIC OUTPUT AND GREEN TECHNOLOGY RIVALRY IN A GLOBALIZED WORLD: THEORY, EMPIRICS AND POLICY IMPLICATION. A Thesis

Transcription

1 STRATEGIC OUTPUT AND GREEN TECHNOLOGY RIVALRY IN A GLOBALIZED WORLD: THEORY, EMPIRICS AND POLICY IMPLICATION A Thess Presented to the Faculty of the Graduate School of Cornell Unversty n Partal Fulfllment of the Requrements for the Degree of Master of Scence by Sang Won Yoon August 2009

2 2009 Sang Won Yoon

3 ABSTRACT The concerns over deteroratng global clmate change have been leadng to the creaton of several global ntatves, such as the Clmate Change Conventon and Kyoto Protocol. However, the effects of those globally coordnated ntatves have been doubted snce ther advent, and research on the effectveness of those efforts has been a focus of global attenton. The purpose of ths paper s to examne the nature of the commons that arse from clmate changes, and nvestgate to what extent current market ncentves perform to reduce the emsson of greenhouse gases. The paper emprcally assesses the factors and condtons that affect the market ncentves n the current envronment, and ntends to provde an nsght nto the future nternatonal scheme for coordnated efforts. The basc premse of the paper s that the development of technology to stop global warmng can serve as an ncentve n and of tself. We develop ths technology drven approach n the framework of an open economy n whch there exsts strong domestc poltcal pressure for economc growth. Ths paper begns by examnng the needs to develop technology for the reducton of carbon emssons. Followng ths dscusson the paper presents a theoretcal model to examne f the desre for growth through nternatonal trade encourages nvestment n technology, and examnes how ths nduced level of nvestment relates to the globally effcent level of nvestment. Fnally, the paper emprcally nvestgates some of the determnants of technology nvestment usng cross country panel data over tme. In our theoretcal model we derve propostons that the level of technology depends on the degree of openness, the cost of developng green technology and the mportance whch a country places on materal growth and a clean envronment (the weghts assocated wth these tems n a country s welfare functon). Through our

4 emprcal studes, we frst examne the potental explanatory varables that affect both welfare weghts and technology development cost, and then choose the level of ncome, unemployment rate, degree of openness, number of ratfed major envronmental conventons, degree of democracy and regonal peer effect as a set of mportant soco-economc explanatory varables that nfluence the level of technology. Our theoretcal dervatons suggest that the degree of openness has a postve effect on stmulatng nvestment n clean technology, whle factors affectng the welfare weght on materal progress are lkely to have a negatve effect. The factors affectng the development costs also need careful attenton. We can summarze our emprcal fndngs as follows. Frst, we fnd the degree of openness s related to the degree of the green technology development. We fnd that countres that have been under hgh growth pressure do not necessarly confrm ths relatonshp. However, when we consder the dfferent openness measurement, the Sachs and Warner openness measure, t seems that degree of openness s postvely related to the development of green technology.. Second, we fnd that unemployment rate has negatve nfluence on developng green technology and the degree of nfluence depends on the stage of economc development. Thrd, we fnd that the degree of democracy has dfferent effect on developng green technology for countres wth dfferent level of ncome. For example, we fnd that the degree of democracy for hgh ncome countres has a negatve effect on the technology nvestment. However, n hghly developng countres, we fnd postve effects. Fourth, we show that there are regonal peer efforts on developng the green technology n certan regons. For nstance, we fnd that the European regon wth shared cultural hertage shows a postve peer effect on developng the green technology. However, we fnd the opposte effect for the North Amercan Regon. Ffth, we fnd that two

5 most recent conventons such as the UNFCCC and the Kyoto protocol have postve effects on developng the technology. Ths mples that the exogenously gven welfare weght on envronment through the major conventon dummes that countres have sgned and ratfed affects the development of technology n a postve way. Fnally, the polcy mplcatons from our examnatons are not straghtforward. In the absence of coordnated efforts, each country has dfferent ncentves for the nvestment n clean technology and the ncentve compatble mechansm to allocate the burden of developng world optmum technology would be extremely dffcult. Those countres wth certan favorable characterstcs wth the hgh degree of openness, low development cost and greater revealed preference for clean envronment may lead the nvestment whle the rest of the world follows leaders ntatves. These propostons however need further scrutny and research n the future.

6 BIOGRAPHICAL SKETCH Sang Won Yoon was born n Seoul, South Korea. He attended the Korea Unversty for hs undergraduate studes n Economcs. Pror to comng to Cornell Unversty for pursung hs Master degree, he had served as a KATUSA (Korean Augmentaton To the Unted States Army) and honorably dscharged recevng Army Commendaton Medal.

7 ACKNOWLEDGMENTS I would lke to acknowledge the graduate faculty and staff of the department of Appled Economcs and Management at Cornell Unversty for ther superor mentorshps and gudance over the past two years. In addton, I would lke to show my deepest apprecaton to my advsor Professor Nancy Chau who has guded my thess from the very early stage. I also would lke to express my ndebtedness professor Hazem Daouk who I learned much about emprcal analyss. Lastly, I would lke to thank my parents and my wfe Soyeon Cho to whom I owe many of my valuable experences at Cornell. v

8 TABLE OF CONTENTS BIOGRAPHICAL SKETCH... ACKNOWLEDGEMENT... v TABLE OF CONTENTS... v LIST OF FIGURES... v LIST OF TABLES... v Chapter INTRODUCTION.... Background and Scope of Thess....2 Internatonal Efforts on Clmate Change The Creaton of UNFCCC Kyoto Protocol Implcatons of Internatonal Cooperaton Proposals to Kyoto Protocol Purpose of the Thess Organzaton of the Thess... 9 Chapter 2 MODEL Background Model Descrpton Theoretcal Analyss of Model Equlbrum n the Output market when Margnal Cost of Abatement s rsng Non-Cooperatve Equlbrum Level of Investment Ineffcency of Non-Cooperatve Equlbrum Green Technology Reconsdered The Effect of a Change n Degree of Openness The Effect of a Change n Development Cost The Effect of a Change n Welfare Weght Polcy Implcaton Issue Remaned Open for Dscusson Chapter 3 EMPIRICAL MODEL AND ANALYSIS Motvaton Lterature Revew v

