New Zealand Archives - Page 6 of 7 - An Economic View of the Environment

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

As I write this, I’m on board a flight from Seoul, South Korea, to San Francisco, California, on my way home to Boston, having spent the week of Harvard spring break meeting with senior government officials, academics, and leaders of civil society in Tokyo and Seoul on behalf of the Harvard Project on International Climate Agreements. Reflecting on these meetings in Asia and recalling meetings I’ve previously had in Brussels and Washington, some important opportunities and ironies about national and international climate policy come to mind.

Opportunities

The 15^th Conference of the Parties (COP-15) of the United Nations Framework Convention on Climate Change (UNFCCC), which met in Copenhagen, Denmark, in December, 2009, produced two significant outcomes. The key substantive outcome, of course, was the Copenhagen Accord, about which I’ve written in detail in a previous blog post. The key institutional outcome was speculation that the UNFCCC may not be the best venue going forward for productive negotiations on climate change. (This is also a topic about which I’ve recently written at this blog.)

These dual outcomes of the Copenhagen conference point to the special importance of two key nations in international climate policy developments this year. I’m not referring to China and the United States (despite the fact that they are, of course, the world’s two leading emitters of carbon dioxide). Rather, I am referring to Korea and Mexico. Why?

First, these two nations are unique in being both long-time members (Korea since 1996, Mexico since 1994) of the Organization of Economic Cooperation and Development (OECD) and members of the group of non-Annex I countries under the Kyoto Protocol, which have no direct commitments under that international agreement. The OECD comes as close as anything to defining the set of industrialized nations of the developed world. Thus, Korea and Mexico have their feet planted firmly both in the developed world and the developing world (a fact that is readily apparent on even brief visits to these nations). This gives Korea and Mexico remarkable credibility with the two key blocks in international climate negotiations. That, on its own, would be of considerable importance, but there is another reality that makes this of even greater significance (and opportunity) in this year of 2010.

Coming out of Copenhagen, many participants in the international climate negotiations (as well as informed observers), noted that the UNFCCC has real limitations as the sole venue for future climate negotiations: too many countries – 192, excessively stringent requirements for agreement – unanimity, and a distinct tendency to polarize debates between developed and developing countries. Two other, potentially supplementary venues stand out as promising: the Major Economies Forum (MEF) and the G20.

The MEF, which has hosted productive discussions among 17 key countries and regions that together account for nearly 90 percent of global carbon dioxide (CO₂) emissions, may be somewhat limited by the fact that is was created by and is chaired by the United States, a nation with constrained credibility on climate issues among some countries, particularly in the developing world. The G20, which brings together twenty of the world’s largest economies, focuses on economic as well as other global issues and consists of almost the same set of nations as the MEF, likewise accounting for about 90 percent of global emissions. The G20 could thus be an exceptionally promising supplementary venue for meaningful and realistic climate discussions. And in November of this year, the G20 will be hosted by Korea, when it convenes in Seoul. This gives the Korean government a special role in setting the agenda for the discussions and presiding at the sessions.

The G20 meetings in Seoul will come just two weeks before the Sixteenth Conference of the Parties of the UNFCCC, which will take place in Cancún, Mexico. Thus, the Mexican government is also in a key position this year, because it will hold the Presidency of COP-16.

Add to this the fact that both Korea and Mexico have been particularly creative in their domestic climate policy initiatives and international proposals over the past year. Harvard Kennedy School Professor Jeffrey Frankel notes at his blog — Views on the Economy and the World — that Korea and Mexico were particularly ambitious with their submissions to the Copenhagen Accord, when comparing the submissions of all countries in terms of 2020 emissions targets relative to business-as-usual, controlling for per capita income.

Together, Korea and Mexico, share credibility in the developing and developed worlds, and likewise share unique international legitimacy as the hosts and presidents of the G20 and COP-16 in 2010. This is why these two countries have a remarkable opportunity this year to provide leadership of the international community, and make real progress on negotiations to address the threat of global climate change. Those are the opportunities. Now, let me turn to the ironies that have come to the fore.

