What Can Universities Do About Climate Change?

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There has been considerable debate about whether universities – and, for that matter, foundations – should divest fossil-fuel stocks from their investment portfolios as a way to reduce the risk of global climate change.  My own institution, Harvard University, decided that such an action was neither warranted nor wise (a position that I have supported in a post at this blog, as well as in a longer essay published by Yale University’s environment360).  Our sister institution on the West Coast of the United States, Stanford University, decided to divest coal stocks only, a position that apparently will have trivial implications for that university’s portfolio, partly because it does not affect investments in funds in which coal stocks are commingled, such as exchange-traded and mutual funds.

A broader, more positive, and fundamentally more important question is what role should universities play in addressing the threat of climate change (a topic I have addressed at this blog in the past).  Recently, the Presidents of Harvard and Stanford co-authored an op-ed on precisely this topic, and so today I am pleased to reproduce it below.  The original version was published in The Huffington Post.

What Universities Can Do About Climate Change

Drew Gilpin Faust, President, Harvard University

John L. Hennessy, President, Stanford University

September 24, 2014

This week’s UN Climate Summit calls upon people and institutions around the world to consider how they can become active leaders in combating climate change. What is the role of our colleges and universities in this effort? Those of us in the academy should be asking ourselves what more can we do to confront one of the most urgent and consequential challenges facing our civilization.Among those advocating for action in New York are many thousands of students, from our institutions and others. We are inspired by the passion and purpose they bring to this issue. We applaud and encourage the dedication of students who are determined to translate passion into action, to invest themselves in a cause that reaches far beyond themselves and their lifetimes and to remind us that the future of our planet is our collective, immediate responsibility, not something to leave to others for another day.

Educating informed, effective citizens of the world is a central part of the mission of our universities. Today’s students will lead our world in what will be a most critical era for assuring our planet’s health. We must continue working to provide innovative academic pathways that will equip them for that responsibility, along with leadership opportunities that build the skills they will need to be effective influencers, consensus builders and decision makers. We must intensify and expand our courses and programs focused on energy and environment, educating our students even as they educate us.In addition to their educational objectives, universities must continue to do even more in the research arena to provide actionable solutions for mitigating and adapting to climate change.

University scientists play crucial roles in investigating the origins and trajectory of climate change, in gauging its present and prospective consequences and in devising the new technologies that will accelerate the transition to renewable energy sources. Whether through breakthroughs on battery technology that will make energy storage more reliable and economical, or improvements in efficiency and production costs for solar systems and hydrogen fuel, a wide span of university research both fundamental and applied will drive many of the solutions to climate change.

The effort must go well beyond our scientists and engineers. University scholars across fields are vital actors in efforts to shape policy, organizational practices and wider attitudes regarding climate change and the grave risks it poses. This week, Rob Stavins and his team at the Harvard Project on Climate Agreements released new research that centers on aligning national and regional climate policies through a new international framework. Stanford faculty have been leaders in the international UN effort to document the scientific consensus on the state of the world’s climate and the impacts of climate change in fields ranging from human health to food security. Economists and lawyers, architects and ethicists, political scientists and experts in organizational behavior and finance, sociologists and humanists — all have essential parts in envisioning and spurring creative, pragmatic strategies to align governments, businesses and others in a shared quest for solutions.

A third area for university leadership is in piloting and modeling effective operational practices. Stanford has dramatically reduced employee drive-alone rates to work and is building a new campus energy system that will substantially reduce water use and carbon emission on campus. Harvard has implemented initiatives that have already resulted in a reduction in greenhouse gas emissions of 21 percent, when we include the effects of growth and renovation in our physical plant (31 percent excluding growth), and has joined forces with other universities and the Commonwealth of Massachusetts to develop the Massachusetts Green High Performance Computing Center, which uses state-of-the-art approaches to reduce energy consumption by minimizing cooling needs. Universities must “walk the walk,” acting as pioneers in embracing the new technologies and policies that will be needed to sustain our ecosystem.

The work of universities alone will not be sufficient, of course. We agree that — in the words of United Nations Secretary General, Ban Ki Moon — ‘everyone must step up and become a leader on climate change’. Nations — including the largest emitters of greenhouse gases — must step up and play a collaborative role in shaping new international agreements if we are to make meaningful progress. Local governments must also step up, as they shape regulations and infrastructure that will guide development and growth in cities around the world. Industry must step up, accelerating the development and deployment of alternative and affordable sources of energy while committing to greater energy efficiency.

But we in higher education must continue to step up, as well. Universities have the opportunity and obligation to look toward the long term. Uniquely, they bring together a wealth of intellectual resources across fields, an abundance of creativity and collaborative energy across generations, an opportunity to convene key actors on neutral ground, a commitment to serving society in ways that privilege objective evidence and rigorous analysis and the dedication to pursuing powerful long-term solutions without becoming subservient to near-term economic interests or partisan political concerns.

Universities must use these inherent strengths to make the most potent possible contribution on climate change. There is no challenge facing the world today whose effective redress depends more on the capacity and commitment of every part of society — governments, industry, universities, nonprofits and each one of us as citizens. Whether we rise to that challenge, with the urgency it demands, will largely determine what sort of world we leave for the generations to come.

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The UN Climate Summit and a Key Issue for the 2015 Paris Agreement

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World leaders converged at the United Nations in New York City this past week for Secretary-General Ban Ki-moon’s much anticipated Climate Summit, a lead-up to global negotiations that will take place in Lima, Peru, in December of this year, and culminate a year later in Paris.  The challenge before negotiators is great, because there are significant obstacles to reaching a meaningful agreement, as I describe in an Op-Ed that appeared in The New York Times on Sunday, September 21st, “Climate Realities.”

However, partly because of the new path that is being taken under the Durban Platform for Enhanced Action, in which all countries will be included under a common legal framework in a politically realistic hybrid policy architecture, the prognosis for a meaningful international agreement is better now than it has been in decades.  I discuss this briefly at the end of the Times article, and emphasize it in a follow-up Op-Ed that appeared in The Boston Globe on September 23rd, “UN summit can accelerate momentum to a new approach to climate change.”  (Also, for my overall assessment of the UN Climate Summit, see this interview carried out by the Harvard Kennedy School’s Doug Gavel.)

A New Development at the UN Climate Summit

The most significant development at the UN Climate Summit this past week was the degree to which carbon pricing became central to so many discussions, including with leaders from the business community.  As carbon pricing – in particular, cap-and-trade systems – have emerged as the policy instrument of choice in many parts of the world, interest in linking these systems together has grown.  Linkage (unilateral or bilateral recognition of allowances) among carbon markets — and, for that matter links with non-market-based systems — can reduce the aggregate cost of achieving climate targets.  And lower compliance costs can in turn encourage countries to increase the ambition of their contributions under the 2015 Paris agreement.

New Research from Harvard

Because of this, the Harvard Project on Climate Agreements has been collaborating with the International Emissions Trading Association (IETA) to explore the role of linkage in the new international climate change agreement to be completed in Paris.  In this new research, my co-authors (Daniel Bodansky of Arizona State University, Seth Hoedl of Harvard Law School, and Gilbert Metcalf of Tufts University) and I examine linkage — not only among cap-and-trade systems, but among cap-and-trade, carbon tax, and non-market regulatory systems — and the role that linkage should play in the 2015 agreement.  We look both at what would inhibit or even prevent linkage and should therefore be avoided in the 2015 agreement, and what – in a positive sense – should be included in the agreement to facilitate effective linkage of regional, national, and sub-national climate policies.

We released an Executive Summary of our research paper (“Facilitating Linkage of Heterogeneous Regional, National, and Sub-National Policies Through a Future International Agreement”) in New York City on September 22nd at an event co-sponsored by IETA and the Harvard Project, on the sidelines of UN Climate Summit, “Carbon Pricing and the 2015 Agreement” (the agenda of the event is available here).

In the executive summary (which can be downloaded in full here), we conclude that among the design elements the 2015 agreement should avoid because they would inhibit linkage are so-called “supplementarity requirements” that require parties to accomplish all (or a large, specified share) of their emissions-reduction commitments within their national borders. The 2015 agreement also should avoid including detailed linkage rules in the core agreement; an agreement with more flexibility would allow rules to evolve on the basis of experience.

Importantly, we also find that, to advance linkage, the 2015 agreement should:  define key terms, in particular the units that are used for compliance purposes; establish registries and tracking mechanisms; and include default or model rules, from which nations are free to deviate at their discretion.  Overall, the most valuable outcome of the Paris Agreement regarding linkage may simply be including an explicit statement that parties may transfer portions of their emissions-reduction contributions to other parties — and that these transferred units may be used by the transferees to implement their own commitments.

Looking Forward

We will release the complete research paper in November of this year, prior to the Twentieth Conference of the Parties (COP-20) of the United Nations Framework Convention on Climate Change in Lima, Peru, in December 2014, where the Harvard Project and IETA plan to conduct a side-event that will focus on this work.

When the full paper is released in November, I will provide a more complete description at this blog of our research methods and our findings.

[Additional press coverage is here, here, here, here, here, here, here, here, here, and here.]

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What are the Benefits and Costs of EPA’s Proposed CO2 Regulation?

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­On June 2nd, the Obama Administration’s Environmental Protection Agency (EPA) released its long-awaited proposed regulation to reduce carbon dioxide (CO2) emissions from existing sources in the electricity-generating sector.  The regulatory (rule) proposal calls for cutting CO2 emissions from the power sector by 30 percent below 2005 levels by 2030.  This is potentially significant, because electricity generation is responsible for about 38 percent of U.S. CO2 emissions (about 32 percent of U.S. greenhouse gas (GHG) emissions).

On June 18th, EPA published the proposed rule in the Federal Register, initiating a 120-day public comment period.  In my previous essay at this blog, I wrote about the fundamentals and the politics of this proposed rule (EPA’s Proposed Greenhouse Gas Regulation: Why are Conservatives Attacking its Market-Based Options?).  Today I take a look at the economics.

Cost-Effective, Perhaps – but Efficient?

The proposed rule grants freedom to implementing states to achieve their specified emissions-reduction targets in virtually any way they choose, including the use of market-based instruments (the White House has referenced cap-and-trade in this context, although somewhat obliquely as “market-based programs,” and state-level carbon taxes might also be acceptable – if any states were to include them in their plans to implement the regualtion).  Also, the proposal allows for multistate proposals and for states and regions to establish linkages among their state and multi-state market-based instruments.  Some questions remain regarding the temporal flexibility (banking and borrowing) that the proposed rule will allow, but it’s reasonable to conclude at this point that although EPA may not be guaranteeing cost-effectiveness, it is allowing for it, indeed facilitating it.  As Dallas Burtraw of Resources for the Future has said, the proposed rule ought to be judged to be potentially cost-effective.

Cost-effectiveness (achieving a given target at the lowest possible aggregate cost) is one thing, but economists – and possibly some other policy wonks – may wonder if the proposal is likely to be efficient (maximizing the difference between benefits and costs).  This is a much higher mountain to climb, and a particularly challenging one for a regional, national, or sub-national climate-change policy, given the global commons nature of the problem.

The Challenge of this Global Commons Problem

GHGs mix globally in the atmosphere, and so damages are spread around the world and are unaffected by the location of emissions.  This means that any jurisdiction taking action – a region, a country, a state, or a city – will incur the direct costs of its actions, but the direct benefits (averted climate change) will be distributed globally.  Hence, the direct climate benefits a jurisdiction reaps from its actions will inevitably be less than the costs it incurs, despite the fact that global climate benefits may be greater – possibly much greater – than global costs.

(An Aside:  This presents the classic free-rider problem of this ultimate global commons problem:  It is in the interest of no country to take action, but each can reap the benefits of any countries that do take action.  This is why international, if not global, cooperation is essential.  See the extensive work of the Harvard Project on Climate Agreements.)

On June 2nd, EPA released its 376-page Regulatory Impact Analysis (RIA) of the proposed “Clean Power Plan” rule, the same day it released the 645-page proposed rule itselfAn RIA is essentially a benefit-cost analysis, required for significant new Federal rules by a series of Executive Orders going back to the presidency of Jimmy Carter, and reaffirmed by every President since, including most recently President Obama.

Given the fundamental economic arithmetic of a global commons problem, it would be surprising – to say the least – if EPA were to find that the expected benefits of the proposed rule would exceed its expected costs, but this is precisely what EPA has found.  Indeed, its central estimate is of positive net benefits (benefits minus costs) of $67 billion annually in the year 2030 (employing a mid-range 3% discount rate).  How can this be?

Two Answers to the Conundrum

First, EPA does not limit its estimate of climate benefits to those received by the United States (or its citizens), but uses an estimate of global climate benefits.

Second, in addition to quantifying the benefits of climate change impacts associated with CO2 emissions reductions, EPA quantifies and includes (the much larger) benefits of human-health impacts associated with reductions in other (correlated) air pollutants.

Of course, even if benefits exceed costs at the given level of stringency of the proposed rule, it does not mean that the rule is economically efficient, because it could be the case that benefits would exceed costs by an even greater amount with a more stringent or with a less stringent rule.  However, if benefits are not greater than costs (negative net benefits), then the rule cannot possibly be efficient, so I will stick with the all-too-common Washington practice and simply ask whether the analysis indicates a winner or a loser at the proposed rule’s given level of stringency.  In other words, the question becomes, “Is the proposed rule welfare-enhancing (even if it is not welfare-maximizing)?”

Now, let’s take a look at the numbers from these two key aspects of EPA’s economic analysis and the issues surrounding the calculations.

U.S. versus Global Damages

There are surely ethical arguments (and possibly legal arguments) for employing a global damage estimate, as opposed to a U.S. damage estimate, in a benefit-cost analysis of a U.S. climate policy, but until recently all Regulatory Impact Analyses over several decades had focused exclusively on U.S. impacts.

In a recent working paper, “Determining the Proper Scope of Climate Change Benefits,” Ted Gayer, Vice President and Director of Economic Studies at the Brookings Institution, and Kip Viscusi, University Distinguished Professor of Law, Economics, and Management at Vanderbilt University, review the history of RIAs, including their virtually exclusive focus on national impacts (defined by geography or U.S. citizenship) in benefit and cost estimates of regulations.

In the context of a conventional RIA, it does seem strange – at least at first blush – to use a global measure of benefits of a U.S. regulation.  If this practice were applied in a consistent manner – that is, uniformly in all RIAs – it would result in some quite bizarre findings.  For example, a Federal labor policy that increases U.S. employment while cutting employment in competitor economies might be judged to have zero benefits!

Another example, this one courtesy of Tim Taylor via Ted Gayer:  Under global accounting, if a domestic climate policy had the unintended consequence of causing emissions and economic leakage (through relocation of some manufacturing to other countries), that would not be considered a cost of the regulation (and with diminishing marginal utility of income, it might be counted as a benefit)!

On the other hand, a counter-argument to this line of thinking is that the usual narrow U.S.-only geographic scope of an RIA is simply not appropriate for a global commons problem.  Otherwise, we would simply restate in economic terms the free-rider consequences of a global commons challenge.  In other words, a domestic-only RIA of a climate policy could have the effect of “institutionalizing free riding,” to quote my Harvard Kennedy School colleague, Professor Joseph Aldy.  Of course, if global benefits are to be included in a regulatory assessment, it can be argued that global costs (such as leakage) should also be considered.

I leave it to legal scholars and lawyers to debate the law, and I defer to the philosophers among us to debate the ethics, but let’s at least ask what the consequences would be for EPA’s analysis if a U.S climate benefits number were used, rather than a global number.  For this purpose, we can start with EPA’s estimates (from Table ES-7 on page ES-19 and Table ES-10 on page ES-23 of its Regulatory Impact Analysis of the proposed rule) for 2030 benefits and costs, using a mid-range 3% real discount rate.  The estimated (global) climate benefits of the rule are $31 billion.

In order to think about what the domestic climate benefits might be, we can turn to the Obama administration’s original calculation of the Social Cost of Carbon in 2010, where the Interagency Working Group estimated a central global value for 2010 of $19 per ton of CO2, and noted (and explained in more detail in a subsequent scholarly paper by several members of the Working Group) that U.S. benefits from reducing GHG emissions would be, on average, about 7 to 10 percent of global benefits across the scenarios analyzed with the one model that permitted such geographic disaggregation.

(The Interagency Working Group also suggested that if climate damages are simply proportional to GDP, then the U.S. share would be about 23%.  However, given the IPCC’s prediction of highly unequal geographic distribution of climate change effects worldwide, combined with the exceptionally heterogeneous nature of climate sensitivity among the world’s economies, which vary from those with trivial reliance on agriculture to those dominated by their agricultural sectors, I find the argument behind this second approach unconvincing.)

Taking the midpoint of the Obama Working Group’s 7-10% range, U.S. damages (benefits) may be estimated to be 8.5% of global damages, which would reduce the $31 billion reported in the new RIA to about $2.6 billion, which is considerably less than the RIA’s estimated total annual compliance costs of $8.8 billion (assuming that the states facilitate cost-effective actions).  This validates the intuition, explained above, that for virtually any jurisdiction, the direct climate benefits it reaps from its actions will be less than the costs it incurs (again, despite the fact that global climate benefits may be much greater than global costs).

There are plenty of caveats on both sides of this simple analysis.  One of the most important is that if the proposed U.S. policy were to increase the probability of other countries taking climate policy actions (which I believe is probably the case), then the impacts on U.S. territory of such foreign policy actions would merit inclusion even in a traditional U.S.-only benefit-cost analysis.  More broadly, although it has been traditional to use a U.S.-only benefits measure in RIAs, the current guidelines for carrying out these analyses from the Office of Information and Regulatory Affairs of the U.S. Office of Management and Budget (Circular A-4) requires that geographic U.S. benefit and cost estimates be provided, but also allows for the optional inclusion of global estimates.

Pending resolution (or more likely, discussion and debate) from lawyers and philosophers regarding the legal and ethical issue of employing domestic benefits versus global benefits in a climate regulation RIA, it is essential to recognize that there is an even more important factor that explains how EPA came up with estimates of significant positive net benefits (benefits exceeding costs) for the proposed rule (and would have even if a domestic climate benefits number had been employed), namely, the inclusion of (domestic) health impacts of other air pollutants, the emissions of which are correlated with those of CO2.

Correlated Pollutants and Co-Benefits

The Obama Administration’s proposed regulation to reduce CO2 emissions from the electric power sector is intended to achieve its objectives through a combination of less electricity generated (compared with a business-as-usual trajectory), greater dispatch of electricity from less CO2-intensive sources (natural gas, nuclear, and renewable sources, instead of coal), and more investment in low CO2-intensive sources.  Hence, it is anticipated that less coal will be burned than in the absence of the regulation (and more use of natural gas, nuclear, and renewable sources of electricity).  This means not only less CO2 being emitted into the atmosphere, but also decreased emissions of correlated local air pollutants that have direct impacts on human health, including sulfur dioxide (SO2), nitrogen oxides (NOx), particulate matter (PM), and mercury (Hg).

It is well known that higher concentrations of these pollutants in the ambient air we breathe – particularly smaller particles of particulate matter (PM2.5) – have very significant human health impacts in terms of increased risk of both morbidity and mortality.  The numbers dwarf the climate impacts themselves.  Whereas the U.S. climate change impacts of CO2 reductions due to the proposed rule in 2030 are probably less than $3 billion per year (see above), the health impacts (co-benefits) of reduced concentrations of correlated (non-CO2) air pollutants are estimated by EPA to be some $45 billion/year (central estimate)!  (By the way, I assume that the co-benefits estimated by EPA are based upon a comparison with a business-as-usual baseline that includes the effects of all existing EPA and state regulations for these same local air pollutants.  If not, the RIA will need to be revised.)

The Bottom Line

The combined U.S.-only estimates of annual climate impacts of CO2 ($3 billion) and health impacts of correlated pollutants ($45 billion) greatly exceed the estimated regulatory compliance costs of $9 billion/year, for positive net benefits amounting to $39 billion/year in 2030.  This is the key argument related to the possible economic efficiency of the proposed rule from the perspective of U.S. welfare.  If EPA’s global estimate of climate benefits ($31 billion/year) is employed instead, then, of course, the rule looks even better, with total annual benefits of $76 billion, leading to EPA’s bottom-line estimate of positive net benefits of $67 billion per year.  See the summary table below.

The Obama Administration’s proposed regulation of existing power-sector sources of CO2 has the potential to be cost-effective, and if you accept these numbers, it can also be welfare-enhancing, if not welfare-maximizing.

That said, I assume that proponents of the Obama Administration’s proposed rule will take this assessment of EPA’s Regulatory Impact Analysis as evidence of the sensibility of the rule, and opponents of the Administration’s proposed actions will claim that my assessment of the RIA provides evidence of the foolishness of EPA’s proposal.  So it is in our pluralistic system (not to mention, in the context of the political polarization that has gripped Washington on this and so many other issues).

————————————————————————————————————————–

Benefits and Costs of EPA’s Proposed Clean Power Plan Rule in 2030

(Mid-Point Estimates, Billions of Dollars)

Climate Change Impacts

Health Impacts (Co-Benefits) of Correlated Pollutants plus …

Domestic

Global

Domestic Climate Impacts

Global Climate Impacts

Benefits
  Climate Change

$ 3

$ 31

$3

$31

  Health Co-Benefits

$45

$45

Total Benefits

$ 3

$ 31

$48

$76

Total Compliance Costs

$ 9

$ 9

$ 9

$ 9

Net Benefits (Benefits – Costs)

- $ 6

$ 22

$ 39

$ 67

————————————————————————————————————————–

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EPA’s Proposed Greenhouse Gas Regulation: Why are Conservatives Attacking its Market-Based Options?

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This week, the Obama Administration’s Environmental Protection Agency (EPA) released its long-awaited proposed regulation to reduce carbon dioxide (CO2) emissions from existing sources in the electricity-generating sector.  The regulatory (rule) proposal calls for cutting CO2 emissions from the power sector by 30 percent below 2005 levels by 2030.

The Fundamentals in Brief

Through a carefully designed formula, EPA’s proposal lists specific targets for each state, under Section 111(d) of the Clean Air Act. States are given broad flexibility for how to meet their targets, including:  increasing the efficiency of fossil-fuel power plants; switching electricity dispatch from coal-fired generating plants to natural gas-fired generating plants; developing new low-emissions generation, such as new natural gas combined cycle plants, more renewable sources (wind and solar), nuclear, or coal with carbon capture and storage; and more efficient end-use of electricity.

States are also given flexibility to employ (in their implementation plans to be submitted to EPA) any of a wide variety of policy instruments, including but by no means limited to market-based trading systems.  Furthermore, states can work together to submit multi-state plans.

The proposed regulation will be finalized after receipt of comments one year from now (June 30, 2015).  Then states will have until July 2016 to submit their plans, and can request one-year extensions (or two-year extensions for multi-state plans). Compliance commences in 2020.

A Big-Picture Assessment of the Proposed Rule

Let’s start by acknowledging that the proposed policy will be less effective environmentally and less cost-effective economically than the economy-wide approach the Administration previously tried with the Waxman-Markey bill, which passed the U.S. House of Representatives in 2009, but failed to receive a vote in the U.S. Senate.  Electricity generation is responsible for about 38 percent of U.S. CO2 emissions, and about 32 percent of U.S. greenhouse gas (GHG) emissions.

Given ongoing political polarization in Washington and the inability of Congress to approve that more comprehensive and more cost-effective approach, this is probably the best the administration could do.  Together with the motor-vehicle fuel efficiency and appliance energy efficiency standards previously put in place, this is certainly a step in the right direction.

More broadly, the importance of these U.S. moves in the international context should not be underestimated.  Although the United States accounts for only about 17% of global CO2 emissions (second to China’s 26% in 2010), these steps by the U.S. government can help international efforts to bring the large emerging economies (China, India, Brazil, Korea, South Africa, and Mexico) on board for a future (Paris, 2015) agreement under the Durban Platform for Enhanced Action.

Domestically, EPA’s proposed state-by-state approach does not guarantee cost-effectiveness, because under the formula employed, marginal abatement costs will initially vary across states.  However, freedom is given to the states to employ market-based instruments, in particular, cap-and-trade systems (with carbon taxes presumably also an option).  And EPA has emphasized its willingness to consider multi-state implementation plans (think, for example, of the existing Regional Greenhouse Gas Initiative – RGGI – the cap-and-trade system operating in nine northeast states; and the likelihood of a future linked policy bringing together California’s AB-32 cap-and-trade system with policies in Oregon and Washington).

The ability of states to develop under EPA’s rule such linked systems of market-based instruments, as well as the freedom for states and regions to subsequently establish linkages means that although EPA may not be guaranteeing cost-effectiveness, it is certainly allowing for it, indeed it is facilitating it.

Response from Environmental Advocacy Groups and Industry

Much of the response this week has not been surprising.  The major environmental advocacy groups have been supportive of the proposed rule, despite the fact that they would prefer even greater ambition.  Many in industry have also offered praise for the approach, particularly because of the flexibility that EPA has given for the means of achieving emissions reductions.  In fact, some electricity-sector executives have been supportive, precisely for this reason, and appear to be encouraging the adoption of cap-and-trade systems.  At a minimum, leading electric utilities, including some that are fossil-heavy, such as FirstEnergy Corporation and American Electric Power, Inc., have taken a “wait-and-see” attitude, rather than attacking the proposal.

Also not surprising has been strong opposition from the coal industry, as well as some prominent industry trade associations, including the U.S. Chamber of Commerce.  Once the rule has become final (about a year from now), lawsuits will surely be filed by some of these private industry opponents and by a number of resistant states.

I will leave it to the lawyers to comment on the likely grounds of those anticipated lawsuits, as well as their probabilities of success.  But, clearly, for the plan to succeed it will need to survive those legal challenges, which will work their way through the courts over several years.

Also, a significant change in the senate majority and in the party holding power after the next presidential election could result in progress being slowed to a crawl, if not the abandonment of the approach proposed by the current administration.

None of that is particularly surprising, but what should be surprising is the fact that conservative attacks on EPA’s proposed rule have focused, indeed fixated, on one of the options that is given to the states for implementation, namely the use of market-based instruments, that is, cap-and-trade systems.  Given the demonization of cap-and-trade as “cap-and-tax” over the past few years by conservatives, why do I say that this fixation should be surprising?

The Irony of Conservatives Targeting Cap-and-Trade

Not so long ago, cap-and-trade mechanisms for environmental protection were popular in Congress. Now, such mechanisms are denigrated. What happened?  Professor Richard Schmalensee (MIT) and I recently told the sordid tale of how conservatives in Congress who once supported cap and trade had come to lambast climate change legislation as “cap-and-tax.” Ironically, in doing this, conservatives have chosen to demonize their own market-based creation.

In the late 1980s, there was growing concern that acid precipitation – the result of SO2 and, to a lesser extent, nitrogen oxides (NOx) reacting in the atmosphere to form sulphuric and nitric acids – was damaging forests and aquatic ecosystems, particularly in the northeast U.S. and southern Canada. In response, the U.S. Congress passed (and President George H.W. Bush signed into law) the Clean Air Act Amendments of 1990. Title IV of this law established the SO2 allowance-trading system.

By the close of the 20th century, the SO2 allowance-trading system had come to be seen as both innovative and successful.  However, the successful enactment and implementation of the SO2 cap-and-trade system in 1990 combined with the subsequent Congressional defeat of CO2 cap-and-trade legislation 20 years later has produced a striking irony. Market-based, cost-effective policy innovation in environmental regulation – in particular, cap-and-trade – was originally championed and implemented by Republican administrations from that of President Ronald Reagan to that of President George W. Bush.  But in recent years, Republicans have led the way in demonizing cap-and-trade, particularly as an approach to limiting carbon emissions.

For a long time, market-based approaches to environmental protection, such as cap-and-trade, bore a Republican label.  In the 1980s, President Ronald Reagan’s EPA put in place a trading program to phase out leaded gasoline. It produced a more rapid elimination of leaded gasoline from the marketplace than had been anticipated, and at a saving of some $250 million per year, compared with a conventional no-trade, command-and-control approach. Not only did President George H.W. Bush successfully propose the use of cap-and-trade to cut SO2 emissions, his administration advocated in international forums the use of emissions trading to cut global CO2 emissions (a proposal initially resisted but ultimately adopted by the European Union). In 2005, President George W. Bush’s EPA issued the Clean Air Interstate Rule, aimed at reducing SO2 emissions by a further 70% from their 2003 level. Cap-and-trade was again the policy instrument of choice.

From Bi-Partisan Support to Ideological Polarization

When the Clean Air Act Amendments were being considered in the Congress in 1989-1990, political support was not divided on partisan lines. Indeed, environmental and energy debates from the 1970s through much of the 1990s typically broke along geographic lines, rather than partisan lines, with key parameters being degree of urbanization and reliance on specific fuel types. Thus, the Clean Air Act Amendments of 1990 passed the Senate by a vote of 89-11 with 87% of Republican members and 91% of Democrats voting yea, and passed the House of Representatives by a vote of 401-21 with 87% of Republicans and 96% of Democrats voting in support.

But twenty years later, when climate change legislation was receiving serious consideration in Washington, environmental politics had changed dramatically, with Congressional support for environmental legislation coming mainly to reflect partisan divisions. In 2009, the House of Representatives passed the American Clean Energy and Security Act of 2009 (H.R. 2454) – the Waxman-Markey bill – that included an economy-wide cap-and-trade system to cut CO2 emissions. The Waxman-Markey bill passed the House by a narrow margin of 219-212, with support from 83% of Democrats, but only 4% of Republicans. In July 2010, the Senate abandoned its attempt to pass companion legislation. In the process of debating this legislation, conservatives (largely Republicans and some coal-state Democrats) attacked the cap-and-trade system as “cap-and-tax,” much as an earlier generation of liberals had denigrated cap-and-trade as “selling licenses to pollute.”

It may be that some conservatives in Congress opposed climate policies because of disagreement about the threat of climate change or the costs of the policies, but instead of debating those risks and costs, they chose to launch an ultimately successful campaign to demonize and thereby tarnish cap-and-trade as an instrument of public policy, rendering it “collateral damage” in the wider climate policy battle.

Today that “scorched-earth” approach may have come back to haunt conservatives.  Have they now boxed themselves into a corner, unable to support the power of the marketplace to reduce their own states’ compliance costs under the new EPA CO2 regulation?  I hope not, but only time will tell.

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Understanding the IPCC: An Important Follow-Up

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A week ago, I wrote at this blog about my recent frustrations with the government approval process of one part of the Summary for Policymakers (SPM) of the Intergovernmental Panel on Climate Change (IPCC) Fifth Assessment Report (AR5) Working Group III (WG3) report, namely the section in the Summary for Policymakers (SPM.5.2) on “International Cooperation,” for which I had major responsibility.

In that post, I described how the government approval process, which took place in Berlin in early April, had led to the deletion of a significant fraction of the text of SPM.5.2, not because governments questioned its scientific validity, but because they found various passages to be inconsistent with their respective positions and national interests within the ongoing international climate change negotiations under the United Nations Framework Convention on Climate Change (UNFCCC).  (That post took the form of a letter to the co-chairs of WG3 – Ottmar Edenhofer, Ramon Pichs-Madruga, and Youba Sokona.  They have since sent a thoughtful response and agreed for me to provide a link to their letter here.)

Why a Follow-Up Post?

My first post has been widely reported in the press.  Some of this coverage was accurate and reasonable.  Pilita Clark of the Financial Times, in particular, wrote an excellent article that accurately presented my views and conveyed some additional useful insights.  Other press coverage, however, inaccurately stated or suggested that my critique of the IPCC process was much broader than it was.  This was despite my very careful caveats in the first blog post, in which I tried hard to communicate clearly the limited focus of my critique, namely the effects of the government approval process on one section (SPM.5.2) of the Summary for Policymakers.

Some in the more fringe elements of the press and blogosphere quickly capitalized on the situation by distorting the message of my original post to meet their own objectives – by stating or implying that I found fault with the overall IPCC process and reports themselves, that I have positioned myself as an opponent of the important work of the IPCC, and/or that I am a skeptic of the science of climate change!  Because of these over-the-top distortions, I am writing this second post to place my original critique in the context of the overall IPCC process and of the IPCC’s recent Fifth Assessment Report.

Understanding the IPCC Process and Reports

The central purpose of the IPCC Assessment Reports is to survey and synthesize the best published research on climate change, including its causes, consequences, and potential mitigation.  Each of the last several reports has therefore consisted of three volumes, prepared by separate scientific working groups, which address respectively:  (1) research from the natural sciences on climate change itself — whether, how, and to what extent it is happening; (2) the impacts of climate change on natural systems and on human society — and how society might adapt to climate change; and (3) approaches to the mitigation of climate change, including, importantly, policy options for reducing greenhouse-gas emissions.  The chapter of which I was a Co-Coordinating Lead Author, “International Cooperation:  Agreements and Instruments,” fell into this third volume. (See my previous post for further details.)

Hundreds of the world’s leading scientists conducting research on the various topics addressed by the IPCC’s Assessment Reports spend countless un-compensated hours over several years preparing the reports, motivated only by a commitment to scientific rigor and the desire to better understand climate change and its implications.  A core principle of the IPCC process is that the reports should be “policy-relevant but not policy-prescriptive” and should synthesize the peer-reviewed literature as objectively as possible.

The IPCC’s three-volume reports — including the recent Fifth Assessment Report — largely succeed in accurately and objectively synthesizing the best scientific research. The reports are, as a result, absolutely essential resources for both understanding climate change and formulating responses to it.

In addition to being divided into three volumes along substantive lines, the recent Fifth Assessment Report is presented in three different “packages”:  (1) the full volumes, each of which consist of multiple chapters totaling about 2,000 pages; (2) the Technical Summaries (TS), which condense the full volumes into documents of less than 100 pages each; and (3) the Summary for Policymakers (SPM), which at one-third the length of the TS, was the focus of my previous blog post.

I emphasized in that post that none of the deletions and revisions I described regarding the section on international cooperation in the 33-page SPM had any effects whatsoever on the key, foundational products of five years of work on AR5 WG3:  the Technical Summary (three times the length of the Summary for Policymakers, but no more “technical” than the SPM), and – most important – the 2,000 pages of the 15 underlying chapters, including Chapter 13, “International Cooperation:  Agreements and Instruments” (with 79 pages of text, and 57 pages of references).  Only the SPM is subject to the (line-by-line) government approval process.

Furthermore, even the severe cuts to the section on international cooperation in the SPM – the focus of my concerns – should be understood in context.  The governments never added text to the section; rather they deleted text, because in the line-by-line approval process they could not agree among each other.  As I explained in my previous post, the government representatives were doing their job – looking out for the interests of their respective countries.  Any text that was considered inconsistent with their countries’ interests and positions in multilateral negotiations was treated as unacceptable.

Overall, my serious concerns about the effects of the government approval process on one section of the SPM should be considered in the much larger context of what is an exceptionally valuable scientific resource for those concerned with climate change.