9 3.3 Emprcal Model Descrpton Testable Hypotheses Econometrc Estmaton Data Analyss Dependent Varable Explanatory Varables Results Degree of Openness Unemployment Regonal Peer Effect Conventon and Protocol Dummes Degree of Democracy Chapter 4 CONCLUSION APPENDIX REFERENCES v

10 LIST OF FIGURES Fgure 2. Best response curves and output determnaton... 4 Fgure 2.2 Comparson between World optmal and Nash Equlbrum Technology Level, where c '( k ) Fgure 2.3 Comparson between World optmal and Nash Equlbrum Technology Level, where c '( k ) Fgure 2.4 Increase n profts when k changes from k to k ' Fgure 2.5 Strategc Substtutes s and s Fgure 2.6 Welfare Weght and Equlbrum Technology Level Fgure 3. CO2/GDP change over tme for hgh ncome countres Fgure 3.2 CO2/GDP change over tme for non-hgh ncome countres Fgure 3.3 CO2/GDP change over tme for BRICs Fgure 3.4 Unemployment rate for all countres and CO2/GDP... 5 Fgure 3.5 Unemployment rate for hgh ncome countres and CO2/GDP Fgure 3.6 Unemployment rate for non-hgh ncome countres and CO2/GDP Fgure 3.7 Unemployment rate for BRICs and CO2/GDP Fgure 3.8 Mean CO2/GDP comparsons for Seven Regons Fgure 3.9 CO2/GDP change after ratfcaton of UNFCCC Fgure 3.0 CO2/GDP after ratfcaton of the KYOTO protocol Fgure 3. Degree of democracy for all countres and CO2/GDP Fgure 3.2 Degree of democracy for hgh ncome countres and CO2/GDP Fgure 3.3 Degree of democracy for non-hgh ncome countres and CO2/GDP Fgure 3.4 Degree of democracy for BRICs and CO2/GDP v

11 LIST OF TABLES Table 3. Summary of CO2/GDP Table 3.2 Summary of Degree of Openness Table 3.3 Summary of Unemployment rates Table 3.4 Summary of Regonal CO2/GDP dfference Table 3.5 Summary of degree of democracy... 6 Table 3.6 Specfcaton test for the base model Table 3.7 Regresson results for Pooled model and Random effect model v

12 CHAPTER INTRODUCTION. Background and the Scope of Thess Most problems of publc goods, both at a domestc and global level, are created when there s a falure to meet the socally optmal supply of publc goods. A free-rdng ssue has been consdered a major lmtaton of publc goods and ths freerdng problem arses because there s an ncentve obtaned by dong so, resultng n a falure to meet the supply level. In ths respect, a government s mostly a major suppler of domestc publc goods. As an example, natonal securty of one country s a publc good n that t has characterstcs of non-rvalry and non-excludablty. A person n the country cannot be excluded from the natonal securty servce provded by the supplers and no one has to compete wth others for the servce. Therefore, n most countres, a government s n charge of supplyng the natonal securty servce by collectng taxes from taxpayers and provdng t accordng to the necessty of the servce. Here one queston arses. Who should be a suppler of the commons such as fresh ar, whch exsts and moves trans-natonally? 2 In other words, f ar was polluted beyond the capacty to purfy, who should be responsble for cleanng up the ar? In addton, what f one or more countres make an effort to recover the polluted commons, but other free-rders just enjoy the result and deterorate the ar for ther own nterests wth the expectaton that other countres wll pck up the slack? How and The goods that have rvalry and non-excludablty 2 Unted Natons Development Programme (UNDP) refers to ths type of publc good as Global Publc Good (GPG) and defnes GPG as follows; Goods ("thngs") whose characterstcs of publcness (nonrvalry n consumpton and non-excludablty of benefts) extend to more than one set of countres or more than one geographc regon and don't dscrmnate aganst any populaton groups or generatons (present and future) are global publc goods. UNDP refers ozone sheld and atmosphere to as so-called pre-exstng" global publc goods. See

13 who wll manage those problems and control ncentves of free-rdng? Ths paper focuses on clmate change, a problem ncurred due to the characterstcs of the ar as the commons. We frst survey global efforts to solve ths clmate change problem n more detal and then present a theoretcal model to provde better nsghts nto the relatonshp between nternatonal trade and global warmng. We derve some theoretcal propostons on the ncentves to develop clean technology n an open economy and explan how to test those propostons emprcally. We also ntroduce a set of potentally mportant determnants of green technology nvestment and specfy a testable model. A detaled explanaton of emprcal analyss s presented along wth the drecton of further research..2 Internatonal Efforts on Clmate Change.2. The Creaton of Unted Natons Framework Conventon on Clmate Change Controversy among scholars has arsen over the problem of clmate change. Snce ths clmate change s closely lnked to the overall vablty of lvng thngs on earth, ths ssue of who and how to clean and mantan ths global publc good-ar, has been the center of attenton wth several dfferent proposals and responses. However, most scholars have agreed on the need for more effectve, globally cooperatve responses to the ssue. In fact, t was the early 970s when envronmental ssues soared as a sgnfcant agenda for countres, especally for developed ones. In 972, the Rome Club ponted out the sgnfcance of envronmental conservaton by publshng the report, The Lmts of Growth. Ths report led, n 988, to the creaton of the World 2

