Thirdly, when cleaner air leads to higher labour productivity, labour supply is boosted
and the existing distortions are mitigated. Finally, if a cleaner environment improves the
productivity of a fixed factor, the benefits of the externality tax are reduced.
The aim of this paper is to explore by means of a computable general
equilibrium (CGE) model to what extent it is important to include the feedback effects
of air pollution in policy assessment. For this we use the GEM-E3 model1, a CGE
model for the European and World economy that covers the interaction between the
economy, the energy system and the environment. In the past it has been used to
evaluate the welfare impacts of several environmental policies (Capros et al., 1999).
Though many CGE models aiming at evaluating environmental policies consider only
the costs of environmental policy measures, in the standard GEM-E3 and some other
CGE models, the benefits of environmental policies are already modelled, through an
index of environmental quality that depends on emissions and provides an ex-post
contribution to the consumers’ welfare. In this paper we explore how the health related
benefits of environmental policies can be modelled in a more realistic way in the GEM-
E3 model and what are the implications for the welfare evaluation of environmental
policies. We concentrate on the health related benefits as they are the largest gain from
an improvement in air quality. A similar exercise for Thailand is presented by Chung-Li
(2002), who explores the economy-wide repercussions of improved air quality through
its effect on labour supply and medical expenditure. The main contribution of our
analysis is threefold: the inclusion of more routes through which air pollution affects the
economic agents, a more encompassing endogenisation of these effects, and the
inclusion of the endogenous effects in a large scale and well-established CGE model.