Photo: DG EMPL

Cross-posted from An Economic View of the Environment.

Two weeks of international climate negotiations begin today in Durban, South Africa. These are the Seventeenth Conference of the Parties (COP 17) of the United Nations Framework Convention on Climate Change (UNFCCC) [PDF]. The key challenge at this point is to maintain the process of building a sound foundation for meaningful, long-term global action, not necessarily some notion of immediate, highly visible triumph. In other words, the answer to the question of whether the Durban climate negotiations can succeed depends — not surprisingly — on how one defines “success.”

Let’s place the climate negotiations in perspective

Why do I say (repeatedly, year after year) that the best goal for the climate talks is to make progress on a sound foundation for meaningful, long-term global action, not some notion of immediate triumph? The reason is that the often-stated cliche about the American baseball season — that it’s a marathon, not a sprint — applies even more so to international climate change policy. Why?

First, the focus of scientists (and policymakers) should be on stabilizing concentrations at acceptable levels by 2050 and beyond, because it is the accumulated stock of greenhouse-gas emissions — not the flow of emissions in any year — that are linked with climate consequences.

Second, the cost-effective path for stabilizing concentrations involves a gradual ramp-up in target severity, to avoid rendering large parts of the capital stock prematurely obsolete.

Third, massive technological change is the key to the needed transition from reliance on carbon-intensive fossil fuels to more climate-friendly energy sources. Long-term price signals (most likely from government policies) will be needed to inspire such technological change.

Fourth and finally, the creation of long-lasting international institutions is central to addressing this global challenge.

For all of these reasons, international climate negotiations will be an ongoing process, not a single task with a clear end point. Indeed, we should not be surprised that they proceed much as international trade talks do; that is, building institutions (the GATT, the WTO), yet moving forward in fits and starts, at times seeming to move backward, but with progress in the long term.

So, the bottom line is that a sensible goal for the international negotiations in Durban is progress on a sound foundation for meaningful long-term action, not some notion of immediate “success.” This does not mean that there should be anything other than a sense of urgency associated with the work at hand, because it is important. But it does mean that we should keep our eyes on the prize.

How can the Durban negotiators keep their eyes on the prize?

The keys to success — real, as opposed to symbolic success — in Durban depend upon four imperatives:

1. Embrace parallel processes

The UNFCCC process must embrace the parallel processes that are carrying out multilateral discussions (and in some cases, negotiations) on climate change policy: the Major Economies Forum, or MEF (a multilateral venue for discussions — but not negotiations — outside of the UNFCCC, initiated under a different name by the George W. Bush administration in the United States, and continued under a new name by the Obama administration, for the purpose of bringing together the most important emitting countries for candid and constructive discussion and debate); the G20 (periodic meetings of the finance ministers — and sometimes heads of government — of the 20 largest economies in the world); and various other multilateral and bilateral organizations and discussions.

The previous leadership of the UNFCCC seemed to view the MEF, the G20, and most other non-UNFCCC forums as competition — indeed, as a threat. Fortunately, the UNFCCC’s new leadership under Executive Secretary Christiana Figueres (appointed by U.N. Secretary-General Ban Ki-moon in May of 2010) has displayed a considerably more positive and pragmatic attitude toward these parallel processes. That’s a positive sign.

2. Consolidate negotiation tracks

There are now three major, parallel processes operative: first, the UNFCCC’s KP track (negotiating national targets for a possible second commitment period — post-2012 — for the Kyoto Protocol); second, the LCA track (the UNFCCC’s negotiation track for Long-term Cooperative Action, that is, a future international agreement of undefined nature); and third, the Cancun Agreements from COP 16 a year ago (based upon the Copenhagen Accord, negotiated and noted at COP 15 in Copenhagen, Denmark, in December, 2009). Consolidating these three tracks into two tracks (or better yet, one track) would be another significant step forward.

The primary way for this to happen would be for the LCA negotiations to focus on the ongoing work of putting more meat on the bones of the Cancun Agreements, which — along with the Copenhagen Accord — marked an important step forward by blurring for the first time (although not eliminating) the unproductive and utterly obsolete distinction in the Kyoto Protocol between Annex I and non-Annex I countries. (Note that more than 50 non-Annex I countries have greater per capita income than the poorest of the Annex I countries.)

In particular, the UNFCCC principle of  “common but differentiated responsibilities” could be made meaningful through the dual principles that: All countries recognize their historic emissions (read, the industrialized world), and all countries are responsible for their future emissions (think of the rapidly growing, emerging economies of China, India, Brazil, Korea, Mexico, and South Africa).

As I’ve said before, this would represent a great leap beyond what has become the “QWERTY keyboard” (that is, unproductive path dependence) of international climate policy: the distinction in the Kyoto Protocol between the small set of Annex I countries with quantitative targets, and the majority of countries in the world with no responsibilities. A variety of policy architectures — including but not limited to the Cancun Agreements — could build on these dual principles and make them operational, beginning to bridge the massive political divide that exists between the industrialized and the developing world.

At the Harvard Project on Climate Agreements — a multinational initiative with some 35 research projects in Australia, China, Europe, India, Japan, and the United States — we have developed a variety of architectural proposals that could make these dual principles operational. (See, for example, “Global Climate Policy Architecture and Political Feasibility” [PDF] by Valentina Bosetti and Jeffrey Frankel, and “Three Key Elements of Post-2012 International Climate Policy Architecture” [PDF] by Sheila M. Olmstead and Robert N. Stavins.)

3. Make progress on narrow, focused agreements

A third area of success at the Durban negotiations could be realized by some productive steps with specific, narrow agreements, such as on REDD+ (Reduced Deforestation and Forest Degradation, plus enhancement of forest carbon stocks). Other areas where talks are moving forward, although somewhat more slowly, are finance and technology, particularly in the context of adding meat to the bones of the Cancun Agreements.

4. Maintain sensible expectations

Finally, it is important to go into these annual negotiations with sensible expectations and thereby effective plans. As I said at the outset, negotiations in this domain are an ongoing process, not a single task with a clear end point. The most sensible goal for Durban is progress on a sound foundation for meaningful long-term action, not some notion of immediate triumph. The key question is not what Durban accomplishes in the short term, but whether it helps put the world in a better position five, 10, and 20 years from now in regard to an effective long-term path of action to address the threat of global climate change.

