Organizational Learning and Optimal Environmental Policy
Bidyut Talukdar
Department of Economics
Saint Mary’s University
(Extended Abstract)
Main Findings
(How) Should environmental policy respond to economics fluctuations? Several recent papers
have begun a literature combining real business cycle models with environmental policy to address questions about the relationship between optimal environmental policies and economics
fluctuations. Two of the major findings in this literature is that allowing climate policy to
adjust to business cycles significantly improves welfare, and optimal environmental policy is
procyclical – the emissions tax rate, carbon dioxide emissions, and the emissions quota all
should increase during expansions and decrease during recessions (Heutel, 2012). To extend
this literature, the current study investigates optimal environmental policy using a full-blown,
welfare-based DSGE Ramsey model and finds that the Ramsey-optimal environmental policy
calls for a countercyclical emission tax if learning-by-doing (LBD) mechanism is present
in production technology. Although optimal Ramsey policy still characterized by procyclical
carbon emissions, I find that the dynamic properties of optimal climate policy depend fundamentally on the availability/presence of other types of distortionary taxes - namely labor and
capital income taxes.
Related Literature
Environmental policy papers have traditionally approached various policy issues from a microeconomic perspective and used typical microeconomic analysis to answer questions about
the effect of pollution on production or on health, the effect of policy on pollution, or the
optimal design of resource policy. Recently, however, there has been a growth in research
that uses methods from macroeconomics to address policy questions related to environmental
economics.
Fischer & Springborn (2011) extends a standard, real business cycle model by introducing
a polluting input in the aggregate production function. The focus in their paper is to study
how three types of static emission policies - an emissions tax, an emissions cap, and an intensity target (a limit on emissions per unit of output) - perform in an economy which is subject
to productivity shocks. They find that the tax policy has the lowest welfare costs when the
transitional adjustment to the emissions regulation is taken into account.
Angelopoulos et al. (2010) also uses a real business model with pollution and compare the
performance of three different policies - a tax, a cap, and what they call “Kyoto-like rules,”
which are rules that specify how fast emissions must decrease from one period to the next. The
economy is subject to two different exogenous shocks - the total factor productivity (TFP)
shock, and a shock to the ratio of emissions to output. Their main finding is that the cap
policy is always the worst policy. For any combination of parameter values that they simulate,
it leads to a lower level of expected lifetime utility than does a tax policy or a rules policy.
A third paper that uses a real business cycle model to analyze pollution policy is Dissou
& Karnizova (2012). The focus of their paper is also a ranking between alternative policy
instruments - taxes and permits. They find that the welfare ranking between the tax and the
cap depends on the source of the shock. For shocks to non-energy sectors, there is no difference between the cap and the tax. For shocks to one of the energy sectors, the tax dominates
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the cap.Also, the cap policy leads to lower volatility of economic variables than does the tax
policy. This finding holds regardless of the source of the economic shock.
Finally, Heutel (2012) develops a DSGE model with persistent productivity shocks and
with pollution as a stock variable to investigate how environmental policy optimally responds
to business cycles. While all other papers’ focus on ranking different static1 policies, Heutel
(2012) focuses on finding the optimal dynamic policy. Heutel’s main finding is that the optimal environmental policy calls for procyclical emissions tax rates, emissions quota, and
carbon dioxide emissions. In terms of modelling choice and focus, my paper is more in line
with Heutel (2012) and aims to study optimal dynamic environmental policy over the business
cycles. However, it contributes to the literature in several counts:
First, this paper incorporates emission and pollution externality within a standard DSGE
Ramsey model and studies the impact of learning-by-doing capital2 on optimal environmental
policy dynamics. The basic notion of learning-by-doing and knowledge accumulation is that
organizations/firms learn from their production experiance and accumulate this firm-specific
knowledge — known as organizational capital (OC) — that raises their future productivity.
Organizational capital may be thought of as a kind of knowledge capital linked to ideas about
the process of production that help to determine how much output results from the application of conventional inputs in the context of a particular technology. In my model firms
accumulate organizational capital by endogenous learning by doing. In other words, firms future stock of organizational capital positively depends of current level of production activity
(output). Pollution is modeled such that it is directly proportional to the quantity employed
of that intermediate polluting input (e.g., energy). Emissions by individual firms contribute
to the stock of pollution, which has an aggregate negative effect on the production of output.
