Roger Guesnerie

A future for Kyoto?

Keywords: Q5, H2, F18 Kyoto protocol, less developed countries, price versus quantity, fossil fuels, trade and environment Q5, H2, F18 Kyoto protocol, Less Developed Countries, Price versus Quantity, Fossil fuels, Trade and Environment Protocole de Kyoto, Pays en Développement, Prix ou Quantité, Carburants fossiles, Commerce

This text is based on the English translation of extracts from a report to an advisory economic group to the French Prime Minister (Conseil d'Analyse Economique). This report was presented on July 2002 and published in 2003, (Guesnerie(2003)). These extracts have been chosen and reorganised to provide an assessment of the future of the Kyoto protocol, as emphasized in the title. The sections successively treat: the present flaws of the Kyoto protocol, the improvement in design that can be thought of, the issues underlying the durability of Kyoto-like arrangements. The main lessons of the analysis are stressed again in conclusion.

Résumé

: Ce texte présente une traduction en langue anglaise d'un rapport au Conseil d'Analyse Economique, organisme rattaché au Premier Ministre français. Le rapport a été présenté en Juillet 2002 et publié en 2003 (Guesnerie (2003)). Ces extraits ont été choisis et réorganisés pour esquisser des avenirs possibles aux arrangements du protocole de Kyoto. On traite successivement des faiblesses présentes du protocole, de la conception statique et des manières de l'améliorer, et de la permanence temporelle de l'arrangement. Les conclusions volontaristes qui sont tirées sont finalement soulignées

1-Kyoto : present flaws.

Elsewhere in the report, (Guesnerie 2003a) we have established that the incentives to reduce emissions and stimulation to technical progress are complements rather than substitutes.

On that basis, we argued for a division of a given economic and financial efforts between R&D and emission reductions 1 according to some principles that need to be refined . Whatever it may be, , the relative weight of the total collective efforts planned in Kyoto is too biased in favour of emissions reduction initiatives and, therefore, unsatisfactory. The flaw of the Kyoto scheme in this regard is obvious and already calls for action. . For instance, the countries having ratified Kyoto, or at least some of them, should involve themselves in collective research on carbon-free technologies. 2 On this matter, a European initiative proposing cooperation on the basis of costs and benefits sharing would be particularly welcome.

Another urgent problem, however, concerns the developing countries. Non participation of the Southern countries, while limiting the 'carbon tax' base, increases the costs to the Northern countries, at first because it increases the level of the tax to attain a given quantitative objective and then it increases the incentive to move activities abroad. From this point of view, the Clean Development Mechanism (CDM) is not very satisfactory even if the arrangement succeeds in keeping the South in the negotiation. Secondly, the Southern countries are rightly refusing a costly effort for the moment. To ask India to pay for reducing its emissions per capita, which is considerably lower than the figures for the United States, is shocking.

Mutually advantageous solutions exist nevertheless: participation of the developing countries with attractive conditions for them also reduces the abatement costs considerably for the developed countries. Most analyses have converged on this conclusion. A simulation exercise done by using the model GEMINI E3 3 on an enlarged Kyoto to the world level with the initial emission rights distributed on per capita basis shows, in a speculative but spectacular manner, a possible middle run reconciliation of equity and efficiency. For example, on a worldwide market for permits with rights proportional to population and a given target, the price of the permits would be two or three times lower in 2040 compared to the price on the assumption of an extended Kyoto scheme with the same target but without participation of the developing countries. The cost for the annex B countries (the list of the Annex B countries is given in Appendix 1) would be three times lower, while the transfers from Annex B countries to the rest of the world would be about 0.5 percentage points of the Annex B GDP.. Even if the situation is less simple in the long run, we would like others to share our conviction that participation in the fight against climate change can be made attractive to the developing countries. Without going into detailed technical discussions, the proposal (see also Philibert (2002)) could be based on either:

• Generous national quotas of 'hot air' such that as soon as the beneficiaries make some minimal efforts it assures them a positive transfer. Or • Non binding quotas, which implies that exceeding them does not entail any penalties whereas any improvement gives access to the international market for permits. This alternative scheme could replace rather than be juxtaposed to the current CDM.

Without doubt they would have to be linked with an increase in the objectives of the Annex B countries, in order not to exacerbate the difficulties of implementing an international market for emissions rights to which the United States would not participate. In this case, the cost of observance would decrease in the end and the system would provide significant transfers towards the 'virtuous' Southern countries. Lastly, to avoid the legitimate mistrust of the developing countries regarding some highly temporary 'carrots', these schemes should provide guarantees in the medium run; for example, by accepting the principles which, in the medium or long run, reflect an egalitarian logic such as quotas on the basis of population, at least until a definite level. We will discuss this point in detail later.

The exploration of the track that has just been suggested should be given high priority today. We have previously discussed in the report (Guesnerie 2003a) the predictable effects on development of the total greenhouse gas (GHG) emissions, the narrow feature of the Kyoto framework, the limits that competitiveness puts to the effectiveness of an environmental policy with a too restricted base. All this and the mutually advantageous character of the suggested extension indicate how decisive this question will be for the future of the policies against the climate change. Let us also point out that even though this paper does not deal with the geopolitical aspects of the question, the position of the three big partners of this negotiation, India, China and Brazil, who could be affected in the future by some notable damages linked to the climate change, offers hope for a realistic treatment of the question that has just been suggested. 5 Of course, it would be desirous to have the United States come back to the bargaining table. In the light of a posteriori judgement and better information, it is clear that Kyoto asked too much from the United States. 6 The late concession of the EU on the issue of market for permits might have been the first acknowledgement of this error. It is astonishing that the well known extreme reluctance of the US citizens to reduce their energy consumption did not make the negotiating partners recognise how difficult it was for them to 'swallow' the Kyoto potion, leaving aside the electoral contingencies. Naturally, it does not appear unreasonable to ask the the biggest polluter in the world (6 tons carbon equivalent per capita) to reduce 7% of its emissions. To evoke its responsibility as both the biggest polluter and the richest country is not out of place. But this is a 'moral' argument and it does not take account of core economic issues such as the cost and what we called earlier 'willingness to pay'. Let's note that today the American trend of the emissions between 1990 and the Kyoto phase 1 is about +25 to +30% due to inaction and the demographic and economic growth. To reduce the emissions by 30 to 35% even between 1997 and 2012 would have meant a rate of decarbonisation of 2% per year, which is a very difficult task given the inertia of equipments and institutions, even if some strong reduction potentialities exist in the USA with weak or negative costs. The strategy that seems most reasonable now is to attempt, by negotiation, to convince the developing countries to rejoin the annex B countries as soon as possible. Paradoxically, the absence of the United States, which is apparently suspicious of solutions implying advantageous transfers to the developing countries in the short run or an egalitarian agreement in the long run, could make this negotiation easier.

Kyoto: can the basic design be improved?

The Kyoto protocol has been designed around two basic dispositions: First, it sets quantity objectives, (for participating nations that are given individual quotas, but consequently for the set of participants, as a whole); second it organizes a world market for exchanging quotas. We come back successively on theses two central features of the arrangement and question them: is this basic design flawed, can it be improved? Most experts agree that the function which links the global damages to the concentration of GHG, in the relevant intervals of carbon concentration, is linear in the short run. Therefore, the marginal damages would be relatively constant. Many economists think that in such a context regulation through a price instrument (to give a price signal in accordance with the expectation of the marginal damage) should be preferred over regulation by quantity (to set a quantitative target according to the calculation of mathematical expectation) from an efficiency point of view (see Weitzman (1974), Philibert 2002). The argument can be explained intuitively: as the marginal cost of reduction, expressed in the variable stock, is rapidly increasing, while the marginal benefit is relatively constant, the rigidity of the quantitative objective entails an important and socially useless increase in costs in the case of unfavourable realisation of hazard on the cost, while it does not allow exploitation of the opportunities of welfare gains in the favourable case.

This argument was used either to refute the whole architecture of the Kyoto Protocol or to propose amendments to it. Here it is necessary to discuss the nature of the argument first and its scope next. We must note first that quantity policy with market for permits constitutes a first insurance mechanism for the participants against internal specific shocks. The argument in favour of a 'price' solution applies therefore to a structural mid-term uncertainty on the costs rather than to a temporary one. Moreover, it raises a lot of technical issues, 7 and one has to keep in mind a more fundamental criticism for the case of the long run; viz. the argument neglects one of the possible factors of ineffectiveness of a price instrument, i.e. it transfers the rent linked with the fossil energies without necessarily reducing their rate of extraction--a remark that pushed to its limits would invalidate all policies of taxation.

The invoked argument in favour of the 'price' solution therefore is not a devastating criticism of the whole architecture of Kyoto, as some people think. If, however, a lesson has to be recommended from this discussion, it is that a quantity policy is likely to increase the variability of costs beyond what is desirable. This is because an insufficient smoothing has negative effects on welfare, but also perhaps because economic agents are risk averse. Therefore, in order to limit the certainty-equivalent of the costs, it is desirable to reduce their exposure. A combination of this argument with the one concerning the pattern of the damage function then suggests the usefulness of a ceiling price on the emissions permit market.

