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A Call for Pragmatic Climate Policies

Economists, including myself, have long favored carbon-pricing policies – either carbon taxes or cap-and-trade – as the best approach to reducing emissions of carbon dioxide (CO₂) in large, complex economies – on the basis of: feasibility of limiting emissions from hundreds of millions of point and non-point sources; short-term cost-effectiveness in the face of highly heterogeneous abatement costs associated with highly diverse sources; and long-term effectiveness and efficiency by bringing about carbon-friendly technological change.

Although economists would therefore argue that carbon-pricing policies will be a necessary element of a truly meaningful policy portfolio, they would not claim that they will be sufficient, partly because of the presence of other market failures (such as principal-agent problems in the context of energy-efficiency technology adoption decisions in renter-occupied properties, and information spillovers leading to insufficient private investments in research and development).

But there is another reason for the insufficiency of carbon-pricing policies, and that reason is captured by a single word: politics. It has become increasingly clear that in the United States carbon-pricing policies do not have sufficient constituencies among either conservative Republicans or “progressive” liberal Democrats to become a central element of meaningful climate change policy. Hence, there is increasing recognition – even by economists – that more attention needs to be given to other, so-called “second-best” policies, which may be more costly but will also be more politically feasible.

This point is made in compelling fashion by Gilbert Metcalf, Professor of Economics at Tufts University and a long-time analyst, expert, and advocate of the use of carbon taxes, in the latest episode of our podcast, “Environmental Insights: Discussions on Policy and Practice from the Harvard Environmental Economics Program.” You can hear Gib’s plea for broader thinking by listening to our conversation here.

In these podcasts, I converse with leading experts from academia, government, industry, and NGOs. Gib Metcalf fits well in this group, as a long-time Professor of Economics at Tufts, a Research Associate at the National Bureau of Economic Research, a University Fellow at Resources For The Future, an Associate Scholar of the Harvard Environmental Economics Program, and a former Deputy Assistant Secretary for Environment and Energy at the U.S. Department of the Treasury (2011-2012). He has spent much of his career working on policy design and evaluation in the area of energy and climate change, both in academia and government.

Gib Metcalf’s call for pragmatism and broader thinking on climate change policy by the economics community is particularly striking (and compelling) because of his extensive analysis over more than a decade and his strong advocacy for the development of a U.S. carbon tax. This is exemplified by his excellent 2019 book, Paying for Pollution: Why a Carbon Tax is Good for America (Oxford University Press).

As a longtime proponent of a carbon tax to affix a social price on CO₂ emissions, Metcalf is particularly convincing when he acknowledges in our conversation that he is now convinced that a carbon tax is not a practical option in today’s exceptionally partisan political climate.

“I am a firm believer that we should do the most efficient policies possible, and I think carbon pricing is precisely the way to do that. I prefer a carbon tax to cap-and-trade, I think for a number of reasons … but the political environment is such that, that’s just not going to happen,” he says. “And meanwhile, the concentration of greenhouse gases in the atmosphere continues to rise. So given, that I think we are obligated, those of us who care about the climate, to promote policies that will reduce emissions now, even if they’re not necessarily our most desirable policies.”

So, Metcalf argues that the Biden Administration should consider regulatory actions and executive orders in addition to statutory subsidies to give polluters incentives to seek cleaner energy alternatives. Commenting on the serious legal challenges that some regulatory initiatives are likely to face (particularly given the 6-3 conservative majority on the U.S. Supreme Court), he offers a cause for optimism:

“I see less of a problem with fuel economy standards [by] ratcheting those up. So, we can do something in transportation. I think we’ll [also] use tax credits in the electricity sector instead of regulation and perhaps we’ll do the same in buildings, but that gets to the third leg of what I would call a policy tripod in a third best world, which is R&D spending. And here, I think the R&D spending really needs to be focused on the technologies that have the greatest potential to lower the cost of clean energy.”

Gib Metcalf argues that production tax credits can be used to encourage further development of clean energy options, including wind power, but they should be designed in a way that will account for the increasingly negative impacts of carbon emissions.

