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Why Cancun Trumped Copenhagen

As we begin the year 2011, a look back at 2010 confirms that the greatest environmental achievement of the past year was the success that was achieved at the Sixteenth Conference of the Parties (COP-16) of the United Nations Framework Convention on Climate Change (UNFCCC) in Cancun, Mexico, in early December. I wrote about this in some detail in my December 13^th essay, “What Happened (and Why): An Assessment of the Cancun Agreements.”

The challenges awaiting delegates later this year (December, 2011) at COP-17 in Durban, South Africa, will be tremendous, particularly in regard to trying to negotiate the massive divide that exists between most Annex I countries and virtually all non-Annex I countries on the fate of a second (post-2012) commitment period for the Kyoto Protocol.

However, on this first day of 2011, it may be helpful to reflect again on the recent success in Cancun, and ask – in particular – why it occurred, because understanding that could provide some valuable lessons for the organizers and hosts of COP-17 in Durban. This was the question I addressed in a brief December 20^th Op-Ed in The Christian Science Monitor, and so rather than attempting to summarize or expand it, I simply reproduce it below.

The Christian Science Monitor

Why Cancun trumped Copenhagen: Warmer relations on rising temperatures

By Robert N. Stavins
December 20, 2010

Boston —

After the modest results of the climate change talks in Copenhagen a little more than a year ago, expectations were low for the follow-up negotiations in Cancun last month. Gloom-and-doom predictions dominated.

But a funny thing happened on the way to that much-anticipated failure: During two intense weeks of discussions in the Mexican resort that wrapped up at 3 AM on Dec. 12, the world’s governments quietly achieved consensus on a set of substantive steps forward. And equally important, the participants showed encouraging signs of learning to navigate through the unproductive squabbling between developed and developing countries that derailed the Copenhagen talks.

Unprecedented first steps

The tangible advances were noteworthy: The Cancun Agreements set emissions mitigation targets for some 80 countries, including all the major economies. That means that the world’s largest emitters, among them China, the United States, the European Union, India, and Brazil, have now signed up for targets and actions to reduce emissions by 2020.

The participating countries also agreed – for the first time in an official United Nations accord – to keep temperature increases below a global average of 2 degrees Celsius. Yes, that goal is no more stringent than the one set out in Copenhagen, but this time, the participating nations formally accepted the goals; a year earlier, they merely “noted” them, without adopting the accord.

Other provisions establish a “Green Climate Fund” to finance steps to limit and adapt to climate change, and designate the World Bank as interim trustee, over the objections of many developing countries. And new initiatives will protect tropical forests, and find ways to transfer clean energy technology to poorer countries.

The Cancun Agreements on their own are clearly not sufficient to keep temperature increases below 2 degrees Celsius, but they are a valuable step forward in the difficult process of constructing a sound foundation for meaningful, long-term global action.

Small steps vs. global accords

The progress was as much about changing the mindset of how to tackle climate disruption. Significantly, the Cancun agreement blurs the distinction between industrialized and developing countries – a vital step to break through the rich-poor divide that has held up progress for years. The 1997 Kyoto Protocol assigned emission targets only to the 40 countries thought to be part of the industrialized world, which left the more than 140 nations of the developing world without any commitments. But today, more than 50 of those so-called developing countries have higher per capita income than the poorest of the countries with emission-reduction responsibilities under Kyoto.

Implicitly, the process in Cancun also recognizes that smaller, practical steps – some of which are occurring outside the United Nations climate process – are going to be more easily achievable, and thus more effective, than holding out for some overarching thunderclap in a global accord.

The parallel processes of multilateral discussions on climate change policy, including the G20 meetings and the Major Economies Forum, have been useful. For the first time at Cancun, the UN Framework Convention on Climate Change, under the new leadership of Executive Secretary Christiana Figueres, offered a positive and pragmatic approach toward embracing these parallel processes.

Fixing the past (and future)

The Kyoto Protocol, which essentially expires at the end of 2012, is fundamentally flawed, especially in dividing the world into competing economic camps. At Cancun, it was encouraging to hear fewer people holding out for a commitment to another phase of the Kyoto Protocol. It was politically impossible to spike the idea of extending the Kyoto agreement entirely, but at least it was punted to the next gathering in Durban, South Africa, a year from now. Otherwise, the Cancun meeting could have collapsed amid acrimony and recriminations.

Usefully, the Cancun Agreements recognize directly and explicitly two key principles:

1) All countries must recognize their historic emissions (read, the industrialized world); and

2) All countries are responsible for their future emissions (think of those with fast-growing emerging economies).

This also helps move beyond the old Kyoto divide.

A better dialogue

An essential goal in Cancun was for the parties to maintain sensible expectations and develop effective plans. That they met this challenge owes in good measure to the careful and methodical planning by the Mexican government, and to the tremendous skill of Mexican Foreign Minister Patricia Espinosa in presiding over the talks.

For example, at a critical moment she took note of objections from Bolivia and a few other leftist states, and then ruled that the support of the 193 other countries meant that consensus had been achieved and the Cancun Agreements had been adopted. She pointed out that “consensus does not mean unanimity.” Compare that with Copenhagen, where the Danish prime minister allowed objections by five small countries to derail the talks.

