The greenhouse effect: The greenhouse effect: economic challenges economic challenges

Roger GuesnerieRoger GuesnerieCollège de France and Collège de France and

Paris School of Economics.Paris School of Economics.

ForewordForeword

Foreword Foreword • From a relatively « new entrant » on the subjectFrom a relatively « new entrant » on the subject• Trough Government consulting, not TheoryTrough Government consulting, not Theory

• A eigtheen month study, A eigtheen month study, • Policy report to the French Prime MinisterPolicy report to the French Prime Minister• « Kyoto et les enjeux économiques de l’effet de serre »,La « Kyoto et les enjeux économiques de l’effet de serre »,La

Documentation Française 2003.Documentation Française 2003. A subjectA subject

Fascinating for everybodyFascinating for everybody For theorists….For theorists….

Plan :Plan :• A brief reminder..of the greenhouse effect.A brief reminder..of the greenhouse effect.• A subjective walk in related and unsatisfqctorily resolved A subjective walk in related and unsatisfqctorily resolved

theory problems (with some advertisement for my own theory problems (with some advertisement for my own investigations).investigations).

• This lecture : institutional design.This lecture : institutional design.

The greenhouse effect : a The greenhouse effect : a reminder.reminder.

Increase in concentration of greenhouse Increase in concentration of greenhouse gases in the atmosphere:gases in the atmosphere:• Beginning with the industrial revolutionBeginning with the industrial revolution• Human responsibility « Anthropogenic»Human responsibility « Anthropogenic»• For CO2, use of fossil fuels…:oil, gas, coal.For CO2, use of fossil fuels…:oil, gas, coal.• Associated with developmentAssociated with development

Concentration is going to increase Concentration is going to increase spectacularly. spectacularly. • 1800 : 270 ppmv1800 : 270 ppmv• 2000 : 360 ppmv2000 : 360 ppmv• 2100 : 450, 550, 750 ppmv 2100 : 450, 550, 750 ppmv

The diagnosis : sectoral originsThe diagnosis : sectoral origins

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EnergieTransportsIndustrieAg+résidentiel

The diagnosis :The diagnosis :Emissions across the world.Emissions across the world.

C02 Emission:C02 Emission: • 7 GT C per year7 GT C per year• 1 T/capita1 T/capita

Emission variability.Emission variability. • 6 T/capita USA6 T/capita USA• 0.3 T India0.3 T India• 2.3 T Europe. 1,7 T 2.3 T Europe. 1,7 T

France France Development linked. Development linked.

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The diagnosis : concentrationsThe diagnosis : concentrations

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conc. CO2

préindustriel2000

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Objec.2100BAU2100Scen.ext

Characteristics :Characteristics :• Cumulative, Cumulative, ((Stock)Stock)

• Weak reversibility.Weak reversibility. Concentration Concentration Climate.Climate.

Worrying Worrying Extrapolations.Extrapolations.• 3.5+-1.5 degrees.3.5+-1.5 degrees.• Compare with the Compare with the

ice ageice age

Diagnosis :Diagnosis :Climate and GES concentration Climate and GES concentration

The Link The Link • Troubling Troubling ParallelismParallelism. . • Theoretically and historically Theoretically and historically

established.established.• other factors of climate other factors of climate

variability, variability, Models forecasts for 2Models forecasts for 2100100

• Significant temp.increases.Significant temp.increases.• Great variability (1,5 à Great variability (1,5 à

6,5)6,5)• Economic scenario, Economic scenario,

modelling modelling • 3.5+-1.5, BAU 3.5+-1.5, BAU • Major effects/ 2100, Major effects/ 2100,

« surprises » after « surprises » after (thermo-aline cic.,  (thermo-aline cic.,  permafrost »..)permafrost »..)

The economics of the greenhouse The economics of the greenhouse effect effect

In some dimension, a standard problemIn some dimension, a standard problem Quality of climate : a « global » public good. Quality of climate : a « global » public good. The questions are standardThe questions are standard

• To act or not to act, When to act, How to act..To act or not to act, When to act, How to act.. In fact, non standard dimensionsIn fact, non standard dimensions

Time horizon …Time horizon … Huge uncertaintiesHuge uncertainties

• On effects : climate or economicOn effects : climate or economic• On abatement costsOn abatement costs• Possibly strong irreversibilitiesPossibly strong irreversibilities

« Nature of the Government »« Nature of the Government »• No government, governance problems. No government, governance problems.