Ironies

More than a decade ago, it was the United States, as the leader of the so-called “Umbrella Group,” that successfully fought for the inclusion in the Kyoto Protocol – over the objections of the European Union – of three “flexibility mechanisms” to bring down the costs of meeting the Protocol’s objectives: joint implementation (Article 4), a global emissions reduction credit system, the Clean Development Mechanism (the CDM, Article 12), and emissions trading among countries (Article 17). Ironically, once the George W. Bush administration officially pulled the United States out of the Kyoto Protocol process, it was the European Union that implemented the world’s first CO₂ emissions trading program, the European Union Emission Trading Scheme (EU ETS).

Beyond this, the United States was a pioneer with the use of national cap-and-trade systems, including lead trading in the 1980s and the SO₂ allowance trading program beginning in 1995 under the Clean Air Act Amendments of 1990. In addition, despite its lack of ratification of the Kyoto Protocol, the U.S. government very early on began to give serious consideration to the development of an economy-wide cap-and-trade system for CO₂ with the McCain-Lieberman legislation in the U.S. Senate (followed later by the Lieberman-Warner bill). More recently, of course, the U.S. House of Representatives passed the Waxman-Markey bill in June of 2009, including a significant economy-wide cap-and-trade system.

Over the past nine months, however, the very phrase, “cap-and-trade,” has evolved from being politically correct in Washington to nothing less than politically anathema. (How and why this happened is a topic for a future essay at this blog.) The great irony is that just when cap-and-trade has been under such vociferous attack in Washington, countries throughout the world are embracing this instrument, recognizing its great potential to address climate change cost-effectively and equitably.

In addition to the EU ETS, already in force, Australia is primed to put its cap-and-trade system in place, as is New Zealand. And just a few days before I arrived in Tokyo, the Japanese cabinet announced that the government will move forward with a cap-and-trade system (in contrast with Japan’s previously proposed sectoral approach). And, not to be outdone, Korea is considering the use of cap-and-trade as an element of its own domestic climate policy.

This irony is striking. Of course, it could be reduced or eliminated if Senators Kerry, Graham, and Lieberman can use their much-anticipated new climate proposal to pull victory from the jaws of anticipated defeat. Only time will tell.

Chaos and Uncertainty in Copenhagen?

Earlier today, I was asked by the Financial Times, “who is responsible for the chaos and uncertainty” at COP-15 in Copenhagen? I’m not sure those are the words I would have chosen to characterize the situation at the climate negotiations in the Danish capital, but here is my response for the FT’s Energy-Source Climate Experts panel — with some elaboration.

There are two aspects to what has been characterized as the “chaotic and uncertain” nature of the COP-15 conference at the Bella Center in Copenhagen. One is the substantive process and eventual outcome, which remains uncertain as of this hour, and the other is the shocking logistical failure.

An Uncertain Outcome for the Negotiations

It should not be surprising that the outcome remains in doubt, because of some basic economic realities. First of all, keep in mind that climate change is the ultimate global commons problem, because greenhouse gases uniformly mix in the atmosphere. Therefore, each country incurs the costs of its emission-reduction actions, but the benefits of its actions are spread worldwide. Hence, for any individual nation, the benefits it receives from its actions are inevitably less than the costs it incurs, despite the fact that globally the total benefits of appropriate coordinated international action would exceed the total costs (and for many countries the national benefits of coordinated international action would exceed their national costs of action).

This creates a classic free-rider problem, and is the reason why international cooperation – whether through an agreement under the United Nations Framework Convention on Climate Change or through some other multilateral or bilateral arrangements – is necessary.

Second, addressing global climate change will be costly and it raises profound distributional implications for the countries of the world. In particular, addressing climate change at minimum cost (i.e., cost-effectively) requires that all countries take responsibility for their emissions going forward, and indeed necessitates that all countries control at the same marginal abatement cost.