14 Meteorologcal Organzaton and the Unted Natons Envronment Program. Meanwhle, the Intergovernmental Panel on Clmate Change (IPCC) has begun ts actvtes under concerns of scentfc evdence regardng global warmng (Roh (2005)). The Unted Natons Framework Conventon on Clmate Change, whch was ntated n 992 as one of the agreements through whch countres are bandng together to solve the global warmng problem, entered nto force on 2 March The Conventon on Clmate Change sets an overall framework for ntergovernmental efforts to curb the challenge posed by clmate change (UNFCCC (2006a)). In lne wth the consderaton of economc development level and hstorcal amount of CO2 emssons, UNFCCC tred to dvde countres nto several groups that share smlar nterests and stuatons. However, dvdng the world nto two groupsdeveloped and developng countres-for settng up rules for each group s much rsker than one mght guess. Ths s because almost every country has dfferent nterests ncludng varyng economc and poltcal concerns such that reachng consensus would become a huge tme-consumng or perhaps never-endng task. Despte ths obstacle, UNFCCC classfes ts sgnatores nto three groups; Annex 4 (ndustralzed countres), Annex 2 5 (developed countres whch pay for costs of developng countres) and Non-Annex. Even though the Conventon was successful n the respect that t made the world recognze the global clmate change problem makng 88 countres jon as of 3 As of November 2006, 89 Partes had ratfed the Conventon. 4 Australa, Austra, Belarus, Belgum, Bulgara, Canada, Croata, Czech Republc, Denmark, Estona, Fnland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Latva, Lechtensten, Lthuana, Luxembourg, Monaco, Netherlands, New Zealand, Norway, Poland, Portugal, Romana, Russan Federaton, Slovaka, Slovena, Span, Sweden, Swtzerland, Turkey, Ukrane, Unted Kngdom, Unted States of Amerca 5 Australa, Austra, Belgum, Canada, Denmark, Fnland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Span, Sweden, Swtzerland, Unted Kngdom, Unted States of Amerca 3

15 today (Barrett (2003)), t could not suffce for the purpose of reducng actual greenhouse gas emsson levels. Accordngly, countres under the Conventon realzed the necessty of a much stronger ntatve, whch led the creaton of the Kyoto Protocol..2.2 Kyoto Protocol As one of the major achevements of the Conventon mentoned above, whch entered nto force n 994, the Kyoto Protocol was adopted n order to legally bnd 6 partes to lmt or reduce ther emssons of sx greenhouse gases n 997 (OECD (2005)). In February 6 th 2005, the Kyoto Protocol, an nternatonal agreement to reduce GHG emssons of the world, was joned by more than 4 world countres. Ths was a great mlestone, because n order to be effectve, the Kyoto Protocol must be supported by more than 55 countres and also by countres that account for more than 55 percent of world CO2 emssons. Ths target seemed mpossble at frst because the US, the largest emtter, had wthdrawn from t n 200. However, Russa s ratfcaton of the Kyoto Protocol n 2004 made ths target a realty. Ths Protocol has set up emsson targets for each country but there are dfferences n grades even though the overall target s reducng at least 5 percent of CO2 emssons durng 2008~202, compared to the level of the year 990. For example, durng ths perod, the EU has to reduce 8 percent, the US 7 percent, Japan and Canada 6 percent respectvely, and Australa has to reduce 8 percent of ther CO2 emsson levels. There are addtonal targets n detal for other greenhouse gases and other mechansms have been studed and mplemented n order to secure flexbltes 6 Legally bndng reductons n greenhouse gas emssons of an average of 6 to 8% below 990 levels between the years , defned as the frst emssons budget perod 4

16 for countres. Also, one mportant fact s that developng countres are exempted from these responsbltes for the frst perod of the Kyoto Protocol n order to gve them more tme to prepare for those responsbltes and also to gve them more chances to ndustralze ther economes whle developed countres have to sacrfce ther economes to some extent. However, t s a far decson n a sense that only 25 countres account for about 83 percent of global emssons whle the remanng 40 countres contrbute only 0 percent of annual emssons and those are normally least developed countres (UNFCCC (2006c)). In addton to the emsson target, the Kyoto Protocol provdes three mechansms to reach the target level effcently. These three mechansms are; Internatonal Emssons Tradng, Jont Implementaton, and the Clean Development Mechansm. The Internatonal Emssons Tradng system allows ndustralzed countres to trade ther emsson amounts wth developng countres n the nternatonal market, and Jont Implementaton allows countres to jontly develop projects that can reduce the emsson level. The Clean Development Mechansm serves to make developng countres develop clean technologes more effcently by makng ndustralzed countres ad developng countres fnancally n the producton of such technologes (Barrett and Stavns (2003))..3 Implcatons of Internatonal Cooperaton When the UNFCCC was created and the Kyoto Protocol was ratfed, there was great hope and expectatons that they would act as key drvers for reducng CO2 emssons curbng global clmate change. A few years later, many people now queston the effectveness of those regmes n the respect that recent emsson trends do not 5

17 look postve. Even though there are downward trends, they are manly due to economes n transton, not because of those greater emtters who should be responsble for the clmate change. Rather, the emssons n most responsble countres have been ncreasng contrary to the expectaton. One possble explanaton s that those responsble countres ncreased ther emsson levels on purpose, consderng that t would be much more benefcal f they emt as much as possble before the actual Kyoto mplementaton terms come nto effect n order to boost ther economes to the utmost. It could then be consdered an example of the tragedy of commons. In addton, commtted countres mght not consder those regmes as bndng thnkng that they could wthdraw whenever t s necessary, as shown n the US case. It s stll early to say that the Kyoto protocol has faled snce the actual commtment perod has not come yet. The data gathered from mples that much stronger acton s mperatve snce to date there has not been much mprovement. Mchael Porter argues that tougher standards trgger nnovaton and upgradng, accordng to hs research (Porter (99)). Also, the chef scentst at the World Bank, Robert Watson, sad n the conference Make markets work for clmate n Amsterdam, that spendng needed to reduce heat-trappng emssons wll cost less and offset bgger damage n the future. He also ponts out that an ncrease n temperatures by 2-3 degrees Celsus could lead to a loss of global economc growth by up to 3 percent and the costs of nacton could run between tens to hundreds of bllons of dollars a year (Yereth (2006)). Wth the recognton of ths fact, tougher standards for stronger actons could be ntroduced beyond the Kyoto Protocol. 6

