economics: thinking globally Geoff Bertram Institute for - - PowerPoint PPT Presentation

Nordhaus, clubs, and climate change economics: thinking globally

Geoff Bertram Institute for Governance and Policy Studies Victoria University of Wellington 3 February 2016

Some general propositions to start

• “Thinking globally” needs to come before “acting

locally”

– especially with climate change

• Paris 2015 has taken us back to Rio 1992

– so let’s learn from last time’s mistakes – specifically, free-riding and too narrow a choice set for policy

• “Pledge and review” will fail because it does not

remove the incentive for free-riding

– even the Pope must contend with market forces

Geoff Bertram, Climate Change Economics

2

No world government – but most economists’ textbook “policies” need a legitimate, hegemonic policymaker and enforcer

“The approach [to global climate policy] taken thus far has been to set economy-wide targets and timetables. This approach would be ideal were it possible to regulate the world’s greenhouse gas emissions in top-down fashion. Unfortunately, however, the world’s governance arrangements have to work from the bottom up. The world does not have one government; it has nearly 200. An agreement to reduce emissions must not only be attractive from the perspective of the global good. It must also be something to which countries individually want to accede and to adhere.”

Scott Barrett, “Rethinking global climate change governance”, Economics 3(5) March 3 2009, p.2.

3

Geoff Bertram, Climate Change Economics

Tragedy of the commons and free riding

• Collective action is required in an

individualistic anti-collectivist age

• It’s economics, not ideology, that is the central

problem

• In a market economy, public goods are under-

supplied, and public bads oversupplied, because individual incentives are to free-ride

Geoff Bertram, Climate Change Economics

4

Gollier and Tirol frame the issue:

“Most benefits of mitigation are global and distant, while costs are local and

• immediate. Climate change is a global commons problem. In the long run, most

countries will benefit from a massive reduction in global emissions of GHGs, but individual incentives to do so are negligible. Most of the benefits of a country’s efforts to reduce emissions go to the other countries. In a nutshell, a country bears 100% of the cost of a green policy and receives, say, 1% of the benefits of the policy, if the country has 1% of the population and has an average exposure to climate-related damages. Besides, most of these benefits, however small, do not accrue to current voters, but to future generations. Consequently, countries do not internalize the benefits of their mitigation strategies, emissions are high, and climate changes dramatically.”

Christian Collier and Jean Tirole, “Negotiating Effective Instruments Against Climate Change”, Economics of Energy and Environmental Policy 4(2):5-27, September 2015, p.6.

Geoff Bertram, Climate Change Economics

5

Three approaches to externalities

• Harness market processes to bring individual

incentives into line with the common good by pricing-in all externalities

• Command and control: central authority

intervenes to block or restrict market-driven threats to the common good

• Some combination of those two => cap-and-

trade?

Geoff Bertram, Climate Change Economics

6

How cap-and-trade came to dominate the policy menu

• Global carbon tax ruled out by lack of world government

and by moral hazard

• Command and control is notoriously “inefficient” in

economists’ eyes because it tends to miss the lowest-cost

• pportunities [but it works….]
• Cap and trade uses the market to allocate a command-

and-control cap, potentially overcoming that source of inefficiency while looking “elegant” to economists.

– But with hindsight, the crucial problem was and is how to set and enforce the cap

Geoff Bertram, Climate Change Economics

7

My own version (1992 vintage*)

• Allocate emission permits per capita to the

world’s population

• Each permit denominated as that individual’s

share of global total emissions

• The market price balances

– tightening cap (=> higher price) – technological progress (=> falling price)

• Central problem is distributional

consequences: the rich have to pay the poor

Geoff Bertram, Climate Change Economics

8 * ‘Tradeable Emission Permits and the Control of Greenhouse Gases’, Journal of Development Studies, 28, 3 (April 1992) pp.423-446, reprinted in T. Tietenberg (ed.) The Economics of Global Warming (Cheltenham, UK: Edward Elgar, 1997).

My wild over-optimism (1992 pp.435 and 440):

“…the peoples of the rich countries have a large stake in protecting the global environment, which might well outweigh political pressures from powerful industry lobby groups.” “The world community faces an historic chance actually to achieve the development goals to which so much lip service is paid on the diplomatic circuit, as a by-product of that community’s willingness jointly to confront the greenhouse issue. The developing countries deserve no less than full partnership in this process. If full partnership is denied them, they have the ability credibly to threaten ecological disaster. Prudence, as well as benevolence, should prompt the rich to tolerate economic redistribution on a very considerable scale.”

