Are the emissions trading systems’ simulations generated with a computable general equilibrium model sensitive to the nested production structure?

Abstract

Computable general equilibrium models are becoming popular for simulating emissions trading systems. However, these models make various assumptions about the production structure and the possibilities of substituting energy for productive factors or inputs. Therefore, this study aims to analyze how different options to incorporate energy into the nested production structure of a computable general equilibrium model affect the obtained impacts when an emissions trading system is implemented. A flexible computable general equilibrium model called ECOMODEL is developed, which is the first model that allows choosing any of the three nested production structures most used in the literature (KEL-M, KL-EM, or KLE-M). The Chilean economy is used as a case study since there is a current database with high disaggregation of the energy sector for calibrating the computable general equilibrium model. The results show that the simulated impacts with KEL-M and KL-EM structures are the best when elasticities of substitution equal to the values ​​most frequently used in previous studies are chosen. However, the KEL-M structure that considers energy as a substitute for capital provides overly optimistic environmental results when high elasticities of substitution are used, obtaining the lowest reduction in Gross Domestic Product and the lowest price of the emissions trading system. Furthermore, the KLE-M structure gives unrealistic results regardless of the elasticities of substitution used. In consequence, a KL-EM nested production structure should be prioritized to simulate an emissions trading system since it provides realistic results and is less sensitive to the values of the elasticities of substitution.