On the other hand, addressing climate change in an equitable fashion clearly requires taking account of the dramatically different economic circumstances of the countries of the world, and may also involve looking backwards at historic responsibility for the anthropogenic greenhouse gases which have already accumulated in the atmosphere. These are profound issues of distributional equity.

This classic trade-off between cost-effectiveness (or efficiency), on the one hand, and distributional equity, on the other hand, raises significant obstacles to reaching an agreement.

So, I place the fault for the substantive uncertainty in the negotiations neither on the industrialized countries (including the United States, for insisting that China and other key emerging economies participate in meaningful and transparent ways), nor on the developing countries (for insisting that the industrialized world pay much of the bill).

The key question going forward is whether negotiators in Copenhagen today and tonight, or in Bonn several months from now, or in Mexico City a year from now, can identify a policy architecture that is both reasonably cost-effective and sufficiently equitable, and thereby can assemble support from the key countries of the world, and thus do something truly meaningful about the long-term path of global greenhouse gas emissions. There are promising paths forward, and – if you’ll forgive me – I will remind readers that many have been identified by the Harvard Project on International Climate Agreements.

Rather than pointing fingers at who is to blame for the current uncertainty at this hour, I can attribute credit to a number of countries and institutions for having brought the negotiations to the point where it appears at least possible that a successful outcome will be achieved in Copenhagen or subsequently.

First of all, tremendous credit must be given to the national leaders and the negotiating teams of the seventeen major economies of the world who together represent about 90% of global emissions, because these countries have worked hard to produce what each considers a sensible outcome over the months and years leading up to COP-15.

This includes not only the European Union, Australia, Japan, New Zealand, and Canada, but also the United States, which at least since January of this year has been an enthusiastic and intelligent participant in this international process. It also includes many of the key emerging economies of the world – China , India, Brazil, Mexico, Korea, South Africa, and Indonesia, among them – as well as a considerable number of poor, developing countries, which likewise take the problem seriously and have been trying to find an acceptable path forward.

Finally, credit should be given to the Danish government and its leadership, the Secretariat of the United Nations Framework Convention on Climate Change, and UN Secretary-General Ban Ki-moon, who have worked tirelessly for months, indeed years, to prepare for the substance of these negotiations at COP-15 in Copenhagen.

That’s the “good news,” but now I should turn to the other aspect of the “uncertainty and chaos” in Copenhagen.

Chaos at COP-15’s Bella Center

As I noted at the outset, there are two aspects of the “chaos” in Copenhagen, and for the second aspect it is (sadly) possible to identify the apparently responsible parties. I am referring to the fact that the organizers – the Secretariat of the United Nations Framework Convention on Climate Change (UNFCCC) and the hosts, the Danish government – apparently approved a list of some 40,000 observers from 900 official, accredited organizations around the world, knowing that the Bella Center could accommodate at most 15,000 persons at any one time. The result is that thousands of people – including not only NGO representatives, but also government negotiators – stood in line outside of the Bella Center in the bitter cold on Monday and Tuesday of this week waiting 8-10 hours to get inside to receive their credentials. Thousands of others never got inside to receive their credentials, despite having waited up to 8 hours, standing in the cold. These are not exaggerations. It is remarkable and very fortunate if no one died in the process.

Then, on Wednesday through Friday, the Bella Center was essentially closed to all representatives of civil society, despite the fact that side-events had been organized by them months in advance with the approval of the COP-15 organizers.

The result is that thousands of people, who had been informed by the COP-15 organizers many months ago that they were approved to attend, had flown to Copenhagen from all over the world, incurred those costs plus the costs of their accommodations, yet never were able to get inside the Bella Center to carry out any of the work they had planned, and flew back home having wasted their time and resources (and having contributed to the COP-15 carbon footprint in non-trivial ways).

Now, I have never been an enthusiast of what some people have described as the annual “circus” of the COPs, a circus – if it is that — which is largely due to the fact that the actual government negotiators are vastly outnumbered by the civil society representatives (“official observers” in the UNFCCC language) and the press. However, if the participation of civil society representatives is going to be encouraged (as required under the original UNFCCC agreement), and if the attendance of those representatives is going to be approved in advance, then surely they should not be denied admission when they arrive, nor forced to stand in line outside in the cold for 8 hours waiting to be admitted.

