Renewable Energy Subsidies: Second-Best Policy or Fatal Aberration for Mitigation?

32 Pages Posted: 27 Jun 2011

See all articles by Matthias Kalkuhl

Matthias Kalkuhl

University of Bonn - Center for Development Research (ZEF); Potsdam-Institut für Klimafolgenforschung (PIK)

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK); Mercator Research Institute on Global Commons and Climate Change (MCC); Technische Universität Berlin (TU Berlin)

Kai Lessmann

Potsdam Institute of Climate Impact Research

Date Written: June 27, 2011

Abstract

This paper evaluates the consequences of renewable energy policies on welfare, resource rents and energy costs in a world where carbon pricing is imperfect and the regulator seeks to limit emissions to a (cumulative) target. We use a global general equilibrium model with an intertemporal fossil resource sector. We calculate the optimal second-best renewable energy subsidy and compare the resulting welfare level with an efficient first-best carbon pricing policy. If carbon pricing is permanently missing, mitigation costs increase by a multiple (compared to the optimal carbon pricing policy) for a wide range of parameters describing extraction costs, renewable energy costs, substitution possibilities and normative attitudes. Furthermore, we show that small deviations from the second-best subsidy can lead to strong increases in emissions and consumption losses. This confirms the rising concerns about the occurrence of unintended side effects of climate policy - a new version of the green paradox. We extend our second-best analysis by considering two further types of policy instruments: (1) temporary subsidies that are displaced by carbon pricing in the long run and (2) revenue-neutral instruments like a carbon trust and a feed-in-tariff scheme. Although these instruments cause small welfare losses, they have the potential to ease distributional conflicts as they lead to lower energy prices and higher fossil resource rents than the optimal carbon pricing policy.

Keywords: Feed-in-Tariff, Carbon Trust, Carbon Pricing, Supply-Side Dynamics, Green Paradox, Climate Policy

JEL Classification: Q4, Q52, Q54, Q58, D58, H21

Suggested Citation

Kalkuhl, Matthias and Edenhofer, Ottmar and Lessmann, Kai, Renewable Energy Subsidies: Second-Best Policy or Fatal Aberration for Mitigation? (June 27, 2011). FEEM Working Paper No. 48.2011, Available at SSRN: https://ssrn.com/abstract=1873197 or http://dx.doi.org/10.2139/ssrn.1873197

Matthias Kalkuhl (Contact Author)

University of Bonn - Center for Development Research (ZEF) ( email )

Walter-Flex-Str. 3
Bonn, NRW 53113
Germany

Potsdam-Institut für Klimafolgenforschung (PIK) ( email )

Telegraphenberg
Potsdam, Brandenburg 14412
Germany

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK) ( email )

P.O. Box 601203
14412 Potsdam, Brandenburg
Germany

Mercator Research Institute on Global Commons and Climate Change (MCC)

Torgauer Straße 12-15
Berlin, 10829
Germany

Technische Universität Berlin (TU Berlin)

Straße des 17
Juni 135
Berlin, 10623
Germany

Kai Lessmann

Potsdam Institute of Climate Impact Research ( email )

HOME PAGE: http://https://pik-potsdam.de/members/lessmann

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