Nevertheless, the analysis just sketched raises some question marks on the adequacy of the recommended measures given the objectives. One may wonder, shouldn't the ceiling price apply rather than to the price of the permits to the "total" price of GHG, a price that adds to the price of the permit itself the market price of the underlying resources (for example oil, gasses or coal for the CO 2 ). In that case, the ceiling price of a permit instead of being ideally rigid might be ideally fluctuating to help stabilizing the global ceiling price, 8

Let us summarize: reducing intervention costs to the minimum helps in the success of any environmental policy. In this respect, the implementation of a policy that sets exclusively quantitative targets triggers cost variability; hence it calls for some insurance mechanism. This is why one may regret the absence of any safety valve in the Kyoto scheme and wishes its inclusion in the future (Kopp et al. 1997). 'Safety' would be obtained by a guaranteed supply of permits at a ceiling price, whenever the market price goes over it. As said before, such a ceiling price should ideally vary in certain cases in order to partially offset significant although possibly irrelevant variations in the energy prices. In any case, the corresponding revenues could be recycled by an international institution following methods experienced at the national levels, although they may be more difficult to implement at the international level. Similarly, an introduction of a floor price of the permits would help limit the randomness of the market value of abatements beyond the national quotas. 9

Apart from these flaws of the quantitative regulation, the performance of the instruments set by the Kyoto Protocol is uncertain. For example, the prejudgement in favour of the markets for emission permits relies on the relative empirical success of experiments, especially experiments done in the SO 2 market in the United States. But the scope of the international market implemented by the Kyoto Protocol is completely different and nothing guarantees that such or such adjustment that has appeared effective in a special context will still be effective in a more general context. For instance, the 'banking' or emission credits accruals that allows a temporal smoothing of the effort, may compromise in certain circumstances an effective stabilization of the expectations. Despite the favourable precedent of the SO 2 market, the time that has been historically required to implement such adjustments in some of the existing financial markets should not be forgotten. There is therefore an experimental dimension in the implementation of the Kyoto mechanisms, 10 (which may be considered a merit and not a defect).

In this respect, a band with a ceiling and a floor prices, within the logic discussed above, would have other virtues beyond the inter-temporal smoothing of the costs emphasized so far (Cournède and Gastaldo, 2001). First, it would contribute to frame expectations, which tackles the risk of market volatility, the reality of which has been confirmed by our few experiences so far. Second, a safety valve, which introduces a price regulation in a system based on quantitative objectives, is not a denial of the Kyoto principles. The ceiling price can be seen as a penalty for exceeding the quotas (it had been discussed as such in the previous negotiations without being adopted). The 'safety valve' would be a substitute for the supervision mechanisms that Kyoto succeeded in making compulsory but in a framework that leaves some grey areas. In the absence of a ceiling price, any country that finally grumbles to the required effort could simply postpone the foreseen reductions and undergo, as planned in the Marrakech agreements, a penalty involving a multiplier effect, which requires that 1.3 tons must be 'recovered' for each lacking ton during the second commitment period. However, despite the ban on participation in the permits market that the failure would entail, the environmental debts could be accumulated until it becomes irrecoverable unless there is a sharp cutting date in place.

Can Kyoto-like arrangements be made durable?.

The above proposed improvements deal with the architecture of the Kyoto Protocol, and especially with its static aspects. To answer the question of the "durability" of Kyoto-like arrangements we need to return to the inter-temporal dynamics of the agreement and to the legitimacy of the international 'grandfathering' clause that Kyoto phase 1 introduces.

Kyoto lends to two extreme interpretations. At minima, it is a mutually advantageous agreement that takes into account the differences of costs and exposure to the greenhouse effect, and does not necessarily call for a universal participation. Apart from the difficulties of the initial negotiations, the renegotiation of the agreement after the contractual period is subject to much potential inefficiency, as all sequential negotiations are. We will not give an exhaustive list here, but simply underline a type of Achilles' heel quite common in such cases, the ratchet effect (see Freixas et al., 1985). First, let us ask the just evoked question, how to punish a country which fails to fulfil its commitments? This question, however, masks a less visible but more fearsome problem, i.e., what will be the starting point for the later period renegotiations?

The response, in principle, is crystal clear: to do as if the previously accepted objectives had been met. It is, however, not very realistic to think that it will be so : the 'default' would, of course, be an argument for future discussion. 11 It will probably increase the de facto bargaining power and then, through successive agreements, give an increasing part of the surplus to the defaulting party.

A more ambitious or a more utopian interpretation of Kyoto is to read it, like many commentators have, as the first step towards a progressive cancellation of the historic rights (grandfathering) which give advantage in the short run to the biggest GHG polluters. 12 One would substitute thus to the logic of the historic rights a more 'egalitarian' logic entailing for instance an allocation of the national emission rights based on population criteria. Such a formula cannot claim to be 'fair' in a deep sense, and even less a solution to the general and widely indefinite problem of implementation of international justice. However, economic development today has generated a need to limit the use of a former free good, and calls for a definition of new rights on a worldwide scale. An egalitarian distribution seems to be, all things being equal, a basis for the allocation of rights that is quite natural and is a step forward in the direction of 'equity', whatever the exact meaning one gives to this word. Without discussing further the above formula, we may think that this utopia was implicit in the Kyoto Protocol. It might have contributed in setting up a high required effort for the US beyond what was politically realistic. On the contrary, an explicit recognition of an egalitarian principle could have contributed to the consent of the developing countries by ascribing to them some 'hot air' today and offering them some good perspectives in the long run. This brief analysis suggests two conclusions:

• In the long run the sustainability of an international agreement like Kyoto would have considerably improved if it had incorporated an agreement on the principles of burden sharing in the long run. Such an agreement should focus on the implicit or explicit property rights that will emerge at the end. In the absence of such an agreement, which might be linked to an indicative target of the long-term objective (and also perhaps with indicative trajectories), opportunistic behaviours that reduce the effectiveness of the action will be recurrent. Even if the adopted scheme must remain simple, it should be flexible so that in particular the transition trajectories may react to a set of considerations absent from the long-term target. For instance transitional indexation on growth (as an insurance mechanism) is compatible with a certain equality of the registered rights in a long-term perspective.

• The arguments of simplicity, equity and political consent at a worldwide scale give a 'focal' status to the egalitarian solution. The egalitarian solutions which allow for real transfers to the developing countries, also bring advantages to the Northern countries: they are hence more politically realistic than what seems at first sight. The efficiency surplus that these solutions determine in the short run, since they entail the consent of the developing countries, has a counterpart in the long run. 13 However, there are two reasons to believe that a purely egalitarian policy, in spite of its focal position, is not the "solution". First, the residual inequality of the emissions distribution would remain important for long. This inequality is clearly shown in the graphs (figure 1) depicting the cumulated emissions according to the cumulated population and to their Gini index, for different scenarios of property right allocation. 14 Second, it should be noted that egalitarian solutions, however, entail unacceptable costs to certain parties (e.g., Russia), given their expected "willingness to pay" as is shown by the Criqui, Vielle and Viguier study (see Guesnerie 2003b), which indicates the middle-term efforts required for North America and the Former Soviet Union countries, under the scenario of convergence of per capita emissions (also see Germain and Steenberghe 2001).

The combination of these two remarks lead us to recommend a widening of short and mid-term agreements like Kyoto and to assign them an agreement not on the amount but on the principles of allocation of the emission rights till 2050-2070. Whatever the exact formulation of this principle, the allocation formula should remain simple and strike a compromise between the egalitarian logic and the one of acceptability. 15 One cannot deal with the question of acceptability without returning to a more basic problem of participation. The permanence of an environmental agreement like Kyoto, as well designed as it could be, is constantly threatened by the free rider problem. It means that it is impossible to exclude someone from the use of the collective good produced by the agreement. Each country's most likely best interest is not to join an agreement when the others have already joined. 16 This problem does not disappear even in the framework of a limited action and increases with increase in the efforts demanded. It is difficult to build an international order when the reasons to participate are so fragile. To reinforce it, do we need to widen the framework of the agreement?

The earlier reflection on the relations between international trade and global collective goods started with the necessity to preserve the efficiency of the environmental efforts undertaken by a group of countries (the signatory countries) and led to the reconsideration of the well-founded separation between the fields of trade and global environmental goods. But the issue is wider: in the absence of any world governmental institution, should ideally international agreements on trade or any global public goods be globalized? We will make only a few remarks here. Economic analysis suggests that the widening scope would increase the range of the mutually advantageous agreements, a conclusion that do not invalidate, it seems, most of the realistic theories of negotiations available today. This suggestion, which of course should be established by more studies, does not imply that the preparatory works for a global agreement cannot or should not be separated. It does not at all imply that the technical agencies such as WTO and a future possible agency for the environment should merge. Let us admit that the compromises are better, from the efficiency point of view, when made global on both trade and environmental policies. Still, it cannot be denied that such a solution also changes the bargaining powers of the partners. In the context of the contention of Kyoto, it would without doubt modify it in favour of Europe and to the detriment of the United States.