Mexico’s adept leadership also made sure smaller countries were able to contribute fully and join any meetings they wanted, avoiding the sense of exclusivity that alienated some parties in Copenhagen. That’s a sign that Mexico is one of the key “bridging states” that have credibility in both worlds. Another is South Korea. They will need to play key roles going forward.

It’s also vital to note that China and the United States set a civil, productive tone, in contrast to the Copenhagen finger-pointing. From the sidelines in Cancun, I can vouch for the tremendous increase in openness of members of the Chinese delegation.

The acceptance of the Cancun Agreements suggests that the international community may now recognize that incremental steps in the right direction are better than acrimonious debates over unachievable targets.

What Happened (and Why): An Assessment of the Cancun Agreements

The international climate negotiations in Cancun, Mexico, have concluded, and despite the gloom-and-doom predictions that dominated the weeks and months leading up to Cancun, the Sixteenth Conference of the Parties (COP-16) of the United Nations Framework Convention on Climate Change (UNFCCC) must be judged a success. It represents a set of modest steps forward. Nothing more should be expected from this process.

As I said in my November 19^th essay – Defining Success for Climate Negotiations in Cancun – the key challenge was to continue the process of constructing a sound foundation for meaningful, long-term global action (not necessarily some notion of immediate, highly-visible triumph). This was accomplished in Cancun.

The Cancun Agreements – as the two key documents (“Outcome of the AWG-LCA” and “Outcome of the AWG-KP”) are called – do just what was needed, namely build on the structure of the Copenhagen Accord with a balanced package that takes meaningful steps toward implementing the key elements of the Accord. The delegates in Cancun succeeded in writing and adopting an agreement that assembles pledges of greenhouse gas (GHG) cuts by all of the world’s major economies, launches a fund to help the most vulnerable countries, and avoids some political landmines that could have blown up the talks, namely decisions on the (highly uncertain) future of the Kyoto Protocol.

I begin by assessing the key elements of the Cancun Agreements. Then I examine whether the incremental steps forward represented by the Agreements should really be characterized as a success. And finally I ask why the negotiations in Cancun led to the outcome they did.

Assessing the Key Elements of the Cancun Agreements

First, the Cancun Agreements provide emission mitigation targets and actions (submitted under the Copenhagen Accord) for approximately 80 countries – including, importantly, all of the major economies. In this way, the Agreements codify pledges by the world’s largest emitters – including China, the United States, the European Union, India, and Brazil – to various targets and actions to reduce emissions by 2020. The distinction between Annex I and non-Annex I countries is blurred even more in the Cancun Agreements than it was in the Copenhagen Accord – another step in the right direction!

Also, for the first time, countries agreed – under an official UN agreement – to keep temperature increases below a global average of 2 degrees Celsius. It brings these aspirations, as well as the emission pledges of individual countries, into the formal UN process for the first time, essentially by adopting the Copenhagen Accord one year after it was “noted” at COP-15. (There’s also an abundance of politically-correct and in some cases downright silly window dressing in the Cancun Agreements, including repetitive references to various interpretations of the UNFCCC’s principle of “common but differentiated responsibilities,” as well as some discussion of examining a 1.5 C target.)

However, despite even the 2 degree (450 ppm concentration) aspirational target, the Agreements are no more stringent that the collection of submissions made under last year’s Copenhagen Accord. But, as Michael Levi (Council on Foreign Relations) has pointed out, the Cancun Agreement “should be applauded not because it solves everything, but because it chooses not to.” As my colleagues and I have repeatedly emphasized in our work within the Harvard Project on Climate Agreements, many of the most important initiatives for addressing climate change will occur outside of the United Nations process (despite the centrality of that process).

Second, the Agreements elaborate on the mechanisms for monitoring and verification that were laid out in last year’s Accord. Importantly, these now include “international consultation and analysis” of developing country mitigation actions. Countries will report their GHG inventories to an independent panel of experts, which will monitor and verify reports of emissions cuts and actions.

Third, the Agreements establish a so-called Green Climate Fund to deliver financing for mitigation and adaptation. Importantly, the Agreements name the World Bank as the interim trustee of the Fund, despite objections from many developing countries, and create an oversight board, half of which consists of donor nation representatives. In addition, the Agreements establish a goal by developed countries to mobilize $100 billion annually by 2020 to support mitigation and adaptation in developing countries, a funding target which would include public and private resources (that is, carbon markets and private finance), bilateral and multilateral flows, as well as the Green Climate Fund.

Whether the resources ever grow to the size laid out in Copenhagen and Cancun will depend upon the individual actions of the wealthy nations of the world. However, it’s interesting that the section in the Cancun Agreements on adaptation comes before the section on mitigation. Things have come a long way since the days when economists were virtually alone in calling for attention to adaptation (along with mitigation). I recall when economists were therefore accused of throwing in the towel, and not caring about the environment!

Fourth, the Agreements advance initiatives on tropical forest protection (or, in UN parlance, Reduced Deforestation and Forest Degradation, or REDD+), by taking the next steps toward establishing a program in which the wealthy countries can help prevent deforestation in poor countries, possibly working through market mechanisms (despite exhortations from Bolivia and other leftist and left-leaning countries to keep the reach of “global capitalism” out of the policy mix).