Wait, what about the Kyoto Protocol?

Those who follow these international negotiations closely — including my colleagues on the ground in Durban — are no doubt wondering why I haven’t said something about the 900-pound gorilla in the closet: The fact that the Kyoto Protocol’s first (and so far only) commitment period runs from 2008 through 2012, and so a decision needs to be reached on a possible second (post-2012) commitment period for the protocol.

Yes, in addition to the LCA (Cancun) track, the Kyoto Protocol (KP) track of negotiations remains. A decision regarding a possible extension (and presumably an enhancement) of the Kyoto Protocol’s emissions-reduction targets for the industrialized (Annex I) countries has been punted annually to the next set of negotiations — from Bali in 2007, to Poznan in 2008, to Copenhagen in 2009, to Cancun in 2010, and now to Durban in 2011. It can’t be delayed any longer, because the necessary process of ratification by individual nations would itself take at least a year to complete.

Keeping the Kyoto Protocol going (and with more stringent targets for the Annex I countries) is very important to the non-Annex I countries (sometimes referred to — inaccurately — as the developing countries). I don’t blame them. An approach that provides benefits (reduced climate damages, as well as financial transfers) for the non-Annex I countries without their incurring any costs is surely an attractive route for those nations.

Is a second commitment period for the Kyoto Protocol feasible?

Putting aside the possible merits of a second commitment period for the Kyoto Protocol, we can ask simply whether it’s in the cards: Is it feasible?

Japan, Russia, and Canada have formally announced that they will not take up targets in a second commitment period. Australia, despite its recent domestic climate policy action, seems unlikely to make a significant commitment. Is Europe (plus New Zealand) on its own credible or feasible? Maybe yes, maybe no.

The “yes” part of the answer comes from the fact that Europe has already committed itself to serious emissions reductions through the year 2020 under the European Union Emission Trading Scheme (EU ETS). This will go forward — barring a change of heart by the E.U. — with or without a second commitment period for the Kyoto Protocol. That said, Europe’s compliance costs under the EU ETS will be much less than otherwise if offsets continue to be made available from non-Annex I countries under the Kyoto Protocol’s Clean Development Mechanism (CDM). This might suggest that the E.U. has a significant motivation to keep the Kyoto Protocol going.

But international law scholars — such as Professor Daniel Bodansky of Arizona State University‘s Sandra Day O’Connor College of Law — maintain that the Kyoto Protocol (and its CDM) continues as an institution of law whether or not a second commitment period is put in place. Hence, it’s conceivable that the E.U. could have its cake and eat it too: an ongoing Kyoto Protocol without a second commitment period. And the political pressure on Brussels from the E.U.’s member states — and from European businesses — might make it difficult for the E.U. to sign up for a new series of commitments, given the obvious absence in such an arrangement of the United States, Russia, Japan, Canada, and — of course — China and the other emerging economies.

A forecast

This highly contentious issue of a possible second commitment period for the Kyoto Protocol may come to dominate the talks in Durban. This would be unfortunate, because it would simultaneously reduce the likelihood of the negotiators making progress on a sound foundation for meaningful, long-term global action. It would probably also have the effect of producing some drama in the form of highly charged debates, and possible threats by some delegations to walk out of the negotiations. For this reason, despite the weather, Durban may come to resemble Copenhagen more than Cancun.

The U.S. Environmental Protection Agency (EPA) has a golden opportunity to opt for a smart, low-cost approach to fulfilling its mandate under a Supreme Court decision to reduce carbon dioxide (CO2) and other greenhouse-gas (GHG) emissions linked with global climate change.

Such an approach would provide maximum compliance flexibility to private industry while meeting mandated emission-reduction targets, would achieve these goals at the lowest possible cost, would work through the market rather than against it, would be consistent with the Obama administration’s pragmatic approach to environmental regulation, and ought to receive broad political support, including from conservatives, who presumably want to minimize the cost burden of any policy on businesses and consumers.

Background and context

By now, it is well known that the 2007 U.S. Supreme Court (5-4) decision in Massachusetts vs. EPA found that EPA has the authority to regulate GHGs under the existing provisions of the Clean Air Act (CAA). This, combined with EPA’s “endangerment finding” in 2009 that GHGs threaten public health and the environment, led first in January, 2011, to new motor vehicle fuel-efficiency standards, and soon will lead to regulations affecting new and modified stationary sources of emissions (under Section 111b of the CAA) via so-called New Source Performance Standards, and regulations for existing stationary sources (under Section 111d).

In quantitative terms, this last set of regulations — for existing stationary sources — will be key, and by far the most important affected sector will be electricity generation, which accounts for fully 40 percent of U.S. CO2 emissions (and a third of national GHG emissions). Within this sector, coal-fired power plants will be the most drastically affected.

The EPA could, in principle, promulgate a regulatory approach that incorporates compliance flexibility, such as through various types of credit, offset, or cap-and-trade mechanisms. It could do this, but may it do so under the legal authority of the Clean Air Act?

Call the lawyers!

Over the past year, there has been a considerable amount of discussion and no small degree of hand-wringing over whether the relevant parts of the Clean Air Act authorize the use of such flexibility mechanisms. In the midst of this, a new report from Resources for the Future (RFF) by Gregory Wannier (Columbia Law School) and others makes a compelling, but nuanced case [PDF] in the affirmative.

Their conclusion, in a nutshell: “EPA has the tools under §111 of the CAA to implement relatively flexible and efficient GHG regulation. The agency could use a range of compliance flexibility options itself, or facilitate state implementation plans that adopt such measures at the state or regional level.” Included are the market-based, economic-incentive instruments mentioned above.

We should take note, by the way, that Section 111d gives states considerable latitude when choosing their actions to follow EPA guidelines, an approach that is consistent with conservatives’ promotion of the primacy of state authorities in tailoring rules for individual state-by-state circumstances.

Now, for some economics

Even if the EPA has the legal authority to adopt a progressive, market-based approach to fulfilling this regulatory mandate, would it really make sense to do this? That is, what would be the consequences of adopting a flexible approach, compared with a conventional, inflexible regulatory scheme? Key issues include the implications for environmental performance, aggregate social cost, and consumer impacts via electricity prices.

