IMT Institute for Advanced StudiesLucca, Italy

Three Essays on the Economics of Climate Change

Ph.D Program in Economics, Markets, InstitutionsXX Cycle

By Carlo Stagnaro2009

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The dissertation of Carlo Stagnaro is approved.

Programme Coordinator: Prof. Fabio Pammolli, Università di Firenze

Supervisor: Prof. Sergio Grea, Università di Genova

Tutor: Prof. Fabio Pammolli, Università di Firenze

IMT Institute for Advanced Studies, Lucca2009

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Contents

Table of Contents................................................................................................. vAcknowledgements.............................................................................................. viiVita and Publications.......................................................................................... ixAbstract................................................................................................................ xiii

1. Let the Polluted Pay: A Coasian Approach to Global Warming................... 1 1.1. Introduction............................................................................................... 2 1.2. Climate stability as a public good............................................................. 3 1.3. The Coase Theorem revisited.................................................................... 5 1.4. The costs and benefits of (in)action.......................................................... 7 1.5. The Polluter, the Polluted, and the Pollution.......................................... 1.5.1. The polluter..................................................................................... 1.5.2. The pollution................................................................................... 1.5.3. The polluted....................................................................................

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1.6. The state of the world............................................................................... 15 1.7. The economics of decoupling................................................................... 1.7.1. EKC does exist................................................................................... 1.7.2. EKC doesn’t exist..............................................................................

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1.8. A case against government intervention.................................................. 23 1.9 Conclusion.................................................................................................. 32References............................................................................................................. 33

2. Economic Freedom and Carbon Intensity: How Free Market Can Address Global Warming................................................................................ 43 2.1. Description of the problem........................................................................ 44 2.2. What drives emissions............................................................................... 44 2.3. GDP and carbon......................................................................................... 46 2.4. Does Kuznets apply to carbon................................................................... 50 2.5. From EKC to institutional factors.............................................................. 53 2.6. What is economic freedom and how it can affect carbon emissions?................................................................................................. 55 2.7. Model specification................................................................................... 59 2.8. The data...................................................................................................... 61 2.9. The results.................................................................................................. 62

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2.10. Comments on the results......................................................................... 76Appendix A. The 2009 Index of Economic Freedom.......................................... 79Appendix B. Kyoto Protocol ratification............................................................ 82References............................................................................................................. 83

3. A Reassessment of European Climate Policies: Cap & Trade vs. Carbon Tax................................................................................................................... 87 3.1. An Energy Policy for Europe.................................................................... 88 3.2. Are European climate policies any useful?............................................. 89 3.3. Do the European climate policies work?................................................. 96 3.4. The new directive..................................................................................... 107 3.5. The final compromise............................................................................... 112 3.6. An alternative proposal: the carbon tax................................................... 115 3.7. Would a carbon tax work?........................................................................ 121 3.8. Which tax?................................................................................................. 122 3.9. Conclusions............................................................................................... 127References............................................................................................................ 129

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Acknowledgements

Scientists have calculated that the chance of anything sopatently absurd actually existing are millions to one.  Butmagicians have calculated that million-to-one chances cropup nine times out of ten.

- Terry Pratchett, Mort (1987)

I am deeply grateful to all the people who have helpedme by commenting upon earlier drafts of this thesis, orby allowing me to “free ride” on the opinions they wereas kind as to share with me. I am particularly indebtedto Filippo Cavazzoni, Corrado Clini, Alberto Clò,Stefano Clò, Francesco Forte, David Henderson, CarloLottieri, Alberto Mingardi, Massimo Nicolazzi, FabioPammolli, David Perazzoni, Massimo Romano, JacopoPerego, Federico Testa and Stefano Verde.

I wish to apologize with my colleagues at IBL and IlFoglio, for having disappeared for more than a while. Itake the opportunity to say thanks to them, as well, forall the insightful conversations we have had on a dailybasis.

A special thanks goes to Sergio Grea for believing thiscould actually be done more than I myself did.

This thesis is dedicated to my wife Silvana for herpatience, as well as to the senior little one and theforthcoming little one.

The usual disclaimer applies.

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Vita

September 9, 1977 Born, Sestri Levante, Italy

2004 Degree in Environmental EngineeringFinal marks: 103/110Università di GenovaGenoa, Italy

Publications

1. FORTE, F. and STAGNARO,C. (2009). “Il sistema energetico inCalabria.Criticità,investimentieregole”,forthcoming.

2. CLO’,A.andSTAGNARO,C.(2009).“Otto,nessunoocentocinquantamila.Latrasparenzadeiprezzideicarburantiinrete”,forthcoming.

3. STAGNARO,C.(2009).“EnergySecurity:TheNeedforConsistentPolicies”.In HERA Foundation, International Security and the Threat of ClimateChange,forthcoming.

4. STAGNARO,C. (ed.) (2009). Indicedelle liberalizzazioni2009.Torino:IBLLibri.ISBN:978‑88‑6440‑008‑2.

5. STAGNARO, C. and TESTA, F. (2009). “Nell’ambito grosso sta l’aziendabuona? Alcune riflessioni sul caso della distribuzione locale del gas”,ManagementdelleUtilities,no.1,pp.20‑25.

6. STAGNARO, C. (2009). “L’ultima risorsa. Simul stabunt, simul cadent”,Aspenia,no.44,pp.55‑63.

7. STAGNARO,C. (ed.) (2009). Ilmercatodelgasnaturale.SoveriaMannelli,CZ:RubbettinoeFacco.ISBN:978‑88‑498‑2340‑0.

8. STAGNARO,C. (ed.) (2008).Cambiamento climatico e libertà economica.Sviluppo, innovazione e trasferimento tecnologico. Rome: GiovaniImprenditori–Confindustria.

9. STAGNARO, C. (ed.) (2008). Indice delle liberalizzazioni 2008. Torino:IstitutoBrunoLeoni.

10. STAGNARO,C.(2008).“Prezzi:cadeil‘mito’delladoppiavelocità”,NotizieStatistichePetrolifere,no.8‑9,pp.3‑6;22‑24.

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StatistichePetrolifere,no.8‑9,pp.3‑6;22‑24.

11. STAGNARO,C. (2008).“UScan learn fromEuropeanexperiencewithcapandtrade”,Oil&GasJournal,vol.106,no.19,pp.22‑26.

12. STAGNARO,C.(2008).“Riflessidellaproduzioneenergeticasull’ambiente”.In CORDOVA, G. and SCURO, S. (eds.). Sicurezza per l’energia. Roma:Centrostudidifesaesicurezza,pp.91‑96.

13. STAGNARO, C. (ed.) (2007). Sicurezza energetica. SoveriaMannelli, CZ:RubbettinoeFacco.ISBN:978‑88‑498‑1922‑9.

14. STAGNARO, C. (ed.) (2007). Indice delle liberalizzazioni 2007. Torino:IstitutoBrunoLeoni.

15. STAGNARO, C. (2007). “European gas supply hinges on solving LNGissues”,Oil&GasJournal,vol.105,no.26,pp.60‑67.

16. STAGNARO,C.(2007).“Climacaldo,Pilfreddo”,Aspenia,no.38,pp.123‑131.

17. STAGNARO, C. (2007). “EU Energy investments drop as developmentobstaclesrise”,Oil&GasJournal,vol.105,no.4,pp.18‑22.

18. STAGNARO, C. (2007). “Battisti e contrabbandieri del global warming”,Limes,no.6,pp.111‑122.

19. STAGNARO,C. (2007). “Biocarburanti.Efficienzaenergeticao inefficienzaagricola?”,Energia,no.1,pp.52‑55.

20. STAGNARO, C. (2007). “The EU and Biofuels: Protectionism as EnergyPolicy”,EnergyTribune,14March.

21. STAGNARO, C. and VERDE, S. (2007). “Collusione e carburanti. L’altrafacciadellamedaglia”,Energia,no.2,pp.38‑48.

22. STAGNARO, C. (2006). “Italy”. In KUMARIA, S. andNOLAN, P. (eds.).PowerFailure.London:StockholmNetwork,pp.10‑11.

23. STAGNARO,C.(2006).“Unaviad’uscitadalvicolociecodiKyoto”,Energia,no.2,pp.52‑57.

24. STAGNARO, C. (2006). “EU may miss Kyoto targets despite EEArecommendations”,Oil&GasJournal,vol.104,no.10,pp.24‑26.

25. STAGNARO,C.andTHORNING,M.M.(eds.)(2005).Piùenergiapertutti.SoveriaMannelli,CZ:RubbettinoeFacco.ISBN:978‑88‑498‑1094‑3.

26. STAGNARO,C.(2004).“Inuovicampidell’onnipotenzadelloStato:saluteeclima”.InINFANTINO,L.andIANNELLO,N.(eds.).LudwigvonMises:lescienze sociali nella Grande Vienna. Soveria Mannelli, CZ: Rubbettino,pp.283‑296.ISBN:978‑88‑498‑0901‑5.

27. STAGNARO, C. and OKONSKI, K. (eds.) (2003). Dall’effetto serra allapianificazioneeconomica.SoveriaMannelli,CZ:RubbettinoeFacco. ISBN:978‑88‑498‑0739‑4.

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pianificazioneeconomica.SoveriaMannelli,CZ:RubbettinoeFacco. ISBN:978‑88‑498‑0739‑4.

28. STAGNARO, C. (2003). “The political economy of climate change”. InOKONSKI,K.(ed.).AdaptorDie.London:ProfileBooks,pp.202‑217.ISBN:1‑86197‑795‑6.

Presentations

1. OAPEC–KuwaitCity–15February2009–“EnergySecurityandEuropeanEnvironmentalPolicies”.

2. LithuanianFreeMarketInstitute–Vilnius–21October2008–“TheEnergyChallengeforEurope–andLithuania”.

3. ICEI – Aix‑en‑Provence – VII International Conference – 23 June 2008 –“PossibilityandLimitsofTradablePermits”.

4. Università Europea di Roma – Rome – 21 April 2008 – Master inEnvironmentalScience–“Environment,Energy,andtheFreeMarket”.

5. HeartlandInstitute–NewYorkCity–IInternationalConferenceonClimate–3March2008–“Uncertainty,DamnedUncertainty,andClimatePolicies”.

6. LaboratoriosuiServiziaRete–LUISSGuidoCarli–Workshopon“Climatechange:mythsandfalsemythsbetweeninformationanddisinformation”–16October2007–“ShortTermPoliciesandLongTermRisks”.

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Abstract

This dissertation collects three essays on the economics of global warming andclimatepolicies.Thepapers,eachofwhomcanbereadasastand‑aloneessay,arearrangedinawaythatgoesfromamoreradical,moregeneralapproachtoamorepragmatic,morespecificone.Thefirstessaydealswiththeveryessenceofglobalwarming: is itaglobalpublicbad?Doesitsnaturejustify,orevenrequire,internationalcollectiveactioninordertolet the external costs be internalized? In order to provide an answer, a Coasianapproach isundertaken.The startingpoint is anoriginal interpretationof the so‑calledCoase Theorem,which is derived from Forte (2007). Forte argues that thesymmetryunderlyingthetheoremcanonlybeheldtrueintheshortrun.Inthelongrun, however, the symmetry ceases to exist because, among the other reasons, adifferentreturnoninvestedcapitalmayemergeunderadifferentinitialallocationofrights.Itfollowsthattheinitialallocationofrightsdoesmatter,eveninatransactionscosts‑freeworld.Anintuitiveconsequenceofthis,isthatthelong‑termconsequencesoftheinitialallocationshouldbeconsidered.Inthecaseofpollution,thismaymeanthat it is not always efficient to follow the Polluter Pays Principle. In fact,whilepollution is a negative externality, the venture that causes it may also generatepositiveexternalities.Whenthisisthecase,byimposingtothepolluterthecostofgetting rid of pollution, the positive externality may be lost together with thenegative one. The present paper argues that this is precisely the case of globalwarming.Greenhousegasesemissions–whicharesuspectedofcausingman‑madeglobalwarming,asopposedtonaturalclimatechange–are,atthepresentstateoftechnology,anunavoidablebyproductofenergyproductionandeconomicgrowth.Cuttingemissions–asisrequestedbymanystakeholdersaswellasbyinternationaltreatiessuchastheKyotoProtocol–mightresultincurbingeconomicgrowth,andbysodoingitmightimposeasocialcostthatisgreaterthantheavoidedcostfromglobalwarming.Theeconometricevidenceonthecostsofglobalwarmingandthecostsofclimatepolicies,aswellasontherespectivebenefits,isstillunclear.Hence,thepresentscenarioischaracterizedbyadeepuncertaintyonthesideofthecostsandbenefitsofcollectiveaction(orthelackthereof),andbyalackofcost‑efficienttechnologicalalternativestothecurrenttechnologies,particularlyintheenergyandtransportationsectors.ByapplyingtheForteinterpretationoftheCoaseTheorem,itmaybearguedthat—whenthisismoreefficient—itmightwellbethecasetoletthecost ofpollution (or the cost of eliminatingpollution)bearon thepollutedparty,instead of the polluter. Since the polluted party, as far as global warming isconcerned,isfuturegenerations,thismeansthatacasecanbemadeagainstclimatechangemitigation.Temperaturesmightbeleftfreetogrow(thatis,carbondioxidemightbeleftfreetoaccumulateintheatmosphere)untilcost‑efficienttechnologies

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become available. Policies should instead focus on accelerating the process oftechnologicalinnovation,andondevelopingadaptationmeasuresinordertobetterfacetheeffects,ratherthanaddressingtheallegedcauses,ofglobalwarming.

The second paper looks at the existing patterns from greenhouse gases (GHGs)emissions,widelysuspectedofcontributingtoglobalwarming.Assumingthatsomesortofpoliticalactionistobetaken,andthatsomeresultmayfollow,itisnotedthatemissions–bothinaggregate,onapercapitabasis,andintermsofcarbonintensity,i.e. the ratio between total emissions and gross domestic product (GDP) – arestabilizingorslightlydeclininginmostdevelopedcountries.Onthecontrary,totalemissions,percapitaemissions,andcarbonintensityaredramaticallyincreasinginthedevelopingworld.Ahighercarbonintensityisinterpretedasaproxyofamoreobsolete technology. An analogy is thenmadewith the pattern governing otherpollutants, that is theso‑calledEnvironmentalKuznetsCurve.Empiricalevidenceshowsthatasageneralruleinmostcountriespollutantshaveincreasedatfirst,thenpeakedanddecreasedasGDPhasgrown.Thisphenomenonhasbeentheoreticallyunderstoodasaconsequenceoftheincreasedconcentrationsofpollutantsthatmadethemevermoreintolerableontheonehand,andtheincreasedavailabilityofwealthtobeinvestedinnewertechnologiesand/orininnovativeinvestmentsontheotherhand.Itisunclear,however,whetherornotcarbonemissionsarefollowingsuchabell‑shapedcurve,too.Further investigationsintothispatternhavesuggestedthatGDP growth is not the only independent variable. The existence of free marketinstitutions also matter, in that this allows GDP growth and creates a morefavourableenvironmentfor investments.Anempiricalmeasureof theexistenceoffree market institutions has been gleaned by the Index of Economic Freedom,publishedyearlybytheHeritageFoundationandtheWallStreet Journal.Apaneldataset has been built with data regarding the Index of Economic Freedom, itssubcomponents,totalGHGsemissions,andanumberofothermacroeconomicandenvironmentalindicators.AmodelhasbeenbuiltthatrelatesGHGsemissionswitheconomicfreedom,controllingforoneormoreoftheabove‑mentionedvariables.Asignificant,negativecorrelationhasbeenfound,whichmeansthateconomicfreedom–alongwithother factors–mayexplainpartof thedifference incarbon intensitybetweencountries.Thecorrelationisstrongerforlowervaluesofeconomicfreedom,consistentlywithother evidence that correlates economic freedomwith economicgrowth.Therearetheoreticalreasonstobelievethatthecorrelationmaybeasignofacausallink,eventhoughtheempiricalevidenceisstillnotenoughtosupportsuchaclaim. If the causal link should be proven true, a policy consequence would bethat–all else being equal–increasing economic freedommight lead to a reducedcarbon intensity in the developing world, which is expected to account for anincreasing share of global emissions in the next few decades. If this is correct,promotingeconomicfreedomcouldbeaneffective,no‑regretwaytocontainfutureemissions.

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ThethirdpaperfocusesontheEuropeanUnion’sclimatepolicies.Afirstassessmentismadeby lookingat the statedobjectivesof thepolicy, i.e. limiting temperaturegrowthwithin2degreesabovethepre‑industriallevels,andthebroadercontextofGHGsemissions.ItisshownthattheEUisresponsibleforarelativelysmallshareofworldemissions,whichisgoingtodeclineifthepresenttrendscontinue.Underthisreasonableassumption,theimpactthatEuropeaneffortsmayorwillhaveonworldemissions isnegligible,as is theirpossibleconsequenceson temperatures riseandglobalwarming.ThismeansthatEUpolicies,absentaninternationalcooperationoncurbingemissions,can’tholdvis‑à‑visanycost‑benefitanalysis,howeverlowisthe“cost” side. The existing policies are not only unlikely to deliver a measurableenvironmental benefit: they are also working very poorly. The most importantEuropeanpolicyistheEmissionsTradingScheme(ETS),acap&tradeschemethatcovers some 12,000 facilities in all Europe. In the ETS First Phase (2005‑2007),emissionsintheareascoveredbytheETSdidactuallyrise.Thereisevidencethatthisisatleastpartlyaconsequenceofanover‑allocationthathappenedintheinitialstageoftheprocess.TheSecondPhase(2008‑2012)isexpectedtodelivermoresubstantialemissionscuts,eventhoughitisnotyetclearwhetherETSortheeconomiccrisiswillbe the major driver. As to the Third Phase (2013‑2020) new rules are to beimplemented,underwhichagrowingnumberofallowances(startingfrom30%in2013)willbeauctionedinsteadofdistributedfreeofcharge;however,someareasorsub‑areaswillstillbegivenextra‑permitsfreeofcharge,inordertolimittheriskofcarbonleakage,i.e.delocalizationofenergy‑intensivefirmsexposedtointernationalcompetitionfromcountrieswhodon’thavestringentemissionsregulations.Thenewframeworkiscriticallyevaluated,byemphasizingtheriskthataveryhighdegreeofuncertaintyandpoliticizationunderminesthesystem.Analternativepolicyisthenproposed,bysuggesting thatacarbontaxcanbemoreappropriate.Twodifferentmodelsofcarbontaxesarefinallyexamined,onedependentupontheprojectionofthefuturecostsfromwarming,theotherdependentuponastate‑contingentfunctionthatmeasurestheamountofglobalwarminginplaceatanygiventime.

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Chapter1.

LetthePollutedPay:ACoasianApproachtoGlobalWarming

Abstract

Anthropogenicclimatechangehasbeenwidelyregardedasamarketfailure,oreven“thegreatestmarketfailure”.Assuch,governmentinterventionismhasbeeninvokedinordertoachieve“climatestability”.Thispapercriticallyassessesthenotionthatman‑madeglobalwarmingisaglobalpublicbad.Itgoesonbyapplyingtoglobalwarmingan interpretationof theCoaseTheoremprovidedbyForte (2007).Underthis framework, the symmetry regarding the initial allocation of the rights in theCoaseTheoremappliesonlytotheshortrun.Inthelongrun,theinitialallocationofrightsmaymakeadifference. It follows that itmaybe reasonable toattribute thepolluterarighttopollute,ifthiscreatestheconditionsforpositiveexternalitiestobegenerated,thataregreaterthanthenegativeexternalities involved.Withregardtoglobalwarming,itisshownthatgreenhousegases(GHGs)emissions–whicharetheallegedcauseoftemperaturerise–areabyproductofeconomicgrowth.Intheshortrun, there is a tradeoff between economic development and environmentalsustainability.Inthelongrun,suchtradeoffmayormaynotbevalid.Ifthelatteristrue,itispossiblethatGHGsemissionswillspontaneouslydecouplefromeconomicgrowth,whichwouldmakeclimatepoliciesquestionablebothfromaneconomicandanenvironmentalpointofview(eventhoughpoliciesmightbeneededtoacceleratethe process of decoupling). If instead there is and will be a tradeoff, a carefulassessment should bemade of what is at stake. Global warming, as an externaldiseconomy,mightbetheothersideofeconomicgrowth,asanexternaleconomy.Inthiscase,fightingglobalwarmingatthecostofcurbingeconomicgrowthmaynotbejustified, that is, itmaybereasonable togive thepolluter (presentgeneration) theright to pollute,while shifting onto the polluted (future generations) the cost ofpollution(thatis,pollutionitself,orglobalwarming).

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Climatechangeisthegreatestmarketfailuretheworldhaseverseen.

‑TheSternReview,p.xviii

Howisthatthesegreatmenhave,intheireconomicwritings,beenledtomakestatementsaboutlighthousesthataremisleadingastothefacts,whosemeaning,ifthoughtaboutinaconcretefashion,isquiteunclear,andwhich,totheextentthat

theyimplyapolicyconclusion,areverylikelywrong?

‑RonaldH.Coase(1990),“TheLighthouseinEconomics”,p.211

1.1.Introduction

Climatechangeiswidelyregardedasthegreatestchallengehumanityhaseverfacedcollectively.According to the conventional story‑tellingabout climate,man‑madegreenhousegases (GHGs),mostlyproducedby the combustionof fossil fuels, arecausingglobal average temperatures to rise.Temperature risewoulddetermineanumberofconsequences,mostofwhicharesupposedlynegative,including(butnotlimited to) sea level rise, desertification, a wide change in climate patterns, anincrease in the frequency and severity of extreme weather events, water stress,resourcewars,etc.Whilesomeoftheseattributionsareunfounded,questionable,orgrosslyexaggerated,theyhavebeeneithercollectivelyorindividuallyconsideredintheeconomicliteratureaboutclimatechange.Asaresult,itwouldbeprobablyfairtoassessthatamajorityofeconomistsdealingwithclimatehavesupportedsomesortofcoordinated government intervention as tomitigate climate change and, to someextent,improvethehumanity’sabilitytoadapttochanges.

Economistshavebothdealtwiththetheoreticalaspects,andtriedtoassesscostsandbenefitsofglobalwarmingand/ortheproposedmeasurestoreacttoglobalwarming.Often, however, they have failed to properly consider the huge uncertaintiesunderlyingclimatescience(Lawson2008;Henderson2009).Infact,mosteconomistshavealmosttakenforgrantedthat(a)climatechangeishappening;(b)theleadingorsolecauseofglobalwarmingisanthropogenicGHGs;(c)theeffectofclimatechangewillbe,onbalance,negativeformostcountries intheworld(althoughnotalwaysnegativeforanycountryintheworld);(d)therecanbenospontaneousresponsetoglobal warming from themarket; and (e) as a consequence, government shouldinterveneinordertoachieveemissionsreductionsandmitigatetheeffectsofglobalwarming.

Thispaperisnotaimedatdealingwithscientificissues,soitwillnotaddress(a)and(b), except forassuming thata significantdegreeofuncertainty isattached to (b),whichmeansthatanypolicywhichisdesignedtoaddressglobalwarmingshouldbe

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flexibleenoughtobeadaptedtonewscientificevidenceregardingtheroleofnaturalcauses, changing temperaturepatterns, orneweconomic evidenceon the costsofglobalwarmingandthebenefitsofclimatepolicies.Inturn,thispaperwilldealwith(c), (d), and (e).Wewill try to show that the economic evidence that the costs ofglobalwarmingaresuchthatrequireimmediateactionislessclearthancommonlybelieved,partlybecauseclimatechangemaynotbeamarket failure.By the sametoken,thebenefitsofpoliticalactionmaybelowerthanexpected,particularlyinthelight of a theoretical framework that can be derived from the so called “CoaseTheorem”(Coase1960;Coase1990;Stigler1966;MedemaandZerbe2000).Infact,theCoaseTheoremwillherebyberevisited, followingForte (2007a), inorder toshowthatitwasnotinRonaldCoaseintention’s,norisalogicalconsequenceofhis1960NobelPrize‑awardedessay,toclaimthatthemerepresenceofa“publicgood”orofan externality, provides a case for government intervention as to provide thesupposedlypublicgoodortosolvetheexternalityproblem.

1.2.Climatestabilityasapublicgood

Sandler(1998,p.225)claimsthat“globalwarmingis thequintessentialglobalpurepublic good, because each country’s release of GHGs augments the world’satmospheric stock in an additive fashion and each country’s cutback results in agreater cost than benefit for that country unless assurances can be given that asufficient number of nations will act”. According to Grasso (2004, p.4), climatestability isa“(global)publicgoodwithnomarketnorprice,andthatdonotofferproperincentivesagainstoverexploitationoftheatmosphere”.Thesestatementsdonotexactlyprovethatclimatechangeisaglobalpublicgood:theymerelyassertso.Little or no demonstration is provided, despite the fact that – assuming globalwarmingreallyis“themotherofallexternalities”(Freebairn2007)–anequaleffortistobeputinmotion.Wils(1994)goessofarastoarguethatpeoplemightsufferfrom“psychicspillovers”fromknowingaboutthepotentialeffectsofglobalwarming.

Michel (2007, p.5) argues that “every countryhasan interest in ensuringa stableclimate system. But every country also as an interest in ensuring economicdevelopment,agriculturalproduction,energysupply, industry, transportation, thewhole panoply of human enterprise fromwhich greenhouse emissions arise. Thecommon interestofallstatesincontrollingglobalwarmingthuscontendswiththeindividual interest of each state in continuing the emitting activities that causeclimate change” (emphasis added).While this statementmay appear obvious, itcontains two strong logicalmistakes,whichdeserve to bedismantled in order toproceedwithanordereddiscussionoftheissue.

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Thefirstmistakeisaninappropriategeneralization:asitwillbeshown,itisnottruethat every country has an interest in countering global warming. In fact, globalwarming–definedastheincreaseintheglobalaveragetemperature–isacomplexphenomenon,which can alsobe seen as the aggregate of individual changes. Forexample,notalwaystemperatureincreaseisbadperse.Thereisevidencethatcoldregionswill benefit fromwarming; by the same token, there is evidence that anincreasedconcentrationofGHGsintheatmosphere–particularlyCO2–mightresultinfasterplantgrowth,underappropriateconditions.So,somecountriesoreconomicsectors will benefit from global warming, while other will be harmed. It can bearguedthatthesumofthesecostsandbenefitsis,onbalance,negative,butnotthatalltheconsequencesofglobalwarmingarenegativeforalltherecipients.Secondly,Michel(2007)arguesthattheworldasawholehasacommoninterest,atthesametime, in economic growth (which determines GHGs emissions) and in cuttingemissions.Thereisclearlyatradeoffbetweenthetwogoals,atleastintheshortrun.Again, it can be argued that the benefits of economic growth are not enough tocompensatethecostsofglobalwarming,butonecanhardlyhavethepieandeatittoo.