Fifth, the Cancun Agreements establish a structure to assess the needs and policies for the transfer to developing countries of technologies for clean energy and adaptation to climate change, and a – as yet undefined – Climate Technology Center and Network to construct a global network to match technology suppliers with technology needs.

In addition, the Agreements endorse an ongoing role for the Clean Development Mechanism (CDM) and other “market-based mechanisms;” indicate that carbon capture and storage (CCS) projects should be eligible for carbon credits in the CDM; and offer some special recognition of the situations of the Central and Eastern European countries (previously known in UN parlance as “parties undergoing transition to a market economy”) and Turkey, all of which are Annex I countries under the Kyoto Protocol, but decidedly poorer than the other members of that group of industrialized nations.

That’s the 32-page Cancun Agreements in a nutshell. As a member of one of the leading national delegations said to me in Cancun a few hours after the talks had concluded, “It’s incremental progress, but progress nonetheless.”

Are Such Incremental Steps Really a Success?

Recall from my November 19^th essay that the best goal for the Cancun climate talks was to make real progress on a sound foundation for meaningful, long-term global action. I said that because of some fundamental scientific and economic realities, which I will not repeat here. In that previous essay, I also described “What Would Constitute Real Progress in Cancun” A quick comparison of my criteria from November 19^th and the Cancun Agreements of December 11^th tells me that the outcome of Cancun should be judged a success.

My first criterion of success was that the UNFCCC should embrace the parallel processes that are carrying out multilateral discussions on climate change policy: the Major Economies Forum or MEF (a multilateral venue for discussions – but not negotiations – among the most important emitting countries); the G20 (periodic meetings of the finance ministers – and sometimes heads of government – of the twenty largest economies in the world); and various other multilateral and bilateral organizations and discussions. Although the previous leadership of the UNFCCC seemed to view the MEF, the G20, and most other non-UNFCCC forums as competition – indeed, as a threat, the UNFCCC’s new leadership under Executive Secretary Christiana Figueres displays a positive and pragmatic attitude toward these parallel processes.

My second criterion was that the three major negotiating tracks be consolidated. These tracks were: first, the UNFCCC’s KP track (negotiating national targets for a possible second commitment period – post-2012 – for the Kyoto Protocol); second, the LCA track (the UNFCCC’s negotiation track for Long-term Cooperative Action, that is, a future international agreement of undefined nature); and third, the Copenhagen Accord, negotiated and noted at COP-15 in Copenhagen, Denmark, in December, 2009.

Permit me, please, to quote from my November 19^th essay:

Consolidating these three tracks into two tracks (or better yet, one track) would be another significant step forward. One way this could happen would be for the LCA negotiations to take as their point of departure the existing Copenhagen Accord, which itself marked an important step forward by blurring for the first time (although not eliminating) the unproductive and utterly obsolete distinction in the Kyoto Protocol between Annex I and non-Annex I countries. (Note that more than 50 non-Annex I countries now have greater per capita income than the poorest of the Annex I countries.)

This is precisely what has happened. The Cancun Agreements – the product of the LCA-track negotiations – build directly, explicitly, and comprehensively on the Copenhagen Accord. The two tracks have become one.

Alas, the KP track remains, and a decision on a potential second commitment period (post-2012) for the Kyoto Protocol has been punted to COP-17 in Durban, South Africa, in December, 2011. It is difficult to picture a meaningful – or any – second commitment period for the Kyoto Protocol, with the United States out of that picture, and with Japan and Russia having stated unequivocally that they will not take up another set of targets, and with Australia and Canada also unlikely to participate. But note that this issue will have to be confronted in Durban a year from now. With the first commitment period of the Kyoto Protocol ending in 2012, COP-17 will provide the last opportunity for punting that contentious issue.

If you agree with my view – which I have written about in many previous blog posts – that the Kyoto Protocol is fundamentally flawed and that the Protocol’s dichotomous distinction between Annex I and non-Annex I countries is the heavy anchor that slows meaningful progress on international climate policy, then you will not consider it bad news that a second commitment period for the Protocol is looking less and less likely. On the other hand, you will, in that case, share my disappointment that the issue has been punted (recognizing, however, that had it not been punted, the Cancun meetings could have collapsed amidst acrimony and recriminations).

I also wrote in my November 19^th post:

The UNFCCC principle of “common but differentiated responsibilities” could be made meaningful through the dual principles that: all countries recognize their historic emissions (read, the industrialized world); and all countries are responsible for their future emissions (think of those rapidly-growing emerging economies).

The Cancun Agreements do this by recognizing directly and explicitly these dual principles. This can represent the next step in a movement beyond what has become the “QWERTY keyboard” (that is, unproductive path dependence) of international climate policy: the distinction in the Kyoto Protocol between the small set of Annex I countries with quantitative targets, and the majority of countries in the world with no responsibilities.

A variety of policy architectures can build on these dual principles and make them operational, bridging the political divide which exists between the industrialized and the developing world. (At the Harvard Project on Climate Agreements, we have developed a variety of architectural proposals that could make these dual principles operational. See, for example: “Global Climate Policy Architecture and Political Feasibility: Specific Formulas and Emission Targets to Attain 460 PPM CO2 Concentrations” by Valentina Bosetti and Jeffrey Frankel; and “Three Key Elements of Post-2012 International Climate Policy Architecture” by Sheila M. Olmstead and Robert N. Stavins.)

