Increasing returns to scale in energy-intensive sectors and its implications on climate change modeling

Highlights: • Questioning prevalent assumption of "constant returns to scale" in integrated assessment models of climate change • Proving the relationship between "increasing returns to scale (IRS)" and the position of countries in climate negotiation • Illustrating such relationship through a set of numerical simulations • Indicating the policy implications of such relationship -- Abstract: Increasing returns to scale (IRS) phenomena are widely present in economies, and integrated assessment models (IAMs) for climate change generally assume constant returns to scale (CRS). This paper studies the connection between IRS in energy-intensive sectors and the regions' attitude towards climate change. In a model of detrimental (negative) externality, we proved that if some agents' activities related to externality generation exhibit IRS, their optimal target in the efficient externality provision can be very close to their inefficient non-cooperative Cournot-Nash equilibrium position. The numerical simulations in this paper confirm the analytical conclusion. The analytical results point out the potential biases of IAMs under the CRS assumption and provide a better explanation of difficulties in international climate negotiations. Finally, the paper offers some policy suggestions on climate negotiation in the presence of IRS.