Tag: revenue-neutral taxes

Martin Weitzman’s Contributions to Environmental Economics

Many of the world’s most eminent economists and climate scientists gathered on October 11th, 2018, at Harvard Kennedy School to celebrate and honor the career of Martin L. Weitzman, professor of economics at Harvard University, who is “retiring” following four decades of research and writing which have illuminated thought and policy across a broad range of important realms. During his “retirement,” Marty will serve as a Research Professor in Harvard’s Department of Economics.

The October 11th event, “Frontiers in Environmental Economics and Policy: A Symposium in Honor of Martin L. Weitzman,” which drew about 250 people, was organized and hosted by the Harvard Environmental Economics Program (HEEP), with additional support from the Harvard University Center for the Environment and the Mossavar-Rahmani Center for Business and Government at the Kennedy School.

A video of the entire event is available here.

Having learned so much from Marty Weitzman, including during the 26 years that he and I have been co-hosting the Harvard Seminar in Environmental Economics and Policy, I was delighted to moderate the symposium.  From the earliest days of planning the event until the day of the symposium, my team – Rob Stowe, HEEP Executive Director, Jason Chapman, HEEP Program Manager, and Casey Billings, HEEP Program Coordinator – and I were inspired by the breathtaking contributions Marty has made to the once-emerging and now mature global discipline of environmental economics.

In my blog essay today, I want to provide for those who could not attend a sense of what it was like to be there, and remind those who did attend what transpired.

Introducing Professor William Nordhaus

I began the symposium by introducing our keynote speaker, William D. Nordhaus, who just a few days earlier had been announced as a recipient of this year’s Nobel Prize in Economics for his work on modeling the economics of climate change and related public policies.

The cliche that “our speaker needs no introduction” certainly applied here, and so I was very brief, noting first that for nearly four decades, Bill Nordhaus has written about the economics of the environment.  Building on his background as a macro-economist concerned about economic growth, Bill began to give particular attention to the role of energy generation and use in the 1970s, not long after beginning his academic career.  What is truly remarkable is that it was in the early 1980s that he began working on the economics of global climate change, long before most other economists were even aware of the problem, let alone analyzed it.

Bill has been on the faculty at Yale University since 1967, where he is the Sterling Professor of Economics, and Professor in Yale’s School of Forestry and Environmental Studies.  He is a member of the National Academy of Sciences, a Fellow of the American Academy of Arts and Sciences, a Distinguished Fellow of the American Economic Association, and a Research Associate of the National Bureau of Economic Research.  In addition to his many scholarly achievements, he served as a Member of the President’s Council of Economic Advisers in the Carter administration.

What is particularly striking about Bill Nordhaus’s contributions is that — as long as I can remember — he has made his path-breaking DICE model of global climate change economics accessible to and usable by other researchers around the world.

Keynote Address by Bill Nordhaus

Bill launched his presentation, “The Intellectual Footprint of Martin Weitzman in Environmental Economics,” by stating that Marty “has changed the way we think about economics and the environment.”  He then went on to itemize Weitzman’s impressive body of work, including his series of studies on the share economy; his research on the Soviet Union and central planning; his seminal 1974 paper, “Prices vs. Quantities,” which provided fresh insight on how regulatory policy can best be leveraged to maximize public good; and his work on so-called “fat tails” and the “dismal theorem,” which questioned the value of a standard benefit-cost analysis when conditions could result in catastrophic events, even if the probability of such events is very low.

But Nordhaus devoted much of his talk to highlighting Weitzman’s extraordinary contributions to the field of environmental economics, in particular, the economics of climate change and climate change policy. It was Weitzman’s “revolutionary” series of papers on the ideal measures of national income, Nordhaus stated, that focused early attention on the need to take the harmful impacts of pollution into account when tabulating the gross domestic product (GDP), a concept referred to as “Green GDP.”

“Our output measures do not include pollution,” said Nordhaus. “They include goods like cars and services like concerts and education, but they do not include CO2 that is pumped into the atmosphere.”  He explained that pollution abatement measures are often blamed for causing a drag on the economy, but aren’t credited for the health and welfare benefits they create.

“If our incomes stay the same but we are healthier, and live a year longer or ten years longer, that will not show up in the way we measure things,” Nordhaus remarked. “But we can apply these Weitzman techniques to value improvements in health and happiness.”

“Those who claim that environmental regulations hurt growth are completely wrong, because they are using the wrong yardstick,” Bill continued. “Pollution should be in our measures of national output, but with a negative sign, and if we use green national output as our standard, then environmental and safety regulations have increased true economic growth substantially in recent years…For this important insight we applaud Martin Weitzman, a radically innovative spirit in economics.”