My third criterion for success was movement forward with specific, narrow agreements, such as on: REDD+ (Reduced Deforestation and Forest Degradation, plus enhancement of forest carbon stocks); finance; and technology. Such movement forward has, in fact, occurred in all three domains in the Cancun Agreements, as I described above.

My fourth criterion for success was keyed to whether the parties to the Cancun meetings could maintain sensible expectations and thereby develop effective plans. This they have done. The key question was not what Cancun accomplishes in the short-term, but whether it helps put the world in a better position five, ten, and twenty years from now in regard to an effective long-term path of action to address the threat of global climate change.

Despite the fact that some advocacy groups – and for that matter, some nations – are no doubt disappointed with the outcome of Cancun, I think it is fair to say that this final criterion for success was satisfied: the Cancun Agreements can help put the world on a path toward an effective long-term plan of meaningful action.

Why Did Cancun Succeed?

If you agree with my assessment of success in Cancun, then a reasonable question to ask is why did the Cancun talks produce this successful outcome, particularly in contrast with what many people consider a less successful outcome of the Copenhagen talks last year. To address this question, let me expand on some points made in an insightful essay by Elliot Diringer, Vice President for International Strategies at the Pew Center on Global Climate Change.

First, the Mexican government through careful and methodical planning over the past year prepared itself well, and displayed tremendous skill in presiding over the talks. Reflect, if you will, on the brilliant way in which Mexican Minister of Foreign Affairs, Patricia Espinosa, who served as President of COP-16, took note of the objections of Bolivia (and, at times, several other leftist and left-leaning Latin American countries, known collectively as the ALBA states), and then simply ruled that the support of 193 other countries meant that “consensus” had been achieved and the Cancun Agreements had been adopted by the Conference. At a critical moment, Ms. Espinosa noted that “consensus does not mean unanimity,” and that was that!

Compare this with the unfortunate chairing of COP-15 in Copenhagen by Danish Prime Minister Lars Løkke Rasmussen, who allowed the objections by a similar same small set of five relatively unimportant countries (Bolivia, Cuba, Nicaragua, Sudan, and Venezuela) to derail those talks, which hence “noted,” but did not adopt the Copenhagen Accord in December, 2009.

The Mexicans were also adept at facilitating small groups of countries to meet to advance productive negotiations, but made sure that any countries could join those meetings if they wanted. Hence, negotiations moved forward, but without the sense of exclusivity that alienated so many small (and some large) countries in Copenhagen.

The key role played by the Mexican leadership is consistent with the notion of Mexico as one of a small number of “bridging states,” which can play particularly important roles in this process because of their credibility in the two worlds that engage in divisive debates in the United Nations: the developed world and the developing world. We have examined this in our recent Harvard Project on Climate Agreements Issue Brief, Institutions for International Climate Governance. Mexico, along with Korea, are members of the OECD, but are also non-Annex I countries under the Kyoto Protocol. This gives Mexico — and gave Minister Espinosa — a degree of credibility across the diverse constituencies in the UNFCCC that was simply not enjoyed by Danish Prime Minister Rasmussen at COP-15 last year.

Second, China and the United States set the tone for many other countries by dealing with each other with civility, if not always with understanding. This contrasts with the tone that dominated in and after Copenhagen, when finger-pointing at Copenhagen between these two giants of the international stage led to a blame-game in the months after the Copenhagen talks.

As Elliot Diringer wrote, they may have recognized that “the best way to avoid blame was to avoid failure.” Beyond this, although the credit must go to both countries, the change from last year in the conduct of the Chinese delegation was striking. It appeared, as Coral Davenport wrote in The National Journal, that the Chinese were on a “charm offensive.” Working in Cancun on behalf of the Harvard Project on Climate Agreements, I can personally vouch for the tremendous increase from previous years in the openness of members of the official Chinese delegation, as well as the many Chinese members of civil society who attended the Cancun meetings.

Third, a worry hovered over the Cancun meetings that an outcome perceived to be failure would lead to the demise of the UN process itself. Since many nations (in particular, developing countries, which made up the vast majority of the 194 countries present in Cancun) very much want the United Nations and the UNFCCC to remain the core of international negotiations on climate change, that implicit threat provided a strong incentive for many countries to make sure that the Cancun talks did not “fail.”

Fourth, under the pragmatic leadership of UNFCCC Executive Secretary Christiana Figueres, realism may have finally eclipsed idealism in these international negotiations. Many observers have noted that many delegations – and probably most civil society NGO participants – at the previous COPs have misled themselves into thinking that ambitious cuts in greenhouse gases (GHGs) were forthcoming that could guarantee achievement of the 450 ppm/2 degrees C cap.

The acceptance of the Cancun Agreements suggests that the international diplomatic community may now recognize that incremental steps in the right direction are better than acrimonious debates over unachievable targets. This harkens back to what I characterized prior to COP-16 as the key challenge facing the negotiators: to continue the process of constructing a sound foundation for meaningful, long-term global action. In my view, this was accomplished in Cancun.

