Designing Climate-Change Treaties E. Maskin Institute for Advanced Study

2 probably can’t deal successfully with climate change without strong international treaty limiting greenhouse gas emissions but getting treaty not easy –we all benefit from emission reductions –but such reductions are economically costly –each country would like others to reduce –so, free-rider problem

3 Also, fairness and efficiency problems –rich countries got rich by emitting carbon dioxide –so why not poor countries too? –reductions costlier for poor countries So fairness and efficiency suggest –poor countries should make smaller reductions than rich countries

4 But how should reductions for each country be determined? Answer: by international treaty Most likely: treaty will be cap-and-trade system –each country given a cap on emissions –can “buy” additional emissions or “sell” excess emissions

5 If countries’ costs of reductions known, then could calculate appropriate caps and obtain treaty that benefits all countries But, though each country likely to know its own costs reasonably well, knowledge not publicly available So, information crucial for calculating caps is missing

6 Mechanism Design can help −shows how to achieve social goals when critical information not publicly known −in this case: social goals = right caps Let’s look at simple example

7 2 countries: rich and poor rich country’s cost of emission reduction x: Suppose want over-all reduction of 10 –efficient reductions solve problem

Assume Then efficient reductions are as follows: 8

How can we achieve these reductions? Must give countries incentive to “reveal” costs Suppose poor country given trade concession from rich country contingent on what countries say their cost parameters are: t (3,9) = concession if rich country says 3 poor country says 9 Similarly, for t (3,3), t (1,9), t (1,3) 9

10

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12 to satisfy all inequalities? Yes. –for example, take t (3,9) = t (1,9) = 0 t (1,3)= 4 t (3,3) = 32 Thus can solve treaty-design problem even though we don’t initially have critical information

13 Designing carbon-reduction treaties important, but difficult mechanism design theory can help