18 .4 Proposals to Kyoto Protocol Throughout the decade, many scholars have suggested varous ways to desgn nternatonal envronmental conventons mechansms more effcently. Some scholars focused on developng green technology jontly. Benedck (200) suggested that there should be technology development ncentves to reach the Kyoto Protocol s target level. For creatng the ncentves he suggested there should be an nternatonal polcy to ad the development of the clean technology such as carbon tax. Barrett (2003) suggested a smlar dea n terms of developng green technology n a cooperatve manner. In addton to ths, he proposed to ntate R&D protocol so as to stmulate the development of the technology n a collaboratve way. Some scholars focused on mposng nternatonal taxes on carbon. Cooper (200) suggested that there should be a carbon tax to all partcpatng countres wthn the regme. Hs proposal was somewhat dfferent n that he dd not dfferentate developng and developed countres. He recommended that to reach a target level effectvely domestc tax on the use of carbon should be the same throughout countres. Others were more attentve to ncreasng the partcpaton n and deepenng the commtment to envronmental conventons. Vctor (200) suggested that we should allow countres to buy and sell unlmted emsson allowances at an agreed prce. He argued that t wll render market orented ncentves to all partcpatng countres and promote ther commtment to the nternatonal regme more effectvely. Lastly, some argued that we need to allocate more of the burden of reducng emssons to developng countres. Aldy, Orszag and Stgltz (200) and Stewart and Wener (200) suggested that developng countres should be more actvely partcpatng to reach the target level. 7

19 .5 Purpose of the Thess Despte all these theoretcal and emprcal dscussons, there have been no sgnfcant attempts to evaluate market outcomes that provde nsghts nto the relatonshp between nternatonal compettveness and global warmng. Therefore, ths paper ntroduces a theoretcal framework where the strategc nvestment polcy of each country can be examned n a model of nternatonal trade. For many years, although scentsts have been warnng of these clmate changes for some tme, people have gnored clmate change ssues snce they focused on the ndustralzaton of ther economes. Now, wth the great concern on future lfe, nternatonal efforts n varous sectors to curb the severe clmate change have been made ncludng the Kyoto Protocol. However, the dffculty assocated wth effcent provson of the global publc goods has often been emphaszed by many promnent scholars (Barrett (2003); Karp and Zhao (2008) among others)), and mplementaton mechansms are suggested. We however take a dfferent approach to global clmate change problems by nvestgatng to what extent the commons of a clean envronment s provded by the nvestment race of each country to maxmze welfare through the development of green technology. Ths welfare conssts of the weghted sum of profts from prvate frms whch engage n nternatonal trade, and the utlty from a country s domestc envronment. The model then offers a testable hypothess on the determnants of the level of nvestment n clean technology and can be used to derve polcy mplcatons. 8

20 .6 Organzaton of the Thess Chapter 2 presents the model that could be consdered as a basc framework to examne the relatonshp between nternatonal trade and global warmng. In the model two representatve prvate frms compete n the global market and greenhouse gases are emtted from the producton process. The government from each country ntervenes to develop green technology whch may reduce both producton cost and emsson of gases. The nvestment race between two countres s explaned as a noncooperatve equlbrum and some testable propostons are derved from the comparatve statc analyss of equlbrum. Chapter 3 presents an emprcal analyss of the determnants of nvestment n clean technology. It reports the result of emprcal estmatons of the mportance of explanatory varables such as the degree of openness, unemployment rate and ncome level. Concludng comments are provded n Chapter 4. 9

21 Chapter 2 MODEL 2. Background Although there has been a consensus among scholars on the sgnfcance of the clmate change problem and the necessty of global efforts to curb global warmng, the controverses over the way to solve the problem have contnued. Even after the regme for clmate change was ratfed, many scholars from a number of dfferent felds have stll been proposng alternatve optons and assertng the need for redesgnng the current regme. Martn I.Hoffert et al. (2002) argued that the clmate change problem s an energy problem, hence research and development on technology optons to fnd an alternatve way of usng energy s necessary. Barrett (2006) also argued that t s mmnent for us to nvest n developng breakthrough technologes so as to curb global warmng and guarantee sustanable development snce the current Kyoto protocol approach does not provde any mechansms that lead to the research and development of green technologes. He addtonally argued that only the advanced technologes that have an ncreasng return to scale would perform better n the current anarchc nternatonal communty. In ths secton, we ntroduce a non-cooperatve theoretcal framework where we can examne a level of nvestment n clean technology for each country. We derve a seres of emprcally testable theoretcal propostons. 0

22 2.2 Model Descrpton We examne a two-stage game theoretc model of the nternatonal competton among natons whch conssts of the compettve race of government nvestment n envronment technology to clean the polluted ar, and output competton n the fnal stage. The model s based on the assumpton that emssons of greenhouse gas (carbon doxde) affect the welfare of neghborng country as ar moves across the border between tradng countres. For expostonal convenence, we assume that there are two countres ( and 2), and two representatve frm and 2 for each country, whch compete n the world market for exports whle producng at ther home countres. The producton of one unt of outputs necesstates the polluton of envronment and ncreases co2 emsson by k. If we denote the output of each frm by y, the remanng clean ar for each country can be expressed as A B k y k j y j for, j = and 2. B can be nterpreted as utlty derved from clean ar measured n a monetary term. We also assume that the demand for the output n the world market s gven by P a by (where y= y y 2 ), and two frms compete n the quantty of the homogeneous output. We assume that the margnal producton cost of each frm s gven as c( k ) for,2. Then the proft of each frm s then defned as a b( y y ) y c ( k ) y (where,2 ) (2.) 2 Natonal welfare of each country s a functon of profts and supply of clean ar. Let us assume that socal welfare s expressed as weghted average of profts and