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Further Reading

In a new blog post, Trevor Houser (Peterson Institute for International Economics) argues that the surest way to kill the progress made in the Cancun Agreements is to try to turn them into a legally-binding treaty at COP-17 next year in Durban, South Africa.

For a nice table showing the correspondence of respective elements of the Cancun Agreements and the Copenhagen Accord, see the commentary on the Cancun climate negotiations by Sarah Ladislaw of the Center for Strategic and International Studies.

And for a detailed description of the major elements of the Cancun Agreements, I recommend the summary prepared by the Pew Center on Global Climate Change.

Some previous essays I have written and posted at this blog may be of interest to those who are interested in the Cancun Agreements. Here are links, in reverse chronological order:

Defining Success for Climate Negotiations in Cancun

Opportunities and Ironies: Climate Policy in Tokyo, Seoul, Brussels, and Washington

Another Copenhagen Outcome: Serious Questions About the Best Institutional Path Forward

What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord

Chaos and Uncertainty in Copenhagen?

Only Private Sector Can Meet Finance Demands of Developing Countries

Defining Success for Climate Negotiations in Copenhagen

Approaching Copenhagen with a Portfolio of Domestic Commitments

Can Countries Cut Carbon Emissions Without Hurting Economic Growth?

Three Pillars of a New Climate Pact

The Real Options for U.S. Climate Policy

The time has not yet come to throw in the towel regarding the possible enactment in 2010 of meaningful economy-wide climate change policy (such as that found in the Waxman-Markey legislation passed by the U.S. House of Representatives in June, 2009, or the more recent Kerry-Lieberman proposal in the Senate). Meaningful action of some kind is still possible, or at least conceivable. But with debates regarding national climate change policy becoming more acrimonious in Washington as midterm elections approach, it is important to ask, what are the real options for climate policy in the United States – not only in 2010, but in 2011 and beyond. That’s the purpose of this essay.

Federal Policy Options

Let’s begin my considering Federal policy options under two distinct categories: pricing instruments and other approaches. Carbon-pricing instruments could take the form of caps on the quantity of emissions (cap-and-trade, cap-and-dividend, or baseline-and-credit), or approaches that directly put carbon prices in place (carbon taxes or subsidies). Beyond pricing instruments, the other approaches include regulation under the Clean Air Act, energy policies not targeted exclusively at climate change, public nuisance litigation, and NIMBY and other public interventions to block permits for new fossil-fuel related investments. I will discuss each of these in turn.

Quantity-Based Carbon Pricing

I’ve frequently written about cap-and-trade in the past (See, for example: Here We Go Again: A Closer Look at the Kerry-Lieberman Cap-and-Trade Proposal; Eyes on the Prize: Federal Climate Policy Should Preempt State and Regional Initiatives; Any Hope for Meaningful U.S. Climate Policy? You be the Judge; Confusion in the Senate Regarding Allowance Allocation?; Cap-and-Trade versus the Alternatives for U.S. Climate Policy; Can Countries Cut Carbon Emissions Without Hurting Economic Growth?; Cap-and-Trade: A Fly in the Ointment? Not Really; National Climate Change Policy: A Quick Look Back at Waxman-Markey and the Road Ahead; Worried About International Competitiveness? Another Look at the Waxman-Markey Cap-and-Trade Proposal; The Wonderful Politics of Cap-and-Trade: A Closer Look at Waxman-Markey; The Making of a Conventional Wisdom), and so I will be very brief on this instrument in this essay.

A Quick Reminder about Cap-and-Trade

In brief, there are four principal merits of the cap-and-trade approach to achieving significant reductions of carbon dioxide (CO₂) emissions. First, this approach achieves overall targets at minimum aggregate cost, that is, it is cost-effective, both in the short term by allocating responsibility among sources, and in the long term, by providing price signals that will drive technological innovation and diffusion of carbon-friendly technologies. Second, the allowance allocation under a cap-and-trade system can be used to build a constituency of political support across sectors and geographic areas without driving up the cost of the program or reducing its environmental performance. Third, we have significant experience in the United States with the use of this approach, including during the 1980s to phase out leaded gasoline from the marketplace, and since the 1990s to cut acid rain by 50 percent. Fourth, and of great importance, a domestic cap-and-trade system can be linked directly and cost-effectively with cap-and-trade systems and emission-reduction-credit systems in other parts of the world to keep costs down domestically.

Three principal concerns have been voiced about cap-and-trade systems in U.S. debates. First, while a cap-and-trade system constrains the quantity of emissions, the costs of control are left uncertain (although such cost uncertainty can be limited — if not eliminated — through the use of safety valves, price collars, or related mechanisms). Second, in the wake of concerns regarding the roll that financial markets played in the global recession, there have been many fears about the possibilities of market manipulation in a cap-and-trade system. A third concern – in a political context – is that this cost-effective approach to environmental protection, pioneered by the Republican administration of President George H. W. Bush, has – ironically — been demonized by conservatives in current debates.

That said, a variety of pending design issues will need to be addressed in the development of any cap-and-trade system, including: ambition, scope (suddenly important because of a renewed focus in Washington on the possibility of a utility-only cap), point of regulation in the economy, allowance allocation, the role of offsets, cost-containment mechanisms, international competition protection, and regulatory oversight. (I’ve written about all of these design issues in previous essays at this blog and elsewhere.)