A Panel of Leading Environmental Economists

Following the keynote address by Nordhaus, I welcomed to the stage fellow economists Maureen Cropper, Lawrence Goulder, Michael Greenstone, Charles Kolstad, Richard Newell, Robert Pindyck, and James Stock for a lively panel discussion.  Each of these economists have themselves made important contributions to scholarship and policy in the environmental realm.

To each panelist, I posed a question about a different aspect of Marty Weitzman’s key contributions – ranging from climate change policy to biodiversity and fisheries management.

First, Richard Newell, the President and CEO of Resources for the Future (RFF) and a former student of Weitzman when he studied for his Ph.D. in Public Policy at the Harvard Kennedy School, described Weitzman’s seminal paper, “Prices vs. Quantities”, as a “gift that keeps on giving” for economists and policy makers invested in improving regulatory policy.

Next, Charlie Kolstad, a Senior Fellow at the Stanford Institute for Economic Policy Research, focused on Marty Weitzman’s research on biodiversity, and cited it for its “significance and importance.”

Third up was Larry Goulder, the Shuzo Nishihara Professor of Environmental and Resource Economics at Stanford University and a former colleague of Weitzman in the Harvard Department of Economics.  Larry described the importance of Marty’s work on long-term discounting, and commended his 1998 paper on declining discount rate profiles, noting that it has affected public policies in Denmark, France, and Norway, as well as public discussion in the Netherlands, Sweden, and elsewhere. Larry noted that “it’s very important, because it affects decisions as to how much we should invest in infrastructure, in mitigation, and in other realms.”

Fourth on the panel was Bob Pindyck, the Bank of Tokyo-Mitsubishi Professor of Economics and Finance at the Sloan School of Management at MIT, who is very familiar with Marty Weitzman’s work on fat-tailed distributions, and has contributed to that literature himself.  Bob cited Weitzman’s prescient 2007 paper “Subjective Expectations and Asset-Return Puzzles” for its significant influence upon the later modeling of the economics of catastrophic climate change.

Next was Jim Stock, the Harold Hitchings Burbank Professor of Political Economy at Harvard University.  I asked Jim to comment on the effect of Marty’s work on the policy world.  Jim started by crediting Weitzman for the “tremendous influence” his ideas have had upon the formation of public policy in the United States and around the world, citing the nine-state Regional Greenhouse Gas Initiative (RGGI), and the Clean Power Plan introduced by President Obama in 2015.

Sixth on the panel was Maureen Cropper, Distinguished University Professor and Chair of the Department of Economics at the University of Maryland.  Maureen had kindly agreed to talk about Marty Weitzman’s research and outreach in the realm of fisheries management.  Maureen explained that his modeling work in Iceland and elsewhere had affected thinking and discussion around the world regarding the use of taxes and quotas to regulate fishing industries. “This is another example of the use of a simple model and treatment of uncertainly that really did start a conversation among fisheries economists when it came out,” she said.

Finally Michael Greenstone, the Milton Friedman Professor in Economics at the University of Chicago, agreed to reflect on how Weitzman’s theoretical insights were fundamental as the foundation for sound empirical analysis.  Greenstone noted that Marty’s work “takes something you are kind of confused about, and then after you read it, you can’t understand how in the world you were confused beforehand. It just clarifies things in a way that is really beautiful.”

A Book of Testimonials

Many of those who attended the symposium — and many who were not able to join us — wanted to tell Marty directly how they feel about him and his work.  And so we assembled and presented to Marty a book in which we had compiled 60 testimonial letters, including from some of his admirers who could not be with us at the symposium, such as:  Orley Ashenfelter, Greg Mankiw, Kerry Smith, Bob Solow, Nick Stern, Cass Sunstein, and others.  As I presented Marty with the book of letters, I took a moment to read aloud from just one of the letters from another person who could not be with us:

When I was an undergraduate in the economics department at MIT, you were a bright and rising young star.  Later, as a faculty member, I routinely assigned your papers to my environmental economics students.  Your scholarship and your leadership enriched their experiences — and mine — tremendously.

I will never forget when you announced that you were moving on to Harvard — what a blow! —but the universe has seen fit to bring us together once again.  It is an honor to acknowledge your extraordinary contributions to the field, and to thank you for shining a light for all of us.