No doubt, both the UNFCCC and the Danish government will point fingers at the other, but ultimately the responsibility must be shared. In seventeen years of these annual conferences, going back to the 1992 Earth Summit in Rio de Janeiro, there has never been such a disastrous logistical failure. It could have been anticipated. And it should have been prevented.

A Final Word

Of course, as of this hour, I — along with millions of others — hope that the negotiators in Copenhagen will achieve agreement on some truly meaningful steps forward in this important process.

Cap-and-Trade versus the Alternatives for U.S. Climate Policy

Let’s credit Senator Lisa Murkowski (R-Alaska) for raising questions in the National Journal about the viability of cap-and-trade versus other approaches for the United States to employ in addressing CO₂ and other greenhouse gas emissions linked with global climate change.

Senator Murkowski says that only one approach – cap-and-trade – has received significant attention in the Congress. Let’s put aside for the moment the fact that most of the 1,428 pages of H.R. 2454 – the American Clean Energy and Security Act of 2009 (otherwise known as the Waxman-Markey bill) – are not about cap-and-trade at all, but about a host of other regulatory approaches (several of which are highly problematic, as I’ve discussed in a previous post). We can also put aside the fact that both conventional regulatory approaches and carbon taxes have been discussed repeatedly in numerous House and Senate committees over the past decade, and received detailed attention from a succession of U.S. administrations.

So, let’s not quibble about the Senator’s claim that cap-and-trade is the only approach that has received serious attention. Instead, let’s address the key substantive questions which Senator Murkowski raises, because they are important questions: Is cap-and-trade the most effective way of addressing climate change? And are there other approaches capable of achieving the same results at lower cost? From my perspective, as a card-carrying environmental economist, these are indeed the key questions.

While political leaders in the European Union, Canada, Australia, New Zealand, Japan, and the United States (Congress) move toward cap-and-trade systems as their preferred approach for achieving meaningful reductions in emissions of CO₂ and other greenhouse gases, many people – including some of my fellow economists — have been critical of the cap-and-trade approach in the climate context and have endorsed the use of carbon taxes. The Senator is correct that we should reflect on the merits of that alternative approach.

But, first, what about conventional regulatory approaches, that is, performance standards and technology standards?

Conventional Regulatory Standards

In short, experience has shown that such standards cannot ensure achievement of emissions targets, create problematic unintended consequences, and are very costly for what they achieve.

Why can conventional standard not ensure achievement of reasonable emissions targets? First, standards typically focus on new emissions sources, and do not address emissions from existing sources. Think about greenhouse gas standards for new cars and new power plants, for example. Second, standards cannot possibly address all types of new sources, given the ubiquity of energy generation and use (and hence CO₂ emissions) in a modern economy. Third, emissions depend upon many factors that cannot be addressed by standards, such as: emissions from existing sources and unregulated new sources; how quickly the existing capital stock is replaced; the growth in the number of new emissions sources; and how intensively emissions-generating plants and equipment are utilized.

Next, what about those unintended consequences? First, by reducing operating costs, energy-efficiency standards – for example — can cause more intensive use of regulated equipment (for example, air conditioners are run more often), leading to offsetting increases in emissions — the “rebound effect.” Second, firms and households may delay replacing existing equipment if standards make new equipment more costly. This is the well-known problem with vintage-differentiated regulations or “New Source Review.” Third, standards may encourage counterproductive, unintended shifts among regulated activities (for example, from purchasing cars to purchasing SUVs under the CAFE program). All of these unintended consequences result from the problematic incentives that standards can create, compared with the efficient incentives created by a cap-and-trade system (or a carbon-tax, for that matter).