Another new study, this one by Dallas Burtraw, Anthony Paul, and Matt Woerman (all at RFF), provides the analysis that is needed, using RFF’s well-regarded Haiku model [PDF] of the U.S. electricity market, to examine the effect of alternative CAA policies on investment and operation of the nation’s electricity system over a 25-year time horizon in 21 interlinked regions [PDF].

Four scenarios which would achieve the same environmental benefits are examined:

1. a conventional approach in which the operating efficiency of individual coal-fired power plants would be regulated (labeled an “inflexible performance standard”);
2. a “flexible performance standard,” under which plants that exceeded the standard could transfer a credit (in exchange for payment) to plants that found it more difficult to achieve the standard. The researchers call these “generation efficiency credit offsets”;
3. cap-and-trade with auctioned CO2 emission allowances, where the revenue generated for government simply displaces the need for other revenue sources on a one-for-one basis (that is, there is no assumption of a double-dividend through increased efficiency of the tax code);
4. and cap-and-trade with free allocation of allowances to local distribution companies, which are regulated and hence assumed to pass the benefits of the free allocation on to consumers.

The results are striking. In terms of aggregate social costs, the inflexible standard would bring with it total costs of about $5 billion per year, whereas — at the other extreme — cap-and-trade with free allocation would involve total costs of only $500 million annually, a 90 percent cost savings!

If — despite its legal authority — EPA believes it is politically unable to adopt a cap-and-trade approach (because of last year’s successful tarnishing of that phrase by congressional conservatives), then it could opt for a second-best approach, the “flexible-performance standard,” above, which would involve total annual costs of about $1.4 billion, still a 70 percent cost savings compared with the conventional, inflexible standard.

Of course, political consideration of such policy alternatives is more frequently driven by estimates of consumer impacts than by overall social costs (which include consumer costs, industry costs, and costs to government). Here, the analysis is also striking. Consumer costs — due to higher electricity prices — under the inflexible standard would increase by 7 percent, while consumer costs under the flexible performance standard would increase by less than 2 percent. With the cap-and-trade regime with free allowances, consumer costs would actually fall by nearly 1 percent, due to lower electricity prices. [For complete numerical results with all of the scenarios, see the RFF discussion paper (PDF).]

The bottom line

Clearly, much is to be gained — and virtually nothing lost — by adopting a more flexi
ble approach to meeting a court-ordered mandate that, one way or another, will have a regulation promulgated and eventually finalized. It would be foolish to turn away from a potential 90 percent cost savings for the country’s economy, particularly when the same approach yields lower electricity prices for consumers. All this, while meeting national obligations to reduce greenhouse-gas emissions.

It’s too soon to forget that a year ago the Senate abandoned its attempt to pass climate legislation that would limit CO2 emissions. In the process, conservative Republicans dubbed cap-and-trade “cap-and-tax.” But, as I’ve said before, regardless of what they think about climate change, conservatives should resist demonizing market-based approaches to environmental protection [PDF] and reverting to pre-1980s thinking that saddled business and consumers with needless costs.

Market-based approaches to environmental protection should be lauded, not condemned, by political leaders, no matter what their party affiliation. Otherwise, there will be severe and perverse long-term consequences for the economy, for business, and for consumers.

Canada confirmed Friday that it will not take on a target under an extension of the Kyoto Protocol following the completion of the first commitment period, 2008-2012. Given that Canada is likely to miss by a wide margin its current target under the first commitment period, this decision may not be surprising, but it is nevertheless important. More striking, it may actually turn out to be a positive and constructive step forward in the drive to address global climate change through meaningful international cooperation. Why do I say that?

The current situation

The Kyoto Protocol, which essentially expires at the end of 2012, divides the world into two competing economic camps. Emission reductions are required for only the small set of “Annex I countries” (essentially those nations that used to be thought of as comprising the industrialized world). Such reductions will not reduce global emissions, and whatever is achieved would be at excessive cost, because of having left so many countries and so many low-cost emissions-reduction opportunities off the table. Furthermore, that dichotomous distinction is by no means fair: More than 50 non-Annex I countries now have higher per capita incomes than the poorest of the Annex I countries.

The United States did not ratify the Kyoto Protocol, and has made it clear that it will not take on a target under a second commitment period. The U.S. position continues to be that a considerably broader agreement is necessary — one that includes commitments not only from the Annex I (industrialized) countries, but also from the key emerging economies, such as China, India, Brazil, Korea, Mexico, and South Africa.

For much the same reason, Russia and Japan announced last year that they would not take on post-2012 commitments under the Kyoto Protocol. Further, it is unlikely that Australia will take on such a commitment under Kyoto, essentially leaving the European Union on its own.

On the other hand, the Kyoto Protocol is enthusiastically embraced by the non-Annex I countries (sometimes inaccurately characterized as the “developing countries”), because it holds out the promise of emissions reductions by the wealthiest nations without any responsibilities (costs) borne by others, including the emerging economies.

The path from Copenhagen to Cancun to Durban

Year after year, the Conference of the Parties to the United Nations Framework Convention on Climate Change has failed to reach agreement on a second commitment period for the Kyoto Protocol. Most recently, in Dec. 2010, the issue was punted from the annual conference held in Cancun, Mexico, to the next conference, scheduled for Dec. 2011, in Durban, South Africa.

Because Durban provides the last opportunity to set up post-2012 targets (with time remaining for national ratification actions), it has been anticipated that the negotiations in Durban will reignite the divisiveness and recriminations that highlighted the Copenhagen negotiations in 2009 — with verbal hostilities between Annex I countries and non-Annex I countries dominating the discussions at the expense of any other considerations or meaningful actions.

A positive and constructive step forward

The decision just announced at meetings in Bonn, Germany, by the Canadian delegation that Canada will not take on a target in a second commitment period of the Kyoto Protocol can be a very constructive step forward. This is because it greatly reduces the risk that this year’s annual meeting of the Conference of the Parties in Durban will be dominated by acrimonious debates about a second commitment period for the Kyoto Protocol.

On the contrary, this announcement should encourage the non-Annex I (“developing”) countries, which have been insisting on a second commitment period, to begin to accept the reality that with the United States, Japan, Russia, and now Canada on record as not endorsing a second commitment period for the Kyoto Protocol, it is infeasible for the European Union to go it alone. (Indeed, one might suspect that Australia and most European nations are privately pleased by Canada’s announcement.)