A Design-Change for Cap-and-Trade?

Does the current political climate call for a design change — or at least a name change — for cap-and-trade? Both stepwise and sectoral approaches are being considered. A stepwise approach of beginning with one or a few sectors of the economy and subsequently expanding gradually to an economy-wide program was embodied in both the Waxman-Markey legislation and in the Kerry-Lieberman proposal. Under a sectoral approach, cap-and-trade would be used for some sectors, but other approaches would be used for other parts of the economy. To some degree, the Kerry-Lieberman proposal embodies this approach. The current focus in Washington is on the possibility of using cap-and-trade for the electricity sector only.

Although the politics may argue for a stepwise or sectoral approach, it should be recognized that neither is likely to be cost-effective, because it is highly unlikely that marginal abatement costs will be equated across all sectors of the economy without the use of a single (implicit) price on carbon.

So the potential approach now receiving much attention in Washington of employing a cap-and-trade system in the electricity sector only would — in all likelihood — achieve less in terms of overall emissions reductions, and would not be cost-effective (due to the exclusion of other sectors). However, it is at least conceivable that will prove to be the best among politically-feasible paths to a better future policy. That is, of course, a political — not an economic — question.

A Populist Approach?

Populism has emerged as a major theme in recent electoral politics in the United States, both from the left and from the right. What might be characterized as a populist approach would be a cap-and-trade system with 100% of the allowances auctioned and the auction revenue returned directly “to the people.” Although this is a standard variant of cap-and-trade design, contemporary politics — with its demonization of the phrase “cap-and-trade” — might well argue for a name change: how about “cap-and-dividend?”

This approach is embodied in the CLEAR Act of Senators Maria Cantwell (D-Washington) and Susan Collins (R-Maine). The merits of this approach include its simplicity, appearance of fairness, and related appeal to the populist mood. Concerns, however, include the proposal’s relatively modest environmental achievements (according to an analysis by the World Resources Institute), its overall cost due to restrictions on trading, and its apparent political infeasibility, given its lack of visible support in the Congress.

Other Trading Mechanisms

In addition to cap-and-trade, the other major type of tradable permit system is an emission-reduction-credit system, or baseline-and-credit system. Because such approaches lack caps, they raise some well-known concerns, in particular the necessity of comparing actual emissions with what emissions would have been in the absence of the policy. In such a system, the latter is fundamentally unobserved and unobservable. This is the problem of “additionality,” which comes up in spades in the case of the Clean Development Mechanism (CDM), but also in the context of most other offset programs.

A related trading mechanism is found in the Clean Energy Standards approach, embodied in Senator Richard Lugar’s (R-Indiana) legislative proposal. This mechanism is similar to a Renewable Portfolio Standard (RPS), but allows for a broader set of qualified sources; not only renewables, but also nuclear power, fossil fuel power with carbon capture and storage (CCS), and – in principle — efficient natural gas. If the clean energy credits are denominated in units of carbon free megawatt hours and are tradable, then the merits of this approach include the flexibility that is provided through trading. The concerns include the lack of an emissions cap, and the difficulty of expanding this approach to other sectors or linking it with a cap-and-trade system. However, if the clean energy credits are denominated in emissions per megawatt hour, then the program can more easily be converted to or linked with a cap-and-trade system.

Direct Carbon Pricing

A carbon tax system would be similar in design to an upstream cap-and-trade approach. There is some real interest in this approach, mainly from academics, and there is also what I would characterize as “strategic interest,” principally from those who recognize that once the focus is on carbon taxes rather than other instruments, political debates will inevitably result in less ambitious targets or, in fact, no policy at all.

Carbon Taxes in Brief

Having said this, the merits of a carbon tax approach compared with cap-and-trade include the fact that cost uncertainty is eliminated with the tax approach (although, of course, there is quantity uncertainty, that is, no emissions cap). And, I mentioned earlier, the cost uncertainty inherent in a cap-and-trade system can be reduced, if not eliminated, with cost-containment mechanisms such as a price collar.

Another merit of the carbon tax approach is that it would generate substantial revenues (as would a cap-and-trade system in which the allowances are auctioned). These revenues can be used – in principle – for a variety of worthwhile public purposes, including reducing distortionary taxes, which would serve to lower the overall social cost of the policy. Third, the tax approach is (at least perceived to be) much simpler than the allowance market that would be generated by a cap-and-trade scheme.

Major concerns regarding carbon taxes are fourfold. First, despite their social cost-effectiveness, pollution taxes can be more costly to the regulated sector than even a non-cost-effective command-and-control instrument. Second, unlike cap-and-trade, the tax approach lacks a benign mechanism for building political constituency, and is likely to lead to requests for tax exemptions, and hence a less ambitious policy and possibly a more costly one. Third, although it is not impossible to link such as system internationally (for purposes of cost containment), it is more challenging to do so than with the quantity based cap-and-trade alternative. A fourth and final concern is the apparent political infeasibility of this approach, at least currently in the United States.