If you favor a regulatory approach, then you may welcome what’s coming from EPA as a result of the Supreme Court ruling of a few years ago combined with the Administration’s endangerment finding. For my part, I don’t welcome it; I worry about it, because the set of regulatory approaches that could be forthcoming will accomplish relatively little, do so at an unnecessarily high cost, and hence play into the hands of opponents of progressive climate policy. (More about that in some other, future post.)

Putting a Price on Carbon

To virtually all participants in the policy world, it has become increasingly clear that the only approach that can do the job and do it cost-effectively is one which involves at its core putting a price on carbon. That leaves cap-and-trade and carbon taxes. Let me take these in turn.

Cap-and-Trade

Let’s step back from the debate regarding the details of the Waxman-Markey House bill or the new Senate proposal by Senators Boxer and Kerry, and think about the essence of the cap-and-trade approach. (For some of those details, however, please see my previous posts, where I have commented on various aspects of Waxman-Markey and described a proposal I developed for The Hamilton Project of an up-stream, economy-wide CO₂ cap-and-trade system to cost-effectively achieve meaningful greenhouse gas emissions reductions.)

Here are the basics. First, aggregate emissions from regulated sources are capped, and the cap is enforced through a requirement for affected firms to hold emissions allowances. Importantly, allowance trading minimizes costs of meeting the cap. It does this because allowances migrate to the highest-valued uses, covering emissions that are the most costly to reduce. So, the emission reductions undertaken are those that are least costly to achieve. In essence, the uniform market price of allowances creates incentives for all covered sources to reduce all emissions, and do so cost-effectively.

A cap-and-trade system can be more environmentally-effective and more cost-effective than standards. First, in terms of environmental-effectiveness, a cap-and-trade system can ensure achievement of emissions targets. Cap-and-trade allows policymakers to set specific overall emissions targets. And a well-enforced system guarantees achievement of those targets, because emissions will not exceed available allowances. An economy-wide, upstream cap-and-trade system on the carbon content of fossil fuels can cover all fossil-fuel-related CO₂ emissions without needing to regulate each emissions source individually.

In terms of cost-effectiveness, a well-designed cap-and-trade system minimizes emission reduction costs. Unlike NO_x, SO₂, and other pollutants, GHG emission reductions have the same effect no matter how, where, or when they are achieved. This makes the climate change problem unique in the degree to which compliance flexibility can be used to lower costs without compromising environmental integrity. Hence, a cap-and-trade system can minimize costs while still meeting environmental objectives by offering three forms of flexibility: what flexibility; where flexibility; and when flexibility.

In regard to “what flexibility,” many types of actions offer low-cost emission reductions, and a cap-and-trade system allows emission reductions through whatever measures are least costly. By contrast, standards can target only certain identified emission reduction measures, leaving other cost-effective opportunities untapped. Furthermore, predictions of what measures are cost-effective may be wrong.

In regard to “where flexibility,” the costs of emission reductions vary widely across industries, across facilities, and even across users of the same equipment. A cap-and-trade system exploits this variation in costs by achieving reductions wherever they are least costly. By contrast, standards would only be cost-effective if they accounted for all of the variation in costs across sectors, technologies, and regulated entities — but it is completely infeasible for standards to do this. Emission reduction costs across sectors and technologies change over time, making the flexibility offered by a cap-and-trade system even more valuable. Also, lower-cost opportunities to reduce emissions may exist in other countries. Importantly, a cap-and-trade system creates a common currency (emissions allowances) that makes it possible to link with other systems.

A cap-and-trade system also minimizes costs through “when flexibility.” Costs can be reduced through flexibility in the timing of emission reductions by avoiding: premature retirement of capital stock or lock-in of existing technologies; and unnecessarily costly reductions in one year due to unusual circumstances when less-costly offsetting reductions can be achieved in other years. A cap-and-trade can incorporate “when flexibility”
without compromising cumulative emissions targets through: allowance banking and borrowing; and multi-year compliance periods.