                                                      All the best,

                                                             Larry

                                                      Lawrence Bacow, President, Harvard University

More Memories

The book did not end with the testimonial letters.  On a personal note, it has been 26 years since Marty Weitzman and I launched the Harvard Seminar in Environmental Economics and Policy.  Over those 52 semesters, we have hosted a total of 398 seminars!  In the very first semester — the fall of 1992 — the seminar presenters included, among others, in alphabetical order: Bill Nordhaus, Kerry Smith, Bob Solow, Rob Stavins, Kip Viscusi, and Marty Weitzman.

In virtually every one of these 400 seminars, everyone in the seminar room – including me — learned not only from each seminar’s presenter, but from Marty’s concise and relevant questions which would inevitably go directly to the heart of the matter.  So, I was pleased to include in the book copies of all 52 seminar schedules, beginning with the fall of 1992 and culminating with the fall of 2018.  I will not say “concluding” with the fall of 2018, because I trust that my collaboration with Marty, which I have valued highly, will continue.

Marty Weitzman has been a treasure for Harvard and for the global scholarly community.  All of us are confident that his contributions will continue to be forthcoming.

Marty Weitzman Responds

Following the Symposium, Weitzman took several minutes to reflect on his remarkable career, recognizing that while he has pursued projects across multiple disciplines, his research would often hit dead ends.

“I’m drawn to things that are conceptually unclear, where it’s not clear how you want to make your way through this maze,” he said. “It’s difficult to describe a creative process, but I get some sort of an inspiration…Most of the time it’s a waste of time because I can’t formalize it, so I try and try and just nothing comes of it. But occasionally it clicks and since it’s typically in an area that’s been understudied, that’s why it’s so dispersed across different fields.”

Weitzman spoke proudly of his work in environmental economics, stating that he “took a decisive step in that direction a few decades ago…getting into the forefront rather than…following everything that went on.” Yet he admitted that he is not very optimistic about the current pace of efforts to combat the harmful mid- and long-term impacts of global climate change.

“It’s not merely sufficient to cut back on carbon emissions or to stabilize carbon emissions. We’ve more or less done that in the last few years, although it could go either way,” he said. “The stuff that does the damage is the stock of carbon dioxide. To get the stock of carbon dioxide to go down, it has almost nothing to do with stabilizing the flow. You have to get the flow down to net zero. That’s what’s so difficult. And the public does not realize that. Victory on the flow front doesn’t translate into victory on the stock front, and that’s what counts.”

As is typical of his style, Marty did not reveal his future plans, saying only that they remain to be determined.  But certainly all those in attendance at the symposium hope that he will continue contributing to the academic and policy discussions surrounding climate change and other critically important environmental economic issues.

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Learning from Thirty Years of Experience with Cap-and-Trade Systems

“Those who do not remember the past are condemned to repeat it.”

The implication of this famous line (often misquoted as “those who do not learn history are doomed to repeat it”) from philosopher George Santayana’s 1905 book, The Life of Reason, Volume I – Reason in Common Sense, is that we are wise to learn from our mistakes.  This is undoubtedly true, as is the parallel recommendation that we are wise to learn from our successes.

Background

China is expected to launch later this year the world’s largest (CO2) emissions trading system; the European Union is in the process of extending and strengthening its CO2 cap-and-trade system; California has just extended and strengthened its CO2 cap-and-trade system; and earlier this week, nine New England and Middle Atlantic U.S. states announced their plan to extend and strengthen the Regional Greenhouse Gas Initiative.  With such developments in place and on the horizon, this is an important time to think carefully and critically about the history of cap-and-trade, and identify lessons that can be learned from three decades of prior experiences – both successes and failures.

That is precisely what Richard Schmalensee (Howard W. Johnson Professor of Economics and Management, Emeritus, at the Massachusetts Institute of Technology, and Dean Emeritus of the MIT Sloan School of Management) and I sought to do in an article which recently appeared in the Review of Environmental Economics and Policy (REEP) (“Lessons Learned from Three Decades of Experience with Cap and Trade,” Review of Environmental Economics and Policy, volume 11, issue 1, Winter 2017, pp. 59-79).  I encourage you to read the full article, which – in keeping with the style of the Review of Environmental Economics and Policy – is brief and broadly accessible.

In the hope that you may be stimulated to read the full article, in today’s blog essay I draw on the article to provide the historical context of our analysis, and to review some of our conclusions (for the actual analysis of individual cap-and-trade systems, and the justifications for our conclusions, you will need to see the article).