Helm(2008,p.225)states thatglobalwarming is“apublicbad”(no justification isprovided), while the famous Stern Review (Stern 2006) suggests it is the biggestexternalityever(interestingly,anderroneously,enough,Sterndoesnotdistinguishbetweenthenaturalandtheanthropogeniccomponentsofclimatechange).Amoresophisticatedargument comes fromNordhaus (2005,p.4),whoargues thatglobalpublic goods (as opposed to the “usual” public goods) do generally showup as“stockexternalities”,i.e.“theirimpactdependsuponastockofcapital‑likevariablethataccumulatesovertime”.Inthecaseofclimate,theflowofman‑madeGHGswillincreasethestockofGHGsintheatmosphere,whichinturnwillcausetemperatureincrease.Thisisanimportantfeature,astheflowofGHGsisthevariablethatcanbecontrolled,whileGHGsconcentration (thatis,astock)iswhatactuallydeterminesthe impactsofglobalwarming.Time scale,hence, is alsoa fundamentalvariable:futuregenerationalonewillknowtheconsequencesofglobalwarming,eventhoughitiscausedbypastandpresentemissions.So,totheextentthatglobalwarmingisaglobalpublicbad,externalitieswilloccurbothcross‑country(i.e.,everycountrywillbeaffected,althoughnotallcountriesinthesamewayandwithnoproportionalitytothe amount of emissions that each country has generated) and over time. Aconsequenceof this, asNordhaus (2005,p.7) shows, is that“thereexists todaynoworkablemarketorgovernmentalmechanismthatisappropriatefortheproblems.There is no mechanism by which global citizens can make binding collectivedecisionstoslowglobalwarming”.Finally,Gardiner(2007)definedglobalwarmingas“theperfectmoralstorm”.

Tomake the picturemore confused, it should be emphasized that –whilemostauthorsspeakaboutclimate–theyareinfactreferringtoclimatestability,or,tobe

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more precise, what might be defined “de‑anthropogenized climate”. Climatevariabilityisafactofnature,thatnohumaninterferenceorpolicycanalter.Climatehasalwayschangedanditalwayswill.Whatiscontendedisthat,sincetheIndustrialRevolutiontookplace,climatehasbeenchanging inasomehow“unnatural”way.Wedon’tknowhowclimatewouldhavechangedabsentanthropogenicGHGs,asthecounter‑factualisobviouslynotavailable.Wejustknowitmighthavechangedinadifferentway,aswellaswesupposeitwouldchangeinadifferentwayifwestopemittingGHGsrightnow.Wealsoassumethat,allelsebeingequal,humanitywouldbebetteroff if theanthropogeniccomponentofclimatechangecouldberemoved.Thetrickisthattheanthropogeniccomponentcan,atleasttheoretically,beremoved,butthatcaninnowayhappenwhileallelseremainsequal.Indeed,allelsewoulddramaticallychange,too.Thisisthecoreoftheargumentwewilldevelopinthenextparagraphs.

1.3.TheCoaseTheoremrevisited

AsRobinson(2008)argues, the idea thatclimate isapublicgood,hencecollectiveactionisneeded,maywellbedefinedas“conventionalwisdom”,inthesensedefinedby Galbraith (1958). Robinson himself exposes a number of reasons why suchwisdomisratheraprejudice.Onereasonisitsverytheoreticalfoundation,accordingtowhich themereexistenceofapublicgoodoranexternalityprovidesacase forgovernment intervention aimed at the provision of the public good or theinternalizationoftheexternality.Suchideahasbeenchallengedbymanyeconomists,mostnotablyCoasehimself inhis1974essayon the lighthouse (nowreprinted inCoase1990).

AninnovativeapplicationoftheCoaseTheoremtothecaseofexternalities,includingenvironmentalexternalities,hasbeendevelopedbyForte(2007a).Forteshowsthat“evenintheabsenceoftransactioncosts,theoptimalallocationofresourcesmaybereachedwhenthepolluted,ifwantstobefreefromthepollution,isobligedtodosoat his own costs or has to pay the polluter to eliminate them”. To develop sucharguments,FortearguesthatCoase’s“symmetrytheorem”undertheassumptionofzerotransactioncosts,wasasimplifiedversionofwhatheactuallyhadinmind.Infact,thefocuswasnotonsymmetryperse,butonthefactthatanoptimalallocationcouldbereachedthroughspontaneousnegotiationsbetweentheparties.As to thesymmetry,itmaybeareasonableassumptionunderashort‑term,staticframework,butcaninnowaybeheldtrueasalonger‑run,dynamicperspectiveisundertaken.

Tomaketheargumentclearer,FortestartswithCoase’sclassicalexampleofafarmer(F) rivalingwith a rancher (R) for the use of F’s piece of land (L). The possiblecombinationsarelistedbelow,dependingupon(a)thevalueofF’sandR’sproduct

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and(b)theinitialallocationofrights.AssumethatF’slossfromgrazingisequaltox,andR’srentfromtheuseofLisequaltoy.Table1showsthepossiblecombinations.

Fhastheright Rhastheright

x<y 1A.RusesL,paysF 1B.RusesL

x>y 2A.FusesL 2B.FusesL,paysR

Table1.PossiblecasesundertheCoaseTheorem.

As is clear from the table, absent transaction costs, in the short run the initialallocationofrightshasnoeffectontheoutcome,asinbothcases1sRusesL,andinbothcases2sFusesL.Thelongerrun,however,isquiteanotherstory,asisevidentfromthetable.“Atthemargin”,writesFortewithregardto1B,“thepriceofmeatshallbe lowerthanincase1Aanditsconsumptiongreaterwhilethepriceofcornshallbehigheranditsconsumptionsmaller”(theoppositeappliesto2Aand2B,ofcourse).Sincetherentsfromagriculturearepresumablytheresultofaninvestment,allelsebeingequalonemayexpectlessinvestmentsinagricultureand,inthelongrun,a reducedsupplyofagriculturalgoods (thispointhasalsobeenexploredbyCalabresi1965andmanyothers).IfRisapolluter,andFisapollutedparty,itmaywellbethecasethat, inthelongrun,it issociallydesirabletohavemoregoodsofwhichpollutionisabyproduct.

Bythesametoken,itshouldbeconsideredthattheliabilityrulechangestheactor’sbehavior,thereforepotentiallyraisingamoralhazardproblem.Forexample,inthecaseofatraingeneratingsparksthatburntheneighboringforest,theassignmentofthe rights to the forest‑ownermaypreventhim fromadopting lowcostmeasuresaimed at reducing the risk of fires (say, keeping lower trees). So, by shifting theliabilityontothepollutermayresultinasub‑optimalemploymentofresources–anhigher amount ofwhichwould be spent by issuing compensations to the forest‑ownerorbypayingforaspark‑freetechnology,orboth.Notirrelevanttothis,isthattheinformationaboutthemostefficientwayofcaringaboutthetress,andthecostofit asopposed to the costof the alternatives,mightbeun‑known to either the railcompany,ora judiciary: itmaybethecasethattheymaybeaccessibleonlytotheforestowner.

Now,considerthecaseofapollutingindustryvis‑à‑visapollutedcommunity.Evenin a transaction‑free world, if the original rights are assigned to the pollutedcommunity, onemay expect to have less industrial goods in the long run. If theoutputof the industryisenergy,onewouldexpect less,morecostlyenergy. If thebusinessofenergyproductionbecomeslessprofitable,investmentsmayfall,too,andasaconsequencetheprobabilityoftechnologicaladvancementsdeclines,including

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those that would leave the humanity better off by removing or reducing thepollution.“Thebroadprinciplethattheindustriesmustbearthecostsofpollution”,writesForte,“impliesthatthereislessindustrialgrowthandthatconsumptionpricesarehigher”.Expost,ifthereductionis“excessive”,inthelongrunonewouldexpectanimpoverished,althoughlesspolluted,humanity.Anotherwaytoexpressthesameconceptisthatpollution,andmoregenerallyexternalities,maybeaninherentfeatureofhumanprogress,whichisreflectedinhigherGDPpercapitaaswellasinbetterlivingstandards.Thecostofremovingpollution,maybethatofcurbingprogress,whichcanhardlybedefinedasadesirablegoal.ToquoteForte,“theessenceoftheCoasetheoremconsistsintellingusthatthereisnoabsolutereasontobelievethattheexternal negative effects are always distorting. The same is true with positiveexternalities.Myadditional conclusion is that bothmaybe important topromoteeconomic growth”. If this is true, a state intervention aimed at removing theexternality,maygenerateitselfagreaterexternaldiseconomy.

1.4.Thecostsandbenefitsof(in)action

How,andtowhatextent,does thisapply toclimate?Beforeaproperargument isdeveloped,itmaybeworthrecallingwhattheavailableliteraturetellsaboutthecostsand cost structure of globalwarming and of policies aimed atmitigating globalwarming.Figure1showstheavailableresults,aspresentedbyTolandYohe(2006).

Figure 1. Estimates of the costs of climate change (left panel) and the costs ofemissionreduction(rightpanel)accordingtotheSternReviewandaccordingtopreviousstudies.Source:TolandYohe(2006).

Twoclearfactsemergefromtheliteraturereview:ontheonehand,thereseemstobeaconsensusthatthecostsofclimatechangeareofthesameorderofmagnitudethanthecostsofemissionsreductions;ontheotherhand,thefamousSternReview(Stern2006)clearlyfindsanoutlierestimate,withhigherestimatedcostsofglobalwarming

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andlowerestimatedcostsofclimateactionthanthepreviousstudies.Thetwomainreasonsforthisdifference,whichisindeedremarkableifoneconsidersthattheSternReviewdoesn’tproducenewevidencebutratherreliesontheexistingone,deriveforthemostfromtworeasons:(a)TheReviewselectivelyemphasizestheresultsfromthemostalarmisticstudiesonthescientificandeconomicaspectsofglobalwarming,and(b)TheReviewquestionablyassumesadiscountrateaslowas0.1percent,whichobviouslymagnifiestheeffectsofhighlyuncertain,fardistantinthefutureclimateeffects. Tol andYohe (2006),Helm (2008),Henderson et al. (2006) andNordhaus(2008, pp.165‑190) provide persuasive criticisms of the Review’s methodology,results, and internal consistency.Helm (2008,p.228) claims that thezero‑discountapproach reliesupona“moral argument” that,howeverphilosophically relevant,tells little in terms of welfare and provides little basis for the creation of theinternationalconsensusthatisneededforclimateactiontobetaken.

Others,mostnotablyWeitzman(2009,p.1),arguethat“theprobabilityofadisastrouscollapse of planetarywelfare is nonnegiglible, even if this tiny probability is notobjectivelyknowable”.Asaconsequence,“theclimatechangeeconomistcanhelp…bystressingsomewhatmoreopenlythefactthatsucha[cost‑benefit]estimatemightconceivablybearbitrarilyinaccuratedependinguponwhatissubjectivelyassumedabout the high‑temperature damage function along with assumptions about thefatnessofthetailsand/orwheretheyhavebeencutoff”(p.18).Thepositiontherebyendorsedissomehowparadoxical:fromtheassumptionthatnotjustwedon’tknow,butinfactwecan’tknow the actualdamagefunctionfromclimatechange,whetherornotman‑induced,theauthorseemstodrawtheconclusionthatweshouldactasiftheworst‑casescenariowasalsothemoreprobableone,ifnotcertain.Inotherfields,“fat‑tailers” tend to emphasize that, in presence ofwide and deep uncertainties,policiesshouldbeasflexibleandlittle‑distortingaspossible(seeforexampleTaleb2007); and the legal consequence is that “simple rules” should be adopted “for acomplexworld” (Epstein 1995). Butwhen it comes to climate, amore aggressiveattitude seems to emerge, basedon the assumption that “itmight happen soweshouldactas if itwill happen”,which can be justified – again – sonly onmoralgrounds.Inhisseminalworkoncatastrophe,alas,Posner(2004),whilerecognizingthatcatastrophicriskofclimatechangecan’tbe ignored,seemstosupportamorerelaxed,noregretpolicy,bysuggestingthatmeasuresaimedataddressingclimatechange(forexampleemissionstaxes)shouldbedesignedinawayastoalsoachieveother targets (for example substituting income taxes in order to reduce thedeadweightloss).(Onthebenefitsofrevenue‑neutralcarbontaxesseealsoNordhaus2008,pp.148‑164andChapter3ofthisthesis).

It should also be added that the costs of global warming can’t be immediatelycomparedwiththecostsofemissionreductions,insofarastheformerdonotcoincidewiththebenefitsofthelatter.Inotherwords,someamountofglobalwarmingisstillto be expected even if the most radical policies are implemented to reduce

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anthropogenicGHGs. So, at least part of the costswill persist in the future. Thismeansthatthecostsofglobalwarmingprovidebydefinitionanoverestimateofthebenefits of climate policies. The cost of climate policies, moreover, is alsounderestimated because it relies on an implicit assumption of efficientimplementation, that is not credible.AsHelm (2008,pp.225‑226) argues, “climatechange… is likely to be one of the largest sources of economic rents frompolicyinterventions.Thereisalargeandgrowingclimatechange‘pork‑barrel’.Itishighlyunlikelythatthepolicycostswillbezero.Indeed,therearegoodreasonstosupposeotherwise–ateverylevelofclimatechangepolicy”.

Itwouldbefair,hence,todescribetheevidenceas“unclear”,eventhoughamajorityofeconomists–includingthemajorityoftheabove‑mentionedones–dofavorsomeclimatepoliciesasopposedtothebusiness‑as‑usual.Thereseemstobeaconsensus,indeed,thatcarbonemissionsdohaveasocialcost(Tol2005),thatmaybesmallintheshort run (hence thepreference formoderate,not radical, immediateemissionreductions – see Kelly and Kolstad 1999 and Nordhaus 2008, for example) butgrowingovertime.

Sinceimmediate,dramatic impactsareunlikely,someauthorshavesuggestedthatdifferentstrategiesareemployed,aimingnotatemissionreductionsintheshorttomedium run (the so called mitigation), but at long‑run‑oriented goals such aspreventing (rather than solving) climate‑change relatedproblemsor achieving aneconomically sustainable de‑carbonization of the economy through technologyimprovements.

Goklany(2007),forexample,arguesthatclimatechangedoesn’tcreateproblems,itrather exacerbates existing problems, especially in the developing and the leastdevelopedworld.Hunger,thirst,andmalaria,aswellasothernegativeconsequencesof globalwarming,will not arise after the global average temperaturewill haveincreasedby agiven amount, howeverdefined.They all are alreadyhere.Globalwarming may just make them worse. The relevant fact, then, is that even thedeveloped world used to suffer from them, and could defeat them despite themoderateincreaseinworldtemperaturesobservedinthelastcoupleofcenturies.AsGoklanystates,“mostoftheimprovementsinclimate‑sensitiveindicatorsofhumanwell‑being are because of technological progress, driven bymarket‑ and science‑basedeconomicgrowth,seculartechnologicalchange,andtrade”(p.290).Therefore,accordingtothisframework,itwouldbemorerationaltoemployresourcestofightthesethreatsnow,insteadoftryingtomitigateglobalwarminginthefuture.Withregard to climate change,Goklany suggests that a limited amountof resources isinvestedonadaptation.

Fromadifferentperspective,Lomborg(2007)arguesthattheonlywaytoachieveamoresustainableenergyandeconomicpattern,istoinvestmoreoninnovationandthediffusionofefficientandcleanertechnologies(notjustcleanertechnologies,that

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areforthemostpartveryuncompetitivewithconventionaltechnologiesevenundertheexistingclimatepolicies,thathavetheeffectofincreasingthecostsoffossilfuelsinordertoreflecttheirsocialcost).AccordingtoLomborg,anaggressive,shortrun‑orientedclimatepolicy–suchastheKyotoProtocol–isbothcostlyintheshortrunandineffectiveinthelongrun.Inotherwords,thisauthorsuggeststhatweinvestininnovativetechnologiesfortomorrow,ratherthaninvestingintheexistent,cleanertechnologiesfortoday(underthereasonableassumptionthat,atthemargin,moneyinvested for today’s technological change are subtracted from innovativeinvestments).

1.5.ThePolluter,thePolluted,andthePollution

How does the Forte interpretation of the Coase Theorem apply to the abovediscussion? To summarize once again, Forte showed that, even in absence oftransactioncosts, (a) there isnoabsoluteasymmetry in the initial rightsallocationand (b)under somecircumstances, itmaybemoreefficient togive thepolluter –insteadofthepolluted–party(ies)therighttopollute.If,anduptotheextentthat,themarginaldamageofpollutionishigherthanthemarginalcostofabatement,thepollutedpartiesmayorwillpaythepollutertostop,reduce,ormovepollutionanditssources.Thatisparticularlytruewhenthepollutingprocessesproducepositiveexternalities, such as economic growth, alongwith negative externalities, such aspollution.Underthisperspective,thenegativeexternalitymaygohandinhandwiththepositiveone:simulstabunt,simulcadent.Thepolicyquestion,hence,iswhetherglobalwarminghassuchfeature, inwhichcaseitmightbeinappropriatetoadoptmitigation policies or, to be more precise, to shift the burden of abatement onpollution‑producersratherthanonthepolluted.

Firstofall,itisnecessarytocharacterizetheactorsandthenatureofthepollution.

1.5.1.Thepolluter

The polluter is the present and past generations. Since global warming is aconsequenceoftheaccumulationofGHGsintheatmosphere,whoeverdid,does,orwill emit even one single molecule of GHGs is pro‑quota responsible for thepollution.Totheextentthatpresentgenerationsinheritliabilitiesfromthepastones,Westernpeoplearecomparativelymoreresponsiblethantherestoftheworld.Totheextentthatprojectionsonfutureconsumptionarereliable(seeforexampleIEA2008),thedevelopingworldholdsagrowingresponsibilityforfuturewarming.

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Fromageographical standpoint,morepopulous countries (suchasChina)holdagreaterresponsibilitythanscarcelypopulatedones(suchasLuxemboug).Fromanindividualstandpoint,individualswhoemitmoreonapercapitabasis(suchasthoselivinginLuxembourg)holdagreaterresponsibilitythanthoseemittingless(suchastheChinese).TheatmosphereisnotabletotellwhereagivenGHGmoleculecomesfrom,soanysinglecountryor individual isdirectlyresponsible for theamountofemissionsithasgenerated.Yet,theimpactoftheamountofemissionsthatanygivenindividual, even thosewho live a very carbon‑intensive life such asNobel PrizewinnerAlGore(Schweizer2006),isnegligible(Reisman2002).Accordingtothelegalrulethatliabilitycanjustbeindividual,andconsistentlywiththe“deminimisnoncuratpraetor”,nobodycanbeheld responsible for anything.Even if one looksatcountries, rather than individual, theaggregateamountofemissionsgeneratedbymostcountriesinthepasttwohundredcenturiesisverylow,ifcomparedwiththeamountofGHGs that canhaveadiscernible impactonclimate–perhaps just thewealthiest and/ormost populated countries in theworld, such as theUS, formerUSSR, andChina can be held individually responsible for any amount of globalwarming,howevertiny.Onlywhenonelooksattheaggregateworldemissionscanaresponsibilityprincipleemerges,butitwouldbeveryweaktotellbeforeacourtthatallareresponsibleforsomething.

Thequestionofwhoisthepolluterbecomesevenmorecomplexasoneconsidersthetimedimension.Infact,inordertofindaliability,onehastofindaharmedparty,inthefirstplace.Thenonehas toshowthatacausalrelationshipexists,betweenthesupposedlyguiltypartyandtheharm.Globalwarming–asitwillbearguedinnextparagraph–isacontinuousprocess.Itisveryhardtotellwhen,andtowhichextent,anthropogenicglobalwarming,asopposedtonaturalglobalwarming,begins.It isalsoverynaïvetoconfuseanthropogenicglobalwarmingwithglobalwarmingperse, as the Stern Review (among the others) does (see the initial quotation of thispaper,andHenderson2009).

1.5.2.Thepollution

Globalwarmingisinherentlydifferentfromthecasesofconventionalpollutionforatleasttworeasons:(a)theexternaldiseconomywillbebornebyfuturegenerations,thatis,virtuallynolivingpersondoesorwillpaythecost;(b)globalwarmingdoesor will not, per se, cause harm to anybody, at least in a strict sense. With theconventionalsourcesofpollution,forexamplesparticulates,asbestos,lead,orcarbonmonoxide, a causal, direct link could be established between exposure to thepollutantandnegativeeffectsonhumanhealthortheenvironment.Forexample,andperhapsmuchtothelayman’ssurprise,arecentinquiryfromtheUSEnvironmentalProtectionAgency(EPA2009)concludedthattheprojectedincreasesinatmospheric

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concentrationsofcarbondioxideare“wellbelowpublishedthresholdsforadversehealth effects” (p.157). As to the other GHGs, the expected concentrations formethane are “well below any recommended exposure limits” (p.157); theconcentrations of nitrous oxidewill be “well below any recommended exposurelimits”(p.158);andtheconcentrationsoffluorinatedgaseswillbe“manyordersofmagnitude below the exposure limits” (p.158). This tells nothing about theconsequenceofglobalwarming,but it suggests that (a)GHGscan’tbedefinedaspollutantsinastrictsenseand(b)therewillbenodirecteffects fromthesupposedsourceofso‑calledpollution(theveryterm“pollution”,infact,iswidelyadoptedinthispaper,too,forthesakeofsimplicity).

GHGsemissions’impactismuchmorecomplicated,andnotjustbecause,inordertoassessthecosts,oneshouldbeabletodistinguishtheconsequencesofanthropogenicglobalwarmingfromthoseofnaturalglobalwarming.Forexample,desertificationorbiodiversitylossaresupposedlylinkedwithglobalwarming:yet,itisunclearwhatamountofdesertificationorbiodiversitylosswouldremain,iftheman‑madecausesofglobalwarmingcouldberemoved.Toput itotherwise, it isunclearhowmuchincreaseinworldaveragetemperaturesinthenext,say,onehundredyearscanbeattributedtoanthropogenicglobalwarming,asopposedtonaturalglobalwarming.Forthesakeofsimplicity,mosteconomicanalysestendtoassumethatanthropogenicglobalwarming is the same as total globalwarming, but this inevitably leads tooverestimate the damages. Fair enough, but at least it should be alwaysacknowledgedthattheestimatedcosts–whichinanover‑simplifiedworldcoincidewiththeexpectedbenefitsfromclimatepolicies–are,infact,overestimated.

Notjusttheamountoffuturewarmingisunknown,butalsoitsspatialdistributionisunknown.Obviously, at least some people (for example those in the business oftourism inplaces thatwould experience longer andwarmer Summers) and somecountries (for example cold countries in the higher latitudes)would benefit fromglobalwarming.Forthem,globalwarmingisapositiveexternality,notanegativeone. Even assuming that the aggregate costs fromwarming are higher than theaggregate benefits, how would this be addressed? Would they have a right tocompensation?According to Brubaker (1975, p.157), collective action “results in‘forced riding’ by individuals who are coerced into expressing non‑existent‘demands’ for collective goods.Orworse a ‘good’ in factmay be a bad, in someviews,fromwhichiseconomicallynotfeasiblefortheindividualtoexcludehimself,and forwhich compensationmay be appropriate”. Therefore, collective action tocontrol climatewouldbeamassive redistributionistaction,not theprovisionofapublicgood(onthetheoryofpublicgoodsbeing,infact,atheoryofpublictransfers,seeForte1967).Somepeoplewouldbebetteroff–movingfromaworseclimatetoabetterone,undertheirownpreferencesandconceptofwhatagoodclimateis–andotherswouldbeworseoff.

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Aright to experienceSummerorWinter as theyused tobe, or a right to agiventemperature,can’tbedefinednot justbecausethelegaloreconomicbasestodosoare lacking. It can’t be defined for themere reason that such a right couldn’t beenforced.First, climate,or average temperature, is just anarbitrary synthesisof avirtuallyinfinitenumberofvariables,mostofwhicharewellbeyondhumancontrolandasamatterof fact areunknownorunmeasurable(Labohmetal.2004).Meantemperaturetellslittleornothingregardingwhatreallymatters,thatistheindividualability topredictweather inaway thatmake itpossible tomakeplans– tomakedecisionsconcerningwhetherornotfarmingapieceoflandandhow,whetherornotto build an house in a given place, whether or not going to the sea or to themountainsonvacation,etc.

Onthetopofthat,anotherquestionarises,thatmakesitevenmoredifficulttodefineglobalwarmingas“pollution”.Whendoesglobalwarmingbecomesharmful,thatis,what is the thresholdbeyondwhichglobalwarmingbecomesa“bad”?Onenaïveanswermightbe,thatglobalwarmingbecomesabadwhen,andtotheextentthat,global temperatures exceed thepre‑industrial level. Thatwould imply the all theemissions‑generatingactivitiesthathavetakenplaceinthepast150yearsaretobeconsidered “costly”. To our knowledge, however, nobody has ever argued thathumanity today is worse off, because it lives in a warmer planet, where somebiodiversity loss may have occurred because of the man‑induced temperatureincreases (Goldberg 2007; Stagnaro 2007). Alternatively, it may be identified a“temperature threshold” beyond which the expected effects of global warmingbecomeintolerable.ThisisthechoicemadebytheEuropeanUnion,thatadoptedthegoalofkeepingtemperatureincreasesbelow2°Cmorethanthepre‑industriallevels.However, this is questionablenot just because such a threshold – given thewideuncertainties – in inherently arbitrary, but also it may well be well beyond thepolicy’sscope,evenunderoptimalconditionsofglobalparticipation.Forexample,theprocessofnaturalwarmingmightbestrongenoughtodetermineatemperatureincreasehigherthantwodegrees(apossibilitywhichisrecognizedbyIPCC2007),ortheinertialnatureofglobalwarming–whichisduetothelongtimeofpersistenceofGHGsmolecules in the atmosphere – may be such that temperatures will keepgrowing beyond the threshold even if anthropogenic emissions fall to zeroimmediately.