23 clean ar, weght on profts beng for each country. s n general decded by poltcal process wthn the country. The socal welfare then s defned as follows n the open economy; (2.2) W ( ) A (,2 ) 2.3 Theoretcal Analyss of Model Throughout the paper, we assume that the margnal producton cost s constant once the co2 emsson level s gven. However, the prvate margnal cost born by each frm depends on k as the abatement cost depends on the polluton level. If the margnal abatement cost ncreases, we have c( k ) 0. However, f the green technologes to conserve energy and generate clean energy at an ndustral level become cost effectve to encourage ther applcaton, the cost functon can have dfferent property. For example, Barrett (2006) emphaszed that the wde-spread use of breakthrough technology such as hydrogen-fuel motor would open the avenue for the green technology. ICT ntensve technology whch s devsed to save energy may actually become a cleaner technology. In ths sense, we can safely assume that c '( k ) 0 n the presence of green technologes Equlbrum n the Output market when Margnal Cost of Abatement s rsng We frst examne equlbrum of our game when the margnal abatement cost s decreasng n k. It used to be the case often quoted as the source of free-rdng 2

24 ncentve. The profts of each frm s (2.5) (2.6) [ a b( y y ) c ( k )] y 2 [ a b( y y ) c ( k )] y It s straghtforward to see that the Nash-Cournot equlbrum output can be expressed as follows: (2.7) (2.8) a 2 c ( k) c2( k2) y ( k, k2) 3b a c ( k) 2 c2( k2) y2( k, k2) 3b Proposton c( k) c2( k2) y ( k, k2) Assume that 0 and 0. It then follows that 0 y ( k k2 k j k, k2) 0 for jand, j and 2 k and Proposton shows that when the margnal cost of reducng CO2 ncreases n k, the output level of home (compettor) country ncreases (decreases) wth states that n the absence of welfare weght on clean envronment, there exsts no mechansm n the market to curb global warmng. k. It 3

25 y 2 Best response curve f ( y ) 2 Isoproft for frm 2 Isoproft for frm Best response curve f ( y ) 2 y Fgure 2. Best response curves and output determnaton and c2( k 2). Fgure 2. descrbes how the equlbrum output gven emsson cost c( k ) When we assume c'( k) 0 and c2'( k2) 0, and when both frms decde to reduce CO2 emsson best response curve for each frms shfts nward leadng the decrease n the output producton snce the producton cost ncreases. We note that as k ncreases, the margnal cost decreases and the best response curve shft outward to produce a new equlbrum where the market share of frm s ncreased. We now extend the model by ncorporatng the strategc determnaton of nvestment n reducng CO2 emsson technology by each government. Gven the welfare weghts and level of technology, we can express welfare objectve of each country by nsertng equlbrum output levels from (7) and (8). Let W ( y ( k, k j ), y j ( k, k j ), k, ) for, j =, 2 denote such welfare levels. 4

26 Let D D ( k ( s )) for =, 2 be cost assocated wth technology level, where k ( s ) k s for = and 2. In addton, the technology development cost denoted as D( s ) s assumed to be an ncreasng convex functon of D country s assumed to be concave n s. That s, 0 s s and the welfare for each 2 D and 0 for =, 2. 2 s Non-Cooperatve Equlbrum Level of Investment Now consder a non-cooperatve equlbrum level technology wth the world optmum. Here we express world welfare as a functon of s and s 2. Frst, the welfare functon for both countres can be wrtten as follows: (2.9) W s s2 y k s k2 s2 y2 k s k2 s2 (, ) ( ( ( ), ( )), ( ( ), ( )) ( )( B k( s ) y( k( s ), k2( s2)) k2 s2 y2 k s k2 s2 ( ) ( ( ), ( )) ( y ( s, s ), y ( s, s )) ( )( B s y ( s, s ) s y ( s, s )) W ( s, s ) ( y ( k, k ), y ( k, k )) ( )( B k y ( k, k ) k y ( k, k )) (2.0) ( y ( s, s ), y ( s, s )) ( )( B s y ( s, s ) s y ( s, s )) We frst consder non-cooperatve determnaton of technology level of each country. Each country decdes ts best response by maxmzng welfare net of costs assocated wth technology level. In fact, gven k and k 2, country and 2 determne best response from the followng equatons: d( W D ( s )) (2.) ds 5

27 W ( y( s, s2), y2( s, s2)) y ( s, s2) y ( s, s ) s 2 W ( y( s, s2), y2( s, s2)) y2 ( s, s2) y s 2 W ( y ( s, s ), y ( s, s )) D s s '( ) 0 d( W2 D2 ( s2)) (2.2) ds 2 W2( y( s, s2), y2( s, s 2 )) y2 ( s, s 2 W) ( y ( s, s ), y ( s, s )) y ( s, s ) y( s, s ) s y s W ( y ( s, s ), y ( s, s )) D s2 s2 '( ) 0 By solvng the best response curve for each country we can derve the equlbrum technology levels for each country and 2. Let us denote the noncooperatve equlbrum technology level as ŝ and ŝ 2. We examne comparatve statc results of ths equlbrum n the later n ths chapter Ineffcency of Non-Cooperatve Equlbrum Now we consder the world optmum technology level. World welfare functon s defned as the sum of two domestc welfare functons. Let us denote t as * W ( s, s2;, 2). Therefore, (2.3) * W s s2 2 y s s2 y2 s s2 B s y s s2 s2y2 s s2 (, ;, ) ( (, ), (, )) ( )( (, ) (, )) ( y ( s, s ), y ( s, s )) ( B)( s y s ( s, ) s y s( s, ))