The assessment of the feasibility and diplomatic opportunities of such actions is of course out of the scope of this paper. It is nevertheless worth mentioning the fact that an environmental compromise like Kyoto is necessarily fragile and that it can be reinforced only by coupling it with some other international agreements (trade, other environmental agreements, etc.) that are less subject to free-riding. It means that a widened space for compromises is beneficial and is likely necessary for the viability of an ambitious environmental agreement.

4-Some final words on perspectives.

The whole report (Guesnerie (2003a,b) renders an overall judgement in favour of the initial action envisaged in Kyoto regarding both its scope and methods. Let us recall the reasons adduced for this judgement.

First of all, in the present state of the scientific knowledge, it is difficult to come to terms with the climatic risks while postponing significant action to an indeterminate date. The timeliness of implementing the 'hardware' and the 'software' of a policy of world-wide control of the greenhouse gas emissions is not very doubtful. The scope of the initial effort envisaged in Kyoto can be discussed. It takes place within a reasonable range, in the sense that there are good reasons, but no convincing proof, to think that Kyoto does too much or too little. The nature of the uncertainty and the temporal horizon make cost-benefit analysis difficult. But the arguments that conclude that the Kyoto reductions pace is too quick rely on simplistic economic calculations, and are rather less convincing than those that conclude, for example using option values arguments, in favour of insufficient present abatement. The truth is that our comprehension of the climatic consequences of the growth of the greenhouse gas concentration is insufficient, and that this position pleads for prudence. Prudence and credibility, as aimed in Kyoto, recommend going well beyond symbolic actions.

The flexibility mechanisms notably aim at lowering the implementation costs of policies.

The markets for tradable emission permits constitute a major innovation, which most likely would considerably increase the efficiency of the action, even if the scheme has never been experimented on this scale before. On the other hand, however, this paper points to some reservations about the implementation of the Clean Development Mechanism (CDM). More generally, the architecture envisaged in Kyoto is based on rigid quantitative commitments that, ideally, should be more flexible. But this quantitative frame is excessively criticized. The implementation of alternative mechanisms, considering probable supply reactions in the energy market, is more difficult than generally expected. Nevertheless, some form of price supervision, like the 'safety valve' mechanism alluded above, is desirable. Besides, the Kyoto architecture allows renegotiations and opens the door to limited transfers between nations. It is an improvable evolving scheme that could possibly lead to other 'Kyoto compatible' architectures.

Even though this paper does not evaluate most of the political aspects of the subject, in particular the political willingness of Europe placed in a position of ecological leader, it underlines the costs of renunciation of Kyoto and argues in favour of keeping it alive and improving it. Nevertheless, before recapitulating the principal suggestions that were made in this direction, it is useful to evoke several scenarios of the post-Kyoto period, starting with two extreme scenarios, an idealized Kyoto and a weak and frayed Kyoto.

Vigorous and "idealized" post-Kyoto governance could include:

• Some quantitative Kyoto-like targets, agreed upon by sovereign entities. But the agreement would be widened to the definition of long term allocation principles for national emission rights. It would match with provisional perspectives of the implementation of these principles. Equality of rights for all the inhabitants of the world would be the focal position of the discussion, even though the long-term principles should necessarily compromise to reconcile it with mobilisation capacity and economic and political realism. Therefore, the agreement would also reflect the exposures of the protagonists to the climatic risk.

• An assignment of binding objectives to be fulfilled within a period together with some indicative paths coherent with the long-term perspectives.

• The possibility of meeting the targets of the period, not only by internal reduction efforts but also by trade on international markets for emission. In this respect, the regulation of these markets by a floor price and a ceiling price would operate, according to the circumstances, as a tax or a subsidy, and would help provide insurance and entail at least a minimum incentive for abatement. Such a regulation, however, should aim to frame the user prices of fossil fuels, that ultimately determine GHG emissions, and not only the price of the permits. The expected receipts of the scheme would be collectively managed and could help implement some specific assistance to developing countries, and also finance an international research network, etc.

• The solidity of the agreement would be guaranteed by its inclusion in a "package deal" of international agreements including trade agreements, and defining rules of the game for interdependent and supportive international order.

The idealised Kyoto sketched here, which can be pleaded at least from the point of view of efficiency, is likely to be utopian. One essential obstacle to such a Kyoto utopia be the reluctance of a part of the international community, not only the US, with regard to the solutions implying a significant, although still very modest, redistribution of the planet's income. The state of things today, therefore, makes this utopia not very probable. But a spectacular increase of the danger of the climatic change, if it was proved, would make an increasing number of people aware of it and thus could give the Kyoto utopia a chance. Nevertheless, in the short run, the situation is less favourable and the danger of seeing a Kyoto becoming weaker and weaker is real.

The demonstration effect of a limited club of nations who have been unsuccessful in convincing the international community to join them and who represent a minority both in terms of number and volume of emissions may neither be very productive nor rewarding. In order not to loose the political support of their citizens worried about a low value of benefit/cost ratio, it may lead to limited efforts by their governments. Moreover, these countries may find their competitiveness weakened in some segments of the world market of goods and services. In a nutshell, the 'demonstration effect' risks being highly limited.

One fears that there stands out another kind of frayed Kyoto today, that is the Russian "hot air", rather than the political erosion of the European determination. Russia due to its recent deindustrialisation is in possession of excess permits for the "hot air" and may lower the price of permits on the market to the extent that it deters abatement efforts by other countries. Furthermore, both the credibility of the climate policy and incentives to research on clean technology that a significantly high carbon price insures, and which are the cardinal virtues of the international permit market, disappear with it. Until the end of the first commitment period in 2012, the European Union has the responsibility to contain these risks. It must proceed in an effective manner to a significant reduction of its emissions, while managing the question of the Russian hot air.

Finally, the action taken within the Kyoto framework will be fully meaningful only if it can go on after 2013, a period for which it is necessary to prepare now. The feeling expressed in this paper is that the ambition of the Kyoto Protocol will be lasting only if at least an important part of the developing countries is associated with the extension of the agreement. For that the Annex B countries will have to present economically attractive solutions to the developing countries, which they have the capacity for. These solutions could be more or less inventive (as explained in the report). But to be mutually advantageous, i.e., to lower the cost for the rich countries and trigger significant income transfers on a sufficiently long period to the developing countries, they will have to be generous in the short run and give solid guarantees on the rules of the game in the middle run.

Without broaching the diplomatic and geopolitical questions, this report expresses the conviction that an agreement on the basis of the suggested solutions is possible, as soon as the two conditions that have just been underlined are met. Supporting the implementation of efficient systems of measurement for emissions in the developing countries is also a concrete priority today.

Still in the middle run, together with a quantitative control, some form of control of the GHG price, that comes either within a safety valve and/or sets an inferior bound to the incentive with a price floor, should be integrated to the scheme. But, although this point deserves more elaboration, the mechanism might be all the more satisfactory if it will stabilize the total price of carbon and not only the "carbon tax". Moreover, the agreement could evolve towards adopting architectures that are "Kyoto compatible", either more effective or more adaptable to the political economy of negotiation. It is necessary, in whatever manner, to solve the problem of the inter-temporal inefficiencies that come with ratchet effect more satisfactorily than we do it today. It is also necessary to widen the space of the carbon tax to the whole planet. In the strict Kyoto logic, the solution of these problems is likely to require an agreement on the principles of a long run distribution of the emission rights on the one hand, and, on the other hand, a coercive participation, of which the privileged mean could be the merging or logrolling of international compromises outside the lone field of environment. However, these problems have other Kyoto compatible solutions the understanding of which future studies must imperatively deepen. Scenario SL : Soft Landing Scenario CC : contraction and convergent Scenario CG : Global Compromise Ind G :. Gini Index

End Notes

1 Ideally, part of the effort should be devoted to adaptation (to global warming), but action on this front today may be quite premature.

2 These actions would eventually involve the private sector but could make creation of some ambitious collective institutions, such as an International Commission for research on freecarbon energies, meaningful, bypassing the too narrow national scope.

3 See Criqui, Vielle and Viguier (in Guesnerie 2003b), as well as Bernard (2001) and Criqui et al. (1999). 4 Within the same logic, one nevertheless may prefer equivalent monetary transfer for the hot air. 5 We may, however, note the success of the first Chinese efforts regarding reduction of the emissions, despite the effective and potential role of the coal in the Chinese economy.