“My recommendation is that we ought to tie that tax credit to the social cost of carbon. Given the official social cost of carbon numbers that the Biden Administration is using, that would be about a two and a half cents per kilowatt hour production tax credit. So, it doesn’t change the [tax] credit now, but as the social cost of carbon rises over time, then the production tax credit should rise over time.”

Gib Metcalf and the author on a panel at COP21 in Paris in 2015

At the end of our conversation, I ask Gib Metcalf for his thoughts on the current, prominent youth movements pressing for more aggressive action on climate change. His response is that he was initially skeptical about their impact, thinking of them as little more than a “side show” to meaningful action through the international climate negotiations, for example. But that is no longer the case.

“I’ve actually changed my mind entirely. I’m more pessimistic [now] about where the negotiations will get us given the urgency of action. But the youth movements, Greta Thunberg and others, are really, to me, incredibly important in that they are driving public opinion and bringing media attention to the problem, in a way that I think is extremely valuable. So, I see them as just absolutely essential.”

I raise the question of whether this very prominent youth activism is an age effect (hence likely to become more moderate as young people become adults) or a cohort effect (likely to retain its strength over time). Gib responds that the young people involved in these climate movements are likely to remain engaged.

“I think the current youth movements see a very clear stake for themselves in terms of the damages that we’re seeing in the world today because of climate change. So, I think that gives them a more enduring stake that may outlast their youth.”

That’s an excellent, optimistic note on which our conversation comes to a close.

For this and much more, I hope you will listen to my complete conversation with Gib Metcalf, the 30^th episode in the Environmental Insights series, with future episodes scheduled to drop each month. You can find a transcript of our conversation at the website of the Harvard Environmental Economics Program. Previous episodes have featured conversations with:

Gina McCarthy, former Administrator of the U.S. Environmental Protection Agency
Nick Stern of the London School of Economics discussing his career, British politics, and efforts to combat climate change
Andrei Marcu, founder and executive director of the European Roundtable on Climate Change and Sustainable Transition
Paul Watkinson, Chair of the Subsidiary Body for Scientific and Technological Advice (SBSTA) within the United Nations Framework Convention on Climate Change
Jos Delbeke, professor at the European University Institute in Florence and at the KU Leuven in Belgium, and formerly Director-General of the European Commission’s DG Climate Action
David Keith, professor at Harvard and a leading authority on geoengineering
Joe Aldy, professor of the practice of public policy at Harvard Kennedy School, with considerable experience working on climate change policy issues in the U.S. government
Scott Barrett, professor of natural resource economics at Columbia University, and an authority on infectious disease policy
Rebecca Henderson, John and Natty McArthur University Professor at Harvard University, and founding co-director of the Business and Environment Initiative at Harvard Business School.
Sue Biniaz, who was the lead climate lawyer and a lead climate negotiator for the United States from 1989 until early 2017.
Richard Schmalensee, the Howard W. Johnson Professor of Management, and Professor of Economics Emeritus at the Massachusetts Institute of Technology.
Kelley Kizier, Associate Vice President for International Climate at the Environmental Defense Fund.
David Hone, Chief Climate Change Adviser, Shell International.
Vicky Bailey, 30 years of experience in corporate and government positions in the energy sector.
David Victor, professor of international relations at the University of California, San Diego.
Lisa Friedman, reporter on the climate desk at the The New York Times.
Coral Davenport, who covers energy and environmental policy for The New York Times from Washington.
Spencer Dale, BP Group Chief Economist.
Richard Revesz, professor at the NYU School of Law.
Daniel Esty, Hillhouse Professor of Environment and Law at Yale University.
William Hogan, Raymond Plank Research Professor of Global Energy Policy at Harvard.
Jody Freeman, Archibald Cox Professor of Law at Harvard Law School.
John Graham, Dean Emeritus, Paul O’Neill School of Public and Environmental Affairs, Indiana University.
Gernot Wagner, Clinical Associate Professor at New York University.
John Holdren, Research Professor, Harvard Kennedy School.
Larry Goulder, Shuzo Nishihara Professor of Environmental and Resource Economics, Stanford University.
Suzi Kerr, Chief Economist, Environmental Defense Fund.
Sheila Olmstead, Professor of Public Affairs, LBJ School of Public Affairs, University of Texas, Austin.
Robert Pindyck, Bank of Tokyo-Mitsubishi Professor of Economics and Finance, MIT Sloan School of Management.