A Word on the Government Approval Process

Notwithstanding the problems and challenges of the government approval process, which I highlighted in my previous post, it is important to note the merits of the process, as well, because there are some distinct advantages of the IPCC being an intergovernmental organization and having some aspect of the Assessment Reports requiring government approval (namely, the SPM).

First, as I emphasized in my previous post, government approval has brought political credibility to the IPCC that it would probably not otherwise enjoy.  Second, this process forces member governments to pay attention to the reports, and agree that a substantial body of research on climate change is valid (which would not be the case with a non-governmental organization). It is hardly trivial that the world’s governments have formally (and unanimously) agreed — through the IPCC process — that climate change is real, caused by human activity, and poses significant threats.

My Bottom Line

In the short term, I am continuing to work within the IPCC, as I currently serve as a lead author of the AR5 Synthesis Report, which brings together the essence of the reports of Working Groups 1, 2, and 3.  That work will be completed in October of this year.

In addition, I hope to work constructively with my colleagues within the IPCC, its member governments, and others to address our shared concerns about the SPM approval process — particularly with regard to policy-relevant material in the third (Working Group III) volume of the assessment reports, and most especially in regard to text on international cooperation, which is so intimately connected with the UN climate negotiations in which those same governments are deeply involved.

I conclude this post with the final paragraph of my previous one, which featured my letter to the IPCC WG3 leadership:  “The mission of the IPCC is important, and the scientific work carried out by the hundreds of lead authors of AR5 Working Group 3 was solid and important, as validated by the Technical Summary and the underlying chapters.  I hope this letter can be constructive and helpful for the future work of the IPCC.”

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Is the IPCC Government Approval Process Broken?

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Over the past 5 years, I have dedicated an immense amount of time and effort to serving as the Co-Coordinating Lead Author (CLA) of Chapter 13, “International Cooperation:  Agreements and Instruments,” of Working Group III (Mitigation) of the Fifth Assessment Report (AR5) of the Intergovernmental Panel on Climate Change (IPCC).  It has been an intense and exceptionally time-consuming process, which recently culminated in a grueling week spent in Berlin, Germany, April 5-13, 2014, at the government approval sessions, in which some 195 country delegations discussed, revised, and ultimately approved (line-by-line) the “Summary for Policymakers” (SPM), which condenses more than 2,000 pages of text from 15 chapters into an SPM document of 33 pages.  Several of the CLAs present with me in Berlin commented that given the nature and outcome of the week, the resulting document should probably be called the Summary by Policymakers, rather than the Summary for Policymakers.

Before returning to the topic of today’s blog entry — the SPM process and outcome — I want to emphasize that the IPCC’s Working Group III “Technical Summary” and the underlying Working Group III report of 15 chapters were completely untouched by the government approval process of the Summary for Policymakers.   So, the crucial IPCC products – the Technical Summary and the 15 chapters of WG 3 – retain their full scientific integrity, and they merit serious public attention.  Now, back to the SPM process and outcome …

The process of the government approval sessions was exceptionally frustrating, and the outcome of that process – the final SPM – was in some regards disappointing.  Two weeks ago, immediately after returning from Berlin, I sent a letter to the Co-Chairs of Working Group III — Ottmar Edenhofer, Ramon Pichs-Madruga, and Youba Sokona — expressing my disappointment with the government approval process and its outcome in regard to the part of the assessment for which I had primary responsibility, SPM.5.2, International Cooperation.  At the time, I did not release my letter publically, because I did not want to get in the way of the important messages that remained in the SPM and were receiving public attention through the Working Group III release.

With two weeks having passed, it is now unlikely that the broader release of my letter will obscure the news surrounding the Working Group III release, and – importantly — it could be constructive to the process going forward, as the IPCC leadership and others think about the path ahead for future climate assessments.  Rather than summarizing or annotating my letter, I believe it makes most sense simply to reproduce it, and let it stand – or fall – as originally written.  It follows below.

==================================================================

From: Stavins, Robert
Sent: Thursday, April 17, 2014 4:06 PM

TO: Ottmar Edenhofer, Co-Chair, Working Group III, AR5, IPCC

        Ramon Pichs-Madruga, Co-Chair, Working Group III, AR5, IPCC

        Youba Sokona, Co-Chair, Working Group III, AR5, IPCC

 CC:  Rajendra Pachauri, Chairman, IPCC

          Jan Minx, Head of Technical Support Unit, Working Group III

 FROM:   Robert Stavins

 SUBJECT:     Thoughts on the Government Approval Process for SPM.5.2 (International Cooperation) of the Summary for Policymakers of Working Group 3, Fifth Assessment Report, Intergovernmental Panel on Climate Change

Dear Ottmar, Ramon, and Youba:

I am writing to you today to express my disappointment and frustration with the process and outcome of the government approval meetings in Berlin this past week, at which the assembled representatives from the world’s governments, considered and, in effect, fundamentally revised or rejected parts of the Summary for Policymakers (SPM) of IPCC Working Group 3 over a period of five long days (and nights).  My focus in this letter is exclusively on one section of the SPM, namely SPM.5.2, International Cooperation.  I am not representing nor referring to any other parts of the SPM.

Also, none of what I have to say should be taken as reflecting negatively on you (the Co-Chairs of Working Group 3), the WG 3 Technical Support Unit (TSU), nor the overall leadership of the IPCC.  On the contrary, I thought that all of you did a remarkable job over the five years of work on AR5, as well as during the week in Berlin.  The problems about which I’m writing arose despite, not because of your excellent leadership and support.

More broadly, the problems I identify in this letter are not a consequence of personal failings of any of the individuals involved.  My intent is not to criticize the country representatives, the IPCC leadership, the TSU, the Lead Authors, or the Coordinating Lead Authors.  The problems I seek to identify are structural, not personal.

Further, as Co-Coordinating Lead Author (CLA) of Chapter 13 (International Cooperation:  Agreements and Instruments) of the underlying report, I had primary responsibility – together with my Co-Coordinating Lead Author, Dr. Zou Ji – for drafting the text for Section SPM.5.2 (International Cooperation) of the SPM, and nothing in this letter should implicate Zou Ji, for whom I have great respect and with whom I have enjoyed working.  He may or may not share any of the views I express below.

Another caveat is that none of the problems I describe in this letter apply to either the Technical Summary nor the underlying Chapter 13.  Indeed, because of the problems with Section SPM.5.2 on international cooperation in the SPM, it is important that interested parties refer instead to the Technical Summary, or better yet, the original Chapter 13.

In this letter, I will not comment on the government review and revision process that affected other parts of the SPM, other than to note that as the week progressed, I was surprised by the degree to which governments felt free to recommend and sometimes insist on detailed changes to the SPM text on purely political, as opposed to scientific bases.

The general motivations for government revisions – from most (but not all) participating delegations – appeared to be quite clear in the plenary sessions. These motivations were made explicit in the “contact groups,” which met behind closed doors in small groups with the lead authors on particularly challenging sections of the SPM. In these contact groups, government representatives worked to suppress text that might jeopardize their negotiating stances in international negotiations under the United Nations Framework Convention on Climate Change (UNFCCC).

I fully understand that the government representatives were seeking to meet their own responsibilities toward their respective governments by upholding their countries’ interests, but in some cases this turned out to be problematic for the scientific integrity of the IPCC Summary for Policymakers.  Such involvement — and sometimes interference — with the scientific process of the IPCC was particularly severe in section SPM.5.2 on international cooperation.  It is to that section of the SPM that I now turn.

In the early morning of Monday, April 7, 2014, a draft of SPM.5.2 was completed and approved by the assembled team of CLAs in Berlin.  The draft, a copy of which is attached as Item A, had been extensively revised over the preceding months in response to comments received from governments around the world (to whom multiple drafts had been sent as part of the normal IPCC process). The draft in Item A was sent to governments on April 7th through the IPCC’s PaperSmart system.

The plenary session of government representatives turned their attention to SPM.5.2 at approximately 10:00 pm on Friday, April 11th.  When it became clear that the country delegates were unwilling to move forward with the consideration of the text in plenary, you established a contact group to work on acceptable text.  You gave the group 2 hours to come up with acceptable text.  That group began its work at approximately 11:00 pm (and continued past 1:00 am on Saturday, April 12th).

The contact group included representatives from of a diverse set of countries, ranging from small to large, and from poor to rich.  Hence, I do not believe that the responsibility for the problems that arose are attributable to any specific country or even set of countries.  On the contrary, nearly all delegates in the meeting demonstrated the same perspective and approach, namely that any text that was considered inconsistent with their interests and positions in multilateral negotiations was treated as unacceptable.  In fact, several (perhaps the majority) of the country representatives in the SPM.5.2 contact group identified themselves as negotiators in the UNFCCC negotiations.  To ask these experienced UNFCCC negotiators to approve text that critically assessed the scholarly literature on which they themselves are the interested parties, created an irreconcilable conflict of interest.  Thus, the country representatives were placed in an awkward and problematic position by the nature of the process.

Over the course of the two hours of the contact group deliberations, it became clear that the only way the assembled government representatives would approve text for SPM.5.2 was essentially to remove all “controversial” text (that is, text that was uncomfortable for any one individual government), which meant deleting almost 75% of the text, including nearly all explications and examples under the bolded headings. In more than one instance, specific examples or sentences were removed at the will of only one or two countries, because under IPCC rules, the dissent of one country is sufficient to grind the entire approval process to a halt unless and until that country can be appeased.

I understand that country representatives were only doing their job, so I do not implicate them personally; however, the process the IPCC followed resulted in a process that built political credibility by sacrificing scientific integrity.  The final version of SPM.5.2, as agreed to by the contact group, and subsequently approved in plenary (at approximately 3:00 am, April 12th), is attached to this letter as Item B.

No institution can be all things for all people, and this includes the IPCC.  In particular, in the case of the IPCC’s review of research findings on international cooperation, there may be an inescapable conflict between scientific integrity and political credibility.  If the IPCC is to continue to survey scholarship on international cooperation in future assessment reports, it should not put country representatives in the uncomfortable and fundamentally untenable position of reviewing text in order to give it their unanimous approval.  Likewise, the IPCC should not ask lead authors to volunteer enormous amounts of their time over multi-year periods to carry out work that will inevitably be rejected by governments in the Summary for Policymakers.

I hope I have made it clear that my purpose is not to condemn the country representatives, the IPCC leadership, the TSU, the Lead Authors, or the Coordinating Lead Authors.  The problem is structural, not personal.  In my view, with the current structure and norms, it will be exceptionally difficult, if not impossible, to produce a scientifically sound and complete version of text for the SPM on international cooperation that can survive the country approval process.

More broadly, I urge the IPCC to direct public attention to the documents produced by the lead authors that were subject to government (and expert) comment, but not subject to government approval. I believe that tremendous public good would arise from publicizing the key findings of the Technical Summary and the individual chapter Executive Summaries, instead of the Summary for Policymakers.  I know that as the leaders of the IPCC, you see it to be your responsibility to convey to the public (and policy makers) the results of the hard scientific work that the hundreds of lead authors put into the report over the past five years, and not simply the constrained version of the Summary for Policymakers produced over the past week.

The mission of the IPCC is important, and the scientific work carried out by the hundreds of lead authors of AR5 Working Group 3 was solid and important, as validated by the Technical Summary and the underlying chapters.  I hope this letter can be constructive and helpful for the future work of the IPCC.

Best wishes,

Rob

Robert N. Stavins, Albert Pratt Professor of Business & Government, John F. Kennedy School of Government, Harvard University
Director, Harvard Environmental Economics Program
Director of Graduate Studies, Ph.D. Programs in Public Policy and Political Economy & Government
Co-Chair, Harvard Business School-Kennedy School Joint Degree Programs
Director, Harvard Project on Climate Agreements
Blog: An Economic View of the Environment          SSRN Paper Downloads
Mail: John F. Kennedy School of Government, Harvard University, 79 JFK St., Room L-306, Box 11, Cambridge, MA 02138
Phone: 617-495-1820   E-Mail: robert_stavins@harvard.edu
University Fellow, Resources for the Future Research Associate, National Bureau of Economic Research

 

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Can There Be a Positive Prognosis for Climate Negotiations?

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I’m writing this brief essay on board my flight to the USA from Europe (where I participated in a workshop at the Center for European Economic Research (ZEW) in Mannheim, Germany).  It was an interesting event, the substance of which (the “energy-efficiency paradox”) I will write about in the future, but today’s post is stimulated by a news article I read on board my flight, titled, “U.S. and China May Find Agreements Outside Stymied Climate Talks.”

Bad News from Bonn

In Bonn this past week, international negotiations continued under the United Nations Framework Convention on Climate Change (UNFCCC).  The two most important countries in terms of greenhouse gas (GHG) emissions – China and the United States – apparently engaged in a war of words on the fundamental question of who should do what.  In particular, these two giants – and their respective allies in the developed and developing worlds – bickered over their very different interpretations of the Durban Platform for Enhanced Action’s call for an agreement to be reached in Paris in 2015 that is “applicable to all Parties” (countries).

The United States and other industrialized countries have insisted that this calls for an agreement with emissions reduction pledges by all countries (in particular, by the industrialized countries plus the large emerging economies of China, India, Brazil, Korea, Mexico, and South Africa).  But China, India, and most countries in the developing world have maintained that because the Durban Platform was adopted under the auspices of the UNFCCC, it calls only for emission reduction commitments by the industrialized countries.  In previous essays at this blog, I’ve written about the potential promise that the Durban Platform can offer for a departure from the paralysis that has characterized the past 15 years under the Kyoto Protocol with its dichotomous distinction between emissions-reductions commitments for industrialized (Annex I) countries and no such commitments for other nations.  But it is difficult to claim that the rhetoric in Bonn has been encouraging in that regard.

Better News from Beijing and Washington

At the same time, U.S. government officials back in Washington were quoted in the news article I read on board my flight as saying that bilateral negotiations with China – possibly outside of the UNFCCC – are where real progress is most likely to be made.  This caught my eye, because it may be the major – and perhaps only — cause for (cautious) optimism regarding the path ahead.  I wrote about this reality shortly after the UNFCCC negotiations concluded in Warsaw, Poland, in November, 2013, and recent developments merit returning to it today.  My premise is what I perceive to be the potential emerging convergence of interests between these two most important countries in the world when it comes to climate change and international policy to address it – China and the United States.  Five factors stand out:  emissions, historical responsibility, fuel sources, policy approaches, and geopolitics.

Emissions

First, the annual carbon dioxide (CO2) and greenhouse gas (GHG) emissions of these two countries have already converged. Whereas U.S. CO2 emissions in 1990 were almost twice the level of Chinese emissions, by 2006 China had overtaken the United States.  We are the world’s two largest emitters.

Historical Responsibility

Second, cumulative emissions are particularly important, because it is the accumulated stock of GHGs in the atmosphere that cause climate change.  Any discussion of distributional equity in the climate realm therefore inevitably turns to considerations of historic responsibility.  Looking at the period 1850-2010, the United States led the pack, accounting for nearly 19% of cumulative global emissions of GHGs, with the European Union in second place with 17%, and China third, accounting for about 12% of global cumulative emissions.  But that picture is rapidly changing, because emissions are flat to declining throughout the industrialized world, but increasingly rapidly in the large emerging economies, in particular, China.  Depending upon the relative rates of economic growth of China and the United States, as well as other factors, China may top all countries in cumulative emissions within 10 to 20 years.

Fuel Sources

Third, China and the United States both have historically high reliance on coal for generating electricity.  At a time at which U.S. dependence on coal is decreasing (due to increased supplies of unconventional natural gas and hence lower gas prices ), China continues to rely on coal, but is very concerned about this, partly because of localized health impacts of particulates and other pollutants.  Importantly, both countries have very large shale gas reserves.  U.S. output (and use for electricity generation) has been increasing rapidly, bringing down CO2 emissions, whereas Chinese exploitation and output have been constrained by available infrastructure (that is, lack of pipelines, but that will change).

Policy Approaches

Fourth, in both countries, sub-national market-based climate policies – in particular, cap-and-trade systems – are moving forward.  In the case of the China, seven pilot CO2 cap-and-trade regimes at the local level are under development, while in the United States, California’s ambitious AB-32 cap-and-trade system continues to make progress, and in the northeast, the Regional Greenhouse Gas Initiative (RGGI) is witnessing higher allowance auction prices due to the more severe targets the RGGI states recently adopted.

Geopolitics

Fifth and finally, there is the reality of global geopolitics.  If the twentieth century was the American Century, then many observers, including leaders in China, anticipate (or at least hope) that the twenty-first century will be the Chinese Century.  In this regard, I’m reminded that I was quoted by David Jolly in the New York Times, as saying, “If it’s your century, you don’t obstruct, you lead.”

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Will Europe Scrap its Renewables Target? That Would Be Good News for the Economy and for the Environment

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The European Union is considering scrapping the use of binding renewable energy targets as part of its global climate change policy mix that will extend action from 2020 to 2030.  The Financial Times reported that this move – presumably due to concerns over high European energy costs during the ongoing economic turndown – will “please big utility companies but infuriate environmental groups.”  The International New York Times framed the story in similar ways.

The press coverage has missed the very important reality that this potential decision by the European Commission will be good news both for the economy and for the environment.  The fundamental reason is that in the presence of the European Union’s Emissions Trading Scheme (EU ETS) – its pioneering, regional cap-and-trade system that covers electricity generators and large-scale manufacturing – the “complementary” renewables mandate conflicts with, rather than complements other policies.  Without the renewables mandate, the cap being planned for the EU ETS will be achieved at lower cost and will foster greater incentives for climate-friendly technological change.

Some Background

In 2007, the European Union established three sets of targets and related policies:  (1) a 20% reduction in greenhouse gas (GHG) emissions below 1990 by 2020, to be achieved by the cap-and-trade system; (2) a 20% target for 2020 for the share of Europe’s electricity consumption coming from renewable resources; and (3) a 20% improvement in energy efficiency by 2020.  These are the so-called “20-20-20 targets” for the year 2020.  A wonderful slogan, but a flawed policy, because of perverse interactions among the three elements.

Europe is well on its way to achieving the first goal, with emissions now reduced by about 18%, and it is now looking to establish targets for the subsequent decade.  At the same time, Europe is continuing to experience its greatest economic downturn since the Great Depression, while European electricity prices have risen by some 40% since 2005 (while the U.S. economy rebounds, with electricity prices actually having fallen – mainly because of low natural gas prices).  Therefore, there is great concern in European capitals and at EU headquarters in Brussels about high energy prices damaging the international competitiveness of European industry.

Plans for 2030

Although the planned, new emissions targets for 2030 may increase stringency from the currently mandated 20% cut by 2020 to perhaps a 35% or even 40% cut by 2030, it now appears that the European Commission may drop specific binding constraints on the share of electricity generated from renewables.  Why would this elimination of the renewables target be good news not only economically, but environmentally as well?

Perverse Policy Interactions

Under the umbrella of a binding cap-and-trade scheme, unless a complementary policy addresses some other market failure that is not addressed by the price signals of the cap-and-trade mechanism (such as the principal-agent problem thought to retard energy-efficiency adoption decisions in renter-occupied properties), these complementary policies that are under the cap will either be irrelevant or counter-productive.  Here is the basic logic.

  • Under the umbrella of the EU ETS, the cap will be achieved cost-effectively (at minimum aggregate cost) if the cap is binding, which it will be with the new 2030 targets.  (Cost effectiveness is achieved because the CO2 cap-and-trade mechanism – like a carbon tax – provides incentives for all sources to control at the same marginal abatement cost.)
  • A “complementary policy” under the cap, such as a renewables target, will either be irrelevant (if it is not binding) or, if it is binding, any additional emissions reductions achieved in the electricity sector under the complementary measure (the renewables program) will cause electricity generators to have additional allowances they do not need.  And they will not tear up those allowances, but will sell them to other sources, such as those in other sectors.  Hence, emissions in those other sectors will be greater than they otherwise would have been, completely neutralizing the emissions-reduction impact of the renewables policy.
  • So, in the presence of the over-arching EU ETS, the renewables target has no incremental impact on CO2 emissions.  On net, the emissions reduction due to the renewables policy is zero.  But the bad news does not stop there.
  • With more emissions reductions in the electricity sector and less in other sectors than under the cost-effective allocation of control achieved by the cap-and-trade system on its own, aggregate abatement costs are actually increased.  Marginal abatement costs are no longer equated, and the allocation of control responsibility is no longer cost-effective.  There is too much abatement in the electricity sector, and not enough in some other sector or sectors.  Costs are driven up.
  • Hence, nothing is being accomplished in terms of CO2 emissions with the renewables policy, and costs have been driven up!  Wait, there is more.
  • If some emissions reductions are being achieved by the binding renewables policy, then there is less demand overall for tradable allowances.  Since the supply of allowances has not changed, this means that allowance prices are inevitably suppressed; and low allowance prices mean less induced climate-friendly technological change over time.

The Path Ahead

That is the perverse trifecta of a complementary renewables policy under the umbrella of a cap-and-trade scheme, such as the EU ETS:  no additional emissions reductions are achieved; but costs are driven up; and technological change is retarded.

If the European Commission decides to eliminate its renewables targets as it proceeds with more stringent emissions targets for 2030 under the EU ETS, it will be good news both for the economy and the environment.

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The Warsaw Climate Negotiations, and Reason for Cautious Optimism

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The Nineteenth Conference of the Parties (COP-19) of the United Nations Framework Convention on Climate Change (UNFCCC) came to a close in Warsaw, Poland, on Saturday, November 23rd, after what has become the norm – several all-night sessions culminating in last-minute negotiations that featured diplomatic haggling over subtle changes to the text on which countries were finally willing to agree.  The key task of this COP was essentially to pave the way for the negotiations next year at COP-20 in Lima, Peru, as a lead-up to the real target, reaching a new international climate agreement at the 2015 negotiations in Paris to be implemented in 2020, when the second commitment period of the Kyoto Protocol comes to an end.  If that was the key objective, then the Warsaw meetings must be judged to be at least a modest success – the baton was not dropped, rather it was passed successfully in this long relay race of negotiations.

Before going further, I would like to acknowledge something else about COP-19 in Warsaw, namely the excellent logistics.  Anyone who suffered through the disastrous logistical arrangements for COP-15 in Copenhagen will not take this for granted.  Perhaps ironically, in the years I’ve been participating in these annual events, the two best organized conferences (in terms of logistical arrangements) were the two Polish COPs – COP-14 in Poznan in 2008 and COP-19 in Warsaw this year.

As I have written in many previous essays at this blog, the challenges standing in the way of an effective international climate change agreement are numerous and severe.  A brief historical account is necessary to explain the significance of what transpired in Warsaw.  However, if you’re familiar with international climate policy, particularly the history of these international negotiations, I suggest you skip the next section and move directly to “Issue #1:  Making Progress toward a Post-Kyoto Agreement.”

Some Historical Background to Place the Warsaw Talks in Context:  the UNFCCC, the Berlin Mandate, the Kyoto Protocol, and the Durban Platform

The U.N. Framework Convention on Climate Change, adopted at the U.N. Conference on Environment and Development (the first “Earth Summit”) in Rio de Janeiro, Brazil, in 1992, contains what was to become a crucial passage:  “The Parties should protect the climate system for the benefit of present and future generations of humankind, on the basis of equity and in accordance with their common but differentiated responsibilities and respective capabilities. Accordingly, the developed country Parties should take the lead in combating climate change and the adverse effects thereof.” [emphasis added]  The countries considered to be “developed country Parties” were listed in an appendix to the 1992 Convention ­– Annex I.

The phrase – common but differentiated responsibilities – was given a specific interpretation three years after the Earth Summit by the first decision adopted by the first Conference of the Parties (COP-1) of the U.N. Framework Convention, in Berlin, Germany, April 7, 1995 ­­– the all important Berlin Mandate, which interpreted the principle as:  (1) launching a process to commit (by 1997) the Annex I countries to quantified greenhouse gas emissions reductions within specified time periods (targets and timetables); and (2) stating unambiguously that the process should “not introduce any new commitments for Parties not included in Annex I.”

Thus, the Berlin Mandate established the dichotomous distinction whereby the Annex I countries were to take on emissions-reductions responsibilities, and the non-Annex I countries were to have no such responsibilities whatsoever.  This had wide-ranging and profound consequences, because it became the anchor that prevented real progress in international climate negotiations.  With 50 non-Annex I countries coming to have greater per capita income than the poorest of the Annex I countries, the distinction was out of whack within a few years.

But, more important than that, this dichotomous distinction meant that:  (a) half of global emissions would be from nations without constraints; (b) the world’s largest emitter – China – would be unconstrained; (c) aggregate compliance costs would be driven up to be four times their cost-effective level, because many opportunities for low-cost emissions abatement in emerging economies were taken off the table; and (d) an institutional structure was perpetuated that made change and progress virtually impossible.

The dichotomous Annex I/non-Annex I distinction remained a central – indeed, the central – feature of international climate negotiations from COP-1 in Berlin in 1995 continuously until COP-15 in 2009, when hints of possible change first appeared.  The Copenhagen Accord (2009) and the Cancun Agreements (2010) began a process of blurring the Annex I/non-Annex I distinction.  But this blurring was only in the context of the interim pledge-and-review system established at COP-15 in Copenhagen and certified at COP-16 in Cancun, not in the context of an eventual successor to the Kyoto Protocol.  Thus, the Berlin Mandate retained its centrality.

Then, in December, 2011, at COP-17 in Durban, South Africa, the Durban Platform for Enhanced Action was adopted.  Under some interpretations, it essentially eliminates the Annex I/non-Annex I (or industrialized/developing country) distinction.  In the Durban Platform, the delegates decided to reach an agreement by 2015 that will be applicable to all countries by 2020.

Rather than adopting the Annex I/non-Annex I (or industrialized/developing country) distinction, the Durban Platform focuses instead on the pledge to create a system of greenhouse gas reductions including all Parties (what matters, really, is all key countries) by 2015 that will come into force by 2020.  Nowhere in the text of the decision were phrases such as “Annex I,” “common but differentiated responsibilities,” “distributional equity,” “historical responsibility,” all of which had long since become code words for targets for the richest countries and blank checks for all others.

By replacing the Berlin Mandate, the Durban Platform opened an important window.  National delegations from around the world took on the challenging task to identify a new international climate policy architecture that is consistent with the process, pathway, and principles laid out in the Durban Platform, namely to find a way to include all (key) countries (such as the 20 largest national and regional economies that together account for upwards of 80% of global carbon dioxide emissions) in a structure that brings about meaningful emissions reductions within an appropriate timetable at acceptable cost, while remaining within the overall framework provided by the UNFCCC, including the celebrated principle of common but differentiated responsibilities.

Issue #1:  Making Progress toward a Post-Kyoto Agreement

In Warsaw, the negotiators were tasked under the Durban Platform track (the so-called “ADP” track) to develop a work plan of substantive topics and a related calendar that will lead to the development of the text of an agreement of a new comprehensive policy architecture that can be discussed at COP-20 in Lima one year from now and then subject to final consideration and adoption a year after that at COP-21 in Paris.  This they did, and in the process they identified six components for the new architecture:  mitigation, adaptation, finance, technology development and transfer, capacity-building, and transparency of action and support.  Some of these are more necessary than others, but it was this package that generated agreement in Warsaw.

The actual agreement in Warsaw could only be achieved through carefully negotiated text.  The delegates’ obligation is to eventually adopt “a protocol, another legal instrument or an agreed outcome with legal force under the Convention applicable to all Parties…”  In truth, the phrase “under the Convention” is not necessary, because any decision by the UNFCCC is under the Convention, and therefore it is the case that any agreement produced under the Durban Platform is still subject to the UNFCCC principle of “common but differentiated responsibilities.”  But the large emerging economies tend to view the phrase “under the Convention” as supporting the dichotomous distinction of, on the one hand, commitments for Annex I (industrialized) countries to reduce emissions, and, on the other hand, no obligations for non-Annex I (developing) countries, who would take actions only voluntarily and only with financial assistance from the Annex I countries.  The same set of large emerging economies insisted that if they were to be included in the agreement, then the word “commitments” must be replaced by “contributions.”

It is looking increasingly likely that the 2015 agreement will take the form of a hybrid architecture, combining:  (1) a bottom-up system of national commitments (sorry, national contributions) that arise from – or are at least consistent with – national policies and goals; plus (2) top-down, centralized management of oversight, guidance, and coordination, with an eye to increasing ambition over time.  At the Harvard Project on Climate Agreements, we outlined such a hybrid international climate policy architecture four years ago (“A Portfolio of Domestic Commitments: Implementing Common but Differentiated Responsibilities”), and we explored it further just last month in a new report (“Identifying Options for a New International Climate Regime Arising from the Durban Platform for Enhanced Action”).  In Warsaw, we co-hosted and participated in two sessions that explored these ideas in considerable detail (you can learn more about that here; we will soon place all of the slide decks from those sessions at the Harvard Project web site).

Issue #2:  Loss and Damage

As I predicted at the conclusion of last year’s climate negotiations (COP-18) in Doha, Qatar, the issue that held the greatest potential for blowing up this year’s talks in Warsaw was the topic of “loss and damage,” which the delegates agreed to put on the agenda for discussion this year at COP-19.  The phrase “loss and damage” is typically understood to refer to the range of damages and loss associated with climate change impacts in developing countries that are particularly vulnerable to the adverse effects of climate change.  Discussions about potential international policy in this realm frequently bring up thoughts about who should pay for such loss and damages, presumably those most responsible for climate change.

Since climate change is a function not of current emissions, but of concentrations, responsibility for damages is presumably correlated with cumulative emissions.  Hence, the industrialized countries, in particular, the United States, worry that negotiations on “loss and damage” would soon raise the specter of unlimited legal liability.

The link is less direct than one might think, however.  First, there is the global commons nature of the problem, meaning that climate change cannot be linked to emissions from a specific country.  Second, there is the highly stochastic link from climate change to changes in weather patterns, so that no specific weather incident – whether Superstorm Sandy in New York, Hurricane Katrina in New Orleans, or Typhoon Haiyan in the Philippines – can be deterministically linked with global climate change.  These two scientific realities mean that moving from “loss and damage” to legal liability would be a long and perilous road.

But this is a very important issue in the climate negotiations for many developing countries, in particular, for the small island states that are most at risk.  Hence, it should not be surprising that this area of discussion – in some ways only a sideshow of the primary talks on reducing emissions and the risk of climate change – almost caused the talks to collapse.

In the end, the delegates agreed to finesse the topic by creating the Warsaw International Mechanism for Loss and Damage, which does not mention liability or promise compensation, but rather states that this is a topic to be discussed further at future meetings, and under the general topic of adaptation to climate change.

Issue #3:  Finance

Those are two – the Durban Platform, and Loss and Damage – of three major issues that were considered in Warsaw.  The third was “finance,” that is, the question of when and how the industrialized countries will meet the commitment they made at COP-15 in Copenhagen in 2009 to begin delivering $100 billion per year of financial assistance to developing countries in 2020 to help with mitigation and adaptation.  Not surprisingly, there was little or no progress on that front.  More about this in a future essay.  For now ….

The Path Ahead – Any Reason for Optimism?

Given my description above of the debates and “resolution” regarding the major issues, is there any cause for optimism regarding the path ahead.  Regular readers of this blog will know that I tend to see the half-full glass (or one-tenth full glass) of water, and in this case I think there really is cause for cautious optimism regarding the path ahead.

This is based upon a singular reality – the growing convergence of interests between the two most important countries in the world when it comes to climate change and international policy to address it, namely, China and the United States.

First of all, the annual carbon dioxide (CO2) and greenhouse gas (GHG) emissions of these two countries have already converged. Whereas U.S. CO2 emissions in 1990 were almost twice the level of Chinese emissions, by 2006 China had overtaken the United States.  We are the world’s two largest emitters.

Second, as I explained above, cumulative emissions are particularly important, because they are what cause climate change.  Any discussion of distributional equity in the climate realm inevitably turns to considerations of historic responsibility.  Looking at the period 1850-2010, the United States led the pack, accounting for nearly 19% of cumulative global emissions of GHGs, with the European Union in second place with 17%, and China third, accounting for about 12% of global cumulative emissions.  But that is changing rapidly, because of the fact that emissions are flat to declining throughout the industrialized world, but increasingly rapidly in the large emerging economies, in particular, China.  Depending upon the relative rates of economic growth of China and the United States, as well as many other factors, China may top all countries in cumulative emissions within 10 to 20 years from now.

Third, China and the United States both have historically high reliance on coal for generating electricity.  At a time at which U.S. dependence on coal is decreasing (due to increased supplies of unconventional natural gas and hence lower gas prices ), China continues to rely on coal, but is very concerned about this, partly because of localized health impacts of particulates and other pollutants.  Importantly, both countries have very large shale gas reserves.  U.S. output (and use for electricity generation) has been increasing rapidly, bringing down CO2 emissions, whereas Chinese exploitation and output has been constrained by available infrastructure (i.e., lack of pipelines, but that will change).

Fourth, in both countries, sub-national climate policies – cap-and-trade systems – are moving forward.  In the case of the China, seven pilot CO2 cap-and-trade regimes at the local level are under development, while in the United States, California’s ambitious AB-32 cap-and-trade system continues to make progress.

Fifth and finally, there is the reality of global geopolitics.  If the twentieth century was the American Century, then many observers, including leaders in China, anticipate (or hope) that the twenty-first century will be the Chinese Century.  And, as I was quoted by David Jolly in the New York Times as saying, “If it’s your century, you don’t obstruct, you lead.”

Conclusion

There was no fundamental setback in Warsaw to the stream of work that needs to be accomplished in Lima in 2014 in preparation for an agreement to be reached in Paris in 2015 under the Durban Platform for Enhanced Action.  This, combined with the reality of increasing convergence of Chinese and U.S. perspectives and interests, leaves me cautiously optimistic (or perhaps, just hopeful) about the path ahead.

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You can view and listen to an assessment of the Warsaw negotiations in a discussion in which I participated on the PBS NewsHour on November 27th, moderated by Judy Woodruff.

For other summaries and analyses of Warsaw’s COP-19 climate conference, I recommend:

Carraro, Carlo.  “COP19:  Between Weak Commitments and Tiny Successes.”  International Center for Climate Governance.  November 27, 2013.

Center for Climate and Energy Solutions.  “Outcomes of the U.N. Climate Change Conference in Warsaw.”  November, 2013.

Stowe, Robert.  “COP-19:  Different Strokes?”The Energy Collective, November 27, 2013.

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Climate Change, Public Policy, and the University

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Over the past year or more, across the United States, there has been a groundswell of student activism pressing colleges and universities to divest their holdings in fossil fuel companies from their investment portfolios.  On October 3, 2013, after many months of assessment, discussion, and debate, the President of Harvard University, Drew Faust, issued a long, well-reasoned, and – in my view – ultimately sensible statement on “fossil fuel divestment,” in which she explained why she and the Corporation (Harvard’s governing board) do not believe that “university divestment from the fossil fuel industry is warranted or wise.”  I urge you to read her statement, and decide for yourself how compelling you find it, and whether and how it may apply to your institution, as well.