Finally,theneedtoidentifyathresholdbegsasignificantproblemregardingtheveryconcept of optimal temperature. It should be recalled that climate has alwayschanged, and it always will: which means that temperatures either increase, ordecrease.Claimingthatweshouldstoptemperatureriseandkeeptemperaturesinthenearbyof thepresent levels, seems to relyon theassumption that thepresenttemperaturesaretheoptimalones(averyfortunatecoincidence).Afterall,ifclimatestabilityisapublicgood‑ Thatmeansthatlowertemperatureswouldbeharmful,too.What shouldwedo, if temperatures started todecrease, either fornaturalor

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man‑madereasons?Shouldwesubsidizecarbonemissions inordertoprevent toomuchcooling?

Suchproblemmaybepurespeculationatthetimebeing,butitposesafundamentalquestion on the true goals of climate policies, that so far – according to ourknowledge–hasnotbeenanswered.

1.5.3.Thepolluted

Thepollutedpartyis,obviously,futuregenerations.Lessobviousis,whatshouldbemeantby“futuregenerations”.Doesnextgenerationqualifyasafutureone?Andtheoneafter?Andallthegenerationssincethenextuntiltheendoftimes?Thequestionis all but trivial. First, it relies upon how globalwarmingwill turn out to be, asopposedtowhatscenariossuggest.Iftheincreaseinworldaveragetemperaturewillbeslowandmild,itislikelythatthenextgenerationwillnotexperiencesignificantbads from global warming. If, instead, abrupt climate change should happen,possiblyeventhepresentgenerationwouldsufferfromit.Moreover,whateverglobalwarminglookslike,therewillbeatimewhenitseffectswillbeabsorbed,oroffsetbyeconomicgrowth,adaptation,orboth.Thatsuggeststhatnoteveryfuturegenerationbelongstotheoperationalconceptof“futuregenerations”thatisneededtodefinetheexpectedcostsfromglobalwarming.

Thisproblemsismostevident,forexample,intheSternReview,whichadoptsaverylong‑termscenario inorder toestimate thediscountedcostofglobalwarming.AsNordhaus(2008,p.181)putsit,“theprojectedimpactsfromclimatechangeoccurfarinthefuture.Takeasexamplethehigh‑climatescenariowithcatastrophicandnon‑marketimpacts.Forthiscase,themeanlossesare0.4percentofworldoutputin2060,2.9percentin2100,and13.8percentin2200”.Largeandlargelyuncertainimpactsinthe far distant future aremagnified by the zero‑discounting, but they canhardlyprovideusefulinformation,astheyrelyonscenariosonclimate,economicgrowth,technology,etc.thatcanbefairlydescribedas“assumptions”.

As faras thedistant future isconcerned, it isverycomplex toassesswhatare theopportunitycostsfromglobalwarming,asopposedtothoseofanti‑globalwarmingpolicies.Wedon’tknowhowtheworldwilllooklike;wedon’tknowwhether,underabusiness‑as‑usual,warmerworld,humanitywillbeabletodeveloptechnologiestoprotectbiodiversity,contrastdesertification,fightmalaria,colonizeotherplanets,etc.eveninthepresenceofhighertemperatures.Sincewecan’thaveinformationaboutthat,itisquitehardtoderiveinformation,oreventomakereasonableassumption,aboutthekindofworldthatthose“futuregenerations”willwanttoinheritfromus.Perhaps they will want a cooler world; or perhaps they won’t care abouttemperatures,andwillwantus topass themona richerworld,withmorecapital

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accumulation andmore technology. AsCordato (1999, p.9) puts it, “This wouldrequireinformationaboutthecourseoffuturetechnologicalchange,entrepreneurialinsights,andinnovation.Moreimportantly,itwouldrequireinformationaboutthesevariables both in the absence and in the presence of the policy. Clearly, this isinformation thatwe can only pretend to have. Even if this information could be‘known,’theanalystwouldsomehowhavetobeabletoassessthe‘aggregateamountofsatisfaction,’aconceptthatwouldfirsthavetobedefinedinan‘operational’way,thatwouldbeexperienced in thepresenceandabsenceof thepolicy.Thekindofinformation that would be necessary to make these precise interpersonal andintergenerational cost comparisons required to justify thepolicy ispracticallyandconceptuallyimpossibletogather”.

Vis‑à‑vis theunknowable, it seemsnaïve to tryandmodel thedistant future.Toomany informationare lacking, including thoseaffectingclimatepatterns. It seemsmorereasonabletofocusoninformationregardingtheeffectsfromglobalwarmingin thenear future.Theymaystill justifycollectiveaction tobe taken,especially ifabruptclimatechange–asopposedtogradualclimatechange–hasatiny,butnon‑negligible,probability(Weitzman2009).

1.6.Thestateoftheworld

Butagain,beforeweturntothefuture,itisimportanttounderstandthepast.Sofar,carbonhasbeenthebasisforprogressandeconomicgrowth(Smil1994;Smil2008).Inthepast150years,thenetbalancebetweenthecostsfromincreasedtemperaturesandthebenefitsfromcheap,easilyaccessible,reliable,and“dense”energy(HuberandMills2005)canonlyberegardedaspositive.Arguably,hadapolicyaimedatcontrollingcarbonemissionsintheearlyXIXCenturybeenenforced,theworldcouldhardly be better off.Most notably, that is true even as far as the environment isconcerned.

Partofthemisconceptionsrelatedtothefutureimpactsfromglobalwarming,derivefrom a number of prejudices concerning the environmental performance of“unrestrainedcapitalism”,aswehadintheXXCentury.Trueenough,“unrestrainedcapitalism”isactuallyawrongdefinition,because–amongtheotherreasons–forthelargepart,theXXCenturywas“thecenturyoftheState”,astheItaliandictatorBenitoMussolinifamouslysaid.Itwouldbeunfairtoclaimthat,inthepastcentury,theenvironmentwasunregulated.Itistrueenough,however,that–untilatleastthe70s– itwascomparatively less regulated than in the followingdecades.Now, theideathat,absentspecificregulation,environmentaldegradationisinevitableshouldbeconfrontedwithaninconvenienttruth:environmentalquality,infact,tendedtoincrease,ratherthandecrease,at least inthefreemarketeconomies.Thefailureto

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understand this fact, and its theoretical foundations, undermines a properunderstandingofwhat lies in frontofus.Examplesofsuchmisunderstandingarewideandcommon.

For example,Helm (2008,p.223) claims: “Theoceans are alreadyhighlypolluted,agricultural land is being affected by salinization and desertification, and globalwarmingwill have serious effects on the areaswherepopulation ismost heavilyconcentrated”.Thetemptationarises,tocommentuponthisbyquotingCoase(1990,p.211)onthelighthouseeconomicliterature:“Howisthatthesegreatmenhave,intheir economicwritings, been led tomake statements about lighthouses that aremisleadingastothefacts,whosemeaning,ifthoughtaboutinaconcretefashion,isquiteunclear,andwhich,totheextentthattheyimplyapolicyconclusion,areverylikelywrong?”.

Astothepast,Helmmentionsoceanpollution,landsalinization,anddesertificationas a proof of the (supposedly man‑induced) increasing pollution. Data on thepollutionof coastalwaters in thedevelopedworlddonotunivocally support thisbelief: in theEU, forexample,pollutionhasbeendeclining fordecades (EC2000),whiletheevidencefortheUSiscontroversialbecauseacommonframeworkfordataismissing.Oilspills intheoceanshavealsobeendeclining,bothinfrequencyandsize.

As far as forests are concerned, “Some regions…havemade significantprogress;institutions are strong, and forest area is stable or increasing. Other regions…continueto loseforestarea…However,eveninregionsthatare losingforestarea,there a number of positive trends” (FAO 2007, p.viii). On desertification andsalinization, the evidence is mixed and different authors provide differentinterpretationbothon theextentof thephenomena, and their causes (CottonandPielke2007).

A positive trend is also evident for a number of other environmental indicators,including those relating to air quality, water quality, lands and forests, toxicpollution,etc.Forexample,Lomborg (2001,p.177) summarizeshis findingsonairpollutionasfollows:“TheachievementofdramaticallydecreasingconcentrationsofthemajorairpollutantsintheWesternworld…isamazingbyitself.Butitisallthemore impressive that it has been attained while the economy and the potentialpollutershaveincreaseddramatically”.MooreandSimon(2000)showadecreaseinsmog,particles,aswellascleanerlakes,riverandstreamsinthemajorUScitiesandregions.Stillonairquality,Goklany(1999)showthedecreaseinairpollution‑relateddiseases in theUSasa consequenceof improvedairquality, that ispartlydue tostricterregulation,butinlargepartcanbetracedbacktobusiness‑as‑usualprocessoftechnologicalinnovationandturnover.

Possibly,themostrelevantproxyforenvironmentalquality–lifeexpectationatbirthfor human beings – has been improving for decades. Several positive trends are

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shown, for example, by Lomborg (2001) and Hayward (2008). A theoreticalframework on why environmental quality tends to improve in the long run isprovidedbySimon(1996)andGoklany(2007),amongtheothers.

The fact thatmany environmental indicators are improvingdoes not in anywaymeanthatthereisnoenvironmentalproblem,orthatnoactionisneededtoaddressspecificproblems.It justmeansthatsomecautionisneeded,whenspeakingaboutenvironmentaldegradationasageneral,unavoidableconsequenceorbyproductofeconomicgrowth.Somedatamaybecontroversial,sosomebelieveamajorproblemdoes exist,while others argue the problem is eithermisinterpreted or it is in theprocessofbeingsolved.Controversyoverdatashouldnotleadtoimmediate,radicalaction,but to anattemptofmoreobjectively assess the reality. It alsomeans thatspecificproblemsshouldbeaddressed,possiblyinspecificways,whileitmaynotbethebeststrategytoputaltogetherasifan“environmentalproblem”didexistwhichstems fromone single cause and can be solved by one single, globalmeasure orpolicy.

To summarize, at least so long as the past is concerned, human and economicdevelopmentisinherentlybondwithcarbon‑basedsourcesofenergy.Itisalsoclearthat fossil fuelswilldominate the21stCentury,both inabusiness‑as‑usualand inalternativescenarios(IEA2008;Odell2004).Itlogicallyfollowsthatglobalwarmingmitigation,howeverwell‑designed,wouldimplyseverecosts–althoughthesecostsmaybelowerthanthecostsofglobalwarming,inwhichcasetheymightbejustified.To estimate the costs of mitigation, however, a portfolio of low‑ or zero‑carbontechnologiesshouldbeavailable,thatcansubstitutefossilfuelsatanacceptablecost.Unfortunately,sofarthereseemstobelittleevidencethatthevariouspoliticalandtechnological proposals that have been set forthwill not fall short of their goals(PacalaandSocolow2004).Apparently,themostpromisingstrategytoreducecarbonemissionsincreaseinthenextfewdecadescomefromtechnologicaltransferandthemodernization of the industrial base in the emerging economies (Bernstein et al.2006).Unfortunately,technologytransfer–howeveruseful–intheshortruncanatmostsavepotentialemissions,ratherthanreducingemissionsinabsoluteterms.Infact, virtually no credible scenario forecasts a reduction in global emissions,particularly intheemergingeconomies, inthenextfewyearsor intheforeseeablefuture.Moreover,sinceglobalwarmingisastronglyinertialprocess,whateverwillbedoneintheshortrun,bydevelopingcountries,developedcountries,orboth,willhave little effect in the short run. The resultswill be delivered in the longer run(which is one reason why international agreements are so hard to close – seeEnevoldsen2005).

While thefuture looksgloomyifput inthisperspective, therearealsoreasonsforhope,evenunderabusiness‑as‑usualscenario.First,thewarmingeffectfromGHGsfollowalogarithmicpattern,thatis,themarginalwarmingeffectofanygivenGHG

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moleculedeclines.Thismeansthat,assumingthatdoublingtheamountofGHGsintheatmosphere causedan increase inglobal average temperaturesbyx,a furthertemperature increaseby thesameamount requiresGHGsconcentration todoubleagain.Toputitotherwise,theamountoftemperatureincreasethatcanbeattributedto anygivenmolecule ofGHG is lower than that of thepreviousmolecules, andlower than the averagemolecule. In very rough terms, future emissions are lessharmfulthanpastones(IPCC2007,Visconti2005).

Secondly,itislikelythatglobalwarmingwilloccurgradually,andthattemperatureincreaseintheforeseeablefuturewillnotbecatastrophic.AccordingtoIPCC(2007),inthemostlikelyscenariotheexpectedtemperatureincreasewillbeintherange1.8‑4°Cby2100.Thismeansthat there isachancethegoalof theEUpolicy– tokeeptemperatureincreasebelow2°C–willbemetevenintheabsenceofspecificpolicies(if thelowerestimateis true),aswellasthereisachancethat itwillneverbemeteven under themost ambitious policies (if the higher estimate is true). The lowprobability of European policies having a significant impact on temperaturesdependsnot juston the fact thatEuropealoneaccounts fora smallanddecliningshare of global emissions, but more fundamentally on the inertial nature of theclimatesystem.AsNordhaus(2008,pp.152‑153)explains,“thebenefitsofemissionsreductionsarerelatedtothestockofgreenhousegases,whilethecostsofemissionsreductionsarerelatedtotheflowofemissions.Thisimpliesthatthemarginalcostsofemissions reductions are highly sensitive to the level of reductions, while themarginal benefits of emissions reductions are insensitive to the current level ofemissionsreductions”(seealsoPizer1999andHoelandKarp2001).Aconsequenceof thismay be that, even in presence of a very small probability of catastrophicclimatechange,theneedforurgentorimmediateactionmaynotbeashighastheneedtodesignefficientpolicies.Thatis,wearenotrunningoutoftime.

Theaboveleadstoapolicyconclusionthatmaybequitedifferentfromthepoliciesthataregenerallyadvocatedbypolicy‑makersand,tosomeextent,byeconomists.

1.7.Theeconomicsofdecoupling

The simplest way to reduce emissions, in fact, is to curb economic growth.Significantly enough, 2008 has been the first year EU’s emissions have fallendramatically,themostsignificantdifferencewithrespecttothepastbeingthattheEuropeaneconomyfellbecauseoftheglobaleconomiccrisis.Obviously,theideathateconomicgrowthshouldbeentirelygivenupinordertocutemissionsistrivial.Therealchallengeistodesignapropersetofincentives,astodecoupleeconomicgrowthfromemissionsgrowth.AsFigure2shows,thusfaremissionshavegrownhandinhandwithpopulation,GDP,andenergyconsumption.AsisclearfromtheFigure,in

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thelast50yearsGDPandemissionshavegrownslightlyfasterthanpopulationandenergyconsumption,indicatingthatpercapitaconsumptionhasgrown,andthattheshareoffossilenergyhasincreasedreflectingitsmanyeconomicandtechnologicaladvantages.

Figure 2. Energy (1971‑2001), Population,GDP, andCO2 emissions (1960‑2001)growth.Eachvariablehasbeenadjustedsothatthe1990levelissetequalto100.Source:ElaborationontheWorldBank’sWorldDevelopmentIndicators.

The apparent aim of climatepolicies, is todecouple emissionsgrowth fromGDPgrowth,whichmayormaynot entaildecoupling energy consumption fromGDPgrowth.Absolute decoupling refers to the fact thatGDP grows,while emissionsstabilize or decline. There is no evidence that absolute decoupling does or willhappen in the foreseeable future at a global level; a few examples of absolutedecoupling exist but they can hardly be reproduced (Pacala and Socolow 2004).RelativedecouplingreferstothefactthatemissionsgrowslowerthanGDP.Relativedecouplingisarealityinmostofthedevelopedworld,asaconsequenceofincrease

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affluenceandhigherpossibilityandwillingnesstospendforcleanertechnologies,aswellasofspecificregulations(OECD2002;OECD2006;Luetal.2007).

Zhang(2000)showsthatthemajordriverforemissionsincreaseinChinahasbeeneconomicgrowth;Mazzarino (2000) andGonzalesandSuarez (2003)obtained thesame result, respectively, for Italy and Spain. At the same time, there is someencouraging evidence fromother sources ofpollution, as it has been emphasizedabove. In fact, as tomost pollutants of the past, a “bell‑shaped curve” has beenobserved,wherebytheamountofpollutiongrowsuptoapointtogetherwithGDPorGDPpercapita,andafterthatstabilizesandeventuallydeclines.Ahugeamountof literaturehasaddressed this socalled“EnvironmentalKuznetsCurve”, since itwasintroducedbysuchauthorsasGrossmanandKrueger(1995);SeldenandSong(1994); Shafik and Bandhopadyaya (1992) (for a longer discussion on theEnvironmentalKuznetsCurveforcarbon,seeChapter2).AstocarbondioxideandotherGHGstheevidenceismixed,tosaytheleast.Someauthors,suchasGoklany(2007),argue thatwhathecalls the“ecological transition”– that is, theshift frommore polluting to less polluting technologies asGDP and the technological levelgrows–willhappen;others claim thatGHGsarenot showingany trend towardsstabilizationorreductioninabsenceofspecificpolicies(RocaandAlcàntara2001);stillothersbelievetheEnvironmentalKuznetsCurvemayormaynotapplytoGHGs(Volleberghetal.2005;GaleottiandLanza1999).Onepossibleexplanationfor thelackofaunivocalevidenceisthatinalmostnocountryintheworldpercapitaGDPishighenoughtostartthetrendreversalforGHGsemissions.

WhateveristherealityofEnvironmentalKuznetsCurveforGHGs,weareleftwiththreehypotheses,eachofthemsupportedbysomepieceofevidence:

(a) EnvironmentalKuznetsCurvewill eventually showup forGHGs, inwhichcase themarketwill take care of globalwarming – even though collectiveaction may be needed either to increase resilience against the adverseconsequencesofglobalwarming,ortoacceleratetheprocess;

(b) Environmental Kuznets Curve will not show up, in which case carbonemissionswillneverbedecoupledfromeconomicgrowth–thatis,anypolicyaimedatcuttingemissions,willsubsequentlycurbeconomicgrowth;

(c) The existence of EnvironmentalKuznetsCurve forGHGsdepends on localvariables,whichmeansthatsomecountrieswilleventuallybeabletodecouplecarbon and growth, while others will face the choice between growing orcontributingtothefightagainstglobalwarming.

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Forthesakeofsimplicity,onlythefirsttwoalternativeswillbeconsidered,assumingaglobalconsensuscanbefoundonwhetherornotactionisneeded.Thisisaverystrong–andapparentlyunlikely–assumption,thatleadstoconsciouslyoverestimatethescopeofclimatepolicies,ifandwhentheyareadopted.

1.7.1.EKCdoesexists

If an Environmental Kuznets Curve (EKC) exists for GHGs, one would expectemissionstostabilizeand/ordeclinespontaneouslyinthelongrun,startingfromthedevelopedworld.That is,anaturalprocesswill takeustothefinalsolutionoftheglobalwarmingprocess,eventhoughthatmayhappen“toolate”,thatis,whentheatmospheric concentrations of GHGs have reached a dangerous level. Ideally,however, thisposesusquiteadifferentproblemthan theonewhich iscommonlyaddressedbytheglobalwarmingliterature: thechallenge, infact,wouldnotbetochangehumanbehaviorortoforcetheadoptionofinefficienttechnologies.Itwouldratherbeabouthowtoimproveoracceleratethetransition.

AccordingtotheframeworkintroducedbyForte(2007a),thiswouldbeastosaythatthe external diseconomy (global warming) can’t be decoupled from the externaleconomy (GDPgrowth) in the short run.Aconsequenceof this is thatanypolicyaimedatcurbingemissionswouldreduceGDPgrowthaswell,andwoulddelay–insteadofmakingfaster–theecologicaltransition(Goklany2007).Intheshortrun,anysuchpolicywouldeitherbe ineffective (ifGDPgrowth is tobepreserved),oreconomicallyverynegative(ifemissionsaretobecut),especiallyforthelow‑incomecountries. In both cases, the outcomewould be questionable in terms ofwelfareeffects,andpoliticallyhardtojustify.

Afurtherconsequenceofthiswouldbethatameaningfulpolicyshouldbelongrun‑oriented,andshouldfocusonthe“lowhangingfruits”thathavenotbeenpickedyet.Asamatteroffact,mostofthemlie inthedevelopingcountries,thathavefarlessefficientindustrialandenergysectorsthanthedevelopedcountries.Bernsteinetal.(2006),forexample,haveestimatedthatthepotentialforreducingfutureemissionsinthemajoremergingeconomiesthroughcost‑effectivetechnologicaltransfersismorepromisingthanwhatcouldbedeliveredbyinternationaltreatiessuchastheKyotoProtocol,atalowercost(infact,itwouldbeaninvestment).

UndertheEKChypothesis,moreover,themajordriverfortheecologicaltransitioninthelongrunwouldbeGDPgrowth.Thatis,pro‑environment,anti‑growthpoliciesmightbeeffectiveintheshortrun,butinthelongrunwouldbeanti‑environment,notjustanti‑growth.Onthecontrary,thebestpolicyinthelongrunwouldbeone,that encourages economic growth as a solution to environmental problems,particularlyglobalwarming.

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Obviously, thismeans thatat least someglobalwarmingwillhappen,beyondtheamountofwarmingthatwewillgetanywayasaconsequenceoftheinertialnatureofclimate.Itwouldbereasonable,then,tofocusourpolicyeffortsonadaptationtochanges,ratherthanonmitigation.Mitigation, infact,willcomewhenGDPlevelswillbehighenough.

1.7.2.EKCdoesn’texist

IfEKCdoesn’tapplytoGHGs,itmeansthateitherdecouplingwillnothappen,orthatitwillbeverycostlytoachieve,becauseanypermanentreductionofemissionsrequireseithertopermanentlyslowdowneconomicgrowth,ortogothroughamajortechnologicalshiftthat,atthetimebeing,doesn’tseemlikelyorevenpossible(Pacalaand Socolow 2004). For example, with regard to solar power – which is widelyregarded as the most promising technology – even under the most favorableassumptions, will not be competitive or technically feasible on a large scale fordecades(Borenstein2008;Bradford2008).AsinthecaseofEKC,hence,atransitionproblem arises, that should be addressed by proper policies, and should not beoverlooked.

Inotherwords,absentEKCintheforeseeablefuturehumanitywill faceatradeoffbetweeneconomicgrowth inawarmerworld,or economic stagnation ina coolerworld.Thechoicebetweenthesetwoalternativesisnotjustaneconomicalone,asitimpliesanumberofethicalarguments regarding, forexample, towhatextent thehuman genre has a right to interfere with the environment and, even morefundamentally,whatare therightsof the futuregenerations,aswellaswhat is intheirbestinterest.Themoralsideoftheissuederivesfromthefactthatweknowthatthe current economic framework is incompatible with “sustainability” strictlydefined, asmany environmentalists have argues (see for exampleWWF 2008).Apreviousversionof thesamereport (WWF2006,p.19)wentas faras toclaimthat“Noregion,northeworldasawhole,metbothcriteriaforsustainabledevelopment.Cuba alone did”.While a similarly explicit statement can’t be found in themostrecenteditionoftheLeavingPlanetReport,theresultisprettymuchthesame.Itisworthbeingemphasizedthatthisisnottheresultofaselectiveinterpretationofthereality or of a poormethodology, but the logical consequence of a definition of“sustainable development” as basically a lack of interference with the naturalenvironment,whichisconsistentwithmuchoftheenvironmentalmovementsaswellas with a significant part of the literature on global warming, that has oftenconsideredtheenvironmentasan“independentvariable”(Clò2008).

Ifthisisthecase,not justtheimmediateorforeseeablecostsandbenefitsofactionandlackthereof,aswellastheunderlyinguncertainties,shouldbeconsidered,but

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alsothelong‑termconsequencesofclimateactiononthefutureofeconomicgrowth,willingness to invest, and possibility of creating a better world for the futuregenerations. That is, addressing the external diseconomy is at least as muchimportantaspreservingtheexternaleconomiesderivingfromgrowth.

1.8.Acaseagainstgovernmentintervention

Underthisrespect,thenon‑EKCcaseleadstosimilarconclusionsastheEKC‑case:under the former, the environment can’t be saved without giving up economicgrowth, or it can be saved only to the extent that economic growth is given up.Significantlyenough,mostestimateonthecostsandbenefitsofglobalwarmingandclimatepoliciesfindcomparableresultforthetwosides.Themainreasonswhymosteconomists seem tobelieve thataction isneededhave todowithaprecautionaryapproach(Morris2000)and/oranover‑simplifiedvisionoftheunderlyingscientificissues(Henderson2009).

In the EKC‑case, instead, the environment can andwill be saved, but for this tohappen,theworld’seconomywillhavetogrowenough.Wealthiercountriesdoorwillexperience first theirecological transition,while lessdevelopedcountrieswillhavefirsttobuilduptheirowninstitutions,capitalaccumulation,andsolvethemostbasicproblemsbeforetheycanconsider,andcanbeaskedtoconsider,GHGsasalegitimateenvironmentalthreat.AsAdler(2000,p.22)putsit,inanEKC‑likeworld,“wealthierishealthierandricheriscleaner”.Publicpoliciesmayplayarole,insofaras theymake faster the innovationprocessand/or the technological improvement,especiallyinthedevelopingworld.

If thingsare like this, the twocasesherebyconsideredare clearly symmetrical: inboth cases, there is short‑ and long‑run tradeoff between reducing emissions andkeeping growth. Hence, there is an intimate relationship between the world’seconomicperformanceanditsenvironmentalfuture.

Now, let’s consider global warming as conventional pollution (which it is not,because temperature increase per se is not linkedwith human or environmentaldeterioration) that determines an external diseconomy. Thepublic goodwhich isapparentlyunder‑produced,absentcollectiveaction,is“climatestability”,thatcanbedefinedastherateofclimatechangethatisdrivenbynon‑humancauses,plustherateofclimatechangewhosemarginalcostisequaltothemarginalbenefitfromitsprimarycause,i.e.economicgrowth.Let’sforgetforawhilethatnoneoftheabovevariables–naturalasopposed toman‑madeglobalwarming,and“acceptable”asopposedto“nonacceptable”anthropogenicglobalwarming–isknown,neitherisitpossiblyknowable.

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ThestandardapproachthatwouldbeundertakeninsuchcaseisdescribedbyForte(2007b,p.188‑190):theprimafacieapproachwouldbetotaxthepolluterinordertocompensatethepolluted,andbysodoinganincentivewouldbesetforthepolluterto adopt cleaner technologies. Often, however, the costs of the underlyingtransactions are too high, so it may be decided that the state subsidizes cleanertechnologies,thatis,theburdenisshiftedontotaxpayers(whomayroughlycoincidewiththepollutedparty).Alas,“notalldiseconomiescanbeeliminated.Toomanyvehicles in the streets generatediseconomies to the other vehicles.Urbangrowthincreases thevalueof land andgeneratesmonetary, externaldiseconomies to theother users. Noise and part of the atmospheric pollution from productive andcommercial activities can’t be eliminated, but only reduced. The costs of externaldiseconomies incongestedareaswill increasenot just for individuals,butalso forbusinesses.Notalwaysthiswillreducetheirdemandforthoseareas,becausetherearealso‘externaleconomies’generatedbytheexistingbusinesses.Themarket,ifleftalone, will stop ‘new entries’ only when they will stop producing differentialbenefits”.

