The Global Economics and Politics of Climate Change

The Global Economics and Politics of Climate Change Joseph Stiglitz Jakarta August 2007

Bali Meeting December 2007 • Important milestone in framing post-Kyoto agenda • An opportunity for Indonesia to show leadership • To shape a global agenda that is fair to developing countries • And protects the world

The changing debate on climate change • Risks of climate change/global warming have long been recognized • But the pace of change is faster than had been anticipated • And the magnitude of the costs are greater than had been realized • Question is no longer whether we can afford to do something about climate change • But whether we can afford not to do anything • We have but one planet—we are engaged in a dangerous experiment

Global Social Justice • Developed countries have contributed most to the increasing concentration of greenhouse gases • And can best afford both to reduce emissions and to adapt to the consequences • Adverse impacts will be felt most strongly in poor countries • Bangladesh • Small island states • Desertification • But developing countries will soon be contributing more than 50% of the emissions • China fast becoming largest emitter • Blaming the North will not solve the world’s problem • Shared planet • What is required is global action • Example of a global public good

The Achievement of Kyoto • Recognition of the importance of global warming • A global agreement signed by most advanced industrial countries • A slowing of global emissions by the advanced industrial countries

The Failure of Kyoto • Enforcement • Failure of U.S., the largest polluter, to join • Impasse in bringing along developing countries • Insufficient progress on deforestation—undoing much of the progress made elsewhere • Global warming is too important to rely on goodwill, • to just hope a way out of the impasse will be found.

What might emerge from Bali • An agreed statement of principles • A program on deforestation • Important for the world • Important for Indonesia • A work program for next steps

A Set of Principles • Global warming is a global problem • Requiring efforts by all countries, both developed and developing • And requiring efforts to control all sources of emissions with all possible instruments • It is a long range problem • Long term focus on level of concentration of greenhouse gases • But requires immediate action

Fairness and Efficiency • Any global system has to be both efficient and fair, • common but differentiated responsibilities • Developing countries have an incentive to become energy efficient • But energy efficiency does not mean carbon efficiency • They need to be supported in the additional costs associated with reducing carbon emissions • Fairness does not mean that because a country has polluted more in the past it should be entitled to pollute more in the future. • fairness, and the principle of the “polluter pays”, means that those who have contributed to the increase in carbon concentration in the atmosphere over the past 200 years should have, in some sense, entitlement to less pollution going forward • they should compensate the rest of the global community, e.g. through support of emissions efficient technologies in developing countries.

Market based incentives • An important component is market based incentives—to reduce emissions, including maintaining and increasing forests • Alternative ways that this may be done • Cap and trade • Carbon taxes • With increasing price of carbon over time • Because so many decisions involving energy usage are so long lived—a transportation system or housing lasts decades—it is imperative that those involved in making decisions today take into account the increasing price of carbon in the future.

Global efficiency requires a single price for carbon everywhere in world, for all sources • There will be an attempt by the developed countries to obtain “carbon on the cheap” from developing countries • Bush Administration reliance on voluntary measures is inadequate, particularly peculiar coming from a government supposedly committed to market mechanisms • Highlights the political pressures coming from affected industries (oil, coal, automobile)

Regulations and standards • But market based incentives will have to be accompanied by regulations and standards • Fortunate that vast majority of emissions can be covered (e.g. transportation, power generation) • Requisite changes in prices to rely solely on price system may be too large • These should include • eliminating subsidies for fossil fuels and • Eliminating distortionary taxes on alternative fuels • a set of standards for power-generating plants, electrical appliances, housing, automobiles, airplanes, and other major sources of pollution • A prohibition against coal-fired plants in advanced developed countries, unless there is some provision for carbon storage.