The reality is that the world will be better off by focusing on sensible alternatives under the Long-Term Cooperative Action track of the U.N. negotiations and by “getting real” about post-Kyoto international climate policy architecture for the long term, such as by putting some additional meat on the Cancun Agreements and by considering any supplemental and sensible architectures the various parties wish to discuss. (For previous posts on the Cancun Agreements, see: Why Cancun Trumped Copenhagen; What Happened (and Why): An Assessment of the Cancun Agreements; Defining Success for Climate Negotiations in Cancun. For descriptions of a wide range of potential global climate policy architectures — ranging from top-down to bottom-up — see the diverse publications of the Harvard Project on Climate Agreements.)

Next steps

At Cancun, it was encouraging to hear fewer people holding out for a commitment to another phase of the Kyoto Protocol, but it was politically impossible to spike the idea of extending the Kyoto agreement entirely. Instead, it was punted to the next gathering in Durban. Otherwise, the Cancun meeting could have collapsed amid acrimony and recriminations reminiscent of Copenhagen.

Usefully, the Cancun Agreements recognize directly and explicitly two key principles: one, all countries must recognize their historic emissions (read, the industrialized world); and two, all countries are responsible for their future emissions (think of those with fast-growing emerging economies). In important ways, this helps move beyond the old Kyoto divide.

The acceptance of the Cancun Agreements last December suggested that the international community may have begun to recognize that incremental steps in the right direction are better than acrimonious debates over unachievable targets. Canada’s announcement should help advance that recognition, and can thereby lead to vastly more productive talks this year in Durban.

Environmental justice is a noble cause, but the lawsuit against AB 32 is misguided.

The ruling [PDF] was in response to a lawsuit brought by a set of “environmental justice” groups, who fear that the cap-and-trade system will hurt low-income communities. These groups hope — at a minimum — to delay implementation of the system, scheduled for Jan. 2012. Their preferred outcome would be for California Gov. Jerry Brown to abandon the approach altogether in favor of conventional regulatory mechanisms.

I’ve written about this controversy before, but the potential importance of Judge Goldsmith’s ruling suggests that it’s important to revisit this territory.

The national context

As far as we know, Brown plans to move forward with the implementation of AB 32, under which California seeks to take dramatic steps to reduce its greenhouse-gas emissions. Questions have been raised about the wisdom of a single state trying to address a global commons problem, but with national climate policy developments having slowed dramatically in Washington, California is now the focal point of meaningful U.S. climate policy action. Indeed, for this reason, Nature recently labeled Mary Nichols, the chair of the California Air Resources Board, “America’s top climate cop.”

California’s plan

A key element of the mechanisms to be used for achieving California’s ambitious emissions reductions will be cap-and-trade, a promising approach with a successful track record, despite its recent demonization as “cap-and-tax” by conservatives and other opponents in the U.S. Congress.

Under this approach, regulators restrict emissions by issuing a limited number of emission allowances, with the number of allowances ratcheted down over time, thus assuring ever-larger reductions in overall emissions. Pollution sources such as electric power plants and factories are allowed to trade allowances, and as a result, sources able to reduce emissions least expensively take on more of the pollution-reduction effort. Experience has shown [PDF] that cap-and-trade programs achieve emissions reductions at dramatically lower cost than conventional regulation.

Concerns

Some groups in California have been very uneasy about the prospect of cap-and-trade. In particular, the environmental justice movement has long opposed this approach, citing concerns that it would hurt low-income communities. Professor Lawrence Goulder of Stanford University and I addressed such concerns in an article in The Sacramento Bee in March of 2008.

One expressed concern has been that a cap-and-trade policy might increase pollution in low-income or minority communities. The apprehension is not about greenhouse gases (the focus of AB 32), since these gases spread evenly around the globe and thus would have no discernible impact in the immediate area. Rather, it’s about “co-pollutants,” such as nitrogen oxides, carbon monoxide, and particulates, which can be emitted alongside greenhouse gases.

Because a cap-and-trade system would reduce California’s overall greenhouse-gas emissions, it would also lower the state’s emissions of co-pollutants. Still, it’s possible, though unlikely, that co-pollutant emissions would increase in a particular locality. But here it’s crucial to recognize that existing air pollution laws address such pollutants, and so any greenhouse-gas allowance trades that would violate local air pollution limits would be prohibited.

If current limits for co-pollutants are thought to be insufficient, the best response is not to scuttle a statewide system that can achieve AB 32′s ambitious targets at minimum cost. Rather, the most environmentally and economically effective way to address such pollution is to revisit existing local pollution laws and perhaps make them more stringent.

While much attention has been given to the effects of potential climate policies on environmental conditions in low-income communities, it’s also important to consider their economic impacts on these communities. Reducing greenhouse-gas emissions will require greater reliance on more costly energy sources and more costly appliances, vehicles, and other equipment. Because low-income households devote greater shares of their income to energy and transportation costs than do higher-income households, virtually any climate policy will place relatively greater burdens on low-income households. But because cap-and-trade will minimize energy-related and other costs, it holds an important advantage in this regard over conventional regulations.

Moreover, a cap-and-trade system gives the public a tool for compensating low-income communities for the potential economic burdens: If some emission allowances are auctioned, revenues can be used to mitigate economic burdens on these communities.

The way forward

All in all, cap-and-trade serves the goal of environmental justice better than the alternatives. This progressive policy instrument merits a central place in the arsenal of weapons California employs. Beyond helping the state meet its emissions-reduction targets at the lowest cost, it offers a promising way to reduce economic burdens on low-income and minority communities. For these reasons, the environmental justice lawsuit is not only misguided, but — if ultimately successful — will be counter-productive.

The latest rage in Washington policy discussions these days (that’s relevant to climate change) is renewed interest in renewable electricity standards, this time in the form of so-called “clean energy standards.” I’ve written about this policy approach recently and will do so again in the near future, but for today I want to turn to an important issue — for the long term — on the related topic of the international dimensions of climate change policy.

The current state of affairs

Despite the death in the U.S. Senate last year of serious consideration of an economy-wide cap-and-trade system for carbon dioxide (CO2) emissions — and the apparent political hiatus of such consideration at least until after the November 2012 elections — a major cap-and-trade system for greenhouse gas (GHG) emissions is in place in the European Union; similar systems are in place or under development in New Zealand, California, and several Canadian provinces; systems are being considered at the national level in Australia, Canada, and Japan; and a global emission reduction credit scheme — the Clean Development Mechanism (CDM) — has an enthusiastic and important constituency of supporters in the form of the world’s developing countries.