Thereisaclearanalogy.Emissionscan’tbeeliminatedwithoutgivinguptheworldeconomy as it is, causing the death of many who can live just because of thecapitalism‑inducedprogresses(Hayek1991;Simon1996).Intheforeseeablefuture,theycan’tevenbereduced.Therateofgrowthofemissionscan justbeslowed,athighcost.Thishighcostconsists,precisely,inthelossofwhatisclearlyan“externaleconomy”thatgoeshandinhand,andatthepresentstateoftechnologycanjustgohand in hand except for a small number of highlydeveloped countries,with theexternaldiseconomy.

The current global markets may underprice carbon. As a consequence of this,emissionsmaybehigher than theoptimum,andpresentand future temperaturesmaybehigherthantheoptimumaccordingly.Yet,theothersideofthesamecoinisthattheworldasawholehasgrowntoalevelofwelfare–asmeasuredbyGDPandvirtuallyanyotherindicator–that,evenintheclosepast,wasprobablyunthinkable.Itwouldbeimportanttoletcarbonbeproperlypriced,butitisevenmoreimportantto keep the benefits of economic growth, especially when it is emphasized thatenergypovertyisprobablyamoreurgent,immediate,andcatastrophicthreatthanglobalwarmingitself(Lomborg2004).

Moreover,itshouldbeemphasizedthat,althoughindirectly,carbonisalreadypricedinmostdevelopedeconomies,andinmanydevelopingones.Energytaxationhasthesame effect of carbon pricing, as it disincentives the use of fossil energy. In fact,carbon is indirectlypricedat least in fourdifferentways, someofwhichare trulyglobal by nature. First, energy taxation. In theEuropeanUnion, for example, thecountrythattaxesgasolineanddieseltheleastwasCyprus,thatinthefirst10monthsof 2008 had an average taxation of 0.445 and 0.399 europer liter of gasoline and

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diesel, respectively (UP 2009),which translates into 189 and 130 euro per ton ofcarbondioxide,respectively.AccordingtoNordhaus(2008,p.91)theoptimalpriceforcarbonin2010is34US$,thatequalstoslightlymorethan9US$pertonofcarbondioxide.TheamountoftaxesthatanyEuropeandriverpaysforpetroleumtaxationismuchhigherthanwhatanyestimateforthesocialcostofcarbonwouldsuggest(Tol2005).

Secondly,whilemanycountriesintheworldsubsidizeenergyconsumption,manyothers tax itmore thanproportionally.A largepartofworldenergyconsumptionhappensincountrieswheretheamountofenergytaxesexceedstheamountofenergysubsidies(seedatafromWB2008).Petroleum,forexample, istaxedinmanywaysand in many jurisdictions, and it is likely that, for example, the consumptionreductionsduetothetaxationoftheoilcompanies’revenuesintheoil‑richcountriesexceeds the increases in consumption in the same countries because of domesticsubsidiesorpricecontrols(foranoverviewonpetroleumtaxation,seeNakhle2008).Theinefficienciesofmanynationalcompaniesinoil‑producingcountriesislikelytohavethesameresult (MarcelandMitchell2006).Subsidiesandmandates fornon‑fossilenergiesalsoworkthesameway.

Thirdly, theamountofoilandgas that isproducedeveryyear, isprobably lowerthantheamountthatwouldbeproducedinaperfectmarket,asaconsequenceofthenumerouspoliticalrestrictions,cartels(suchasOPEC),etc.

Fourthly, most developed countries and an increasing number of developingcountries have adopted environmental regulation that also increase the cost ofenergy.Totheextentthatregulationis,topracticalpurpose,equivalenttotaxation(Posner1971),eventhisworksasacarbontax,eventhoughitisobviouslyintendedforothergoals(includingabatingdifferentpollutantsfromcarbondioxide).

Onemaystillarguethatalltheaboveisnotenough,butatleastalltheaboveshouldbe considered. On the contrary, most of the global warming literature tends tocompletelyignorethispoint,asifthepriceofcarbon‑basedenergywasatruemarketprice,exceptfortheexternalitywhichisnotpriced,insteadoftheresultofmarketforcesandmanyothercomponents,including(butnotlimitedto)marketdistortions,taxation,regulations,andsubsidiestocarbon‑freeenergysourcesorenergy‑savingtechnologies.

Tosumup,thefollowingcanbestated:(a)inthepastaswellasintheforeseeablefuture, carbon emissions are a byproduct of economic growth; (b) a relativedecouplingbetweenemissionsandgrowthisverylikelytohappenatagloballevel,aswellasitoccurredforthedevelopedworld,whileanabsolutedecouplingmayormaynothappen;(c)ineithercase,itispossiblethatanEnvironmentalKuznetsCurvedescribesfairlyenoughthelong‑termpatternforcarbonemissions,thathavenotyetstartedtofallbecausetheGDPpercapitahasnotyetreachedthelevelcorrespondingtoa trendreversal; (d) if theEKChypothesis is true,and if thepoliticalgoal is to

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achievea long‑termreductionofemissions, thepolicy instrumentshouldpossiblyacceleratetherateofgrowthinordertogetsoonertotheturningpoint,orat leastshouldcarefullyavoidtohaveananti‑growtheffect;(e)if insteadtheEKCdoesn’tdescribethelong‑termpatternforcarbonemissions,orifitappliesonlytoregionalcases anddepends on local variables,whatever policy is adopted, a tradeoffwillemergebetweenacoolerworld,andawealthierfuture.Ultimately,thequestionisamoralone,anditreferstotheamountoffuturewealththatshouldbegivenupinordertoreducetheexpectedamountoffuturewarming.Incomparingthecostsandbenefitsofthepolicy,itshouldbeconsideredthefact,thatthebenefitsofmitigationpoliciesare likely tobe lesscertain than thecosts (because thecomplexitiesof theclimatesystemareveryhigh),andthattherewillbeasignificanttimelagbetweenthelatter(thatwillstartimmediately)andtheformer(thatwillshowupsometimeinthefuture).

Themostimportantstatementintheabovesummary,isthat,whetherornottheEKCexists at a global level, the economic consequences of climate policies should beadequatelyconsidered. Itshouldalsobeconsideredthateventhemostaggressivepolicies,aimedatachievingthemostdramaticreductioninglobalemissionsintheshortesttime,willbepaidfornotjustbythepresentgeneration,butalsobyfuturegenerations.Infact,allelsebeingequal,reducingcarbonemissionsforthepresentgenerations requires to consume less energy (that is, to pay more for the sameamountofenergy)andhencegrowmoreslowly.Thisslowergrowthwillresult inlower capital accumulation, less wealth, and arguably less technologicalimprovement for the future generations, who will be impoverished by climatepolicies,andnotjustbytheamountofunmitigatedglobalwarming.1

Inotherwords, futuregenerationswill faceclimatecostswhateverchoice ismadetodayandwhateveristherealstateoftheworldandscientifictruth.Table2showsthedistributionof costs in simplifiedscenarios,dependingon thescienceand thepolicyofglobalwarming.

1Someamountofwarmingwillhappenanyhow,unless(a)allglobalwarmingisassumedtobeanthropogenicand(b)emissionsarereducedtozeroinstantaneously.(b)wouldleadtostarvationandthedeathofmany,maybemost,humanbeings.(a)impliesascientificassumption,that–absentman‑madeforcing–globaltemperatureswouldbeeitherstableordecreasing.Ifthisistrue,weareintheveryfortunateeventoflivingunderaclimateoptimumthat,differentlyfromwhathappenedinthepast,willpersist.Iftemperaturesdecrease,acasemightbemade(followingexactlythesamekindofreasoningwhichisunderlyingmostoftheglobalwarmingeconomicliterature)forsubsidizingemissions,inordertostabilizetemperaturesatthepresentlevel.Infact,wheninthepastscientistsfearedtheplanetcouldgetintoglobalcooling,economistssuggestedthatmeasuresaretakeninordertoaddressthethreatofcooling.See,forexample,Adler(2006).

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Warming is mostlyanthropogenic

Warmingismostlynatural

Strongclimatepoliciesareimplemented

1A. Less warming, lesswealth

1B. Less warming, lesswealth

Weak or no climatepoliciesareimplemented

1B. More warming, morewealth

2B. Less warming, morewealth

Table2.Possiblescenariosforthefuturegenerations.

FromTable2,itisclearthatthemostfavorableconditionforfuturegenerationsis2B,whilethelessfavorablemaybeeitheroneoftheremainingthree,dependingontheexpectedcostsandbenefitsfromwarmingandfromthepolicies.Primafacie,keepinginmindtheestimatesforthecostsandbenefitsofclimatepoliciesthatwerereviewedinapreviousparagraph,thethreescenariosmaybethoughtofasbeingequivalent.Whatisrelevantfromourperspective,however,isthatfuturegenerationswillfacesomecostsanyway,eitherinformofreducedgrowth,orincreasedwarming,orboth.Therealpoliticalchoicewearefacingishowmuchcostshouldbepassedontothem,asopposedtohowmuchcostshouldbebornebythepresentgeneration.

UndertheForteframework,thiscaseresemblestheonewhereitmaybereasonabletoshiftthecostofpollutiononthepollutedparty,insteadofthepollutingone.Threedifferentargumentscanberaised.

In the first place, adopting strong climate policies today would raise a fairnessdilemma:since,underthebusinessasusual,futuregenerationsmaybeexpectedtobewealthierthanthepresentone,bearingacosttodayinordertoproduceafuturebenefitwouldbeequivalenttotakingfromthepoortogivetotherich.

Secondly,notonlythepoorwillbepoorerasaconsequenceofthepolicy,butalsotherichwill be poorer despite the subsidy, because theymight be living in a coolerworld,buttheywillalsohavehadalowerrateofeconomicgrowthandpresumablyalowercapitalaccumulation.

Third, while it may be true that global warming is a global public bad whoseabatementiscostly,itisequallytruethateconomicgrowthisapublicgoodwhoseproduction is costly, at least in terms of higher carbon concentrations in theatmosphere.Atthepresentstateofscientificknowledge,littlecanbesaidregardingtheactualeffectsofglobalwarmingortheeffectsofmitigationpolicies,butweknowthat themarginal greenhouse effect of GHGsmoleculeswill be decreasing. Thissuggeststhatthedecisiontomakestrongclimatepoliciesmightbeshiftedsometimein the future, without losing much in terms of slower temperature increase.

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Consistently,mostclimateeconomists(forexampleNordhaus2008),albeitfavorableto implementing climate policies, suggest that amoderate action is taken, not aradicalone,withincreasingintensityovertime.

Hence, a prima facie case can bemade for shifting the cost of pollution onto thepollutedparty,i.e.onfuturegenerations,becauseontheonehandthereseemstobestill time enough to make policy changes as the evidence on the scientific factsbecomesmore (or less) compelling,2ontheotherhandtheexternaldiseconomy(global warming) apparently goes hand in hand with the external economy(economic growth). In this perspective, anthropogenic globalwarming is neitherdistorsivenoramarketfailure;itisratherpartofthebigpicture.

Forte (2007) argues that the symmetry between external economies anddiseconomies,whenitexistssuchasinthepresentcase,maynotbeenoughtojustifythechoiceofshiftingtheburdenontothepolluted.Somesortofreasoningontheriskofmoralhazardshouldbeconsidered.Forexample,inthemost‑citedcaseofatraingeneratingsparksthatburnthetree, ifachoiceismadethatthepolluterpays,theforest‑ownermight end upwith not taking care of the forest itself. This lack ofattentionmightleadtohighersocialcosts.

Inthecaseofglobalwarming,ofcourse,thepollutedpartyhasnochoiceregardinghowtobehave,as theywill just inherit theworldaswe leave it.However,moralhazardstillexists.

Policiesareoftenassumedtoworkproperly.However,agreatamountofliteraturehas focusedon theextent towhich“government failures”, that canbe causebyavarietyofreasonssuchasinefficientimplementationofpressuregroups,canbeasmuch harmful asmarket failures (see, for example, Buchanan and Tullock 2004,Tullocketal.2002,andmorespecificallyonclimatechange,Yandle1998).Beyondthat, which turns almost every estimate of the benefits of a policy into anoverestimate, several authors have emphasized that, under appropriatecircumstances,safetyregulationsmayresultintohigheranetlossofsafety,becausepeopletendtoreactbyincreasingotherriskybehaviors.Thisiswhathasbeencalledthe“Peltzmaneffect”,namedaftertheChicagoeconomistSamPeltzman(1975)whofamously argued that mandatory seat belts didn’t reduce highway deaths. Anapplication of the Peltzman effect, which has directly to dowith environmentalissues,istheperverseconsequencesoftheEndangeredSpeciesAct(ESA),aUSlawthat aims at protectingwildlife that faces extinction. Peltzman (2007, pp.194‑196)showedthatESAcreatesanincentiveforimmediatetree‑cuttinginordertopreventendangered species tomove onto newpieces of land, otherwise ESA regulationswouldenterinforce(seealsoLueckandMichael2003andMargolisetal.2007).Awideamountofliteraturediscusseswhetherornotregulationmayhaveanadverse 2Remarkablyenough,theestimatesforsuchvariablesastemperatureincreaseandsealevelriseovertimehavefallen.SeeIPCC(2007)forthemostrecentones.

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effect(see,fordifferentperspectives,Adams2001;Sunstein2002;Sunstein2005;and,contraPeltzman,Sklansky2006).

To find moral hazard within the global warming debate, one should betterunderstand the issueof adaptationversusmitigationpolicies.Mitigation, namelycarbonemissioncuts,isintendedtoreducetheamountoffuturewarming.Acostisincurredtoday,inordertopreventacosttomorrow.Ifthediscountedvalueoftheavoidedfuturecostishigherthanthecostofthemitigationpolicy,thanthelatterisjustified on economic grounds. Since global warming is a very long‑termphenomenon,oneneedstounderstandwhatfuturecostswilllooklike,andtosolvetheverycomplexquestionaboutdiscount rates, forexample in theway theSternReviewdoes(thatis,bypickingaclose‑to‑zerodiscountrate)orinthewayNordhaus(2008)does(thatis,bypickingahigherdiscountrate).Evenmorechallengingthanpicking the“right”discount rate, ishow toaddress thedistant future.AsAdams(2001,p.175)recalls,“300yearsagotheUSdollardidnotexistandmostoftheNorthAmerican continentwas still ownedby the Indians.Onewayof appreciating themagnitude of the task that the greenhouse economists have set themselves is toimaginethemtransportedbytimemachinebackto1693,andsetthetaskofdoingacost‑benefit analysis of the European conquest of North‑America – with the netpresentvalueoftheconquestcalculatedin1693wampum”.

Adaptationconsistsofchanginghumanbehavior,oradjustingindustrialprocesses,ourwayoflife,buildings,cities,andprotectionmeasurestoachangingenvironment.Ifsealevelsrise,agradualmigrationisexpectedfromwhatarenowcoastalareastotheinternalones,aswellasmoreinvestmentsincoastalprotection.Ifwarmregionswillbecometoohotwhilecolderregionswillgainamoderateweather,thevalueoflandintheformerwilldecrease,whilethelandvalueintoday‑inhospitablelandswillgraduallyincrease,creatinganincentivetourbanizethelatter.Mostproponentsofclimate policies,most notably the IPCC (2007), propose that both adaptation andmitigationeffortsare taken.Unfortunately, there isa tradeoffbetweenadaptationandmitigation,whichisduenotjusttothefactthatonceagivenamountisspentformitigation(say,ininstallingmorerenewablecapacity)itcan’tanylongerbespentinadaptation(say,inbuildingcoastalprotectiondevices),andviceversa.

Therealnatureofthetradeoffisadeeperandconceptualone.Inthefirstplace,thetradeoff is related to the outcome of the policies. There is, in fact, an inverserelationship between adaptation and mitigation: the more you adapt to climatechange,thelessyouneedtomitigateit,andviceversa.Ononeextreme,ifwecananddofullymitigateglobalwarming,youhavenoneedtoadapttochanges;ontheotherextreme,ifyoucananddocompletelyadapttochanges,wedon’tneedtomitigatethem.Toputitotherwise,unmitigatedclimatechangerequireshugeinvestmentsinadaptation,whilenoadaptationisrequiredastemperaturesgrowthisclosetozero.

30

Moresubstantially,asWildavsky(1989,pp.78‑79)explainsinhisfundamentalbookontheconceptandpoliciesforsafety,“theverypurposeofanticipatorymeasuresistomaintainahighlevelofstability.Anticipationseekstopreservestability:thelessfluctuation,thebetter.Resilienceaccommodatesvariability;onemaynotdosowellingoodtimesbutlearnstopersistinthebad”.Wildavskygoesonbyclarifyingthatthereisnoapriorireasontoprefertheonestrategyovertheother,exceptthat“Anenvironment with periodic extremes would correspond to a situation whereuncertainties are large…while the conditionof steady,unvarying stabilitywouldcorrespond to a situation of low uncertainty about the future… Thus, underconsiderableuncertainty,resilienceisthepreferablestrategy”.Thisapproachseemstofitverywellwiththecharacteristicsofglobalwarming,athreatwhichisdefinedby the largeamountandscopeofuncertainties, rather thanbya reasonablygoodknowledgeofcausalrelationshipsandthefutureweatherpatterns.

Ineconomic terms, themaindifferencebetweenadaptationandmitigation is thatadaptationcostsaremorelikelytooccuroverthelongrun,asthephysicalevidenceofglobalwarmingwillbecomeclearer,aswellasthemagnitude,sign,andintensityofitsconsequences.Ontheopposite,mitigationrequiresanimmediatecommitmenttoinvestinordertoreducecarbonemissions,withouthavingaclearideaofwhattheoutcome will be and perhaps even what probability is attached to any possibleoutcome. Mitigation efforts are made even more complicated by the largeuncertaintiesunderlyingtheprobabilityofaglobalparticipationtoGHGscuts,thequality of implementation, and the role of pressure groups in turning anti‑globalwarmingeffortsintorent‑seekingactivities(Helm2009;Kasper2007;Bailey2008).

UndertheForteframework,hence,adaptation–asopposedtomitigation–equalstolettingthepollutedpay.Apolicymixthatincludesbothadaptationandmitigationmeasures, as real policies do, shares the risk between the present and futuregenerations,proportionallytotheamountofmitigationandadaptation,respectively.Obviously,realpoliciesareinherentlyamixofadaptationandmitigation.Moreover,itisverylikelythatmitigationefforts,howeverambitious,willfallshortofavoidingall futurewarming,at leastbecauseof the inertialcomponentofclimatedynamics(i.e., some futurewarmingwill happen as a consequence of today’s atmosphericconcentrationsofGHGs)and,evenmoreimportant,thenaturalcomponentofglobalwarming.Nevertheless,itismostusefultooperateatheoreticaldistinctionbetweenthe two policies, in order to better understand both the respective “doses” and“timings”.

Asithasbeenalreadyrecalled,someauthors–suchasGoklany(2000)andOkonski(2003) – have emphasized that adaptation is more economically efficient thanmitigationbecauseitfocusesonrealproblems,notonuncertainones.Moreover,itallows to tackleproblems thatmaybe exacerbated, rather than caused, byglobalwarming, suchas thediffusionof tropicaldiseasesand the lackofaccess toclear,

31

drinking water in the developing world. Finally, adaptation has been usuallyunderestimated(Mendelsohn1999),as,forexample,ithasoftenbeenassumedthatno health response would be taken against rising malaria. On the contrary,adaptationeffortsarelikelytoproducesignificantresultsintermsofmitigatingtheeffects, rather than the presumed cause, of global warming (Mendelsohn andNeumann1999).

As comparedwithmitigation, adaptation is relatively less exposed to the risk ofmoralhazard.Everyadaptivemeasure is inherentlymore transparent, in the firstplace, so the risk and cost structure can be more clearly known. Paradoxically,mitigationcanleadtohigherrisks:forexample,investingconsiderableresourcesin“green”energymightpreventinvestmentsinmoreefficient,conventionalfuels,thataremoresubstantiallycontributingtotheglobalamountofemissions.Thisproblemhas emerged clearlywith the so calledCleanDevelopmentMechanisms (CDMs)under theKyotoProtocol, thatgenerate carbon credits in regulatedmarkets frominvestments in thedeveloping, less carbon‑efficientworld.By insistingonenergysourcesthatarewellbeyondevenWesternstandards,CDMsgeneratedafairamountof investments,butcoulddolittletoaddresswhatisthemainsourceofpollution,todayaswellas in thefuture. Itwouldbefarmoreprofitable tocreateacommonframeworkforinvestmentincleaner,ratherthanclean,energies,butitisclearthatemissionswouldstill rise (insteadofbeingreduced).Amitigation‑orientedpolicycanhardlycapturesuchongoingprocess(Bernsteinetal.2006).

By the same token, under a lowerdegree of uncertainty, rent seeking activities –whilestillexistent–wouldbelessambitious,becausethetimewouldcomewhenaline isdrawnin thesandto tellwhich investmentsandpoliciesareproducingtheexpectedresults,andwhetherornottheseresultsareactuallydesirable.

Finally,itwouldbemorallyquestionabletofund–throughsubsidiesorregulation–thecreationofcostly“green”capacity,whensomanypeopleintheworldlackaccesstoelectricity.Theproblemofenergypovertycan’tbeseparatedfromthatofgrowingcarbonemissions:aspeoplegetconnectedtoelectricitylines,emissionsarelikelytogrow.Underamitigationpolicy,thereductionofenergypovertywouldbeindirectlydisincentived, because itwould require emitting installations to offset their ownemissionsbybuyingcredits,payingtaxes.Thealternativewouldbeto installonlycleanenergies,butthiswouldmean–assumingtheamountoftheinvestmentsisthesame–thatlesspeoplewouldgetoutofenergypoverty.Thismayormaynotbeseenas a good economic argument, but for sure it is amoral one that can hardly beignored.

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1.9.Conclusion

Globalwarminghasbeendescribedasthebiggestthreattheworldisfacing,orasaglobalpublicbad.Climateeconomists,however,havesometimesfailedtoproperlyassess (a) the real magnitude and scope of scientific uncertainties, and (b) thereciprocalnatureofglobalwarming, that canbeseenasabyproductofeconomicgrowth.Ifthesetwoquestionsareproperlyset,onewillrealizethattheeffectiveness– leave aside efficiency – of the proposed policiesmay be lower than expected.Moreover, to theextent thatglobalwarming isapublicbad, itgoeshand inhandwiththemanypositiveexternalitiesofeconomicgrowth.Economicanalysisof thecostsandbenefitsofglobalwarmingandclimatepoliciessuggestthattheymaybeofthesameorderofmagnitude.Differentlyfrommostclimateeconomists,weconcludethatthisprovidesaprimafaciecaseagainstgovernmentinterventionism.Giventhedistributionofthecostsandbenefitsandthelargeinefficienciesthatcanbeassumedto be underlying the policies implementation, thismaywell be a casewhen it isreasonable to shift the cost of pollution onto the polluted party, instead of thepolluter.

FollowingaframeworkproposedbyForte(2007)whospeculateduponthelong‑termconsequencesoftheCoaseTheorem,thispaperarguesthatthefuturegenerations,allelsebeingequal,wouldbebetteroffbybeingwealthierinawarmerworld,ratherthanpoorer in a coolerworld.Thepresentgenerationmight alsobebetteroff bykeepingahighrateofeconomicgrowth.Inthisrespect,aggressiveclimatepoliciessuchasthoseproposedbytheSternReviewmightresultintorelativelyhighcosts,andlittleornon‑discerniblebenefits.Afurtherreasontobetterchecktheusefulnessof aggressive climate policies today, is the risk ofmoral hazard underlying newregulations.Inthecaseofclimate,aparticularsortof“politicalmoralhazard”shouldbeconsidered,inthesensethatwrongpoliciesmightleadtoperverseresultsandthatthepoliciesthemselvesmightbecomeaTroyHorseforrentseekers.

UndertheForteframework,itmightbesensibletoshiftthecostofpollutionontothepolluted.Inpractice, thiswouldmeanthatthepresentgenerationshouldfocusonacceleratingtherateofeconomicgrowthinordertoleavefuturegenerationswell‑equippedwithcapitalaccumulation,humancapital,and technologies thatmaybegraduallyemployedtoadapttochanges,ratherthanpreventingchanges.Adaptationmay also be a no‑regret short‑run policy: globalwarming is likely to exacerbateexistingproblems,ratherthancreatingnewones,andthisprovidesapointforthesolutionofthoseproblemsassoonaspossible,insteadofpreventingtheirgrowthinthefuture.

Thelargestissuesurroundingglobalwarmingpoliciesis,anyway,theamountandscopeofscientific,economic,andpoliticaluncertainties.Furtherandbetterfocuses

33

research is needed to address each field of uncertainty, in order to design betterpolicies.Whilethedegreeofuncertaintyisstillsohigh,though,investinginmakinghumansystemsandtheenvironmentmoreresilientmightbeamorecomprehensivestrategy,thaninvestingintheconservationofthingsastheystand.

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Chapter2.

EconomicFreedomandCarbonIntensity:HowFreeMarketCanAddressGlobalWarming

Abstract

Greenhousegases(GHGs)emissionsareafunctionofpopulation,GDP,andcarbonintensityoftheeconomy,i.e.theratiobetweencarbonemissionsandGDP.Inordertoreduceemissions,atleastoneoftheabovevariablesshouldbereduced.Thispaperfocuses on the determinants of carbon intensity. Two factors are considered, inparticular:oneisGDP,theother is“economicfreedom”.TherelationshipbetweenGDPandcarbonintensityisunclear:accordingtosomeauthors,inthelongrunGDPgrowthwillleadtoreductionsofcarbonintensity(so‑called“EnvironmentalKuznetsCurve”).Economicfreedomisameasureofhowmuchopenisaneconomy,andofthe freedom of businesses and individuals to invest, operate, trade, and of thestability of the legal framework. Economic freedom ismeasured by theHeritageFoundation and theWall Street Journal (“Index of Economic Freedom”), whichestimatethedegreeofeconomicfreedomforanycountryintheworld,basedonanumberofobjectiveindicators.Apaneldatasethasbeenbuilt,thatincludes–butisnotlimitedto–severalmacroeconomicandenvironmentalvariables,suchascarbonintensity,population,GDP,theindustrialsectorasashareofthewholeeconomy,thenumberofprivatevehicles, etc.Thedataset refers to 162 countries for theperiod1995‑2008. The correlation is searched between economic freedom and carbonintensity,controllingforallorsomeoftheabove‑mentionedvariables.Consistentlywiththetheoreticalinsightsandsomeresultsavailableinliterature,thecorrelationisfoundconsistentlysignificantandnegative,indicatingthatanincreaseineconomicfreedomisassociatedwithareductionincarbonintensity.Whilethisdoesnotmean,perse,thatacausallinkbetweenthetwodoesexist,itsuggeststhattheremaybearelation between the institutional factors subsumed in the Index of EconomicFreedom,andcarbon intensity (that canbe interpretedasaproxy for theaveragetechnologicallevelofaneconomy).Ifthetheoreticalapproachherebydevelopedisgrounded,itfollowsthatpromotingeconomicfreedom(especiallyinthedevelopingcountries)maybeaneffectivewaytoreducecarbonemissionsbelowthebaseline.