In this regard, it is important to note that what has frequently been interpreted as hostility to cap-and-trade in the U.S. Senate is actually – on closer inspection — broader hostility to the very notion of carbon pricing (or any climate change policy). Surely, the political reception to a carbon tax would be even less enthusiastic than the reception that has greeted recent cap-and-trade proposals.

Subsidies: The Good, the Bad, and the Ugly

If it’s so politically difficult to tax “bad behavior,” how about subsidizing “good behavior?” The mirror image of a tax is indeed a subsidy, and two potential price-based approaches to achieving greenhouse gas emission reductions are the use of climate-friendly subsidies and the elimination of problematic subsidies that exacerbate the climate problem.

In thinking about climate-friendly subsidies, we should first keep in mind that the Obama economic stimulus package enacted by the Congress includes significant subsidies (and tax credits) for renewables and efficiency upgrades — to the tune of about $80 billion. A major problem has been that the administration (in particular, the Department of Energy) has been finding it difficult to spend the money fast enough. Also, some would consider subsidies for biofuels, such as ethanol, as falling within this category of climate-friendly subsidies, but clearly that is a matter of considerable controversy.

Principal among the problematic subsidies – and hence major candidates for reduction or elimination – are subsidies for the development and use of fossil fuels. According to the Environmental Law Institute, U.S. fossil-fuel subsidies and tax breaks currently amount to $8-$10 billon per year. At the global level, the International Energy Agency has estimated that such fossil-fuel subsidies now amount to $550 billion annually! President Obama proposed at the G20 meeting in Pittsburgh in November, 2009, that such subsidies be phased out around the world, and there seemed at the time to be broad-based support for this proposal. However, it should not be surprising that less than a year later, it now appears that the commitment may be watered down somewhat at the G20 meeting in Toronto this June.

The merit of trying to use climate-friendly subsidies is based on the fact that subsidies affect relative prices, much like taxes do, but are much more politically attractive, since politicians prefer to give out benefits rather than costs to their constituents. And eliminating problematic subsidies can be economically efficient.

But a major concern of using climate-friendly subsidies is that the funds go not only to marginal units that otherwise would not be taking specific actions, but also to infra-marginal units that are pleased to accept the funds, but whose behavior is unaffected by them. This means that this approach is relatively costly to the government (and to society at large) for what is accomplished. And a concern of removing fossil fuel subsidies – particularly in the current political climate of worries about oil imports – is that this can work against so-called “energy security” (some have therefore suggested the addition of an “oil import fee”).

Climate Change Regulation under the Clean Air Act

Regulations of various kinds may soon be forthcoming – and in some cases, will definitely be forthcoming – as a result of the U.S. Supreme Court decision in Massachusetts v. EPA and the Obama administration’s subsequent “endangerment finding” that emissions of carbon dioxide and other greenhouse gases endanger public health and welfare. This triggered mobile source standards earlier this year, the promulgation of which identified carbon dioxide as a pollutant under the Clean Air Act, thereby initiating a process of using the Clean Air Act for stationary sources as well.

Those new standards are scheduled to begin on January 1, 2011, with or without the so-called “tailoring rule” that would exempt smaller sources. Among the possible types of regulation that could be forthcoming for stationary sources under the Clean Air Act include: new source performance standards; performance standards for existing sources (Section 111(d)); and New Source Review with Best Available Control Technology standards under Section 165.

The merits that have been suggested of such regulatory action are that it would be effective in some sectors, and that the threat of such regulation will spur Congress to take action with a more sensible approach, namely, an economy wide cap-and-trade system.

However, regulatory action on carbon dioxide under the Clean Air Act will accomplish relatively little and do so at relatively high cost, compared with carbon pricing. Also, it is not clear that this threat will force the hand of Congress. Indeed it is reasonable to ask whether this is a credible threat, or will instead turn out to be counter-productive (when stories about the implementation of inflexible, high-cost regulatory approaches lend ammunition to the staunchest opponents of climate policy).

Furthermore, there is the question of possible preemption. Although Senator Lisa Murkowski’s (R-Alaska) resolution was defeated in the Senate, Senator Jay Rockefeller’s (D-West Virginia) proposal of a two-year delay of Clean Air Act regulatory action is still pending; and depending upon the outcome of the November elections, there may be a series of further Congressional actions to tie the hands of EPA in this regard.

Regulation of Conventional Pollutants under the Clean Air Act

It’s also possible that air pollution policies for non-greenhouse gas pollutants, the emissions of some of which are highly correlated with CO₂ emissions, may play an important role. For example, the three-pollutant legislation co-sponsored by Senator Thomas Carper (D-Delaware) and Senator Lamar Alexander (R-Tennessee), focused on SO_x, NO_x, and mercury, could have profound impacts on the construction and operation of coal-fired electricity plants, without any direct CO₂ requirements. Beyond this, there are also possibilities of policies for the non-CO₂ greenhouse gases.

Important, Unanswered Questions

An important pending question regarding EPA’s use of the Clean Air Act is whether EPA may legally create CO₂ cap-and-trade or offset markets under existing Clean Air Act authority. The answer appears to be “probably yes.” There is positive precedent from EPA’s emissions trading program of the 1970s, and it’s a leaded gasoline phase-down of the 1980s, although recent court decisions regarding the Bush administration’s Clean Air Interstate Rule may cause concern in this regard.