About 10 days later, two leaders of the student movement at Harvard responded to President Faust in The NationAndrew Revkin, writing at the New York Times Dot Earth blog, highlighted the fact that the students responded in part by saying, “We do not expect divestment to have a financial impact on fossil fuel companies …  Divestment is a moral and political strategy to expose the reckless business model of the fossil fuel industry that puts our world at risk.”

I agree with these students that fossil-fuel divestment by the University would not have financial impacts on the industry, and I also agree with their implication that it would be (potentially) of symbolic value only.  However, it is precisely because of this that I believe President Faust made the right decision.  Let me explain.

The Value of Symbolic Action

If divestment would at best be a symbolic action, without meritorious direct financial impacts, can it not nevertheless be important and of great value?  More broadly, can’t symbolic actions be valuable?

One major problem is that symbolic actions often substitute for truly effective actions by allowing us to fool ourselves into thinking we are doing something meaningful about a problem when we are not.

But even if there are such opportunity costs of symbolic actions, can they not still be merited as part of moral crusades (as the students would presumably argue)?  The answer is, in my view, yes.  The problem, however, is that climate change is fundamentally a scientific, economic, and political challenge.  Viewing it as a moral crusade, I fear, will only play into and exacerbate the terrible political polarization that is already paralyzing Washington, a topic about which I have written previously at this blog.

The Climate Impacts of Divestment

Divestment of fossil fuel stocks would hurt, not help efforts to address global climate change.  First, natural gas is the crucial transition fuel to address climate change.  A major reason for the drop in U.S. CO2 emissions is the increased use of natural gas to generate electricity, as documented in this recent report from the U.S. Energy Information Administration.

Second, even if divestment were to reduce the financial resources of coal, oil, and gas companies (which it would not do), this would only serve to reduce research and development at those same companies of carbon capture and storage (CCS) technologies, as well as other potential technological breakthroughs; and could reduce the development of some renewable sources of energy (which the fossil fuel companies are carrying out as part of their financially rational diversification strategies).

The University’s Comparative Advantage

Most important, as I have argued for years, Harvard’s real contributions to fight climate change and promote sound climate change policies will be through our products:  research, teaching, and outreach.  That is how this great university has made a difference on other societal challenges for decades and centuries, and it is how we will make a real difference on this one.

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Three and a half years ago, I posted an essay at this blog about what I saw to be the proper role of individuals and institutions in addressing climate change.  Frequently I refer to my previous blog posts, but today I’m going a step further, and reproducing that one from March, 2010, because it applies so directly to the topic at hand (including its Epilogue at the very end):

What’s the Proper Role of Individuals and Institutions in Addressing Climate Change?

Posted on March 8, 2010 by Robert Stavins

This may seem like a trivial question with an obvious answer.  But what really is the proper role for individuals and institutions in addressing climate change?  An immediate and natural response may be that everyone should do their part.  Let’s see what that really means.

Decisions affecting carbon dioxide (CO2) emissions, for example, are made primarily by companies and consumers.  This includes decisions by companies about how to produce electricity, as well as thousands of other goods and services; and decisions by consumers regarding what to buy, how to transport themselves, and how to keep their homes warm, cool, and light.

However, despite the fact that these decisions are made by firms and individuals, government action is clearly key, because climate change is an externality, and it is rarely, if ever, in the self-interest of firms or individuals to take unilateral actions.  That’s why the climate problem exists, in the first place.  Voluntary initiatives – no matter how well-intended – will not only be insufficient, but insignificant relative to the magnitude of the problem.

So, the question becomes how to shift decisions by firms and individuals in a climate-friendly direction, such as toward emissions reductions.  Whether conventional standards or market-based instruments are used, meaningful government regulation will be required.

But where does this leave the role and responsibility of individuals and institutions?  Let me use as an example my employer, a university.  A couple of years ago, I met with students advocating for a reduced “carbon foot-print” for the school.  Here is what I told them.

“I was asked by a major oil company to advise on the design of an internal, voluntary tradable permit systems for CO2 emissions.  My response to the company was ‘fine, but the emissions from your production processes — largely refineries — are trivial compared with the emissions from the use of your products (combustion of fossil fuels).  If you really want to do something meaningful about climate change, the focus should be on the use of your products, not your internal production process.’  (My response would have been different had they been a cement producer.)  The oil company proceeded with its internal measures, which – as I anticipated – had trivial, if any impacts on the environment (and they subsequently used the existence of their voluntary program as an argument against government attempts to put in place a meaningful climate policy).”

My view of a university’s responsibilities in the environmental realm is similar.  Our direct impact on the natural environment — such as in terms of CO2 emissions from our heating plants — is absolutely trivial compared with the impacts on the environment (including climate change) of our products:  knowledge produced through research, informed students produced through our teaching, and outreach to the policy world carried out by faculty.

So, I suggested to the students that if they were really concerned with how the university affects climate change, then their greatest attention should be given to priorities and performance in the realms of teaching, research, and outreach.

Of course, it is also true that work on the “greening of the university” can in some cases play a relevant role in research and teaching.  And, more broadly — and more importantly — the university’s actions in regard to its “carbon footprint” can have symbolic value.  And symbolic actions — even when they mean little in terms of real, direct impacts — can have effects in the larger political world.  This is particularly true in the case of a prominent university, such as my own.

But, overall, my institution’s greatest opportunity — indeed, its greatest responsibility — with regard to addressing global climate change is and will be through its research, teaching, and outreach to the policy community.

Why not focus equally on reducing the university’s carbon foot-print while also working to increase and improve relevant research, teaching, and outreach?  The answer brings up a phrase that will be familiar to readers of this blog – opportunity cost.  Faculty, staff, and students all have limited time; indeed, as in many other professional settings, time is the scarcest of scarce resources.  Giving more attention to one issue inevitably means – for some people – giving less time to another.

So my advice to the students was to advocate for more faculty appointments in the environmental realm and to press for more and better courses.  After all, it was student demand at my institution that resulted in the creation of the college’s highly successful concentration (major) in environmental science and public policy.

My bottom line?  Try to focus on actions that can make a real difference, as opposed to actions that may feel good or look good but have relatively little real-world impact, particularly when those feel-good/look-good actions have opportunity costs, that is, divert us from focusing on actions that would make a significant difference.  Climate change is a real and pressing problem.  Strong government actions will be required, as well as enlightened political leadership at the national and international levels.

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Epilogue:  After I posted the above essay, I was reminded of an incident that took place many years ago (before I came to Harvard for graduate school, in fact) when I was working full-time for the Environmental Defense Fund in Berkeley, California, under the inspired leadership of the late (and truly great) Tom Graff, the long-time guru of progressive California water policy.  EDF was very engaged at the time in promoting better water policies in California, including the use of trading mechanisms and appropriate pricing schemes for scarce water supplies.  A prominent national newspaper which was not friendly to EDF’s work sent a reporter to EDF’s Berkeley office to profile the group’s efforts on water policy in the State.  A staff member found the reporter in the office bathroom examining whether EDF had voluntarily installed various kinds of water conservation devices in its plumbing.  Our reaction at the time was that whether or not EDF had voluntarily installed water conservation devices was simply and purely an (intentional) distraction from the important work the group was carrying out.   After several decades, my view of that incident has not changed.

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Remembering Ronald Coase’s Contributions

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On September 2nd, Ronald Coase, professor emeritus of economics at the University of Chicago Law School, Nobel laureate, and principal creator of the academic field of law and economics, passed away at the age of 102.  Numerous, lengthy obituaries have appeared in the national and international press.  And in an effective essay posted at the Energy Economics Exchange web site, Severin Borenstein, professor of economics at the University of California, Berkeley, wrote about the effect that Coase’s thinking had decades ago on his own intellectual development (while lamenting that the Wall Street Journal in its own tribute to Coase had twisted the implications of his work to fit the Journal’s view of the world).

The passing of Professor Coase brings to mind an essay I wrote for this blog in July of 2012, in which I recalled that a group of economists and legal scholars had gathered in December, 2010, at the University of Chicago to celebrate two notable events.  One was the fiftieth anniversary of the publication of Ronald Coase’s “The Problem of Social Cost” (Coase 1960).  The other was Professor Coase’s 100th birthday.  The conference resulted in a special issue of The Journal of Law and Economics.

Robert Hahn (of the University of Oxford) and I were privileged to participate in the conference (a video of our presentation is available here).  We recognized that the fiftieth anniversary of the publication of Coase’s landmark study provided an opportunity for us to examine one of that study’s key implications, which is of great importance not only for economics but for public policy as well, in particular, for environmental policy.

The Coase Theorem and the Independence Property

In our article, “The Effect of Allowance Allocations on Cap-and-Trade System Performance,” Hahn and I took as our starting point a well-known result from Coase’s work, namely, that bilateral negotiation between the generator and the recipient of an externality will lead to the same efficient outcome regardless of the initial assignment of property rights, in the absence of transaction costs, income effects, and third party impacts. This result, or a variation of it, has come to be known as the Coase Theorem.

We focused on an idea that is closely related to the Coase theorem, namely, that the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights (typically referred to as permits or allowances). That is, the overall cost of achieving a given emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation, under certain conditions (conditional upon the permits being allocated freely, i.e., not auctioned). We called this the independence property. It is closely related to a core principle of general equilibrium theory (Arrow and Debreu 1954), namely, that when markets are complete, outcomes remain efficient even after lump-sum transfers among agents.

The Practical Political Importance of the Independence Property

We were interested in the independence property because of its great political importance.  The reason why this property is of such great relevance to the practical development of public policy is that it allows equity and efficiency concerns to be separated. In particular, a government can set an overall cap of pollutant emissions (a pollution reduction goal) and leave it up to a legislature to construct a constituency in support of the program by allocating shares of the allowances to various interests, such as sectors and geographic regions, without affecting either the environmental performance of the system or its aggregate social costs.  Indeed, this property is a key reason why cap-and-trade systems have been employed and have evolved as the preferred instrument in a variety of environmental policy settings.

In Theory, Does the Property Always Hold?

Because of the importance of this property, we examined the conditions under which it is more or less likely to hold — both in theory and in practice.  In short, we found that in theory, a number of factors can lead to the independence property being violated. These are particular types of transaction costs in cap-and-trade markets; significant market power in the allowance market; uncertainty regarding the future price of allowances; conditional allowance allocations, such as output-based updating-allocation mechanisms; non-cost-minimizing behavior by firms; and specific kinds of regulatory treatment of participants in a cap-and-trade market.

In Reality, Has the Property Held?

Of course, the fact that these factors can lead to the violation of the independence property does not mean that in practice they do so in quantitatively significant ways.  Therefore, Hahn and I also carried out an empirical assessment of the independence property in past and current cap-and-trade systems: lead trading; chlorofluorocarbons (CFCs) under the Montreal Protocol; the sulfur dioxide (SO2) allowance trading program; the Regional Clean Air Incentives Market (RECLAIM) in Southern California; eastern nitrogen oxides (NOX) markets; the European Union Emission Trading Scheme (EU ETS); and Article 17 of the Kyoto Protocol.

I hope some of may find time to read our article, but a quick summary of our assessment is that we found modest support for the independence property in the seven cases we examined (but also recognized that it would surely be useful to have more empirical research in this realm).

Political Judgments

That the independence property appears to be broadly validated provides support for the efficacy of past political judgments regarding constituency building through legislatures’ allowance allocations in cap-and-trade systems. Governments have repeatedly set the overall emissions cap and then left it up to the political process to allocate the available number of allowances among sources to build support for an initiative without reducing the system’s environmental performance or driving up its cost.

This success with environmental cap-and-trade systems should be contrasted with many other public policy proposals for which the normal course of events is that the political bargaining that is necessary to develop support reduces the effectiveness of the policy or drives up its overall cost.  So, the independence property of well-designed and implemented cap-and-trade systems is hardly something to be taken for granted.  It is of real political importance and remarkable social value.  It is just one of many lasting contributions of Ronald Coase.

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Economics and Politics in California: Cap-and-Trade Allowance Allocation and Trade Exposure

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In my previous essay at this blog – The Importance of Getting it Right in California – I wrote about the precedents and lessons that  California’s Global Warming Solutions Act (AB 32) and its greenhouse gas (GHG) cap-and-trade system will have for other jurisdictions around the world, including other states, provinces, countries, and regions.  This is particularly important, given the failure of the U.S. Senate in 2009 to pass companion legislation to the Waxman-Markey bill, passed by the U.S. House of Representatives, highlighting the absence of a national, economy-wide carbon pricing policy.

In my previous essay, I focused on three pending design issues in the emerging rules for the AB-32 cap-and-trade system:  (1) the GHG allowance reserve; (2) the role of offsets; and (3) proposals for allowance holding limits.  I drew upon a presentation I made on “Offsets, Holding Limits, and Market Liquidity (and Other Factors Affecting Market Performance)” at the 2013 Summer Issues Seminar of the California Council for Environmental and Economic Balance.

At the same conference, I made another presentation, which was on “Allowance Value Distribution and Trade Exposure,” a topic that is of great importance both economically and politically, not only in the context of the design of California’s AB-32 cap-and-trade system, but for the design of any cap-and-trade instrument in any jurisdiction.  It is to that topic that I turn today.  (For a much more detailed discussion, please see a white paper I wrote with Dr. Todd Schatzki of Analysis Group, “Using the Value of Allowances from California’s GHG Cap-and-Trade System,” August, 2012).

Why Does Anyone Care About the Allowance Value Distribution?

A cap-and-trade policy creates a valuable new commodity – emissions allowances.  In a well-functioning emissions trading market, the financial value of these allowances (per ton of emissions, for example) is approximately equivalent to their opportunity cost, which is the marginal cost of emissions reductions.  This is because of the existence of the overall cap, which – if binding – fosters scarcity of available allowances, and hence generates their economic value.

It should not be surprising, then, that the initial allocation of these allowances can have important consequences both for environmental and for economic outcomes.

Environmental Consequences of the Initial Allowance Allocation

No matter how many times I meet with policy makers around the world to talk about alternative policy instruments (for climate change and other environmental problems), I never cease to be struck by the confusion that abounds regarding the environmental (and the economic) consequences of the initial allocation of allowances in a cap-and-trade system.  As I have written many times in the past at this blog, the initial allocation does not directly affect environmental outcomes.  Regardless of the allocation method used, aggregate emissions are limited by the emissions cap.  This is true whether the allowances are sold (auctioned) or distributed without charge.  Furthermore, which firms or sources receive the initial allocation of allowances has no effect on either aggregate emissions or the ultimate distribution of emissions reductions among sources.

This independence of a cap-and-trade system’s performance from the initial allowance allocation was established as far back as 1972 by David Montgomery in a path-breaking article in the Journal of Economic Theory (based upon his 1971 Harvard economics Ph.D. dissertation). It has been validated with empirical evidence repeatedly over the years.  (More below about the initial allocation’s potential effects on economic performance.)

However, it is also true that the initial allocation method can indirectly affect emissions.  In particular, emissions leakage can arise if economic activity shifts to unregulated sources – this risk is greatest with auctions or free fixed allocations.  In contrast, an updating, output-based allocation (used in AB 32 for “industry assistance”) can reduce leakage risk by making the free allocation of allowances marginal, rather than infra-marginal (as is the case with a simple free allocation).

Economic Consequences of the Initial Allowance Allocation

A favorite topic of academic economists is that the allowance allocation method in a cap-and-trade system can affect the overall social cost of the policy if the allowances are auctioned (sold by government to compliance entities), and if the revenues are then used to reduce distortionary taxes (such as taxes on labor and investment), thereby eliminating some deadweight loss and cutting overall social cost.  I discuss this a bit more below, but for now let’s recognize that the combination of two California propositions and subsequent court rulings means that the State is not permitted to use the auction proceeds to cut taxes (rather, any auction proceeds must be used to achieve the purposes of AB 32, that is, reducing GHG emissions).

So, within the set of feasible options, the initial allowance allocation will not directly affect the cost-effectiveness of actions taken by emission sources to reduce emissions.  In other words, aggregate abatement costs will not be directly affected by the nature of the initial allocation.

I was careful to use the word, “directly,” because the initial allowance allocation can indirectly affect economic outcomes.  In particular, the use of updating, output-based allocations can:  (1) lower the costs seen by consumers, which can reduce incentives to conserve; (2) avoid reductions in economic activity within California, with associated distributional impacts; and (3) avoid potential shifts of production to less efficient, more distant producers.

Auction Revenue Use

Decisions about how auction revenues are used can have profound consequences for the potential benefits of auctioning.  There are three basic options.

First, as I emphasized above, in theory, reducing distortionary taxes provides the greatest net economic benefit (by reducing the social cost of the policy).  But California’s unique legal context takes this option off the table.

Second, funding programs to address other market failures that are not addressed by the price signals provided by the cap-and-trade system can be meritorious.   For example, information spillovers can be addressed through financing of research and development activities, and the principal-agent problems that infect energy-efficiency adoption decisions in rental properties can be addressed — to some degree — through zoning and other local policies.

The third and final option, however, is highly problematic, if not completely without merit, and yet, ironically, there are strong incentives in place for policy makers to go this third route.  This third option is to use auction revenues to fund programs to subsidize emission reductions.  There is a strong incentive to do this, because of California’s legal constraint to employ any auction revenues in pursuit of the objectives of the statute, that is, reducing GHG emissions.

What’s the problem?  The AB-32 cap-and-trade system will cover approximately 85% of the economy.  In other words, the vast majority of sources are under the cap.  As I have explained in detail in several previous essays at this blog, under the umbrella of a cap-and-trade mechanism, (successful) efforts to further reduce emissions of capped sources will have three consequences:  (1) allowance prices will be supressed (take a look at the hand-wringing in Europe over allowance prices in its CO2 Emissions Trading System); (2) aggregate compliance costs will be increased (cost-effectiveness is reduced because marginal abatement costs are no longer equated among all sources); and (3) nothing is accomplished for the environment, in the sense that there are no additional CO2 emissions reductions (rather, the CO2 emissions reductions are simply relocated among sources under the cap).

Economics, Policy, and Politics

As I concluded in my previous essay, the California Air Resources Board has done an impressive job in its initial design of the rules for its GHG cap-and-trade system.  Of course, there are flaws, and therefore there are areas for improvement. A major issue continues to be the mechanisms used for the initial allocation of allowances.  Because of the economics and politics of this issue, it will not go away.  But, going forward, it would be helpful if those debating this issue could demonstrate better understanding of the allowance allocation’s real – as opposed to fictitious – environmental and economic consequences.

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The Importance of Getting it Right in California

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Why should sub-national climate policies exist?  In the case  of California’s Global Warming Solutions Act (AB 32), the answer flows directly from the very nature of the problem — global climate change, the ultimate global commons problem.

The Standard Theory

Greenhouse gases (GHGs) uniformly mix in the atmosphere.  Therefore, any jurisdiction taking action — whether a nation, a state, or a city — will incur the costs of its actions, but the benefits of its actions (reduced risk of climate change damages) will be distributed globally.  Hence, for virtually any jurisdiction, the benefits it reaps from its climate‑policy actions will be less than the cost it incurs.  This is despite the fact that the global benefits of action may well be greater — possibly much greater — than global costs.

This presents a classic free-rider problem, in which it is in the interest of each jurisdiction to wait for others to take action, and benefit from their actions (that is, free-ride).  This is the fundamental reason why the highest levels of effective government should be involved, that is, sovereign states (nations).  And this is why international, if not global, cooperation is essential. [See the extensive work in this area of the Harvard Project on Climate Agreements.]

What’s Missing?

Despite this fundamental reality, there can still be a valuable role for sub-national climate policies, as I wrote about in an essay at this blog in 2010 (which drew, in part, on work I did with Professor Lawrence Goulder of Stanford University).  This is particularly true when appropriate national policies fail to materialize.  The failure of the U.S. Senate to pass companion legislation to the Waxman-Markey bill, passed by the U.S. House of Representatives in June, 2009, highlighted the absence of a national, economy-wide carbon pricing policy.

Recently, another argument has arisen for the importance of California’s climate policy, namely its potential precedent and lessons for other jurisdictions around the world, including other states, provinces, countries, and regions.

The Importance of Getting the Design Right

Getting the design right of AB 32’s cap-and-trade system is particularly important, because the performance of the system will receive great attention from other jurisdictions around the world considering their own climate policies (as I argued recently at the 2013 Summer Issues Seminar of the California Council for Environmental and Economic Balance).  In fact, from conversations I’ve had with government officials and others in many parts of the world, it’s clear that the performance of the AB 32 suite of policies, including its centerpiece – a GHG cap-and-trade system – is being very closely watched.  The outcome of California’s program will affect the likelihood of future commitments being made by other jurisdictions beyond California, as well as the ambition of those commitments.  And the system’s design and performance will have significant effects on design decisions in other states, provinces, countries, and regions.

Getting the Design Right

Current allowance prices, which are near the auction reserve (floor) price, should not diminish attention to getting the design details right.  Market conditions could change, leading to price increases, in which case the details of design will affect environmental performance and economic consequences.  Consideration of potential market rule changes to refine the program is prudent.  It would be a mistake to wait until it’s necessary to make ad hoc decisions in a time of crisis.  Three issues stand out (as I wrote recently in much more detail in a white paper with Dr. Todd Schatzki of Analysis Group, “Three Lingering Design Issues Affecting Market Performance in California’s GHG Cap-and-Trade Program”).

Issue 1:  The GHG Allowance Reserve

A recent, credible study by University of California economist, Severin Borenstein, and colleagues suggests that allowances prices in the AB 32 cap-and-trade system are likely to remain relatively low over the remainder of this decade, and that the probability is small of triggering and exhausting the system’s allowance reserve, which is intended to moderate prices.  Nevertheless, the possibility remains that as a result of unanticipated changes in the market (such as higher than anticipated economic growth in California, slower diffusion than anticipated of low-cost abatement technologies, etc.), the current reserve structure could lead to excessively high allowance prices if the reserve is exhausted.  Establishing a mechanism now to avoid this potential future outcome is important to avoid ad hoc policy responses that might be developed in a crisis atmosphere.

A variety of mechanisms could be made available for providing incremental allowances to the reserve.  For example, specific criteria could be established up front to grant the Governor discretion (allowed under AB 32) to relax compliance obligations.  Or provision could be made to replenish the reserve with allowances from other cap-and-trade systems or from the post-2020 AB 32 system.  Another possibility (recommended by Dallas Burtraw of Resources for the Future) would be overlapping compliance periods, which in effect provide for limiting borrowing, as well as banking, thereby providing an additional cushion on price changes.

Of course, the most effective device would be a simple safety valve (or price collar), whereby the government would offer to sell an unlimited number of allowances at a given price, thereby capping allowance prices and abatement costs.  However, my understanding is that the authorities at the California Air Resources Board (ARB) believe that this would not be allowed under AB 32, since a safety valve could result in the statute’s specific emissions targets not being met.

Issue 2:  Offsets

Offsets (emission reduction credits) from outside the AB 32 cap-and-trade system made available to entities with AB 32 compliance responsibilities can effectively limit allowance prices (and abatement costs).  What are needed now are administrative procedures that are efficient (low transaction costs) and ensure the environmental integrity of offsets.  This is fundamentally a question of balance.  Too much attention to efficient procedures of providing a large number of offsets risks flooding the market with meaningless offsets that lack additionality.  And a singular focus on environmental integrity will result in virtually no offsets being made available.

Up until now, relatively few offsets have been certified under existing ARB procedures.  It would be helpful to identify an appropriate potential supply of offset types.  Currently eligible offset types appear to be insufficient to take advantage of full offset flexibility.  It’s also important to establish appropriate liability rules for offset integrity.  A “seller-liability-first/buyer-liability-second” approach may offer efficiencies over the current buyer-liability approach.

Issue 3:  Allowance Holding Limits

Limits on purchases and holdings of allowances, intended to discourage market manipulation, could put in place a “cure” that is significantly more harmful than the “illness” it’s intended to address.  Rules for allowance holding and transacting are needed that carefully balance multiple considerations:  potential market manipulation; maintenance of adequate market liquidity; cost-effective program compliance (for example, to avoid constraining allowance banking); and effective risk management.

To that end, potential improvements would include establishing greater flexibility for legitimate banking, hedging, and risk-management purposes.  Also helpful would be tailoring holding limits to recognize market-participant differences, taking account of the size of a firm’s compliance obligations and the purpose of its holdings.  Finally, more frequent auctions would be helpful, including near the end of compliance periods, when market manipulation is most likely.

The Path Ahead

The California Air Resources Board has done a remarkable job in its initial design of the rules for its path-breaking GHG cap-and-trade system.  That’s not to say that it is perfect, or that it could be perfect.  There will inevitably be unanticipated challenges that will arise, whether from complying firms, from the broader economy, from litigation, or from other legislation.  The goal at this stage should be to design a system that is reasonably robust to such unanticipated shocks.

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Thinking About the Energy-Efficiency Gap

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Adoption of energy-efficient technologies could reap both private and social rewards, in the form of economic, environmental, and other social benefits from reduced energy consumption. Social benefits include improvements in air quality, reduced greenhouse-gas emissions, and increased energy security. In response, governments around the world have adopted policies to increase energy efficiency.  Still, there is a broadly held view that various barriers to the adoption of energy-efficient technologies have prevented the realization of a substantial portion of these benefits.

For some thirty years, there have been discussions and debates among researchers and others in academia, government, non-profits, and private industry regarding the so-called “energy efficiency gap” (or “energy paradox”) — the apparent reality that many energy-efficiency technologies are not adopted even when it makes sense for consumers and businesses to do so, based on their private costs and benefits. That is, decision makers appear to “under-invest” in energy-efficient technologies, relative to the predictions of some engineering and economic models.

What causes this gap?  The answer to that question could presumably help inform the development of better public policy in this realm.

Possible Explanations for the Energy-Efficiency Gap

Potential explanations for the energy efficiency gap tend to fall into three broad categories: (1) market failures, such as lack of information or misplaced incentives; (2) behavioral effects, such as inattentiveness to future energy savings when purchasing energy-consuming products; and (3) modeling flaws, such as assumptions that understate the costs or overstate the benefits of energy efficiency.  In this essay, I simply want to outline the types of hypothetical explanations of the gap that have been posited within these three broad categories.

Market-Failure Explanations

First, various Innovation Market Failures have been posited, including:  research and development (R&D) and learning-by-doing spillovers; inefficient product quality and differentiation due to market power; and inefficient introduction of new products due to consumer taste spillovers (for example, consumers becoming comfortable with a new technology).

Second, another set of potential market-failure explanations for the gap may be characterized as Information Problems.  These include:  lack of information on the part of consumers (learning-by-using or so-called experience goods; energy prices; energy consumption of products; and available substitutes); asymmetric information (the “lemons problem”); and split incentives and principal-agent issues (such as the frequently-discussed renter/owner dichotomy).

Third, there are Capital Market Failures and Liquidity Constraints, which may be a particularly significant issue in developing-country contexts.

Fourth, there are Energy Market Failures, including various externalities (environmental, energy security, congestion, and accident risk), as well as average-cost pricing of electricity.

Behavioral Explanations

The rise of behavioral economics has brought to the fore another well-defined set of potential explanations of the energy efficiency gap.  A variety of alternative taxonomies could be employed to separate these explanations, but one such taxonomy would categorize the explanations as:

Model and Measurement Explanations

The third category of possible explanations of the energy efficiency gap consists essentially of a set of reasons why observed levels of diffusion of energy-efficiency technologies may actually be privately optimal.

First, there is the possibility of unobserved or understated adoption costs, including unaccounted for product characteristics.

Second, there may be overstated benefits of adoption, due to inferior project execution relative to assumptions, and/or poor policy design.

Third, an incorrect discount rate may be employed in an analysis, when the correct consumer and firm discount rates should vary with:

  • opportunity cost of and access to capital
  • income
  • buying versus retrofitting equipment
  • systematic risk
  • option value (see below)

Fourth, there is frequently heterogeneity across end users in the benefits and costs of employing energy-efficiency technologies, so that what is privately optimal on average will not be privately optimal for all.  This can refer either to static (cross-sectional) heterogeneity or to dynamic (intertemporal) heterogeneity, that is, technology improvements over time, which raises two possibilities:  the reality of some potential adopters being short of the frontier, and the presence of option value to waiting.

Fifth and finally, there is the possibility of uncertainty (real, not informational, as above), irreversibility, and option value.  This could be due to uncertainty regarding future energy prices, or can be linked with option value that arises for delaying investments that have only minimal if any salvage value.

Public Policy and Next Steps

Determining the validity of each of these possible explanations — and the degree to which each contributes to the energy efficiency gap — are crucial steps in crafting the most appropriate public policy responses.

To inform future research and policy, Professor Richard Newell of Duke University and I have launched an initiative – sponsored by the Alfred P. Sloan Foundation — to synthesize past work on these potential explanations of the energy paradox and identify key gaps in knowledge.  We are conducting a comprehensive review and assessment of published and ongoing social-science research on the adoption of energy-efficient technologies, including scholarly literature, industry case studies, reports from national and sub-national governments, and, to the extent possible, consulting reports evaluating specific programs.

We are working with leading social scientists — including scholars from economics, psychology, and other disciplines — to examine the various possible explanations of the energy paradox and thereby to help identify the frontiers of knowledge on the diffusion of energy-efficient technologies.  We hope the products of this initiative will help decision makers in industry and government better understand the energy efficiency gap, and will thereby contribute to decisions that maximize the potential economic, environmental, and other social benefits associated with optimal adoption of energy-efficient technologies.  As materials become available, we will post them at the project’s Harvard website and the project’s Duke website, and I will alert readers of this blog.  In the meantime, please stay tuned.

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On the Origins of Research

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In response to my last essay at this web site, “On Becoming an Environmental Economist,” several readers suggested that someday I should write about the origins of my various research initiatives over the past 25 years.  Today, I’m doing that sooner than anyone might have expected!

This is feasible because — also quite recently — I was asked by my colleague, Hannah Riley Bowles, the instructor in the Harvard Kennedy School’s Doctoral Research Seminar, to make a presentation to the first-year students in the Ph.D. program in public policy on how research programs develop.  To prepare for this, I reflected on my research projects over the past 25 years since receiving my PhD in economics at Harvard and joining the Kennedy School faculty, and as I began to write some notes for my presentation, a flow chart of research origins, subjects, and products started to emerge.  You can view my PowerPoint presentation (you need to use Slide Show mode to see the animation) here.

In this essay, I describe the elements of that flow chart of research sources, topics, and selected publications (and provide some screen shots of the PowerPoint deck).

As will probably be apparent, I found the process of preparing for Professor Bowles’s seminar valuable, because it forced me – for the first time in 25 years – to step back and reflect systematically on the origins of my research projects and the connections among them.  So, I recommend this process to other researchers, as I think you may find it rewarding.  And, for would-be researchers, that is, PhD students, I hope the results below will be informative.

An Ex Post Exploration of How Research Programs Develop

In carrying out this ex post exploration of how research programs may develop, I identified eleven types of sources of research ideas and projects.  In approximate chronological order (but not necessarily in order of importance), these are:

      • Dissertation
      • Involvement with the Policy World
      • Picking Up on Someone Else’s Work
      • Conferences
      • Funders
      • Student Interest
      • Responding to Others’ Work
      • Teaching
      • Consulting
      • Class Assignment
      • Invitation

I begin with how my dissertation research subsequently led to several avenues of further research and writing.

Dissertation — Analyzing Land Use

My 1988 Ph.D. thesis examined econometrically the factors that had led to the dramatic depletion of forested wetlands in the southern United States over the previous five decades.  Before commenting on how my dissertation stimulated my subsequent research, I should acknowledge that my dissertation topic itself grew of out of some consulting work I was doing at the time for the Environmental Defense Fund, in particular an analysis for James T. B. Tripp of how U.S. Army Corps of Engineers flood control projects were providing economic incentives for landowners to convert their forested wetlands to agricultural croplands.

My dissertation led directly to a pair of journal articles published in 1990 in the American Economic Review (with Adam Jaffe) and the Journal of Environmental Economics and Management.  But more striking – given the theme of this essay – is that several years later I realized that the general econometric approach and simulation model could be applied to a very different question, namely, analyzing the anticipated costs of biological carbon sequestration as a means of reducing net concentrations of carbon dioxide (CO2) in the atmosphere, linked with global climate change.  That recognition led to another article in the American Economic Review (1999), and then to a series of other, related projects on carbon sequestration (with Richard Newell 2000, and with Ruben Lubowski and Andrew Plantinga 2006, both in the Journal of Environmental Economics and Management), as well as a broader research initiative on factors affecting land-use decisions (with Plantinga and Lubowski in the Journal of Urban Economics in 2002 and Land Economics in 2008).  More recent work with Andrew Plantinga and Robin Cross (that does not appear in the schematic below) has involved an econometric analysis of the concept and reality of “terroir” associated with the production of premium wines (American Economic Review 2011, Journal of Wine Economics 2011).

A Less Direct Legacy of Dissertation:  Economics of Technological Change

A fundamental aspect of the econometric modeling involved in some of the land-use models above, including my dissertation research, was the estimation of the parameters of an empirical distribution of some heterogeneous attribute of land parcels, such as potential crop revenue (due to varying land quality, for example).  As costs of production fall, for example, that distribution would be swept, with various parcels going into production at various points in time.  Adam Jaffe and I hoped that this same sort of model could be applied to the process of technological diffusion, that is, the process of gradual adoption of some new technology over time.

As it turned out, however, the model was less useful than we first thought it would be for analyzing the factors affecting technology diffusion, and so we abandoned it for that purpose.  But this led us to explore other conceptual and empirical approaches to assessing the factors that lead to the diffusion of environmental technologies.  We developed a new framework for comparing empirically the effects of alternative environmental policy instruments on the diffusion of new technology, including Pigouvian taxes, technology adoption subsidies, and technology standards, with an empirical application to the diffusion of thermal insulation in new home construction, comparing the effects of energy prices, insulation cost, and building codes (Journal of Environmental Economics and Management 1995).  Related work with Nolan Miller and Lori (Snyder) Bennear followed in 2003 (American Economic Review).

Given our interest in the diffusion (adoption) of energy-efficiency technologies, it was natural to think about exploring the factors that affect the innovation (commercialization) of such technologies.  A very different model was developed — with Richard Newell taking the lead as part of his Harvard dissertation research — and an empirical application was made to analyzing the innovation of specific household energy-consuming durable goods (such as water heaters and air conditioners).  This work appeared in the Quarterly Journal of Economics in 1999.

More broadly, our interest in the innovation and diffusion energy efficiency technologies led us to explore in a series of articles the so-called “energy paradox” of apparently slow diffusion of technologies that appear to pay for themselves, as well as other issues related to energy-efficiency technological change (Energy Journal 1994, Resource and Energy Economics 1994, Energy Policy 1994, Elsevier Handbook of Economics 2003, Ecological Economics 2005, Energy Economics 2006, and many others).  And, recently, with a resurgence of interest in the energy paradox in the context of global climate change, Richard Newell and I have launched a new research initiative, with support from the Alfred P. Sloan Foundation.