28 Here agan we consder technology development cost for the world. Therefore the welfare net of technology development cost can be wrtten as * W y s s2 y2 s s2 D s D2 s2 ( (, ), (, )) ( ) ( ) If we assume that there s an nternatonal authorty to govern the world, the world optmum technology level for both countres would be selected so as to maxmze the world welfare. Thus, the world optmum technology level can be derved by smply takng the frst order condton of the world welfare functon wth respect to s and s 2. Let us denote the world optmum level of reducton n CO2 as * s and * s 2. Recall that welfare functon for each country s concave n and the world level of technology s decded by solvng the equatons below: s (,2 ) (2.4) (2.5) W W2 D ' 0 s s W W2 D 2 s2 s2 ' 0 A natural queston to ask s whether there exsts any dvergence between the world optmum level of nvestment and non-cooperatve equlbrum level. Ths queston can be examned by smply comparng the level of the world s optmum technology wth the Nash equlbrum level. Before begnnng our analyss, let us assume that country 2 decded to take the offer from the World Authorty, say World Bank or UN so that ther technology level s fxed to s * 2. Then we have 7

29 ( W D ) W2 (2.6) where W2 W2 ( y, y2, s, s2) s s We also know from smple chan rule that, (2.7) W W y W y s y s y s where y and y 2 s selected through second stage Cournot compettons that descrbed earler. Therefore, (2.8) W 2 2 y 2 y 2 2 ( ) (, 2) k y y s s k y k2 s y s y2 s s s s The frst term expresses the effect of ncreased effcency of country on the profts of country 2. The second term denotes the resultng welfare effects of country 2 when the country reduces emsson of greenhouse gas. 2 y k y 2 y Snce 0, y( s, s2) 0, k2 0 and k 0 the sgn y s s s s W 2 of s not obvous. Therefore t s not apparent whether non-cooperatve s technology level falls short of the world level. W2 However, there are certan cases where the sgn of s unambguous. Let s us consder the symmetrc case for both countres and 2. That s, ntal level of drty ar for both countres and tax cost for both frm n country and 2 are exactly the same. We can wrte the condton as follows:. 8

30 (2.9) k k2 (2.20) c( ) c2( ) Recall the Cournot output equlbrum, the equaton (7) and (8) a 2 c ( k) c2( k2) y ( k, k2) 3b a c ( k) 2 c2( k2). y2( k, k2) 3b Therefore, (2.2) W2( s, s2) s 2 ( ) 2 ( ) ( ) c k y2( k, k2) ( ) y( k, k2) k k c s c s k 2 3 k s 3b s 3b s 2 a c ( s ) 2 c ( s ) 2 k k c ( s ) ( ) y ( k k ) , 2 b b s a c a c c( s) ( ) k b b b s W2 a c k c ( s ) For to be postve we need a condton and a c 0. s 3b 3b s 3b c ( s) Snce we assumed that 0, and we know from our demand functon that the s ntercept s a so that t should be larger than c, the comparson between ŝ and * s s as follows: If c ( s ) 0 c a ( W D) and ths mples that 0 so that s 3k s ŝ s. * 9

31 ( W D) * ŝ Fgure 2.2 Comparson between World optmal and Nash Equlbrum Technology Level, where c '( k ) 0 s s Proposton 2 Suppose c '( k ) 0, D '( s) 0 and D ''( s) 0 for,2, then n the symmetrc case where two countres faces the same technology and envronment under the same welfare weghts, non-cooperatve equlbrum level of nvestment n technologcal development falls short of world optmum level Green Technology Reconsdered Consder now the case that the producton method, whch pollutes less amount of envronment, s more effcent n the sense that t uses less energy. We can thnk of ICT (Intensve Producton Technology), whch economzes on energy, materal and tme etc. Then, our assumpton on c '( k ) changes n the opposte drecton so that greener technology gans the compettve advantage. In other words, 20 c '( k ) 0. Then the proposton changes accordngly so that the country whch uses y k j 0 for

32 y j and 0 for j. Nevertheless, the sgn of equaton (8) however k j becomes ndetermnate agan. However, we can agan consder the perfectly symmetrc case for both countres and 2. That s, f equalty (9) and (20) holds, for W s 2 to be postve we need a condton a c k c ( s ) 0. 3b b s c( s) c a That s, t must hold. s 3k W2 For to be negatve, however, opposte nequalty must hold. As s mentoned, we know from our demand functon that the ntercept s a so that t should be larger than c. cases. Therefore the comparson between ŝ and * s depends on two dfferent c a c( s) ( W Case. D) 0, whch mples that 0 so that 3k s s ŝ s * c( s) c a ( W D) * Case2. 0, whch mples that 0 so that ŝ s s 3k s To llustrate our pont graphcally, we can draw a concave functon for ( W D) wth respect to s gven * s 2. 2

33 ( W D) a b c s Fgure 2.3 Comparson between World optmal and Nash Equlbrum Technology Level, where c '( k ) 0 From Fgure 2.2, we know that pont b s non-cooperatve technology level and pont a and c are canddates for world optmum technology level for country gven country 2 s world optmum technology level Thus, n the perfectly symmetrc case where equaton (9) and (20) hold, we know that the world optmum technology level s dfferent from non-cooperatve equlbrum technology level and the dfference depends on the relatve magntude of c a c( s) and. 3k s Now let us consder the elastcty of cost wth respect to CO2 emsson. d ln c( k) The elastcty s wrtten as. From the defnton of the elastcty we dln k know the followng: * s 2. (2.22) c '( k) k c( k) Therefore, over and under nvestment of the technology depends on the followng nequaltes. 22