“Environmental Insights” is hosted on SoundCloud, and is also available on iTunes, Pocket Casts, Spotify, and Stitcher.

The Future of European Climate Change Policy

In my previous blog post, on January 14^th, I offered my personal views regarding “International Climate Change Policy & Action in the Biden Administration.” Today, I’m pleased to turn to a parallel assessment of future European climate change policy by Ottmar Edenhofer, a greatly-accomplished German economist, admired by academics, as well as leaders in government, industry, and non-governmental organizations.

Professor Edenhofer’s presentation, “The European Green Deal – Reform or Regulatory Tsunami?” and our subsequent discussion is the most recent webinar in our series, Conversations on Climate Change and Energy Policy, sponsored by the Harvard Project on Climate Agreements (HPCA). As you know, in this webinar series we feature leading authorities on climate change policy, whether from academia, the private sector, NGOs, or government. A video recording (and transcript) of the entire webinar is available here.

Ottmar Edenhofer is Professor of Economics at the Technical University of Berlin, the Founding Director of the Mercator Research Institute on Global Commons and Climate Change, and Co-Director and Chief Economist of the Potsdam Institute for Climate Impact Research. He has been a major contributor to scholarship on the economics of energy and climate change, and served as Co-Chair of Working Group III of Fifth Assessment Report of the Intergovernmental Panel on Climate Change, where I had the pleasure of working under his leadership. He is a key advisor of the German Government, as well as the European Union. He holds a Ph.D. in economics and a B.A. degree in philosophy (a pairing of degrees which – I’m delighted to say – he and I share).

In his presentation and the discussion that follows, Ottmar Edenhofer offers a frank assessment of the European Green Deal’s potential to significantly address the impacts of global climate change.

“It’s a very good time to talk about the European Green Deal because now the prospects that United States and Europe could work closer together on climate change or climate policy and energy policy are very good,” Ottmar notes, referring to the change in U.S. administrations and recent remarks by European Commission President Ursula von der Leyen reaffirming the European Union’s (EU’s) intent to reduce its target for emission reductions from 40 percent to 55 percent by the year 2030 and to achieve net carbon neutrality by the year 2050.

Calling it a “huge task,” Edenhofer outlines the actions that would need to occur to achieve such ambitious goals, including enhanced efforts to decarbonize the power sector, accelerated electrification for end-users, increased investments in bio-energy and semi-synthetic fuels, and advancements in carbon dioxide removal technologies. Using the EU’s climate policy impact assessment as a framework, he walks us through three different policy scenarios, ranging from one that relies heavily on regulation to one structured primarily around carbon pricing.

Characterizing the heavily regulatory approach as a “high-risk scenario,” he instead promotes the idea of an “intermediate step” in a which a mix of policy measures and carbon pricing are deployed to move toward the goal of a 55-percent carbon emissions reduction, and toward a longer-term strategy of using carbon pricing alone as the primary driver in CO₂ reduction efforts.

“The crucial question therefore is, how can we design this intermediate step, and this is really the most important debate around this reform proposal,” he says, noting that several issues would need to be addressed. “The intermediate step has to address the distributional issues and guarantee the stability and manage the political economy challenge between the sectors.”

Professor Edenhofer suggests that the intermediate step that may gain the political support necessary to succeed would be one that would allow for two separate emissions trading systems – one for the energy and industry sector, and the other for transportation and buildings.

“Meanwhile we could define gateways between these two systems. “Creating such gateways might have a two-fold effect – the first one is that market participants already anticipate that there are gateways and they anticipate these enterprise expectations, and this could lead to a convergence of the different prices across the sectors. And secondly, this is a starting point to manage the division of labor among the sectors, and this could be a credible pathway toward a carbon-price scenario when we have one ETS with one credible CO₂ price scenario.”

In his presentation, Edenhofer also acknowledges the role that fiscal federalism could play in affecting the future direction of climate policy in Europe. While arguing that carbon pricing could generate roughly 800 billion euros between now and 2050, he notes that the funding base would shrink over time as emissions decrease, and therefore would not serve as a stable revenue source. He has answers for this challenge as well.