So, despite the fact that there has been an undeniable loss of momentum due to recent political developments in Australia, Japan, and the United States, it remains true that cap-and-trade is still the most likely domestic policy approach for CO2 emissions reductions throughout the industrialized world, given the rather unattractive set of available alternative approaches. This makes it important to think about the possibility of linking these national and regional cap-and-trade systems in the future. Such linking occurs when the government that maintains one system allows regulated entities to use allowances or credits from other systems to meet compliance obligations.

Thinking about linkage

In 2007, with support from the International Emissions Trading Association and the Electric Power Research Institute, Judson Jaffe and I analyzed the opportunities and challenges presented by linking tradable permit systems. Jaffe was then at Analysis Group in Boston, and is now at the U.S. Department of the Treasury. We presented our findings at the 13th Conference of the Parties of the U.N. Framework Convention on Climate Change in Bali, Indonesia, in December, 2007. In 2010, Matthew Ranson (a Ph.D. student in Public Policy at Harvard), Jaffe, and I expanded on these ideas in an article that was published in Ecology Law Quarterly, “Linking Tradable Permit Systems:  A Key Element of Emerging International Climate Policy.” In today’s blog post, I summarize the highlights of this complex, yet important topic.

First, for anyone new to this territory, let me review the basic facts. Tradable permit systems fall into two categories: cap-and-trade and emission reduction credits. Under cap-and-trade, the total emissions of regulated sources are capped and the sources are required to hold allowances equal to their emissions. Under a credit system, entities that voluntarily undertake emission reduction projects are awarded credits that can be sold to participants in cap-and-trade systems.

The merits of linking

By broadening markets for allowances and credits, linking increases the liquidity and improves the functioning of markets. Linking can reduce the costs of the linked systems by making it possible to shift emission reductions across systems. Just as allowance trading within a system allows higher-cost emission reductions to be replaced by lower-cost reductions, trading across systems allows higher-cost reductions in one system to be replaced by lower-cost reductions in another system.

Other implications

Along with the cost savings it can offer, linking has other implications that warrant serious consideration. Under some circumstances, linked systems collectively will not achieve the same level of emission reductions as they would absent linking. This can result either from a link’s impact on emissions under the linked systems, or from its impact on emissions leakage from those systems. Linking also has distributional impacts across and within systems. And linking can reduce the control that a country has over the impacts of its tradable permit system. In particular, when a domestic cap-and-trade system is linked with another cap-and-trade system, decisions by the government overseeing the other system can influence the domestic system’s allowance price, distributional impacts, and emissions.

By the way, linkage can also occur among a heterogeneous set of domestic policy instruments, including carbon taxes and various types of regulation, although the linking is more challenging under such circumstances. On this, see “Linking Policies When Tastes Differ: Global Climate Policy in a Heterogeneous World,” a discussion paper by Gilbert Metcalf, Department of Economics, Tufts University, and David Weisbach, University of Chicago Law School, for the Harvard Project on Climate Agreements.

Concerns about linking

Importantly, trading brought about by unrestricted links between cap-and-trade systems will lead to the automatic propagation of certain design elements, including: offset provisions and linkages with other systems; banking and borrowing of allowances across time; and safety-valve provisions. If these provisions, sometimes characterized as cost-containment measures, are present in one of the linked systems, they will automatically be made available to participants in the other system.

In the near-term, some links will be more attractive and easier to establish than others. Given the design-element propagation implications of two-way links between cap-and-trade systems, to facilitate such links it may be necessary to harmonize some design elements. And in some cases, it may be necessary to establish broader international agreements governing aspects of the design of linked cap-and-trade systems beyond mutual recognition of allowances.

An emerging de facto international climate policy architecture?

Whereas some two-way links between cap-and-trade systems may thus take more time to establish, in the near-term one-way links between cap-and-trade and credit systems likely will be more attractive and easier to establish. A one-way link with a credit system may offer a cap-and-trade system greater cost savings than a two-way link with another cap-and-trade system. Also, such one-way links can only reduce allowance prices in the cap-and-trade system, giving a government greater control over its system than if it established a two-way link with another cap-and-trade system. The additionality problem is an important concern associated with such links, but it can be managed — to some degree — through the criteria established for awarding or recognizing credits.

Most important, if emerging cap-and-trade systems link with a common credit system, such as the CDM, this will create indirect links among the cap-and-trade systems. Through the indirect links that they create, such one-way linkages can achieve much of the near-term cost savings and risk diversification that direct two-way links among cap-and-trade systems would achieve. And they can do this without requiring the same foundation that likely would be needed to establish direct two-way links, such as harmonization of cost-containment measures. Such linkage may well emerge as part of the de facto post-Kyoto international climate policy architecture, and is fully consistent with the bottom-up, decentralized approach of the Cancun Agreements.

As the first decade of the 21st century comes to a close, the problem of the commons is more important to our lives — and more central to economics — than a century ago when the first issue of the American Economic Review appeared, with an examination by Professor Katharine Coman of Wellesley College of “Some Unsettled Problems of Irrigation” (1911). Since that time, 100 years of remarkable economic progress have accompanied 100 years of increasingly challenging problems.

As the U.S. and other economies have grown, the carrying-capacity of the planet — in regard to natural resources and environmental quality — has become a greater concern, particularly for common-property and open-access resources. In an article that appears in the 100th anniversary issue of the American Economic Review (AER) – “The Problem of the Commons: Still Unsettled After 100 Years” — I focus on some important, unsettled problems of the commons.

Within the realm of natural resources, there are special challenges associated with renewable resources, which are frequently characterized by open-access. An important example is the degradation of open-access fisheries. Critical commons problems are also associated with environmental quality, including the ultimate commons problem of the 21st century — global climate change.

Small communities frequently provide modes of oversight and methods for policing their citizens, a topic about which Professor Elinor Ostrom of Indiana University has written extensively. But as the scale of society has grown, commons problems have spread across communities and even across nations. In some of these cases, no overarching authority can offer complete control, rendering commons problems more severe.