The Historical Context

Thirty years ago, many environmental advocates argued that government allocation of rights to emit pollution legitimized environmental degradation, while others questioned the feasibility of such an approach.  At the time, virtually all pollution regulations took a command-and-control approach, specifying the type of pollution-control equipment to be used or setting uniform limits on emission levels or rates.

Today, it is widely recognized – at least among students of economics – that because emission reduction costs can vary greatly, the aggregate abatement costs under command-and-control approaches can be much higher than under market-based approaches, which establish a price on emissions – either directly through taxes or indirectly through a market for tradable emissions rights established under a cap-and-trade policy.  Because market-based approaches tend to equate marginal abatement costs rather than emissions levels or rates across sources, they can achieve aggregate pollution-control targets at minimum cost.

In the REEP article, Dick Schmalensee and I examined the design and performance of seven of the most prominent emissions trading systems that have been implemented over the past 30 years in order to identify key lessons for future applications.  We focused on systems that have been important environmentally and/or economically, and whose performance has been well documented.  We excluded emission-reduction-credit (offset) systems, which offer credits for emissions reductions from some counterfactual baseline, because while emissions can generally be measured directly, emissions reductions are unobservable and often ill-defined.

The seven emissions trading systems we examined were:

  • the U.S. Environmental Protection Agency’s (EPA’s) phasedown of leaded gasoline in the 1980s;
  • the U.S. sulfur dioxide (SO2) allowance trading program under the Clean Air Act Amendments of 1990;
  • the Regional Clean Air Incentives Market (RECLAIM) in southern California;
  • the trading of nitrogen oxides (NOX) in the eastern United States;
  • the Regional Greenhouse Gas Initiative (RGGI) in the northeastern United States;
  • California’s cap-and-trade system under Assembly Bill 32; and
  • the European Union (EU) Emissions Trading System (ETS).

All of these programs except the first are textbook cap-and-trade systems.

In the article, we reviewed the design, performance, and lessons learned from each of the seven systems (and briefly discussed several other cap-and-trade systems).  In this blog essay, however, I turn immediately to our summary of key lessons.

Lessons from Thirty Years of Experience

Overall, we found that cap-and-trade systems, if well designed and appropriately implemented, can achieve their core objective of meeting targeted emissions reductions cost-effectively.  This is not something that was taken for granted in the past, and is still not accepted in some quarters.  That said, the devil is in the details, and design as well as the economic environment in which systems are implemented are very important.  Moreover, as with any policy instrument, there is no guarantee of success.  Based on the numerous specific lessons we identified in our analysis, several design and implementation features of cap-and-trade programs appear critical to their performance.

Key Features for System Design and Implementation

First, it is important not to require prior approval of trades.  In contrast to early U.S. experience with emissions offset systems, transactions costs can be low enough to permit considerable efficiency-enhancing trade if prior approval of trades is not required.

Second, it is clear from both theory and experience that a robust market requires a cap that is significantly below BAU emissions.

Third, to avoid unnecessary price volatility, it is important for final rules (including those for allowance allocation) to be established and accurate data supplied well before commencement of a system’s first compliance period.

Fourth, high levels of compliance in a downstream system can be achieved by ensuring there is accurate emissions monitoring combined with significant penalties for non-compliance.

Fifth, provisions for allowance banking have proven to very important for achieving maximum gains from trade, and the absence of banking provisions can lead to price spikes and collapses.

Sixth, price collars are important.  A changing economy can reduce emissions below a cap, rendering it non-binding, or a growing economy can increase emissions and drive allowance prices to excessive levels.  Price collars reduce price volatility by combining an auction price floor with an allowance reserve.  The resulting hybrid systems will generally have lower costs (as more stable prices facilitate investment planning) at the expense of less certain emissions reductions.

Finally, economy-wide systems are feasible, although downstream, sectoral programs have been more commonly employed.

Political Considerations that Affect Cap-and-Trade Design

Experiences with cap-and-trade also indicate the importance of political considerations for the design of cap-and-trade programs.

First, because of the potentially large distributional impacts involved, the allocation of allowances has inevitably been a major political issue.  Free allowance allocation has proven to help build political support. Under many circumstances, the equilibrium allowance distribution, and hence the aggregate abatement costs of a cap-and-trade system, are independent of the initial allowance allocation (Montgomery 1972; Hahn and Stavins 2012).  This means that the allowance allocation decision can be used to build political support and address equity issues without concern about impacts on overall cost-effectiveness.

Of course, free allowance allocation eliminates the opportunity to cut overall social costs by auctioning allowances and using the proceeds to cut distortionary taxes.  On the other hand, experience has shown that political pressures exist to use auction revenue not to cut such taxes, but to fund new or existing environmental programs.  Indeed, cap-and-trade allowance auctions can and have generated very significant revenue for governments.