6 Despite the apparent contradiction between the positions of the candidate Al Gore and the elected president George W. Bush, most of the observers think that another result of the American elections might not have basically changed the situation. One might argue that this American position reflects a bad interpretation of their interests, in view of the rate of substitution between moral leadership and military leadership and the economic cost of the latter. 7 The technical argument of Newell and Pizer (2000) in favour of the price solutions calls for some reservations. It relies on a formalization of costs, some convex cost functions in each period, which raises the question of inter-temporal aggregation. See the report (Guesnerie 2003a) for details. Lastly, regulations by quantities have advantages that are not taken into account in the model. For example, one could argue that a price fluctuation around the average value will have a positive effect on the incentive to research (the "convexity in prices" of the revenue function of the innovator does not, however, seem to be empirically validated).

8 This suggestion deserves a greater theoretical discussion as well as a more practical precision, since it raises the question of the relevance of the spot price signals for the energy market on the one hand and since the prices of the various GHG sources are themselves likely to vary in a different manner on the other hand. 9 Some suggestions were made by Victor (2000) to avoid "junk permit" coming from countries not respecting their commitments. Let us also note the requirements of already adopted solutions, for example, that of a reserve for the commitment period. This is an unrecognized but essential mechanism: every country must keep in reserve an important part of its initial emissions. But the buying countries can also sell (temporarily) a part of their assigned quantity (10%). The environmental integrity of the market is preserved (one cannot flood the market with permits which the country would need later to cover its emissions), while assuring its liquidity.

A firm which is located in a net buying country, but surpasses its target, would have nonetheless access to the international market.

10 The price volatility observed on the American market for SO 2 is somewhat disturbing.

11 Even if some dispositions envisage an early renegotiation that would limit this risk at the first steps. In that way Kyoto Protocol specifies in its item 3.9 that "Commitments for subsequent 12 The Bonn agreement stipulates that the Annex I countries will have to implement some domestic actions that aim to reduce emissions such that it reduces the per capita differences between the developed countries and the developing countries, while working towards the ultimate objective of the Convention. 13 In the long run, the political acceptability of per capita emissions convergence scenarios can be improved by the fact that the "veil of ignorance", even very incomplete, reinforces the acceptability of the distributive argument that they incorporate. 14 One of which integrates the convergence objective of the per capita emissions at the planetary scale and leads to the curve nearest to the bissectrix.

15 One can, for example, define for each country a fictitious population taking account of its present and future population and its degree of exposure to the greenhouse effect (Russia having then a fictitious population that is greater than its real population). 16 One can envisage penalties, of which Adly, Orzag and Stiglitz (2002) suggest a list, including the most anecdotic ones like exclusion from the Olympic Games or Soccer World Cup.

Figure 1 .

 1 Figure 1.

  periods for Parties included in Annex I shall be established in amendments to Annex B to this Protocol[…]. The Conference of the Parties serving as the meeting of the Parties to this Protocol shall initiate the consideration of such commitments at least seven years before the end of the first commitment period.


Bruno Amable

Donatella Gatti

Jan Schumacher

Donatella Cepremap

Gatti

Andrew Clark

Pierre Pestiau

Claudia Senik

Welfare state retrenchment: The partisan effect revisited

Keywords: Welfare state, ideology, structural change Welfare State, ideology, structural change JEL classification: H5, I1, J8

This paper aims to shed light on the role of the 'ideology' of political parties in shaping the evolution of the welfare state in 18 developed democracies, by providing empirical findings on the determinants of social programs entitlements and social spending over the period 1981-1999. The paper shows that structural change is a major determinant of the extent of social protection. Our results suggest that overall spending is driven up by structural change. On the other hand, strong structural change has a negative influence on welfare entitlements measured by net replacement rates of sickness insurance or unemployment benefits. Partisan influence plays an important role in the dynamics of the welfare state. Left-wing governments strengthen the positive

Introduction

This paper aims to shed light on the role of the 'ideology' of political parties in shaping the evolution of the welfare state in 18 developed democracies, by providing empirical findings on the determinants of social programs entitlements and social spending over the period 1981-1999. A number of contributions in the field of economics study the impact of welfare state institutions on economic performance (see Atkinson, 1999; Blanchard and Wolfers, 2000; Nicoletti et al., 2001; Nickell and Layard, 1999). Following the process of European integration, economists have recently shown a renewed interest toward the analysis of the changes taking place in the architectures of the welfare state (see Andersen, 2003; Bertola et al., 2001). Drawing on existing economic models (Andersen, 2002; Lizzeri and Persico, 2001; Milesi-Ferretti, Perotti and Rostagno, 2002; Persson, Roland and Tabellini, 2003; Persson and Tabellini, 1998), one can identify several factors that may help explain the evolution of the welfare state: the features of the pre-tax income distribution;1 income volatility; 2 the social costs of taxation and the income mobility of the median voter; and the characteristics of political institutions. In this respect, Amable and Gatti (2005) present a coalition model where social groups can trade -within the political arenaincome redistribution against income protection through labour market regulation; one insight of the model is that the relative political power of specific social groups within political coalitions shape welfare state institutions and their evolution following economic processes such as globalization: the decline in workers' political power is thus associated to a political equilibrium yielding weaker income redistribution and/or employment protection. A rich body of literature within the field of political economy stresses the role of political factors to explain recent and past changes in welfare state institutions (see, among others, Garrett and Mitchell, 2001; Huber and Stephens, 2001) as well as the variety of national configurations (Amable, 2003). Political partisanship, in conjunction with political institutions, is a key factor that helps understanding the features of modern welfare states: the power resources approach (Korpi and Palme, 2003) submits that the architecture of the welfare state is the outcome of distributive conflicts between socioeconomic groups; because these conflicts are solved in the political arena, partisan politics plays a crucial role in shaping their outcome. [START_REF] Alesina | Why Doesn't the US Have a European Style Welfare State?[END_REF] Recent developments in political economy have been marked by two major debates, the first concerning the direction and importance of changes in national welfare states, the second related to the driving factors behind welfare states' evolution. Since the 1980s, growing external and internal constraints (such as globalization, capital markets integration, and budget deficits) together with structural change (i.e. biased technological change and rising inequalities, union decline, and demographic revolution) have radically modified the situation faced by political parties in developed democracies. These forces, often deemed as irresistible, have contributed to create the basis for what Pierson (2001) designates as the era of austerity. As a consequence of austerity, the evolution of modern welfare states is held to have entered a new phase and is supposed to have experienced a shift from expanding to defending social entitlements. This alleged overwhelming trend is taken to be a constraint for all governments, irrespective of their partisan positions. In this respect, positions within the political economy arena differ greatly in relation to the following two questions: 1) are countries experiencing massive welfare state retrenchment or just reforms of mature welfare states in response to challenges stemming from external and internal constraints? 2) does political partisanship still play a role in the era of 'austerity' ? Answers to those questions oppose, on the one side, the 'partisans' of the "new politics" of welfare states and, on the other side, the supporters of the "amended" power resources approach.

According to the "new politics" approach (Pierson, 2001), the most salient fact about recent welfare state changes is that they are surprisingly weak. Hence, institutional inertia -despite growing external and internal pressures -seems to characterize the era of austerity. To explain institutional inertia two main factors are put forward: first, welfare dismantling is a fairly unpopular policy; second, the existence of formal and informal institutional veto points prevents radical reforms (Bonoli, 2001). Pierson submits that the expansion of the welfare state has itself contributed to the fading away of traditional class divides, and given room to the emergence of "powerful groups surrounding social programs" (Pierson, 1996, p. 2). In this case, one should expect to find little evidence supporting the effects of partisan politics on welfare state changes since 1970. The 'amended' power resources approach raises the idea that the contemporary era of austerity is better characterized as an epoch where social citizenship rights in major insurance programs are in danger (Korpi and Palme, 2003; Allan and Scruggs, 2004). [START_REF] Alesina | Partisan Politics, Divided Government and the Economy[END_REF] Social citizenship rights are entitlements allowing individuals to share their risks more equally within the community. Crucial examples are pension and sickness programs but equally important are programs insuring individuals who are more fragile because, for instance, of their position in the labour market. The unemployment insurance scheme is one notable example. Empirical findings on the evolution of social programs entitlements are indeed few. To our knowledge only two contributions (Korpi and Palme, 2003; Allan and Scruggs, 2004) address the issue. Their results, based on the study of net replacement rates in sickness and unemployment insurance programs, seem to indicate that partisan politics still plays a role as a driving force of modern welfare states evolution. In particular, on the ground of their analysis of the British case, Korpi and Palme (2003, p. 434) identify "a radical change in an advanced welfare state, a change carried through by a Conservative party within a constitutional structure with few veto points and in the context of a markedly weakened Labour Party and a largely defeated trade union movement".

In spite of the growing body of literature, economists are still few to present empirical contributions uncovering the determinants of welfare states evolution. A few works have set the agenda for empirical investigations. Alesina and Wacziarg (1998) present empirical evidence pointing to the role of trade openness in determining the size of the welfare state. Alesina, Glaeser and Sacerdote (2001) raise the issue of ethnic fragmentation and racial animosity as crucial determinants of the small size of the US welfare state.