Beyond such “static cost-effectiveness,” cap-and-trade creates incentives for technology innovation, and thereby lowers long-run costs. By rewarding any means of reducing emissions, a cap-and-trade system provides broad incentives for any innovations that lower the cost of achieving emissions targets. Although standards may encourage development of lower cost means of meeting the standards’ specific requirements, they do not encourage efforts to exceed those standards.

Several cap-and-trade systems have been successful at achieving environmental goals and cost savings: the phase-out of leaded gasoline in the 1980s; the phase-out of ozone depleting substances; and the Clean Air Act amendments of 1990 SO₂ allowance trading program to cut acid rain by 50%. Perceived shortcomings in other cap-and-trade systems reflect design choices, not problems with the policy instrument itself. This applies both to California’s RECLAIM program, and the pilot phase of the EU Emissions Trading Scheme (which is operating successfully in its real, Kyoto phase).

In summary, compared with conventional standards, a cap-and-trade system can be more environmentally-effective and more cost-effective. As with any policy instrument, however, careful design is important.

Taxing Carbon

As I mentioned, it is clear that the only approach that can do the job and do it cost-effectively is one that involves putting a price on carbon. So, what about the other carbon-pricing approach — a carbon tax?

I am by no means opposed to the notion of a carbon tax, having written about such approaches for more than twenty years. Indeed, both cap-and-trade and carbon taxes are good approaches to the problem; they have many similarities, some tradeoffs, and a few key differences. I am opposed, however, to the confused and misleading straw-man arguments that have sometimes been used against cap-and-trade by carbon-tax proponents.

While there are tradeoffs between these two principal market-based instruments targeting CO₂ emissions — a cap-and-trade system and a carbon tax – the best (and most likely) approach for the short to medium term in the United States is a cap-and-trade system. I say this based on three criteria: environmental effectiveness, cost effectiveness, and distributional equity. So, my position is not capitulation to politics. On the other hand, sound assessments of environmental effectiveness, cost effectiveness, and distributional equity should surely be made in the real-world political context.

The key merits of the cap-and-trade approach I have described above are, first, the program can provide cost-effectiveness, while achieving meaningful reductions in greenhouse gas emissions levels. Second, it offers an easy means of compensating for the inevitably unequal burdens imposed by a climate policy. Third, it provides a straightforward means to harmonize with other countries’ climate policies. Fourth, it avoids the current political aversion in the United States to taxes. Fifth, it is unlikely to be degraded – in terms of its environmental performance and cost effectiveness – by political forces. And sixth, this approach has a history of successful adoption and implementation in this country over the past two decades.

Having said this, there are some real differences between taxes and cap-and-trade that need to be recognized. First, environmental effectiveness: a tax does not guarantee achievement of an emissions target, but it does provides greater certainty regarding costs. This is a fundamental tradeoff. Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly a cost-containment mechanism. On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade – this is not a tradeoff, and this is why environmental NGOs are opposed to the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design — the distributional consequences of the two approaches can be the same. But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table. But political pressures on a cap-and-trade system lead to different allocations of allowances, which affect distribution, but not environmental effectives, and not cost-effectiveness.

Proponents of carbon taxes worry about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax is sensitive to the same political pressures, and may be expected to succumb in ways that are ultimately more harmful: reducing environmental achievement and driving up costs.

The Bottom Line

The Hamilton Project staff concluded in an overview paper (which I highly recommend) that a well-designed carbon tax and a well-designed cap-and-trade system would have similar economic effects. Hence, they said, the two primary questions to use in deciding between them should be: which is more politically feasible; and which is more likely to be well-designed?

The answer to the first question is obvious; and I have argued here that given real-world political forces, the answer to the second question also favors cap-and-trade. In other words, it is important to identify and design policy that will be “optimal in Washington,” not just from the perspective of Cambridge, New Haven, or Berkeley.

In “policy heaven,” the optimal instrument to address climate-change emissions may well be a carbon tax (largely because of its simplicity), but in the real world in which policy is developed and implemented, cap-and-trade is the best approach if one is serious about addressing the threat of climate change with meaningful, effective, and cost-effective policies.