After his presentation, Professor Edenhofer responds to questions from the virtual audience of more than 200 people. One question focuses on the impact of the new Biden-Harris Administration in Washington on global efforts to address climate change.

“The good thing is they are back in the Paris Agreement. The announcement alone that the U.S. is committed has already helped.”

All of this and much more can be seen and heard in the full webinar here. I hope you will check it out.

Previous webinars in this series – Conversations on Climate Change and Energy Policy – have featured Meghan O’Sullivan’s thoughts on Geopolitics and Upheaval in Oil Markets, Jake Werksman’s assessment of the European Union’s Green New Deal, Rachel Kyte’s examination of “Using the Pandemic Recovery to Spur the Clean Transition,” Joseph Stiglitz’s reflections on “Carbon Pricing, the COVID-19 Pandemic, and Green Economic Recovery,” Joe Aldy describing “Lessons from Experience for Greening an Economic Stimulus,” and Jason Bordoff commenting on “Prospects for Energy and Climate Change Policy under the New U.S. Administration.”

The next bi-monthly HPCA Conversation on Climate Change and Energy Policy will take place in March. You can register in advance for that event at the HPCA website.

Market Mechanisms in the Paris Climate Agreement: International Linkage under Article 6.2

The Harvard Project on Climate Agreements hosted a research workshop in Cambridge, Massachusetts, on July 14–15, 2016, the purpose of which was to identify options for elaborating and implementing the Paris Climate Agreement, and to identify policies and institutions that might complement or supplement the United Nations Framework Convention on Climate Change (UNFCCC) process. We were motivated by our recognition that while the Paris Agreement sets forth an innovative and potentially effective policy architecture for dealing with global climate change, a great deal remains to be done to elaborate the accord, formulate required rules and guidelines, and specify means of implementation.

Participants in the workshop – International Climate Change Policy after Paris – included twenty-one of the world’s leading researchers focusing on climate-change policy, representing the disciplines of economics, political science, international relations, and legal scholarship. They came from Argentina, Belgium, China, Germany, India, Italy, Norway, the United Kingdom, and the United States. (A list of workshop participants is here, biographies here, and the agenda here.)

The Harvard Project will next focus on communicating the ideas, insights, and recommendations of workshop participants to climate negotiators and policy makers, in the expectation that they might prove useful in elaborating and implementing the Paris Agreement. Each participant is preparing a brief—based largely on her or his presentation during the workshop. These briefs, together with a workshop summary, will be conveyed to participants in the Twenty-Second Conference of the Parties (COP-22) of the UNFCCC in Marrakech, Morocco in November 2016. This will be done in meetings with negotiators representing UNFCCC member governments and in a side-event panel at COP-22.

Today I wish to share with readers just one of these draft briefs – namely, my own – on the topic of “International Linkage under Article 6.2 of the Paris Agreement.”

A Key Challenge for Sustained Success of the Paris Agreement

For sustained success of the international climate regime, a key question is whether the Paris Agreement with its Intended Nationally Determined Contributions (INDCs), anchored as they are in domestic political realities, can progressively lead to submissions with sufficient ambition? Are there ways to enable and facilitate increased ambition over time?

Linkage of regional, national, and sub-national policies can be part of the answer. By “linkage,” I mean connections among policy systems that allow for emission reduction efforts to be redistributed across systems. Such linkage is typically framed as being between two (or more) cap-and-trade systems, but national policies will surely be highly heterogeneous under the Paris climate regime. Fortunately, research – by Gilbert Metcalf of Tufts University and David Weisbach of the University of Chicago – indicates that linkage between pairings of various types of domestic policy instruments may be feasible.

Linkage and the Paris Agreement

Experience indicates that linkage will bring both merits and concerns in most applications. To begin with the good news, linkage offers a number of important advantages. First, it offers the possibility of achieving cost savings if marginal abatement costs are heterogeneous across jurisdictions, which they surely are. In addition, linkage can improve the functioning of individual markets by reducing market power, and by reducing price volatility, although we should recognize that price volatility will also be transmitted from one jurisdiction to another by linkage. Finally linkage can allow for the UNFCCC’s important principle of Common but Differentiated Responsibilities (CBDR), but do so without sacrificing cost-effectiveness.