Persson and Tabellini (1998) study the determinants of the size of government and the provision of public goods and find support to the claim that the size of government is smaller under presidential regimes. These results are confirmed and extended by Persson (2002). Milesi-Ferretti, Perotti and Rostagno (2002) present evidence on the relationship between proportional versus majoritarian systems and the size and composition of public spending. Moreover, the authors apply the methodology proposed by Blanchard and Wolfers (2000) and run time series regression to study the government response to shocks through fiscal spending, conditional to a set of political institutional variables. Their results indicate that proportional systems tend to show stronger fiscal reactions following economic shocks.

Building on a methodology close to the one proposed by Blanchard and Wolfers (2000), our paper aims to provide an answer to the questions as to whether and how governments' political and ideological positions shape welfare states' reactions following exogenous economic shocks. Contrary to existing empirical contributions focusing on the role of political institutions, we investigate the joint effect of economic shocks and political partisanship on the features of modern welfare states. Welfare state reactions are captured through three different dependent variables: the first one is total social security expenditure as a percentage of GDP (Armingeon et al., 2004); the second and third ones are the net replacement rates of sickness and unemployment insurance programs proposed by Allan and Scruggs (2004). Social security expenditure is a standard indicator of an individual country's generosity in social protection and allows us to account for the effect of partisanship and shocks on the size of the welfare effort. Net replacement rates are more structural measures of social entitlements and enable us to explore the influence of partisanship and shocks on the institutional structure of the welfare state. We model shocks by constructing two structural change variables on the basis of the OECD STAN industrial database, the first one reflecting changes in industry value added shares, the second one based on changes in labour force shares across industries.

To account for political partisanship, we make use of two continuous variables, one capturing the government's ideological position in the left-right spectrum, the other one measuring the ideological gap between government and opposition as the distance between their respective positions in the leftright spectrum. [START_REF] Allen | Political Partisanship and Welfare State Reform in Advanced Industrial Societies[END_REF] The rationale for the use of such a measure is that par-ties' ideological positions have changed appreciably over the period under scrutiny, a fact that may explain why the power resources and the "new politics" approaches may both capture some of the substance of the evolutions under way in welfare systems. Under the pressure of economic and social changes, social groups may experience various processes of decomposition and recomposition which will have consequences for the strategy of parties seeking political support. In such circumstances, the assumption that parties classified as 'conservative' would systematically aim at dismantling the welfare state while parties classified as progressive would defend the welfare state may no longer be true.

In order to take into account the evolution of the position of political parties, we do not, as most studies investigating the link between partisanship and the welfare state do, take a dichotomous left/right classification but build specific partisanship variables. The advantage is that, being defined on a continuous scale, these variables allow us to account for changes, across countries and over time, in the (strategical) positioning of political party in the left-right spectrum. We are thus able to address properly the issue of the redefinition of the left-right political distribution that may have taken place since the 1980s. Our variables indicate nevertheless that the left-right ideological rift persists in spite of 'austerity'. Hence, two interesting questions follow: first, assessing to what extent such ideological rift is still relevant to understand modern welfare state evolution; and second, exploring whether the 'shocks and partisanship' combined effect acts differently on the size versus the institutional structure of the welfare state.

The paper is organized as follows. Section 2 presents some methodological remarks, i.e. our method of estimation and the definition of our data set and variables. Section 3 investigates the determinants of social expenditure by focusing on the role of government ideology. Section 4 presents a similar empirical analysis conducted on the determinants of sickness and unemployment net replacement rates. Section 5 provides some conclusive remarks and prospects for future research.

Methodology

Estimation Method

One of the central questions in empirical political economy literature has been that of the interaction between the economic and the political spheres, i.e. the link between political and/or institutional variables on the one side and (macro)economic variables on the other side.

Empirical research in this area has been shaped in a remarkable way by an estimation method proposed by Blanchard and Wolfers [2000]. They used a nonlinear specification to clarify the role of a number of exogenous shocks (measured for example by TFP growth or the real interest rate) in interaction with institutional components such as employment protection, replacement rates and the role of unions in the evolution of unemployment in Europe. Their estimation supposed multiplicative interactions between shocks and institutions:

u i,t = c i + k Y k,i,t • a k • 1 + j X i,j • b j + e i,t (1)
with c i being country fixed effects, Y i,t exogenous shocks, X i,j institutional variables. The idea is thus that countries will react differently to a given size shock according to their specific institutional features.

The estimation technique has been frequently adopted in a more or less modified form by a number of researchers in the domain of political economics. Persson [2002] makes use of an estimation specification based on the Blanchard-Wolfers method in order to shed light on the joint influence of economic shocks and political institutions on policy outcomes. Milesi-Ferretti, Perotti and Rostagno [2002] use the approach to estimate interaction effects between unemployment and the countries' electoral system with respect to government spending. One may find applications in political economy too: Iversen [2004] tries to explain the development of social spending while accounting for the interaction of shocks and institutional settings.

In the present paper we shall make use of a very similar specification, but for a different purpose. While these authors mainly let institutional variables interact with economic shocks, we are interested in the link between structural changes in the economy and partisanship and their common influence on the welfare state variables. The basic underlying question is thus the following: does the government's political and ideological position have an influence on the reaction of the social welfare system to exogenous structural change?

The Blanchard-Wolfers equation is specified in levels and many subsequent papers have adopted such a specification too. Since we intend to use annual data over a period of 20 years in our estimations, [START_REF] Amable | The diversity of modern capitalism[END_REF] the problem of data stationarity arises. We ran a series of panel unit-root tests on the main variables of our data set, which led to the conclusion that most of these variables could be integrated of order 1. Therefore, testing a model in level would mean looking for cointegration relationships, interpreted as long-run relationships regarding the evolution of the welfare state. On the other hand, testing a model in difference means looking for a modeling of the 'short-run' dynamics of the welfare state. [START_REF] Amable | The Political Economy of Job Protection and Income Redistribution[END_REF] For both statistical and theoretical reasons, we chose the latter option. The investigation of a long-run relationship would require some additional theoretical work in order to have a theory of the longrun determinants of the welfare systems, as well as the relevant data. The partisan and institutional influences on the size of welfare spending or the generosity of the entitlements appear as explanations for the evolution of already existing welfare systems and are thus more suited for the investigation of 'short-run' dynamics. Therefore, the basic equation underlying our estimations can be written as follows:

∆Y i,t = α i + β • S i,t • (1 + γ • I i,t ) (2)
+ j δ j • Y i,t-j + k ζ k X k,i,t + η • trend + i,t
with ∆Y i,t being the first difference of the dependent variable, α i country fixed effects, S i,t the variable measuring structural change, I i,t the variable capturing partisanship, j Y i,t-j lagged levels of the dependent variable and k X k,i,t a set of control variables. The trend may either be linear or a full set of year dummies to account for unobserved year effects. Some technical remarks are to be made on the estimation technique. First, as the use of a nonlinear estimators requires a balanced panel (while our panel is slightly unbalanced) we shall systematically linearize the specification. This is straightforward in the case of one shock and one political variable, for no restrictions on the coefficients are required. A simple transformation of our equation yields

∆Y i,t = α i + β • S i,t + β • γ • S i,t • I i,t (3)
+ j δ j • Y i,t-j + k ζ k X k,i,t + η • trend + i,t
The estimated coefficient β • γ of the interaction term S i,t • I i,t together with the estimation of β can be used to compute γ, which gives an estimation of how far the institution influences the reaction of the dependent variable to a shock.

Second, and as a consequence, we will be enabled to use OLS with Beck and Katz ' [1995] panel corrected standard errors, [START_REF] Andersen | European Integration and the Welfare State[END_REF] which, taking account of the structure of our dataset, is supposed to give us reasonable standard errors for the estimated parameters and to control the risk of overoptimistic t-statistics. [START_REF] Andersen | International Integration, Risk and the Welfare State[END_REF] We shall also include in our regressions lagged levels of the dependent variable to eliminate within-autocorrelation. We systematically include fixed effects. We check for the stationarity of the residuals of our estimations using Maddala and Wu's test. Another problem is that of the potential endogeneity of the political variable used in the regressions. In these cases, we used an instrumental variables estimator10 .

Variables

Our estimations are based on a pooled time series cross section data set, comprising observations on 18 countries, covering the time period between 1981 and 1999. This dataset has been built on variables from a number of different sources which are mentioned in the appendix along with the description of the variables. Some of the indicators used in the following have been merely imported from existing data sources, others have been built on the basis of available statistics.