Although the type of water allocation problems of concern to Coman have frequently been addressed by common-property regimes of collective management, less easily governed problems of open-access are associated with growing concerns about air and water quality, hazardous waste, species extinction, maintenance of stratospheric ozone, and — most recently — the stability of the global climate in the face of the steady accumulation of greenhouse gases.

Whereas common property resources are held as private property by some group, open-access resources are non-excludable. My article in the AER focuses exclusively on the latter, and thereby reflects on some important, unsettled problems of the commons. It identifies both the contributions made by economic analysis and the challenges facing public policy.

The article begins with natural resources, highlighting the difference between most non-renewable natural resources, pure private goods that are both excludable and rival in consumption, and renewable natural resources, many of which are non-excludable.

Some of these are rival in consumption but characterized by open-access. An example is the degradation of ocean fisheries. An economic perspective on these resources helps identify the problems they present for management, and provides guidance for sensible solutions.

The article then turns to a major set of commons problems that were not addressed until the last three decades of the 20th century — environmental quality. Although frequently characterized as textbook examples of externalities, these problems can also be viewed as a particular category of commons problems: pure public goods, that are both non-excludable and non-rival in consumption.

A key contribution of economics has been the development of market-based approaches to environmental protection, including emission taxes and tradable rights. These have potential to address the ultimate commons problem of the 21st century, global climate change.

Themes that emerge

First, economic theory — by focusing on market failures linked with incomplete systems of property rights — has made major contributions to our understanding of commons problems and the development of prudent public policies.

Second, as our understanding of the commons has become more complex, the design of economic policy instruments has become more sophisticated, enabling policy makers to address problems that are characterized by uncertainty, spatial and temporal heterogeneity, and long duration.

Third, government policies that have not accounted for economic responses have been excessively costly, often ineffective, and sometimes counterproductive.

Fourth, commons problems have not diminished. While some have been addressed successfully, others have emerged that are more important and more difficult.

Fifth, environmental economics is well positioned to offer better understanding and better policies to address these ongoing challenges.

Although I hope you will read the full article — which is very accessible — I will summarize its conclusions here.

Problems of the commons are both more widespread and more important today than when Coman wrote about unsettled problems in the first issue of the American Economic Review 100 years ago. A century of economic growth and globalization have brought unparalleled improvements in societal well-being, but also unprecedented challenges to the carrying-capacity of the planet. What would have been in 1911 inconceivable increases in income and population have come about and have greatly heightened pressures on the commons, particularly where there has been open access to it.

The stocks of a variety of renewable natural resources — including water, forests, fisheries, and numerous other species of plant and animal — have been depleted below socially efficient levels, principally because of poorly-defined property-right regimes. Likewise, the same market failures of open-access — whether characterized as externalities, following A. C. Pigou (1920), or public goods, following Ronald Coase (1960) — have led to the degradation of air and water quality, inappropriate disposal of hazardous waste, depletion of stratospheric ozone, and the atmospheric accumulation of greenhouse gases linked with global climate change.

Over this same century, economics — as a discipline — has gradually come to focus more and more attention on these commons problems, first with regard to natural resources, and more recently with regard to environmental quality. Economic research within academia and think tanks has improved our understanding of the causes and consequences of excessive resource depletion and inefficient environmental degradation, and thereby has helped identify sensible policy solutions.

Conventional regulatory policies, which have not accounted for economic responses, have been excessively costly, ineffective, or even counterproductive. The problems behind what Garrett Hardin (1968) characterized as the “tragedy of the commons” might better be described as the “failure of commons regulation.” As our understanding of the commons has become more complex, the design of economic policy instruments has become more sophisticated.

Problems of the commons have not diminished, and the lag between understanding and action can be long. While some commons problems have been addressed successfully, others continue to emerge. Some — such as the threat of global climate change — are both more important and more difficult than problems of the past.

Fortunately, economics is well positioned to offer better understanding and better policies to address these ongoing challenges. As the first decade of the 21st century comes to a close, natural resource and environmental economics has emerged as a productive field of our discipline and one that shows even greater promise for the future.

California Gov. Jerry Brown plans to move forward with the implementation of Assembly Bill 32 (AB 32), the Global Warming Solutions Act, under which California seeks to take dramatic steps to reduce its greenhouse-gas emissions. Questions have been raised about the wisdom of a single state trying to address a global commons problem, but with national climate policy developments having slowed dramatically in Washington, California is now the focal point of meaningful U.S. climate policy action.

California’s plan

A key element of the mechanisms to be used for achieving California’s ambitious emissions reductions will be cap-and-trade, a promising approach with a successful track record, despite its recent demonization as “cap-and-tax” by conservatives and other opponents in the U.S. Congress.

Under this approach, regulators restrict emissions by issuing a limited number of emission allowances, with the number of allowances ratcheted down over time, thus assuring ever-larger reductions in overall emissions. Pollution sources such as electric power plants and factories are allowed to trade allowances, and as a result, sources able to reduce emissions least expensively take on more of the pollution-reduction effort. Experience has shown that cap-and-trade programs achieve emissions reductions at dramatically lower cost than conventional regulation.

Concerns

Yet some groups in California have been very uneasy about the prospect of cap-and-trade. In particular, the Environmental Justice movement has opposed this approach, citing concerns that it would hurt low-income communities. Professor Lawrence Goulder of Stanford University and I addressed such concerns in an article in The Sacramento Bee.

One expressed concern has been that a cap-and-trade policy might increase pollution in low-income or minority communities. The apprehension is not about greenhouse gases (the focus of AB 32), since these gases spread evenly around the globe and thus would have no discernible impact in the immediate area. Rather, it’s about “co-pollutants,” such as nitrogen oxides, carbon monoxide, and particulates, which can be emitted alongside greenhouse gases.

Because a cap-and-trade system would reduce California’s overall greenhouse-gas emissions, it would also lower the state’s emissions of co-pollutants. Still, it’s possible, though unlikely, that co-pollutant emissions would increase in a particular locality. But here it’s crucial to recognize that existing air pollution laws address such pollutants, and so any greenhouse-gas allowance trades that would violate local air pollution limits would be prohibited.

If current limits for co-pollutants are thought to be insufficient, the best response is not to scuttle a statewide system that can achieve AB 32′s ambitious targets at minimum cost. Rather, the most environmentally and economically effective way to address such pollution is to revisit existing local pollution laws and perhaps make them more stringent.