Limits /economic argument.Limits /economic argument.• Dependant on the climate diagnosis Dependant on the climate diagnosis • External Limits. External Limits.

Moral and metaphysical dimension (H. Jonas)Moral and metaphysical dimension (H. Jonas) Intergenerational Equity.Intergenerational Equity.

Costs of climate policies.Costs of climate policies.

How to reduce CO2 emissions ?How to reduce CO2 emissions ?• Pre-industrial life style. Pre-industrial life style. • Or ?Or ?

Economic Actions. Economic Actions. • Decrease consumption of fossil fuels. Decrease consumption of fossil fuels.

Saving energy.Saving energy. Improving energy efficiency. Improving energy efficiency. Using less carbonized techniques. Using less carbonized techniques.

• Electricity : gaz instead of coal. Electricity : gaz instead of coal. Using decarbonized techniquesUsing decarbonized techniques

• Changes Changes in productionin production At the final demand level At the final demand level

how ?how ?

Snapshots of specific difficulties.Snapshots of specific difficulties.

ObjectivesObjectives : : Stress inadequacies of standard theory.Stress inadequacies of standard theory. A selective overview…A selective overview…

The selected fieldsThe selected fields.. Institutional design 1.Institutional design 1.

• The participation issue. The participation issue. Long run discount rates.Long run discount rates. Institutional design 2. Institutional design 2.

• The « prices versus quantities » issue. The « prices versus quantities » issue.

Institutional design : Institutional design : Kyoto and post KyotoKyoto and post Kyoto

How to trigger cooperation How to trigger cooperation and induce LDC to and induce LDC to

participate ?participate ?

The simple economics of The simple economics of internalizing externalities. internalizing externalities.

The model : The model : • Amount of depollution qAmount of depollution q• 2(n) firms.2(n) firms.• Marginal cost curves.Marginal cost curves.

Rules : Rules : • uniform quotas. uniform quotas. • The economic argument The economic argument • An adequate tax lowers An adequate tax lowers

total cost. total cost. The economic instruments. The economic instruments.

• Tax, subsidy.Tax, subsidy.• Markets for permitsMarkets for permits• Limits of the equivalence.Limits of the equivalence.

profit,profit, RightsRights Information Information

q

Marginal cost.

Uniform quota

optimumTax, subsidy

Kyoto and Kyoto-compatible schemesKyoto and Kyoto-compatible schemes..

The Kyoto protocol : key features. The Kyoto protocol : key features. • National quotas rigid, based on emissions at a year basis National quotas rigid, based on emissions at a year basis • An international market for permits (exchange of quotas).An international market for permits (exchange of quotas).• Voluntary participation (Annex B).Voluntary participation (Annex B).

A simplistic formal model :A simplistic formal model : without uncertainty, Notation q : emissions abatementwithout uncertainty, Notation q : emissions abatement. . NashNash : :

q°(i): Max {U[i, Q°(-i)+q(i)]-C(i,q(i)}, iq°(i): Max {U[i, Q°(-i)+q(i)]-C(i,q(i)}, iBB iiq°(i)=Q°q°(i)=Q°

KyotoKyoto : : Quotas s(i), iQuotas s(i), iB, q°°(i),B, q°°(i), q°°(i) : Max {t°°[(q(i)-s(i)]-C(i,q(i)}, iq°°(i) : Max {t°°[(q(i)-s(i)]-C(i,q(i)}, iBB iiB B s(i)=s(i)= iiB B q°°(i)=Q°°q°°(i)=Q°° IR ?IR ?

• Market for permits, world carbon price t°°. Market for permits, world carbon price t°°.

Kyoto and Kyoto-compatible schemesKyoto and Kyoto-compatible schemes..