34 Case. Case 2. a ck ( ) 3 a ck ( ) 3 In case, non-cooperatve determnaton results n over nvestment on technology level than the world optmum level and, n case 2, under-nvestment. We state ths result n the followng proposton. Proposton 3 Suppose c '( k ) 0 for,2. Then n the symmetrc case where two countres faces the same technology and envronment under the same welfare weghts, the world optmum technology level and non-cooperatve equlbrum for technology level depends on elastcty of the cost wth respect to k. Dependng on the a a nequalty ck ( ) or ck ( ) 3 3, overnvestment or undernvestment can preval. Consder the case when c ( k) tk where t>0. The elastcty then equals to. If we apply proposton 2, then under-nvestment prevals dependng on a c( k). 4 The ntuton behnd the proposton 3 s that when the avenue of green technology s open and avalable, t s lkely that the government have to nvest more aggressvely to gan the nternatonal compettveness. It s also sustanable poltcally snce t upgrades the domestc envronment as well. In the certan case that we examned n the Proposton 3, ths ncentve may be greater that the ncentve for free 23

35 rdng. The proposton 2 and 3 are vald only when two countres are n the symmetrc stuaton. If the dfference between the two countres s large enough, the model may need to be changed to reflect asymmetrc postons as n the model of leader-follower n the olgopoly market. However, we do not pursue ths topc n our thess. We now attempt to derve some theoretcal propostons that have polcy mplcaton. Although the comparatve statc analyss of the Nash equlbrum level of nvestment wth respect to exogenous varables such as degree of openness, welfare weghts and the cost of development s complcated, we here attempt to sketch the underlyng reasonng and use t to derve some testable hypothess n the next chapter. These propostons wll be tested n the next chapter The Effect of a Change n Degree of Openness Degree of openness s an mportant determnant of technologcal nvestment. Suppose c '( k ) 0 as n the proposton 3. We compare the margnal effect of a change n k on domestc profts and utlty from clean envronment before and after the economy opens. When there s no trade between the two countres, the effect of greener technology for country s confned to an ncrease n domestc monopoly profts and changes n harmful effect on envronment, whch s captured as d k y( k). dk However, when the economy opens, the effect of greener technology on the profts of domestc frm s realzed through an ncrease of the market share of the domestc frm n the nternatonal duopoly market. Snce the perceved margnal 24

36 revenue n the world duopoly market s greater than the margnal revenue of monopoly frm n the closed domestc market, the proft effect becomes greater than n the closed economy. We sketch the underlyng reasonng n a smple model wth two symmetrc countres. We frst explan that the perceved margnal revenue for the duopoly frm n the open economy has a lower slope than the slope of autarky. Although ths does not hold generally, t s true n the symmetrc case where the ntercept of demand functon and output levels are the same for both frms. Suppose that the frm n the closed economy faces the demand functon p a by. Then the world demand functon for b frms that operate at an open duopoly economy becomes p a y for symmetrc 2 case where a a2 and y y 2. The margnal revenue for domestc monopoly s a 2by so that the monopoly output becomes ( a c) for any cost level c. On 2b the other hand, the perceved margnal revenue for frm n an open economy becomes (2.23) b d a ( y y ) y 2 dy 2 b y b 3b a by y2 a b y a y where y denotes world output and each frm produces half of t. The resultng output 3b for the duopoly frm s derved from the half of the world output, a y c, 4 4( a c) namely y. 3b 4( a c) Therefore the output of a duopoly frm becomes y, whch s 6b greater than the domestc monopoly output n the autarky. Suppose now that c '( k ) 0 and symmetrc frms exst facng the same 25

37 market demand as we stated above. Fgure 2.4 shows the beneft of trade for frms when ther perceved margnal revenue moves outward as the economy opens. When the margnal cost for producton at country decreases from c( k ) to c( k '), the resultng ncrease n proft changes from [abde] to [acdf] as the economy opens. Prce a b c c( k ) d e f c( k ') MR (autarky economy) MR (open economy) Output Fgure 2.4 Increase n profts when k changes from k to k ' Furthermore snce the output of the compettve foregn frm decreases, t d y2( k2) reduces the harmful external effect of the foregn frm ( k2 ). dk2 Snce the changes n margnal harmful effects of an ncrease n domestc d y( k) output( k ) remans the same as n the autarky economy, we can conclude dk that when the economy opens, the margnal effect of an nvestment n green technology on socal welfare becomes greater than n the autarky economy. We summarze ths as the followng graph and proposton 26

38 Proposton 4 Suppose the assumpton on c '( k ) holds as n Proposton 3 and suppose both representatve frms for each country s symmetrc. As the economy lberalze the trade, the technologcal nvestment level becomes greater than n the closed autarky economy The Effect of a Change n Development Cost Consder now the case when the cost of development of green technology decreases. The effect on the Nash equlbrum s very complcated. Suppose, however, that the welfare weght on envronment s zero so that natonal polcy target conssts solely of proft. At the Cournot equlbrum n the output market, the profts of home frm becomes (2.24) a 2 c ( k ) c ( k ) b Then the same holds for foregn frm 2. We can easly calculate the effect of cost changes on the Nash equlbrum level of the proposton 3, we have k. Under the same assumpton as n (2.25) 4( a 2 c ( k ) c ( k )) dc dk s 9b dk ds dc ( a 2 c ( k ) c ( k )) 4 dc ( a 2 c ( k ) c 2( k 2)) 9b dk 3b 3 dk 2 2 y 4 3 dc dk 27

39 Let us wrte the frst-order condton as D'( s) d. In order to fgure s out the shape of best response functon for both countres we need to take a look at second partal dervatve wth respect to both s and s 2. These are gven by: (2.26) (2.27) y 4 d c dk y 4 d c s s 3 dk ds s 3 dk 2 a 2 c ( k) c2( k2) 4 dc 4 dc2 dk2 4 dc2 s s s 3b 3 dk 3b 3 dk ds 3b 3 dk Second partal dervatve of profts wth respect to s becomes negatve f we 2 dc y assume that 0 snce 0 and cross partal dervatve wth respect to s 2 2 dk s dc2 becomes negatve f we assume that 0 dk gven the assumpton that c'( k) 0. 2 ds Therefore we can conclude that s and s 2 are strategc substtutes ( 0 ds ) and 2 that as d decreases, gven s 2, the best response curve of country moves to 2 2 d rghtward drecton. Snce we know that 0, 0 2 and 0 we ds s s s2 can plot the relatonshp between s and s 2 as n Fg 2.4. s 2 Best response (Country ) Best response (Country 2) Fgure 2.5 Strategc Substtutes s and s 2 s 28

