Accounting for Uncertainty Affecting Technical Change in an Economic-Climate Model

37 Pages Posted: 3 Jan 2006

See all articles by Valentina Bosetti

Valentina Bosetti

Bocconi University; CMCC - Euro Mediterranean Centre for Climate Change

Laurent Drouet

HEC Geneva

Date Written: December 2005

Abstract

The key role of technological change in the decline of energy and carbon intensities of aggregate economic activities is widely recognized. This has focused attention on the issue of developing endogenous models for the evolution of technological change. With a few exceptions this is done using a deterministic framework, even though technological change is a dynamic process which is uncertain by nature. Indeed, the two main vectors through which technological change may be conceptualized, learning through R&D investments and learning-by-doing, both evolve and cumulate in a stochastic manner. How misleading are climate strategies designed without accounting for such uncertainty? The main idea underlying the present piece of research is to assess and discuss the effect of endogenizing this uncertainty on optimal R&D investment trajectories and carbon emission abatement strategies. In order to do so, we use an implicit stochastic programming version of the FEEM-RICE model, first described in Bosetti, Carraro and Galeotti, (2005). The comparative advantage of taking a stochastic programming approach is estimated using as benchmarks the expected-value approach and the worst-case scenario approach. It appears that, accounting for uncertainty and irreversibility would affect both the optimal level of investment in R&D - which should be higher - and emission reductions - which should be contained in the early periods. Indeed, waiting and investing in R&D appears to be the most cost-effective hedging strategy.

Keywords: Stochastic Programming, Uncertainty and Learning, Endogenous Technical Change

JEL Classification: D62, D63, H23, Q29

Suggested Citation

Bosetti, Valentina and Drouet, Laurent, Accounting for Uncertainty Affecting Technical Change in an Economic-Climate Model (December 2005). FEEM Working Paper No. 147.05, Available at SSRN: https://ssrn.com/abstract=871442 or http://dx.doi.org/10.2139/ssrn.871442

Valentina Bosetti (Contact Author)

Bocconi University

Via Gobbi 5
Milan, 20136
Italy

CMCC - Euro Mediterranean Centre for Climate Change

via Augusto Imperatore, 16
Lecce, I-73100
Italy

Laurent Drouet

HEC Geneva

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

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