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Four Roadblocks to a Global Climate Agreement

Environnement & Ressources Naturelles 
Billet du 18 septembre 2015
Par Jean Pisani-Ferry
As the pace of action looks set to rumble on, countries should seek to make progress on resolving several key issues including the free-rider problem.

This article is part of a special series discussing the economic dimensions of environmental issues ahead of the - COP 21 Climate change Conference held in Paris on 30 November-11 December 2015. Read more about it here.

Jean Pisani-Ferry teaches at the Hertie School of Governance in Berlin and serves as commissioner-general for Policy Planning in Paris. He is a former director of Bruegel, the Brussels-based economic think tank.

The issue of global warming will dominate the international agenda in the second half of the year. In December, representatives of all countries will gather in Paris for the UN conference on climate change, with the aim to reach a universal, legally-binding agreement that would limit the earth's temperature rise to 2 degrees.

To this end, four roadblocks must be cleared – or at least circumvented. First, sceptics must be convinced. Second, distributional issues must be addressed. Third, the free-riding problem must be solved and commitments must be delivered upon. Fourth, proper instruments must be put in place at the national level. Each is intimidating. Their addition is daunting.

There are fewer climate skeptics, in part because extreme climatic events – droughts, storms, and floods – have captured public attention. Had temperatures risen slowly and uniformly, there would still be many, because change would hardly be noticeable. But the tail risks, as statisticians name them, are increasingly visible. Opinion worldwide has woken up.

Agreement is, however, far from unanimous. In the U.S., a senior white Republican male is very likely to be a doubter, even more so if his education level is low. Whereas 87 percent of scientists in the U.S. attribute global warming to human activity, only 50 percent of U.S. citizens agree. Even many environmentalists underestimate the problem, because they focus on local, rather than global damages. Furthermore, attention to climate issues recedes when opinion focuses on other concerns such as growth or financial stability. So attitudes have changed, but the fight is not over.

Whereas warming is global, not everybody is affected in the same way. What is a curse to some – a citizen of the Maldives, where storms are having devastating consequences – is a blessing to others – someone who lives in Siberia may actually benefit from higher temperatures. Furthermore, people do not value the future in the same way. As discussed in a famous controversy between Nicholas Stern of the London School of Economics and William Nordhaus of Yale University, future outcomes are bound to be of lesser importance for people suffering from famine than for a well-off community.

Finally, climate change is related to the stock of CO2, not to the flow, which means that advanced countries have contributed to it much more than developing ones. For this reason, an onus is on them to solve a problem that they have created.

Because of their moral dimensions, these are very hard problems to solve. But the issue is less formidable to tackle than it seemed to be a few years ago. This is because catastrophic events such as droughts and floods affect poor regions disproportionately and are exerting more devastating consequences on these areas than on the rich regions, whose inhabitants are better protected from severe damage. Whereas 10 years ago climate change was sometimes derided as a rich man's concern, this is not the case anymore. Furthermore, the claim that it belongs to advanced countries to solve the problem does not pass the test of reality anymore: Should these countries suddenly stop emitting greenhouse gases altogether, the planet would continue warming. Also, rich countries have agreed – in principle at least – to contribute US$ 100 billion per year to the financing of climate efforts in the developing world.

The third problem, free-riding, has not been solved yet. It arises from the fact that climate preservation is what economists call a global public good. As action by any country to limit emissions benefits all countries equally, there is little incentive to act individually. Each country is tempted to free-ride on the efforts of others, and at the very least, each is fearful of others free-riding on its own efforts.

This is basically what made the 1997 Kyoto Protocol ineffective. Under this agreement, which limited emissions by advanced countries, the incentive for each participant was to avoid taking more than its fair share of the burden.

Instead, the new approach is based on individually-chosen targets: the so-called Intended Nationally Determined Contributions. Each country is free to choose its timetable, nature of objective and degree of ambition, whereas a common secretariat runs the calculations and checks whether the individual commitments add up to an ambitious enough effort.

