The sensitivity of climate-economy CGE models to energy-related elasticity parameters: Implications for climate policy design

A dynamic climate-economy CGE model based on the GTAP framework is used to analyse how sensitive simulation results are to alternative values assumed by several types of elasticity of substitution in energy-related linkages. Input substitutability in the production function is also tested for the relationship between capital and energy in different manufacturing sectors. The simulation exercise reveals that the model produces highly differentiated results when different sets of elasticity parameters are adopted. As a general result, lower substitutability values correspond to a reduction in the flexibility of energy substitution possibilities, making carbon abatement efforts more expensive. Moreover, this restriction generates changes in the distribution of costs associated with abatement efforts across regions. This brings to severe implications on international competitiveness especially for energy-intensive industrial sectors. The direct implication derived from this work is that in order to use CGE models to assess the amount and distribution of mitigation costs and to inform the international community involved in discussing the feasibility of climate policies, the use of empirically estimated behavioural parameters at the highest possible disaggregation level is highly recommended.