Variant 1Variant 1 : Flexible (or negotiable) quotas : : Flexible (or negotiable) quotas : FKFK• Quotas are bargainedQuotas are bargained• Flexibility reflects exposition, etc…Flexibility reflects exposition, etc…

Variant 2Variant 2 : Open Kyoto : OK : Open Kyoto : OK• Non Annex B countries would be given BAU Non Annex B countries would be given BAU

objectivesobjectives Reminiscent of GPGP…,, Reminiscent of GPGP…,, Pershing, Philibert, One sided/non bindingPershing, Philibert, One sided/non binding

• Triggering participation ? …Triggering participation ? … Variant 3Variant 3 : : OFK OFK Mixes both F and K.Mixes both F and K.

Kyoto compatible schemes and others. Kyoto compatible schemes and others.

To compare withTo compare with : : GPGP : the scheme. (GPGP : the scheme. (Bradford DBradford D))

• Fixed initial contributions from voluntary Fixed initial contributions from voluntary countries. countries.

• Business As Usual (BAU) level of emissions for Business As Usual (BAU) level of emissions for all countriesall countries

Complex,… contingent assesment.Complex,… contingent assesment. Even for non participants (generous). Even for non participants (generous).

• An agency (International Bank for Emissions. An agency (International Bank for Emissions. Allowances), buys reductions from BAUAllowances), buys reductions from BAU..

Harmonized taxation.Harmonized taxation.

Formal definitions. Formal definitions. Open Flexible Kyoto.Open Flexible Kyoto.

• Quotas s(i), iQuotas s(i), iB, q**(i),B, q**(i),• q**(i): Max {t**[(q(i)-s(i)]-C(i,q(i)}, iq**(i): Max {t**[(q(i)-s(i)]-C(i,q(i)}, iBB• q*(i): Max {t**(q(i)-C(i,q(i)}, iq*(i): Max {t**(q(i)-C(i,q(i)}, iNBNB iiBBs(i)=s(i)=iiq**(i)=Q**q**(i)=Q**

GPGP :GPGP :• Fixed Contributions F(i), iFixed Contributions F(i), iB, q*(i),B, q*(i),• q*(i): Max {U[i, Q*(-i)+q(i)]+t*(q(i)-C(i,q(i)}, q*(i): Max {U[i, Q*(-i)+q(i)]+t*(q(i)-C(i,q(i)},

iiBB• q*(i): Max {t*(q(i)-C(i,q(i)}, iq*(i): Max {t*(q(i)-C(i,q(i)}, iNBNB iiBBt*q*(i)+ t*q*(i)+ iiNBNBt*q*(i)= t*q*(i)= iiBBF(i)F(i)

Formal definitionsFormal definitions

FOKFOK Quotas s(i), iQuotas s(i), iB, q**(i),B, q**(i), q**(i): Max {t**[(q(i)-s(i)]-C(i,q(i)}, iq**(i): Max {t**[(q(i)-s(i)]-C(i,q(i)}, iBB q*(i): Max {t**(q(i)-C(i,q(i)}, iq*(i): Max {t**(q(i)-C(i,q(i)}, iNBNB iiBBs(i)=s(i)=iiq**(i)=Q**. q**(i)=Q**. IRIR

Harmonised taxation :Harmonised taxation : q°’(i) : Max {t°’[(q(i)]-C(i,q(i))}, iq°’(i) : Max {t°’[(q(i)]-C(i,q(i))}, iBB iiI I q°’(i)=Q°’q°’(i)=Q°’ Welfare : U(i, Q°’)-C(i, q°’(i))Welfare : U(i, Q°’)-C(i, q°’(i))

Questions for the comparisonQuestions for the comparison....

Participation : short runParticipation : short run• A limited viewpoint/ participation of non-Annex B A limited viewpoint/ participation of non-Annex B

countries. countries. • Effects on efficiency and ..participation of Annex B Effects on efficiency and ..participation of Annex B

countries. countries. Participation : long run aspects.Participation : long run aspects.

• « Dynamic » participation, « Dynamic » participation, • The « ratchet effect ».The « ratchet effect ».