The good aspect in this pledge-and-review approach is that unlike with the Kyoto method, everybody takes part. There are no categories and pre-set targets, which makes it realistic. The downside is that there is no enforcement mechanism. Even assuming that countries come up with targets low enough to contain warming, delivery will remain highly uncertain. Europe 10 years ago tried a similar approach to foster economic reforms: it was dubbed the open method of coordination and failed miserably.

A solution to combine flexibility and the avoidance of free riding has been proposed by William Nordhaus in his presidential address to the American Economic Association. He suggests forming a "climate club" of like-minded countries. If big and numerous enough, their action would have meaningful consequences on global climate. Other countries would be free to join the club or to face penalties in the form of trade tariffs. These would not be sanctions but would balance the social cost inflicted by free-riders on the rest of mankind.

Christian Gollier and Jean Tirole of the Toulouse School of Economics would rather revive the cap-and-trade regime but, on a global scale. A number of countries or regions have already put such schemes in place, not least the EU. The scheme would require agreeing on targets, making resulting permits tradable, and putting in place an enforcement mechanism, which could also rely on trade instruments.

The choice between a carbon price-based system and a quantitative targets-based system has long been debated. The advantage of a carbon tax is that it provides more stable guidance to investors. The return on any given project is more certain than with a cap-and-trade system, which can result in excessive fluctuations of the carbon price. For example, the price of carbon in the EU collapsed when it became clear that the outlook for GDP had been dented by the financial crisis and that in the short run, quantitative emission targets could therefore be reached without much effort. The downside of a carbon tax is that it requires a higher degree of harmonization and an effective, inevitably, somewhat intrusive monitoring on enforcement.

Whichever the choice, compliance is a challenge. It is not the first time that trade tariffs are considered. For example, the taxing of imports according to carbon content has been proposed. So far this method has been rejected on the fear of being accused of protectionism and the complexity of determining carbon content. These are serious concerns and this is why trade tariffs are not on the agenda. But ultimately there will be a need for a response to the free-riding problem.

The last challenge is to put in place domestic instruments that would translate national commitments into actual economic decisions – and in a cost-effective way. The economists' preferred solution is, again, to set a price for carbon through taxation. In this way, all decisions by all agents – be them companies or households – would take the climate objective into account. Unlike with sectoral quantity targets, which may result in paying too high a price for curbing emissions, efficiency would be ensured.

Carbon taxation provides an important signal but is no panacea. For example, some investments that would cut emissions and be profitable even without a carbon tax are actually not undertaken for lack of financing. Standards, dedicated financing and incentives to research must complement carbon pricing. Furthermore, a problem with a carbon tax is that it makes certain business models unprofitable and that it lets households, including the poor, pay more for their heating and other essentials. Setting it at the right level is hard politically and socially. Governments are tempted to promise a high price for tomorrow and procrastinate or backtrack when facing a public outcry.

For these reasons interest for green financing has increased. The idea is that instead of having to set a price, governments should create a scheme for the financing of emission-reducing investments. The German KfW already devotes 40 percent of its loans to emission-reducing projects.

Some have proposed to go beyond and use green finance as a substitute to a carbon tax. For example, Michel Aglietta and Etienne Espagne of CEPII have proposed that companies use emission-saving certificates allocated to new projects by a special agency to redeem credit with their banks. Banks in turn would post these credits with the central bank against liquidity. The solution would, however, only be temporary. Ultimately, a carbon price would need to be set that would make emission-reducing investments profitable, or the government would need to subsidize them. Choices can be postponed, but not avoided.

Summing up, we are making progress, but slowly and partially. Success in Paris is indispensable in view of the mounting evidence that the climate is deteriorating faster than expected, but the international community must avoid the temptation of declaring victory and departing the field. If successful, the conference will only help put mankind on a better track. Many more conferences and many more efforts will be needed to reach the goal of preserving the climate.
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