Because I’ve sought to describe the origins of my research somewhat chronologically, I began with my dissertation research.  The fact that several strands of research — some directly related and some indirectly related to my dissertation — subsequently emerged will surely not surprise academic readers of this essay.  However, a considerably greater influence (indeed, the most important influence) on my research portfolio has come from my involvement — not with fellow scholars — but with practitioners in the world of public policy.  That may come as a surprise to some readers, and it is to this illustration of the two-way street between research and practice to which I now turn.

Involvement with the Policy World

A phone call I received in the late spring of 1988 — a week before my Harvard graduation — from Senator Timothy Wirth (D-Colorado), and a meeting shortly thereafter in Washington with Senator Wirth and his long-time friend and colleague, Senator John Heinz (R-Pennsylvania) led to an agreement that I would direct for them a study intended to inform the Presidential debates on environmental policy in that election year — Project 88:  Harnessing Market Forces to Protect the Environment (and a follow-up study in 1991, Project 88 — Round II, Incentives for Action: Designing Market-Based Environmental Strategies).

Many pages could be written — and, indeed, many have been written — about the influence that Project 88, sponsored by Senators Wirth and Heinz, subsequently had on policy developments at the federal level in Washington (including the path-breaking SO2 allowance trading program in the 1990 Clean Air Act amendments), within many states, and internationally in locations ranging from the European Union to China.  But my purpose in this essay is to examine the origins of my research portfolio, and so I will turn instead to reflect on the ways my experience with Project 88 (and related policy engagements with the White House, the Congress, and others) stimulated new paths of my scholarly research.

One path of research activity soon focused on normative analysis of alternative policy instruments, including work on:  transaction costs in cap-and-trade markets (Journal of Environmental Economics and Management 1995), the effects of correlated uncertainty on the choice between price and quantity instruments (Journal of Environmental Economics and Management 1996), vintage-differentiated regulations (Stanford Environmental Law Journal 2006), and policy instruments in second-best settings (with Lori Bennear, Environmental and Resource Economics 2007).  [The work on correlated uncertainty also illustrates an example of another source of research ideas, namely picking up on research by someone else, because this work was directly inspired by a footnote in Professor Martin Weitzman's classic work on "Prices vs. Quantities" (Review of Economic Studies 1974).]

Another area of work on normative analysis of policy instruments focused broadly on market-based instruments (with Robert Hahn, American Economic Review 1992; with Richard Newell, Journal of Regulatory Economics 2003; and the Elsevier Handbook of Environmental Economics 2003).  Other work focused more specifically on cap-and-trade systems (Journal of Economic Perspectives 1998; with Robert Hahn, Journal of Law and Economics 2011; and with Richard Schmalensee, Journal of Economic Perspectives 2013).

A conceptually distinct path of research that also found its origins in my work on Project 88 has involved examinations of the positive political economy of environmental policy (with Robert Hahn, Ecology Law Quarterly 1991; with Nathaniel Keohane and Richard Revesz, Harvard Environmental Law Review 1998; with Robert Hahn and Sheila Olmstead, Harvard Environmental Law Review 2003).

Even this extensive set of research projects and publications that derive from my work on Project 88 — depicted in the figure above — understates the influence that my work on Project 88 with Senators Wirth and Heinz has had on my scholarly research over the years.  This is because much of my work on global climate change policy, for example, has in fact focused on the potential use of market-based instruments in that realm, but for purposes of this essay, I associate that later work on climate policy with two other origins, namely, conferences and funders.

Conferences and Funders

Gradually over the 25 years since receipt of my PhD, my research has evolved from diverse work across environmental and natural resources economics, to more and more focus each year on various aspects of global climate change and related public policies.

“Climate skeptics” and other opponents of action to address climate change have sometimes accused the research community of focusing on climate change because “that is where the money is.”  Although there are sound reasons for focusing on climate change other than the availability of funds (such as the importance of the problem, and the methodological challenges it poses), there is some partial truth to the accusation.  Indeed, numerous national governments and major philanthropic foundations have made it their goal to stimulate research (and action) on climate change.

One part of my work in this realm has been research on national and sub-national climate policy instruments, often focused on the design of market-based instruments, including but not limited to cap-and-trade mechanisms (Brookings Institution 2007; Harvard Environmental Law Review 2008; Oxford Review of Economic Policy 2008; and my work on the Intergovernmental Panel on Climate Change, Second, 1995, and Third, 2001, and Fifth Assessment Reports.

An invitation from the Doris Duke Charitable Foundation to propose and eventually direct an international research and outreach project on international climate policy architecture led to much (but not all) of my work on international climate policy cooperation (with Joseph Aldy and Scott Barrett, Climate Policy 2003; with Scott Barrett, International Environmental Agreements 2003: with Sheila Olmstead, American Economic Review 2006; three books with Joseph Aldy published by Cambridge University Press 2007, 2009, 2010; an article with Judson Jaffe and Matthew Ranson, Ecology Law Quarterly 2010; and ongoing work on the IPCC Fifth Assessment Report 2010-2014; and much more).

Student Interest

Many professors who are reading this essay will not be the least bit surprised to learn that another origin of research ideas has been interest expressed by graduate students.  Three important examples stand out in my case.

One I have already written about above.  When Richard Newell (my very first PhD student) came to Harvard for graduate school in 1993, he brought with him an abiding interest in the relationship between science, technology, and policy.  At the time, Adam Jaffe and I were continuing our work on the diffusion of energy-efficiency technologies, and then the U.S. Department of Energy (DOE) solicited proposals for research that could improve the modeling of technological change in integrated assessment models of climate change (so this covers two other origins — involvement with the policy world, and potential funding).  All of this came together in a joint research initiative, funded by DOE, which supported Newell’s dissertation research on factors affecting the pace and direction of energy-efficiency technology innovation.  This led to a subsequent publication with Jaffe and Newell (Quarterly Journal of Economics 1999), as well as series of other collaborations with Newell, which are on-going to this day.

In 1999, Sheila (Cavanagh) Olmstead came to the Harvard PhD program in public policy with a strong background and keen interests in water resources and water policy.  I brought on board Michael Hanemann, then a professor at the University of California at Berkeley, as a collaborator, and together we applied (successfully) to the National Science Foundation for a grant that supported Sheila’s dissertation research on econometrically estimating demand for municipal water in the presence of block-rate pricing schedules.  Not only did that lead directly to some published work (with Olmstead and Hanemann, Journal of Environmental Economics and Management 2007), but led indirectly to other research on water pricing(with Olmstead, Water Resources Research 2009).

The work on carbon sequestration and land use described above with Ruben Lubowski and Andrew Plantinga (Journal of Environmental Economics and Management 2006; Journal of Urban Economics 2002; Land Economics 2008) also deserves mention in this part of the essay, because it all grew out of Ruben Lubowski‘s PhD dissertation research at Harvard.

Responding to Others’ Work

I mentioned above an example of picking up on someone else’s work (in a positive sense), namely a footnote in Marty Weitzman’s classic 1974 article on “Prices vs Quantities” in which he noted that he was assuming statistical independence between marginal benefits and marginal costs, which stimulated me to relax that assumption and pursue the analysis (which led to my article on the effects of correlated uncertainty in 1996 in the Journal of Environmental Economics and Management).

By contrast, sometimes researchers can be stimulated to do work in order to question others’ previous work (and related conventional wisdom).  This was the case with my collaborative work examining the topic of “corporate social responsibility,” an area of scholarship that some colleagues and I believed was populated by research and writing that generated more heat than light.  A conference we organized at Harvard led to a subsequent book that examined Environmental Protection and the Social Responsibility of Firms:  Perspectives from Law, Economics, and Business (with Harvard Law School professor, Bruce Hay, and Harvard Business School professor, Richard Vietor, 2005).  Later, I took the next step with a follow-up article with Vietor and his Harvard Business School colleague, Forest Reinhardt (Review of Environmental Economics and Policy 2008), and another with Reinhardt (Oxford Review of Economic Policy 2010).

Teaching

Classroom teaching can itself provide inspiration for research.  In 2002, I was teaching a small “reading and research course” for PhD students interested in environmental economics, and lamented one day that the increasingly popular concept of “sustainability” seemed to lack a clear definition or interpretation that made sense in economic terms.  I offered a possible economic interpretation in class, and within a week, two students — Gernot Wagner and Alexander Wagner (unrelated) — had written out a mathematically formalized version of my interpretation.  We collaborated on writing a brief article that provided background as well as further exploration (Economic Letters 2003).

Consulting

It may (or may not) come as a surprise that consulting (work I do outside of my Harvard responsibilities, sometimes for compensation, sometimes not) can also lead to interesting research ideas.  In my case, this has led to my thinking more carefully — with collaborators — about the analytical methods that surround net present value analysis (also called, benefit-cost analysis).

This has led to a series of papers on various dimensions of net present value analysis in the environmental realm, including such topics as:  the meaning, limits, and value of the Kaldor-Hicks criterion (with Kenneth Arrow and others, Science 1996); the role of discounting (with Lawrence Goulder, Nature 2002); new benefit-estimation methods (with Paul Portney, Journal of Risk and Uncertainty 1994; and with Lori Bennear and Alexander Wagner, Journal of Regulatory Economics 2005); and the use of Monte Carlo analysis to incorporate uncertainty in regulatory impact analysis (with Judson Jaffe, Regulation and Governance 2007).

Also, as I mentioned at the outset, my 1988 dissertation topic had grown out of some consulting work I was doing at the time for the Environmental Defense Fund.

Class Assignments

Many of my PhD students over the years have written term papers for courses that led to manuscript that were eventually published in academic journals.  But in my own case, because my PhD training in economics at Harvard did not include any courses in environmental economics (none existed at the time, as you may have noted in my previous essay, “On Becoming an Environmental Economist”), the only example I can provide of this origin of research is in a different area, namely economic history.  This is an area in which I took two wonderful courses from Professor Jeffrey Williamson (about which I wrote in my previous post).  An econometric analysis I carried out for one of those courses — “A Model of English Demographic Change: 1573-1873″ was subsequently published (Explorations in Economic History 1988).

Invitations (and other origins)

There’s a clear positive correlation between the onset of grey hair and the frequency of invitations to write articles (or books) for publication.  These have included:  an article with Don Fullerton on how economists view the environment in Nature (1998); an article on common property resources in the American Economic Review (2011); my ongoing column, “An Economic Perspective” in The Environmental Forum (2006-present); my blog, “An Economic View of the Environment,” which was launched in 2009; two books of my collected works, 1988-1999 and 2000-2011 (Edward Elgar 2001, 2013); and three editions of a book of selected readings in environmental economics (W. W. Norton 2000, 2005, 2012).

Results of an Ex Post Exploration of Research Origins

Putting all of that together in a single flow chart results in the figure below, which is much clearer in a PDF version.  You can also view the entire PowerPoint presentation (you need to use Slide Show mode to see the animation) here.

As I said at the outset, I found the process of preparing this slide deck for Professor Bowles’s seminar valuable, because it enabled me to step back and reflect systematically on the origins of my research initiatives over the years and the relationships among them.  I recommend this process to other academics, because I believe it can be rewarding.  And, for academics in-the-making, that is, PhD students, I hope this essay may be informative.

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On Becoming an Environmental Economist

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My essay this month represents a departure from my standard blog posts about a contemporary environmental policy issue.  Rather, it is of a more personal nature, and stems from the fact that the second volume of my collected papers has just been published by Edward Elgar, Economics of Climate Change and Environmental Policy:  Selected Papers of Robert N. Stavins, 2000-2011 (2013), a successor to the first volume, published in 2000, Environmental Economics and Public Policy:  Selected Papers of Robert N. Stavins, 1988-1999.

When the publisher invited me to collect my papers in these edited volumes, it was suggested that I write a personal introduction in which I might reflect on the professional path that led to my research and writing.  I did this, and the introductory chapter of the second volume contains my latest reflections on that path.  This essay essentially consists of an abbreviated version.  My hope is that some readers will find it of interest, particularly students and others who aspire to work in this exciting and growing field.

A Professional Path

Over the past two decades, environmental and resource economics has evolved from what was once a relatively obscure application of welfare economics to a prominent field of economics in its own right.  The number of articles on the natural environment appearing in mainstream economics periodicals has continued to increase, as has the number of economics journals dedicated exclusively to environmental and resource topics.  Likewise, the influence of environmental economics on public policy has increased significantly, particularly as greater use has been made of market-based instruments for environmental protection.

In retrospect, my own professional path may now appear somewhat direct, if not altogether linear, but it hardly seemed so as I traveled along it.  The path I describe below took me back and forth across the United States and to several continents, and it took me from physics to philosophy, to agricultural extension, to international development studies, to agricultural economics, and eventually to environmental economics.  It culminated in my receipt in 1988 of a Ph.D. degree in economics at Harvard University, where I have since been a faculty member at the John F. Kennedy School of Government.  During this time, much has changed in the profession.

Early Days at Harvard

The early ascendency of the field of environmental economics, during the period from 1970 to 1990, was centered within departments of agricultural and resource economics, mainly at U.S. universities, and at Resources for the Future (RFF), the Washington research institution.  Within most economics departments, however, environmental studies remained a relatively minor area of applied welfare economics.  So, when I enrolled in the Ph.D. program in Harvard’s Department of Economics in 1983, and when I received my degree five years later, no field of study was offered in the field of environmental or resource economics.

Fortunately, Harvard permitted its graduate students to develop an optional, self-designed field as one of two “special fields” on which they were to be examined orally before proceeding to dissertation research.  Without an active environmental economist in the Department of Economics (Robert Dorfman had retired, and Martin Weitzman had yet to move to Harvard from the Massachusetts Institute of Technology), I developed an outline and reading list of the field through correspondence with leading scholars from other institutions, most prominently Kerry Smith, then at North Carolina State University.  My proposal to prepare for and be examined in the special field of environmental and resource economics (along with econometrics) was approved by the Department’s director of graduate study, Dale Jorgenson.  So began my entry into the scholarly literature.

A Nurturing Environment at Cornell

But my interest in environmental economics pre-dated by a considerable number of years my matriculation at Harvard.  Like many others before and since, I came to the field because of a personal interest in the natural environment (the origin of which I describe below).  This personal interest evolved into a professional one while I was studying for an M.S. degree in agricultural economics at Cornell University in the late 1970′s, where my thesis advisor and mentor was Kenneth Robinson.  I had originally gone to Cornell to study for a professional degree in international development, but found agricultural economics more appealing, largely because of the opportunity to examine social questions with quantitative methods within a disciplinary framework.

The faculty at Cornell and the care given to graduate students (including masters students like me) were both outstanding.  Ken Robinson, my first mentor within the economics profession, became my ongoing role model for intellectual integrity.  It was a very sad day in 2010 when Professor Robinson passed away.

A course in linear algebra, brilliantly taught by S. R. Searle, inspired me to pursue quantitative methods of analysis, and I was fortunate to then have the opportunity to study econometrics with Tim Mount.  One summer I had the great privilege of learning comparative economic systems in a small workshop setting from George Staller of the Cornell Department of Economics.   Working with Bud Stanton, I had my first experience teaching at the university level, and with Olan Forker, I had my first try at serious writing.  All of this led to research and writing of an M.S. thesis, “Forecasting the Size Distribution of Farms:  A Methodological Analysis of the Dairy Industry in New York State.”  The methodology in question was a variable Markov transition probability matrix, the cells of which were estimated econometrically in a multinomial logit framework.  Much to my surprise, this work subsequently received the Outstanding Master’s Thesis Award in the national competition of the American Agricultural Economics Association.

A Defining Move from Ithaca to Berkeley

Armed with my M.S. degree, I moved from Cornell to Berkeley, California, where I eventually met up with Phillip LeVeen, who had until shortly before that time been a faculty member in the Department of Agricultural and Resource Economics at the University of California, Berkeley.  Phil was another superb mentor, and from him I learned the power of using simple models — by which I mean a set of supply and demand curves hastily drawn on a piece of scrap paper — to develop insights into real-world policy problems.  He introduced me to a topic that was to occupy me for the next few years — California’s perpetual concerns with water allocation.  I remember many afternoons spent working with Phil at his dining room table on questions of water supply and demand.

This work with Phil LeVeen led to a consultancy and then a staff position with the Environmental Defense Fund (EDF), the national advocacy group consisting of lawyers, natural scientists, and — then almost unique among environmental advocacy organizations — economists.  At EDF, I was able to experience for the first time the use of economic analysis in pursuit of better environmental policy.  With W. R. Zach Willey, EDF’s senior economist in California, as a role model, and Thomas Graff, EDF’s senior attorney, as my mentor, I thrived in EDF’s collegial atmosphere, while thoroughly enjoying life in Berkeley’s “gourmet ghetto,” as my neighborhood was called.  Sadly, Tom Graff — without whose mentorship I would not be where I am today — passed away in 2009 after a heroic battle with cancer.

Although I found the work at EDF exceptionally rewarding, I worried that I would eventually be constrained — either within the organization or outside it — by my limited education.  So, like many others in similar situations, I considered a law degree as the next logical step.  In fact, I came very close to enrolling at Stanford Law School, but instead, in 1983, I accepted an offer of admission to the Department of Economics at Harvard, moved back east to Cambridge, Massachusetts, and began what has turned out to be a long-term relationship with the University.

Origins of Interest in Environmental Economics

But where did my interest in the natural environment begin?  Not at Cornell; it was present long before those days.  But it had not yet arisen when I was studying earlier at Northwestern University, from which I received a B.A. degree in philosophy, having departed from my first scholarly interest, astronomy and astrophysics.

Rather, the origins of my affinity for the natural environment and my interest in resource issues are to be found in the four years I spent in a small, remote village in Sierra Leone, West Africa, as a Peace Corps Volunteer, working in agricultural extension (in particular, paddy rice development).  It was there that I was first exposed both to the qualities of a pristine natural environment and the trade-offs associated with economic development.

So, I had begun in astrophysics, moved to philosophy (both at Northwestern), then to agricultural extension in a developing country (Sierra Leone), then to international development studies and subsequently to agricultural economics (both at Cornell), then to environmental economics and policy (EDF), and eventually to graduate study in economics at Harvard.

From Berkeley to Cambridge

My dissertation research at Harvard was directed by a committee of three faculty members:  Joseph Kalt, Zvi Griliches, and Adam Jaffe.  Joseph Kalt was the first faculty member at the Department of Economics to validate my interest in environmental and resource issues, and he was unfailingly generous to me and many other graduate students in making his office (and computer, then a rather scarce resource) available at all hours.  Now a colleague at the Kennedy School, Joe provided examples never to be forgotten — that economics could be a meaningful and enjoyable pursuit, and that excellence in teaching was a laudable goal.

Zvi Griliches was not only my advisor and mentor, but my spiritual father as well.  Generations of Harvard graduate students would offer similar testimony.  My own father had died only a year before I entered Harvard, and Zvi soon filled for me many paternal needs.  It is now more than a decade since Zvi himself passed away.  I felt as if I had lost my father a second time.

If Zvi Griliches provided caring and inspiration, Adam Jaffe provided invaluable day-to-day guidance.  It was Adam who convinced me not to go on the job market in my fourth year with what would have been a mediocre dissertation, but to put in another year and do it right.  That turned out to be some of the best professional advice I have ever received.  Our intensive faculty-student relationship from dissertation days subsequently evolved into a very productive professional (and personal) one that continues to this day.  The name of Adam Jaffe appears frequently in my curriculum vitae as a co-author; he has been and continues to be much more than that.

Although they were not members of my thesis committee, I should acknowledge two other faculty members at the Harvard Department of Economics who played important roles in my education.  I was fortunate to take two courses in economic history (a department requirement) from Jeffrey Williamson, who had recently arrived from the University of Wisconsin.  Williamson’s class sessions were as close as anything I have witnessed to being an economic research laboratory.  In class after class, we would carefully dissect one or more articles — examining hypothesis, theoretical model, data, estimation method, results, and conclusions.  If there was any place where I actually learned how to carry out economic research, it was in those classes.

The other name that is important to highlight is that of Lawrence Goulder, then a faculty member at Harvard, and now a professor at Stanford.  I say this not simply because he was willing to be my examiner in my chosen field of environmental and resource economics, nor because he subsequently became such a close friend.  Rather, what is striking about my professional relationship with Larry is the degree to which he has been an unnamed collaborator on so many projects of mine.  Although he and I have co-authored no more than a few articles, his name probably appears more frequently than anyone else’s in the acknowledgments of papers I have written.  There is no one whose overall judgement in matters of economics I trust more, and no one who has been more helpful.

First Steps for a Newly-Minted Ph.D. Recipient

When I began graduate school at Harvard in 1983, it was my intention to return to EDF as soon as I received my degree.  But by my third year in the program, I had decided to pursue an academic career, although one that was heavily flavored with involvement in the real world of public policy.  Within the context of this professional objective, it was not a difficult decision to accept the offer I received in February, 1988, to become an Assistant Professor at the Kennedy School.  Although some of the other offers I received at that time were also very attractive, the choice for me was obvious, and I have never regretted it — not for a moment.

I remain at the Kennedy School today, where I was promoted to Associate Professor in 1992 (an untenured rank at Harvard), and to a tenured position as Professor of Public Policy in 1997.   In 1998, I accepted an appointment as the Albert Pratt Professor of Business and Government.

Twenty-Five Years on the Harvard Faculty

Two years later, I launched the Harvard Environmental Economics Program, which today brings together — from across the University — thirty Faculty Fellows and twenty-five Pre-Doctoral Fellows, who are graduate students studying for the Ph.D. degree in economics, political economy and government, public policy, or health policy.  The Program, which I continue to direct, forms links among faculty and graduate students engaged in research, teaching, and outreach in environmental, natural resource, and energy economics and related public policy, by sponsoring research projects, convening workshops, and supporting graduate (and undergraduate) education.

A key reason why the Program — and its various projects, including the Harvard Project on Climate Agreements — have been so successful is the superb administrative leadership and staff support  it enjoys.  Everyone who has been involved in virtually any way has come away impressed by our Executive Director, Robert Stowe, and Program Manager, Jason Chapman.

At the Kennedy School, I have had an excellent mentor, William Hogan, and a superb advisor and friend, Richard Zeckhauser.  Over the years, five successive deans have provided leadership, guidance, and support (including abundant time for my research and writing) — Graham Allison, Robert Putnam, Albert Carnesale, Joseph Nye, and David Ellwood.  At Harvard more broadly, I have benefitted from regular interactions with Daniel Schrag, director of the Harvard University Center for the Environment, and Martin Weitzman of the Department of Economics.  For two decades, Marty and I have co-directed a bi-weekly Seminar in Environmental Economics and Policy, which has provided me with frequent opportunities to learn both from seminar speakers and from Marty’s questions and comments.  I will refrain from naming the many others at Harvard and elsewhere from whom I continue to learn — including my many co-authors — only because the list of such valued colleagues and friends is so long.  Included have been a most remarkable set of Ph.D. students, many of whom have gone on to productive — indeed illustrious — careers.

Along the way, I have had my share of administrative responsibilities at Harvard, including serving as Director of Graduate Studies for the Doctoral Program in Public Policy and the Doctoral Program in Political Economy and Government, and Co-Chair of the Harvard Business School-Harvard Kennedy School Joint Degree Programs.  Outside of Harvard, I have had the privilege of being a University Fellow of Resources for the Future, a Research Associate of the National Bureau of Economic Research, and the founding Editor and now Co-Editor of the Review of Environmental Economics and Policy, as well as a member of the Board of Directors of Resources for the Future, the Scientific Advisory Board of the Fondazione Eni Enrico Mattei, and numerous editorial boards. I must also note that I serve as an editor of the Journal of Wine Economics.  In 2009, I was elected a Fellow of the Association of Environmental and Resource Economists.

Working with the “Real World”

What originally attracted me to the Kennedy School was the possibility of combining an academic career with extensive involvement in the development of public policy.  I have not been disappointed.  Indeed, a theme that emerges from my collected papers is the interplay between scholarly economic research and implementation in real-world political contexts.  This is a two-way street.   In some cases, my policy involvement has come from expertise I developed through research, following a path well worn by academics.  But, in many other cases, my participation in policy matters has stimulated for me entirely new lines of inquiry.

What I have characterized as involvement in policy matters is described at the Kennedy School as faculty outreach, recognized to be of great institutional and social value, along with the two other components of our three-legged professional stool — research and teaching.  Because they relate to a number of the papers collected in this volume, I should note that my outreach efforts fall into five broad categories:  advisory work with members of Congress and the White House (for example, Project 88, a bipartisan effort co-chaired by former Senator Timothy Wirth and the late Senator John Heinz, to develop innovative approaches to environmental and resource problems); service on federal government panels (for example, my role as Chairman of the Environmental Economics Advisory Committee of the U.S. Environmental Protection Agency Science Advisory Board); on-going consulting — often on an informal basis — with environmental NGOs (most frequently, the Environmental Defense Fund) and private firms; advisory work with state governments; and professional interventions in the international sphere, such as service as a Lead Author for the Second and the Third Assessment Reports and a Coordinating Lead Author for the Fifth Assessment Report of the Intergovernmental Panel on Climate Change, professional roles with the World Bank and other international organizations, and advisory work with foreign governments.

Finally, because my two books of collected papers focus on my articles, not my books, I should note that over the years I have been privileged to be co-editor with Joseph Aldy of Post-Kyoto International Climate Policy:  Implementing Architectures for Agreement (Cambridge University Press, 2010), Post-Kyoto International Climate Policy:  Summary for Policymakers (Cambridge University Press, 2009), and Architectures for Agreement: Addressing Global Climate Change in the Post-Kyoto World (Cambridge University Press, 2007); editor of three editions of Economics of the Environment (W. W. Norton, 2000, 2005, 2012); co-editor with Bruce Hay and Richard Vietor of Environmental Protection and the Social Responsibility of Firms:  Perspectives from Law, Economics, and Business (Resources for the Future, 2005); editor of The Political Economy of Environmental Regulation (Edward Elgar, 2004), co-editor with Paul Portney of Public Policies for Environmental Protection (Resources for the Future, 2000); and author of Environmental Economics and Public Policy: Selected Papers of Robert N. Stavins, 1988-1999 (Edward Elgar, 2000).

The New Volume

That last book is the predecessor of the new volume.  Whereas the first volume (Stavins 2000) included selected papers from the period 1988 through 1999, the second volume covers the period from 2000 through 2011.  To prepare this new book, I selected 26 articles from the (many more) published papers I wrote  — frequently with co-authors — over the past decade.  Making this selection was not an easy task, but it was a rewarding one, because choosing the papers and organizing them has forced me to step back and reflect on the set of research endeavors in which I have been engaged over this decade, and thus to think more clearly about current and possible future directions.

The book is divided into seven parts.  The papers in Part I provide an overview of environmental and resource economics, treating broadly several key topics, including economic views of:  the problem of the commons (Stavins, American Economic Review, 2011); the history of U.S. environmental regulation (Hahn, Olmstead, and Stavins, Harvard Environmental Law Review, 2003); and corporate social responsibility (Reinhardt, Stavins, and Vietor, Review of Environmental Economics and Policy, 2008).

The articles in Part II deal with methods of environmental policy analysis, focusing, respectively, on:  interpreting sustainability in economic terms (Stavins, Wagner, and Wagner, Economic Letters, 2003); the use of discounting in net present value analysis (Goulder and Stavins, Nature, 2002); the development of a new revealed-preference method for inferring environmental benefits (Bennear, Stavins, and Wagner, Journal of Regulatory Economics, 2005); and the value of formal assessment of uncertainty (that is, Monte Carlo analysis) in regulatory impact analysis (Jaffe and Stavins, Regulation and Governance, 2007).

Part III turns to economic analysis of alternative environmental policy instruments, with examinations of: vintage-differentiated environmental regulation (Stavins, Stanford Environmental Law Journal, 2006); cost heterogeneity and the potential savings from employing market-based environmental policies (Newell and Stavins, Journal of Regulatory Economics, 2003); the effects of allowance allocations on the performance of cap-and-trade systems (Hahn and Stavins, Journal of Law and Economics, 2011); and second-best theory and the use of multiple policy instruments (Bennear and Stavins, Environmental and Resource Economics, 2007).

Part IV focuses on a topic that also received considerable treatment in the predecessor to this volume, namely the economics of technological change.  Here the articles include: a survey of the literature on environmental policy and technological change (Jaffe, Newell, and Stavins, Environmental and Resource Economics, 2002); an analysis of the interaction of environmental and technological market failures (Jaffe, Newell, and Stavins, Ecological Economics, 2005); an empirical assessment of the effect of environmental regulation on technology diffusion in the case of chlorine manufacturing (Miller, Snyder, and Stavins, American Economic Review Papers and Proceedings, 2003); and the effects of economic and policy incentives on carbon mitigation technologies (Jaffe, Newell, and Stavins, Energy Economics, 2006).

Part V consists of three articles in the area of natural resource economics dealing with land and water resources:  an analysis of the factors driving land-use change in the United States (Lubowski, Plantinga, and Stavins, Land Economics, 2008); an econometric examination of the significance of terroir, the notion that wine quality is primarily determined by location (Cross, Plantinga, and Stavins, American Economic Review Papers and Proceedings, 2011); and an assessment of urban water demand under alternative pricing structures (Olmstead, Hanemann, and Stavins, Journal of Environmental Economics and Management, 2007).

Part VI consists of four articles on domestic (national and sub-national) climate change policy, beginning with a description and assessment of a comprehensive U.S. cap-and-trade system for carbon dioxide and other greenhouse gas emissions (Stavins, Oxford Review of Economic Policy, 2008), and followed by:  an examination of the interactions of national and sub-national climate policies (Goulder and Stavins, American Economic Review Papers and Proceedings, 2011); an econometric study of the carbon-sequestration supply function (Lubowski, Plantinga, and Stavins, Journal of Environmental Economics and Management, 2006); and an assessment of the factors that affect the costs of biological carbon sequestration (Newell and Stavins, Journal of Environmental Economics and Management, 2000).

Finally, Part VII focuses on the international dimensions of climate change policy, and consists of four articles:  a comparison of alternative global climate change policy architectures (Aldy, Barrett, and Stavins, Climate Policy, 2003); an assessment of the Kyoto Protocol (Stavins, Milken Institute Review, 2005); an examination of a promising post-Kyoto international climate regime (Olmstead and Stavins, American Economic Review Papers and Proceedings, 2006); and a detailed examination of a key element of emerging international climate policy architecture, namely the linkage of regional, national, and sub-national tradable permit systems (Ranson, Jaffe, and Stavins, Ecology Law Quarterly, 2010).

Reflections on Common Themes

Selecting the essays for this second volume of my papers permitted me to take note of some common themes that emerge from this decade of research and writing.  First, there is the value — or at least, the potential value — of economic analysis of environmental policy.  The cause of virtually all environmental problems in a market economy is economic behavior (that is, imperfect markets affected by externalities), and so economics offers a powerful lens through which to view environmental problems, and therefore a potentially effective set of analytical tools for designing and evaluating environmental policies.

A second message, connected with the first, is the specific value of benefit-cost analysis for helping to promote efficient policies.  Economic efficiency ought to be one of the key criteria for evaluating proposed and existing environmental policies.  Despite its limitations, benefit-cost analysis can be useful for consistently assimilating the disparate information that is pertinent to sound decision making.  If properly done, it can be of considerable help to public officials when they seek to establish or assess environmental goals.

Third, the means governments use to achieve environmental objectives matter greatly, because different policy instruments have very different implications along a number of dimensions, including abatement costs in both the short and the long term.  Market-based instruments are particularly attractive in this regard.

Fourth, an economic perspective is also of considerable value when reflecting on the use of natural resources, whether land, water, fisheries, or forests.  Excessive rates of depletion of these resources are frequently due to the nature of the respective property-rights regimes, in particular, common property and open-access.  Economic instruments — such as ITQ systems in the case of fisheries — can and have been employed to bring harvesting rates down to socially efficient levels.

Fifth and finally, policies for addressing global climate change — linked with emissions of carbon dioxide and other greenhouse gases — can benefit greatly from the application of economic thinking.  On the one hand, the long time-horizon of climate change, the profound uncertainty in links between emissions and actual damages, and the possibility of catastrophic climate change present significant challenges to conventional economic analysis.  But, at the same time, the ubiquity of energy generation and use in modern economies means that only market-based policies — essentially carbon pricing regimes — are feasible instruments for achieving truly meaningful emissions reductions.  Hence, despite the challenges, an economic perspective on this grandest of environmental threats is essential.

Final Words

On a personal level, the professional path I have taken offers some confirmation that research can influence public policy, and it also illustrates that involvement in public policy can stimulate new research.  The quest — both professional and personal — that took me from Evanston, Illinois, to Sierra Leone, West Africa, to Ithaca, New York, to Berkeley, California, and finally to Cambridge, Massachusetts suggests some consistency of purpose and even function.  I continue to find myself doing similar things, but in different contexts.  It is fair to say that my professional life has taken me along a path that has brought me home.  The words of T. S. Eliot (1943) ring true:

                                        We shall not cease from exploration
                                        And the end of all our exploring
                                        Will be to arrive where we started
                                        And know the place for the first time.
 

Selecting the papers for this volume forces me to reflect on the past and think more clearly about the future.  The twenty-six articles that comprise this book and the twenty-two essays that comprised the predecessor volume are the product of twenty-three wonderful years on the faculty of the Harvard Kennedy School.  During this time, I have continued to learn about environmental economics and related public policy from colleagues, collaborators, students, friends, and inhabitants of the ”real world” of public policy, individuals from government, private industry, advocacy groups, and the press.  I hope that my learning will continue.

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The Second Term of the Obama Administration

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In his inaugural address on January 21st, President Obama surprised many people – including me – by the intensity and the length of his comments on global climate change.  Since then, there has been a great deal of discussion in the press and in the blogosphere about what climate policy initiatives will be forthcoming from the administration in its second term.

Given all the excitement, let’s first take a look at the transcript of what the President actually said on this topic:

            We will respond to the threat of climate change, knowing that the failure to do so would betray our children and future generations. Some may still deny the overwhelming judgment of science, but none can avoid the devastating impact of raging fires, and crippling drought, and more powerful storms.  The path towards sustainable energy sources will be long and sometimes difficult. But American cannot resist this transition.  We must lead it.  We cannot cede to other nations the technology that will power new jobs and new industries.  We must claim its promise. That’s how we will maintain our economic vitality and our national treasure, our forests and waterways, our crop lands and snow capped peaks.  That is how we will preserve our planet, commanded to our care by God.

Strong and plentiful words.  Although I was certainly surprised by the strength and length of what the President said in his address, I confess that it did not change my thinking about what we should expect from the second term.  Indeed, I will stand by an interview that was published by the Harvard Kennedy School on its website five days before the inauguration (plus something I wrote in a previous essay at this blog in December, 2012).  Here it is, with a bit of editing to clarify things, and some hyperlinks inserted to help readers.