Regarding the variables used, the estimations made in this paper are characterized by certain improvements with respect to the estimations found in the literature. The modeling of structural change is based on an indicator built using the OECD STAN industrial database, based on the changes in the value added in different industries (VA shocks). [START_REF] Atkinson | The economic consequences of rolling back the welfare state[END_REF] For the construction of this variable we use a modification of the basic idea found in Lilien (1982) and Abraham and Katz (1986): We suppose that high structural fluctuations in both underlying values reflect exogenous economic shocks to which the economy has to adapt. These shocks (respectively this structural change) are likely to have consequences on the welfare systems, either raising the demand for social insurance or inducing pressures to downsize the welfare entitlements. Iversen and Cusack [2000] have ventured that most of the risks generated in modern industrialized societies are the product of technologically induced transformations inside national labour markets. These transformations take the form of structural change, shifts in the production structure, which increase risks for individuals. When people lose their employment, they may lose the skills they have acquired when these are not easily transferable to other firms, occupations or sectors. Structural change may not only affect the structure of employment or production but also the structure of worker representation. A decline in 'traditional sectors' parallels a decline in unionization and hence in the resistance capacity of organized labour to welfare state retrenchment. Faced with an increase in risk exposure, agents will express a demand for social protection and public risk-sharing. Unemployment benefits, but also other aspects of social protection such as sickness benefits, are ways to guarantee the status of workers by public means. Taking into account a finer structural change than just the shift of employment from manufacturing to services as in Iversen and Cusack [2000] allows to have a more precise assessment of the transformations likely to influence the process described above. Our variable on structural change is positively defined. However, it has a caveat: It may, in few rare cases, overshoot in value. This is the reason why we proceed systematically in the elimination of a couple of outlying values of this variable.

To account for partisanship, we propose a proxy for the government's ideological position (Government position). It specifies the government's position on a left-right scale and is based on the PGL File Collection by Thomas R. Cusack and Lutz Engelhardt of the Wissenschaftszentrum Berlin für Sozialforschung. We have thus an indicator for partisanship on a yearly basis which exhibits major advantages over traditional variables. Not only can a party's vote or cabinet share in country A have quite different implications than the same vote or cabinet share in country B but also can a party, which is qualified as "left-wing" with respect to the parties on the right end of the political spectrum, be in fact not so much on the left. The same applies in reverse for conservative parties. Such an indicator has the advantage over the more traditional binary variable (left/right) often found in the literature of taking account of ideological changes even within a given party or coalition.

The shock variable and the institutional parameter may enter the estimation with their first-lag-value to take into account the potential delay with which economic variables eventually react to shocks and to political decisions.

Our choice of control variables is in line with the existing literature and reflects standard assumptions about structural welfare state determinants. To capture the effect of the size of groups that are likely to benefit from or depend on social protection, we may include OECD unemployment rates (unemployment) and the share of the population over 65 years of age (Elderly People) taken from Armingeon et al. [2004]. To take into account what is known as "Wagner's law", i.e. the positive link between GDP and public expenditure, we use the growth of GDP (GDP growth) in percent as a control, taken from the same source. In times of budgetary restrictions (whether self-imposed or as a consequence of stability pacts) the government's budget balance may play a role in explaining welfare state austerity, so we include alternatively the budget balance (budget balance/GDP) variable given by Allan and Scruggs (2004), the OECD ratio of public debt over GDB (debt/GDP) as well as the OECD cyclically adjusted government balance over GDP (cycl. adjusted balance/GDP ), the latter being a good proxy for the structural deficit or surplus. Finally, we may include a variable comprising the sum of exports and imports as a percentage of real GDP (openness) to account for the role of economic openness. This measure has been taken from the Huber et al. [2004] dataset and is a widespread measure of the influence of globalization.

We test three different dependent variables: First, overall social security spending as a percentage of GDP taken from Armingeon et al. (2004), which is the standard indicator for a country's effort in social protection. It will allow us to draw conclusions on the volume-effect of government partisanship and exogenous shocks. Second and third, Allan's and Scruggs' (2004) net replacement rates of sickness and unemployment insurance. These variables will give us an indication of existing structure-effects. Furthermore, the latter two dependent variables have major advantages: First, they are fairly new and thus not very much explored, and second, they much better reflect the structural development of social protection than the gross replacement rates that have been in use in most of the literature.

3 Assessing welfare state retrenchment, structural change and partisan influence

Analyzing global social expenditure

As our study tries to identify the main factors that influence welfare state developments, we first have a look on overall welfare spending even if estimations based on social spending alone are not likely to tell us the whole story of recent welfare state development. Nevertheless, they give us a first idea on the global role of shocks or structural change on social protection, and on the strength of partisan influence in the transmission of these shocks.

More precisely, we want to explore whether the partisan position influences governments' effort to cushion exogenous structural change by augmenting social security expenditure.

As mentioned above, the dependent variable (total social expenditure) enters our equation in the form of its first difference (∆y = y t -y t-1 ). Fixed effects are systematically included.

The OLS regression shows a positive and significant impact of the value added shock on welfare expenditure (table 1): The higher the variable VA shock, i.e. the stronger the structural change, the higher the rise in social expenditure. This result can at first view be understood as a support for the Rodrick [1998] argument that higher economic insecurity and increasing volatility lead to a welfare state expansion. Furthermore, the left-right ideological position of the respective governments has a significant influence on the propagation of the shock into the sphere of social protection: The more the incumbent government is positioned at the right end of the political spectrum (the higher our indicator is), the lower is the expansionary effect of the shock. Additionally to the coefficients of VA shock and the interaction term we calculate the marginal effects of the shock and the marginal effect of the shock together with a shift to the left in ideology by one standard deviation in terms of our partisan variable. The first gives the marginal change in total social expenditure with respect to the shock when the partisan variable is evaluated at its mean value. The second gives an idea of what the effect of the shock is at the margin when the government is more left-wing by one standard deviation than the mean government. The results underline the findings described above: The marginal effect of the shock is positive, driving global welfare expenditures up. With a more left-wing government, the welfare expansion as a reaction to the shock more than doubles in size. [START_REF] Barr | The economics of the welfare state[END_REF] We also ran the same estimation with unemployment rates as an additional control. Results concerning the effect of structural change, partisanship and the budget deficit did not change much: neither the estimated coefficients, nor the associated significance level. The coefficient of unemployment, however, was weakly negative but largely insignificant.

We already pointed to the extreme variance of the employed shock proxy and its tendency to overshoot. In order to avoid problems with extreme outliers, we eliminate from our panel a couple of observations for which the VA shock takes extraordinarily large values [START_REF] Bertola | EU Welfare Systems and Labor Markets: Diverse in the Past, Integrated in the Future?[END_REF] , with the result that the significance of the interaction term rises considerably, letting signs and tendencies basically unchanged. In the course of the paper we shall systematically undertake this elimination strategy for all following estimations with this variable.

When we replace the linear time trend by unobserved year effects (Table 2), results are fairly similar to those presented above. Only the effect of strong structural change as well as the combined effect of shock and partisanship rise significantly in levels: both marginal effects more than double in size. Nevertheless, the relative importance of the influence of partisanship with respect to the the consequences of structural change stays merely the same: The marginal shock-effect together with a government which is more left-wing by one standard deviation has twice the size of the marginal effect of structural change alone. This means that having a government which is located to the left (resp. right) of the average governments of our sample by one standard deviation of our partisan variable means that the impact of the shock is increased (resp. lessened) by about 100%.

The partisan influence can be confirmed by estimations using an alternative shock variable which is constructed accordingly using inter-industry shares of labour fluctuations (evenly taken from the OECD STAN-database) instead of value added shares. We don't report detailed results here, but the signs of the coefficients of interaction terms once again indicate that shocks lead to a reduction of welfare spending when the government coalition is located on the right end of the political spectrum; the more right wing the government coalition, the stronger the welfare reducing effect of shocks.

It seems plausible to summarize, that these results constitute strong arguments in favor of the idea that ideologies keep playing a significant role in welfare state dynamics.

Table 2 shows that estimated results are stable, even if the government budget balance is replaced by its cyclically adjusted counterpart which accounts more for the purely structural effects of budget deficits or surpluses. In both cases, the effect has about the same magnitude and the same significance level. Whichever control variable is used, it is worth mentioning that the lower the budget deficit (respectively the higher the surplus), the lower are the global social expenditure. At first sight, this would mean that in the period under consideration, a higher financial margin in times of small budget deficits or even surpluses has not systematically been used for higher welfare expenditures. There is -at least in part -a mechanical explanation for this observation: Budget surpluses frequently coincide with times of economic prosperity and low unemployment, so that the number of people claiming welfare benefits is lower. The partisan influence can be confirmed by estimations using an alternative shock variable which is constructed accordingly using inter-industry shares of labour fluctuations instead of value added shares. We don't explicitely report these results, but the signs of the coefficients of interaction terms once again indicate that shocks lead to a reduction of welfare spending when the government coalition is located on the right end of the political spectrum.

Analyzing sickness and unemployment benefits

The limits of comprehensive spending variables have already been mentioned: they may be driven by influencing factors that we cannot control for in a reasonably tractable way. Besides, it has been shown that overall social expenditure includes components that react in a fairly mechanical way to structural change and shocks, which may lead to higher unemployment, leading to a rise in the number of beneficiaries, boosting transfer payments and therefore overall spending, without any political intervention. [START_REF] Blanchard | The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence[END_REF] Last but not least, austerity and retrenchment are keywords of much of the debate on social protection in recent years (see for example Korpi [2003]), but announced cutbacks on overall spending levels may be politically dangerous. Structural cuts in benefits are thus likely to be "hidden" in subcategories of welfare expenditure.

