Regulation Against Global Warming in an Unequal World Sylvestre Gaudin Hultberg

The Issue : Global Warming: Evidence: Earth 1°F warmer than 100 years ago 4 warmest years of 20 th century in the 90’s Temperature anticipated to increase 2-6 °F more in next 100 years Small change in climate makes a big difference Scientists agree on the source of Global Warming: Greenhouse Gases (GHG) and reduced carbon sequestration – All human induced

Greenhouse Gases Carbon Dioxide Methane Nitrous oxide CFC synthetics Ozone Water vapor

Sources of Increased GHG Concentrations Industrial: 77% Developing Countries produce less than 1/3 of industrial CO2, 1/5 excluding China Land use changes: 25% Developing Countries are virtually responsible for this type of GHG emission Combined effect of reducing sequestration

Per Capita Emissions: Per capita emissions in the US = Twice the per capita emissions in Europe 19 times the per capita emissions in Africa 23 times the per capita emissions in India US emits 25% of total GHGs But the world is changing… Share of LDCs is increasing rapidly

How Much Do We Know? Effect of global warming could be Catastrophic Mild or even positive Do we want to run the risk? Do we care about future generations? How much do we care about today? How valuable is what we would give up? Who is “we”?

To reduce the risk we need to: Reduce human induced GHG emissions on a global scale Protect and/or restore carbon “sinks” But how? Economists like to use markets to restore price incentives

The Economics of Global Warming Global negative externality: When emitting GHG, polluters do not take account of the cost of their actions on Society – We need to put a price on the pollution! Graphical analysis with electricity producers: Fossil fuel producers produce too much Alternative Fuels producers produce too little In a world of certainty, we can internalize the costs:  less “dirty” electricity and more “clean” electricity

Market Based Mechanisms A tax per unit of GHG emission: Optimal Pigouvian Tax: Tax = MEC Producers face MSC and produce Qe Producers abate until MCA=MBA (the tax) Distribution of tradable permits Optimal quantity is set so that Qe is produced Firms have different costs of abatement Costs of achieving the target are minimized Price of the permits = MEC

The worse kind of Externality Intertemporal Future generations are affected Global The whole world is affected Uncertain Both costs and benefits are highly uncertain

Taxes Versus Permits Equivalent in a world of certainty But costs and benefits of abatement are highly uncertain

Taxes Vs Permits Under Uncertainty Taxes fix price and allow firms to adjust abatement so that MCA=MBA. The level of pollution cannot be controlled  Risk is imposed on the environment Permits fix the emission target and allow price of GHG emissions to vary. The price of permits cannot be controlled  Risk is imposed on the regulated firms

Which approach seems preferable if we think that the environmental risk is high because of potential catastrophic consequences?

Which approach seems preferable if we live in a developing country and present consequences on costs and production may be catastrophic ?  Discount rate issue

Choices Made in Kyoto, 12/97 Parties of the UNFCCC: Annex I countries: Industrialized countries plus Transition economies LDCs not in Annex I Set Emission target for Annex I countries: Chosen rule for distribution: grand-fathering On average 5.2% less than 1990 emission levels – First budget period – 6 GHG included Carbon sequestration activities offset emissions

Market Mechanisms to Achieve the Targets IET – International Emissions trading Participating Annex I countries only JI – Joint Implementation mechanism Participating Annex I countries/firms only CDM – Clean Development Mechanism Annex I countries/firms with projects in LDCs

Permits Allowances in ERUs (Emission Reduction Units) Credits from JI or CDM projects in CERs (Certified Emission Reductions) Different prices for ERUs and CERs Carbon sequestration activities increase allowances: CTO (Certified Tradable Offsets)

Equity Considerations North North Trade The “French” view (Ministry of Equipment) Efficiency is attained with tradable permits but benefits USA with highest emission per head and per $ GDP penalizes France who has significantly lower rates of emission Transition Economies

Equity Considerations North-South Trade View that a per-capita allocation of GHG allowances would be more equitable Understanding that share of non-industrialized countries in costs is close to zero – could be a net gain -> equitable LDCs cannot participate in selling CERs even if they contribute (incentive to join) Poorest countries cannot afford to join – limits to growth.

Equity Considerations – N/S Different stage of development Different preferences Different marginal utility of income Different personal discount rates Different experiences with markets On the rising part of the Environmental Kuznets curve Value of ERUs will impact the value of the CERs Other issues: Transaction costs? Market power?

Equity Considerations S/S What countries will first benefit Countries with high reduction potential Countries with pre-existing FDI regulation Countries with least transaction costs and best monitoring Poorest countries score badly… Corruption?

The future Participation of developing countries is essential Need to control at least 55% of all emissions Need a closed market to avoid leakages and free riding Moving later to per-capita targets could increase equity both N/N and N/S and encourage LDCs participation Enforcement clauses need to be strengthened Monitoring and accounting needs to be improved The CEM offers opportunity to lead LDCs onto a sustainable development path.