The Second Term: Robert Stavins on Energy and Environmental Policy

January 16, 2013

By Doug Gavel, Harvard Kennedy School Communications

President Obama’s second term in office began on Inauguration Day, January 21st, and the list of policy challenges facing his administration is daunting. Aside from the difficult task of addressing the nation’s economic woes, the president and his administration will also deal with the increasing complexities of global climate change, a rapidly changing energy market, entitlement and tax reform, healthcare reform, and the repercussions from the still simmering “Arab Spring.” Throughout this month, we will solicit the viewpoints of a variety of HKS faculty members to provide a range of perspectives on the promise and pitfalls of The Second Term.

We spoke with Robert Stavins, Albert Pratt Professor of Business and Government, and Director of the Harvard Environmental Economics Program, about energy and environmental policy issues the president will face in the next four years.

Q: What are the top priorities for a second Obama administration in energy and environmental policy?

A: The Obama administration faces a number of impending challenges in the energy and environmental policy realm in its second term, which I would characterize – in very general terms – as finding balance among three competing factors: (1) demands from some constituencies for more aggressive environmental policies; (2) demands from other constituencies – principally in the Congress – for progress on so-called “energy security;” and (3) recognition that nothing meaningful is likely to happen if the country’s economic problems are not addressed.

Q: What will be the potential challenges/roadblocks in the way of implementing those top priorities?

A: The key challenge the administration faces in its second term as it attempts to achieve some balance among these three competing objectives is the reality of a very high degree of political polarization in the two houses of Congress.

The numbers are dramatic.  For example, when the Clean Air Act Amendments of 1990 that established the landmark SO2 allowance trading system were being considered in the U.S. Congress, political support was not divided on partisan lines. Indeed, environmental and energy debates from the 1970s through much of the 1990s typically broke along geographic lines, rather than partisan lines, with key parameters being degree of urbanization and reliance on specific fuel types, such as coal versus natural gas. The Clean Air Act Amendments of 1990 passed the U.S. Senate by a vote of 89-11 with 87 percent of Republican members and 91 percent of Democrats voting yea, and the legislation passed the House of Representatives by a vote of 401-21 with 87 percent of Republicans and 96 percent of Democrats voting in support.

But, 20 years later when climate change legislation was receiving serious consideration in Washington, environmental politics had changed dramatically, with Congressional support for environmental legislation coming mainly to reflect partisan divisions. In 2009, the U.S. House of Representatives passed the American Clean Energy and Security Act of 2009 (H.R. 2454), often known as the Waxman-Markey bill, that included an economy-wide cap-and-trade system to cut carbon dioxide (CO2) emissions. The Waxman-Markey bill passed by a narrow margin of 219-212, with support from 83 percent of Democrats, but only 4 percent of Republicans. (In July 2010, the U.S. Senate abandoned its attempt to pass companion legislation.) Political polarization in the Congress (and the country) has implications far beyond energy and environmental policy, but it is particularly striking in this realm.

Q: In the Obama administration’s second term, are there openings/possibilities for compromises in those areas?

A: It is conceivable – but in my view, unlikely – that there may be an opening for implicit (not explicit) “climate policy” through a carbon tax. At a minimum, we should ask whether the defeat of cap-and-trade in the U.S. Congress, the virtual unwillingness over the past 18 months of the Obama White House to utter the phrase “cap-and-trade” in public, and the defeat of Republican Presidential candidate Mitt Romney indicate that there is a new opening for serious consideration of a carbon-tax approach to meaningful CO2 emissions reductions in the United States.

First of all, there surely is such an opening in the policy wonk world. Economists and others in academia, including important Republican economists such as Harvard’s Greg Mankiw and Columbia’s Glenn Hubbard, remain enthusiastic supporters of a national carbon tax. And a much-publicized meeting in July, 2012, at the American Enterprise Institute in Washington, D.C. brought together a broad spectrum of Washington groups – ranging from Public Citizen to the R Street Institute – to talk about alternative paths forward for national climate policy. Reportedly, much of the discussion focused on carbon taxes.

Clearly, this “opening” is being embraced with enthusiasm in the policy wonk world. But what about in the real political world? The good news is that a carbon tax is not “cap-and-trade.” That presumably helps with the political messaging! But if conservatives were able to tarnish cap-and-trade as “cap-and-tax,” it surely will be considerably easier to label a tax – as a tax! Also, note that President Obama’s silence extends beyond disdain for cap-and-trade per se. Rather, it covers all carbon-pricing regimes.

So as a possible new front in the climate policy wars, I remain very skeptical that an explicit carbon tax proposal will gain favor in Washington. Note that the only election outcome that could have lead to an aggressive and successful move to a meaningful nationwide carbon pricing regime would have been: the Democrats took back control of the House of Representatives, the Democrats achieved a 60+ vote margin in the Senate, and the President was reelected. Only the last of these happened. It’s not enough.

A more promising possibility – though still unlikely – is that if Republicans and Democrats join to cooperate with the Obama White House to work constructively to address the short-term and long-term budgetary deficits the U.S. government faces, and if as part of this they decide to include not only cuts in government expenditures, but also some significant “revenue enhancements” (the t-word is not allowed), and if (I know, this is getting to be a lot of “ifs”) it turns out to be easier politically to eschew increases in taxes on labor and investment and turn to taxes on consumption, then there could be a political opening for new energy taxes, even a carbon tax.

Such a carbon tax – if intended to help alleviate budget deficits – could not be the economist’s favorite, a revenue-neutral tax swap of cutting distortionary taxes in exchange for implementing a carbon tax. Rather, as a revenue-raising mechanism – like the Obama administration’s February 2009 budget for a 100%-auction of allowances in a cap-and-trade scheme – it would be a new tax, pure and simple. Those who recall the 1993 failure of the Clinton administration’s BTU-tax proposal – with a less polarized and more cooperative Congress than today’s – will not be optimistic.

Nor is it clear that a carbon tax would enjoy more support in budget talks than a value added tax (VAT) or a Federal sales tax. The key question is whether the phrases “climate policy” and “carbon tax” are likely to expand or narrow the coalition of support for an already tough budgetary reconciliation measure.  The key group to bring on board will presumably be conservative Republicans, and it is difficult to picture them being more willing to break their Grover Norquist pledges because it’s for a carbon tax.

What remains most likely to happen is what I’ve been saying for several years, namely that despite the apparent inaction by the Federal government, the official U.S. international commitment — a 17 percent reduction of CO2 emissions below 2005 levels by the year 2020 – is nevertheless likely to be achieved!  The reason is the combination of CO2 regulations which are now in place because of the Supreme Court decision [freeing the EPA to treat CO2 like other pollutants under the Clean Air Act], together with five other regulations or rules on SOX [sulfur compounds], NOX [nitrogen compounds], coal fly ash, particulates, and cooling water withdrawals. All of these will have profound effects on retirement of existing coal-fired electrical generation capacity, investment in new coal, and dispatch of such electricity.

Combined with that is Assembly Bill 32 (AB 32) in the state of California, which includes a CO2 cap-and-trade system that is more ambitious in percentage terms than Waxman-Markey was in the U.S. Congress, and which became binding on January 1, 2013.  Add to that the recent economic recession, which reduced emissions. And more important than any of those are the effects of developing new, unconventional sources of natural gas in the United States on the supply, price, and price trajectory of natural gas, and the consequent dramatic movement that has occurred from coal to natural gas for generating electricity.  In other words, there will be actions having significant implications for climate, but most will not be called “climate policy,” and all will be within the regulatory and executive order domain, not new legislation.

Q: Are there lessons that a second Obama administration can draw upon from the first administration, or from history, when constructing its energy & environmental policy over the next four years?

A: It will take a great deal of dedicated effort and profound luck to find political openings that can bridge the wide partisan divide that exists on climate change policy and other environmental issues. Think about the following. Nearly all our major environmental laws were passed in the wake of highly publicized environmental events or “disasters,” including the spontaneous combustion of the Cuyahoga River in Cleveland, Ohio, in 1969, and the discovery of toxic substances at Love Canal in Niagara Falls, New York, in the mid-1970s. But note that the day after the Cuyahoga River caught on fire, no article in The Cleveland Plain Dealer commented that the cause was uncertain, that rivers periodically catch on fire from natural causes. On the contrary, it was immediately apparent that the cause was waste dumped into the river by adjacent industries. A direct consequence of the observed “disaster” was, of course, the Clean Water Act of 1972.

But climate change is distinctly different. Unlike the environmental threats addressed successfully in past U.S. legislation, climate change is essentially unobservable to the general population. We observe the weather, not the climate.  Notwithstanding last year’s experience with Super Storm Sandy, it remains true that until there is an obvious, sudden, and perhaps cataclysmic event – such as a loss of part of the Antarctic ice sheet leading to a dramatic sea-level rise – it is unlikely that public opinion in the United States will provide the tremendous bottom-up demand that inspired previous congressional action on the environment over the past forty years.

That need not mean that there can be no truly meaningful, economy-wide climate policy (such as carbon-pricing) until disaster has struck.  But it does mean that bottom-up popular demand may not come in time, and that instead what will be required is inspired leadership at the highest level that can somehow bridge the debilitating partisan political divide.

Postscript:  Please note that the Kennedy School series on the second term of the Obama administration also includes an interview with my colleague, Professor Joseph Aldy, offering his own views on potential environmental policy developments in the next four years.

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Reflections from Cambridge on the Climate Talks in Doha

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Ever since I returned – some two weeks ago – from Doha, Qatar, the site of the Eighteenth Conference of the Parties (COP-18) of the United Nations Framework Convention on Climate Change (UNFCCC), I have planned to offer some commentary on this year’s annual climate negotiations, including the principal outcome, namely, the “Doha Gateway.” I decided to wait, mainly in order to put some geographic and temporal distance between the conference and my thoughts, so that I could reflect on “the forest,” rather than enumerating “the trees.”

Then, a few days ago, a reporter from the Harvard Gazette, Alvin Powell, came to my office to discuss this very subject. Having covered this and related topics for a number of years, he has considerable background on both the science and the policy. And he had done his homework to prepare for the interview. When I read the published result just now in the Harvard Gazette, I realized that this is – in fact – the reflection I had wanted to write for readers of this blog. So I’m offering it here.

The interview started with a quick history of climate negotiations, a brief description of my own role at COP-18 in Doha, and then an assessment of the conference’s outcome. From there, the conversation became more freewheeling, with Mr. Powell asking me about the status of U.S. climate policy, as well as the potential role and responsibility of a major research university such as ours. At the end of the interview, we returned to reflections on the slow pace of international climate negotiations.

You can read the original version in the Harvard Gazette here, but I also offer the published version below without any editing (but with the addition of some hyperlinks for interested readers).

Harvard Gazette

Climate change on world stage

Q&A with Robert Stavins on prospects for adopting a plan to confront it

By Alvin Powell

Harvard Staff Writer

Wednesday, December 19, 2012

International climate talks wrapped up last week in Qatar. Harvard Professor Robert Stavins attended and characterized the gathering as a qualified success, representing another step in a long process of reaching a workable international agreement.

Gazette staff writer Al Powell talked with Stavins about the work of international delegates and the prospects for a meaningful agreement going forward.

GAZETTE: Can you explain the purpose of these talks?

STAVINS: In 1992, at a United Nations conference in Rio de Janeiro, a major outcome was the adoption of the United Nations Framework Convention on Climate Change. Among other things, that convention provided for annual conferences at which representatives of countries would get together to discuss and negotiate how to address the threat of climate change. These annual negotiations go by the name of a “Conference of the Parties,” commonly abbreviated as a “COP.” COP-1 took place in Berlin in 1995, and COP-18 just took place in Doha, Qatar, in December 2012.

GAZETTE: What is your role at these conferences?

STAVINS: My role is typically on behalf of the Harvard Project on Climate Agreements. Our purpose is to help the various national negotiating teams identify modes of international cooperation that will address climate change in ways that are scientifically sound, economically rational, and politically pragmatic.

We hold events to which everyone is invited, two events this time. One of the mandates that came out of the Durban conference in December 2012 was for the delegates to think about new ways they can make use of the market to address the threat of climate change. We put together a panel of people to talk about potential “new market mechanisms.” We had a room with a capacity of several hundred, and every seat was taken. People were standing in the aisles, sitting on the floors, and spilling out into the hallway waiting to get in. In other words, interest in our intellectual contributions was at a high level. Importantly, the session was jointly sponsored with the Enel Foundation and the International Emissions Trading Association, which is a trade association of companies interested in emissions trading and related mechanisms.

The second event was co-sponsored with the government of the State of Qatar, and looked forward, post-Doha, to the potential paths ahead, with particular focus on the problems of arid countries, a chronic issue for the Middle East. The panel included Fahad Bin Mohammed Al-Attiya, chairman of the Qatar National Food Security Programme, who is one of the key thinkers and leaders on these issues.

In addition, we carry out bilateral meetings with negotiating teams and also do press meetings. Typically, we hold a couple dozen such meetings.

GAZETTE: How do you feel the conference went?

STAVINS: My view is that these international negotiations need to be viewed not as a sprint, in which you win or lose, but as a very long distance relay race, and the Qataris succeeded in handing off the baton.

The Qataris invited us to Doha last summer to help them begin to think about what success at the December conference would look like and how they could achieve it. There were three aspects to what we identified in advance as success, and they achieved all three, though maybe not to the degree or in the way that every country in the world would have preferred.

GAZETTE: What were those three?

STAVINS: First, they successfully brought to a close negotiations on a second commitment of the Kyoto Protocol, that is, extending the protocol beyond its first commitment period, which expires at the end of 2012. The second commitment period is now set. It will run to 2020. Second, they also brought to a successful close negotiations in what was called the Long Term Cooperative Action track, which included a set of issues that were put on the table at COP-13 in Bali in December 2007. Third, they began to make some progress on the one remaining negotiating track, which is the Durban Platform for Enhanced Action. They initiated discussions about establishing, by 2015, a comprehensive new international agreement, for implementation by 2020, that will include all key countries in the world, including the major emerging economies of China, India, Brazil, Korea, South Africa, and Mexico. That itself is a departure from the Kyoto Protocol, which is focused exclusively on a subset of countries of what used to be characterized as the industrialized world.

The negotiators from around the world did not make as much progress on the Durban platform as I would have hoped. But at a very minimum they did no harm, and that’s very important. That is, they did not introduce any problematic text into the negotiations that will later cause problems. In general, my view of these annual Conferences of the Parties is similar to the physician’s Hippocratic Oath: Do no harm, and keep things moving ahead.

GAZETTE: In looking at news coverage, I read about two emotions, anger and despair, felt by some after the conference. Are those warranted?

STAVINS: AOSIS [Alliance of Small Island States] nations are the most extreme in their point of view, for very good reasons, and they were surely disappointed by the outcomes. They’ve been very vocal, again for good reason. But the major emitters, the only ones that can do anything about the problem — the United States, China, the other large economies of the world, among them — there was recognition that in the real world, this is what success looks like.

I think of this as if we’re back at Bretton Woods in 1944, when Europe was in shambles. An agreement was reached at Bretton Woods, but it took 50 years to establish the World Trade Organization, and to continue the process of putting the global financial house in order. The problem of global climate change is actually more difficult politically than the economic problems that the world faced after World War II. We have this terrible situation where those who can reduce their emissions now are not the ones who will be damaged by climate change. You’re asking current voters to foot the bill, while it’s the future generation that will benefit from reduced damage. Furthermore, any country taking action will foot the bill for its costs, but the benefits of those actions — reduced climate change — will be spread globally. Hence, for any individual country the direct benefits of action will inevitably be less than the direct costs of action, despite the fact that global benefits may be considerably greater than global costs. That’s the global commons problem, and it creates an incentive for each country to free ride on the actions of others. So politically, it’s an exceptionally challenging problem.

GAZETTE: What about the gap between the emissions cuts that were promised and that have been achieved?

STAVINS: What became clear to me at the conference is that there is increasing acceptance of three facts from a broad set of delegations. One was that the frequently discussed target of limiting concentrations to 450 parts per million [of CO2 in the atmosphere], which is equated to approximately 2 degrees centigrade maximum warming, is simply not achievable.

Number two, there’s increasing recognition that a bottom-up international policy architecture is probably the future path forward, not a top-down approach. By top down, I mean a highly centralized approach like the Kyoto Protocol, with targets and timetables, as opposed to a bottom-up, pledge-and-review approach in which each country essentially says, “Look, this is what I can do,” and they put all of those into the hopper.

The third thing I observed was that there was greatly increased acceptance of the reality that market–based approaches to emissions reduction are absolutely essential. One heard this in the past from economists and from certain countries, but now it is unanimous, except for the small set of Marxist economies that essentially object to the world economic order.

GAZETTE: Where does the U.S. stand on that issue?

STAVINS: The U.S. has been at the forefront of that approach back to the Clinton administration. What’s interesting is that the official U.S. commitment under this pledge-and-review approach, a 17 percent reduction below 2005 emissions by the year 2020, is very likely to be achieved.

The reason is the combination of CO2 regulations which are now in place because of the Supreme Court decision [freeing the EPA to treat CO2 like other pollutants under the Clean Air Act], together with five other regulations or rules on SOX [sulfur compounds], NOX [nitrogen compounds], coal fly ash, particulates, and cooling water withdrawals. All of those will have profound effects on retirement of existing coal-fired electrical generation capacity, investment in new coal, and dispatch of such electricity. Combined with that is California, which Jan. 1, 2013, is putting in place a CO2 cap-and-trade system that is more ambitious in percentage terms than Waxman-Markey was in the U.S. Congress. Add to that the recent economic recession, which reduced emissions. And more important than any of those is what new, unconventional sources of natural gas in the United States have done to the price and price trajectory of natural gas, and the dramatic movement from coal to natural gas for generating electricity.

GAZETTE: Are there things that places like Harvard can do?

STAVINS: My view is that the best thing that Harvard can do is to carry out first-rate research, combined with the best possible teaching, and effective outreach to the public sector and the private sector. That’s our comparative advantage. In other words, our greatest impacts on the environment, including with regard to global climate change, will be through our products (research findings, smart and capable alumni, and direct impact on the policy world and private industry), not our processes. The emissions reductions that Harvard will achieve as a result of changing our carbon footprint, for example, whether it’s through increased energy efficiency of some buildings or some other means, are absolutely trivial compared with our impacts on the world [through teaching, research, and outreach]. And all of us — students, faculty, and administrators — have only so much time available. A very important concept in economics is “opportunity cost,” and there’s an important opportunity cost of a faculty member’s time, for example. If they’re working on one thing, they can’t be working on something else.

GAZETTE: Isn’t there kind of a living-laboratory aspect to what we’re doing?

STAVINS: I agree with that. So the one caveat — which I always mention — to what I said would be if direct actions by the University to limit emissions or energy demand were part and parcel of a research initiative or part and parcel of teaching, then those would be part of our core functions.

GAZETTE: Does that extend to the conversation on divestment?

STAVINS: I guess the way in which it links to that issue is whether or not symbolic actions are of value, but again you have to weigh symbolic actions against truly meaningful actions.

GAZETTE: What’s the most important thing for a member of the public to know about the climate talks and about climate change generally?

STAVINS: I think the most important thing to understand is that this is a long-term problem. Economically, a cost-effective approach is going to be very gradual reductions in emissions, not sudden changes. We’re not confiscating everyone’s automobiles tomorrow, but putting in place incentives or regulations so that next time they buy an automobile they move in the right direction, one that is less carbon intensive.

A massive amount of technology change is going to be required. That’s long term, and the creation of durable international institutions is going to be necessary, and that’s long term. That’s why that cliché we always hear from ballplayers each spring when they’ve lost their first 10 games — that it’s a marathon, not a sprint — applies even more to global climate change policy.

People should get neither excited nor depressed, in my view, over one single negotiation. It’s an ongoing process that’s going to be with us for a long time.

GAZETTE: Are you confident that ultimately what needs to happen will happen?

STAVINS: I’m not sure that it will happen through a centralized, top-down, international agreement. Nor am I even certain that the core of the action will be through international negotiations. Remember, 20 countries and regions account for about 90 percent of emissions. So there are alternative venues where meaningful action can happen without requiring agreement from 195 countries! One way or another, — through national action, bilateral action, multilateral action — things will be addressed. That doesn’t mean they will be addressed without the world first experiencing significant climate change damages.

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While International Climate Negotiations Continue, the World’s Ninth Largest Economy Takes an Important Step Forward

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A little more than two weeks ago, while some 195 nations prepared to meet in Doha, Qatar, for the Eighteenth Conference of the Parties (COP-18) of the United Nations Framework Convention on Climate Change (UNFCCC) in an ongoing effort to hammer out a durable scheme of effective international cooperation, the ninth largest economy in the world took an important step forward to achieve its own ambitious greenhouse gas reduction goals.  I’m referring to the CO2 cap-and-trade allowance auction held by the State of California (which ranks just below Brazil and just above India in the size of its economy) on November 14, 2012.

The Design

Under the California auction design (a single-round, sealed-bid, uniform price auction), all allowances are sold at the same price, no matter what the specific bid submitted.  This is done by awarding the first allowances to the highest bidder, then the next highest bidder, and so on until all allowances (or bids) are exhausted.  The bid for the last allowance becomes the price of all allowances sold in the auction.  The auction had two parts:  a current auction of 2013 vintage allowances, and advance auction of 2015 vintage allowances.

The Results

Just a few days after the auction, the California Air Resources Board released the results.  In brief, they were as follows:

  • All 23,126,110 (metric tons of) allowances for 2013 emissions were sold, with the number of qualified bids exceeding the number available by about 6 percent.
  •  These 2013 vintage allowances sold for $10.09, just above the auction’s reserve price of $10.00.  (Note, however, that the bids ranged from $10 to over $90, with a median bid of about $13 and a mean bid of nearly $14.)
  • Some 97% of the allowances were bought by compliance entities, as opposed to investors of various kinds.
  • The advance auction of 2015 allowances produced significantly different results, with only 14% of available allowances sold, at the auction reserve price of $10.00.  (The bids ranged from $10 to about $17, with median and mean bids of about $11.)

Those are the results, but what do they mean?  Here’s my view of the implications.

The Implications

First of all, the fact that the auction ran smoothly and compliance entities and others put their money down is one important step in establishing the program’s credibility and operational success.

Second, given that all 2013 vintage allowances sold and there was significant demand above the clearing price (mean prices were $13.75 per MT), the cap is clearly binding.

Third, the expected marginal abatement cost (accounting for market uncertainty and regulatory risk) is roughly at the reservation price of $10/ton (fairly close to the current price in the European Union Emissions Trading System, it so happens).

On the one hand, it is very good news that the allowance price is as low as it is, because this is indicative of the market’s prediction of what the marginal cost of abatement will be.  Lower cost is good news for the California economy.  Of course, low prices mean smaller funds raised by the auction ($233 million raised by the 2013 auction, and $56 million by the 2015 auction).  However, given that the fundamental purpose of the auction is to cap emissions through the cap-and-trade system, not to raise revenues for the state, this doesn’t appear to be bad news either.

But there is some “bad news” in these low allowance prices, and in the 2015 results.  First, the 2015 results may indicate that there is significant “regulatory risk” that is lowering prices firms are willing to pay for allowances.  Such regulatory risk could arise from concerns that state legislators will back-pedal on the program, or that legal challenges to certain rules (for example, reshuffling requirements or regulation of out-of-state electricity) or Federal policy action in Washington will reduce allowance demand.

It could also arise from this being the first auction, bringing about reluctance to put a lot of money down before seeing any results.   Significant uncertainty over abatement costs could also have been a factor.  In these regards, it will be interesting to see whether bidding is much different at the second auction next year.

An Ongoing Concern

Other factors driving down demand for allowances and the auction price are the emission reductions that have already been achieved or are expected to be achieved by so-called “complementary programs,” such as energy efficiency programs, renewable portfolio standards, and low-carbon fuel standards.  You might think this is good news, but it’s not.  Why?

These “complimentary programs” exist under the cap of the cap-and-trade system.  Hence, there are two possible outcomes from this situation.  On the one hand, these additional programs can be irrelevant in terms of CO2 emissions; that is, their emission reductions would be achieved anyway by the cap-and-trade system on its own, which – remember – allocates the abatement burden cost-effectively across sectors and sources.  Or, on the other hand, these programs could achieve greater emissions reductions in some sector or by some sources than the cap-and-trade regime would have done on its own.  But, by doing this, the effect is simply to free up allowances for other sources and/or other sectors through the trading mechanism.

On the margin, nothing is accomplished in terms of additional CO2 emissions reductions; rather the emissions are simply relocated.  And, because under such circumstances marginal abatement costs are no longer equated, the allocation of the reductions is no longer cost-effective, that is, aggregate costs are driven up.  As I recently wrote, this is precisely what has happened in the European Union Emissions Trading System.  (By the way, for a more favorable view of the role of the complimentary measures under the California cap-and-trade scheme, see this essay by Dallas Burtraw and Clayton Munnings.)

So, this specific “bad news” about perverse policy interactions is not a problem of the cap-and-trade system per se, any more than it is in the European system.  Rather, the problem is with adding well-intentioned “complimentary programs” under the coverage of a cap-and-trade (or any “quantity-based averaging”) system.  Unfortunately, it is misguided public policy, at least from the perspective of this environmental economist.

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Cap-and-Trade, Carbon Taxes, and My Neighbor’s Lovely Lawn

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The recent demise of serious political consideration of an economy-wide U.S. CO2 cap-and-trade system and the even more recent resurgence in interest among policy wonks in a U.S. carbon tax should prompt reflection on where we’ve been, where we are, and where we may be going.

Lessons

Almost fifteen years ago, in an article that appeared in 1998 in the Journal of Economic Perspectives, “What Can We Learn from the Grand Policy Experiment?  Lessons from SO2 Allowance Trading,” I examined the implications of what was then the very new emissions trading program set up by the Clean Air Act Amendments of 1990 to cut acid rain by half over the succeeding decade.  In that article, I attempted to offer some guidance regarding the conditions under which cap-and-trade (then known as “tradable permits”) was likely to work well, or not so well.  Here’s a brief summary of what I wrote at the time:

(1)  SO2 trading was a case where the cost of abating pollution differed widely among sources, and where a market-based system was therefore likely to have greater gains, relative to conventional, command-and-control regulations (Newell and Stavins 2003). It was clear early on that SO2 abatement cost heterogeneity was great, because of differences in ages of plants and their proximity to sources of low-sulfur coal. But where abatement costs are more uniform across sources, the political costs of enacting an allowance trading approach are less likely to be justifiable.

(2)  The greater the degree to which pollutants mix in the receiving airshed or watershed, the more attractive a cap-and-trade (or emission tax) system will be, relative to a conventional uniform standard. This is because taxes or cap-and-trade can – in principle – lead to localized “hot spots” with relatively high levels of ambient pollution. Some states (in particular, New York) tried unsuccessfully to erect barriers to trades they thought might increase deposition within their borders.  This is a significant distributional issue.  It can also be an efficiency issue if damages are nonlinearly related to pollutant concentrations.

(3)  The efficiency of a cap-and-trade system will depend on the pattern of costs and benefits. If uncertainty about marginal abatement costs is significant, and if marginal abatement costs are quite flat and marginal benefits of abatement fall relatively quickly, then a quantity instrument, such as cap-and-trade, will be more efficient than a price instrument, such as an emission tax (Weitzman 1974).  With a stock pollutant (such as CO2), this argument favors a price instrument (Newell and Pizer 2003).  However, when there is also uncertainty about marginal benefits, and marginal benefits are positively correlated with marginal costs (which, it turns out, is a relatively common occurrence for a variety of pollution problems), then there is an additional argument in favor of the relative efficiency of quantity instruments (Stavins 1996).

(4)  Cap-and-trade will work best when transaction costs are low (Stavins 1995), and the S02 experiment showed that if properly designed, private markets will tend to render transaction costs minimal.

5)  Considerations of political feasibility point to the wisdom of proposing trading instruments when they can be used to facilitate emissions reductions, as was done with SO2 allowances and lead rights trading, less so for the purpose of reallocating existing emissions abatement responsibility (Revesz and Stavins 2007).

(6)  National policy instruments that appear impeccable from the vantage point of Cambridge, Massachusetts, Berkeley, California, or Madison, Wisconsin, but consistently prove infeasible in Washington, D.C., can hardly be considered “optimal.”

Implications for CO2 Policy

In the same article, I noted that many of these issues could be illuminated by considering a concrete example:  the “current interest” in applying cap-and-trade to the task of cutting CO2 emissions to reduce the risk of global climate change.  Some of the points I made in this regard in my 1998 article were:

(a)  The number of sources of CO2 emissions are vastly greater than in the case of SO2 emissions as a precursor of acid rain, where the focus could be placed on a few hundred electric utility plants.  Feasibility considerations alone argue for market-based instruments (cap-and-trade or taxes) to achieve meaningful reductions of CO2 emissions.

(b)  The diversity of sources of CO2 in a modern economy and the consequent heterogeneity of emission reduction costs bolster the case for using cost-effective market-based instruments.

(c)  As the ultimate global-commons problem, CO2 is a truly uniformly-mixed pollutant.  With no concern for hot spots, market-based instruments present none of the problems that can arise in the case of localized environmental threats.

(d)  Any pollution-control program must face the possibility of emissions leakage from regulated to unregulated sources. This would be a severe problem for an international CO2 program, where emissions would tend to increase in nonparticipant countries. Furthermore, it raises concerns for the emission-reduction-credit (not cap-and-trade) system in the Kyoto Protocol known as the Clean Development Mechanism (CDM).  Such an offset system can lower aggregate costs by substituting low-cost for high-cost control, but may also have the unintended effect of increasing aggregate emissions beyond what they would otherwise have been, because there is an incentive for adverse selection: sources in developing countries that would reduce their emissions, opt in, and receive credit for actions they would have taken anyway.

(e)  Although any trading program could potentially serve as a model for the case of global climate change, I argued that the trading system that accomplished the U.S. phaseout of leaded gasoline in the 1980s merited particular attention. The currency of that system was not lead oxide emissions from motor vehicles, but the lead content of gasoline. So too, in the case of global climate, great savings in monitoring and enforcement costs could be had by adopting input trading linked with the carbon content of fossil fuels. This is reasonable in the climate case, since – unlike in the SO2 case – CO2 emissions are roughly proportional to the carbon content of fossil fuels and scrubbing alternatives are largely unavailable, at least at present.

(f)   Natural sequestration of CO2 from the atmosphere by expanding forested areas is available (even in the United States) at reasonable cost (Stavins 1999).  Hence, it could be valuable to combine any carbon trading (or carbon tax) program with a carbon sequestration program, although this will raise significant challenges in regard to monitoring and enforcement.

(g)  In regard to carbon permit allocation mechanisms, auctions would have the advantage that revenues could be used to finance reductions in distortionary taxes.  Free allocation could increase regulatory costs enough that the sign of the efficiency impact could conceivably be reversed from positive to negative net benefits (Parry, Williams, and Goulder 1999).  On the other hand, free allocation of carbon permits would meet with much less political resistance.

The Necessity of Market-Based Instruments:  Cap-and-Trade or Carbon Taxes

I concluded that developing a cap-and-trade system for climate change would bring forth an entirely new set of economic, political, and institutional challenges.  At the same time, I recognized that the diversity of sources of CO2 emissions and the magnitude of likely abatement costs made it equally clear that only a market-based instrument – some form of carbon rights trading or (probably revenue-neutral) carbon taxes – would be capable of achieving the domestic targets that might eventually be forthcoming.

In other words, my conclusion in 1998 strongly favored a market-based carbon policy, but was somewhat neutral between carbon taxes and cap-and-trade.  Indeed, at that time and for the subsequent eight years or so, I remained agnostic regarding what I viewed as the trade-offs between cap-and-trade and carbon taxes.  What happened to change that?  Three words:  The Hamilton Project.

The Making of an Advocate

For those of you who don’t know, the Hamilton Project is an initiative based at the Brookings Institution that – according to its web site – “offers a strategic vision and produces innovative policy proposals on how to create a growing economy that benefits more Americans.”

In 2007, the Project’s leadership asked me to write a paper proposing a U.S. CO2 cap-and-trade system.  I responded that I would prefer to write a paper proposing the use of a market-based CO2 policy, describing the two alternatives of cap-and-trade and carbon taxes.  I explained that I was by no means opposed to the notion of a carbon tax, having written about such approaches for more than twenty years.  Indeed, I noted, both cap-and-trade and carbon taxes would be good approaches to the problem; they have many similarities, some tradeoffs, and a few key differences.

The Hamilton Project leaders said no, they wanted me to make the best case I could for cap-and-trade, not a balanced investigation of the two policy instruments.  Someone else would be commissioned to write a proposal for a carbon tax.  (That turned out to be Professor Gilbert Metcalf of Tufts University – now on leave at the U.S. Department of the Treasury – who did a splendid job!)  Thus, I was made into an advocate for cap-and-trade.  It’s as simple as that.

Giving It My Best Shot

I argued in my Hamilton Project paper (which you can read here) that despite the tradeoffs between the two principal market-based instruments that could target CO2 emissions, the best (and most likely) approach for the short to medium term in the United States was a cap-and-trade system, based on three criteria:  environmental effectiveness, cost effectiveness, and distributional equity.  Although my position was not simple capitulation to politics, I argued that sound assessments of environmental effectiveness, cost effectiveness, and distributional equity should be made in a real-world political context.

I said that the key merits of the cap-and-trade approach were, first, the program could provide cost-effectiveness, while achieving meaningful reductions in greenhouse gas emissions levels.  Second, it offered an easy means of compensating for the inevitably unequal burdens imposed by a climate policy.  Third, it provided a straightforward means to link with other countries’ climate policies.  Fourth, it avoided the political aversion in the United States to taxes.  Fifth, it was unlikely to be degraded – in terms of its environmental performance and cost effectiveness – by political forces. And sixth, this approach had a history of successful adoption and implementation in this country over the past two decades.

I recognized that there were some real differences between taxes and cap-and-trade that needed to be recognized.  First, environmental effectiveness:  a tax does not guarantee achievement of an emissions target, but it does provide greater certainty regarding costs.  This is a fundamental tradeoff.  Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly cost-containment mechanisms.  On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade – this is not a tradeoff, and is why virtually no environmental NGOs have favored the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design — the distributional consequences of the two approaches can be the same.  But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table.  But political pressures on a cap-and-trade system lead to different allocations of the free allowances, which affect distribution, but not environmental effectiveness, and not cost-effectiveness.

I concluded that proponents of carbon taxes worried about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax would be sensitive to the same political pressures, and should be expected to succumb in ways that are ultimately more harmful:  reducing environmental achievement and driving up costs.

Of course, such positive political economy arguments look much less compelling in the wake of the defeat of cap-and-trade legislation in the U.S. Congress and its successful demonization by conservatives as “cap-and-tax.”

A Political Opening for Carbon Taxes?