As already mentioned above, we shall make use of two entitlement variables that have only recently been constructed by Allan and Scruggs ( 2004) : net-replacement-rates of unemployment and sickness insurance, i.e. the percentage of foregone earnings replaced by those insurances, net of taxes and other charges. They are far more precise than the gross replacement rates proposed by the OECD. Besides the fact that these data are fairly new and relatively unexplored, they have the advantage of not indicating spending volumes but being highly comparable structural measures of two important welfare state components. These variables enter our equations (analogous to what has been done in the preceding section) in the form of their one year difference (∆y = y t -y t-1 ). [START_REF] Beck | What to do (and not to do) with Time-Series Cross-Section Data[END_REF] The story on the link between structural change and replacement rates would have to be told like this: Strong structural change as we measure it can be seen as the expression of an adaptative process the economy undergoes to handle globalization, deindustrialization and exogenous shocks. These phenomena may reduce governments' tax earnings, raise the number of those who claim welfare state entitlements and so put pressure on government budgets. Governments desirous to maintain budget discipline would not only cut back overall welfare spending, but also make structural reforms in the design of social programs -such as systematic reductions of replacement rates. Were these forces irresistible and were welfare state retrenchment without alternative, governments' reactions would be independent of partisanship: Left wing and right wing politics would both be characterized by massive welfare state cutbacks as a consequence of structural change.

The specification of our estimations are roughly the same as in the previous section. Here, structural change forces the year to year change of replacement rates of sickness insurances down in a statistically significant manner (table 3). However, there appears to be a time lag in the influence of shocks on replacement rates, which comes without surprise and can be explained on theoretical grounds: While overall welfare spending may react (at least in part) mechanically and immediately to structural change (e.g. through the channel of a higher number of claimants and thus higher benefit payments), replacement rates are to a large degree the result of a political decision process, which usually takes time. We used first lags of the shock proxies and the corresponding interaction term to account for this phenomenon. The coefficient for the interaction term is significantly negative (tables 3 and 4). Structural change and an ideologically right-oriented government (which translates into high positive values of the interaction term) are associated with a relatively lower replacement rate than weak shocks or leftoriented governments. Knowing that the structural change variable has itself a significantly negative influence on the replacement rate, we can conclude that the more the government is ideologically on the right end of the political spectrum, the stronger the reduction of the replacement rate as a consequence of the shock will be. On the other hand, the presence of a left-wing government would imply that the negative effect of the shock is weakened. The marginal effects for both the structural change and the partisan effects strikingly underline this interpretation: At the margin, the effect of the shock with the partisan variable evaluated at its mean is negative, i.e. the shock itself drives down replacement rates. The marginal effect of this structural change with a government which is more left-wing by one standard deviation even turns positive. In our sample, left-wing governments reacted to shocks not with cutbacks of replacement rates, but with a rise in welfare state generosity in order to cushion the effects of structural changes. Comparing marginal effects in tables 3 and 4 one notes that the influence of the government being (by one standard deviation) more leftwing than the mean on the marginal shock effect has two to three times the size of the marginal effect of the shock alone.

Using replacement rates of unemployment insurance, we applied basically the same estimation techniques, and results are similar to what has been found for sickness insurance replacement rates: Both coefficients (shock and interaction term) are negative, giving in principle rise to the same interpretation as for the sickness insurance replacement rate: Right-wing governments together with strong shocks lead to lower replacement rates; left-wing governments or weak structural shocks lead to higher replacement rates. Changes in the control variables do not fundamentally alter our main results and leave the significance of the interaction term estimation basically unchanged. As in previous sections, the partisan position plays a strong role in explaining the change of welfare entitlements in reaction to structural change induced by labour fluctuations. 4 What can be learned from the controls?

The emphasis of the econometric section of this paper clearly lies on the determination of the joint influence of structural change and political partisanship on the welfare state. However, a complete set of standard controls has been included in order to account for effects of which theory tells us that they are probably playing a decisive role in welfare state development: the unemployment rate, the share of elderly people in the population, GDP growth, public debt, government budget balance (or its cyclically adjusted counterpart), economic openness or government's ideology. As much can be learned on welfare state retrenchment from these estimations, we summarize the main findings in this section. Before turning to the interpretation of controls that have actually been included, a comment should be made on a variable that has systematically not been excluded from our estimations: Following a stringent application of the Blanchard/Wolfers approach we estimated the joint influence of shocks and partisanship on welfare state variables. The purpose of this paper was not to estimate the influence of partisanship on its own. The latter approach has already been at the center of a large part of the literature on welfare state retrenchment and results are generally in line with our findings. Furthermore, simply adding the partisanship variable to the list of controls would have exposed us to a serious problem of multicollinearity between the shock proxy, the partisan variable and the interaction term.

Economic openness is an explanatory factor of welfare state downsizing (tables 3 and 4). It seems as if economies relying heavily on foreign trade were in fact more vulnerable to exogenous shocks, which may force social expenditure down. Similarly, budgetary restrictions also seem to have their part in the explanation of welfare state development. As detailled above, the budget balance is negatively correlated with global welfare spending. The reason can be seen in the fact that times of low budget deficits (or even surpluses) usually coincide with a prosper economic situation, where the number of people claiming welfare state entitlements falls considerably. The effect on overall welfare expenditure is about the same for the government budget balance (in percent of GDP) as for its more structural counterpart: the cyclically adjusted government balance (in percent of GDP). The influence of these parameters on the replacement rates, however, cannot be confirmed: Tables 3 and4 show that coefficients are marginal and highly insignificant. These findings underline that replacement rates are indeed measures for welfare state development that react much less mechanically to changes in the economic environment than global entitlement measures. We do not find clear evidence for an effect of economic growth on replacement rates: Tables 3 shows that its influence is positive, but insignificant. On the contrary, high GDP growth rates drive global social spending down in a highly significant way (table 2). Contrary to a first intuition one should conclude from this finding, that favorable economic development does not automatically lead to higher welfare spending. Turning to the influence of public debt on replacement rates (table 3), findings are evenly surprising with a higher debt rate leading to higher replacement rates. Further research should explore these phenomena more in detail.

The size of groups of potential claimants are important factors of welfare state evolution: The share of elderly people in the population is significantly and positively linked either to global spending as well as to the replacement rates. Two explanations should be considered: Elderly people are usually claimants of welfare state entitlement in more than one branch of social security (retirement, health care). First, with a rising share of elderly people in the population welfare spending mechanically goes up (tables 1 and 2).

Second, as the elderly rely more heavily on social insurance income, they are more likely to vote for politics favoring welfare state expansion, which may explain the positive effect on the more structural variable (tables 3 and4). Unemployment has a significantly negative effect on replacement rates without altering the influence of partisanship. The consequence of a high number of unemployed are high social expenses and strong budgetary pressures, which translate into the necessity of structural spending cuts. Together with the comparatively weak political power of the unemployed (who do not seem to have homogenous political preferences), this explains the negative effect of unemployment on replacement rates.

Conclusions and outlook

The main task of this paper was to provide an answer to the question whether partisan politics and the ideology of governments still play a role in welfare state evolution. Do left and right governments find different answers in terms of social policy to exogenous shocks ? In the present paper, these shocks were proxied by structural change in the industry shares of the value added. The interaction with a newly designed partisan variable was tested. The main results can be summarized as follows.

Structural change is itself a major determinant of the extent of social protection. Our results suggest that overall spending is driven up by structural change, which may to a large degree be the result of a mechanical rise of transfers when shocks lead to economic frictions and unemployment. On the other hand, strong structural change has a negative influence on welfare entitlements measured by net replacement rates of sickness insurance or unemployment benefits.

Partisan influence plays an important role in the dynamics of the welfare state. It does so in the direction that one would expect not only from political intuition, but also from former empirical work. Left-wing governments strengthen the positive effect of shocks on aggregate social expenditure while right-wing governments undertake even stronger cutbacks in replacement rates as a reaction to structural change.

Our paper supports previous findings underlining the role of structural change on the welfare state, but also underlines the importance of ideologies. It is well documented that partisan politics played a role in the emergence of welfare states. It also plays a role in the current evolution of welfare systems, even in times of 'austerity' and retrenchment.

A couple of questions will have to be left for further research. While the present paper exhibited the importance of incumbents' ideology for its political reaction to shocks, the interaction between government partisanship and the ideology of the opposition should be carefully explored as one would like to have information on their mutual influence in recent welfare state development. Furthermore, in this paper we had to leave aside the relation between partisanship and diverse institutional characteristics, such as fractionalization of the political scene, vote mechanisms or the influence of social groups.