« « Full Stability » issuesFull Stability » issues Efficiency issues :Efficiency issues :

• Prices versus quantities.Prices versus quantities.• Taxation and the prices of fossil fuel.Taxation and the prices of fossil fuel.• Etc…Etc…

Comparing GPGP and Kyoto variants : Comparing GPGP and Kyoto variants : 1- short run participation. 1- short run participation.

RG « The design post Kyoto climate schemes : an introductory analytical RG « The design post Kyoto climate schemes : an introductory analytical assesment »(2006) assesment »(2006)

An equivalence « Theorem » ? : An equivalence « Theorem » ? : • Is GPGP « essentially » identical to OFK ?Is GPGP « essentially » identical to OFK ?

The  « game form  », the characteristics function, .. The  « game form  », the characteristics function, .. Connections :Connections :

• Given FOK, Given FOK, a (family) of GPGP/ same total a (family) of GPGP/ same total abatment (welfare of non annex B countries is abatment (welfare of non annex B countries is lower)lower)

In some cases, Annex B welfare is higher In some cases, Annex B welfare is higher Similar cost functions, similar B preferencesSimilar cost functions, similar B preferences

• Given a GPGP equilibrium, Given a GPGP equilibrium, an OFK / same an OFK / same total abatment (welfare of non annex B total abatment (welfare of non annex B countries is higher).countries is higher).

Comparing GPGP and Kyoto variants : Comparing GPGP and Kyoto variants : 3- Coalitional Stability.3- Coalitional Stability.

The full stability problem is much more complex :The full stability problem is much more complex :• The Core is empty : The Core is empty :

non excludable public good.non excludable public good. Free riding.Free riding.

• What is the arrangement more conducive to global effort What is the arrangement more conducive to global effort in a given bargaining situation ?in a given bargaining situation ?

HT does not solve LDC participationHT does not solve LDC participation If LDC are involved the tax instrument is less conducive to If LDC are involved the tax instrument is less conducive to

high level effort, but the arrangements may be more stable high level effort, but the arrangements may be more stable between B countries ?between B countries ?

• Etc..Etc.. An extensive literature..An extensive literature..

• Chandler-Tulkens (2006), Carraro (1999).Chandler-Tulkens (2006), Carraro (1999).

Some references.Some references. Aldy, J.E., P. R. Orszag and J. E. Stiglitz, ''(2001) ''Climate Change: Aldy, J.E., P. R. Orszag and J. E. Stiglitz, ''(2001) ''Climate Change:

An Agenda for Global Collective Action'', Prepared for the An Agenda for Global Collective Action'', Prepared for the conference on ``The Timing of Climate Change Policies'', Pew conference on ``The Timing of Climate Change Policies'', Pew Center on Global Climate Change, October. Center on Global Climate Change, October.

Bradford, D.F. (2001), « Improving on Kyoto: A No Cap but Trade Bradford, D.F. (2001), « Improving on Kyoto: A No Cap but Trade Approach to Greenhouse Gas control » Princeton University.Approach to Greenhouse Gas control » Princeton University.

Chakrovorty U, Magné B. and Moreaux M, (2003) « Energy Chakrovorty U, Magné B. and Moreaux M, (2003) « Energy resource substitution and carbon concentration targets with non resource substitution and carbon concentration targets with non stationary needs'', Leerna 31, Université de Toulouse.stationary needs'', Leerna 31, Université de Toulouse.

Cooper, R., (1998), ''Toward a real global warming treaty'', Foreign Cooper, R., (1998), ''Toward a real global warming treaty'', Foreign Affairs, vol. 77 no 2, March-AprilAffairs, vol. 77 no 2, March-April CC

Carraro C.(1999) ''The Structure of International Agreements on Carraro C.(1999) ''The Structure of International Agreements on Climate Change''in C. Carraro C. (ed), International Environmental Climate Change''in C. Carraro C. (ed), International Environmental Agreements on Climate Change, Kluwer Academic Publishers, Agreements on Climate Change, Kluwer Academic Publishers, Dordrecht, NLDordrecht, NL

Chandler L and Tulkens H. (2005) « Stability issues and climate Chandler L and Tulkens H. (2005) « Stability issues and climate related dynamic externalities »38p related dynamic externalities »38p

Some references.Some references. Freixas X, Guesnerie R, et Tirole J. (1985) « Planning under Freixas X, Guesnerie R, et Tirole J. (1985) « Planning under

incomplete information and the ratchet effect », Review of incomplete information and the ratchet effect », Review of Economic Studies, LII, 173-191..Economic Studies, LII, 173-191..