Does the defeat of cap-and-trade in the U.S. Congress, the obvious unwillingness of the Obama White House to utter the phrase in public, and the outspoken opposition to cap-and-trade by Republican Presidential candidate Mitt Romney indicate that there is a new opening for serious consideration of a carbon-tax approach to meaningful CO2 emissions reductions?

First of all, there surely is such an opening in the policy wonk world.  Economists and others in academia, including important Republican economists such as Harvard’s Greg Mankiw and Columbia’s Glenn Hubbard, remain enthusiastic supporters of a national carbon tax.  And a much-publicized meeting in July at the American Enterprise Institute in Washington, D.C. brought together a broad spectrum of Washington groups – ranging from Public Citizen to the R Street Institute – to talk about alternative paths forward for national climate policy.  Reportedly, much of the discussion focused on carbon taxes.

Clearly, this “opening” is being embraced with enthusiasm in the policy wonk world.  But what about in the real political world?  The good news is that a carbon tax is not “cap-and-trade.”  That presumably helps with the political messaging!  But if conservatives were able to tarnish cap-and-trade as “cap-and-tax,” it surely will be considerably easier to label a tax – as a tax!   Also, note that Romney’s stated opposition and Obama’s silence extend beyond disdain for cap-and-trade per se.  Rather, they cover all carbon-pricing regimes.

So as a possible new front in the climate policy wars, I remain very skeptical that an explicit carbon tax proposal will gain favor in Washington, no matter what the outcome of the election.  Note that the only election outcome that could lead to an aggressive and successful move to a meaningful nationwide carbon pricing regime would be:  the Democrats take back control of the House of Representatives, and the Democrats achieve a 60+ vote margin in the Senate, and the President is reelected.  A quick check at Five Thirty Eight (Nate Silver’s superb election forecast website at the New York Times) and other polling web sites makes it abundantly clear that the probability of such Democratic control of the White House and Congress is so small that it’s hardly worth discussing.

What About Fiscal Policy Reform?

A more promising possibility – though still unlikely – is that if Republicans and Democrats join to cooperate with either a Romney or Obama White House to work together constructively to address not only the short-term fiscal cliff at the end of this calendar year, but also the longer-term budgetary deficits the U.S. government faces, and if as part of this they decide to include not only cuts in government expenditures, but also some significant “revenue enhancements” (the t-word is not allowed), and if (I know, this is getting to be a lot of “if’s”) it turns out to be easier politically to eschew increases in taxes on labor and investment and therefore turn to taxes on consumption, then there could be a political opening for new energy taxes, in particular, (drum roll ….) a carbon tax.

Such a carbon tax – if intended to help alleviate budget deficits – could not be the economist’s favorite, a revenue-neutral tax swap of cutting distortionary taxes in exchange for implementing a carbon tax.  Rather, as a revenue-raising mechanism – like the Obama administration’s February 2009 budget for a 100%-auction of allowances in a cap-and-trade scheme – it would be a new tax, pure and simple.  Those who recall the 1993 failure of the Clinton administration’s BTU-tax proposal – with a less polarized and more cooperative Congress than today’s – are not optimistic.

Nor is it clear that a carbon tax would enjoy more support in budget talks than a value added tax (VAT) or a Federal sales tax.  The key question is whether the phrases “climate policy” or “carbon tax” are likely to expand or narrow the coalition of support for an already tough budgetary reconciliation measure.  The key group to bring on board will presumably be conservative Tea Party Republicans, and it is difficult to picture them being more willing to break their Grover Norquist pledges because it’s for a carbon tax.

Research

Even if the much-ballyhooed political opening for carbon taxes is largely illusory, the opening for policy wonks is real.  And here is where action is happening, and should continue to happen.  At some point the politics will change, and it’s important to be ready.  This is why economic research on carbon taxes is very much needed, particularly in the context of broader fiscal challenges, and it is why I’m pleased to see it happening at Resources for the Future, Harvard University, and elsewhere.

Bottom Line

I would personally be delighted if a carbon tax were politically feasible in the United States, or were to become politically feasible in the future.  But I’m forced to conclude that much of the current enthusiasm about carbon taxes in the academic and broader policy-wonk community in the wake of the defeat of cap-and-trade is – for the time being, at least – largely a manifestation of the grass looking greener across the street.

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A Challenge for Climate Negotiators, and an Opportunity for Scholars

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As I have written in many previous essays at this blog, the challenges standing in the way of an effective international climate change agreement are numerous and severe.  It is also true that the prospects for a truly meaningful deal may be better now than at any time in the past decade or more.  That is the theme of a new article I’ve co-authored with my Harvard Kennedy School colleague, Joseph Aldy.  The article, “Climate Negotiators Create an Opportunity for Scholars,” was published in the August 31st edition of Science.

Changes emerged gradually from the Major Economies Forum on Energy and Climate in 2009, the Copenhagen Accord (2009), the Cancun Agreements (2010), and – most important – the Durban Platform for Enhanced Action (2011).  Together these have now increased the likelihood that the ongoing negotiations can move beyond the debilitating Annex I/non-Annex I dichotomy of the Berlin Mandate (1995), as codified in the Kyoto Protocol (1997); and instead develop a comprehensive legal regime for implementation in 2020 that includes all key countries, based upon a more nuanced and effective interpretation of the principle of “common but differentiated responsibilities and respective capabilities” from the original United Nations Framework Convention on Climate Change (UNFCCC, 1992).

In our Science article, Joe Aldy and I trace this history and describe several potential international climate policy architectures that could be consistent with the process and principles laid out in both the Durban Platform and the UNFCCC.  Our article is very brief, and so rather than trying to summarize it here, I encourage you to follow this link to read the essay in its entirety.

The negotiating teams are now tasked under the Durban Platform with identifying a new comprehensive policy architecture by 2015 (for 2020 implementation).  The negotiators are therefore hungry for new ideas, in particular for outside-the-box thinking.  This presents an important opportunity for researchers in universities, think tanks, and advocacy groups around the world.

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Two Notable Events Prompt Examination of an Important Property of Cap-and-Trade

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In December of 2010, a group of economists and legal scholars gathered at the University of Chicago to celebrate two notable events. One was the fiftieth anniversary of the publication of Ronald Coase’s “The Problem of Social Cost” (Coase 1960).  The other was Professor Coase’s 100th birthday.  The conference resulted in a special issue of The Journal of Law and Economics, which has just been published (although it is dated November 2011).

My frequent co-author, Robert Hahn (of the University of Oxford), and I were privileged to participate in the conference (a video of our presentation is available here).  We recognized that the fiftieth anniversary of the publication of Coase’s landmark study provided an opportunity for us to examine one of that study’s key implications, which is of great importance not only for economics but for public policy as well, in particular, for environmental policy.

The Coase Theorem and the Independence Property

In our just-published article, “The Effect of Allowance Allocations on Cap-and-Trade System Performance,” Hahn and I took as our starting point a well-known result from Coase’s work, namely, that bilateral negotiation between the generator and the recipient of an externality will lead to the same efficient outcome regardless of the initial assignment of property rights, in the absence of transaction costs, income effects, and third party impacts. This result, or a variation of it, has come to be known as the Coase Theorem.

We focused on an idea that is closely related to the Coase theorem, namely, that the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights (typically referred to as permits or allowances). That is, the overall cost of achieving a given emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation, under certain conditions (conditional upon the permits being allocated freely, i.e., not auctioned). We call this the independence property. It is closely related to a core principle of general equilibrium theory (Arrow and Debreu 1954), namely, that when markets are complete, outcomes remain efficient even after lump-sum transfers among agents.

The Practical Political Importance of the Independence Property

We were interested in the independence property because of its great political importance.  The reason why this property is of such great relevance to the practical development of public policy is that it allows equity and efficiency concerns to be separated. In particular, a government can set an overall cap of pollutant emissions (a pollution reduction goal) and leave it up to a legislature to construct a constituency in support of the program by allocating shares of the allowances to various interests, such as sectors and geographic regions, without affecting either the environmental performance of the system or its aggregate social costs.  Indeed, this property is a key reason why cap-and-trade systems have been employed and have evolved as the preferred instrument in a variety of environmental policy settings.

In Theory, Does the Property Always Hold?

Because of the importance of this property, we examined the conditions under which it is more or less likely to hold — both in theory and in practice.  In short, we found that in theory, a number of factors can lead to the independence property being violated. These are particular types of transaction costs in cap-and-trade markets; significant market power in the allowance market; uncertainty regarding the future price of allowances; conditional allowance allocations, such as output-based updating-allocation mechanisms; non-cost-minimizing behavior by firms; and specific kinds of regulatory treatment of participants in a cap-and-trade market.

In Reality, Has the Property Held?

Of course, the fact that these factors can lead to the violation of the independence property does not mean that in practice they do so in quantitatively significant ways.  Therefore, Hahn and I also carried out an empirical assessment of the independence property in past and current cap-and-trade systems: lead trading; chlorofluorocarbons (CFCs) under the Montreal Protocol; the sulfur dioxide (SO2) allowance trading program; the Regional Clean Air Incentives Market (RECLAIM) in Southern California; eastern nitrogen oxides (NOX) markets; the European Union Emission Trading Scheme (EU ETS); and Article 17 of the Kyoto Protocol.

I encourage you to read our article, but, a quick summary of our assessment is that we found modest support for the independence property in the seven cases we examined (but also recognized that it would surely be useful to have more empirical research in this realm).

Politicians Have Had it Right

That the independence property appears to be broadly validated provides support for the efficacy of past political judgments regarding constituency building through legislatures’ allowance allocations in cap-and-trade systems. Governments have repeatedly set the overall emissions cap and then left it up to the political process to allocate the available number of allowances among sources to build support for an initiative without reducing the system’s environmental performance or driving up its cost.

This success with environmental cap-and-trade systems should be contrasted with many other public policy proposals for which the normal course of events is that the political bargaining that is necessary to develop support reduces the effectiveness of the policy or drives up its overall cost.  So, the independence property of well-designed and implemented cap-and-trade systems is hardly something to be taken for granted.  It is of real political importance and remarkable social value.

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Can Market Forces Really be Employed to Address Climate Change?

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Debate continues in the United States, Europe, and throughout the world about whether the forces of the marketplace can be harnessed in the interest of environmental protection, in particular, to address the threat of global climate change.  In an essay that appears in the Spring 2012 issue of Daedalus, the journal of the American Academy of Arts and Sciences, my colleague, Joseph Aldy, and I take on this question.  In the article – “Using the Market to Address Climate Change:  Insights from Theory & Experience” – we investigate the technical, economic, and political feasibility of market-based climate policies, and examine alternative designs of carbon taxes, cap-and-trade, and clean energy standards.

The Premise

Virtually all aspects of economic activity – individual consumption, business investment, and government spending – affect greenhouse gas emissions and, therefore, the global climate. In essence, an effective climate change policy must change the nature of decisions regarding these activities in order to promote more efficient generation and use of energy, lower carbon-intensity of energy, and a more carbon-lean economy.

Basically, there are three possible ways to accomplish this: (1) mandate that businesses and individuals change their behavior; (2) subsidize business and individual investment; or (3) price the greenhouse gas externality proportional to the harms that these emissions cause.

Harnessing Market Forces by Pricing Externalities

The pricing of externalities can promote cost-effective abatement, deliver efficient innovation incentives, avoid picking technology winners, and ameliorate, not exacerbate, government fiscal conditions.

By pricing carbon emissions (or, equivalently, the carbon content of the three fossil fuels – coal, petroleum, and natural gas), the government provides incentives for firms and individuals to identify and exploit the lowest-cost ways to reduce emissions and to invest in the development of new technologies, processes, and ideas that can mitigate future emissions. A fairly wide variety of policy approaches fall within the concept of externality pricing in the climate-policy context, including carbon taxes, cap-and-trade, and clean energy standards.

What About Conventional Regulatory Approaches?

In contrast, conventional approaches to environmental protection typically employ uniform mandates to protect environmental quality. Although uniform technology and performance standards have been effective in achieving some established environmental goals and standards, they tend to lead to non-cost-effective outcomes in which some firms use unduly expensive means to control pollution.

In addition, conventional technology or performance standards do not provide dynamic incentives for the development, adoption, and diffusion of environmentally and economically superior control technologies. Once a firm satisfies a performance standard, it has little incentive to develop or adopt cleaner technology. Indeed, regulated firms may fear that if they adopt a superior technology, the government will tighten the standard.

Given the ubiquitous nature of greenhouse gas emissions from diverse sources, it is virtually inconceivable that a standards-based approach could form the centerpiece of a truly meaningful climate policy. The substantially higher cost of a standards-based policy may undermine support for such an approach, and securing political support may require weakening standards and lowering environmental benefits.

How About Technology Subsidies?

Government support for lower-emitting technologies often takes the form of investment or performance subsidies. Providing subsidies for targeting climate-friendly technologies entails revenues raised by taxing other economic activities. Given the tight fiscal environment throughout the developed world, it is difficult to justify increasing (or even continuing) the subsidies that would be necessary to change significantly the emissions intensity of economic activity.

Furthermore, by lowering the cost of energy, climate-oriented technology subsidies can actually lead to excessive levels of energy supply and consumption. Thus, subsidies can undermine incentives for efficiency and conservation, and impose higher costs per ton abated than cost-effective policy alternatives.

In practice, subsidies are typically designed to be technology specific. By designating technology winners, such approaches yield special-interest constituencies focused on maintaining subsidies beyond what would be socially desirable. They also provide little incentive for the development of novel, game-changing technologies.

That said, there is still a role for direct technology policies in combination with externality pricing, as I have argued in a previous essay at this blog.  This is because in addition to the environmental market failure (appropriately addressed by externality pricing) there exists another market failure in the climate change context, namely, the public-good nature of information produced by research and development.  I addressed this in my essay, “Both Are Necessary, But Neither is Sufficient: Carbon-Pricing and Technology R&D Initiatives in a Meaningful National Climate Policy.”

Back to Markets, and Some Real-World Experience

Empirical analysis drawing on actual experience has demonstrated the power of markets to drive profound changes in the investment and use of emission-intensive technologies.

The run-up in gasoline prices in 2008 increased consumer demand for more fuel-efficient new cars and trucks, while also reducing vehicle miles traveled by the existing fleet. Likewise, electricity generators responded to the dramatic decline in natural gas prices in 2009 and 2010 by dispatching more electricity from gas plants, resulting in lower CO2 emissions.

Longer-term evaluations of the impacts of energy prices on markets have found that higher prices have induced more innovation – measured by frequency and importance of patents – and increased the commercial availability of more energy-efficient products, especially among energy-intensive goods such as air conditioners and water heaters.

Experience with Externality Pricing

Real-world experience with policies that price externalities has illustrated the effectiveness of market-based instruments. Congestion charges in London, Singapore, and Stockholm have reduced traffic congestion in busy urban centers, lowered air pollution, and delivered net social benefits.  Likewise, the British Columbia carbon tax has reduced carbon dioxide emissions since 2008.

More prominently, the U.S. sulfur dioxide (SO2) cap-and-trade program has cut SO2 emissions from U.S. power plants by more than 50 percent since 1990, resulting in compliance costs one-half of what they would have been under conventional regulatory mandates.

The success of the SO2 allowance trading program motivated the design and implementation of the European Union’s Emissions Trading Scheme (EU ETS), the world’s largest cap-and-trade program, focused on cutting CO2 emissions from power plants and large manufacturing facilities throughout Europe.

And the 1980s phasedown of lead in gasoline, which reduced the lead content per gallon of fuel, served as an early, effective example of a tradable performance standard.

These positive experiences have provided ample reason to consider market-based instruments – carbon taxes, cap-and-trade, and clean energy standards – as potential approaches to mitigating greenhouse gas emissions.

The Rubber Hits the Road

The U.S. political response to possible market-based approaches to climate policy has been and will continue to be largely a function of issues and structural factors that transcend the scope of environmental and climate policy. Because a truly meaningful climate policy – whether market-based or conventional in design – will have significant impacts on economic activity in a wide variety of sectors and in every region of the country, it is not surprising that proposals for such policies bring forth significant opposition, particularly during difficult economic times.

In addition, U.S. political polarization – which began some four decades ago and accelerated during the economic downturn – has decimated what had long been the key political constituency in Congress for environmental (and energy) action: namely, the middle, including both moderate Republicans and moderate Democrats. Whereas congressional debates about environmental and energy policy have long featured regional politics, they are now largely partisan. In this political maelstrom, the failure of cap-and-trade climate policy in the Senate in 2010 was collateral damage in a much larger political war.

Better economic times may reduce the pace – if not the direction – of political polarization. And the ongoing challenge of large federal budgetary deficits may at some point increase the political feasibility of new sources of revenue. When and if this happens, consumption taxes – as opposed to traditional taxes on income and investment – could receive heightened attention; primary among these might be energy taxes, which, depending on their design, can function as significant climate policy instruments.

Many environmental advocates would respond that a mobilizing event will surely precipitate U.S. climate policy action.  But the nature of the climate change problem itself helps explain much of the relative apathy among the U.S. public and suggests that any such mobilizing events may come “too late.”

Nearly all our major environmental laws have been passed in the wake of highly publicized environmental events or “disasters,” including the spontaneous combustion of the Cuyahoga River in Cleveland, Ohio, in 1969, and the discovery of toxic substances at Love Canal in Niagara Falls, New York, in the mid-1970s. But note that the day after the Cuyahoga River caught on fire, no article in The Cleveland Plain Dealer commented that the cause was uncertain, that rivers periodically catch on fire from natural causes. On the contrary, it was immediately apparent that the cause was waste dumped into the river by adjacent industries. A direct consequence of the observed “disaster” was, of course, the Clean Water Act of 1972.

But climate change is distinctly different. Unlike the environmental threats addressed successfully in past U.S. legislation, climate change is essentially unobservable to the general population. We observe the weather, not the climate. Until there is an obvious and sudden event – such as a loss of part of the Antarctic ice sheet leading to a dramatic sea-level rise – it is unlikely that public opinion in the United States will provide the bottom-up demand for action that inspired previous congressional action on the environment over the past forty years.

A Half-Full Glass of Water?

Despite this rather bleak assessment of the politics of climate change policy in the United States, it is really much too soon to speculate on what the future will hold for the use of market-based policy instruments, whether for climate change or other environmental problems.

On the one hand, it is conceivable that two decades (1988–2008) of high receptivity in U.S. politics to cap-and-trade and offset mechanisms will turn out to be no more than a relatively brief departure from a long-term trend of reliance on conventional means of regulation.

On the other hand, it is also possible that the recent tarnishing of cap-and-trade in national political dialogue will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments. Perhaps the ongoing interest in these policy mechanisms in California (Assembly Bill 32), the Northeast (Regional Greenhouse Gas Initiative), Europe, and other countries will eventually provide a bridge to a changed political climate in Washington.

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Posted in Climate Change Policy, Economic Policy, Economic Stimulus Policy, Energy Economics, Energy Policy, Environmental Economics, Environmental Policy, Politics, Positive Political Economy | Tagged , , , , , , , , , , , , | 20 Comments

Low Prices a Problem? Making Sense of Misleading Talk about Cap-and-Trade in Europe and the USA

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Some press accounts and various advocates have labeled the Regional Greenhouse Gas Initiative (RGGI) as near “the brink of failure” because of the recent trend of very low auction prices.  Likewise, commentators have recently characterized the European Union Emission Trading Scheme (EU ETS) as possibly “sinking into oblivion” because of low allowance prices.  Since when are low prices (which in this case reflect low marginal abatement costs) considered to be a problem?  To understand what’s going on, we need to remind ourselves of the purpose (and promise) of a cap-and-trade regime, and then look at what’s been happening in the respective markets.

The Purpose and Promise of Cap-and-Trade

A cap-and-trade system– if well designed, implemented, and enforced – will limit total emissions of the regulated pollutant to the desired level (the cap), and will do this (if the cap is binding) in a cost-effective manner, by leading regulated sources to each make reductions until they are all experiencing the same marginal abatement cost (the allowance price).  Thus, the sources that initially face the highest abatement costs, reduce less, and those sources that face the lowest abatement costs, reduce more, achieving system-wide minimum costs, that is, cost effectiveness.  So, the purpose and promise, in a nutshell, is to achieve the targeted level of aggregate pollution control, and – if the cap is binding – do this at the lowest possible cost.

RGGI Allowance Prices

The Regional Greenhouse Gas Initiative (RGGI) – a downstream cap-and-trade system for CO2 emissions from the power sector in 10 northeast states (Connecticut, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, and Vermont, with New Jersey now in the process of withdrawing from the coalition), was launched with relatively unambitious targets, principally in order to keep prices down to prevent severe leakage of electricity demand and hence leakage of CO2 emissions from the RGGI region to states and provinces outside of the region (mainly from New York to Pennsylvania).

Emissions are capped from 2012 to 2014, and then, starting in 2015, the cap decreases 2.5% per year until it is down by 10% in 2019.  This would represent a level of emissions 13% below the 1990 level of emissions.  It was originally thought that this would be some 35% below the Business-as-Usual (BAU) level in 2019.  Sounds good.  What happened is not that the system performed other than designed, but that “business was not as usual.”  That is, what happened is that unregulated power-sector (BAU) emissions in the northeast fell significantly.  (See the graph below of the RGGI cap and historical emissions.)


For source, please click here.

So, Why Did Emissions Fall in the RGGI States?

This happened for three reasons.  First, because of increasing supplies in the United States of low-cost, unconventional sources of natural gas, prices for this fuel have fallen dramatically since 2008. (See the graph below of natural gas and coal prices.)  That has meant greater dispatch of electricity from gas-fueled power plants (relative to coal-fired plants), more investment in new gas-fired generating plants, less investment in coal-fired generating capacity, and retirement of existing coal-fired capacity, all of which has contributed to lower CO2 emissions.


For source, please click here.

Second, the worst economic recession since the Great Depression hit the United States in 2008, causing dramatic reductions in electricity demand in the industrial and commercial sectors, reducing emissions.  (See the graph below of quarterly percentage change in U.S. GDP, 2007-2009.)

For source, please click here.

Third and finally, moderate northeast temperatures have kept down CO2 emissions linked with both heating and cooling.

Low Emissions, Low Allowance Demand, Low Allowance Prices

So, for the three reasons above, BAU CO2 emissions from the power sector in the RGGI states are dramatically below what was originally (and quite reasonably) anticipated.  The supply of RGGI CO2 allowances made available at auction is – by law – unchanged, but demand for these allowances has fallen dramatically, hence the fall in RGGI allowance prices.  (See the graph below of RGGI allowance prices, 2008-2010.)

For source, please click here.

Given that emissions are below the RGGI cap and – due to expectations regarding future natural gas prices – are likely to remain below the cap, there is no scarcity of allowances.  Shouldn’t the price fall to zero?  In theory, yes, except that the system has an auction reservation price of $1.86 per ton built in, thereby creating a price floor of precisely this amount.

Is RGGI a Failure?

So, the cap put in place by the RGGI system is being achieved, but it is not binding.  RGGI may not be particularly relevant, but it is not thereby a flawed system; surely it is not a failure.  Rather, a great environmental success has been achieved by the “fortunate coincidence” of low natural gas prices, economic recession, and mild weather.  This is hardly something to be lamented.

True enough, the RGGI system does have flaws (such as its narrow scope limited to electricity generation, and its lack of a simple safety valve, as I have written about in the past).  But the low allowance prices are evidence of a success outside of the RGGI market, not evidence of failure within the RGGI market.

If the RGGI states have the desire and the political will to tighten the cap in the future, then the system can again become binding, environmentally relevant, and cost-effective.  That’s an ongoing political debate.

To be fair, I should note that the same outcome I have described here can be spun – perhaps for political purposes – quite differently.  Recently, a self-described “free-market energy blog” commentator claimed – not without some justification – that RGGI is irrelevant or worse:  “Bottom line, the program has raised electricity prices, created a slush fund for each of the member states, and has had virtually no impact on emissions or on global climate change.”

Phrased differently, due to exogenous circumstances (I’ve described above), the RGGI program is non-binding, and so has no direct effect on emissions, but its relatively low auction reservation price does lead to very small impacts on electricity prices, and produces revenues for participating states, revenues which those states would surely claim are of value for state-level energy-efficiency and other programs that indirectly do affect CO2 emissions.  So, the real bottom line is that low RGGI allowance prices are not a consequence of poor system design or a fatal flaw of cap-and-trade systems in general, but rather a consequence of what are in reality some exogenous coincidences that have turned out to be good news for the environment.

Now, let’s turn to the European Union Emissions Trading Scheme (EU ETS).

EU ETS Allowance Prices

Unlike RGGI, the EU ETS has not been irrelevant.  It has successfully capped European CO2 emissions, achieved significant emissions reductions, and it has done so — more or less — cost-effectively.  (More about this hedging on cost-effectiveness below).  Not surprisingly, like RGGI, the EU ETS has some design flaws (principally, its limited scope – electricity generation and large-scale manufacturing – and lack of a safety-valve), but as with RGGI, its low allowance prices should not be taken as bad news, but to some degree as good news, and certainly not as a sign of failure of the EU ETS.

Hand-wringing in Europe over Low Allowance Prices

There has been much hand-wringing in Europe over the “failure of the system” because of low allowance prices.  Indeed, Danish Energy Minister Martin Lidegaard said earlier this month that low carbon prices threaten the EU ETS.

Of course, he’s correct that EU ETS allowance prices are “low.”  They are down from their historic average of about $20 per ton of CO2 to about $9 per ton currently (having reached an all-time low of $7.88 in early April).  Here’s a graph of EU ETS allowance prices (EUAs) over the crucial period of change, January 2007 to January 2009.

For source, please click here.

At this point in this essay, I probably don’t need to say that this pattern is partly explained by the global recession, which has hit Europe particularly hard (and now threatens a double-dip recession in a number of European nations).  Lower European – and global – demand has meant decreased economic activity in Europe, hence lower energy demand, lower CO2 emissions, and therefore lower demand and lower prices for EU ETS allowances.

Even if we assume a growth rate of European CO2 emissions 1 percent less than the growth rate of GDP (represented by the dotted “counterfactual” BAU line in the graph below, which estimates what emissions would have been from 2005 to 2010 without the introduction of the EU’s Emissions Trading System), the evidence makes clear that the EU ETS has succeeded in reducing emissions significantly below what would be expected from the recession alone.

For source, please click here.

This is where an important caveat needs to be introduced.  Also feeding into this allowance price depression has been a set of national and regional energy policies, such as those promoting use of renewables, which have served to reduce emissions, demand for allowances, and hence allowance prices (while rendering the overall CO2 program less cost-effective by ensuring that marginal abatement costs remain heterogeneous).  So, to the degree that the low allowance prices are due to so-called complimentary policies, the low prices are bad news about public policy (in cost-effectiveness terms), not good news.  But this refers to misguided complimentary policies (which fail to bring about any incremental emissions reductions — under the cap-and-trade umbrella — and drive up aggregate cost), not to any design flaw in the EU ETS itself.

Multiple Goals Typically Require Multiple Policy Instruments

No doubt, Minister Lidegaard is aware of the allowance price impacts of the recession, and I hope he’s aware of the allowance price consequences of these other energy and environmental policies.  The problem arises, however, because he sees the fundamental purpose of the EU ETS as somewhat broader than what I described at the beginning of this essay (namely, achieving emissions consistent with some cap, and doing so cost-effectively – if the cap is binding).  For him – and many other European observers – “the purpose of the ETS was to cap CO2 emissions in the E.U. and ensure clear economic incentives for investment in renewables.”  So, the hand-wringing is not about a failure to achieve emissions reductions cost-effectively, but to have prices high enough to achieve other goals – in this case, greater use of renewable sources of energy.  For others, the “other goals” have involved allowance prices high enough to bring about some targeted amount of technology innovation.

As I have written at this blog in the past, having multiple policy goals typically necessitates multiple policy instruments.  For example, if the goal is a combination of reducing emissions cost-effectively and having prices maintained at some minimum (whether to bring about greater use of renewable energy sources or to inspire more technology innovation), then two policy instruments are needed to do the job:  a cap-and-trade system for the first goal in combination with a carbon tax in the form of a price floor (as in RGGI) for the second goal.

Don’t Throw Out the Baby with the Bath Water

In other words, the EU ETS has not failed, but the design was inadequate (that is, incomplete) for what politicians now seem to want.  If the Europeans want a price floor in their system (or better yet, a price collar, which would combine a price floor with a safety valve, i.e., price ceiling), then this is certainly feasible technically and economically.  Likewise, if the EU member states have the desire and the political will to tighten the cap in the future, there are a variety of ways in which they can accomplish this, rendering the program more stringent and increasing allowances prices.  But, in any event, the European Commission’s Energy division, Environment division, and Climate division should sort out the real effects of the “complimentary policies” that have contaminated the EU ETS, and which fail to bring about additional emissions reductions but drive up costs.  Whether any of this is feasible politically is a question that my European colleagues and friends can best address.

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If the Durban Platform Opened a Window, Will India and China Close It?

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In my December 12th essay – following the 17th Conference of the Parties (COP-17) of the United Nations Framework Convention on Climate Change (UNFCCC), which adjourned on December 11, 2011 – I offered my assessment of the Durban climate negotiations by taking note of three major outcomes of the negotiations:  (1) elaboration on several components of the Cancun Agreements; (2) a second five-year commitment period for the Kyoto Protocol; and (3) a “non-binding agreement to reach an agreement” by 2015 that will bring all countries under the same legal regime by 2020.   Subsequently, in my January 1st essay – The Platform Opens a Window: An Unambiguous Consequence of the Durban Climate Talks – I focused on the third outcome of the talks, the “Durban Platform for Enhanced Action.”

Some Necessary History

The U.N. Framework Convention on Climate Change, adopted at the U.N. Conference on Environment and Development (the first “Earth Summit”) in Rio de Janeiro, Brazil, in 1992, contains what was to become a crucial passage:  “The Parties should protect the climate system for the benefit of present and future generations of humankind, on the basis of equity and in accordance with their common but differentiated responsibilities and respective capabilities. Accordingly, the developed country Parties should take the lead in combating climate change and the adverse effects thereof.” [emphasis added]  The countries considered to be “developed country Parties” were listed in an appendix to the 1992 Convention ­– Annex I.

The phrase – common but differentiated responsibilities – was given a specific interpretation three years after the Earth Summit by the first decision adopted by the first Conference of the Parties (COP-1) of the U.N. Framework Convention, in Berlin, Germany, April 7, 1995 ­­– the all important Berlin Mandate, which interpreted the principle as:  (1) launching a process to commit (by 1997) the Annex I countries to quantified greenhouse gas emissions reductions within specified time periods (targets and timetables); and (2) stating unambiguously that the process should “not introduce any new commitments for Parties not included in Annex I.”

Thus, the Berlin Mandate established the dichotomous distinction whereby the Annex I countries are to take on emissions-reductions responsibilities, and the non-Annex I countries are to have no such responsibilities whatsoever.  This had wide-ranging and profound consequences, because it became the anchor that prevented real progress in international climate negotiations.  With 50 non-Annex I countries having greater per capita income than the poorest of the Annex I countries, the distinction is clearly out of whack.

But, more important than that, this dichotomous distinction means that:  (a) half of global emissions soon will be from nations without constraints; (b) the world’s largest emitter – China – is unconstrained; (c) aggregate compliance costs are driven up to be four times their cost-effective level, because many opportunities for low-cost emissions abatement in emerging economies are taken off the table; and (d) an institutional structure is perpetuated that makes change and progress virtually impossible.

The dichotomous Annex I/non-Annex I distinction remained a central – indeed, the central – feature of international climate negotiations ever since COP-1 in Berlin in 1995.  Then, at COP-15 in 2009, there were hints of possible change.

The Copenhagen Accord (2009) and the Cancun Agreements (2010) began a process of blurring the Annex I/non-Annex I distinction.  But this blurring was only in the context of the interim pledge-and-review system established at COP-15 in Copenhagen and certified at COP-16 in Cancun, not in the context of an eventual successor to the Kyoto Protocol.  Thus, the Berlin Mandate retained its centrality.

The Durban Platform for Enhanced Action

The third of the three outcomes of the December 2011 talks in Durban, South Africa – the Durban Platform for Enhanced Action – eliminates the Annex I/non-Annex I (or industrialized/developing country) distinction.  In the Durban Platform, the delegates reached a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020.  That’s a strange sentence, but it’s important.

Rather than adopting the Annex I/non-Annex I (or industrialized/developing country) distinction, the Durban Platform focuses instead on the pledge to create a system of greenhouse gas reductions including all Parties (that is, all key countries) by 2015 that will come into force by 2020.  Nowhere in the text of the decision are phrases such as “Annex I,” “common but differentiated responsibilities,” “distributional equity,” “historical responsibility,” all of which had long since become code words for targets for the richest countries and blank checks for all others.

Thus, in a dramatic departure from some seventeen years of U.N. international negotiations on climate change, the 17th Conference of the Parties in Durban turned away from the Annex I/non-Annex I distinction, which had been the centerpiece of international climate policy and negotiations since it was adopted at the 1st Conference of the Parties in Berlin in 1995.  In truth, only time will tell whether the Durban Platform delivers on its promise, or turns out to be another “Bali Roadmap,” leading nowhere, but there is a key unambiguous consequence of this development.

Durban Opens a Window

By replacing the Berlin Mandate, the Durban Platform has opened an important window.  National delegations from around the world now have a challenging task before them:  to identify a new international climate policy architecture that is consistent with the process, pathway, and principles laid out in the Durban Platform, namely to find a way to include all key countries (such as the 20 largest national and regional economies that together account for upwards of 80% of global carbon dioxide emissions) in a structure that brings about meaningful emissions reductions on an appropriate timetable at acceptable cost, while remaining within the overall framework provided by the UNFCCC.

Is India Seeking to Close the Window?

As part of the agreement to launch the Durban Platform for Enhanced Action, the nations of the world agreed to initiate a work plan on enhancing mitigation ambition.  As a first step, each country was to submit its initial ideas.

On February 28, 2012, the Indian government made its official submission to the UNFCCC, “Increasing Ambition Level under Durban Platform for Enhanced Action.”  In seventeen paragraphs across three pages of text, India’s submission makes absolutely clear its view that the Durban Platform is under the overall legal umbrella of the UNFCCC, and therefore that the principles of “equity” and “common but differentiated responsibilities” remain intact and must inform all commitments for enhanced action.  In fact, the lion’s share of India’s submission talks about the responsibilities of industrialized countries, not about India’s ideas for its own contributions.

India’s submission actually quantifies what it sees as the necessary future commitments of Annex I (“developed”) countries – by referring to the 2007 Fourth Assessment Report (AR4) of the Intergovernmental Panel on Climate Change:  “AR4 has recommended that Annex I Parties should reduce their emissions at least by 25-40% in the short term by 2020” [emphasis added].  But, in truth, AR4 made no such recommendation.  Indeed, the IPCC – in general – does not make any policy recommendations whatsoever.  This is one of the key organizing principles under which the IPCC operates.  I know this from decades of direct work with the IPCC, having served as a Lead Author in two rounds of the IPCC, and currently serving as a Coordinating Lead Author in AR5.