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2.1.Descriptionoftheproblem

Undertheassumptionthatanthropogenicgreenhousegases(GHGs)emissionsareadiscernibledriverofglobalwarming,theinternationalcommunityhassetambitiousgoals of reducing GHGs. In 1997, the Kyoto Protocol was agreed upon, whichrequirestoratifyingcountriesanemissionscutof5.2%below1990levels,by2008‑2012.TheEuropeanUnionhasmadetheKyototargetofreducingitsownemissionsby8%belowthereferenceyearby2008‑2012amandatorytarget,andsubsequentlyhas passed a plan to achieve amajor cut by 20% by 2020. The newly electedUSPresident, BarackObama, has also committed himselfwith the goal of reducingemissions.Atagloballevel,talksarestillinprocesstoreachapost‑Kyotoagreement,which might emerge as early as late 2009 in Copenhagen. There seems to be,however,asortofdivideasfarasGHGspoliciesareconcerned:whilethedevelopedworld–which is relatively lesspopulated, less carbon‑intensive, andwithhigherlevels of emissions per capita – is designingpolicies in order tomove towards acarbon‑freeworld, thedevelopingworld seems less involved in theprocess.Twomajorreasonsareoftenraisedforthis:(1)developedworldishistoricallyresponsiblefortheobserved,anthropogenicglobalwarming,soitshouldtakeactioninthefirstplace; (2) economicgrowth ismore important than the environment, in countrieswithlowpercapitaincomewhichstillsufferforpoverty.Underlyingthiscriticism,istheassumptionthatclimatepoliciesarenotcost‑free.Thatcriticismshouldbetakenvery seriously, as itwill be seen in thenext chapter, thatwill address twopolicymodelsthatcanbeemployedtoreduceGHGs–namely,acap&tradeschemeandacarbontax.

Thischapterwilladdressthequestionwhetherornotapolicycanbefound,thatisatthesametimeabletoachievealong‑termreductioninemissions,andgeneratemoreeconomicbenefitsthancosts.

2.2.Whatdrivesemissions

Carbonemissionsarenotan independentvariable.Theydependonmany inputs,someofwhicharewellbeyondhumancontrol.Forexample,weathersignificantlyaffects carbon’s short run variability: colder Winters and warmer Summers areusuallyassociatedwithhigheremissions,becausepeopletendtoconsumemoreforheatingorairconditioning.Thelongruntrendinemissions,however,canbethoughtasbeingdescribedbyanequationthat isknownasthe“KayaIdentity”(KayaandYokobori1997):

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EC

GDPE

PGDP

PC = (2.1)

Where:C=carbonemissions;P=population;E=energyconsumption.Consequently,GDP/P=GDPpercapita;E/GDP=energy intensityof theGDP, i.e. thecontentofenergyperunitofGDP;andC/E=carbonintensityofenergy,i.e.thecarboncontentofenergy.TheKayaIdentitytellshowcarbonemissionschangeaseachofthedriverschange,orwhatdrivershouldbechanged,andinwhatdirection,ifagivenlevelofcarbonemissionsistobeachieved.

An increase in population, GDP per capita, energy intensity, or carbon intensityresults in an emissions increase. Hence, the political goal of reducing emissionswouldrequireatleastoneoftheabovevariablestobereducedatafasterratethanthatatwhichtheothervariablesincrease(iftheydo).

Allelsebeingequal,oneobviouswayofreducingemissionsistoreducepopulation.Several authors have, in fact, suggested that theworld is overpopulated (see, forexample,Ehrlich1968;EhrlichandEhrlich2008;Meadowsetal.1972;Meadowsetal.2004).Beyondtheintellectualcriticismtotheoverpopulationargument(forexampleHayek 1988; Simon1996;Eberstadt 2007), the issueofpopulation control raises anumberofmoralaswellaseconomicproblemsthatwon’tbeaddressedinthispaper.However, because of its controversial nature, population control will not beconsideredasapoliticallyviable– leaveasidemorallyacceptableoreconomicallyefficient–policy.

AlsoGDPgrowth(eitherasanaggregateoronapercapitabasis),intheshortrun,ispositivelycorrelatedwithcarbonemissions.Inthelongrun,though,therelationshipmaybemorecomplex,asitwillbearguedinthenextparagraph.Anyway,assumingthattherelationshipisstraightforward,reducingGDPinordertoreduceemissionsmaynotbethemostefficientstrategy,anddefinitelynotadesirableone–unlessitisassumed that the damages from global warmingwill be higher than the loss ofwelfareunderlyingalower,ornegative,GDPgrowth.ControllingGDPinordertocontrolemissions,hence,shouldbeconsideredasaresidualoption,andmorelikealesserevilthanasecondbest,sotospeak.

EnergyintensityofGDPandcarbonintensityofenergyarealsopositivelycorrelatedwithcarbonemissions.EnergyintensityoftheGDPexpressesthecontentofenergyof an economy,while carbon intensity of energy expresses the amount of carbonemissions3thatisgeneratedbyburningfossilfuels.Thetwoconceptsmaybeunified

3Tobemoreprecise,theamountofGHGsthataregenerated,ofwhichthemostfamous–butnotthemostdangerous–iscarbondioxide.GHGsemissions,though,canbe–andusuallyare–expressedintonsofcarbonequivalent,orcarbondioxideequivalent,sothesimplificationisreasonable.

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in thatof carbon intensityofaneconomy, thatexpress thecarbon intensityof theGDP.SoasimplifiedformoftheKayaIdentitymaybewrittenasfollows:

GDPC

PGDP

PC = (2.2)

While itmaybeanalyticallyuseful todistinguishbetweenenergy intensityof theeconomy and carbon intensity of energy, to the purpose of this paper it is alsosufficient to focus on carbon intensity of the GDP (from now on, just carbonintensity).Moreover, carbon intensityof theeconomyalso includes somepieceofinformation that may be lost by disaggregating it in just the product of energyintensityoftheeconomyandcarbonintensityofenergy:infact,eventhoughmostman‑madeemissionsareenergyrelated,ahugeamountofemissionsisgeneratedbynon‑energyrelatedactivities,suchasagriculture.Theconceptofcarbonintensityoftheeconomyisastraightforwardwaytoembodyall theemissions,whatevertheirsourceis.

Interestinglyenough,whilepopulationandGDPcanbeexpectedtogrowunderabusiness‑as‑usualscenarioastheydidinthepast,carbonintensity(aswellasE/GDPandC/E)maybeexpectedtodecrease.Thatis,inthelongrunandunderabusiness‑as‑usualscenariocarbonemissionsaresubjecttooppositeforces:ontheonehand,population andGDPwill driveup emissions,while carbon intensitywill drive itdown.Worldcarbonemissionshavegrownsofarbothintheworldasawhole,andinmostsubsetsofcountries(mostnotably,bothinOECDandnon‑OECDcountries).That suggests that GDP and population growth have offset the gains in carbonintensity,aswellas inenergycontentofGDPandcarboncontentofenergytakenindividually.Notwithstanding,theobserveddynamicssuggeststhatapolicypriorityshouldbeplaced inaccelerating the trend incarbon intensity reductions– that is,doingthesame(ormore)withlessandcleanerenergy–ratherthanindeceleratingpopulation or GDP growth. Carbon intensity can also be viewed as a proxy fortechnicalprogress:infact,thereductionincarbonintensityhasnotbeendrivensofarbya lowerconsumptionofenergyora loweruseof fossil fuels,butbybetterandcleanertechnologies(Guptaetal.1997;Smil2003;Lomborg2008).

2.3.GDPandcarbon

Whiletheshortruncorrelationbetweeneconomicgrowthandcarbonemissionsisclearlyandstronglypositive,inthelongrunthingsmaybequitedifferent.

Figure1illustratesthepercapitaemissionstrendinsomecountries.

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Aswecansee,thereisadifferencebetweendevelopedanddevelopingcountriesinorder of magnitude as well as trend when it comes to per capita emissions. Indeveloped countries ‑‑ with the exception of Spain, which is clearly showingincreases–percapitaemissionsarestableorinmoderatedeclineintheperiodunderconsideration.Inthedevelopingcountries,theystartfromasignificantlylowerlevel,butalsoshowatrendofsharpincrease.Allotherfactorsbeingequal,thiswillendupcreatingaveryseriousproblem,as increasesofpercapitaemissionsbyaverylargemassofindividualswillbedestinedtoincreaseoverallemissions,withpossibleconsequenceson theatmosphericconcentrationofGHGsand thuson theclimate.Table1suppliesfurtherinformation.

Figure1.Percapitaemissionsinsomecountries(1980–2005).Note:forGermany,1991–2005.Source:ownelaborationonEIA(2008).

Table 1 shows the variation in per capita emissions between 1980 and 2005, andbetween1997(theyearwhentheKyotoProtocolwasagreedupon)and2005.Inotherwords, itshowsboththevariationduringtheperiodunderconsideration,andthebreakdownofthatvariation.Fourcountriesoutofthenineconsideredhavereducedtheirpercapitaemissionsduringthelastquartercentury:theUS,France,GermanyandtheUnitedKingdom.EmissionsfellinFranceby25%,andinGermanyandtheUKbymore than 11%.The countries that increased their emissions in theperiod

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consideredareChina(+175%),India(+153%),andSpain(+75%).Italytoohadasharpgrowthtrend,increasingitsemissionsbyover20%.

1980‑2005 1997‑2005

US ‑3,38 ‑0,85

France ‑24,63 4,33

Germany* ‑11,31 ‑4,67

Italy 23,64 9,85

Spain 75,76 41,94

UK ‑11,60 ‑0,03

China 175,83 64,56

India 152,89 17,68

Table1.Percentilevariationsofpercapitaemissionsinsomecountries(1980‑2005and1990‑2005).Note:ForGermany,thefirstintervalreferstothe1991‑2005period.Source:ownelaborationonEIA(2008).

Ifwecomparethesedatawiththoseconcerningthe1997‑2005period(Figure2),othervery interesting elements emerge. Firstly, only Germanywas able tomaintain aconsistentquotaofpercapitaemissionsreduction(‑5%),followedbytheUSA(‑1%),while theUnitedKingdom stayedbasically at the same level.All other countriesincreasedtheiremissions,withItalyandChinaby10%and65%respectively, thusconfirming thepreceding trend. India slowed thegrowthofper capita emissions,Spainacceleratedit,andFrancereversedthetrend.

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Figure2.Percapitaemissionsinsomecountries(1997‑2005).Note:incontrastwiththeprecedingfigure,theUScurvehasbeenomittedtofacilitatereading.Source:ownelaborationonEIA(2008).

ThedifferencebetweenthetwographsisexplainedbythefactthatincountriessuchastheUnitedKingdom,FranceandGermany(whicharetheleadersofthepercapitaemissionreductionsinthe25‑yearperiod),thephenomenonofemissionsreductionismainlytheproductofpoliciesadoptedbefore1997andgenerallynotassociatedwith

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environmental goals: the introductionof nuclear energy in France for the sake ofenergy independence, the switch to natural gas and the relative increase of thefinancialandservicesectorasopposedtotheindustrialsectorinGreatBritain,andtheindustrialrestructuringofEastGermanyaftertheunification.InItaly,mostoftheefficiencygainswereachievedevenearlier.Thatismainlythankstothetraditionallyhighpriceofenergy(duetobothmonopolisticinefficienciesandheavytaxation)andtowhatmightbedescribedasanover‑reactiontotheoilshocksinthe70s(BernardiniandFoti1982).AgaininthecaseofItaly,itmustbeemphasizedthattheincreasesinemissions have been relatively contained because increasing demand for electricenergyhasbeensatisfiedbyturningmainlytonaturalgasinsteadofrelyingonfuelssuchascoalandoilwhicharecharacterizedbygreaterquantitiesofemissionsperkWh.ForSpain,ChinaandIndia,themaincauseof increasingemissionshasbeeneconomicgrowth.

2.4.DoesKuznetsapplytocarbon?

Forseveral traditionalpollutants,economistshavedevelopedawide literatureon“EnvironmentalKuznets Curves” (EKCs), named after theNobel‑laureate SimonKuznet’s seminalworkonaverage incomeand income inequality (Kuznets 1955).Kuznetsfoundthat,asaverageincomegrows,socialinequalitiesgrowuptoapoint,afterwhich they start todecline.A similar bell‑shaped curve (Figure 3) has beenfoundforanumberofpollutants.

Figure5.EnvironmentalKuznetsCurve.

The EKC basically shows that economic development produces an increase inpollution (in our case, greenhouse gases emissions) during an initial phase thatcoincideswiththeleftpartofthecurve.Inthatphase,societyisextremelypoorand,

Pollution

GDPpercapita

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simply,doesnotconsidertheproblemofpollution,asitfirstmustsolvemoreurgentquestionssuchashunger,mortality,unemploymentandsoon.Astimepasses,twothingshappen:societygetsricherandpollutionincreases.Thishastwosimultaneousconsequences:oneisagrowthinthe incomethateconomicactorsandsocietyasawholecandisposeofintheimprovementoftheirstandardofliving(sincethemosturgent problems have been solved); the second is that pollution becomes moreintolerable.Eventually,thecombinationofthesefactorswillinducetheadoptionofproductiontechnologies thatarecharacterizedbyasmallerenvironmental impact.Thisexplanationisalsofavoredbytheevidencethat,ingeneral,cleanertechnologiesarealsomoreefficient,andtherefore it is logical that theyareobtainedassoonasthey are affordable. It is a consequence of the fact that a richer society hasmoreavailableresources toeitherspendor invest in theenvironment. Inconclusion,anincrease in wealth may cause an environmental problem, but under the EKChypothesisitmayalsosolveit.

ShafikandBandyopadhyay(1992)lookedateightdifferentenvironmentalindicators,and found that “many indicators tend to improve as countries approachmiddle‑income levels”. SeldenandSong (1994) foundan inverted‑Ucurve for suspendedparticulatematter,sulfurdioxide,oxidesofnitrogen,andcarbonmonoxide,althoughthey concluded that the trend‑inversion would show up in the very long run.Grossman andKrueger (1995) examined four types of environmental indicator –concentrationsofurbanairpollution;measuresofthestateoftheoxygenregimeinriverbasins;concentrationsoffecalcontaminantsinriverbasins;andconcentrationsof heavymetals in river basins – finding that “economic growthbrings an initialphaseofdeteriorationfollowedbyasubsequentphaseofimprovement”.Carsonetal. (1997) focused on the 50US States and found evidence of the EKC for sevendifferenttypesofpollutants.

Table2showstheresultsofsomestudiesregardingtheexistenceofEKCsandthepercapita GDP level corresponding to the turning point, according to the studiesreviewedbyColeetal.(1997).

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PollutantTurningpoint

(US$1985)

Turningpoint

(US$2007)

CO2 22500‑34700 43000‑66000

CO 9900‑10100 19000‑19500

NOx 15600‑25000 30000‑48000

N2O(industrial) 14700‑15100 28000‑29000

N2O(transport) 15100‑17600 29000‑34000

SO2 5700‑6900 11000‑13000

SO2(transport) 9400‑9800 18000‑19000

Particulates(nontransport)

7300‑8100 14000‑15500

Particulates(transport) 15000‑18000 29000‑34500

Table 2. Average value of the per capita GDP corresponding to the peak ofEnvironmentalKuznetsCurvesforsomepollutants.Source:elaborationonColeetal.(1997).

TheevidenceforacarbonEKCismixed.Shmalenseeetal.(1998,p.19)argue,“Thedeveloping countries,with lowervaluesofGDPper capita, experience continuedrapidcarbonemissionsgrowth,eventhroughtheperiodofoilshocksofthe1970s.Themorehighlydevelopedcountriesshowedaclearchangeincarbonemissionsinthe1970sfromgrowthtoeitherstabilityordecline”.Aldy(2005)findsnoevidenceforEKCinthe50USStates.GaleottiandLanza(1999)foundsomeevidenceforEKC,but just forveryhigh income levels, thatwilloccuronly in the longrun formostdevelopingcountries.Aslanidisand Iranzo (2009) foundnoevidence fora carbonEKC, but highlighted that “we found two regimes, namely a low‑income regimewhere emissions accelerate with economic growth and amiddle to high‑incomeregimeassociatedwithadecelerationinenvironmentaldegradation”,whichmaynotbeinconsistentwithEKCs.

AmajorcriticismtotheEKChypothesiscamefromArrowetal.(1995),whoarguedthattheEKCassumesGDPandGDPgrowthasfullyexogenousvariables,withnofeedbacks from the state of environment. On the contrary, they claim thatenvironmental deteriorationmay have a negative impact on economic growth aswell.Sternetal.(1996)alsosuggestedthattheEKCmayjustbecapturinganeffectofinternational trade, that induces developed countries to specialize in goods andservicesthatarelessintensiveinfactorsthatcandamagetheenvironment.

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WhiletheevidenceforEKCinmostcases–otherthancarbon–appearscompelling,this paperwill not take side in the EKC debate.One reason is that evidence forcarbondioxideismixed,inpartbecausetheturningpointmayhavebeenreachedinaverylimitednumberofcountries,ornocountryatall,whichmakesitdifficulttoforeseethefuturetrendswithanacceptabledegreeofuncertainty.Moreover,mostwealthiercountrieshavealsoadoptedcarbon‑specificpolicies,thatmayhavehiddentheEKCeffects;ortheymaystillbesubsidizingcarbon‑basedenergysources,whichwouldoffsettheEKC.

2.5.FromEKCtoinstitutionalfactors

To the extent that EKChas been observed for carbon emissions, itwould be toosimplistictothinkthat justGDPdrivesemissions.Panayotou(2003)suggeststhreemainreasonswhythismayhappen:(a)awealthiercommunityplacemorevalueonenvironmentalquality; (b)awealthiereconomybecomesalsomorediversified, sothatlesscarbon‑intensiveindustriesgainmomentum;(c)awealthiersocietyisalsomoreableandwillingtoinvestininnovation.Beyondthat,onemayaddthat(d)awealthier community can afford cleaner,more costly technologies and (e) as theturningpointapproaches,pollutionbecomesmoreandmore intolerable, that is, itbecomesmoreofaproblemthanitwasoriginallyperceived.

Moredeeply,Yandleetal. (2004,p.86)argue,“institutionalchange liesbehindtheobservedcorrelation.Humankindisaninstitutionbuilder.Ifnewinstitutionsaretoemerge,olderonesmustbedisplaced.Aprocessofcreativedestructiontakesplacewhen resources are conserved”. (The reference is obviously to Schumpeter 1975).Alongthesamelines,Goklany(2007)developedatheoryof“ecologicaltransition”which,althoughitisformallysimilartothatoftheKuznetsʹEnvironmentalCurve,differsfromitbecauseofafundamentalfactor.Ontheabscissaaxis,timeisreportedratherthanpercapitaGDP.TimeisutilizedasaproxyforbothpercapitaGDPandtechnologicaldevelopment.

Goklany’shypothesisisthat,althoughtherearecasesinwhichtheaverageincomeisreducedonaveragewiththepassageoftime,societiesfollowtheirnaturalinclinationtoimprovetheirstandardsoflivingandthustoincreasepercapitaGDPandthelevelof technology utilized. The transition from a phasewhere environmental impactgrowstooneinwhichitisreduced–arealitycapturedbyEnvironmentalKuznetsCurvesaswell–coincideswiththeecologicaltransition. Goklany(2007,pp.106‑7)writes:“Anexplanationofferedforanenvironmentaltransitionisthatsocietyisonacontinual quest to improve its quality of life,which is determined by numeroussocial,economic,andenvironmentalfactors.Theweightgiventoeachdeterminantisconstantly changingwith society’s precise circumstances and perceptions. In the

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early stagesof economicand technologicaldevelopment,whichgohand‑in‑hand,societyplacesahigherpriorityonincreasingaffluencethanonotherdeterminants,evenifthatmeanstoleratingsomeenvironmentaldeterioration,becauseincreasingwealthprovidesthemeansforobtainingbasicneedsandamenities(e.g.food,shelter,water,andelectricity)andreducingthemostsignificantrisks topublichealthandsafety(e.g.malnutrition,infectiousandparasiticdiseases,andchildmortality).Also,in those early stages, society may, in fact, be unaware of the risk posed by adeterioration in the specific environmental impact, measured by the particularindicatorinquestion.However,associetybecomeswealthier;tacklestheseproblems;and, possibly, gains more knowledge about the social, health, and economicconsequencesoftheenvironmentalimpactinquestion,reducingtheenvironmentalimpactduetothespecificindicatorautomaticallyriseshigheronitsprioritylist”.

The focus on institutional factors (broadlydefined following Sala‑i‑Martin 2002),4ratherthanonthemerelevelsofGDP,ledothereconomiststotryandlinkcarbonintensity, or carbon emissions, with economic freedom, as measured by suchinstitutionsastheFraserInstituteinCanadaandtheHeritageFoundationintheUS.Broadlydefined,economicfreedommeansthefreedomofmarketactorstomakeuseofthevariousproductionfactorstheydeemmostefficient,basedonareliableandstable legal framework, without being subjected to state interference. Variousattemptshavebeenmadetomeasureeconomicfreedom(seethenextparagraphforadiscussionontheconceptofeconomicfreedomherebyemployed)andtocorrelateitwithcarbonemissions.

Montgomery and Bate (2005) found a significant negative correlation betweeneconomic freedom, as measured by the Fraser Institute, and carbon intensity,indicatingthateconomicallyfreercountriestendtobelesscarbonintensive,allelsebeingequal.“Thereareseveralcausalroutes–theyargue–throughwhichgreatereconomicfreedomcouldleadtolowerenergyuseandemissionperdollarofoutput”(p.143). Among the others, they suggest that economic freedom is positivelycorrelatedwithGDPgrowth,andthroughGDPgrowthitaffectsemissions,aswell(are‑interpretationofEKC).Moreover,theysuggestthatfreercountriestendtobetterand sooner benefit from technological innovation and the deployment of cleanertechnologies.Economicfreedomisalsoassociatedwithlowerbarrierstoinvestments,andhencehigherinvestmentsininnovationandmorecompetitivepressurestoadoptmoreefficienttechnologiesintheenergy‑intensiveindustries.

Montgomery and Tuladhar (2006) also found a negative correlation between thesubcomponentsofeconomicfreedomandenergy(theydidn’ttestcarbon)intensity.Theprovidedexplanationisthat“thelackofamarket‑orientedinvestmentclimatehinderstechnologytransfer,bydiscouragingforeigndirect investmentsanduseof 4“[V]ariousaspectsoflawenforcement…thefunctioningofmarkets…inequalityandsocialconflicts…politicalinstitutions…thehealthsystem…financialinstitutions…aswellasgovernmentinstitutions”.

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mostadvancedtechnologyadoptedelsewhere”(p.41).Inotherwords,accordingtotheseauthors themaineffectof economic freedomoncarbon intensity is throughtechnologytransfer, thatmostlyapplies todevelopingcountries,andtheability toadoptcleanertechnologies.

Carlsson andLundström (2003) found that an increase in economic freedom, andmorepreciselyanincreaseinspecificsubcomponentsofeconomicfreedom,maybenegatively correlated with carbon emissions. That particularly applies to pricestabilityandlegalstability.Theresultappearstobemorerobustforcountrieswitharelatively lower industrial sector as a share of GDP. Other subcomponents ofeconomicfreedom,suchasfreedomtotrade,ormeasuresofotherfreedoms,suchaspoliticalfreedom,arelittleornosignificantatall.Threemainreasonsareprovidedfor this: (a) an efficiency effect, i.e. competitive pressures create an incentive forbusinessestoinvestinmoreefficient,lessenergy‑intensivetechnologies;(b)atraderegulationeffect,underwhichamoreefficientresourceallocationisexpectedtotakeplace; (c) a stability effect, concerning of the higher level of investments that canresultfromagreaterpricestability.

Onadifferentlevel,CornillieandFankhauser(2002)showedthatamarket‑orientedregulation has contributed to the reduction of energy intensity in the EasternEuropeantransitioncountries.HeandWang(2007)foundasimilarresultforChina,where economic liberalizations are negatively correlated with energy intensity.Montgomery and Tuladhar (2005) showed that economic reforms improved thecarbon‑efficiencyinIndia,whileKarakayaandOzcag(2005)foundsimilarevidenceforCentralAsia.

2.6.Whatiseconomicfreedomandhowitcanaffectcarbonemissions?

Thispaperwill investigate the correlationbetweeneconomic freedomandcarbonemissions.

Economicfreedommeansthefreedomofmarketactorstomakeuseofthevariousproduction factors they deemmost efficient, based on a reliable and stable legalframework,withoutbeingsubjectedtostateinterference.Variousattemptshavebeenmadetomeasureeconomicfreedom.ThispaperreferstotheindexdrawnupbytheHeritage Foundation and theWall Street Journal (Miller 2009). According to theauthors: “The highest form of economic freedom provides an absolute right ofproperty ownership, fully realized freedoms ofmovement for labor, capital, andgoods,andanabsoluteabsenceofcoercionorconstraintofeconomiclibertybeyondtheextentnecessaryforcitizenstoprotectandmaintainlibertyitself.Inotherwords,

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individualsarefreetowork,produce,consume,andinvestinanywaytheyplease,andthatfreedomisbothprotectedbythestateandunconstrainedbythestate”.5

TheIndexofEconomicFreedom,asdefinedbyHeritageFoundation, isdefinedasthe average of ten components, each ofwhom is also the result of theweightedaverageofothersubcomponents.Amoredetaileddescriptionof themethodologyemployedbytheHeritageFoundaionisavailableonlineatwww.heritage.org/index.Below, somequalitativedetails areprovided for the ten components of economicfreedom, with some hints about how they could be expected to affect carbonintensity.