Guesnerie R. (2003) « Les enjeux économiques de l'effet de Guesnerie R. (2003) « Les enjeux économiques de l'effet de serre » in «Kyoto et l‘économie de l'effet de serre », sous la serre » in «Kyoto et l‘économie de l'effet de serre », sous la direction de R. Guesnerie, La Documentation Française, Paris.direction de R. Guesnerie, La Documentation Française, Paris.

Guesnerie R. ( 2004) « Calcul Economique et Développement Guesnerie R. ( 2004) « Calcul Economique et Développement Durable », Revue Economique, p.363-382.Durable », Revue Economique, p.363-382.

Guesnerie R. (2005) ''Assessing Rational Expectations :2- Guesnerie R. (2005) ''Assessing Rational Expectations :2- ''Eductive'' stability in economics », MIT Press, 453 P.''Eductive'' stability in economics », MIT Press, 453 P.

Guesnerie R. (2006) The design post Kyoto climate schemes : an Guesnerie R. (2006) The design post Kyoto climate schemes : an introductory analytical assesment ». introductory analytical assesment ». 

Ha-Duong M, Grubb M et. Hourcade J.C, (1997) ''Influence of Ha-Duong M, Grubb M et. Hourcade J.C, (1997) ''Influence of socio--economic inertia and uncertainty on optimal CO2-emissions socio--economic inertia and uncertainty on optimal CO2-emissions abatment'', Nature, Vol. 390.abatment'', Nature, Vol. 390.

Newell, R.G. and W.A. Pizer, (2000), « Regulating Stock Newell, R.G. and W.A. Pizer, (2000), « Regulating Stock Externalities Under Uncertainty », Discussion Paper 99-10, Externalities Under Uncertainty », Discussion Paper 99-10, Resources for the Future, Washington DC, February. Resources for the Future, Washington DC, February.

Some references.Some references. Nordhaus, W.D, (2002), ''After Kyoto: Alternative Mechanisms to Nordhaus, W.D, (2002), ''After Kyoto: Alternative Mechanisms to

Control Global Warming'', Paper prepared for the meetings of the Control Global Warming'', Paper prepared for the meetings of the American Economic Association and the Association American Economic Association and the Association of.IEA/SLT(2002)28of.IEA/SLT(2002)28

Philibert, C. (2000). ``How could emissions trading benefit Philibert, C. (2000). ``How could emissions trading benefit developing countries.'' Energy Policy , volume 28, no 13.developing countries.'' Energy Policy , volume 28, no 13.

Philibert, C., and J. Pershing. (2001). ``Des objectifs climatiques Philibert, C., and J. Pershing. (2001). ``Des objectifs climatiques pour tous les pays : les options.'' Revue de l‘Energie 524.pour tous les pays : les options.'' Revue de l‘Energie 524.

Pizer, W.A., (2001), ''Combining Price and Quantity Control to Pizer, W.A., (2001), ''Combining Price and Quantity Control to Mitigate Global Climate Change'', Journal of Public Economics, 85,Mitigate Global Climate Change'', Journal of Public Economics, 85,(3), 409-434.(3), 409-434.

Rieu J.(2002) ''Politiques nationales de lutte contre le changement Rieu J.(2002) ''Politiques nationales de lutte contre le changement climatique et réglementation de la concurrence : le cas de la climatique et réglementation de la concurrence : le cas de la fiscalité », mimeo.fiscalité », mimeo.

Weitzman, M. L., (1974) ''Prices vs. Quantities'', Review of Weitzman, M. L., (1974) ''Prices vs. Quantities'', Review of Economic Studies, vol.41, October.Economic Studies, vol.41, October.

Weitzman, M. L., (2000),AERWeitzman, M. L., (2000),AER