China Weighs In

A week after India made its submission, the Chinese government followed suit on March 8th with “China’s Submission on Options and Ways for Further Increasing the Level of Ambition.”  The submission is consistent with India’s, maintaining that industrialized countries alone bear responsibility for reducing emissions before 2020:  “Developed country Parties should take the lead in reducing their emissions by undertaking ambitious mitigation commitments and fulfill their obligations by providing financial resources and transferring technology to developing country Parties.”

They Have a Point

India and China have a point.  The Durban Platform did not supplant the Convention, so the general notions of “equity” and “common but differentiated responsibilities” do remain.  But – and here is the key reality – the Durban Platform did replace the Berlin Mandate.  And so a window has been opened to explore new, more sophisticated, and more subtle ways of involving all key countries in an environmentally effective and cost-effective global agreement, with a new interpretation of common but differentiated responsibilities.

For example, replacing the dichotomous Annex I/non-Annex I distinction with a formula that generates a continuous spectrum of degrees of responsibility would be fully consistent both with the Durban Platform for Enhanced Action and the U.N. Framework Convention on Climate Change.  Such a formulaic approach – as developed by Professors Jeffrey Frankel and Valentina Bosetti for the Harvard Project on Climate Agreements – merits serious consideration, along with other innovative international policy architectures.

Although some in the press and blogosphere have characterized the Chinese and Indian submissions as hitting “the brakes on Durban pledges” and “hitting the reset button on international climate change commitments,” in reality the Chinese and Indian submissions refer only to emission reductions prior to 2020, whereas the Durban Platform for Enhanced Action focuses on (agreeing by 2015 on) a new international agreement that would be implemented only in 2020.  Thus, there’s no inconsistency.

Stay Tuned

Whether or not the submissions by China and India are part of a diplomatic dance or represent a real step backward from their positions in Durban, the fact remains that the Durban Platform – by replacing the Berlin Mandate – has opened an important window.  Governments around the world need fresh, outside-of-the-box ideas over the next few years of a possible future international climate policy architecture that can meet the call of the Durban Platform while remaining true to the Framework Convention on Climate Change.  That’s the challenge, as well as the opportunity.

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Reflections on Twenty Years of Policy Innovation

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In 2009, the U.S. Congress considered but ultimately failed to enact legislation aimed at limiting U.S. greenhouse-gas (GHG) emissions.  The bill under consideration at that time, the American Clean Energy and Security Act of 2009, was the last in a series considered over several years.  Sponsored by Representatives Henry Waxman (D-California) and Edward Markey (D-Massachusetts), the bill passed the U.S. House of Representatives but failed to win sufficient support in the Senate.  No legislation was enacted, and by 2010, both Congress and the White House had abandoned efforts to pass federal climate legislation.

Over months of contentious debate, while the Waxman-Markey bill and subsequent Senate action were being considered, millions of Americans were introduced for the first time to the phrase “cap and trade,” a regulatory approach that first came to prominence in the 1990s as the centerpiece of a national program to address the threat of acid rain by limiting emissions of sulfur dioxide (SO2), primarily from electric power plants.

The 1990 SO2 cap-and-trade program was conceived by the administration of President George H. W. Bush and was widely viewed as a success.  Yet cap and trade became a lightning rod for congressional opposition to climate legislation from 2009 through 2010.

Some of that hostility reflected skepticism about whether climate change was real and, if it was, whether humans played a key role in causing it. A larger group of opponents in Congress worried about the proper role of government and the costs of combating climate change, particularly given the lack of commitments for action by the large emerging economies of China, India, Brazil, Korea, South Africa, and Mexico.  The congressional debate touched only lightly on the relative merits of various policy options to reduce greenhouse-gas emissions. Thus, cap and trade may not have been defeated on its merits (or demerits), but rather as collateral damage in the larger climate policy wars.

Congress (to the extent it did assess policy alternatives to cap and trade), as well as the broader community of analysts and observers in the late 2000s, raised a number of substantive questions about the merits of this policy instrument as a means for responding to a major environmental policy challenge of the sort posed by climate change:

  • How do the costs of a market-based approach, such as cap-and-trade, compare with traditional regulatory policies to reduce pollution?
  • Can market-based policies—and the markets they create—be trusted to reduce emissions? That is, are they environmentally effective?
  • What are the distributional impacts of market-based environmental policies; who are the winners and losers?
  • How well does a cap-and-trade system stimulate technological innovation, as compared with an environmental policy that sets performance standards, specifies technologies for reducing pollution, or both?

In May 2011, the Harvard Environmental Economics Program hosted a two-day research workshop and policy roundtable in Cambridge, Massachusetts, to reflect on these and other questions in light of twenty years of experience implementing the SO2 cap-and-trade program, established under Title IV of the Clean Air Act Amendments (CAAA) of 1990. Also known as the Acid Rain Program and the SO2 allowance-trading system, Title IV represented the first large-scale application of cap and trade to control pollution—in the United States or any other country.  (Of course, the largest emissions trading program in the world is now the European Union Emissions Trading System (EU ETS), a greenhouse-gas, cap-and-trade system that was implemented in 2005 and whose design was influenced by the U.S. SO2 program.)

A “policy brief” synthesizing the main conclusions and insights that emerged from the May 2011 Harvard workshop and roundtable has just been released, The SO2 Allowance Trading System and the Clean Air Act Amendments of 1990:  Reflections on Twenty Years of Policy Innovation.  The workshop and roundtable – sponsored by the Alfred P. Sloan Foundation – featured a dream team of economists and legal experts who had conducted extensive research on the SO2 allowance-trading system, as well as leaders of non-governmental organizations and former government officials who had guided the formulation and passage of the CAAA.

The new policy brief examines the design, enactment, implementation, and performance of the SO2 allowance trading system, with an eye toward identifying lessons learned for future efforts to apply cap and trade to other environmental challenges, including global climate change.  The first section provides background on the acid rain program and summarizes data and analysis on its benefits. Subsequent sections examine key questions regarding cost, environmental effectiveness, market performance, distributional implications, and effects on technology innovation.  The report also examines the political context of the formulation, enactment, and implementation of the SO2 allowance-trading system.  Finally, the conclusions feature some reflection on implications for climate change policy.

The participants in the research workshop were:  Joseph Aldy, Assistant Professor of Public Policy, Harvard Kennedy School; Dallas Burtraw, Darius Gaskins Senior Fellow, Resources for the Future; Denny Ellerman, Part-time Professor, European University Institute, Robert Schuman Centre for Advanced Studies; Michael Greenstone, 3M Professor of Environmental Economics, Massachusetts Institute of Technology; Lawrence H. Goulder, Shuzo Nishihara Professor of Environmental and Resource Economics, Stanford University; Robert Hahn, Director of Economics, Smith School, University of Oxford; Paul L. Joskow, President, Alfred P. Sloan Foundation; Erin T. Mansur, Associate Professor of Economics, Dartmouth College; Albert McGartland, Director, National Center for Environmental Economics, U.S. Environmental Protection Agency; Brian J. McLean, Former Director, Office of Atmospheric Programs, U.S. Environmental Protection Agency; W. David Montgomery, Senior Vice President, NERA Economic Consulting; Erich J. Muehlegger, Associate Professor of Public Policy, Harvard Kennedy School; Karen L. Palmer, Senior Fellow, Resources for the Future; John Parsons, Executive Director, Center for Energy and Environmental Policy Research, MIT Sloan School of Management; Forest L. Reinhardt, John D. Black Professor of Business Administration, Harvard Business School; Richard L. Schmalensee, Howard W. Johnson Professor of Economics and Management, MIT Sloan School of Management; Daniel Schrag, Sturgis Hooper Professor of Geology, Harvard University; Robert N. Stavins, Albert Pratt Professor of Business and Government, Harvard Kennedy School; Thomas Tietenberg, Mitchell Family Professor of Economics, Emeritus, Colby College; and Jonathan B. Wiener, William R. and Thomas L. Perkins Professor of Law, Duke University Law School.

The participants in the policy and politics roundtable were:  Robert Grady, General Partner, Cheyenne Capital Fund (1989–1991: Associate Director, Office of Management and Budget for Natural Resources, Energy & Science; 1991–1993 Executive Associate Director, OMB, and Deputy Assistant to the President); C. Boyden Gray, Principal, Boyden Gray & Associates (1989–1993: White House Counsel); Fred Krupp, President (1984–present), Environmental Defense Fund; Mary D. Nichols, Chairman, California Air Resources Board (1993–1997: Assistant Administrator for Air and Radiation, U.S. Environmental Protection Agency); Roger Porter, IBM Professor of Business and Government, Harvard Kennedy School (1989–1993: Assistant to the President for Economic and Domestic Policy); Richard L. Schmalensee, Howard W. Johnson Professor of Economics and Management, MIT Sloan School of Management (1989–1991: Member, President’s Council of Economic Advisers); and Philip Sharp, President, Resources for the Future (1975–1995: Member, U.S. House of Representatives, Indiana, and Chairman, Energy and Power Subcommittee, House Committee on Natural Resources).

I want to acknowledge the contributions of all of these participants in the research workshop and policy roundtable, as well as the comments and edits some provided on earlier drafts of the policy brief.  Their expertise and experience made this project possible. And, of course, I’m very grateful to the Alfred P. Sloan Foundation for having provided generous support for the workshop and for the preparation of the study.  I hope you find it of interest and value.

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Economics of the Environment

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The Sixth Edition of Economics of the Environment: Selected Readings has just been published by W. W. Norton & Company of New York and London.  Through five previous editions, Economics of the Environment has served as a valuable supplement to environmental economics texts and as a stand-alone book of original readings in the field of environmental economics.  Nearly seven years have passed since the previous edition of this volume was published, and it is now more than three decades since the first edition appeared, edited by Robert and Nancy Dorfman.  The Sixth Edition continues this tradition.

Motivation and Audience

Environmental economics continues to evolve from its origins as an obscure application of welfare economics to a prominent field in its own right, which combines elements from public finance, industrial organization, microeconomic theory, and many other areas of economics.  The number of articles on the environment appearing in mainstream economics periodicals continues to increase, and more and more economics journals are dedicated exclusively to environmental and resource topics.

There has also been a proliferation of environmental economics textbooks for college courses.  Many are excellent, but none can be expected to provide direct access to timely and original contributions by the field’s leading scholars.  As most teachers of economics recognize, it is valuable to supplement the structure and rigor of a text with original readings from the literature.

Scope and Style

With that in mind, this new edition of Economics of the Environment consists of thirty-four chapters that instructors will find to be of great value as a complement to their chosen text and their lectures.  The scope is comprehensive, and the list of authors is a veritable “who’s who” of environmental economics, including:  Joseph Aldy, Kenneth Arrow, Trudy Cameron, Ronald Coase, Maureen Cropper, Peter Diamond, George Eads, Jeffrey Frankel, Rick Freeman, Don Fullerton, Lawrence Goulder, John Graham, Robert Hahn, Michael Hanemann, Jerry Hausman, Steven Kelman, Nathaniel Keohane, Alan Krupnick, Lester Lave, John Livernois, Eric Maskin, Leonardo Maugeri, Gilbert Metcalf, Richard Newell, Roger Noll, William Nordhaus, Wallace Oates, Sheila Olmstead, Elinor Ostrom, Karen Palmer, Ian Parry, Carl Pasurka, Robert Pindyck, William Pizer, Michael Porter, Paul Portney, Forest Reinhardt, Richard Revesz, Milton Russell, Michael Sandel, Richard Schmalensee, Steven Shavell, Jason Shogren, Kerry Smith, Robert Solow, Nicholas Stern, Laura Taylor, Richard Vietor, and myself.

The articles are timely, with more than 90 percent published since 1990, and half since 2005.  There are two completely new sections of the book, “Economics of Natural Resources” and “Corporate Social Responsibility,” and all of the chapters in the section on global climate change are new to the sixth edition.

In order to make the readings in Economics of the Environment accessible to students at all levels, one criterion I use in the selection process is that articles should not only be original and well written — and meet the highest standards of economic scholarship — but also be non-technical in their presentations.  Hence, readers will find virtually no formal mathematics in any of the book’s 34 chapters throughout its 733 pages.

The Path Ahead

Environmental economics is a rapidly evolving field.  Not only do new theoretical models and improved empirical methods appear on a regular basis, but entirely new areas of investigation open up when the natural sciences indicate new concerns or the policy world turns to new issues.  Therefore, this book remains a work in progress.  I owe a great debt to the teachers and students of previous editions who have sent their comments and suggestions for revisions.  Looking to future editions, I invite all readers — whether teachers, students, or practitioners — to send me any thoughts or suggestions for improvement.

In the meantime, if you’re interested finding out more about the book, immediately below is a chapter-by-chapter summary of the book.  Alternatively, you can check out the W. W. Norton or Amazon web sites.

——————————————————————————————————————–

Appendix:  A Summary of Economics of the Environment, Sixth Edition

Part I of the volume provides an overview of the field and a review of its foundations.  Don Fullerton and I start things off with a brief essay about how economists think about the environment (Nature 1998).  This is followed by the classic treatment of social costs and bargaining by Ronald Coase (Journal of Law and Economics 1960), and a new article by Jason Shogren and Laura Taylor on the important, emerging field of behavioral environmental economics (Review of Environmental Economics and Policy 2008).

The Costs of Environmental Protection

Part II examines the costs of environmental protection, which might seem to be without controversy or current analytical interest.  This is not, however, the case.  This section begins with a survey article by Carl Pasurka that reviews the theory and empirical evidence on the relationship between environmental regulation and so-called “competitiveness” (Review of Environmental Economics and Policy 2008).

A somewhat revisionist view is provided by Michael Porter and Class van der Linde, who suggest that the conventional approach to thinking about the costs of environmental protection is fundamentally flawed (Journal of Economic Perspectives 1995).  Karen Palmer, Wallace Oates, and Paul Portney provide a careful response (Journal of Economic Perspectives 1995).

The Benefits of Environmental Protection

In Part III, the focus turns to the other side of the analytic ledger — the benefits of environmental protection.  This is an area that has been even more contentious — both in the policy world and among scholars.  Here the core question is whether and how environmental amenities can be valued in economic terms for analytical purposes.

The book features a provocative debate on the stated-preference method known as “contingent valuation.”  Paul Portney outlines the structure and importance of the debate, Michael Hanemann makes the affirmative case, and Peter Diamond and Jerry Hausman provide the critique (all three articles are from the Journal of Economic Perspectives 1994).

In the final article in Part III, the book turns to a concept that is both very important in assessments of the benefits of environmental regulations and is also very widely misunderstood — the value of a statistical life.  In an insightful essay, Trudy Cameron seeks to set the record straight (Review of Environmental Economics and Policy 2010).

There are two principal policy questions that need to be addressed in the environmental realm:  how much environmental protection is desirable; and how should that degree of environmental protection be achieved.  The first of these questions is addressed in Part IV and the second in Part V.

The Goals of Environmental Policy:  Economic Efficiency and Benefit-Cost Analysis

In an introductory essay, Kenneth Arrow, Maureen Cropper, George Eads, Robert Hahn, Lester Lave, Roger Noll, Paul Portney, Milton Russell, Richard Schmalensee, Kerry Smith, and I ask whether there is a role for benefit-cost analysis to play in environmental, health, and safety regulation (Science 1996).

Then, Lawrence Goulder and I focus on an ingredient of benefit-cost analysis that non-economists seem to find particularly confusing, or even troubling — intertemporal discounting (Nature 2002).  Next, Robert Pindyck examines a subject of fundamental importance — the role of uncertainty in environmental economics (Review of Environmental Economics and Policy 2007).  Steven Kelman provides an ethically-based critique of benefit-cost analysis, which is followed by a set of responses (Regulation 1981).

Part IV concludes with an up-to-date essay by John Graham on the critical role of the U.S. Office of Management and Budget in federal regulatory impact analysis (Review of Environmental Economics and Policy 2008).

The Means of Environmental Policy:  Cost Effectiveness and Market-Based Instruments

Part V examines the policy instruments — the means — that can be employed to achieve environmental targets or goals.  This is an area where economists have made their greatest inroads of influence in the policy world, with tremendous changes having taken place over the past twenty  years in the reception given by politicians and policy makers to so-called market-based or economic-incentive instruments for environmental protection.

Lawrence Goulder and Ian Parry start things off with a broad-ranging essay on instrument choice in environmental policy (Review of Environmental Economics and Policy 2008).  Following this, I examine lessons that can be learned from the innovative sulfur dioxide allowance trading program, set up by the Clean Air Act Amendments of 1990 (Journal of Economic Perspectives 1998).  Finally, Michael Sandel provides a critique of market-based instruments, with responses offered by Eric Maskin, Steven Shavell, and others (New York Times 1997).

Economics of Natural Resources

Part VI consists of three essays on a new topic for this book — the economics of natural resources.  First, John Livernois examines the empirical significance of a central tenet in natural resource economics, namely the Hotelling Rule — the proposition that under conditions of efficiency, the scarcity rent (price minus marginal extraction cost) of natural resources will rise over time at the rate of interest (Review of Environmental Economics and Policy 2009).

Essays by Leonardo Maugeri (Review of Environmental Economics and Policy 2009) and Sheila Olmstead (Review of Environmental Economics and Policy 2010), respectively, examine two particularly important resources:  petroleum and water.

The next four sections of the book treat some timely and important topics and problems.

Corporate Social Responsibility and the Environment

Part VII examines corporate social responsibility and the environment, discussion of which has too often been characterized by more heat than light.  Forest Reinhardt, Richard Vietor, and I provide an overview of this realm from the perspective of economics, examining the notion of firms voluntarily sacrificing profits in the social interest.  In a second essay, Paul Portney provides a valuable empirical perspective (both are from the Review of Environmental Economics and Policy 2008).

Global Climate Change

Part VIII is dedicated to investigations of economic dimensions of global climate change, which may in the long term prove to be the most significant environmental problem that has arisen, both in terms of its potential damages and in terms of the costs of addressing it.  First, a broad overview of the topic is provided in a survey article by Joseph Aldy, Alan Krupnick, Richard Newell, Ian Parry, and William Pizer (Journal of Economic Literature 2010).

Next, William Nordhaus critiques the well-known Stern Review on the Economics of Climate Change, and Nicholas Stern and Chris Taylor respond (both are from Science 2007).  In the final essay in this section, Gilbert Metcalf examines market-based policy instruments that can be used to address greenhouse gas emissions (Journal of Economic Perspectives 2009).

Sustainability, the Commons, and Globalization

Part IX begins with Robert Solow’s economic perspective on the concept of sustainability.  This is followed by Elinor Ostrom’s development of a general framework for analyzing sustainability (Science 2009), and my own historical view of economic analysis of problems associated with open-access resources (American Economic Review 2011).  Then, Jeffrey Frankel draws on diverse sources of empirical evidence to examine whether globalization is good or bad for the environment (Council on Foreign Relations 2004).

Economics and Environmental Policy Making

The final section of the book, Part X, departs from the normative concerns of much of the volume to examine some interesting and important questions of political economy.  It turns out that an economic perspective can provide useful insights into questions that might at first seem to be fundamentally political.

Nathaniel Keohane, Richard Revesz, and I utilize an economic framework to ask why our political system has produced the particular set of environmental policy instruments it has (Harvard Environmental Law Review 1998).  Myrick Freeman reflects on the benefits that U.S. environmental policies have brought about since the first Earth Day in 1970 (Journal of Economic Perspectives 2002).  Lastly, Robert Hahn addresses the question that many of the articles in this volume raise:  what impact has economics actually had on environmental policy (Journal of Environmental Economics and Management 2000)?

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The Platform Opens a Window: An Unambiguous Consequence of the Durban Climate Talks

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In my previous essay – following the 17th Conference of the Parties (COP-17) of the United Nations Framework Convention on Climate Change (UNFCCC), which adjourned on December 11, 2011 – I offered my assessment of the Durban climate negotiations, addressing the frequently-posed question of whether the talks had “succeeded.”  I took note of three major outcomes from the negotiations:  (1) elaboration on several components of the Cancun Agreements; (2) a second five-year commitment period for the Kyoto Protocol; and (3) a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020.  My conclusion was that this package – in total – represented something of a “half-full glass of water,” that is, an outcome that could be judged successful or not, depending upon one’s perspective.

However, something I did not discuss last month is that this third provision ­– the “Durban Platform for Enhanced Action” – has opened an important window.  To explain what I mean requires a brief review of some key points from twenty years of history of international climate negotiations.

The Rio Earth Summit (1992)

The U.N. Framework Convention on Climate Change, adopted at the U.N. Conference on Environment and Development (the first “Earth Summit”) in Rio de Janeiro, Brazil, in 1992, contains what was to become a crucial passage.  The first “principle” in Article 3 of the Convention reads as follows:  “The Parties should protect the climate system for the benefit of present and future generations of humankind, on the basis of equity and in accordance with their common but differentiated responsibilities and respective capabilities. Accordingly, the developed country Parties should take the lead in combating climate change and the adverse effects thereof.” [emphasis added]  The countries considered to be “developed country Parties” were listed in an appendix to the 1992 Convention ­– Annex I.

The phrase – common but differentiated responsibilities – has been repeated countless numbers of times since 1992, but what does it really mean?  The official answer was provided three years after the Earth Summit by the first decision adopted by the first Conference of the Parties (COP-1) of the U.N. Framework Convention, in Berlin, Germany, April 7, 1995 ­­– the Berlin Mandate.

The Berlin Mandate (1995)

The Berlin Mandate interpreted the principle of “common but differentiated responsibilities” as:

(1) launching a process to commit (by 1997) the Annex I countries to quantified greenhouse gas emissions reductions within specified time periods (targets and timetables); and

(2) stating unambiguously that the process should “not introduce any new commitments for Parties not included in Annex I.”

Thus, the Berlin Mandate established the dichotomous distinction whereby the Annex I countries are to take on emissions-reductions responsibilities, and the non-Annex I countries are to have no such responsibilities whatsoever.

The Kyoto Protocol (1997)

It was in direct response to this Mandate that the U.S. Senate subsequently passed unanimously (95-0) the Byrd-Hagel Resolution in August of 1997 (Senate Resolution 98, 105th Congress, 1st Session) stating that:

“It is the sense of the Senate that the United States should not be a signatory to any protocol to, or other agreement regarding, the United Nations Framework Convention on Climate Change of 1992, at negotiations in Kyoto in December 1997, or thereafter, which would mandate new commitments to limit or reduce greenhouse gas emissions for the Annex I Parties, unless the protocol or other agreement also mandates new specific scheduled commitments to limit or reduce greenhouse gas emissions for Developing Country Parties within the same compliance period.”

So, in a very real sense, the Berlin Mandate brought about sustained bi-partisan opposition in the United States to the international climate regime and the Kyoto Protocol.  This sealed the Protocol’s fate in terms of ever being ratified by the U.S. Senate.  President Clinton did not submit the Protocol to the Senate for ratification, nor would Al Gore have done so had he been elected to succeed Clinton.  Likewise, Senator John Kerry was explicit about his opposition to Kyoto when he ran for President against George W. Bush, and President Bush was subsequently more than explicit about his lack of support for the Protocol and, for that matter, the UNFCCC process.  When Barack Obama ran against John McCain for President in 2008, one thing on which they agreed was their opposition to the Kyoto Protocol.

Beyond those decisive impacts on U.S. climate politics, the Berlin Mandate had wide-ranging and worldwide normative consequences, because it became the anchor that prevented and has – until very recently – continued to prevent real progress in international climate negotiations.  With 50 non-Annex I countries having greater per capita income than the poorest of the Annex I countries, the distinction is clearly out of whack.  But, more important than that, this dichotomous distinction means that:

(a) half of global emissions soon will be from nations without constraints;

(b) the world’s largest emitter – China – is unconstrained;

(c) aggregate compliance costs are driven up to be four times their cost-effective level, because many opportunities for low-cost emissions abatement in emerging economies are taken off the table; and

(d) an institutional structure is perpetuated that makes change and progress virtually impossible.

Fast Forward to Copenhagen (2009) and Cancun (2010)

The dichotomous Annex I/non-Annex I distinction remained a central – indeed, the central – feature of international climate negotiations ever since COP-1 in Berlin in 1995.  Then, at COP-15 in 2009, there were hints of possible change.

The Copenhagen Accord (2009) and the Cancun Agreements (2010) began a process of blurring the Annex I/non-Annex I distinction.  However, this blurring was only in the context of the interim pledge-and-review system established at COP-15 in Copenhagen and certified at COP-16 in Cancun, not in the context of an eventual successor to the Kyoto Protocol.  Thus, the Berlin Mandate retained its centrality.

Finally, We Arrive in Durban (2011)

The third of the three outcomes of the December 2011 talks in Durban, South Africa, which I mentioned at the beginning of this essay – the Durban Platform for Enhanced Action – completely eliminates the Annex I/non-Annex I (or industrialized/developing country) distinction.  In the Durban Platform, the delegates reached a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020.  That’s a strange and confusing sentence, but it’s what happened, and it’s potentially important.

Rather than adopting the Annex I/non-Annex I (or industrialized/developing country) distinction, the Durban Platform focuses instead on the (admittedly non-binding) pledge to create a system of greenhouse gas reductions including all Parties (that is, all key countries) by 2015 that will come into force (after ratification) by 2020.  Nowhere in the text of the decision will one find phrases such as “Annex I,” “common but differentiated responsibilities,” “distributional equity,” “historical responsibility,” all of which had long since become code words for targets for the richest countries and blank checks for all others.

A Dramatic Departure

Thus, in a dramatic departure from some seventeen years of U.N. hosted international negotiations on climate change, the 17th Conference of the Parties in Durban turned away from the Annex I/non-Annex I distinction, which had been the centerpiece of international climate policy and negotiations since it was adopted at the 1st Conference of the Parties in Berlin in 1995.

Because of this, the international law scholar, Daniel Bodansky, has labeled “the Durban Platform a complete departure from the Berlin Mandate.”  Likewise, Indian professor of international law, Lavanya Rajamani says that Durban delivered a “new process and with it, a clean slate on differentiation.”  And Elliot Diringer of the Center for Climate and Energy Solutions, finds the overall Durban deal to be “delicately poised between two eras – the fading age of Kyoto, and a new phase … with developed and developing countries presumably on a more equal footing.”

This is of vast potential importance, but – of course – only “potential” importance, because just as it was the Kyoto Protocol’s numerical targets and timetables that fulfilled the Berlin Mandate’s promise, it remains for the delegates to the UNFCCC to meet this Durban mandate with a new post-Kyoto agreement by 2015 (to come into force by 2020).  Only time will tell whether the Durban Platform delivers on its promise, or turns out to be another “Bali Roadmap,” leading nowhere.

So, with such uncertainty, what’s the “unambiguous consequence” of Durban that I refer to in the title of this essay?

An Unambiguous Outcome:  The Platform Opens a Window

The Durban Platform – by replacing the Berlin Mandate – has opened an important window.  It is this.  The national delegations from around the world now have a challenging task before them:  to identify a new international climate policy architecture that is consistent with the process, pathway, and principles laid out in the Durban Platform, namely to find a way to include all key countries (such as the 20 largest national and regional economies that together account for upwards of 80% of global carbon dioxide emissions) in a structure that brings about meaningful emissions reductions on an appropriate timetable at acceptable cost.

Having broken the old mold, a new one must be forged.  There is a mandate for change.  Governments around the world now need fresh, outside-of-the-box ideas from the best thinkers, and they need those ideas over the next few years.  This is a time for new proposals for future international climate policy architecture, not for incremental adjustments to the old pathway.  I trust that this call will be heard by a diverse set of universities, think tanks, and – for that matter – advocacy and interest groups around the world.  With 48 research initiatives in Australia, China, Europe, India, Japan, and the United States, the Harvard Project on Climate Agreements is prepared to contribute to this effort.  Please stay tuned.

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Assessing the Climate Talks — Did Durban Succeed?

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The 17th Conference of the Parties (COP-17) of the United Nations Framework Convention on Climate Change (UNFCCC) adjourned on Sunday, a day and a half after its scheduled close, and in the process once again pulled a rabbit out of the hat by saving the talks from complete collapse (which appeared possible just a few days earlier).  But was this a success?

The Durban Outcome in a Nutshell

The outcome of COP-17 includes three major elements:  some potentially important elaborations on various components of the Cancun Agreements; a second five-year commitment period for the Kyoto Protocol; and (read this carefully) a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020.

Is This a Success?

If by “success” in Durban, one means solving the climate problem, the answer is obviously “not close.”

Indeed, if by “success” one meant just putting the world on a path to solve the climate problem, the answer would still have to be “no.”

But, I’ve argued previously – including in my pre-Durban essay last month – that such definitions of success are fundamentally inappropriate for judging the international negotiations on the exceptionally challenging, long-term problem of global climate change.

The key question, at this point, is whether the Durban outcome has put the world in a place and on a trajectory whereby it is more likely than it was previously to establish a sound foundation for meaningful long-term action.

I don’t think the answer to that question is at all obvious, but having read carefully the agreements that were reached in Durban, and having reflected on their collective implications for meaningful long-term action, I am inclined to focus on “the half-full glass of water.”  My conclusion is that the talks – as a result of last-minute negotiations – advanced international discussions in a positive direction and have increased the likelihood of meaningful long-term action.  Why do I say this?

The Significance of Durban

Let’s look at the three major elements of the Durban outcome.

     1.  Putting More Flesh on the Bones of the Cancun Agreements

First, the delegates agreed to a set of potentially important details on various components of the Cancun Agreements.  This progress may turn out to be very important indeed, and helps advance – at least for the interim – a workable bottom-up, pledge-and-review approach to international climate cooperation.  The progress on this front includes work done on the Green Climate Fund to help mobilize public and private funding of climate change mitigation and adaptation in developing countries; more specifics on technology transfer mechanisms; mechanisms to enhance the transparency of national commitments under the Cancun Agreements; and an international scheme to reduce deforestation, which – importantly – includes market mechanisms.

     2.  A Second Commitment Period for the Kyoto Protocol

Second, the delegates agreed to a second five-year commitment period for the Kyoto Protocol.  Without this element, the talks would have collapsed, because the key emerging economies of China, India, Brazil, South Africa, Korea, and Mexico (not to mention the much larger number of truly poor, developing countries) would have walked out.  Would this have been so bad?

I have long argued that the Kyoto Protocol – with its structure of relatively ambitious targets for a small set of industrialized countries (the Annex I countries) and no targets whatsoever for the much larger set of other nations in the world (the non-Annex I countries) – is fundamentally flawed as a basis for addressing the climate change problem in a meaningful way, that is, in a way that can eventually limit global temperature increases to no more than 2 or 3 degrees Centigrade above pre-industrial levels.  In the past, some observers have gone so far as to argue that such a collapse of the talks would be necessary to free the world to consider alternative and ultimately more productive routes going forward.  Eventually, that may turn out to be true, but extending the Kyoto Protocol at this time for another period does little mischief.

The major effect – in addition to keeping the emerging economies (and developing countries) from walking out of the room – was to place the European Union in a position of accepting a target (for a second five-year period) that is no more stringent than what it has already committed to do under the European Union Emission Trading Scheme (EU ETS).  The United States is not a party to the Kyoto Protocol, and Canada, Japan, and Russia have indicated that they will not take up targets in a second commitment period.  Europe (and New Zealand, and possibly Australia) will be doing what they would have done anyway.  In exchange for this, the major emerging economies agreed to the third key element.

     3.  The Durban Platform for Enhanced Action

Third and finally, the delegates reached a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020.  That’s a strange and confusing sentence, but it’s what happened, and – in my opinion – it’s potentially important, although it’s much too soon to say for sure.

The anchor that has been preventing real progress in the international climate negotiations for the past fifteen years has been the Kyoto Protocol’s dichotomous distinction between Annex I and non-Annex I countries.  With 50 non-Annex I countries now having greater per capita income than the poorest of the Annex I countries, it is clearly out of whack.  But, much more than that, this dichotomous distinction means that the world’s largest emitter – China – is unconstrained, that half of global emissions soon will be from nations without constraints, it drives up costs to four times their cost-effective level, and it creates a structure that makes change and progress virtually impossible.

Fortunately, the Copenhagen Accord and the Cancun Agreements began the process of blurring the Annex I/non-Annex I distinction, which was an important accomplishment, although it was only in the context of the interim pledge-and-review system, not in the context of an eventual successor to Kyoto.  Now, the COP-17 decision for “Enhanced Action” completely eliminates the Annex I/non-Annex I (or industrialized/developing country) distinction.  It focuses instead on the (admittedly non-binding) pledge to create a system of greenhouse gas reductions including all Parties (that is, all key countries) by 2015 that will come into force (after ratification) by 2020.  Nowhere in the text of the decision will one find phrases such as “Annex I,” “common but differentiated responsibilities,” or “distributional equity,” which have – in recent years – become code words for targets for the richest countries and a blank check for all others.

We should not over-estimate the importance of a “non-binding agreement to reach a future agreement,” but this is a real departure from the past, and marks a significant advance along the treacherous, uphill path of climate negotiations.

The Path Ahead

In my previous essay at this blog, I expressed the fear that contentious debates over a possible second commitment period for the Kyoto Protocol might disrupt the Durban talks, divert them from making sound progress on the Cancun structure, and keep the delegates from moving toward a sound foundation for meaningful long-term action.  I worried, in essence, that Durban – despite the weather – might resemble Copenhagen more than Cancun.

My conclusion is that this did not happen.  Not only did Durban not undo the progress made in Cancun, it built upon it, and moved forward.  This won’t satisfy the 350.org crowd, and it must greatly annoy the opponents of sensible climate policy, but in the real world of international negotiations on this exceptionally difficult global commons problem, this is what success looks like.

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For an interesting and helpful assessment of “The Legal Aspects of the Durban Platform Text,” I recommend an insightful Q&A by Jacob Werksman of the World Resources Institute.

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Can the Durban Climate Negotiations Succeed?

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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).  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 policy makers) 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, with progress only over the long term, 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 twenty 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 UN 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, large, 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 multi-national 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: Specific Formulas and Emission Targets to Attain 460 PPM CO2 Concentrations” by Valentina Bosetti and Jeffrey Frankel; and “Three Key Elements of Post-2012 International Climate Policy Architecture” 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, ten, and twenty 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 emission-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 EU — 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 EU 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 EU 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 EU’s member states — and from European businesses — might make it difficult for the EU 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.

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Further Reading

The Harvard Project on Climate Agreements has pulled together an archive of relevant publications, which we call “The Durban Branch” of our climate library.  We hope it will be helpful for those gathered in Durban or watching from afar.

Also, a number of previous essays I have written and posted at this blog will be of interest to those who wish to follow developments at the Seventeenth Conference of the Parties of the UN Framework Convention on Climate Change in Durban.  Here are links, in reverse chronological order:

Canada’s Step Away From the Kyoto Protocol Can Be a Constructive Step Forward

A Wave of the Future: International Linkage of National Climate Change Policies

Why Cancun Trumped Copenhagen

What Happened (and Why): An Assessment of the Cancun Agreements

Defining Success for Climate Negotiations in Cancun

Three Pillars of a New Climate Pact

Can Countries Cut Carbon Emissions Without Hurting Economic Growth?

