This paper is co-authored by Francesco Bosello and Ramiro Parrado.

In this paper we address one specific criticism that can be raised against the economic climate change impact assessments conducted with CGE models: that of overly optimistic assumptions on the ability of markets to react to climate change induced shocks, i.e. market driven adaptation. These models indeed usually assumes frictionless and instantaneous adjustment to a new equilibrium. We do this first running a standard climate change impact assessment exercise with a recursive-dynamic CGE model using updated estimates of climate change impacts, referring to a 2°C warming. Then we perform the same exercise, but restricting the elasticity of input substitution in the production function, the substitution of domestic and imported inputs, and finally sectoral workforce mobility. We demonstrate that these frictions increase the cost of climate change from 0.64% to 0.87% of Gross World Product (GWP).

This suggests a further caution in handling the impact assessment stemming from CGE models as climate change losses can be high also in a moderately warming world. It also points to the need of conducting careful sensitivity analyses on model parameterization. This basic practice is not yet that widespread at least when CGE models are used. More on the positive ground, it also shows that CGE models are not “structurally unable” to highlight relevant losses from climate change and that they can remain useful and credible investigation tools.

This research has received funding from the European Union’s Seventh Framework Programme (FP7/2007-2013) under the grant agreement n°266992 (Global IQ).

This seminar has been jointly organized by FEEM and IEFE, Bocconi University.