Any system dealing with global warming must be global in scope, and therefore must impose strong sanctions on non-compliaint countries • Otherwise “leakage” but lead to an increase in global emissions

The Forest Initiative • Developing countries provide enormous environmental services to developed countries, for which they are not being compensated • Biodiversity • Carbon sequestration • Fair market value of compensation is very large • Incentives needed to avoid deforestation and to encourage reforestation • Major mistake at Kyoto – failure to include avoided deforestation • Magnitude of which is huge (accounting for about a fifth of carbon emissions) • Offsetting much of the gains from Kyoto

Rainforest Coalition • South cooperative effort • Recognizing global warming as a global problem • In which there must be South participation • Could make substantial difference for global environment and development of affected countries • Increased supply of carbon credits will lower overall cost of meeting emissions reduction targets

Key questions • Can it be enforced? • New technologies allow easier monitoring • But there need to be national commitments • Certified lumber • Can it be implemented? • Costa Rica has shown that such a system can work, delivering benefits to small landowners • In Indonesia, requires partnership at every level of government • So that the benefits are equitably shared • Government will need to set priorities • Including regulations to stop further deforestation • Especially in sensitive areas and in areas with high biodiversity • Enforce existing contracts against clear cutting and which require replanting

How can it be financed? • Carbon trading—single global price of carbon • Foreign assistance—increasingly will focus on support for global public goods • Higher price of lumber will provide additional revenues • Can be basis of more sustainable development • Current pace of exploitation not sustainable

Bringing the Developing Countries into the Post Kyoto Framework • Key problem with Kyoto framework—establishing targets for developing countries • Has to be done in a way they find acceptable • Which means it has to be perceived as fair • But reductions from 1990 base makes no sense: • Why should those who polluted more in the past be entitled to pollute more in the future?

Alternative Approaches • Common standards • Developing countries argue that advanced industrial countries should reduce pollution more because their pollution caused most of the current problem • And besides, the advanced industrial countries can more easily afford pollution reductions • A common emission per capita standard • Will not constrain developing countries for decades • But will not likely be acceptable to U.S. • A common emissions per dollar GDP standard • Might be acceptable to U.S., but not to developing countries • Why should richer countries be granted larger entitlement to pollute just because they are richer?

Further problems with cap-and-trade • Can’t agree on primciples of awarding caps • Huge amounts of money at stake • Political economy of allocating emission rights within countries • Even Europe finding it difficult • Likely to generate corruption

An Economics-Based Solution • Problem is that polluters do not pay the marginal social cost of pollution—marginal social cost of emissions • Solution: force all to pay marginal cost through common tax • High enough tax would lead to same level of reductions as in Kyoto

Critique of Emissions Tax • Setting targets has more certainty of achievement (if only agreement could be reached and enforced) • But tax could be adjusted over time • And risk is not related to annual emissions • But to overall concentration level • So with regular adjustments in tax rates, little additional risk in area of concern

Further Advantage of Emissions Tax • Revenues could be used to finance global public goods • Of increasing importance as globalization proceeds • Resulting in greater interdependence • And therefore greater need for collective action • Including the provision of global public goods • Including financing development

Taxing “bads” (with corrective, Pigouvian taxes) is preferable to taxing “goods” • Emissions tax substitutes for other taxes (labor, capital) • For most countries, cost negative • Only difference is between deadweight loss of emissions tax and the taxes for which it substitutes • And distributional consequences relate only to differences in those differences

Global Politics • There are global distributional consequences from the reduction in the demand for emission-generating activities • And there will, as a result, be opposition from special interest groups • Especially important in flawed democracies where special interests play large role, e.g. through campaign contributions • And from countries which have large reserves of carbon (oil and coal) • A “fair” allocation of emission rights and a global forestry initiative at a market price for carbon will entail large redistributions from developed to developing country

Opposition from environmentalists • The world has invested enormously in the targets approach • Including creation of emissions trading schemes • Represents major achievement • And it is understandable to try to take advantage of political momentum behind it, to make it work • But there have been no serious proposals for a way out of the current impasse

Should a compromise be acceptable? • Importance of achieving a global agreement • But there should not be compromise on principles • Single price • Equal rights to emissions per capita • Only on transition paths

Global Warming Is Too Important • Global warming is too important to rely on goodwill, just to hope a way out of the current impasse will be found • It is time to begin exploring other ways of reaching a global agreement on what can be done to solve this problem • The Forest Initiative provides a common ground—an achievable objective for the Bali meeting

The Global Economics and Politics of Climate Change