Strategic Issues In Global Climate Change Policy Harry Clarke

Strategic Issues in Global Climate Change Policy Harry Clarke 27th Australasian Economic Theory Workshop Auckland

Climate change mitigation

• Examine prospects for reaching a global cooperative agreement to mitigate GGEs.

Background • ‘Common property’ problems involve textbook Prisoner’s Dilemma issues . • How do side policies, embarrassment effects, carbon leakages & policy commitments affect this?

Description. • US & China provide > 50% of GGEs. ‘Large’. • 13 countries provide 30% then a fringe of ‘small’ countries - like Australia provide 20%. • Problem to derive an international agreement.

Intuition • Each country may/may not gain from unilateral mitigation – depends on ‘size’ & ‘moral suasion’ impacts. • Each gains most if all mitigate. • Irrespective of stance of others each may gain most by not mitigating.

Model 1: US & China • Choices: mitigate (M) or not (DM). • National benefits πu πc are actual environmental costs/benefits – don’t reflect ‘prestige’ or ‘embarrassment’ effects. • Spill-overs to other party Buc & Bcu.

Carbon leakages

• Without global GGE tax (or freely traded carbon quotas) can be carbon leakages. • If US (u) controls GGEs but China (c) does not there is a cost to u of Luu & gain to c of Luc.

The game. US Two Country Game with Carbon Leakage

M

DM

M

πc +Buc, πu +Bcu

πc -Lcc, Bcu+Lcu

DM

Buc +Luc, πu -Luu

0,0

China

Analysis • Spill-overs & leakages impact asymmetrically. • For US to have dominant strategy mitigate: πu > max(Lcu , Luu) • US must gain more than it loses by mitigating alone (Luu) or gains by being

Carbon leakages important? • Tighten conditions for each country to find it ‘individually rational’ to unilaterally mitigate. • But empirically important? Evidence from EU experience – suggests unimportant. • In some cases ‘side’ policies can

Side policies for leakages • ‘Destination accounting’ based on GGE consumption. • Main difficulty is probable illegality of specific ‘border taxes’ under Article 1 GATT. • Practical difficulties - assessing carbon content of goods produced with different technologies.

Side policies • Also problems with rebating taxes local firms pay on exported output. • Can do this ‘lump-sum’ to limit disadvantage & incentive to divert high GGE outputs overseas. With output-based rebate there is a distorting incentive to export high GGE goods.

PDs • Leakages increase likelihood of PDs – more likely countries have dominant strategies of not mitigating. • Countries can lose a lot by going it alone in mitigating. Can also gain a lot by not mitigating when others do.

‘Embarrassment’ costs • Increase payoffs when all other countries mitigate but you don’t. • If large can transform PD to an Assurance game with (M,M) & (DM,DM) being Nash equilibria but where each prefers (M,M). • Prospects for co-operation improve.

PD structures • PD obtains when local pollution issues are insufficient to drive mitigation but the outcome where both mitigate is collectively rational. • Less standard outcome - collectively best if one country mitigates. Requires payoff asymmetry + sidepayment.

u compensates c with $ε to mitigate (10 > ε > 0) US Two Country Game

China

M

DM

M

0.5+ε, 6-ε

ε, 10-ε

DM

1,-4

0,0

Transfers

• Transfers make sense if one country has high MWTP for GGE mitigation but faces high abatement costs. • Can be understood using public goods model.

Public goods model

$ M W TP u+ M W TP

MCmin lies in China to cutback level G. Aggregating MWTPs - all cutbacks in China.

M W TP

c

M C

u

m in

E

A A'

E'

Cost AEG*0. Of this benefits principle suggests FE’A’B paid by US.

M W TP

B 0

G

c

F

c

G*

G G E c u tb ac k s G

Benefits principle implemented by GGE quota allocation.

• This can be implemented by appropriate quota allocation.

A striking (& implausible) result • Assumes all low cost options in China & that US can compensate China for making cuts with a price covering mitigation costs. • But general implication sound - efficiencydriven transfers from rich to poor countries can meet GGE targets at minimum cost.

CDM

• Rationale for CDM under Kyoto.

Penalties • Non-co-operation in common property management resolvable using penalties. • Penalties on a single non-mitigator can turn PD into Assurance game. • If imposed on all game can become one where all have dominant strategies to mitigate.

What penalties? • Might impose retaliatory tariffs (‘Kyoto tariffs’) against nonmitigators as Europe threatened to do to US. • Strange & costly! - penalises all who would otherwise derive enhanced ‘gains-from-trade’.

Gersbach proposal • All industrialised countries contribute initially to a Global Refunding System (GRS). • Each country receives refund proportionate its GGE reduction over previous year relative to global GGE reduction over previous year. • Each country sets its own GGE taxes but all tax revenue paid to GRS.

Non-PD games • Leadership games - sometimes possibile. Might make sense. • Chicken games – can only work with carbon leakages. Each prefers to be sole mitigator but prefers joint mitigation to ‘frying’. • Assurance games – as observed, can arise with ‘embarrassment’ or with punishments. Otherwise – to arise naturally - need carbon leakages.

Multi-country models • N = 3. US, China & Europe. • Interesting because of asymmetrical mitigating incentives (compare US & Europe). • Nothing much changes unless account for carbon leakages.

Main leakage results • A non-mitigating country thinking about mitigating will focus on: – Carbon leakage costs accrued as consequence of mitigating. – Carbon leakage benefits forgone by ‘holding out’ & hoping everyone else mitigates.

Mitigation contagion • If an extra country mitigates does that enhance mitigation incentives of current non-mitigators? • Some improvement - less carbon leakage losses but still enhanced prospects of large gains by holding out to be last non-mitigator.

Moral suasion effects • Insights from behavioural economics & ‘reciprocity ‘ literature. • When do people cooperate though not individually rational to do so? • If they see others doing so or attempting to do so (irrespective of consequences). • Results for individuals not groups. For groups evidence goes both ways.

Self-serving biases -

may

limit reciprocity • Perceptions of ‘fairness’ converge on selfinterest. • Rich policymakers may avoid ethics of developing country needs because of ‘discomfit’. • Cognitive dissonance may lead emitters to deny damages. • Policy implication – force negotiators to

Intermediate & ‘no regrets’ policy • Few results. • China might pursue ‘no regrets’ options with low spill-overs. • Implications for other countries?

If China commits to ‘no regrets’: (rather than not mitigating) • Case for US to mitigate fully is strengthened - now smaller potential carbon leakage losses

Repeated game view & cheating

• Analysis well-known. For brevity I’ll ignore.

Dynamics • Numerous ways of dynamising. • Consider ‘now’ /‘future’ setting with 2 countries (China, US). • Ignore carbon leakages. • Suppose GGE control a luxury good with low quantity demanded ‘now ‘ in China.

Dynamics - China • Faces development imperatives ‘now ‘ providing incentives to forego mitigation. Some incentive for positive mitigation because future income higher. • Also faces severe impacts ‘now’ from unmitigated change & high adjustment costs of reorienting energy consumption entirely in ‘future’ to less polluting sources. • Will recognise US has increased commitment to mitigate tempered by an increased US capacity to adapt & increased US incentives to mitigate due

Dynamics - US • May place higher weight on environment now & retaining quality into the future. • Face lower future impacts & adaptation costs from unmitigated change. • Will recognise incentives China faces to undersupply mitigation now but to more fully mitigate in future. • Recognition China faces severe costs of adaptation in future which tempers pressure to shift mitigation responses forward.

Conclusion

• These notes throw light on the insight that it is important for nations to put themselves ‘in the shoes of others’ to resolve climate change issues.

Thank you