In deciding optimal emission tax rate and emission level the Ramsey planner faces a tradeoff. On the one hand emission is detrimental to welfare as it affects aggregate production by
contributing to the pollution stock. On the other hand it not only increases a firm’s current
productive capacity, it also contributes to the accumulation of the firms’ future organizational
capital and productivity. This dynamic link between current production choices and future
productivity is the key for our main findings.
Second, unlike other studies, my model analyzes optimal emission tax in presence of other
distortionary taxes - capital and labor income taxes. As Bovenberg & Goulder (1996) points
out - “ . . . . . . Tax systems generally rely on both environmental (corrective) and other taxes.
However, economists typically have analyzed environmental taxes without taking into account
the presence of other distortionary taxes. The omission is significant because the consequences
of environmental taxes depend fundamentally on the levels of other taxes including income
and commodity taxes. . . . . . . ” In fact, in this paper I show that the dynamic properties of optimal environmental policy fundamentally depends on the interaction between all three types
of distortionary taxes.
Finally, using Ramsey approach to study optimal environmental policy is itself a contribution to environmental policy literature. Ramsey approach has become a very standard
1
They are static in the sense that the rate/level of the policy variables do not change with the business
cycle.
2
There is a large empirical literature documenting the pervasive influence of learning-by-doing in productive
activities. In particular, Atkeson & Kehoe (2005) model and estimate the size of organizational capital for
the US manufacturing sector and find that it has a value of roughly 66 percent of physical capital. Learningby-doing has been shown to improve the predictions of dynamic general equilibrium models (see e.g., Gunn &
Johri (2011); Chang et al. (2002); Cooper & Johri (2002)).
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approach in studying optimal fiscal and monetary policy3 . In the Ramsey framework a social planner (benevolent government) maximizes household’s welfare subject to a resource
constraint, to the constraints describing the equilibrium in the private sector economy, to
a government budget constraint, and via an explicit consideration of all the distortions that
characterize both the long-run and the cyclical behavior of the economy. In optimal environmental policy papers (see e.g.,Fischer & Springborn (2011); Dissou & Karnizova (2012); Heutel
(2012)) emission tax is used only to correct/minimize externality - tax revenue is returned to
the consumer in a lump sum fashion. In Ramsey models, however, the government finances
an exogenously given level of expenditures by levying distortionary taxes, issuing debt, and
printing money (in monetary Ramsey models). In my model, the emission tax is only one
of the available three tax instruments. Therefore, the Bovenberg & Goulder (1996) critique,
mentioned in the previous paragraph, is automatically addressed.
References
Angelopoulos, K., Economides, G., & Philippopoulos, A. (2010). What is the Best Environmental Policy?
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3
See, e.g., Lucas & Stokey (1983); Chari et al. (1991); Chari & Kehoe (1999); Chari et al. (1994); SchmittGrohé & Uribe (2004); Siu (2004); Schmitt-Grohé & Uribe (2007); Chugh (2007); Faia (2009); Aruoba &
Chugh (2010); Arseneau & Chugh (2012) and many others.
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Dissou, Y., & Karnizova, L. (2012). Emissions Cap or Emissions Tax? A Multi-sector Business Cycle Analysis.
Working Papers 1210E University of Ottawa, Department of Economics.
Faia, E. (2009). Ramsey monetary policy with labor market frictions. Journal of Monetary Economics, 56 ,
570–581.
Fischer, C., & Springborn, M. (2011). Emissions targets and the real business cycle: Intensity targets versus
caps or taxes. Journal of Environmental Economics and Management, 62 , 352–366.
Gunn, C., & Johri, A. (2011). News and knowledge capital. Review of Economic Dynamics, 14 , 92–101.
Heutel, G. (2012). How should environmental policy respond to business cycles? optimal policy under persistent productivity shocks. Review of Economic Dynamics, 15 , 244–264.
Lucas, R. E., & Stokey, N. L. (1983). Optimal fiscal and monetary policy in an economy without capital.
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Schmitt-Grohé, S., & Uribe, M. (2004). Optimal fiscal and monetary policy under sticky prices. Journal of
Economic Theory, 114 , 198 – 230.
Schmitt-Grohé, S., & Uribe, M. (2007). Optimal simple and implementable monetary and fiscal rules. Journal
of Monetary Economics, 54 , 1702 – 1725.
Siu, H. E. (2004). Optimal fiscal and monetary policy with sticky prices. Journal of Monetary Economics,
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