ThevaluesoftheIndexofEconomicFreedomfor2009arereportedinAppendixA.

Businessfreedom

Businessfreedomisdefinedas“aquantitativemeasureoftheabilitytostart,operate,andcloseabusinessthatrepresentstheoverallburdenofregulation,aswellastheefficiencyofgovernment in regulatoryprocess”.Becauseof theway it isdefined,businessfreedomisunlikelytohaveapowerfuleffectoncarbonintensity.Whileitmaybecrucialtoensureafaircompetitionistakingplace,especiallybetweensmallbusinesses,businessfreedomdoesn’tseemtoreflectanysignificantdeterminantofenergy intensity, such as the incentive to invest in cleaner technologies, thecompetitionlevelbetweenenergy‑intensivecompaniesandutilities,etc.

Tradefreedom

Tradefreedomis“acompositemeasureoftheabsenceoftariffandnon‑tariffbarriersthat affects imports and exports of good and services”. Being a proxy forprotectionism, trade freedommighthavean impactoncarbon intensity,byeitherprotecting energy‑intensive companies (hence creating a lower incentive fortechnological improvement) or by protecting national champions in non‑energyintensive sectors (which would, all else being equal, determine a lower carbonintensity).Therefore,whiletradefreedommayhaveanimpactoncarbonintensity,but the sign of the effect is likely to depend on exogenous variables, such as thecompositionoftheeconomy,ratherthanthescoreoftradefreedomitself.Moreover,someeconomistshave argued that the increase in international trade, thatwouldresult frommore trade freedom,may reduce carbon emissions in the developed

5http://www.heritage.org/research/features/index/faq.cfm

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world,while increasingemissions in thedevelopingcountries,withaneteffectofnearlyzero(HeilandSelden2001).

Fiscalfreedom

Fiscalfreedomis“ameasureoftheburdenofgovernmentfromtherevenueside.Itincludesboththetaxburdenintermsofthetoptaxrateonincomes(individualandcorporateseparately)andtheoverallamountoftaxrevenueasapercentageofGDP”.Likewise trade freedom, fiscal freedom is likely to have an impact on carbonintensity, but the signof the impactmaybe ambiguous: all else being equal, onemightexpectthathighertaxesresultinlowerinvestments.However,theactualsizeofinvestmentsincarbonefficiencymaydependonfactorswhicharepartof–butarenotfullycapturedby–thenotionoffiscalfreedom,suchastheuseoftaxrevenuestofinancesuchinvestments.So,carbonintensitymaydependon“what’sinside”fiscalfreedom,ratherthanonfiscalfreedomperse.

Governmentsize

Governmentsize“considersthelevelofgovernmentexpenditureasapercentageofGDP.Governmentexpenditures–includingconsumptionandtransfer–accountfortheentirescore”.Evengovernmentconsumptionmayhaveanambiguouseffectoncarbon intensity: in fact, the level of carbon intensitymay depend onwhat’s thegovernment spends upon.However, itmay be argued that government size is aproxy for the broader degree of government interventionismwithin the society,includingthefactthatgovernmentrunsbusinessesbyitselfratherthanleavingituptothemarket,andintervenethroughtheregulatoryprocess(Nakada2005).Sinceonemayexpectthat,wheregovernmentrunsbusinesses,competitionislesseffective,onemayalsoexpectapositivecorrelationbetweengovernmentsizeandcarbonintensity,i.e.,when the government size grows, carbon intensity grows aswell.However,governmentsize isdefined inaway that100%equals to thesmallestgovernmentsize, while 0% equals to the biggest government, so the expected correlation isnegative.

Monetaryfreedom

Monetaryfreedom“combinesameasureofpricestabilitywithanassessmentofpricecontrols. Both inflation and price controls distort market activity. Price stability

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withoutmicroeconomicinterventionisidealstateforfreemarket”.Pricestabilityandabsence of price controls are also twokey variables for thewillingness to invest,especiallyincapital‑intensivebusinesses(KimandWu1993)suchasthepowersectorandmostenergy‑intensivesectors. It is likely thatmonetaryfreedomisnegativelycorrelatedwithcarbonintensity.

Investmentfreedom

Investment freedom “scrutinizes each country’s policies towards the free flow ofinvestmentcapital(foreigninvestmentaswellasinternalcapitalflows)inordertodetermine its overall investment climate”. Investments are a key feature fortechnologicalinnovation,that,inthelongrun,isamajordriverforcarbonintensityreductions (Bernstein et al. 2006). It is likely that a negative correlation exists,betweeninvestmentfreedomandcarbonintensity.

Financialfreedom

Financial freedom is “a measure of banking security as well as measure ofindependence from government controls. State ownership of banks and otherfinancialinstitutionssuchasinsurersandcapitalmarketsisaninefficientburdenthatreducescompetitionandgenerallylowersthelevelofavailablereserves”.Financialfreedomcanbeexpectedtobenegativelycorrelatedwithcarbonintensity,becausethe efficiency of capitalmarkets is quite important for the investment process incapital‑intensivesectors.

Propertyrights

Propertyrightsprovide“anassessmentoftheabilityoftheindividualstoaccumulateprivateproperty,securedbyclearlawsthatarefullyenforcedbythestate”.Propertyrightsislikelytobeanimportantdriverforcarbonintensity:absentacleardefinitionandareliableenforcementofpropertyrights,acompany is less likely to invest incapital‑intensiveactivitiesthatcouldbeseizedortakenbygovernmentatanytime(AndersonandLeal2001).

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Freedomfromcorruption

Freedom from corruption is baseduponTransparency International’sCorruptionPerception Index, and is based upon the assumption that “corruption erodeseconomic freedom by introducing insecurity and uncertainty into economicrelationship”.Howeverimportantingeneral,freedomfromcorruptionisunlikelytobe,perse,adriverforcarbonintensityandthesubsequentinvestments.

Laborfreedom

Laborfreedomis“aquantitativemeasurethatlooksintovariousaspectsofthelegalandregulatoryframeworkofacountry’slabormarket.Itprovidescross‑countrydataon regulations concerning minimum wages; laws inhibiting layoffs; severancerequirements;andmeasurableburdensonhiring,hours,andsoon”.Neitheroftheseislikelytoaffectcarbonintensity,eitherintheshort‑orinthelong‑run.

2.7.Modelspecification

Thegoalof thispaper is to checkwhether a correlationexists, betweeneconomicfreedomandcarbon intensity.Whilea correlationdoesn’tnecessarilymean thatacausalityexists,nordoesittellwhatisthedirectionofthecausality,thetheoreticalframeworkprovidedabove–aswellastheresultsfromotherstudiesandinsights–seemtosuggestthat,allelsebeingequal, thedifferenceineconomicfreedommayexplain part of the difference in carbon intensity. The focus on carbon intensity,ratherthanonothermeasures,isjustifiedbothbecausecarbonintensityistheonlytermintheKayaIdentitythatcanbechangedinthedesireddirectioninawin‑winperspective(theothertermsbeingpopulationandeconomicgrowth),andbecauseitallows toovercomeanumberofdifficulties thathave so farpreventedapositiveoutcomefrominternationalnegotiations(Pizer2005).

Anumberof controlvariableshavebeen inserted, inorder tocapture factors thatmayaffectcarbonintensity.

Theproposedmodelisthefollowing:

CI=β0+β1EF+β2GDP+β3Pop+β4En+β5Ind+β6Veh+β7EnImp+β8Urb+β9

Nuke+u

60

WhereCI=carbonintensity,i.e.theratiobetweencarbonequivalentemissionsandGDP(tonCO2/US$2000);EF=economicfreedom(themodelhasbeentestedwiththeIndexofEconomicFreedom,eachofitscomponents,andasub‑indexwhichwillbedefined);GDP=GrossDomesticProduct (US$2000);Pop=Population;En = totalprimaryenergyuse(tonsofoilequivalent);Ind=industrysectorasashareofGDP;Veh=numberofprivatevehicles;EnImp= energy imports as a shareofprimaryenergyuse;Urb=urbanareasasa shareof the total surfaceofacountry;Nuke=nuclear energy as a share of total primary energy consumption; u representsstatisticalerror.

The goal of the model is to test whether (a) economic freedom is significantlycorrelatedwithcarbonintensityand(b)whether thecorrelationisnegative,as thetheoreticalframeworkprovidedabovewouldsuggest.

ThecorrelationbetweenGDPandCIisexpectedtobenegativebutloose.WhilethereisastrongcorrelationbetweenimprovementsincarbonintensityandGDPgrowth(Hanaokaetal.2006),theabsolutelevelsofGDPandcarbonintensitymaynotbethatmuch interdependent. In fact, both GDP and carbon intensitymay depend on anumberofvariablessuchasinstitutionalfactors,population,thecompositionoftheeconomy, etc., thatmaybe individually significant toboth, but in aggregatemayhaveamoderateeffect.However, if theEnvironmentalKuznetsCurvehypothesisappliestocarbonemissions,oneshouldexpectanegativecorrelation.

Astopopulation,thereisnoreasontobelievethatitaffectscarbonintensity.Infact,theratiobetweencarbonemissionsandGDPappears tohave little todowith thenumberofpeople living ina country,while itmighthavesomerelationshipwithGDPpercapita.

Allelsebeingequal,onewouldexpectapositivecorrelationbetweenenergyuseandcarbonintensity:sincealmosteverywhereintheworldfossilfuelscoveralargeshareof energy needs, an increase in energy demand would result in higher carbonemissions.Intuitively,thecorrelationmightbenegativebetweenenergyimportsandcarbonintensity,becauseagovernmenthasnoreasontosubsidizetheuseofforeignenergysourcesandthereforeonewouldexpectittobeusedefficiently.

Thesizeof industrysectorasashareof thewholeeconomyisprobablypositivelycorrelatedwithcarbonintensity,becauseindustryisthemostenergy‑(andhence,inmostcountries,carbon‑)intensiveeconomicsector.

The number of circulating vehicles, as a proxy for the people’smobility, can beexpectedtobepositivelycorrelatedwithcarbonintensity.

Nuclearpowerhasbeenconsideredseparatelyfromothersourcesofenergybecause(a) nuclear iswidely regarded as themost economically competitive, carbon‑freesourceofenergyand(b)theshareofnuclearpowerisalmosteverywheretheresult

61

ofspecificpoliciesadopteddecadesago,andsoitreflectsasetofindicatorswhichmaynotbefullycapturedbytheothercontrolvariablesherebyconsidered.

Finally, the size of urban areas as a share of a country’s total surfacemay affectcarbonintensitybothpositivelyandnegatively.

Alongthelinesoftheabove‑presentedmodel,anumberofothermodelshavebeendeveloped,forexampleincludingthesinglecomponentsofeconomicfreedom,asub‑indexwhichhasbeenbuiltbyaveragingthecomponentswhichmightappeartobemost significant (investment freedom, monetary freedom, government size andpropertyrights)accordingtotheabovediscussion.AlsoquadraticandcubictermshavebeeninsertedforeconomicfreedomandGDP,inordertoconsidertheobviousnon‑linearitiesof therelationshipthatmayholdbetweeneachof themandcarbonintensity. Finally, themodel has been explored both in its absolute form, and re‑framingitinfully‑logandsemi‑logway.

2.8.Thedata

Apaneldatasethasbeenbuiltfor162countriesintheworld,coveringatime‑periodof13years(1995through2008).

TheIndexofEconomicFreedom,aswellasitscomponents,havebeenderivedfromtheHeritage Foundation’swebsite (http://www.heritage.org/index).All theothervariables have been downloaded from the World Bank’s World DevelopmentIndicatorswebsite (http://publications.worldbank.org/WDI/).Notallcountriesarecoveredforallthetimeperiod,particularlyforsuchindicatorsascarbonemissionsandcarbonintensity.Fortunately,boththeextentofthedatasetandtheconsequentsolidityoftheestimatorsenablesustoleveloutthesemeasurementerrors,therebyeliminatingthemandobtainingveryreliableresults.

Figure6plotseconomicfreedomversuscarbonintensity.

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Figure 6. Economic freedom vs. Carbon intensity. Source: own elaboration onMiller(2009),WDI2008.

Figure 6 provides an insight of what has been investigated. On the left side(economicallyunfreecountries)bothcountrieswithveryhighandverylowcarbonintensities can be found. The latter are very poor countries, whose low energyintensity is quite a proxy for energy poverty (under the EnvironmentalKuznetsCurvehypothesis, these countrieswouldbeon theextreme left aswell).Then, aseconomic freedomgrows, carbon intensity covers awide rangeofvalues,but thespread tends to be reduced towards the highest scores of economic freedom.Interestinglyenough,noeconomicallyfreecountryshowsahighdegreeofcarbonintensity.

2.9.Theresults

Afirst regressionhasbeen runwithapooledOLS, inorder to checkwhether thecorrelationmayexist.Aquadratic term for economic freedomandGDPhasbeenincluded inorder toconsider thenon‑linearitiesof thesupposedrelationship.Thefollowingtablesummarizestheresults.

63

(R.1). regress intensity freedom sqfreed gdp_2 sqgdp_2 urban vehicles nuclear_energy import> s population industry energy_use

Source | SS df MS Number of obs = 735-------------+------------------------------ F( 11, 723) = 39.04 Model | 9.2774e-10 11 8.4340e-11 Prob > F = 0.0000 Residual | 1.5618e-09 723 2.1601e-12 R-squared = 0.3727-------------+------------------------------ Adj R-squared = 0.3631 Total | 2.4895e-09 734 3.3917e-12 Root MSE = 1.5e-06

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- freedom | -2.02e-07 4.27e-08 -4.74 0.000 -2.86e-07 -1.18e-07 sqfreedom | 8.37e-10 3.50e-10 2.39 0.017 1.50e-10 1.52e-09 gdp_2000 | -3.48e-19 1.62e-19 -2.15 0.032 -6.67e-19 -2.98e-20 sqgdp_2 | 4.16e-32 1.70e-32 2.44 0.015 8.19e-33 7.51e-32 urban | 1.79e-08 4.31e-09 4.16 0.000 9.45e-09 2.64e-08 vehicles | -2.98e-09 5.23e-10 -5.69 0.000 -4.00e-09 -1.95e-09nuclear_en~y | 3.75e-09 3.37e-09 1.11 0.267 -2.88e-09 1.04e-08 imports | 2.14e-09 4.14e-10 5.16 0.000 1.32e-09 2.95e-09 population | 5.53e-16 3.61e-16 1.53 0.127 -1.57e-16 1.26e-15 industry | 3.48e-08 7.27e-09 4.79 0.000 2.05e-08 4.91e-08 energy_use | 2.50e-10 4.55e-11 5.51 0.000 1.61e-10 3.40e-10 _cons | 8.55e-06 1.35e-06 6.35 0.000 5.91e-06 .0000112------------------------------------------------------------------------------

As expected, both economic freedom and square economic freedom appearsignificantata5%level.Thesignofeconomicfreedomisnegative,indicatingthatthecorrelationisnegative.Interestinglyenough,thesignisnegativeforGDPaswell.Allother controlvariables, except for the shareofnuclearpowerandpopulation,aresignificant,andthesignsareasexpected.

Thesameregressionhasbeenrununderafixedeffectscheme,inordertotakeintoaccountsomedriversofcarbonintensitythatmaybecountry‑specific,andthereforemay not be captured by the considered control variables. The following tablesummarizestheresults.

64

(R.2). xtreg intensity freedom sqfreed gdp_2 sqgdp_2 urban vehicles nuclear_energy imports> population industry energy_use, fe

Fixed-effects (within) regression Number of obs = 735

Group variable: id_country Number of groups = 114

R-sq: within = 0.3951 Obs per group: min = 1 between = 0.0883 avg = 6.4

overall = 0.0955 max = 11

F(11,610) = 36.23

corr(u_i, Xb) = -0.4443 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+----------------------------------------------------------------

freedom | -2.48e-07 2.25e-08 -11.06 0.000 -2.92e-07 -2.04e-07 sqfreedom | 1.74e-09 1.96e-10 8.86 0.000 1.35e-09 2.12e-09

gdp_2000 | -9.67e-19 3.69e-19 -2.62 0.009 -1.69e-18 -2.43e-19 sqgdp_2 | 4.55e-32 1.97e-32 2.30 0.022 6.68e-33 8.42e-32

urban | 1.69e-08 1.25e-08 1.35 0.177 -7.63e-09 4.13e-08 vehicles | -2.29e-09 5.13e-10 -4.45 0.000 -3.29e-09 -1.28e-09nuclear_en~y | -3.98e-08 8.69e-09 -4.58 0.000 -5.69e-08 -2.27e-08

imports | 2.75e-09 1.02e-09 2.70 0.007 7.50e-10 4.75e-09 population | 1.45e-15 2.52e-15 0.58 0.565 -3.49e-15 6.39e-15

industry | 1.24e-08 6.16e-09 2.02 0.044 3.43e-10 2.45e-08 energy_use | 1.35e-10 6.57e-11 2.05 0.040 5.90e-12 2.64e-10

_cons | 9.37e-06 9.57e-07 9.79 0.000 7.49e-06 .0000112-------------+---------------------------------------------------------------- sigma_u | 1.748e-06

sigma_e | 3.208e-07 rho | .96741251 (fraction of variance due to u_i)

------------------------------------------------------------------------------F test that all u_i=0: F(113, 610) = 128.91 Prob > F = 0.0000

Theresultsisfullyconsistentwiththeformerregression.

Inordertotesttherobustnessofthemodel,acubictermforeconomicfreedomhasbeen considered. As the following table, the result – economic freedom beingsignificantlyandnegativelycorrelatedwithcarbonintensity–stillholds.

65

(R.3). xtreg intensity freedom sqfreed cubfreed gdp_2 sqgdp_2 urban vehicles nuclear_energ> y imports population industry energy_use, fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.4004 Obs per group: min = 1 between = 0.0899 avg = 6.4 overall = 0.0983 max = 11

F(12,609) = 33.89corr(u_i, Xb) = -0.4179 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- freedom | -4.92e-07 1.08e-07 -4.56 0.000 -7.03e-07 -2.80e-07 sqfreedom | 6.16e-09 1.93e-09 3.20 0.001 2.37e-09 9.94e-09 cubfreed | -2.59e-11 1.12e-11 -2.31 0.021 -4.79e-11 -3.84e-12 gdp_2000 | -9.53e-19 3.67e-19 -2.60 0.010 -1.67e-18 -2.32e-19 sqgdp_2 | 4.65e-32 1.97e-32 2.36 0.018 7.86e-33 8.51e-32 urban | 1.54e-08 1.24e-08 1.24 0.215 -8.98e-09 3.99e-08 vehicles | -2.28e-09 5.12e-10 -4.46 0.000 -3.28e-09 -1.27e-09nuclear_en~y | -3.96e-08 8.66e-09 -4.57 0.000 -5.66e-08 -2.26e-08 imports | 2.55e-09 1.02e-09 2.50 0.013 5.50e-10 4.55e-09 population | 1.35e-15 2.51e-15 0.54 0.590 -3.57e-15 6.27e-15 industry | 1.26e-08 6.14e-09 2.05 0.041 5.26e-10 2.46e-08 energy_use | 1.58e-10 6.63e-11 2.39 0.017 2.82e-11 2.88e-10 _cons | .0000137 2.10e-06 6.51 0.000 9.56e-06 .0000178-------------+---------------------------------------------------------------- sigma_u | 1.729e-06 sigma_e | 3.197e-07 rho | .96695281 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 609) = 128.57 Prob > F = 0.0000

Stilltotesttherobustnessofthemodel,thesameregressionasabovehasbeenrunwithtwodifferentsetsofcontrols.Theresultsstillhold,asthefollowingtablesshow.

(R.4). xtreg intensity freedom sqfreed gdp_2 sqgdp_2 urban imports population industry, fe

Fixed-effects (within) regression Number of obs = 1227Group variable: id_country Number of groups = 123

R-sq: within = 0.1798 Obs per group: min = 1 between = 0.1264 avg = 10.0 overall = 0.1235 max = 11

F(8,1096) = 30.03corr(u_i, Xb) = -0.1993 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- freedom | -1.51e-07 1.69e-08 -8.94 0.000 -1.85e-07 -1.18e-07 sqfreedom | 1.02e-09 1.49e-10 6.83 0.000 7.26e-10 1.31e-09 gdp_2000 | -1.30e-18 3.34e-19 -3.88 0.000 -1.95e-18 -6.41e-19 sqgdp_2 | 6.53e-32 1.83e-32 3.56 0.000 2.93e-32 1.01e-31 urban | -6.39e-10 8.04e-09 -0.08 0.937 -1.64e-08 1.51e-08 imports | 7.52e-10 2.49e-10 3.02 0.003 2.64e-10 1.24e-09 population | 2.92e-15 2.04e-15 1.43 0.153 -1.09e-15 6.93e-15 industry | 5.14e-09 3.50e-09 1.47 0.142 -1.72e-09 1.20e-08 _cons | 6.80e-06 6.33e-07 10.74 0.000 5.56e-06 8.04e-06-------------+---------------------------------------------------------------- sigma_u | 1.875e-06 sigma_e | 3.437e-07 rho | .96747293 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(122, 1096) = 190.45 Prob > F = 0.0000

66

(R.5). xtreg intensity freedom sqfreed gdp_2 sqgdp_2 vehicles imports nuclear_energy employ> ment_industry , fe

Fixed-effects (within) regression Number of obs = 622Group variable: id_country Number of groups = 100

R-sq: within = 0.4806 Obs per group: min = 1 between = 0.0573 avg = 6.2 overall = 0.0705 max = 11

F(8,514) = 59.44corr(u_i, Xb) = -0.5290 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- freedom | -3.21e-07 2.26e-08 -14.22 0.000 -3.65e-07 -2.77e-07 sqfreedom | 2.31e-09 1.90e-10 12.15 0.000 1.94e-09 2.69e-09 gdp_2000 | -1.05e-18 3.88e-19 -2.71 0.007 -1.81e-18 -2.90e-19 sqgdp_2 | 5.05e-32 2.12e-32 2.38 0.018 8.80e-33 9.21e-32 vehicles | -1.49e-09 3.96e-10 -3.77 0.000 -2.27e-09 -7.15e-10 imports | 2.75e-09 1.07e-09 2.58 0.010 6.54e-10 4.85e-09nuclear_en~y | -3.79e-08 7.63e-09 -4.97 0.000 -5.29e-08 -2.29e-08employment~y | 6.86e-09 6.28e-09 1.09 0.275 -5.47e-09 1.92e-08 _cons | .0000132 7.14e-07 18.46 0.000 .0000118 .0000146-------------+---------------------------------------------------------------- sigma_u | 1.888e-06 sigma_e | 2.775e-07 rho | .97885721 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(99, 514) = 160.08 Prob > F = 0.0000

Afterthisfirsttestwaspassed,asubindexhasbeendefinedastheaverageoffourcomponents of economic freedom: government size, property rights, investmentfreedom,andmonetaryfreedom.Asdiscussedabove,suchcomponentsofeconomicfreedomarethosemostlikelytoaffectinvestments–eitherdomesticorforeign–incapital‑intensiveindustries,suchasthepowersectorandenergy‑intensiveindustries.Thefollowingtablessummarizetheresultsoftheregressionsonthesubindex,withthesamesetofcontrolsadoptedabove.

67

(R.6). xtreg intensity subind sqsub gdp_2 sqgdp_2 urban vehicles nuclear_energy imports pop> ulation industry energy_use, fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.4779 Obs per group: min = 1 between = 0.0485 avg = 6.4 overall = 0.0547 max = 11

F(11,610) = 50.77corr(u_i, Xb) = -0.4362 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | -2.07e-07 1.38e-08 -15.06 0.000 -2.34e-07 -1.80e-07 sqsub | 1.52e-09 1.24e-10 12.30 0.000 1.28e-09 1.77e-09 gdp_2000 | -6.63e-19 3.43e-19 -1.94 0.053 -1.34e-18 9.65e-21 sqgdp_2 | 3.29e-32 1.83e-32 1.80 0.073 -3.07e-33 6.88e-32 urban | 1.51e-08 1.17e-08 1.30 0.195 -7.79e-09 3.80e-08 vehicles | -1.93e-09 4.75e-10 -4.06 0.000 -2.86e-09 -9.97e-10nuclear_en~y | -3.21e-08 8.08e-09 -3.97 0.000 -4.80e-08 -1.62e-08 imports | 2.17e-09 9.48e-10 2.29 0.022 3.09e-10 4.03e-09 population | -2.78e-15 2.34e-15 -1.19 0.235 -7.37e-15 1.81e-15 industry | 1.48e-08 5.73e-09 2.59 0.010 3.59e-09 2.61e-08 energy_use | 1.09e-10 6.08e-11 1.79 0.073 -1.03e-11 2.28e-10 _cons | 7.74e-06 7.47e-07 10.37 0.000 6.28e-06 9.21e-06-------------+---------------------------------------------------------------- sigma_u | 1.804e-06 sigma_e | 2.980e-07 rho | .97342921 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 610) = 141.98 Prob > F = 0.0000

(R.7). xtreg intensity subinde sqsub cubsub gdp_2 sqgdp_2 urban vehicles nuclear_energy im> ports population industry energy_use, fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.4936 Obs per group: min = 1 between = 0.0498 avg = 6.4 overall = 0.0637 max = 11

F(12,609) = 49.46corr(u_i, Xb) = -0.3903 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | -4.51e-07 5.78e-08 -7.80 0.000 -5.64e-07 -3.37e-07 sqsub | 6.13e-09 1.07e-09 5.73 0.000 4.03e-09 8.24e-09 cubsub | -2.79e-11 6.42e-12 -4.34 0.000 -4.05e-11 -1.52e-11 gdp_2000 | -6.15e-19 3.38e-19 -1.82 0.069 -1.28e-18 4.86e-20 sqgdp_2 | 3.16e-32 1.80e-32 1.75 0.081 -3.85e-33 6.70e-32 urban | 1.20e-08 1.15e-08 1.04 0.296 -1.06e-08 3.47e-08 vehicles | -1.88e-09 4.68e-10 -4.02 0.000 -2.80e-09 -9.62e-10nuclear_en~y | -3.01e-08 7.98e-09 -3.78 0.000 -4.58e-08 -1.45e-08 imports | 1.85e-09 9.38e-10 1.98 0.049 1.05e-11 3.69e-09 population | -2.70e-15 2.30e-15 -1.17 0.243 -7.22e-15 1.83e-15 industry | 1.74e-08 5.68e-09 3.06 0.002 6.24e-09 2.85e-08 energy_use | 1.28e-10 6.01e-11 2.13 0.034 9.77e-12 2.46e-10 _cons | .0000118 1.19e-06 9.90 0.000 9.48e-06 .0000142-------------+---------------------------------------------------------------- sigma_u | 1.801e-06 sigma_e | 2.938e-07 rho | .97409144 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 609) = 144.12 Prob > F = 0.0000

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Thesubindexofeconomicfreedom–aswellasitsquadraticandcubicterms–holdsignificanceandthesignofthefirstordertermremainsnegative.