IN D V A c,t = i (V A c,i,t -V A c,i,t-1 ) 2 (4)
and in an similar way:

IN D LAB c,t = i (LAB c,i,t -LAB c,i,t-1 ) 2 (5)
with

IN D LAB c,t (IN D V A c,t
) being the structural change variable based on employment shares (value added shares) for year t in country c. Taking squared differences has two major implications: First, the indices are positively defined, and second, they exhibit much variance and some values may "overshoot" for strong structural changes, leading to a risk of overinterpretation of shocks.

These two synthetic proxies for structural change show only low correlation: The correlation coefficient is 0.1105 for both series. Taking lags into account does lead to significant differences. However, elimininating the most extreme values from the series drives the correlation coefficient up to 0.3007. Nevertheless we state that the two variables are proxies for two different sorts of shocks -one may be seen as taking place in product markets, the other in the labour market.

The construction of the Government Position Variable

We have constructed Government Position on the basis of a 2002 version of the PGL File Collection by Thomas R. Cusack and Lutz Engelhardt of the Wissenschaftszentrum Berlin für Sozialforschung. Their dataset provides variables for numerous political parties reflecting the relative frequency of statements in party manifestos on characteristic economic and non-economic political topics such as Keynesian demand management, peace or decentralization. From this voluminous list of variables, we have chosen a subset in Ignoring truncation errors and missing categories, value added and labor shares of these subgroups add up to 100%.

order to construct a useful indicator. In that sense, our indicator for a leftright positioning of a party includes the relative frequencies of statements on: Governmental and Administrative Efficiency, political authority, free enterprise, incentives, economic orthodoxy, welfare state limitation, traditional morality (positive statements), law and order, labour groups (negative statements), military (positive statements). Those frequencies are summed up and have a positive influence on the indicator, rising up its value. We substract (lowering the indicator's value) relative frequencies of statements on: market regulation, economic planning, Keynesian demand management, controlled economy, nationalization, Marxist analysis, social justice, welfare state expansion, traditional morality (negative statements), social harmony, positive statements on labour groups, underprivileged minority groups, military (negative statements). The resulting indicator gives us a positioning of parties on a positive-negative scale, higher values standing for more right-leaning parties. However, its absolute value is difficult to interpret precisely, but it it very useful for intertemporal and inter-country comparisons. For a multiparty government (which is a frequent political constellation), the indicator is the vote-weighted mean of the indicators' of all governing parties. Let i be the country in question, let r = 1...n be the governing parties in parliament, let s r be the respective last election share of votes, let C rL , L = 1...m be the values of left characteristic variables for party r and C rR , R = 1...k be the values of right characteristic variables for party r, then Government position (GP) can be written as:

GovernmentP osition = 1 n r ( R C rR - L C rL )s r

List of control variables

  sale and retail trade; repairs, 28. Hotels and restaurants, 29. Transport and storage, 30. Post and telecommunications, 31. Financial intermediation, 32. Real estate activities, 33. Renting of machinery and equipment and other business activities, 34. Public admin. and defence; compulsory social security, 35. Education, 36. Health and social work, 37. Other community, social and personal services, 38. Private households with employed persons.

Table 1 :

 1 Effects of structural change and partisanship on social expenditure (PCSE estimation). No outliers eliminated. t-statistics in brackets, significant coefficients (significance-level ≤ 10%) printed in bold.

		Yearly Change in Social Expenditure
	VA shock	0.0489**
		(2.13)
	VA shock*gov-position	-0.0023*
		(-1.68)
	Elderly People	0.1737***
		(3.20)
	Budget Balance	-0.1220***
		(-3.99)
	Linear Trend	0.0489*
		((1.83))
	Social Expenditure (t-1)	0.0717
		(0.70)
	Social Expenditure (t-2)	-0.3628***
		(-3.71)
	Estimator	PCSE (pairwise)
	Eliminated extreme shocks?	no
	Number of observations	284
	Baltagi autocorr.-test	0.483
	Maddala	Wu	224.325***
	R 2	0.38
	marginal shock-effect	0.0413*
	marginal shock-effect with government	0.0831***
	more left wing by one standard-deviation

Table 2 :

 2 Effects of structural change and partisanship on social expenditure (PCSE estimation)

Table 3 :

 3 Effects of structural change and partisanship on sickness replacement rates (IV estimation)

Table 4 :

 4 Effects of structural change and partisanship on sickness replacement rates (IV estimation) without taking GDP growth into account

Following Romer (1975), increased inequality in pre-tax earnings is considered to yield a larger political demand for redistributive policies. Recent contributions (Moene and Wallerstein,

2001) suggest that the relation between inequality and redistribution is indeed more complex and might even be non linear.2 Following the seminal work by[START_REF] Cameron | The Expansion of the Public Economy: A Comparative Analysis[END_REF], income volatility is frequently related to globalization (see[START_REF] Rodrik | Why do more open economies have bigger governments?[END_REF][START_REF] Alesina | Openness, country size and government[END_REF].[START_REF] Iversen | The Causes of Welfare State Expansion. Deindustrialization or Globalization?[END_REF] submit that growing insecurity is due to deindustrialization. Deindustrialization increases insecurity because it exposes individuals to the risk of losing their job and having to "cross the borders" from traditional sectors (agriculture plus industry) to the service sector. The authors produce estimates including internationalization variables, partisanship variables and deindustrialization variables. They conclude that the coefficient of trade openness is statistically insignificant once appropriate control variables are included in the regression.

One should note that, within the economic literature, the role of partisanship is widely acknowledged in theoretical and empirical contributions focusing on the determinants of fiscal policy over the business cycle[START_REF] Alesina | Partisan Politics, Divided Government and the Economy[END_REF][START_REF] Persson | Political Economics. Explaining Economic Policy[END_REF].

These authors consider it necessary to abandon welfare state expenditure as measure of generosity. This measure is in fact sensible to the business cycle: periods of high unemployment and weak growth might in fact lead to a higher value of the welfare state effort indicator, which are not due to accrued generosity but simply to economic crisis.

Both variables are built by using the PGL File Collection by Cusack and Engelhardt

[START_REF] Blanchard | The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence[END_REF] use 5-year averages.

Some contributions[START_REF] Iversen | Economic Shocks and Varieties of Government Responses[END_REF] for instance) test a model in levels without the appropriate testing procedures and are therefore plagued by the problem of 'spurious regressions'. Most of the other contributions choose a model in difference.

Applying PCSE on an unbalanced dataset, we have to specify how missing observations shall be treated when computing the covariance matrix of the disturbances: either using only observations common to all panels, completely excluding time-periods with at least one missing observation (CASEWISE option in STATA terminology) or using observations common to the two panels used to calculate the covariance (PAIRWISE option). For highly unbalanced panels with many missing observations, the PAIRWISE option may be advisable. The chosen option is indicated with the results of our regressions. For more details on the theory see[START_REF] Woolridge | Econometric Analysis of Cross Section and Panel Data[END_REF], p.578 -581.

On the issue of the choice of PCSE for time series -cross section data rather than panel data estimators (random effects model), see also[START_REF] Beck | Time-Series-Cross-Section Issues: Dynamics[END_REF].

Instruments are lagged values of the interaction term between shock and ideology and of a shock proxy.

See the appendix for a more detailed description.

On the interpretation of multiplicative effects see the debate in[START_REF] Braumoeller | Hypothesis Testing and Multiplicative Interaction Terms[END_REF] and[START_REF] Friedrich | In Defense of Multiplicative Terms In Multiple Regression Equations[END_REF].

In fact we reduce the panel to observations for which the variable VA shock takes values under 10.

See Pierson [1996],[START_REF] Korpi | New Politics and Class Politics in the Context of Austerity and Globalization: Welfare State Regress in 18 Countries, 1975-95[END_REF], and for the "dependent variable problem" Green-Peddersen[2004].

The very few missing values in the original replacement rate series have been filled in by linear interpolation.

Appendix

The construction of VA shock and labour shock:

The basis of their construction is constituted by two time series cross section datasets from the 2004 STAN Indicators database: Value added shares relative to the total economy (VA) and employment shares in the total economy (LAB). Let i be the industy [START_REF] Beck | Time-Series-Cross-Section Issues: Dynamics[END_REF] , c the country, t a time index, we compute the following indicator [START_REF] Beck | Time-Series-Cross-Section Issues: Dynamics[END_REF] For each series, the following industies and sub-industries are taken into account: 1. AGRICULTURE, HUNTING, FORESTRY AND FISHING, 2. MINING AND QUAR-RYING, 3. Food products, beverages and tobacco, 4. Textiles, textile products, leather and footwear, 5. Wood and products of wood and cork, 6. Pulp, paper, paper products, printing and publishing, 7. Coke, refined petroleum products and nuclear fuel, 8. Chemicals excluding Pharmaceuticals, 9. Pharmaceuticals, 10. Rubber and plastics products, 11. Other non-metallic mineral products, 12. Iron and steel, 13. Non-ferrous metals, 14. Fabricated metal products, except machinery and equipment, 15. Machinery and equipment, n.e.c., 16