Geoff Bertram, Climate Change Economics

9

My unfortunate prescience (1992 p.440):

“If the opportunity is lost to tackle development and sustainability as simultaneous parts of a joint problem, then the global outlook darkens seriously. Either the greenhouse effect could be held at bay by condemning the poor countries to long-term underdevelopment; or the South might grow for a generation or two without regard to the environmental consequences, exposing the entire global community to the risk of catastrophic climate change.”

Geoff Bertram, Climate Change Economics

10

How and why I (and a lot of other economists!) got it wrong

• Too optimistic about the ease of establishing

and enforcing a single global cap

– Without that, we were left with the Kyoto morass

• f individual country targets with free-riding

incentives

• Incomplete listing of the options for organising

a global policy regime

Geoff Bertram, Climate Change Economics

11

My 1992 list of 4 supposedly exhaustive options

1. Direct regulation: transparent and certain, but

– administratively costly – hard to harmonise across many countries/jurisdictions – hard to enforce effectively (in the absence of a world government)

2. Carbon tax: the textbook answer, but

– would have to be specified in some currency => exchange rate issue – no global authority exists with the mandate to impose the tax – revenues on a huge scale present a moral hazard problem

3.

Private litigation: the initiative would lie with individuals, agencies and companies around the world to sue polluters through the courts of each country, but

– wealthy polluters could stall litigation indefinitely – unclear what sanctions courts could impose – loss of sovereignty as each country faced having its courts invaded by non-residents

4. Tradable permits: judged best if done as laid out in the paper, even though

– big wealthy polluting countries have to swallow large wealth transfers to poor ountries – attempt by large vested interests to capture the scheme by seeking grandfathered permits would have to be defeated.

Geoff Bertram, Climate Change Economics

12

The big missing option: a global price without a carbon tax

• Problems of implementing a global tax were

allowed to sink the direct-pricing option

• Cap-and-trade was a fallback attempt to get a

global price

– but failed for the same reason the carbon tax did: no world government to set and enforce the cap

• Nordhaus’s new (2015) insight: an international

carbon price can be set and enforced bottom-up by a “climate club”

Geoff Bertram, Climate Change Economics

13

Club theory

• Private goods: excludable and rival

– baked beans, petrol, an overcoat

• Public goods: non-excludable and non-rival

– roads, defence, sunshine

• Club goods: excludable but non-rival

– golf, movies, TV sports coverage, uncongested toll roads

• Climate change is a pure public bad (negative good) =>

club option works if excludability can be achieved – i.e. if free-riding incentive can be eliminated

Geoff Bertram, Climate Change Economics

14

Four types of economic goods (or bads)

15

Geoff Bertram, Climate Change Economics

Municipal swimming pool, golf links, Sky TV, public transport) Contents of a typical supermarket

16

Geoff Bertram, Climate Change Economics

Municipal swimming pool, golf links, Sky TV, public transport) Contents of a typical supermarket

Four types of economic goods (or bads)

Coase (1960) framed these as a matter of poorly defined property rights, which gave ‘legs’ to cap-and-trade

17

Geoff Bertram, Climate Change Economics

Municipal swimming pool, golf links, Sky TV, public transport) Contents of a typical supermarket

Four types of economic goods (or bads)

Identified by Buchanan (1965) as a sub-type of public goods

18

Geoff Bertram, Climate Change Economics

Municipal swimming pool, golf links, Sky TV, public transport) Contents of a typical supermarket

Four types of economic goods (or bads)

Coase (1960) framed these as a matter of poorly defined property rights, which gave ‘legs’ to cap-and-trade

The 1960 Coase approach is central to the Kyoto market mechanisms; it involves institutional innovations to convert key aspects of a public good to private property

• 1. Reframe the

issue from stock to flow terms, and declare a cap on total permitted flows: emission flows replace GHG stocks

• 2. Allocate newly-minted private property rights and let

the market mechanism do the work from here But actually a more common model in international agreements is to create a club: NATO, GATT/WTO, UNO, ASEAN, South Pacific Forum ……

19

Geoff Bertram, Climate Change Economics

Municipal swimming pool, golf links, Sky TV, public transport) Contents of a typical supermarket

The 2015 Nordhaus plan

• All countries joining the club agree to apply

the single carbon price

• Each country sets whatever policies it wishes

in place to make that the ruling carbon price in their domestic market [with some obvious caveats]

• The club imposes a uniform border carbon

tariff on imports from non-members

Geoff Bertram, Climate Change Economics

20

Dimensionality: the big advantage

• Only a single price to be negotiated in place of

200 country target quotas

• Price provides a ‘focal point’ that country quotas

do not

• Schelling (1965): “some clue for coordinating

behaviour, some focal point for each person’s expectation of what the other expects him to expect to be expected to do…”

Geoff Bertram, Climate Change Economics

21

Weitzman’s summary:

“A meaningful comprehensive quantity-based treaty involves specifying as many different binding emissions quotas … as there are national entities. Each national entity has a self-interested incentive to negotiate for itself a high cap on carbon emissions – much higher than would be socially optimal. The resulting free-rider problem plagues a quantity-based approach….. [L]ow dimensionality argues in favour of a one-dimensional harmonized carbon price over an n-dimensional harmonized cap-and-trade system among n nations….. Put directly, it is easier to negotiate one price than n quantities – especially when the one price can be interpreted as ‘fair’ in terms of equality of marginal effort.”