Inordertobetterinterprettheresults,fully‑logandsemi‑logmodelshavebeenrun.

(R.8). xtreg lnintens lnfreed lngdp urban vehicles nuclear_energy imports population indust> ry energy_use, fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.5492 Obs per group: min = 1 between = 0.0751 avg = 6.4 overall = 0.1114 max = 11

F(9,612) = 82.85corr(u_i, Xb) = -0.7405 Prob > F = 0.0000

------------------------------------------------------------------------------ lnintens | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- lnfreed | -.1082467 .0658146 -1.64 0.101 -.2374966 .0210032 lngdp | -.7537776 .0471546 -15.99 0.000 -.846382 -.6611732 urban | .0261885 .0038096 6.87 0.000 .018707 .0336699 vehicles | -.0005374 .0001488 -3.61 0.000 -.0008296 -.0002452nuclear_en~y | -.0053931 .0023187 -2.33 0.020 -.0099466 -.0008396 imports | .001462 .0002775 5.27 0.000 .000917 .002007 population | 1.29e-09 5.65e-10 2.29 0.023 1.83e-10 2.40e-09 industry | .0103763 .0016672 6.22 0.000 .0071022 .0136504 energy_use | .000158 .0000182 8.68 0.000 .0001223 .0001937 _cons | 2.842775 .9349811 3.04 0.002 1.006615 4.678936-------------+---------------------------------------------------------------- sigma_u | 1.2990633 sigma_e | .0873018 rho | .99550397 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 612) = 371.55 Prob > F = 0.0000

(R.9). xtreg lnintens freed sqfreed gdp_2 sqgdp urban vehicles nuclear_energy import> s population industry energy_use, fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.3806 Obs per group: min = 1 between = 0.1584 avg = 6.4 overall = 0.2063 max = 11

F(11,610) = 34.07corr(u_i, Xb) = -0.1918 Prob > F = 0.0000

------------------------------------------------------------------------------ lnintens | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- freedom | -.0117048 .007175 -1.63 0.103 -.0257955 .0023858 sqfreedom | 2.63e-06 .0000626 0.04 0.966 -.0001203 .0001256 gdp_2000 | -4.52e-13 1.18e-13 -3.84 0.000 -6.83e-13 -2.21e-13 sqgdp_2 | 2.00e-26 6.31e-27 3.18 0.002 7.66e-27 3.24e-26 urban | -.000171 .0039843 -0.04 0.966 -.0079956 .0076536 vehicles | -.0014124 .0001641 -8.61 0.000 -.0017345 -.0010902nuclear_en~y | -.0075629 .0027759 -2.72 0.007 -.0130143 -.0021114 imports | .0015827 .0003258 4.86 0.000 .0009429 .0022224 population | 8.98e-10 8.04e-10 1.12 0.264 -6.80e-10 2.48e-09 industry | .004978 .0019674 2.53 0.012 .0011144 .0088416 energy_use | .0001002 .000021 4.77 0.000 .0000589 .0001414 _cons | -13.13527 .3058581 -42.95 0.000 -13.73594 -12.53461-------------+---------------------------------------------------------------- sigma_u | .83276377 sigma_e | .10250789 rho | .98507412 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 610) = 268.84 Prob > F = 0.0000

69

The results are still valid, even if theyappear to lose significance– inboth cases,economicfreedomisn’tsignificantat95%,butjustat90%.

Finally,aslightlydifferentlineofreasoninghasbeenfollowed.Ithasbeenarguedthattoday’scarbonintensityisunlikelytodependupontoday’seconomicfreedom.In fact, today’s carbon intensity is the resultofpast investments, thatmayhavearelationshipwithpastlevelsofeconomicfreedom,ratherthanwiththecurrentlevels.To test against this phenomenon, an attempt has been done to regress carbonintensityversusthesubindexofeconomicfreedomthreeperiodsahead.Theresults–thatincludethequadraticandcubicterms–aresummarizedbelow.

(R.10). xtreg intensit L3.(subind due) gdp_2 sqgdp_2 urban vehicles nuclear_energy im> ports population industry energy_use, fe

Fixed-effects (within) regression Number of obs = 460Group variable: id_country Number of groups = 87

R-sq: within = 0.4063 Obs per group: min = 1 between = 0.0548 avg = 5.3 overall = 0.0507 max = 8

F(11,362) = 22.52corr(u_i, Xb) = -0.3014 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | L3. | -1.35e-07 1.27e-08 -10.65 0.000 -1.61e-07 -1.10e-07 duesub | L3. | 1.02e-09 1.19e-10 8.58 0.000 7.86e-10 1.25e-09 gdp_2000 | -3.00e-19 4.00e-19 -0.75 0.454 -1.09e-18 4.86e-19 sqgdp_2 | 9.73e-33 2.04e-32 0.48 0.634 -3.04e-32 4.99e-32 urban | 2.22e-08 1.74e-08 1.27 0.204 -1.21e-08 5.65e-08 vehicles | -1.01e-09 5.97e-10 -1.69 0.092 -2.18e-09 1.65e-10nuclear_en~y | -2.51e-08 8.05e-09 -3.12 0.002 -4.09e-08 -9.27e-09 imports | 2.15e-09 1.05e-09 2.04 0.042 7.85e-11 4.22e-09 population | -1.19e-15 3.26e-15 -0.36 0.716 -7.60e-15 5.23e-15 industry | 2.14e-08 6.82e-09 3.13 0.002 7.95e-09 3.48e-08 energy_use | -7.45e-11 7.06e-11 -1.06 0.292 -2.13e-10 6.44e-11 _cons | 4.60e-06 1.08e-06 4.27 0.000 2.48e-06 6.72e-06-------------+---------------------------------------------------------------- sigma_u | 1.668e-06 sigma_e | 2.163e-07 rho | .98344658 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(86, 362) = 170.02 Prob > F = 0.0000

70

(R.11). xtreg intensit L3.(subind due tre) gdp_2 sqgdp_2 urban vehicles nuclear_energ> y imports population industry energy_use, fe

Fixed-effects (within) regression Number of obs = 460Group variable: id_country Number of groups = 87

R-sq: within = 0.4434 Obs per group: min = 1 between = 0.0645 avg = 5.3 overall = 0.0536 max = 8

F(12,361) = 23.96corr(u_i, Xb) = -0.2486 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | L3. | -3.72e-07 4.98e-08 -7.47 0.000 -4.70e-07 -2.74e-07 duesub | L3. | 5.58e-09 9.38e-10 5.95 0.000 3.74e-09 7.43e-09 tresub | L3. | -2.81e-11 5.73e-12 -4.90 0.000 -3.93e-11 -1.68e-11 gdp_2000 | -2.41e-19 3.88e-19 -0.62 0.534 -1.00e-18 5.21e-19 sqgdp_2 | 1.06e-32 1.98e-32 0.54 0.592 -2.83e-32 4.95e-32 urban | 1.75e-08 1.69e-08 1.03 0.303 -1.58e-08 5.08e-08 vehicles | -8.64e-10 5.79e-10 -1.49 0.137 -2.00e-09 2.75e-10nuclear_en~y | -2.83e-08 7.83e-09 -3.62 0.000 -4.37e-08 -1.29e-08 imports | 1.76e-09 1.02e-09 1.72 0.087 -2.56e-10 3.78e-09 population | -1.35e-15 3.16e-15 -0.43 0.671 -7.57e-15 4.87e-15 industry | 2.50e-08 6.65e-09 3.76 0.000 1.19e-08 3.81e-08 energy_use | -2.19e-11 6.93e-11 -0.32 0.753 -1.58e-10 1.14e-10 _cons | 8.53e-06 1.32e-06 6.47 0.000 5.94e-06 .0000111-------------+---------------------------------------------------------------- sigma_u | 1.632e-06 sigma_e | 2.098e-07 rho | .98374296 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(86, 361) = 179.78 Prob > F = 0.0000

Inbothcases,thesubindexofeconomicfreedomissignificantanditssignisnegative.

Inordertotakeintoaccountclimate‑relatedpoliciesthatmighthaveanimpactovercarbonintensity,adummyvariablehasbeeninserted.Thedummyhasbeendefinedbased upon the year of ratification (not just signature) of theKyoto Protocol forAnnex‑B countries (i.e., the countries that have formal obligations under theProtocol),assumingtheKyotoratificationprovidesareliableproxyfortheadoptionofclimatepolicies.SomecountriesmayhaveratifiedKyotowhilenothavingtakenany step tomeet its goals, and othersmay not have ratifiedKyotowhile havingadoptedemissions‑reducingpolicies.Onaverage, though, theratificationofKyotosuggestsacommitmentreasonableenoughtowardsthetargetofreducingemissions(whichmightarguablyleadtoalowercarbonintensity,allelsebeingequal).TheyearofratificationoftheKyotoProtocolbyAnnex‑BcountriesisreportedinAppendixB.Theregressionresultsarepastedbelow.

71

(R.12). xtreg intensity subind sqsub gdp_2 sqgdp_2 policy urban vehicles nuclear_energy imports po> pulation industry energy_use, fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.4827 Obs per group: min = 1 between = 0.0405 avg = 6.4 overall = 0.0446 max = 11

F(12,609) = 47.36corr(u_i, Xb) = -0.4228 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | -2.09e-07 1.37e-08 -15.20 0.000 -2.36e-07 -1.82e-07 sqsub | 1.54e-09 1.23e-10 12.46 0.000 1.30e-09 1.78e-09 gdp_2000 | -6.05e-19 3.42e-19 -1.77 0.078 -1.28e-18 6.72e-20 sqgdp_2 | 3.02e-32 1.83e-32 1.65 0.099 -5.69e-33 6.60e-32 policy | -1.13e-07 4.75e-08 -2.38 0.018 -2.06e-07 -1.97e-08 urban | 1.29e-08 1.17e-08 1.11 0.268 -9.98e-09 3.58e-08 vehicles | -1.42e-09 5.20e-10 -2.72 0.007 -2.44e-09 -3.94e-10nuclear_en~y | -3.03e-08 8.09e-09 -3.75 0.000 -4.62e-08 -1.45e-08 imports | 2.05e-09 9.46e-10 2.17 0.030 1.95e-10 3.91e-09 population | -3.04e-15 2.33e-15 -1.30 0.193 -7.62e-15 1.54e-15 industry | 1.36e-08 5.73e-09 2.37 0.018 2.34e-09 2.48e-08 energy_use | 1.24e-10 6.09e-11 2.03 0.043 4.15e-12 2.43e-10 _cons | 7.77e-06 7.44e-07 10.45 0.000 6.31e-06 9.23e-06-------------+---------------------------------------------------------------- sigma_u | 1.798e-06 sigma_e | 2.969e-07 rho | .97345905 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 609) = 142.57 Prob > F = 0.0000

The dummy variable “Policy”, as expected, is significant with a negative sign.Nevertheless, Economic Freedom (herebymeasured through the subindexabove‑defined)remainssignificantandthesignremainsnegative.

Morecontrolshavebeen inserted,while controlling for the“Policy”variable.Thenew controls are: foreign direct investments (FDI),whose sign is expected to benegatively correlatedwith carbon intensity; theamountof energygenerated fromcoalasashareoftotalenergyconsumption(expectedtobepositivelycorrelatedwithcarbonintensity,becausecoalisthemostcarbonintensivefossilfuel);theamountofcoal‑relatedCO2emissions;thelengthofroads;staterevenuesfromenergytaxation(expected tobenegativelycorrelatedwithcarbon intensity,because,allelsebeingequal,highertaxationisexpectedtoleadtolowerconsumption);powerconsumptionasashareofenergyconsumption;andthetotalsurfaceofacountry.

72

(R.13). xtreg intensity subind sqsub gdp_2 sqgdp_2 policy fdi population coal_energy nuclear_ener> gy imports co2solidfuel roads vehicles urban industry state_revenue power_consumpt surface> , fe

Fixed-effects (within) regression Number of obs = 403Group variable: id_country Number of groups = 81

R-sq: within = 0.4879 Obs per group: min = 1 between = 0.0011 avg = 5.0 overall = 0.0132 max = 10

F(18,304) = 16.09corr(u_i, Xb) = -0.9996 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | -1.39e-07 1.83e-08 -7.58 0.000 -1.75e-07 -1.03e-07 sqsub | 9.94e-10 1.62e-10 6.14 0.000 6.76e-10 1.31e-09 gdp_2000 | -4.99e-19 4.12e-19 -1.21 0.227 -1.31e-18 3.12e-19 sqgdp_2 | 2.26e-32 2.56e-32 0.89 0.377 -2.77e-32 7.30e-32 policy | -2.36e-08 5.98e-08 -0.40 0.693 -1.41e-07 9.41e-08 fdi | -7.38e-10 1.15e-09 -0.64 0.521 -3.00e-09 1.52e-09 population | -6.05e-15 2.98e-15 -2.03 0.043 -1.19e-14 -1.82e-16 coal_energy | 1.90e-08 7.82e-09 2.43 0.016 3.60e-09 3.44e-08nuclear_en~y | -2.28e-08 1.25e-08 -1.83 0.068 -4.74e-08 1.67e-09 imports | 2.38e-09 1.11e-09 2.15 0.033 1.97e-10 4.56e-09co2solidfuel | 1.24e-08 1.05e-08 1.19 0.236 -8.16e-09 3.30e-08 roads | 2.14e-13 1.77e-13 1.21 0.225 -1.33e-13 5.62e-13 vehicles | -5.36e-10 7.12e-10 -0.75 0.452 -1.94e-09 8.65e-10 urban | -8.72e-09 1.82e-08 -0.48 0.632 -4.45e-08 2.70e-08 industry | 4.78e-08 9.05e-09 5.29 0.000 3.00e-08 6.56e-08state_reve~e | -1.89e-08 7.88e-09 -2.39 0.017 -3.44e-08 -3.34e-09power_cons~t | -1.85e-12 3.55e-11 -0.05 0.959 -7.17e-11 6.80e-11 surface | -3.19e-11 2.68e-10 -0.12 0.905 -5.59e-10 4.95e-10 _cons | .000033 .0002272 0.15 0.885 -.0004141 .0004801-------------+---------------------------------------------------------------- sigma_u | .00006504 sigma_e | 2.642e-07 rho | .9999835 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(80, 304) = 92.18 Prob > F = 0.0000

TheSubindexofEconomicFreedomissignificantlyandnegativelycorrelatedwithcarbonintensity,butmostoftheothervariables(includingthedummyforclimatepolicies)losesignificance.

Then,afewregressionshavebeenperformedwhilenotcontrolling,alternatively,forGDPofforEconomicFreedom.Theresultsarepastedbelow.

73

(R.14). xtreg intensity freed gdp_2 population energ industry policy urban vehicles nuclear_energ> y , fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.3015 Obs per group: min = 1 between = 0.0381 avg = 6.4 overall = 0.0478 max = 11

F(9,612) = 29.35corr(u_i, Xb) = -0.3861 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- freedom | -5.22e-08 4.36e-09 -11.97 0.000 -6.08e-08 -4.37e-08 gdp_2000 | -8.02e-20 1.17e-19 -0.68 0.494 -3.10e-19 1.50e-19 population | -2.75e-15 2.29e-15 -1.20 0.232 -7.25e-15 1.76e-15 energy_use | 2.40e-10 6.82e-11 3.52 0.000 1.06e-10 3.74e-10 industry | 6.94e-09 6.53e-09 1.06 0.289 -5.89e-09 1.98e-08 policy | -3.54e-08 5.53e-08 -0.64 0.522 -1.44e-07 7.31e-08 urban | 1.47e-08 1.33e-08 1.11 0.268 -1.14e-08 4.08e-08 vehicles | -2.08e-09 5.87e-10 -3.54 0.000 -3.23e-09 -9.25e-10nuclear_en~y | -4.57e-08 9.16e-09 -4.99 0.000 -6.37e-08 -2.77e-08 _cons | 4.11e-06 7.96e-07 5.16 0.000 2.55e-06 5.67e-06-------------+---------------------------------------------------------------- sigma_u | 1.779e-06 sigma_e | 3.442e-07 rho | .96394037 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 612) = 117.36 Prob > F = 0.0000

ThisiswhathappensinthesameregressionwhilenotcontrollingforGDP:

(R.15). xtreg intensity freed population energ industry policy urban vehicles nuclear_energy , fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.3009 Obs per group: min = 1 between = 0.0331 avg = 6.4 overall = 0.0412 max = 11

F(8,613) = 32.98corr(u_i, Xb) = -0.3959 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- freedom | -5.23e-08 4.36e-09 -11.99 0.000 -6.08e-08 -4.37e-08 population | -3.29e-15 2.15e-15 -1.53 0.126 -7.51e-15 9.26e-16 energy_use | 2.38e-10 6.81e-11 3.50 0.001 1.04e-10 3.72e-10 industry | 7.57e-09 6.47e-09 1.17 0.242 -5.13e-09 2.03e-08 policy | -3.71e-08 5.52e-08 -0.67 0.501 -1.46e-07 7.13e-08 urban | 1.35e-08 1.32e-08 1.02 0.307 -1.24e-08 3.93e-08 vehicles | -2.06e-09 5.86e-10 -3.52 0.000 -3.21e-09 -9.13e-10nuclear_en~y | -4.52e-08 9.13e-09 -4.95 0.000 -6.31e-08 -2.73e-08 _cons | 4.17e-06 7.90e-07 5.28 0.000 2.62e-06 5.72e-06-------------+---------------------------------------------------------------- sigma_u | 1.792e-06 sigma_e | 3.440e-07 rho | .96446206 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 613) = 117.64 Prob > F = 0.0000

EconomicFreedommaintainssignificanceandthesignispersistentlynegative.

74

This is, instead,whathappens in the sameregressionasEconomicFreedom isnolongerconsidered:

(R.16). xtreg intensity gdp_2 population energ industry policy urban vehicles nuclear_energy , fe

Fixed-effects (within) regression Number of obs = 778Group variable: id_country Number of groups = 118

R-sq: within = 0.1307 Obs per group: min = 1 between = 0.0002 avg = 6.6 overall = 0.0000 max = 11

F(8,652) = 12.26corr(u_i, Xb) = -0.6301 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- gdp_2000 | -1.58e-19 1.42e-19 -1.12 0.264 -4.37e-19 1.20e-19 population | -4.62e-15 2.77e-15 -1.67 0.096 -1.01e-14 8.23e-16 energy_use | 3.19e-10 7.21e-11 4.42 0.000 1.77e-10 4.60e-10 industry | -2.19e-08 7.09e-09 -3.09 0.002 -3.58e-08 -7.97e-09 policy | -1.48e-07 6.58e-08 -2.25 0.025 -2.77e-07 -1.87e-08 urban | 3.47e-08 1.57e-08 2.22 0.027 3.95e-09 6.55e-08 vehicles | -4.24e-09 6.66e-10 -6.37 0.000 -5.55e-09 -2.93e-09nuclear_en~y | -4.28e-08 9.40e-09 -4.55 0.000 -6.12e-08 -2.43e-08 _cons | 9.61e-07 8.78e-07 1.10 0.274 -7.62e-07 2.68e-06-------------+---------------------------------------------------------------- sigma_u | 2.241e-06 sigma_e | 4.181e-07 rho | .96637855 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(117, 652) = 108.99 Prob > F = 0.0000

Interestinglyenough,GDPlosessignificance.

Thesameresultsareobtained,as theSubindexofEconomicFreedomisemployedinsteadoftheIndex:

75

(R.17). xtreg intensity sub gdp_2 population energ industry policy urban vehicles nuclear_energy> , fe

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.3406 Obs per group: min = 1 between = 0.0089 avg = 6.4 overall = 0.0110 max = 11

F(9,612) = 35.12corr(u_i, Xb) = -0.5518 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | -4.16e-08 3.04e-09 -13.72 0.000 -4.76e-08 -3.57e-08 gdp_2000 | -5.64e-21 1.14e-19 -0.05 0.961 -2.29e-19 2.18e-19 population | -6.27e-15 2.23e-15 -2.82 0.005 -1.06e-14 -1.90e-15 energy_use | 2.02e-10 6.64e-11 3.04 0.002 7.17e-11 3.32e-10 industry | 5.48e-09 6.34e-09 0.86 0.387 -6.97e-09 1.79e-08 policy | -9.15e-08 5.32e-08 -1.72 0.086 -1.96e-07 1.29e-08 urban | 5.38e-09 1.30e-08 0.42 0.678 -2.01e-08 3.09e-08 vehicles | -1.42e-09 5.79e-10 -2.45 0.014 -2.56e-09 -2.83e-10nuclear_en~y | -3.86e-08 8.93e-09 -4.32 0.000 -5.62e-08 -2.11e-08 _cons | 4.16e-06 7.65e-07 5.44 0.000 2.66e-06 5.66e-06-------------+---------------------------------------------------------------- sigma_u | 1.983e-06 sigma_e | 3.344e-07 rho | .97236154 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 612) = 116.38 Prob > F = 0.0000

(R.18). xtreg intensity subind population energ industry policy urban vehicles nuclear_energy , f> e

Fixed-effects (within) regression Number of obs = 735Group variable: id_country Number of groups = 114

R-sq: within = 0.3406 Obs per group: min = 1 between = 0.0087 avg = 6.4 overall = 0.0108 max = 11

F(8,613) = 39.58corr(u_i, Xb) = -0.5532 Prob > F = 0.0000

------------------------------------------------------------------------------ intensity | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- subindex | -4.16e-08 3.03e-09 -13.76 0.000 -4.76e-08 -3.57e-08 population | -6.31e-15 2.08e-15 -3.03 0.003 -1.04e-14 -2.22e-15 energy_use | 2.02e-10 6.63e-11 3.05 0.002 7.18e-11 3.32e-10 industry | 5.53e-09 6.27e-09 0.88 0.378 -6.79e-09 1.78e-08 policy | -9.17e-08 5.31e-08 -1.73 0.085 -1.96e-07 1.26e-08 urban | 5.29e-09 1.28e-08 0.41 0.680 -1.99e-08 3.05e-08 vehicles | -1.42e-09 5.78e-10 -2.45 0.014 -2.55e-09 -2.83e-10nuclear_en~y | -3.86e-08 8.89e-09 -4.34 0.000 -5.60e-08 -2.11e-08 _cons | 4.16e-06 7.58e-07 5.49 0.000 2.67e-06 5.65e-06-------------+---------------------------------------------------------------- sigma_u | 1.986e-06 sigma_e | 3.341e-07 rho | .97246482 (fraction of variance due to u_i)------------------------------------------------------------------------------F test that all u_i=0: F(113, 613) = 116.98 Prob > F = 0.0000

76

2.10.Commentsontheresults

Theresultsobtainedfromtheregressionsprimarilymanifesttwoaspects.Thefirstregards their robustness:howevermuch themodel is changed the coefficients forGDPpercapitaandeconomicfreedom–asmeasuredbytheHeritageFoundation’sIndexofEconomicFreedomorbythesubindexherebydefined–maintainsignsthatarealwaysequalandsufficientlystablevalues.Secondly,itappearstobepreferabletousethesubindexasitcontainsmorecarbonintensity‑specificinformationthantheaggregate index, which includes pieces of information thatmay be irrelevant ormisleading.Table 3 summarizes themain results from the regressionsperformedabove.

From the table, it appears evident that economic freedom – whether measuredthroughtheIndexortheSubindex–appearsconsistently,negativelycorrelatedwithcarbonintensity.Othervariableswhichareconsistently,negativelycorrelatedwithcarbon intensity include the share of nuclear power and, to much surprise, thenumber of privately vehicles. Consistently, positively correlated with carbonintensityareenergyuse,theshareofindustrialsector,energyimports,andinmostcasetheenergyfreedomsecondorderterm.Mostoftheotherconsideredcontrolsaregenerallynon‑significant.GDP is inmost casesnegatively correlatedwith carbonintensity,andinsomecasesthecorrelationisnon‑significant.

77

ModelEconomicFreedom[Sign]

GDP[Sign]

Othersignificant,positivecontrols

Othersignificant,negativecontrols

Non‑significantcontrols

R.1 I‑ ‑ U,Im,In,E V I2,GDP2,N,P

R.2 I‑ ‑ I2,GDP2,Im,In,E

V,N, U,P

R.3 I‑ ‑ I2,GDP2,Im,In,E

I3,V,N, U,P,

R.4 I‑ ‑ I2,GDP2,Im,

U,P,In

R.5 I‑ ‑ I2,GDP2, V,N, Im,Em

R.6 S‑ ns S2,Im, N, GDP2,U,P,In,E

R.7 S‑ S2,Im,In,E S3,V,N, GDP,GDP2,U,P

R.8 lnI,ns(*) ln,‑ U,Im,P,In,E

V,N

R.9 lnI,ns(*) ln,‑ GDP2,Im,E V,N, I2,U,P,In,

R.10 S,L3,‑ ns (S,L3)2,In N, GDP2,U,V,Im,P,E

R.11 S,L3,‑ ns (S,L3)2,In (S,L3)3,N, GDP2,U,V,Im,P,E

R.12 S‑ ns(*) S2,Im,In,E Pol,V,N GDP2,U,P,

R.13 S‑ nsS2,CE,Im,

In, P,ET,GDP2,Pol,FDI,N,CO2C,R,V,U,PC,Sur,

R.14 I‑ ns E, V,N P,In,Pol,UR.15 I‑ nt E V,N P,In,Pol,U

R.16 nt ns E,U, In,Pol,V,N

P,

R.17 S‑ ns E, P,V,N In,Pol,UR.18 S‑ nt E, P,V,N In,Pol,U

Table3.Resultsofthe18regressions.CE=coalasashareofenergyconsumption;CO2C = coal‑related carbon dioxide emissions; E = energy consumption; Em =employment;ET=energytaxation;FDI=foreigndirectinvestments;GDP=GrossDomesticProduct;I=IndexofEconomicFreedom;Im=shareofenergyimports;In= industrial sector as a share of the economy;N = share of nuclear power; P =population; PC = power consumption as a share of energy consumption;Pol =

78

climatepolicies;R=roads;S=SubindexofEconomicFreedom;Sur=surfaceofacountry;U=urbansurface;V=numberofprivatevehicles.ln=naturallogarithm;L3=laggedby3periods(years);ns=non‑significant;nt=non‑tested;(*)significantat90%.