Approaching Copenhagen with a Portfolio of Domestic Commitments

Defining Success for Climate Negotiations in Copenhagen

Only Private Sector Can Meet Finance Demands of Developing Countries

Chaos and Uncertainty in Copenhagen?

What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord

Another Copenhagen Outcome: Serious Questions About the Best Institutional Path Forward

Opportunities and Ironies: Climate Policy in Tokyo, Seoul, Brussels, and Washington

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The Promise and Problems of Pricing Carbon

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Friday, October 21st was a significant day for climate change policy worldwide and for the use of market-based approaches to environmental protection, but it went largely unnoticed across the country and around the world, outside, that is, of the State of California.  On that day, the California Air Resources Board voted unanimously to adopt formally the nation’s most comprehensive cap-and-trade system, intended to provide financial incentives to firms to reduce the state’s greenhouse gas (GHG) emissions, notably carbon dioxide (CO2) emissions, to their 1990 level by the year 2020, as part of the implementation of California’s Assembly Bill 32, the Global Warming Solutions Act of 2006.  Compliance will begin in 2013, eventually covering 85% of the state’s emissions.

This policy for the world’s eighth-largest economy is more ambitious than the much heralded (and much derided) Federal policy proposal – H.R. 2454, the Waxman-Markey bill – that was passed by the U.S. House of Representatives in June of 2009, and then died in the U.S. Senate the following year.  With a likely multi-year hiatus on significant climate policy action in Washington now in place, California’s system – which will probably link with similar cap-and-trade systems being developed in Ontario, Quebec, and possibly British Columbia – will itself become the focal point of what may evolve to be the “North American Climate Initiative.”

The Time is Ripe for Reflection

California’s formal adoption of its CO2 cap-and-trade system is an important milestone on the multinational path to carbon pricing policies, and signals that the time is ripe to reflect on the promise and problems of pricing carbon, which is the title of a new paper that Joe Aldy and I have written for a special issue of the Journal of Environment and Development edited by Thomas Sterner and Maria Damon on “Experience with Environmental Taxation” (“The Promise and Problems of Pricing Carbon:  Theory and Experience,” October 27, 2011).  [For anyone who is not familiar with my co-author, let me state for the record that Joseph Aldy is an Assistant Professor of Public Policy at the Harvard Kennedy School, having come to Cambridge, Massachusetts, from Washington, D.C., where he served, most recently, during 2009 and 2010, as Special Assistant to the President for Energy and Environment.  Before that, he was a Fellow at Resources for the Future, the Washington think tank.]

Why Price Carbon?

In a modern economy, nearly all aspects of economic activity affect greenhouse gas – in particular, CO2 – emissions.  Hence, for a climate change policy to be effective, it must affect decisions regarding these diverse activities.  This can be done in one of three ways:  mandating that businesses and individuals change their behavior; subsidizing businesses and individuals; or pricing the greenhouse gas externality.

As economists and virtually all other policy analysts now recognize, by internalizing the externalities associated with CO2 emissions, carbon pricing can promote cost-effective abatement, deliver powerful innovation incentives, and – for that matter – ameliorate rather than exacerbate government fiscal problems.  [See the concise and compelling argument made by Yale Professor William Nordhaus in his essay, “Energy:  Friend or Enemy?” in The New York Review of Books, October 27, 2011.]

By pricing CO2 emissions (or, more likely, by pricing the carbon content of the three fossil fuels – coal, petroleum, and natural gas), governments wisely defer to private firms and individuals to find and exploit the lowest cost ways to reduce emissions and invest in the development of new technologies, processes, and ideas that could further mitigate emissions.

Can Market-Based Instruments Really Work?

Market-based instruments have been used with considerable success in other environmental domains, as well as for pricing CO2 emissions.  The U.S. sulfur dioxide (SO2) cap-and-trade program cut U.S. power plant SO2 emissions more than 50 percent after 1990, and resulted in compliance costs one half of what they would have been under conventional regulatory mandates.

The success of the SO2 allowance trading program motivated the design and implementation of the European Union’s Emission Trading Scheme (EU ETS), the world’s largest cap-and-trade program, focused on cutting CO2 emissions from power plants and large manufacturing facilities throughout Europe.  The U.S. lead phase-down of gasoline in the 1980s, by reducing the lead content per gallon of fuel, served as an early, effective example of a tradable performance standard.  These and other positive experiences provide motivation for considering market-based instruments as potential approaches to mitigating GHG emissions.

What Policy Instruments Can be Used for Carbon Pricing?

In our paper, Joe Aldy and I critically examine the five generic policy instruments that could conceivably be employed by regional, national, or even sub-national governments for carbon pricing:  carbon taxes, cap-and-trade, emission reduction credits, clean energy standards, and fossil fuel subsidy reduction.  Having written about these approaches many times in previous essays at this blog, today I will simply direct the reader to those previous posts or, better yet, to the paper we’ve written for the Journal of Environment and Development.

Although it is natural to think and talk about carbon pricing using the future tense, a few carbon pricing regimes are already in place.

Regional, National, and Sub-National Experiences with Carbon Pricing

Explicit carbon pricing policy regimes currently in place include the European Union’s Emissions Trading Scheme (EU ETS); the Regional Greenhouse Gas Initiative in the northeast United States; New Zealand’s cap-and-trade system; the Kyoto Protocol’s Clean Development Mechanism; a number of northern European carbon tax policies; British Columbia’s carbon tax; and Alberta’s tradable carbon performance standard (similar to a clean energy standard).  We describe and assess all of these in our paper.

Also, the Japanese Voluntary Emissions Trading System has operated since 2006 (Japan is considering a compulsory emissions trading system), and Norway operated its own emissions trading system for several years before joining the EU ETS in 2008.  Legislation to establish cap-and-trade systems is under debate in Australia (combined with a carbon tax for an initial three-year period) and in the Canadian provinces of Ontario and Quebec.  And, of course, California is now committed to launching its own GHG cap-and-trade system.

International Coordination Will Be Needed

Of course, climate change is truly a global commons problem:  the location of greenhouse gas emissions has no effect on the global distribution of damages.  Hence, free-riding problems plague unilateral and multilateral approaches, because mitigation costs are likely to exceed direct benefits for virtually all countries.  Cost-effective international policies – insuring that countries get the most environmental benefit out of their mitigation investments – will help promote participation in an international climate policy regime.

In principle, internationally-employed market-based instruments can achieve overall cost effectiveness.  Three basic routes stand out.  First, countries could agree to apply the same tax on carbon (harmonized domestic taxes) or adopt a uniform international tax.  Second, the international policy community could establish a system of international tradable permits, – effectively a nation-state level cap-and-trade program.  In its simplest form, this represents the Kyoto Protocol’s Annex B emission targets and the Article 17 trading mechanism.  Third and most likely, a more decentralized system of internationally-linked domestic cap-and-trade programs could ensure internationally cost-effective emission mitigation.  We examine the merits and the problems associated with each of these means of international coordination in the paper.

What Lies in the Future?

In reality, political responses in most countries to proposals for market-based approaches to climate policy have been and will continue to be largely a function of issues and factors that transcend the scope of environmental and climate policy.  Because a truly meaningful climate policy – whether market-based or conventional in design – will have significant impacts on economic activity in a wide variety of sectors and in every region of a country, proposals for these policies inevitably bring forth significant opposition, particularly during difficult economic times.

In the United States, political polarization – which began some four decades ago, and accelerated during the economic downturn – has decimated what had long been the key political constituency in the Congress for environmental action, namely, the middle, including both moderate Republicans and moderate Democrats.  Whereas Congressional debates about environmental and energy policy had long featured regional politics, they are now fully and simply partisan.  In this political maelstrom, the failure of cap-and-trade climate policy in the U.S. Senate in 2010 was essentially collateral damage in a much larger political war.

It is possible that better economic times will reduce the pace – if not the direction – of political polarization.  It is also possible that the ongoing challenge of large budgetary deficits in many countries will increase the political feasibility of new sources of revenue.  When and if this happens, consumption taxes (as opposed to traditional taxes on income and investment) could receive heightened attention, and primary among these might be energy taxes, which can be significant climate policy instruments, depending upon their design.

That said, it is probably too soon to predict what the future will hold for the use of market-based policy instruments for climate change.  Perhaps the two decades we have experienced of relatively high receptivity in the United States, Europe, and other parts of the world to cap-and-trade and offset mechanisms will turn out to be no more than a relatively brief departure from a long-term trend of reliance on conventional means of regulation.  It is also possible, however, that the recent tarnishing of cap-and-trade in U.S. political dialogue will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments.  It is much too soon to say.

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What’s Good for the Goose is Good for the Gander: Rahm’s Doctrine and Mercutio’s Complaint

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In a January 2009 article – “The Big Fix” – in the New York Times Magazine, David Leonhardt introduced a frequently-employed political strategy into popular political culture by identifying it with the new President’s Chief of Staff, Rahm Emanuel:

Two weeks after the election, Rahm Emanuel, Obama’s chief of staff, appeared before an audience of business executives and laid out an idea that Lawrence H. Summers, Obama’s top economic adviser, later described to me as Rahm’s Doctrine. “You never want a serious crisis to go to waste,” Emanuel said. “What I mean by that is that it’s an opportunity to do things you could not do before.” … That’s the crux of the doctrine.

Exploiting a Crisis

Stated less sympathetically, perhaps, the argument seems to be that sensible political strategy calls for exploiting the existence of a crisis by using it as an opportunity (excuse) to pursue policies you want, whether or not they are the best responses to the specific crisis.  The crisis in this case was the worst recession since the Great Depression, and the “opportunities” on the new President’s mind were ambitious policies for health care costs and coverage, energy and climate change, and taxes.

Killing Two Birds with One Stone:  Fixing the Economy and the Environment

At about the same time that Leonhardt’s article appeared in the New York Times Magazine, Elizabeth Kolbert’s profile of green jobs activist Van Jones, “Greening the Ghetto: Can a Remedy Serve for Both Global Warming and Poverty,” was published in The New Yorker.  Kolbert included the following passage:

When I presented Jones’s arguments to Robert Stavins, a professor of business and government at Harvard who studies the economics of environmental regulation, he offered the following analogy: “Let’s say I want to have a dinner party. It’s important that I cook dinner, and I’d also like to take a shower before the guests arrive. You might think, Well, it would be really efficient for me to cook dinner in the shower. But it turns out that if I try that I’m not going to get very clean and it’s not going to be a very good dinner. And that is an illustration of the fact that it is not always best to try to address two challenges with what in the policy world we call a single policy instrument.”

I elaborated on that analogy and explained my concerns about the “greening of the economic stimulus package” (one element of the White House attempt “not to let a serious crisis go to waste”) in my essay on “Green Jobs” at this blog in March, 2009.

Two activities — each with a sensible purpose — can be very effective if done separately, but sometimes combining them means that one does a poor job with one, the other, or even both.  In the policy world, such dual-purpose policy instruments are sometimes a good, even great idea, but other times, they are not. Whether trying to kill two birds with one stone makes sense depends upon the proximity of the birds, the weapon being used, and the accuracy of the stoner.  In the real world of important policy challenges — such as environmental degradation and economic recession — these are empirical questions and need to be examined case by case.

In this case, it was (and is) important to separate the two issues:  (1) environmental degradation (which in economic terms calls for pricing the externality, i.e. getting relative prices right); and (2) the economic downturn (which calls for increasing and maintaining aggregate demand in the economy).  Environmental regulations address the first issue, while broad-based fiscal and/or monetary policies address the second.  So, in economic terms, the imperative is to get relative prices right (internalize externalities), and avoid tilting an economic stimulus package toward any particular type of activity (such as “green jobs”).

I argued in my March, 2009 essay (and argue now) that addressing the worst economic recession in generations called for the most effective economic stimulus package that could be devised, not a stimulus package that was diminished in effectiveness through excessive bells and whistles meant to address a myriad of other (legitimate) social concerns.  (And, likewise, getting serious about global climate change would require the enactment and implementation of meaningful, dedicated climate policies.)

By the way, I do not wish to add any fuel to the current political fire raging over the bankruptcy of Solyndra, the solar power manufacturer supported by a $500 million Federal loan guarantee under the stimulus package.  The failure of Solyndra was largely due to the collapse of silicon prices and the consequent increased competitiveness of conventional solar cell technologies.  I will leave it to others to debate whether the government should have seen this coming.

My point rather is that there is a strong counterargument to Rahm’s Doctrine, and that counterargument is – in the words again of David Leonhardt – “hardly trivial — namely, that the financial crisis is so serious that the administration shouldn’t distract itself with other matters. That is a risk, as is the additional piling on of debt for investments that might not bear fruit for a long while.”

That’s the Goose – What About the Gander?

Do not think for a moment that only Democrats are quick to subscribe to and employ Rahm’s Doctrine.  On the contrary, Republicans – particularly the ultra-conservative ones that are coming to dominate the Party – have recently embraced it with breathtaking enthusiasm by exploiting national concerns about the sluggish economy and stubbornly high levels of unemployment in order to pursue their anti-regulatory agenda and focused attack on the U.S. Environmental Protection Agency.

As I have also written at this blog (“Good News from the Regulatory Front,” April 25, 2011), the blanket characterization of environmental regulations as “job killers” is simply inconsistent with decades of economic research.  In the short term, new environmental regulations can have either positive or negative effects on employment in particular sectors, but in the long term, their employment impacts are trivial when compared with those of the overall set of factors that affect national employment levels.  Attacking EPA “to save jobs” is a shameful attempt to exploit economic fears in pursuit of an ideological agenda (whether or not that agenda has social merit).

Enter Mercutio

So, as is so often the case, this economist (like many – maybe most – others) disagrees with the economic arguments put forward by both sides in the political world.  Talking about “job-killing environmental regulations” is dishonest, and no more than another cynical application of Rahm’s Doctrine.  But the same must be said about the “greening of the stimulus,” and the ongoing, bloated claims about “clean energy jobs.”  As usual, those of us in the moderate middle are left to echo Mercutio’s censure:  “A plague o’ both your houses!”

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The Credit Downgrade and the Congress: Why Polarized Politics Paralyze Public Policy

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There’s room for debate about whether U.S. government deficits justify Standard & Poor’s downgrading last week of long-term U.S. debt, but the more important factor cited in S&P’s report is that “the effectiveness, stability, and predictability of American policymaking and political institutions have weakened…” The S&P team emphasizes that “the difficulties in bridging the gulf between the political parties … makes us pessimistic about the capacity of Congress and the Administration” to address the crucial problems the country faces.

Although these S&P judgments were intended to refer exclusively to fiscal policy, they really apply to a much broader set of issues, ranging from economic to health to environmental policies. The key reality is this: there is a widening gulf between the two political parties that is paralyzing sensible policy action.

Political Polarization

This increasing polarization between the political parties has shown up in a number of studies by political scientists employing a diverse set of measures that place roll-call votes by members of Congress on an ideological spectrum from extreme right to extreme left. This polarization – the disappearance of moderates – has been taking place for four decades. The rise of the Tea Party movement within the Republican Party is only the most recent vehicle that has continued a 40-year trend.

Why has this collapse of the middle taken place; why has party polarization increased so dramatically in the Congress over the past 40 years? In my view, three structural factors stand out.

Three Structural Factors

First, there has been the increasing importance of the primary system, a consequence of the “democratization” of the nomination process that took flight in the 1970s. A small share of the electorate vote in primaries, namely those with the strongest political preferences – the most conservative Republicans and the most liberal Democrats. This self-selection greatly favors candidates from the extremes.

Second, decades of redistricting – a state prerogative guaranteed by the Constitution – has produced more and more districts that are dominated by either Republican or Democratic voters. This increases the importance of primary elections, which is where the key choices among candidates are now made in many Congressional districts. Because of this, polarization has proceeded at a much more rapid pace in the House than in the Senate.

Third, the increasing cost of electoral campaigns greatly favors incumbents (with the ratio of average incumbent-to-challenger financing now exceeding 10-to-1). This tends to make districts relatively safe for the party that controls the seat, thereby increasing the importance of primaries.

These three factors operate mainly through the replacement of members of Congress (whether due to death, retirement, or challenges from within the party) – that is, the ideological shifts that cause increasing polarization largely occur when new members are elected (from either party, although a disproportionate share of polarization has been due to the rightward shift of new Republicans).

To a lesser degree, polarization has also taken place through the adaptation of sitting members of Congress as they behave more ideologically once in office. Such political conversions are due to the same pressures noted above: in order to discourage or survive primary challenges, Republican members shift rightward and Democratic members shift leftward.

A recent case in point is Senator John McCain, Republican of Arizona, who evolved from being a moderate at the time of his 2008 Presidential run to being a solid conservative in 2010, in response to a primary challenge from a Tea Party candidate.

Long-Term Implications

If the increasing polarization of the Congress is due to these factors, then it is difficult to be very optimistic about the prognosis in the near term for American politics. This is because it is unlikely that any of these factors will soon reverse course.

The two parties are not about to abandon the primary system to return to smoke‑filled back rooms. Likewise, no state legislature is willing to abandon its power to redistrict. And public financing of campaigns and other measures that would reduce the advantages of incumbency remain generally unpopular (among incumbents, who would – after all – need to vote for such reforms).

Other Factors?

True enough, in addition to these long-term structural factors that have driven political polarization, shorter-term economic and social fluctuations have also had pronounced effects. In particular, significant economic downturns – whether the Great Depression of the 1930s or the Great Recession of the past several years – increase political polarization.

The 1930s saw not only the rise of American socialists and communists, but also the rise of American right-wing extremism. It took World War II to bring an end both to the economic upheaval of the 1930s and the destructive political polarization that had accompanied it.

U.S. participation in the war brought a degree of political unity at home, largely because U.S. action was precipitated by the attack on Pearl Harbor. Under conditions of less clear motivation for U.S. military action abroad – such as the war in Vietnam – the result has not been political unity, but divisiveness and polarization. The ultimate impacts on domestic politics of the wars in Afghanistan and Iraq may hinge on whether they are perceived to be patriotic responses to a foreign attack (9/11) or the latest manifestations of U.S. military adventurism.

The Future

So, it’s reasonable to anticipate – or at least to hope – that better economic times will reduce the pace of ongoing political polarization. However, in the face of the three long-term structural factors I’ve identified above – the increasing importance of primaries, continuing redistricting, and the increasing costs of electoral campaigns – it is difficult to be optimistic about the long-term prognosis for American politics.

No matter how one feels about the wisdom of Standard & Poor’s downgrading of long-term U.S. debt, the issue of greater concern should be their assessment of the state of the U.S. body politic.

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A Golden Opportunity to Please Conservatives and Liberals Alike

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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 v. 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.

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 by Gregory Wannier (Columbia Law School) and others makes a compelling, but nuanced case in the affirmative. (See “Prevailing Academic View on Compliance Flexibility under §111 of the Clean Air Act”).

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 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. (See: “Retail Electricity Price Savings from Compliance Flexibility in GHG Standards for Stationary Sources”)

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) cap-and-trade with free allocation of allowances to Local Distribution Companies (LDCs), 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.]

The Bottom Line

Clearly, much is to be gained – and virtually nothing lost – by adopting a more flexible 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-tradecap-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 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.

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Canada’s Step Away From the Kyoto Protocol Can Be a Constructive Step Forward

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Canada confirmed this week 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.  (I have written about this and other issues surrounding the Kyoto Protocol in the past:  Defining Success for Climate Negotiations in Cancun; Defining Success for Climate Negotiations in Copenhagen; Three Pillars of a New Climate Pact).

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 December, 2010, the issue was punted from the annual conference held in Cancun, Mexico, to the next conference, scheduled for December, 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 re-ignite 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 UN 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:  (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).  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.

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What’s in a Name? Wine, Economics, and Terroir

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Today, I’m pleased to offer a temporary respite from analysis of climate change policy (and other environmental policies, for that matter), while remaining well within the general province of environmental and natural resource economics.  I do this through a merger of profession and avocation, in my case, economics and oenonomy (the study – as well as the enjoyment – of fine wine).

A Blend of Economy and Oenonomy

As some readers may know, in addition to having served as the founding Editor (and current Co-Editor) of the Review of Environmental Economics and Policy, I have had the distinct pleasure of being one of the founding Editors (along with Kym Anderson, Orley Ashenfelter, Victor Ginsburgh, and Karl Storchmann) of the Journal of Wine Economics.  If you’re laughing, let me quickly note that the Journal consists of serious, refereed articles, many by leading economists, and has been referenced by the New York Times, The Economist, and The Financial Times.  And – in what may be our high point or low point, depending upon your perspective – a discussion paper from the affiliated American Association of Wine Economists was referenced – and mocked – by Stephen Colbert on his “Colbert Report.”

A New Article

In an article that is forthcoming in the Journal of Wine Economics, Robin Cross, Andrew Plantinga (both of the Department of Agricultural and Resource Economics at Oregon State University), and I examine a concept that is central to the thinking of wine geeks around the world – terroir.  The Journal article – “The Value of Terroir:  Hedonic Estimation of Vineyard Sale Prices” – has not yet been published, but a brief version of our analysis – “What is the Value of Terroir?” – has just been published in the American Economic Review Papers and Proceedings 2011, and so I’m pleased to provide an even briefer summary here (quoting and paraphrasing from our AER P&P article) – both for wine geeks and for others.  First, however, let me acknowledge Chuck Mason and other participants in a session at the 2011 American Economic Association meetings for having offered helpful comments on a previous version of the paper.   Now, to the subject at hand.

Some Background

Wine producers and enthusiasts use the term “terroir,” from the French terre (meaning land), to refer to the special characteristics of a place that impart unique qualities to the wine produced.  The Appellation d’Origine Contrôlée (AOC) system in France, and similar systems adopted in other wine-producing countries, are based upon the geographic location of grape production, predicated on this notion of terroir.  Under the U.S. system, production regions are designated as American Viticultural Areas (AVAs), with finer geographical designations known as sub-AVAs.  Such designations allow wineries to identify the geographical origin of the grapes used in producing their wines, and – equally important – seek to prevent producers outside an AVA from making false claims about the nature and origin of their wines.

Some Empirical Questions

“What is the value of terroir in the American context?”  Does the “reality of terroir” – the location-specific geology and geography – predominate in determining the quality of wine?  Does the “concept of terroir” – the location within an officially named appellation – impart additional value to grapes and wine?  Does location within such an appellation impart additional value to vineyards?

The central question we sought to address in this work was whether measurable site attributes – such as slope, aspect, elevation, and soil type – or appellation designations are more important determinants of vineyard prices.  We did this by conducting a hedonic price analysis to investigate sales of vineyards in Oregon’s Willamette Valley, one of the most important wine-producing regions in the United States.

Thinking About These Questions

How should site attributes and sub-AVA designations influence vineyard prices?  If site attributes significantly affect wine quality and if consumers are able to discriminate such quality, then vineyard prices would depend on site attributes, and AVA designations might be redundant.

Alternatively, consumers might not be able to discriminate among wines perfectly and might use AVA designations as signals of average quality of wines from respective areas, and/or might derive utility directly from drinking wines which they know to be of particular pedigree.  In this case, site attributes and AVA designations would influence vineyard prices, with parameters for site attributes indicating how producers value intra-AVA differences in vineyard characteristics.  Presumably, producers attach premiums to site attributes that enhance wine quality, provided that consumers can perceive and are willing to pay for such quality differences.

What if, at the extreme, variation in vineyard prices were explained completely by AVA designations (that is, site attributes are irrelevant)?  This would indicate that terroir matters economically – as a concept, though not as a fundamental reality.  In other words, producers recognize the value of the AVA designation because they know that consumers will pay more for the experience of drinking wine from designated areas.  (Likewise, producers might bid up the value of vineyards located in designated appellations because there is prestige associated with owning vineyards in these areas.)  But if site attributes known to affect wine quality have no impact on vineyard prices, this would suggest that consumers cannot discern quality differences.  Any appreciation they might express for an area’s terroir would essentially be founded on reputation, not reality.

Our Analysis

We estimated a hedonic model of vineyard prices in Oregon to examine whether such prices vary systematically with designated appellation, after controlling for site attributes.  In other words, we carried out an econometric (statistical) analysis to examine the factors that appear to affect vineyard prices.

We employed a new data set we developed on vineyard sales with extensive information about respective properties, combined with GIS-based information on specific parcels.  In our sample (actually, the universe of sales of vineyard – and potential vineyard – properties in the Willamette Valley between 1995 and 2007), the average price of vineyards was about $10,000 per acre, with prices ranging from $2,500 to $42,000 per acre.

We also carried out a check on our vineyard pricing analysis by examining price premiums paid by consumers for wines from related origins.  If you’d like to read about either methodology, or see our quantitative results, please take a look at the article.  But, for now, I will just summarize our results.

Some Answers

We found that vineyard prices are strongly determined by location within specific sub-AVAs, but not by site attributes.  These appellations are supposed to reflect the area’s terroir, but our finding that the physical characteristics of vineyards are not priced implicitly in land markets raises questions about whether sub-AVA designations have a fundamental connection with terroir.

On the other hand, our results make clear that the concept of terroir matters economically, both to consumers and to wine producers.  Buyers and sellers of vineyard parcels in the Willamette Valley of Oregon attach a significant premium to sub-AVA designations.  One possibility is that buyers are less informed than sellers about how the attributes of a vineyard will affect wine quality and, therefore, rely on sub-AVA designations as quality signals.

In any event, consumers are evidently willing to pay more for the experience of drinking wines from these areas.  While they may not discriminate among wines in terms of their intrinsic qualities, consumers are apparently responding to extrinsic qualities of wines, such as price and area of origin.  So, terroir survives – as a concept, but somewhat less as a fundamental reality.

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Misguided Objection to Progressive Policy: The EJ Lawsuit Against Implementation of California’s AB 32 Climate Policy

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On May 20th, San Francisco Superior Court Judge Ernest Goldsmith ruled that the California Air Resources Board had not adequately explained its choice of a market-based mechanism –  a cap-and-trade system  — to achieve approximately 20 percent of targeted emissions reductions by 2020 under Assembly Bill 32, the Global Warming Solutions Act of 2006.

The ruling 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 January 2012.  Their preferred outcome would be for California Governor 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, Governor Jerry Brown plans to move forward with the implementation of Assembly Bill 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.  Indeed, for this reason, Nature Magazine recently labeled Mary Nichols, the Chairman 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 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 EJ lawsuit is not only misguided, but — if ultimately successful — will be counter-productive.

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Good News from the Regulatory Front

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As each day passes, the upcoming November 2012 general elections produce new stories about potential Republican candidates for President, as well as stories about President Obama’s anticipated re-election campaign.  At the same time, the 2012 elections are already affecting Congressional debates, where each side seems increasingly interested in taking symbolic actions and scoring political points that can play to its constituencies among the electorate, rather than working earnestly on the country’s business.

The new Tea Party Republicans in the House of Representatives decry the “fact” that the U.S. Environmental Protection Agency (EPA) continues to promulgate “job-killing regulations” for made-up non-problems.  And Democrats in the Congress – not to mention the Administration – are eager to talk about “win-win” policies that will produce “clean energy jobs” and protect Americans from the evils of imported oil and gas.

Neither side seems willing to admit that environmental regulations bring both good news – a cleaner environment – and bad news – costs of compliance that affect not only businesses but consumers as well.  Sometimes the cost-side of proposed regulations dominates.  Those regulatory moves are – from an economic perspective – fundamentally unwise, since they make society worse off.  In other cases, the benefits of a proposed regulation more than justify the costs that will be incurred.  Such regulations are – to use a word now favored by President Obama –  a wise investment.  They make society better off.  Failure to take action on such opportunities is imprudent, if not irresponsible.  Just such an opportunity now presents itself with EPA’s Clean Air Transport Rule.

In an op-ed that appeared on April 25, 2011, in The Huffington Post (click here for link to the original op-ed), Richard Schmalensee and I assess this opportunity.  Rather than summarize (or expand on) our op-ed, I simply re-produce it below as it was published by The Huffington Post, with some hyperlinks added for interested readers.

For anyone who is not familiar with my co-author, Richard Schmalensee, please note that he is the Howard W. Johnson Professor of Economics and Management at MIT, where he served as the Dean of the Sloan School of Management from 1998 to 2007.  Also, he served as a Member of the President’s Council of Economic Advisers in the George H. W. Bush administration from 1989 to 1991.  By the way, in previous blog posts, I’ve featured other op-eds that Dick and I have written in The Huffington Post (“Renewable Irony”) and The Boston Globe (“Beware of Scorched-Earth Strategies in Climate Debates”).

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An Opportunity for Timely Action:  EPA’s Transport Rule Passes the Test

by Richard Schmalensee and Robert Stavins

The Huffington Post, April 25, 2011

At a time when EPA regulations are under harsh attack, one new environmental regulation – at least – stands out as an impressive winner for the country.  Studies of the soon-to-be-finalized Clean Air Transport Rule have consistently found that the benefits created by the rule would far outweigh its costs.  By reducing sulfur dioxide and nitrogen oxide emissions from power plants in 31 states in the East and Midwest, the Transport Rule will create substantial benefits through lower incidence of respiratory and heart disease, improved visibility, enhanced agricultural and forestry yields, improved ecosystem services, and other environmental amenities.  According to EPA, these benefits will be 25 to 130 times greater than the associated costs.  We document this in our new report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation.

Despite the benefits offered by the Transport Rule, some argue that it – and other EPA regulations – will stifle economic growth and threaten the reliability of our electric power system.  However, a careful look at the evidence reveals that the Transport Rule is unlikely to create such risks.  Analyses of the Transport Rule have found that it need not lead to significant plant retirements.   Robust regulatory and market mechanisms ensure that the nation can meet emission targets while reliably meeting customer demand.

While compliance with the Transport Rule would – in some cases – require installation of new pollution control equipment, the capital expenditures required would comprise a small fraction of aggregate capital spending by the power industry.  In fact, because of the Transport Rule’s unique legal circumstances, in which the Courts have mandated that EPA replace a stringent predecessor, utilities have already begun to make pollution control investments needed to comply with the Transport Rule.

The Rule’s timing can also contribute to lowering its cost and supporting other policy goals.  Installation of the pollution control technologies needed to comply with the Rule could increase short-term employment.  Although the longer term job impacts are less clear, these short-term employment effects would complement other policy initiatives aimed at supporting the nation’s economic recovery.

EPA analysis estimates modest impacts on regional electricity rates, but reductions in health care expenditures could partially or fully offset these effects.  Expanded supplies of low-cost natural gas can also help lower the Transport Rule’s cost by providing a less costly substitute for power generated from coal.

Most importantly, actions taken to reduce emissions would create substantial health benefits.  Tens of thousands of premature deaths would be eliminated annually, as would millions of non-fatal respiratory and cardiovascular illnesses.  A diverse set of studies find that these health improvements will create $20 to over $300 billion in benefits annually.  And, while the Transport Rule is designed to reduce the impact of upwind emissions on downwind states, upwind states would also receive substantial health benefits from the cleaner air brought about by the Rule.  These upwind states have much to gain, because states with the highest emissions from coal-fired power plants are also among those with the greatest premature mortality rates from these emissions.

Along with these health benefits, the largest shares of short-term improvements in employment and regional economies are likely to accrue to the regions that are most dependent on coal-fired power, as they invest in new pollution control equipment.  Thus, while designed to help regions downwind of coal-fired power plants, the Transport Rule also offers substantial benefits to upwind states.

As the U.S. economy emerges from its worst recession since the Great Depression of the 1930s and faces an increasingly competitive global marketplace, regulation such as the Transport Rule that creates positive net benefits and allows industry flexibility in creating public goods can complement strategies intended to foster economic growth.  Such regulations are best identified by careful analyses to ensure that benefits truly exceed costs and avoid unfair impacts on particular groups or sectors.  The Transport Rule has undergone a series of such thorough assessments, and the results consistently indicate that it would create benefits that far exceed its costs.  Failure to take timely action on this opportunity would seem to be imprudent, if not irresponsible.

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*Richard Schmalensee is the Howard W. Johnson Professor of Economics and Management at the Massachusetts Institute of Technology, a research associate of the National Bureau of Economic Research, and a fellow of the Econometric Society and the American Academy of Arts and Sciences.  He served as a member of the Council of Economic Advisers with primary responsibility for environmental and energy policy from 1989 through 1991.  Robert N. Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School, a university fellow of Resources for the Future, a research associate of the National Bureau of Economic Research, and a fellow of the Association of Environmental and Resource Economists.  He served as chairman of the EPA’s Environmental Economics Advisory Committee from 1997 through 2002.  Their report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation, can be downloaded at: http://www.analysisgroup.com/uploadedFiles/Publishing/Articles/2011_StavinsSchmalansee_TransportRuleReport.pdf

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A Wave of the Future: International Linkage of National Climate Change Policies

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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 at this blog (Renewable Energy Standards: Less Effective, More Costly, but Politically Preferred to Cap-and-Trade?, January 11, 2011), 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 (IETA) and the Electric Power Research Institute (EPRI), 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 thirteenth 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 (CAT), 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 CAT system is linked with another CAT 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 CAT 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.

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For much more detailed discussions, here are some publications available on the web that describe various aspects of linkage:

Jaffe, Judson, Matthew Ranson, and Robert Stavins.  “Linking Tradable Permit Systems:  A Key Element of Emerging International Climate Policy Architecture.” Ecology Law Quarterly 36(2010):789-808.

Jaffe, Judson, and Robert Stavins.  “Linkage of Tradable Permit Systems in International Climate Policy Architecture.” The Harvard Project on International Climate Agreements, Discussion Paper 08-07, Cambridge, Massachusetts, September, 2008.

Jaffe, Judson, and Robert Stavins. Linking a U.S. Cap-and-Trade System for Greenhouse Gas Emissions: Opportunities, Implications, and Challenges. Washington, D.C.: AEI-Brookings Joint Center for Regulatory Studies, January 2008.

Jaffe, Judson, and Robert Stavins.  Linking Tradable Permit Systems for Greenhouse Gas Emissions: Opportunities, Implications, and Challenges. Prepared for the International Emissions Trading Association, Geneva, Switzerland. November, 2007.

Also, this issue of linkage among tradable permit systems has come up previously in a number of my essays at this blog:

AB 32, RGGI, and Climate Change: The National Context of State Policies for a Global Commons Problem

The Real Options for U.S. Climate Policy

What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord

Only Private Sector Can Meet Finance Demands of Developing Countries

Approaching Copenhagen with a Portfolio of Domestic Commitments

Worried About International Competitiveness? Another Look at the Waxman-Markey Cap-and-Trade Proposal

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Reflecting on a Century of Progress and Problems

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As the first decade of the twenty-first 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.

100 Years of Economic Progress and More Challenging Environmental Problems

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 twenty-first 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 over-arching 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 twentieth 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 twenty-first century,