Geoff Bertram, Climate Change Economics

22

Martin Weitzman, “Internalizing the Climate Change Externality: Can a Uniform Price Commitment Help?”, Economics of Energy and Environmental Policy 4(2):37- 49, September 2015, pp.38 and 40.

Subsidiarity: the redistributive agenda is dropped overboard

• Negotiating the single carbon price is given absolute

priority

• The detailed policies to make that price applicable are left

to participating governments

• So are any revenues generated
• Redistributive climate finance therefore is left to another

day and other channels

– I used to think that a carbon price and global equity could be achieved jointly – I now concede that the myopic self-interest of the rich is an immovable roadblock, and that we simply have to work around it.

Geoff Bertram, Climate Change Economics

23

Enforcement is incentive-compatible

• Free-riding incentive vanishes: defectors are

simply excluded from the club

• All club members have uniform incentive to

abate emissions

• Non-members face an enforcement

mechanism that operates impersonally through the market

– no need for prosecution, sanctions, or gunboats

Geoff Bertram, Climate Change Economics

24

Implications for New Zealand policy?

• Accept that the current NZ policy stance is

‘rational’ given the global regime

• So something about the global regime has to

change

• The beauty of clubs is that they form bottom-up
• So there might be a national policy that

– is painless to adopt – has a chance of breaking the free-riding deadlock – could conceivably evolve into a collective global policy with consistent worldwide incentives to abate – does not require premature costly unilateral action ?

Geoff Bertram, Climate Change Economics

25

Three elements of the strategy

• Some country proposes a single price

commitment, in place of country-by-country quantity targets

– ‘I-will-if-you-will’ means no action until the club is formed

• All club participants translate the agreed price

into domestic terms:

– Either a price floor for the ETS with restrictions on imported carbon credits – Or a carbon tax

• All club members impose a common carbon tariff

– Form to be discussed and determined

Geoff Bertram, Climate Change Economics

26

Tariff design

• Two options:
• 1. Carbon-content of imported goods and services

– WTO-compliant but complex

• 2. Straight-out penalty tariff on non-members of

the club

– May require a change to international law, though principle is similar to anti-dumping

• Some WTO challenge would be almost inevitable

– If lost, the default is simply the status quo

Geoff Bertram, Climate Change Economics

27

So

• The downside is no change from status quo
• The upside is costless leadership of (or

participation in) a plan that just might work

• New Zealand seems an unlikely leader, but

could at least be a quick supporter (fast follower?)

• Maybe Tuvalu and AOSIS will step up to give it

a try?

Geoff Bertram, Climate Change Economics

28

Nordhaus:

“Here is the bottom line: … without sanctions there is no stable climate coalition other than the non-cooperative, low-abatement

• coalition. This conclusion is soundly based on public-goods theory, on

C-DICE model simulations, on the history of international agreements, and on the experience of the Kyoto Protocol. … [A]n international climate treaty that combines target carbon pricing and trade sanctions can induce substantial abatement. … The attractiveness of a Climate Club must be judged relative to the current approaches, where international climate treaties are essentially voluntary and have little prospect of slowing climate change.”

Geoff Bertram, Climate Change Economics

29

William Nordhaus, “Climate clubs: overcoming free-riding in international climate policy” American Economic Review 105(4): 1339-1370, April 2015, p.1368.

Geoff Bertram, Climate Change Economics 30

Two diagrams on risk analysis

Geoff Bertram, Climate Change Economics

31

Emissions quantity Mt Carbon price $ per tonne 100 BAU emissions 90 Emissions target 20 Harberger triangle area

100−90 ∗20 2

= 10 A B C

Geoff Bertram, Climate Change Economics 32

Emissions quantity Mt Carbon price $ per tonne 100 BAU emissions 90 Emissions target 20 Harberger triangle area is still

110𝑛−100𝑛 ∗20 2

= $10𝑛 110 BAU emissions after unexpected increase Additional cost of buying-in permits is 10m x $20 = $200m A B C D E

Geoff Bertram, Climate Change Economics 33