The Political Economy of Climate Change

1. The Political Economy of Climate Change Addressing Cost

2. Overview • Introduction • Overarching Issues • Dimensions of Cost • Long-term Climate Regime • Conclusion

3. Introduction • Efforts to mitigate GHG emissions will require investments in new technology – entailing costs to society • Addressing cost essential in ensuring broad participation full commitment • Costs are perceived differently – willingness to bear costs more of politics than economics • Cost minimization integral in architecture of KP – inclusion of market based mechanisms (ET, JI CDM)

4. Overarching Issues • Efficiency vs. cost-effectiveness • Efficient is justified if in the long run, the costs are justified by the benefits e.g. level of GHG in the atmosphere to be stabilized, and the path to achieve it • Cost Effective if goal is achieved at lowest possible cost • Calculating them is complicated due to timing and uncertainty

5. Timing • Emission abatements in the near term that deliver benefits in the long term • Lag time between costs and benefits poses political dilemma • Consumers and businesses apply a discount rate to compare present and future costs and benefits • Goals to be achieved by the end of the decade vs by 2020

6. Uncertainty • Economic models rely heavily on assumptions to overcome uncertainties. • Long-term emissions forecasts reflect uncertainties in population growth, economic output, energy prices, technological change, land use activities and geopolitical changes. • IPCC has 6 illustrative scenarios with CO2 emissions varying by a factor of 6 and concentration levels by a factor of 2 • Concentrations of GHG have uncertainty in magnitude, variability and geography of impacts • Assigning economic values to impacts is not straightforward • Longer projections mean more uncertainty • Projecting costs entails ambiguity • Social and economic responses to a given GHG mitigation policy also uncertain • On cost perspective – value in postponing investment and maintaining flexibility as much as possible • Climate perspective – uncertainty with irreversibility favors a stronger environmental objective

7. Three Dimensions of CostAggregate, Relative and Cost Certainty • Aggregate cost • Projected cost is often analyzed and expressed as a reduction in GDP • Best minimized by allowing flexibility as to where, when and what type of mitigation • To minimize costs, abatement should occur where it is cheapest • KP provides all elements of flexibility: • Trading exploits where • Five year commitment and the possibility to bank reductions for use in the future reflect when • Basket approach and inclusion of carbon sinks address what

8. Relative Cost Issue when sector competing in the international marketplace faces climate related costs different from those of its competitors in other countries Concerns among parties to an agreement with or without mitigation commitments Also issues between parties and non-parties Differences influence not only the political viability of a climate agreement, but also its environmental effectiveness Energy intensive industries may attempt to avoid this increase by relocating plants or shifting production to countries with lower costs Ultimately falls to national policy to redistribute the burden domestically

9. Cost Certainty • Greater certainty may promote stronger participation and compliance • Greater cost certainty can facilitate better investment strategies, allowing firms to adjust behavior over time to mitigate the costs of the policy change • Firms interest is primarily in the direct costs they will face

10. Shaping Long-term Climate Regime • International Emissions Trading • Quantitative Targets • Indexed Targets • Sectoral Targets • “No-lose” Targets • Emissions Taxes • Technology Standards

11. International Emissions Trading • International Emissions Trading • Allows negotiation over the distribution of cost by setting country targets • Efficiency gain by not requiring countries to meet their obligations exclusively through domestic measures • Reduces leakage by lowering incentives to relocate • Can help absorb country-level spikes in emissions

12. Quantitative Targets with safety valve Countries have initial emission allocations but would have option to buy additional allowances at a predetermined price Safety valve must be set above the forecast marginal cost of the agreed emissions target Safety valve provides greater cost certainty, they would know how much an extra ton of CO2 would cost (just now how many they would need

13. Indexed targets • Don’t fix the quantity commitment at the time of the negotiation • Reduce uncertainties from the unpredictability of future economic and emissions trends • Two important principles • Indexing criteria should not create perverse incentives • Indexing formula cannot be too complicated • Level of effort depends on form of index approach, rate of economic growth, and structure of country’s economy

14. Sectoral Targets • Narrow the scope of emissions target from entire economy to certain sectors • Some industries and activities may be more amenable to mitigation in the near term • More suitable for developing countries that cant monitor emissions • Allow country to engage in international emissions trading on activities in the sector • Relative costs issues • Reduce competitiveness in the sector • Reduce sector-specific leakage • Do not specifially promote cost certainty

15. No-Lose Targets Completely eliminated the economic risk of mitigating emissions With international EM it may allow developing countries to experiment with emissions mitigation At end of commitment period , if emissions are lower than forecasted, country could sell the excess allowances Promotion of emissions mitigation could reduce incentive for emissions leakage

16. Emission Taxes • Common world price for emitting GHG • Certainty about the costs of emitting another ton of GHG • Several drawbacks: • Trade emissions certainty for cost certainty • Governments could circumvent the effect of emissions tax by reducing other taxes affecting energy-related activities • Fiscal cushioning undermines the environmental effectiveness without triggering non-compliance penalties • Make equitable distribution of mitigation burden more difficult • More difficult to include developing countries • Costs of climate policy are more transparent than quantitative approach • Tax may be politically less palatable because it highlights the costs • This option has never been seriously pursued in the climate negotiation

17. Technology Standards • Focus on financing climate-friendly R & D and mandate those technologies once commercially available • It would deliver the breakthroughs necessary to abate GHG in the medium to long term but little for the near term • Not easy to agree with: • Imposing tech standards would not result in cost-minimizing emissions abatement because technology would be very expensive for some and not for others • Governments selecting technologies may result in the choice of an unnecessarily expensive suite of technologies • No certainty about the costs

18. Conclusion • Complicated answer due to various players and their interests • Overall best solution according to the three kinds of cost: • Aggregate cost – efficient international emissions trading seems to be the most effective at minimizing cost • Relative costs – international emissions trading again could help eliminate differences in marginal cost across countries • Cost certainty – quantitative targets with some modifications such as the safety valve or indexed targets could reduce uncertainty of marginal cost