While much attention has rightly been given to the effects of potential climate policies on environmental conditions in low-income communities, it’s also important to consider their economic impacts on these communities. Reducing greenhouse-gas emissions will require greater reliance on more costly energy sources and more costly appliances, vehicles, and other equipment. Because low-income households devote greater shares of their income to energy and transportation costs than do higher-income households, virtually any climate policy will place relatively greater burdens on low-income households. But because cap-and-trade will minimize energy-related and other costs, it holds an important advantage in this regard over conventional regulations.

Moreover, a cap-and-trade system gives the public a tool for compensating low-income communities for the potential economic burdens: If some emission allowances are auctioned, revenues can be used to mitigate economic burdens on these communities.

The way forward

All in all, cap-and-trade serves the goal of environmental justice better than the alternatives. This progressive policy instrument merits a central place in the arsenal of weapons California employs. Beyond helping the state meet its emissions-reduction targets at the lowest cost, it offers a promising way to reduce economic burdens on low-income and minority communities.

California Gov. Jerry Brown plans to move forward with the implementation of Assembly Bill 32 (AB 32), the Global Warming Solutions Act, under which California seeks to take dramatic steps to reduce its greenhouse-gas emissions. Questions have been raised about the wisdom of a single state trying to address a global commons problem, but with national climate policy developments having slowed dramatically in Washington, California is now the focal point of meaningful U.S. climate policy action.

California’s plan

A key element of the mechanisms to be used for achieving California’s ambitious emissions reductions will be cap-and-trade, a promising approach with a successful track record, despite its recent demonization as “cap-and-tax” by conservatives and other opponents in the U.S. Congress.

Under this approach, regulators restrict emissions by issuing a limited number of emission allowances, with the number of allowances ratcheted down over time, thus assuring ever-larger reductions in overall emissions. Pollution sources such as electric power plants and factories are allowed to trade allowances, and as a result, sources able to reduce emissions least expensively take on more of the pollution-reduction effort. Experience has shown that cap-and-trade programs achieve emissions reductions at dramatically lower cost than conventional regulation.

Concerns

Yet some groups in California have been very uneasy about the prospect of cap-and-trade. In particular, the Environmental Justice movement has opposed this approach, citing concerns that it would hurt low-income communities. Professor Lawrence Goulder of Stanford University and I addressed such concerns in an article in The Sacramento Bee.

One expressed concern has been that a cap-and-trade policy might increase pollution in low-income or minority communities. The apprehension is not about greenhouse gases (the focus of AB 32), since these gases spread evenly around the globe and thus would have no discernible impact in the immediate area. Rather, it’s about “co-pollutants,” such as nitrogen oxides, carbon monoxide, and particulates, which can be emitted alongside greenhouse gases.

Because a cap-and-trade system would reduce California’s overall greenhouse-gas emissions, it would also lower the state’s emissions of co-pollutants. Still, it’s possible, though unlikely, that co-pollutant emissions would increase in a particular locality. But here it’s crucial to recognize that existing air pollution laws address such pollutants, and so any greenhouse-gas allowance trades that would violate local air pollution limits would be prohibited.

If current limits for co-pollutants are thought to be insufficient, the best response is not to scuttle a statewide system that can achieve AB 32′s ambitious targets at minimum cost. Rather, the most environmentally and economically effective way to address such pollution is to revisit existing local pollution laws and perhaps make them more stringent.

While much attention has rightly been given to the effects of potential climate policies on environmental conditions in low-income communities, it’s also important to consider their economic impacts on these communities. Reducing greenhouse-gas emissions will require greater reliance on more costly energy sources and more costly appliances, vehicles, and other equipment. Because low-income households devote greater shares of their income to energy and transportation costs than do higher-income households, virtually any climate policy will place relatively greater burdens on low-income households. But because cap-and-trade will minimize energy-related and other costs, it holds an important advantage in this regard over conventional regulations.

Moreover, a cap-and-trade system gives the public a tool for compensating low-income communities for the potential economic burdens: If some emission allowances are auctioned, revenues can be used to mitigate economic burdens on these communities.

The way forward

All in all, cap-and-trade serves the goal of environmental justice better than the alternatives. This progressive policy instrument merits a central place in the arsenal of weapons California employs. Beyond helping the state meet its emissions-reduction targets at the lowest cost, it offers a promising way to reduce economic burdens on low-income and minority communities.

One day after the election, the White House Press Secretary Robert Gibbs said that a national renewable electricity standard could be an area of bipartisan energy cooperation, after President Obama had said cap-and-trade was not the only way “to skin the cat.” It is ironic that while cap-and-trade — a sensible approach to reducing carbon dioxide emissions linked with climate change — is dead and buried in the Senate, considerable support has emerged for an approach that would be both less effective and more costly. A national renewable electricity standard would mandate that a given share of an electric company’s production come from renewable sources (most likely wind power), or, in the case of a “clean energy standard,” from an expanded list including nuclear and hydroelectric power.

One irony is that cap-and-trade is a market-based approach to environmental protection, which harnesses the power of the marketplace to reduce costs imposed on business and consumers, an approach championed by Republican presidents beginning with Ronald Reagan. Within its narrow domain, the renewable standard approach, which involves nationwide trading of renewable energy credits, is also market-based. Whereas cap-and-trade would raise the cost of fossil fuel, as its opponents have stressed so effectively, renewable standards would raise the cost of electricity, which its supporters seem reluctant to admit. If renewables really were cheaper, even with federal subsidies, it wouldn’t take regulation to get utilities to use them.

A second source of irony is that renewable or clean electricity standards are a very expensive way to reduce carbon dioxide (CO2) emissions — much more expensive than cap-and-trade. These standards would only affect electricity, thereby omitting about 60 percent of U.S. CO2 emissions. And even then, the standards would provide limited incentives to substitute away from coal, the most carbon-intensive way to generate electricity. Even more problematic, renewable/clean electricity standards would provide absolutely no incentives to reduce CO2 emissions from heating buildings, running industrial processes, or transporting people and goods. And unlike cap-and-trade, which would also affect oil consumption, the electricity standards would make no contribution to energy security. Only a very tiny fraction of U.S. oil consumption is used to generate electricity.

