Projecting the course of the world economy over the next few decades is a daunting task. One only need look at the history of the last half century to see precisely how difficult it is. How accurately, for example, would we have been able to predict the 1995 world economy in 1965? To take a single economy as an example, 1965 forecasts of the 1995 US economy would almost certainly have missed all of the following: the sharp decline of the US steel industry, the rapid increase in market share by Japanese automobile manufacturers, the explosion of the computer industry, the decline in manufacturing employment and the expansion in services, the sharp decrease in energy use per capita and per unit of GDP brought about by the oil price shocks, and the transition of the US from international creditor to net debtor. Moving from the US economy to the world as a whole adds countless more events which would probably not have been predicted in 1965, ranging from the extraordinary growth of Japan to the rapid increase in the volume of world trade.
History holds at least three lessons which are important to remember. The most obvious is simply that today’s projections are unlikely to be right. The immediate consequence of this is that projections of the world economy should be used more to discover which variables are important than to develop point estimates of future GDP or other variables. The second lesson is that the most interesting and important events are likely to lie in the details of individual industries and countries. The third lesson, demonstrated vividly by the oil shocks of the 1970's, is that people respond to changes in prices. Together these lessons mean that projecting aggregate GDP is unlikely to be useful: it will almost certainly be wrong and it will fail to capture the most important events. To put this another way, the 1995 world economy is clearly not a simple scaling of the 1965 economy.
To make this point more concrete, consider the effect of the 1973 and 1979 oil price shocks on the economies of the U.S. and Japan. Figure 1 shows GDP, energy use and carbon dioxide emissions for the United States from 1965 to 1990 (each series has been normalized to one in 1965). Figure 2 shows the same series for Japan3. Before the 1973 increase, oil prices were low and energy use per unit of GDP was relatively constant. When prices rose, however, energy use per unit of GDP began to fall significantly. During that period, in other words, energy use was growing substantially more slowly than GDP. In economic terminology, American and Japanese energy users substituted away from energy when oil prices where high; in ordinary language, they conserved energy. From this example it is clear that economies can be highly responsive to changes in relative prices, even over fairly short periods of time.
The evidence in these graphs has been analyzed more formally in a number of papers using econometric techniques to quantify the responsiveness of energy demand to changes in relative prices. For example, using a model with moderate disaggregation, Ban (1991) estimates that the responsiveness of the Japanese economy to changes in energy prices has been high and much of the change in the energy/GNP ratio from the early 1970's to the late 1980's has been due to the response of households and firms to changes in relative prices of energy. A recent OECD study covering a range of countries also comes to the same conclusion. Hoeller and Coppel (1992) estimate price and income elasticities for carbon emissions using a cross-section of 20 OECD countries. After accounting for energy taxes in each economy, the authors found that for 1988 the income elasticity of carbon emissions was 0.95 and the price elasticity was -0.75. In other words these results imply that a 10 percent rise in the price of carbon emissions would potentially reduce carbon emissions by 7.5 percent. (Since this figure is based on a cross-section study it should be considered a longrun result.) Both the income elasticity and the price elasticity are somewhat larger than would be consistent with the results we present below. Comparing this to the historical record suggests that a 1960 projection of current carbon emissions based on output growth alone would miss nearly half of the actual movements in carbon emissions for OECD countries.
Thus, future projections for carbon emissions depend not just on GDP growth projections but also importantly on changes in relative energy prices as well as a range of other economic factors. This suggests that an exercise of this kind requires the use of a global general equilibrium model that embodies the empirical relationships we have observed during the recent decades.
In this paper we use a multi sector, multi region world economic growth model called G-Cubed to explore the roles of population growth and differential rates of productivity growth across countries and sectors in determining the future course of the world economy. G-Cubed is a neoclassical growth model in the spirt of Cass Koopmans and Ramsey. The behavior of households and firms in the model is based on econometric evidence from the postwar period. As a result, G-Cubed will be able to capture the demonstrated ability of economies to respond to changes in relative prices. In addition, the model also accounts for physical capital accumulation, perhaps the single most important determinant of economic growth. We base our forecasts of future population on projections produced by the World Bank; our productivity figures are taken from various papers in the productivity literature.
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