The more important question, however, may turn out to be whether EPA can politically create significant CO₂ markets in the face of Congressional opposition. The answer to this is considerably less clear.

Energy Policies Not Targeted Exclusively at Climate Change

The “positive politics” generated by the Gulf oil spill, combined with the “negative politics” of addressing climate change explicitly, may well increase the likelihood of so-called “energy-only” legislation being enacted this year. Senator Jeff Bingaman’s (D-New Mexico) bill from the Environment and Natural Resources Committee and perhaps Senator Richard Lugar’s bill will feature centrally in any bipartisan initiative.

The possible components of such an approach which would be relevant in the context of climate change include: a national renewable electricity standard; Federal financing for clean energy projects: energy efficiency measures (building, appliance, and industrial efficiency standards; home retrofit subsidies; and smart grid standards, subsidies, and dynamic pricing policies); and new Federal electricity-transmission siting authority.

Other Legal Mechanisms

Even without action by the Congress or by the Administration, legal action on climate policy is likely to take place within the judicial realm. Public nuisance litigation will no doubt continue, with a diverse set of lawsuits being filed across the country in pursuit of injunctive relief and/or damages. Due to recent court decisions, the pace, the promise, and the problems of this approach remain uncertain.

Beyond the well-defined area of public nuisance litigation, other interventions which are intended to block permits for new fossil energy investments, including both power plants and transmission lines will continue. Some of these interventions will be of the conventional NIMBY character, but others will no doubt be more strategic.

Does the Road to National Climate Policy Need to Go through Washington?

With political stalemate in Washington, attention may increasingly turn to regional, state, and even local policies intended to address climate change. The Regional Greenhouse Gas Initiative (RGGI) in the Northeast has created a cap-and-trade system among electricity generators. More striking, California’s Global Warming Solutions Act (Assembly Bill 32, or AB 32) will likely lead to the creation of a very ambitious set of climate initiatives, including a statewide cap-and-trade system (unless it’s stopped by ballot initiative or a new Governor, depending on the outcome of the November 2010 elections). The California system is likely to be linked with systems in other states and Canadian provinces under the Western Climate Initiative.

These sub-national policies will interact in a variety of ways – some good, some bad — with Federal policy when and if Federal policy is enacted. As Professor Lawrence Goulder (Stanford University) and I have written in a new paper for the National Bureau of Economic Research (NBER), some of these interactions could be problematic, such as the interaction between a Federal cap-and-trade system and a more ambitious cap-and-trade system in California under AB 32, while other interactions would be benign, such as RGGI becoming somewhat irrelevant in the face of a Federal cap-and-trade system that was both more stringent and broader in scope.

An important question is whether there can be sensible sub-national policies even in the presence of an economy-wide Federal carbon-pricing regime? The answer is surely yes, partly because other market failures will continue to exist that are not addressed by carbon pricing. A prime example is the principal-agent problem of insufficient energy-efficiency investments in renter-occupied properties, even in the face of high energy prices. This is a problem that is best addressed at the state or even local level, such as through building codes and zoning.

In the meantime, in the absence of meaningful Federal action, sub-national climate policies could well become the core of national action. Problems will no doubt arise, including legal obstacles such as possible Federal preemption or litigation associated with the so-called Dormant Commerce Clause. Also, even a large portfolio of state and regional policies will not be comprehensive of the entire nation, that is, not truly national in scope. And even if they are nationally comprehensive, with different policies of different stringency in different parts of the country, carbon shadow-prices will by no means be equivalent, and so overall policy objectives will be achieved at excessive social cost.

Is there a solution, if only a partial one? Yes, state and regional carbon markets can be linked. Such linkage occurs as a result of bilateral recognition of allowances, which results in reduced costs, price volatility, leakage, and market power. Such bottom-up linkage of state and regional cap-and-trade systems may be an important part or perhaps the core of future of U.S. climate policy, at least until there is meaningful action at the Federal level. In the meantime, it is at least conceivable that linkage of state-level cap-and-trade systems across the United States will become the de facto post-2012 national climate policy architecture.

The Path Ahead

Conventional politics clearly disfavors market-based (pricing) environmental policy approaches that render costs obvious or at least somewhat transparent, despite the fact that the costs of these same policies are actually less than those of alternative approaches. Instead, conventional politics favors approaches to environmental protection that render costs less obvious (or better yet invisible), such as renewable portfolio standards, and — for that matter — all sorts of command-and-control performance and technology standards.

But carbon pricing will be necessary to address the diverse economy-wide sources of CO₂ emissions effectively and at sensible cost, whether the carbon pricing comes about through an economy-wide Federal cap-and-trade system or through a Federal carbon tax. It is inconceivable that truly meaningful reductions in CO₂ emissions could be achieved through purely regulatory approaches, and it remains true that whatever would be achieved, would be accomplished at excessively high cost.

So, although it is true – as I have sought to explain in this essay – that there are a diverse set of options for future climate policy in the United States, the best available alternative to an economy-wide cap-and-trade system enacted in 2010 may be an economy-wide cap-and-trade system enacted in 2011. But ultimately, the question of what is the best alternative this year to an economy-wide cap-and-trade system is a political, not an economic question.