Increasing renewable electricity generation is no more than a means to an end for one part of the economy. Cap-and-trade keeps our eyes on the prize: moving the entire economy toward climate-friendly energy generation and use.

Those who believe that renewable electricity standards would create a huge number of green jobs have forgotten the lesson of Detroit: a large domestic market does not guarantee a healthy domestic industry. At the end of 2008, for instance, the U.S. led the world in installed wind generation capacity, but half of new installations that year were accounted for by imports. And a recent Lawrence Berkeley Laboratory study [PDF] of the impacts of the economic stimulus package incentives for renewable electricity investments estimated that about 40 percent of the (gross) jobs created by new wind-energy investments were outside the United States, where many wind turbines are manufactured.

A sounder approach, for those concerned about green jobs, would focus on the long-term determinants of economic growth, such as technological innovation. That’s where cap-and-trade — which creates broad-based incentives for technology innovation — holds another edge over renewable electricity standards.

It is often argued that if cap-and-trade is dead, enacting renewable or clean electricity standards is better than doing nothing at all about climate change. While that argument has some merit, since the risks of doing nothing are substantial, there is a real danger that enacting these standards will create the illusion that we have done something serious to address climate change. Worse yet, it could create a favored set of businesses that will oppose future adoption of more efficient, serious, broad-based policies — like cap-and-trade.

If a national renewable electricity standard is nonetheless inevitable, it should not impose excess costs on businesses or consumers. It should pre-empt state renewable portfolio standards, since with a national standard in place, states’ programs simply impose extra costs on their citizens without affecting national use of renewables at all. And any national program should allow unlimited banking to encourage early investments. No environmental or economic purpose is served by limiting banking to two years, as current Senate legislation would do.

Carbon cap-and-trade has been killed in the Senate, presumably because of its costs. Renewable electricity standards or clean energy standards would accomplish considerably less and would impose much higher costs per ton of emissions reduction than cap-and-trade would. This does not sound like a step forward.

But a funny thing happened on the way to that much-anticipated failure: During two intense weeks of discussions in the Mexican resort that wrapped up at 3 a.m. on Dec. 12, the world’s governments quietly achieved consensus on a set of substantive steps forward. And equally important, the participants showed encouraging signs of learning to navigate through the unproductive squabbling between developed and developing countries that derailed the Copenhagen talks.

Unprecedented first steps

The tangible advances were noteworthy: The Cancun Agreements set emissions mitigation targets for some 80 countries, including all the major economies. That means that the world’s largest emitters, among them China, the United States, the European Union, India, and Brazil, have now signed up for targets and actions to reduce emissions by 2020.

The participating countries also agreed — for the first time in an official United Nations accord — to keep temperature increases below a global average of 2 degrees C (3.6 degrees F). Yes, that goal is no more stringent than the one set out in Copenhagen, but this time, the participating nations formally accepted the goals; a year earlier, they merely “noted” them, without adopting the accord.

Other provisions establish a “Green Climate Fund” to finance steps to limit and adapt to climate change, and designate the World Bank as interim trustee, over the objections of many developing countries. And new initiatives will protect tropical forests, and find ways to transfer clean energy technology to poorer countries.

The Cancun Agreements on their own are clearly not sufficient to keep temperature increases below 2 degrees C, but they are a valuable step forward in the difficult process of constructing a sound foundation for meaningful, long-term global action.

Small steps vs. global accords

The progress was as much about changing the mindset of how to tackle climate disruption. Significantly, the Cancun agreement blurs the distinction between industrialized and developing countries — a vital step to break through the rich-poor divide that has held up progress for years. The 1997 Kyoto Protocol assigned emission targets only to the 40 countries thought to be part of the industrialized world, which left the more than 140 nations of the developing world without any commitments. But today, more than 50 of those so-called developing countries have higher per capita income than the poorest of the countries with emission-reduction responsibilities under Kyoto.

Implicitly, the process in Cancun also recognizes that smaller, practical steps — some of which are occurring outside the United Nations climate process — are going to be more easily achievable, and thus more effective, than holding out for some overarching thunderclap in a global accord.

The parallel processes of multilateral discussions on climate change policy, including the G20 meetings and the Major Economies Forum, have been useful. For the first time at Cancun, the U.N. Framework Convention on Climate Change, under the new leadership of Executive Secretary Christiana Figueres, offered a positive and pragmatic approach toward embracing these parallel processes.

Fixing the past (and future)

The Kyoto Protocol, which essentially expires at the end of 2012, is fundamentally flawed, especially in dividing the world into competing economic camps. At Cancun, it was encouraging to hear fewer people holding out for a commitment to another phase of the Kyoto Protocol. It was politically impossible to spike the idea of extending the Kyoto agreement entirely, but at least it was punted to the next gathering in Durban, South Africa, a year from now. Otherwise, the Cancun meeting could have collapsed amid acrimony and recriminations.

Usefully, the Cancun Agreements recognize directly and explicitly two key principles:

1. All countries must recognize their historic emissions (read, the industrialized world); and
2. All countries are responsible for their future emissions (think of those with fast-growing emerging economies).

This also helps move beyond the old Kyoto divide.

A better dialogue

An essential goal in Cancun was for the parties to maintain sensible expectations and develop effective plans. That they met this challenge owes in good measure to the careful and methodical planning by the Mexican government, and to the tremendous skill of Mexican Foreign Minister Patricia Espinosa in presiding over the talks.

For example, at a critical moment, she took note of objections from Bolivia and a few other leftist states, and then ruled that the support of the 193 other countries meant that consensus had been achieved and the Cancun Agreements had been adopted. She pointed out that “consensus does not mean unanimity.” Compare that with Copenhagen, where the Danish prime minister allowed objections by five small countries to derail the talks.

Mexico’s adept leadership also made sure smaller countries were able to contribute fully and join any meetings they wanted, avoiding the sense of exclusivity that alienated some parties in Copenhagen. That’s a sign that Mexico is one of the key “bridging states” that have credibility in both worlds. Another is South Korea. They will need to play key roles going forward.

It’s also vital to note that China and the United States set a civil, productive tone, in contrast to the Copenhagen finger-pointing. From the sidelines in Cancun, I can vouch for the tremendous increase in openness of members of the Chinese delegation.

The acceptance of the Cancun Agreements suggests that the international community may now recognize that incremental steps in the right direction are better than acrimonious debates over unachievable targets.