The possibility of linkage also raises concerns, including that there will be distributional impacts within jurisdictions, that is, the creation of both winners and losers. Also, linkage can bring about the automatic propagation from one jurisdiction to another of some design elements, in particular, cost-containment mechanisms, such as banking, borrowing, and price collars. In this and other ways, linkage raises concerns about decreased autonomy.

Linkage under Article 6.2 of the Paris Agreement

It was by no means preordained that the Paris Agreement would allow, let alone encourage, international linkage. Fortunately, the negotiations which took place in Paris in December, 2015, produced an Agreement that includes in its Article 6.2 the necessary building blocks for linkages to occur.

Under Article 6.2, emissions reductions occurring outside of the geographic jurisdiction of a Party to the Agreement can be counted toward achieving that Party’s Nationally Determined Contribution (NDC) via Internationally Transferred Mitigation Outcomes (ITMOs). This enables both the formation of “clubs” or other types of coalitions, as well as bottom-up heterogeneous linkage. Such linkage among Parties to the Agreement would provide for exchanges between compliance entities within the jurisdictions of two different Parties, not simply the government-to-government trading (of Assigned Amounts or AAUs), as was the case with the Kyoto Protocol’s Article 17.

Linkage among Heterogeneous Nationally Determined Contributions

There are three types of heterogeneity which are important in regard to linkage under Article 6.2 of the Paris Agreement. First is heterogeneity among policy instruments. As demonstrated by Metcalf and Weisbach (see above), not only can one cap-and-trade system be linked with another cap-and-trade system, but it is also possible to link a cap-and-trade system with a carbon tax system. In addition, either a cap-and-trade system or a tax system can be linked (via appropriate offsets) with a performance standard in another jurisdiction. (Linkage with systems employing technology standards are not feasible, however, because such systems are not output-based.)

A second form of heterogeneity that affects linkage and is potentially very important under the Paris Agreement is heterogeneity regarding the level of government action of the relevant jurisdictions. Although the Paris Agreement has as Parties both regional jurisdictions (in the case of the European Union) and national jurisdictions, sub-national jurisdictions are also taking action in some parts of the world. In fact, linkage has already been established between the state of California in the United States and the provinces of Québec and Ontario in Canada.

A third form of relevant heterogeneity is with regards to the NDC targets themselves. Some are in the form of hard (mass–based) emissions caps, while others are in the form of rate-based emissions caps, either emissions per unit of economic activity, or emissions per unit of output (such as per unit of electricity production). There are also relative mass-based emissions caps in the set of existing NDCs, such as those that are relative to business-as-usual emissions in a specific future year. Beyond these, there are other parties that have put forward NDCs that do not involve emission caps at all, but rather targets in terms of some other metric, such as the degree of penetration of renewable energy sources.

Combinations of various options under these three forms of heterogeneity yield a considerable variety of types of potential linkages, which may be thought of as the cells of a three-dimensional matrix. Not all of these cells, however, represent linkages which are feasible, let alone desirable.

The Path Ahead – Key Issues and Questions

There are a substantial number of issues that negotiators will eventually need to address, and likewise, there are a set of questions that researchers (including within the Harvard Project on Climate Agreements) can begin to address now. Among the key issues for negotiators will be the necessity to develop accounting procedures and mechanisms. Also, it will be important to identify means for the ITMOs to be tracked in order to avoid double-counting of emissions reductions. And a broader question is whether and how the UNFCCC Secretariat or some other designated institution will provide any oversight that may be required.

For research, three questions stand out. First, among pairings from the (3-D matrix) set of instrument–jurisdiction–target combinations that emerge from the three types of heterogeneity identified above, which linkages will actually be feasible? Second, within this feasible set, are some types of linkages feasible, but not desirable? And third, what accounting treatments and tracking mechanisms will be necessary for these various types of linkages? Future research will need to focus on these and related questions in order to achieve the potential benefits of Article 6.2 of the Paris Agreement. Please stay tuned as this work develops.