Second, the possibility of emissions leakage and adverse competitiveness impacts has been a prominent political concern in the design of cap-and-trade systems.  Virtually any meaningful environmental policy will increase production costs and thus could raise these concerns, but this issue has been more prominent in the case of cap-and-trade instruments.  In practice, leakage from cap-and-trade systems can range from non-existent to potentially quite serious.  It is most likely to be significant for programs of limited geographic scope, particularly in the power sector because of interconnected electricity markets.  Attempts to reduce leakage and competitiveness threats through free allocation of allowances do not per se address the problem, but an output-based updating allocation can do so.

Third, although carbon pricing (through cap-and-trade or taxes) may be necessary to address climate change, it is surely not sufficient.  In some cases, abatement costs can be reduced through the use of complementary policies that address other market failures, but the types of “complementary policies” that have emerged from political processes have instead addressed emissions under the cap, thereby relocating rather than reducing emissions, driving up abatement costs, and suppressing allowance prices.

Identifying New Applications

Cap-and-trade systems are now being seriously considered for a wide range of environmental problems.  Past experience can offer some guidance as to when this approach is most likely to be successful.

First, the greater the differences in the cost of abating pollution across sources, the greater the likely cost savings from a market-based system – whether cap-and-trade or tax — relative to conventional regulation (Newell and Stavins 2003).  For example, it was clear early on that SO2 abatement cost heterogeneity was great, because of differences in ages of plants and their proximity to sources of low-sulfur coal (Carlson et al. 2000).

Second, the greater the degree of mixing of pollutants in the receiving airshed (or watershed), the more attractive a market-based system, because when there is a high degree of mixing, local hot spots are not a concern, and the focus can thus be on cost-effective achievement of aggregate emissions reductions.  Most cap-and-trade systems have been based on either the reality or the assumption of uniform mixing of pollutants. However, even without uniform mixing, well-designed cap-and-trade systems can be effective, as illustrated by the two-zone trading system under RECLAIM, at the cost of greater complexity.

Third and finally, since Weitzman’s (1974) seminal analysis of the effects of cost uncertainty on the relative efficiency of price versus quantity instruments, it has been well known that in the presence of cost uncertainty, the relative efficiency of these two types of instruments depends on the pattern of costs and benefits.  Subsequent literature has identified additional relevant considerations (Stavins 1996; Newell and Pizer 2003).  Perhaps more importantly, theory (Roberts and Spence 1976) and experience have shown that there are efficiency advantages of hybrid systems that combine price and quantity instruments in the presence of uncertainty.

Implications for Climate Change Policy

Two highly relevant lessons from thirty years of experience with cap-and-trade systems stand out.  First, cap-and-trade has proven itself to be environmentally effective and economically cost-effective relative to traditional command and control approaches. Moreover, less flexible systems would not have led to the technological change that appears to have been induced by market-based instruments (Schmalensee and Stavins 2013) or the induced process innovations that have resulted (Doucet and Strauss 1994).

Second, and equally important, the performance of cap-and-trade systems depends on how well they are designed.  In particular, it is important to reduce unnecessary price volatility, and hybrid designs can offer an attractive option if some variability of emissions can be tolerated, since substantial price volatility generally raises costs.

All of this suggests that cap-and-trade merits serious consideration when regions, nations, or sub-national jurisdictions are developing policies to reduce greenhouse gas (GHG) emissions.  And, indeed, this has happened.  However, because any meaningful climate policy will have significant impacts on economic activity in many sectors and regions, proposals for such policies have often triggered significant opposition.

In the United States, the failure of cap-and-trade climate policy in the Congress in 2010 was essentially collateral damage from a much larger political war that decimated the ranks of both moderate Republicans and moderate Democrats.  Nevertheless, political support for using cap-and-trade systems to reduce GHG emissions has emerged in many other parts of the world.  In fact, in the negotiations leading up to the Paris climate conference in 2015, many parties endorsed key roles for carbon markets, and broad agreement emerged concerning the value of linking those markets (codified in Article 6 of the Paris Agreement).

It is certainly possible that three decades of high receptivity to cap-and-trade in the United States, Europe, and other parts of the world will turn out to have been only a relatively brief departure from a long-term trend of reliance on command and control environmental regulation.  However, in light of the generally positive experience with cap-and-trade, there is reason for optimism that the tarnishing of cap-and-trade in US political debates will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments.  Only time will tell.

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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.

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