40 In ths case, the nvestment level at Nash equlbrum ncreases when the cost of development decreases. Although we derved the result assumng that the welfare weght for the envronment s zero, t holds n general when the welfare for profts s suffcently great. We state ths as the followng proposton. Proposton 5 Under the mantaned assumpton on the cost c '( k ) 0 as n the proposton 3, the nvestment level ncrease when the cost of development decreases f the welfare weght for profts s suffcently close to The Effect of a Change n Welfare Weght In addton to ths, we now consder our last testable assumpton. Although t would be nterestng to see the effect of welfare weght on both growth and envronment on Nash equlbrum t s qute dffcult to derve obvous comparatve statcs results because of the complcaton of equlbrum levels. Here however we assume strcter assumpton n order to draw some mplcaton of welfare weght effect on Nash equlbrum level. Let us assume the followng: (2.28) c ( k) c2( k2) 0 Then equlbrum output and proft levels for both frms no longer depend on values. Thus, the frst order condton for welfare maxmzaton for country would be as follows: k 29

41 W (2.29) ( ) y D '( s ) 0 s where, 2 When c and c 2 are not affected by k and k 2 the optmal * s ncreases as margnal development cost D '( s) 0 decreases. Therefore gven D '( s) 0 and D''( s) 0 when ncrease the optmum * s decreases. ( ) y T D '( s ) T s Fgure 2.6 Welfare Weght and Equlbrum Technology Level From Fgure 2.6, we can see the effect of welfare weght for output expanson on equlbrum technology level. As the welfare weght ncreases, the equlbrum pont moves from T to T. And ths mples decreasng clean technology nvestment. Thus, we can summarze the effect of welfare weght nto followng proposton. Proposton 6 Suppose that c s not affected by k for, 2. The optmal * s ncreases (decreases) as margnal development cost D '( s) 0 decreases (ncreases) and 30

42 technology nvestment ncreases (decreases) where, Polcy Implcaton The polcy mplcatons from our analyss are not straghtforward. In the absence of coordnated efforts, each country has dfferental ncentves for nvestment n clean technology. Those countres wth certan favorable characterstcs wth hgh degree of openness, low development cost and greater revealed preference for clean envronment may lead the nvestment. As we stated earler n Chapter, there may arse a need for nternatonal assstance from developed leadng countres to laggng developng countres n copng wth technologcal challenges to curb global warmng. The paper has shown also that a non-cooperatve equlbrum level of nvestment s dfferent from the world optmum level of nvestment and there have to be coordnated efforts to acheve an effcent level. It would however be extremely dffcult to desgn an ncentve compatble mechansm that can allocate the cost burden of developng a world optmum technology. The theoretcal propostons suggest that n certan cases where the reducton of greenhouse gases also decreases producton costs, each government have enough ncentve to nvest n such technology. When so called green technologes are avalable, t s lkely that the government nvest more aggressvely to gan the nternatonal compettveness. It s also sustanable poltcally snce t upgrades the domestc envronment as well. Ths effect certanly has to be consdered n the desgn of ncentve compatble mechansm for developng breakthrough technologes (Barrett, 2006). It would also be nterestng f we can examne the government tax polcy that nfluence the prvate cost of greenhouse emsson and nternatonal compettveness. 3

43 The credble change n tax polcy certanly nfluences the entrepreneural actvtes n nternatonal output market and subsequently the fnal nvestment polcy. However, unless we specfy how the tax revenue s spent for socal welfare, t would be extremely complcated to examne the tax polcy n our model. 2.5 Issues remaned open for dscusson There are a few shortcomngs of our analyss whch we would lke to emphasze before we move on to the next chapter. Frst, n our theoretcal model, we manly assumed that two countres are n a strategcally symmetrc poston. However, n the real world, the technologcal bases for developng green technologes are not symmetrc. It wll be an nterestng area for future research to model the asymmetrc case. Second, we assumed away the exstence of non-tradable sector whch s nsulated from nternatonal competton. The basc ntuton s that f the non-tradable sector s small enough, our proposton wll reman ntact. Incorporaton of nontradable sector makes our model more complcated to derve theoretcal propostons unless we mpose more restrctve assumptons. We, however, leave ths topc also for the future research area. Thrd, there can be prvately sponsored research and development efforts for green technologes whch we largely neglected. We mplctly assumed that the prvate R&D result s already reflected n the prvate producton cost of producton. However, the role of prvate R&D and publc R&D need to be further clarfed n the future work. 32

44 Chapter 3 EMPIRICAL MODEL AND ANALYSIS 3. Motvaton In ths chapter, we brng the model to the data, and examne f the fndngs from the theoretcal model n chapter 2 are supported emprcally. Our dataset contans over 200 countres that have dfferent poltcal, economc and cultural aspects. These would allow us to take a closer look at the characterstcs and ncentves of countres, and to learn whch of these countres favor or dsfavor the technology nvestment opton. In order to estmate the determnants that reflect these characterstcs and ncentves, we frst revew the exstng lterature on the relatonshp between envronment and soco-economc varables. 3.2 Lterature Revew As dscussed n the prevous chapter, we wll conduct emprcal analyss usng our panel data set to fnd soco-economc varables that affect the technology level and emsson of greenhouse gas. Over the past decades, there have been a growng number of studes, whch attempt to fgure out the soco-economc determnants of envronmental polluton. Snce the purpose of our emprcal analyss s to estmate the mpact of soco economc varables that mght affect the natonal clean technology level, a revew of the lterature on ths research topc provdes some nsghts as to our choce of varables. Grossman and Krueger (995) fnd that ncome and lagged ncome varables 33