Atanyrate,tothepurposeofthispaperandreflectingthetheoreticalframeworkthathasbeenprovided,anegativecorrelationseemstoexistbetweencarbonintensityandeconomicfreedom.Thisisconsistentwiththeresultsavailableinliterature,althoughthenumberofpreviouspapersthatexploredthiskindofapproachisverylimited.Acorrelationisobviouslynot–andshouldneverbeconfusedwith–acausality,butthetheoreticalframeworkpresentedaboveseemstosuggestthattheremaybemorethanamerecoincidence,here. In fact, the institutional factors thatareexploredtodefine economic freedom,mayhave a clear impact on carbon intensity. It can beexpectedthat,astheindicatorsthatdefineeconomicfreedomincrease,areductionofcarbonintensitymayoccur,especiallyinthecountrieswithmediumorlowscoresofeconomicfreedom.

While this result is far frombeing conclusive, it seems to suggest thatpromotingeconomic freedom–particularlywith regard to the components subsumed in thesubindexherebyemployed–mighthelptoachievelong‑termreductionsincarbonintensity,especiallyinthedevelopingworld.Moreresearchisneededontheissue.

79

AppendixA.The2009IndexofEconomicFreedom

Country Score

1. HongKong 90.0

2. Singapore 87.1

3. Australia 82.6

4. Ireland 82.2

5. NewZealand 82.0

6. UnitedStates 80.7

7. Canada 80.5

8. Denmark 79.6

9. Switzerland 79.4

10. UnitedKingdom 79.0

11. Chile 78.3

12. Netherlands 77.0

13. Estonia 76.4

14. Iceland 75.9

15. Luxembourg 75.2

16. Bahrain 74.8

17. Finland 74.5

18. Mauritius 74.3

19. Japan 72.8

20. Belgium 72.1

21. Macau 72.0

22. Barbados 71.5

23. Austria 71.2

24. Cyprus 70.8

25. Germany 70.5

26. Sweden 70.5

27. Bahamas,The 70.3

28. Norway 70.2

29. Spain 70.1

30. Lithuania 70.0

31. Armenia 69.9

32. Georgia 69.8

33. ElSalvador 69.8

34. Botswana 69.7

35. Taiwan 69.5

36. SlovakRepublic 69.4

37. CzechRepublic 69.4

38. Uruguay 69.1

39. SaintLucia 68.8

40. SouthKorea 68.1

41. TrinidadandTobago 68.0

42. Israel 67.6

43. Oman 67.0

44. Hungary 66.8

45. Latvia 66.6

46. CostaRica 66.4

47. Malta 66.1

48. Qatar 65.8

49. Mexico 65.8

50. Kuwait 65.6

51. Jordan 65.4

52. Jamaica 65.2

53. Portugal 64.9

54. UnitedArabEmirates 64.7

80

55. Panama 64.7

56. Bulgaria 64.6

57. Peru 64.6

58. Malaysia 64.6

59. SaudiArabia 64.3

60. St.VincentandG. 64.3

61. SouthAfrica 63.8

62. Albania 63.7

63. Uganda 63.5

64. France 63.3

65. Romania 63.2

66. Belize 63.0

67. Thailand 63.0

68. Slovenia 62.9

69. Mongolia 62.8

70. Dominica 62.6

71. Namibia 62.4

72. Colombia 62.3

73. Madagascar 62.2

74. KyrgyzRepublic 61.8

75. Turkey 61.6

76. Italy 61.4

77. CapeVerde 61.3

78. Macedonia 61.2

79. Paraguay 61.0

80. Fiji 61.0

81. Greece 60.8

82. Poland 60.3

83. Kazakhstan 60.1

84. Nicaragua 59.8

85. BurkinaFaso 59.5

86. Samoa 59.5

87. Guatemala 59.4

88. DominicanRepublic 59.2

89. Swaziland 59.1

90. Kenya 58.7

91. Honduras 58.7

92. Vanuatu 58.4

93. Tanzania 58.3

94. Montenegro 58.2

95. Lebanon 58.1

96. Ghana 58.1

97. Egypt 58.0

98. Tunisia 58.0

99. Azerbaijan 58.0

100. Bhutan 57.7

101. Morocco 57.7

102. Pakistan 57.0

103. Yemen 56.9

104. Philippines,The 56.8

105. Brazil 56.7

106. Cambodia 56.6

107. Algeria 56.6

108. Zambia 56.6

109. Serbia 56.6

110. Senegal 56.3

111. SriLanka 56.0

112. Gambia,The 55.8

113. Mozambique 55.7

114. Mali 55.6

115. Benin 55.4

116. Croatia 55.1

81

117. Nigeria 55.1

118. Gabon 55.0

119. Coted’Ivoire 55.0

120. Moldova 54.9

121. PapuaNewGuinea 54.8

122. Tajikistan 54.6

123. India 54.4

124. Rwanda 54.2

125. Suriname 54.1

126. Tonga 54.1

127. Mauritania 53.9

128. Niger 53.8

129. Malawi 53.7

130. Bolivia 53.6

131. Indonesia 53.4

132. China 53.2

133. Nepal 53.2

134. BosniaandH. 53.1

135. Ethiopia 53.0

136. Cameroon 53.0

137. Ecuador 52.5

138. Argentina 52.3

139. Micronesia 51.7

140. Djibouti 51.3

141. Syria 51.3

142. EquatorialGuinea 51.3

143. Maldives 51.3

144. Guinea 51.0

145. Vietnam 51.0

146. Russia 50.8

147. Haiti 50.5

148. Uzbekistan 50.5

149. Timor‑Leste 50.5

150. Laos 50.4

151. Lesotho 49.7

152. Ukraine 48.8

153. Burundi 48.8

154. Tongo 48.7

155. Guyana 48.4

156. CentralAfricanR. 48.3

157. Liberia 48.1

158. SierraLeone 47.8

159. Seychelles 47.8

160. Bangladesh 47.5

161. Chad 47.5

162. Angola 47.0

163. SolomonIslands 46.0

164. Kiribati 45.7

165. Guinea‑Bissau 45.4

166. RepublicofCongo 45.0

167. Belarus 45.0

168. Iran 44.6

169. Turkmenistan 44.2

170. SaoToméandP. 43.8

171. Libya 43.5

172. Comoros 43.3

173. Dem.Rep.ofCongo 42.8

174. Venezuela 39.9

175. Eritrea 38.5

176. Burma 37.7

177. Cuba 27.9

178. Zimbabwe 22.7

82

179. NorthKorea 2.0

180. Afghanistan N/A

181. Iraq N/A

182. Liechtenstein N/A

183. Sudan N/A

AppendixB.KyotoProtocolratification

Note:OnlyAnnex‑Bcountrieshavebeenconsidered

Country Yearofratification

1. Australia 2007

2. Austria 2002

3. Belgium 2002

4. Bulgaria 2002

5. Canada 2002

6. Croatia 2007

7. CzechRepublic 2002

8. Denmark 2002

9. Estonia 2002

10. Finland 2002

11. France 2002

12. Germany 2002

13. Greece 2002

14. Hungary 2002

15. Iceland 2002

16. Ireland 2002

17. Italy 2002

18. Japan 2002

19. Latvia 2002

20. Liechtenstein 2004

21. Lithuania 2003

22. Luxembourg 2002

23. Monaco 2006

24. Netherlands 2002

25. NewZealand 2002

26. Norway 2002

27. Poland 2002

28. Portugal 2002

29. Romania 2001

30. Russia 2004

31. Slovakia 2002

32. Slovenia 2002

33. Spain 2002

34. Sweden 2002

35. Switzerland 2003

36. UK 2002

37. Ukraine 2004

38. US nr

83

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Chapter3.

AReassessmentofEuropeanClimatePolicies:Cap&Tradevs.CarbonTax

Abstract

TheEuropeanUnionhasunilaterallydecidedtoimplementacap&tradeschemetocontaingreenhousegases (GHGs)emissions, startingon1 January2005.After theFirstPhaseoftheSchemehadbeenconcludedon31December2007,emissionsfromthesectorscoveredbytheEuropeanEmissionsTradingScheme(ETS)hadactuallyincreased.Thatisnotenoughtotellthattheschemedidn’twork:therearetoolittledatatoperformacredibleassessment.Theliteratureontheissueisnotunanimous.Itseemsplausible,however, thatsomepermitsover‑allocationoccurredin2005, thatmightexplainthenot‑so‑excitingperformanceofthescheme.Infact,tosomeextentsomeover‑allocationwas also acknowledgedby theEuropeanCommission itself,whichadoptedmorestringentcriteriafortheSecondPhaseofETS(2008‑2012).NowthecriteriaandtherulesfortheThirdPhase(2013‑2020)arebeingdebated,withanemphasisoverdefiningevenmorestringentcriteriaandashiftfromagrandfatherinsystemintheinitialallocation(wherebyallowancesareinitiallygivenfree‑of‑chargeonthebasisofhistorical trackrecordsforemissions), towardsapartialauctioningsystem(wherebypermitsareinitiallygiventothehighestbidders),withagoalofafullauctioningin2027.Atthesametime,safeguardmeasuresarebeingconsideredinordertoprevent“carbonleakage”(i.e.delocalizationduetohighercostsofenergy)intheenergy‑intensiveeconomicsectorsorsub‑sectorsthatareexposedtointernationalcompetition.ThispaperexaminestheguidelinesfortheEnergyPolicyforEuropebyassessing itseffectiveness inachieving thestatedenvironmental targets,assumingnot every country in the world will be willing to pursue similar targets.Subsequently, it identifies themajor shortcomings in the European policies, thatmostlydependonthecomplexityandpossiblepoliticizationof theETS.Finally, itreviewsthepossiblealternatives,byemphasizingthebenefitsthatarevenue‑neutralcarbontaxmightdeliverbothintermsofreachingtheenvironmentalgoals,andofthe policy’s efficiency and allocational efficiency. Twomodels of carbon tax areconsidered: one defined on the basis of the expected social cost from GHGsemissions,theotherdependentonastatefunctionthatmeasuresthedegreeofglobalwarminginanygivenyear.

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3.1.AnEnergyPolicyforEurope

The reduction of greenhouse gas emissions is the cornerstone of the newEnergyPolicyforEurope(EPE).If,atarhetoricallevel,theUnionaimstobeandremainagloballeaderinthefightagainstclimatechange,6inpracticeenvironmentalpolicyistheonlywayfortheEuropeanCommissiontoinfluencethenationalgovernments’energypolicies.Infact,theEuropeanTreatydoesn’tincludeenergypolicywithinthecommunity’sareaofjurisdiction.

ItisinthiscontextthattheEuropeanCouncilheldinthespringof2007formulatedtheambitiousgoalsofcuttingEuropeangreenhousegases(GHGs)emissionsby20%belowthereferenceyearby2020;increasingtheshareofrenewableenergysourcesupto20%ofprimaryenergyconsumption;andreducingby20%belowthebaselinethetotalconsumptionofenergy.7Suchobjectiveshavebeensomehowdownsized–the renewable share is to be referred to final energy consumption,will the totalconsumptionreductiongoalhasbeenturnedintoanon‑bindingtargetofincreasingenergyefficiencyby20%.Thewaytoachievesuchgoalsisembodiedinapackageofdirectives thatwas launchedby theEuropeanCommissionon January 23rd, 2008.Since then, a wide debate emerged and some major changes have been made.Technical issues are beingdebated, too.After a longnegotiation in late 2008, theCommission has proposed an amended version of theDirective,which has beenpassedbytheEUParliamentandisnowtoberatifiedbythememberStates.8

As far as emissions reductions are concerned, Europe plans to strengthen itsEmissionsTradingScheme(ETS),a“cap&trade”mechanismthathasbeeninplacesinceJanuary1st,2005.

This paper intends to examine the objective of emission reductions. Firstwewillevaluatetheusefulnessofthisobjectivefromthepointofviewofitsenvironmentalimpact. In the second partwewill look at the performance of European climatepolicies,whilethethirdpartwillbefocusedontheEmissionsTradingScheme(ETS).Although theavailabledatarefer toa relativelyshortperiod,someelementshavealready emerged anddeserve deep reflection. Finally, in the fourth part,wewill

6SosaidEuropeanCommissionPresidentJoséManuelBarroso,who–inastatementreleasedonDecember15th,2007–attributedtoEurope’s“leadership”the“successfuloutcome”ofBalinegotiations.Seehttp://europa.eu/rapid/pressReleasesAction.do?reference=IP/07/1941&format=HTML&aged=0&language=EN&guiLanguage=en7Initiallythethirdtargetwasformulatedwithregardtoprimaryconsumptionofenergy,butinthelatestversionsofthepackageitbecameclearthatthereferencewastofinalconsumption,andthetarget–differentlyfromtheothertwo–wasmadenon‑binding.8http://www.europarl.europa.eu/sides/getDoc.do?pubRef=‑//EP//TEXT+TA+P6‑TA‑2008‑0610+0+DOC+XML+V0//EN&language=EN

89

comparetheapproachthattheEUcurrentlytakes–thequantitativeone–withanalternativepath,thatis,theimpositionofanenvironmentaltax.

3.2.AreEuropeanclimatepoliciesanyuseful?

Theobjectiveof theEuropeanclimatepolicies is to“adoptthenecessarydomesticmeasuresandtaketheleadinternationallytoensurethatglobalaveragetemperatureincreasesdonotexceedpre‑industriallevelsbymorethan2°C”.FortheCommission,“thisistechnicallyfeasibleandeconomicallyaffordableifmajoremittersactswiftly.The benefits far outweigh the economic costs.”9Thisstatement–containedinacommunication of the Community’s executive body preceding the 2007 SpringmeetingoftheEuropeanCouncil–restsonapreviouscommunicationof2005(that“demonstrated that the benefits of limiting climate change outweigh the costs ofaction”),10andalsorestsontheSternReview(Stern2006).

The 2005 communication “demonstrates” that the benefits exceed the costs in asuccinct12‑lineparagraphtowhichwereaddedtwoannexesontheeffectsofclimatechange (two faces of a sheet of paper compiled into points without even onebibliographicreferenceevenwhenlong‑termprojectionsaregiven)andacost‑benefitanalysis (less than three pages where the following quote by IPCC is reported:“comprehensive, quantitative estimates of the benefits of stabilization at variouslevelsofatmosphericconcentrationsofgreenhousegasesdonotyetexist”).11Anotherreference is theStaffWorkingPaper,12whichsuppliesallthematerialbehindthecommunication.Thisisamorearticulatedocumentconsistingof51pageswhich,ofcourse,“demonstrates”nothing,asitdoesnotcontainanythingthatisoriginalotherthan a review of the literature – which, however, does not even mention lesspessimisticstudies–withtheambitionofsummingupthebodyofthescientificandeconomicknowledgeoncausesandeffectsofglobalwarmingandcostsandbenefitsofthedifferentpolicyoptions(includingthebusinessasusualandmostambitiousscenarios).SimilarconsiderationsapplytotheStaffWorkingPaperinsupportofthe2007Communication,13whichpicksupandupdatestheprecedingpaper.

The reference to the Stern Review is seemingly more solid. The report wascommissionedbytheBritishgovernmenttotheformerWorldBankchiefeconomist,

9EuropeanCommission,“LimitingGlobalClimateChangeto2degreesCelsius”,COM(2007)2,http://europa.eu/press_room/presspacks/energy/comm2007_02_en.pdf,p.2.10Ivi,p.4.11EuropeanCommission,“WinningtheBattleAgainstGlobalClimateChange”,COM(2005)35,http://ec.europa.eu/environment/climat/pdf/comm_en_050209.pdf,pp.4and12‑16.12http://ec.europa.eu/environment/climat/pdf/staff_work_paper_sec_2005_180_3.pdf.13http://ec.europa.eu/environment/climat/pdf/ia_sec_8.pdf.

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NicholasStern,withtheobjective“tounderstandmorecomprehensivelythenatureoftheeconomicchallengesandhowtheycanbemet,intheUKandglobally”.14Themostshockingandemphasizedresultofthereport–some575pagesofanalysisofevidenceandstudiesavailableontheeconomicaspectsofglobalwarming– is theforecastthat,dependingontheclimatescenario,intheabsenceofcountermeasures,theglobalmean temperatures growth couldbring about economic losses rangingfrom5to20%oftheglobalGDP.Itisaresoundingresult,asthepreviousestimatesgravitatedaroundonepercentofglobalGDP,whichisalsotheorderofmagnitudeofthemitigationcostsaccordingtomanyauthors.Togettosuchafigure,SirNicholasmakestwosingularhypotheses:ononehand,heassumesadiscountratenexttozero(infact,0.1%);ontheother,hereferssystematicallytothemostalarmisticstudiesonthe possible consequences of globalwarming. In all cases, by simply adopting adiscount rateof 3%–avalue typically employed in the literature– theestimatedcostsofthegreenhouseeffectcrumble,dependingonthescenario,from5‑20%to0.4‑1.1%oftheglobalGDP(Dasgupta2006;GaleottiandLanza2006;Nordhaus2007;Tol2006).

TolandYohe(2006,pp.233‑234)goasfarastofindsixcriticalissuesintheReview.Ofthese,fourrefertotechnicallimitsoftheReview:

• First,TheSternReviewdoesnotpresentnewestimatesofeithertheimpactofclimatechangeorthecostsofgreenhousegasemissionreduction.Rather,theSternReviewreviewsexistingmaterial.ItisthereforesurprisingthattheSternReviewproducednumbers thatare so faroutside the rangeof thepreviouspublishedliterature;

• Second,thehighvaluationofclimatechangeimpactsreportedintheReviewcanbeexplainedbyaverylowdiscountrate,riskthatisdouble‑counted,andvulnerability that is assumed tobe constant oververy longperiodsof time(twoormorecenturies,tobeexact).Thelattertwosourcesofexaggerationareproductsofsubstandardsanalysis.Theuseofaverylowdiscountrate is,ofcourse,debatable;

• Third,thelowestimatesforthecostofclimatechangepolicycanbeexplainedby the Review’s truncating time horizon over which they are calculated,omittingtheeconomicrepercussionsofdearerenergy,andignoringthecapitalinvestedintheenergysector.Thefirstassumptionissimplywrong,especiallysincetheverylowdiscountratesputenormousweightontheothersideofthe

14http://www.hm‑treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_backgroundtoreview.cfm.

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calculuson impacts thatmightbe feltafter theyear2050.The latter twoaremisleading;

• Fourth, the cost and benefit estimates reported in the SternReview do notmatchitspolicyconclusions.IftheimpactsofclimatechangeareasdramaticastheSternReviewsuggests,andifthecostsofemissionreductionsareassmallasreported,thenaconcentrationtargetthatisfarmorestringentthantheonerecommendedintheReviewshouldhavebeenproposed.TheReview,infact,doesnotconductaproperoptimizationexercise.

But theweakness – or at any rate the selectivity of the calculations used by theEuropeanCommission–isnotthemostexposedflankoftheCommunity’sstrategyon climate. The deepest problem concerns policy objectives, functions, andconsistence.

The ultimate goal of the European policies is to contain the increase in globaltemperatureswithinthe“magic”thresholdoftwodegreescentigrade.Arguably,thisisasymbolicvalue,becausethereisnoreasontobelievethatawarmingofuptotwodegreesisharmless,whileagreaterincreaseintemperatures,nomatterhowsmall,willbringaboutanykindofdisasters.Furthermore,itrisksbecominganunrealisticobjective.Although Europe is persuaded of the human responsibility for climatechanges,noonecanexcludethatallorpartofthetemperatureincreaseisgovernedby natural dynamics such as solar cycles (see Fig. 1) (Soon and Yaskell 2004).Therefore,Brusselscouldhavesetatargetthatgoesbeyondthepowersthatmankind– leaveasideEurope–has todayof influencing the environment. In this sense, itwould have been desirable to express the objective in terms of stabilization ofatmospheric concentrations of carbon dioxide and other greenhouse gases.Furthermore, the ratio betweenCO2 emissions and temperature variation (which,rather,dependsonatmosphericconcentrations,notonyearlyemissions)issubjecttogreat uncertainties, so there is an extremely high degree of arbitrariness in thedefinitionofthenecessaryemissionreductionsandintheirtemporaldisplacementtotheendoflimitingthegrowthtotwodegrees–andnot1.99,2.01,or2.1or3°C.

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Figure 1. Artic temperature, solar activity and cumulative hydrocarbonconsumption.Source:Robinson,RobinsonandSoon(2007).15

The FourthAssessmentReport (AR4) of the Intergovernmental Panel onClimateChange (IPCC2007)evaluates temperature increaseby2100 in the interval1.8‑4.0degreescentigradeinthedifferentscenarios.Insixscenariosoutofseven,thelowerendoftheforkisequaltoorlowerthan2degrees,andinscenario4itisevensmallerthan1.5degrees.16Thatmeansthatthereisasomechance–evenassumingthatthehypothesis and conjectures underlying the IPCC scenarios are valid – that theincrease of temperature in the absence of any political measure stays below thecritical thresholdof twodegrees.This fact in itself shouldsupplyaprecisepolicyindication:asitispossiblethattheEuropeaneffortsareuseless–onewayoranother– they should be conceived in such a way so as to allow for adjustments in arelativelyquickandsimplemannerasthescientificevidencegrowsandallowstheunveilingofatleastsomeofthemanyunknownsatthebasisoftheglobalwarmingphenomenon.

15http://www.oism.org/pproject/GWReview_OISM150.pdf.16Ipcc,“SummaryforPolicymakers”,inClimateChange2007:ThePhysicalScienceBasis.ContributionofWorkingGroupItotheFourthAssessmentReport(Cambridge,UKeNewYork,NY:CambridgeUniversityPress),http://ipcc‑wg1.ucar.edu/wg1/Report/AR4WG1_Print_SPM.pdf,p.13.

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During the Spring 2007 European Council, the leaders of the EUmember Statescommittedtoareductionofemissionsofatleast20%by2020,butalsore‑launchedafurthercommitmenttoreducetheemissionsby30%ifitbecomespossibletofindanagreement between all industrialized countries.17Thisiscontradictory.IftheemissionscauseglobalwarmingandifpreventingglobalwarmingistheEuropeanpoliticalpriority,thenthecommitmenttoreduceemissionsshouldbestronger,astheparticipation of other countries is smaller. In fact, the presumed cause of globalwarming comes from global emissions; in the absence of reductions by othercountries,Europeshoulddomore,notless,sothatthesameresultisachieved.WhyistheCommissionnotfollowingthissimplelogic?Theanswer,whichisnevergivenopenly in the official documents of theUnion, is that the Commission believes,correctly, that thereduction inemissionsrepresentsaballast foreconomicgrowthandthatitmaycausealossofinternationalcompetitiveness.Europedoesnotwanttopushbeyondacertainlimitwhichissetarbitrarily,withoutanypreliminarystudy,andquantifiedby 20%.That is obviously because it believes that the cost for theEuropeaneconomywouldbebyfargreaterthanenvironmentalbenefitswhichareuncertainandatanyrateremoteintime.Therefore,implicitly,theEUreasonsaboutthefuturewithadiscountratewhichisquitedifferentthanthe0.1%usedbyStern,andhence itdemonstrateswith facts that itdoesnotbelieve in the studies that itneverthelesscallsontosupportitspolicies.ThenhowdoweexplaintheEuropeanchoices? It is not the objective of this paper to put intentions on trial, nor toinvestigatetheideologicalmotivationsoreconomicadvantagesofsomeeffectiveandwell‑organizedpressure groups inBrussels, Berlin, London and in othermemberStatesthathavebeenpushinghardtosetclimatepoliciesinmotion.Totheendsofthisreflection,whatisrelevantisthat, infact,theEuropeanUniongiveseconomicweightto“salvagingtheclimate”andthat,regardlessofthenumbers,itattemptstoreconciletheverbalextremismwithaseriesofpracticalcaveats.Wecanseethatinawholeseriesofdetails–andanybodyknowsthatthedevil’srightthere.Forexample,atthesametimeastheEUpromotesbiofuels(evenbyadoptingaspecifictargetofa10% themarket share by 2020), and it prevents or discourages, through customsduties, the import of biofuels coming from tropical countries, which are moreeconomicalandcharacterizedbyalowerenvironmentalimpactascomparedtothose

17CounciloftheEuropeanUnion,PresidencyConclusions,8‑9March2007,7224/1/07,http://www.consilium.europa.eu/ueDocs/cms_Data/docs/pressData/en/ec/93135.pdf.Sections31and32state,respectively:“theEuropeanCouncilendorsesanEUobjectiveofa30%reductioningreenhousegasemissionsby2020comparedto1990asitscontributiontoaglobalandcomprehensiveagreementfortheperiodbeyond2012, provided that other developed countries commit themselves to comparable emission reductions andeconomically more advanced developing countries to contributing adequately according to theirresponsibilities and respective capabilities”.Moreover, “The European Council emphasises that the EU iscommitted to transformingEurope intoahighlyenergy‑efficientand lowgreenhouse‑gas‑emittingeconomyanddecidesthat,untilaglobalandcomprehensivepost‑2012agreementisconcluded,andwithoutprejudicetoitspositionininternationalnegotiations,theEUmakesafirmindependentcommitmenttoachieveatleasta20%reductionofgreenhousegasemissionsby2020comparedto1990.”

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producedinEurope.Inthiscase,theEUseemstoputthecreationofasafetynetforEuropeanagriculture(whichisthreatenedbythereformofthecommonagriculturalpolicy)beforeactualclimatesalvation(Clini2007;Stagnaro2007).Buteventhisrisksleading us astray. In fact, regardless of the internal contradictions or perhapsexcessive ambitions of European policy, another element exists that dictates thepossibleirrelevanceofthismeasure:therestoftheworld.

Europe,infact,doesnotactinavoid,butthebackgroundofitsactionsconsistsinthedecisionsofothernations.Itisofcourseanever‑changingbackgroundthatmovesinfunctionofawidearrayofvariables–social,economicandpoliticalinthefirstplace– towhichEurope itselfbelongs. Inotherwords, Europeandecisionsareseenbyotheractors,whichreactinsometimesacooperativeandsometimesanopportunisticmanner.Whenwetalkaboutchoicesinenergypolicy,however,theinfluenceoftheEU on the rest of theworld is relatively low, because the time horizon of suchdecisions isverylong.Today,everybodyisanheirof thechoicesmadeyesterday,andthosechoicescountformorethantheaccelerationofacertainlyimportantactor(butperhaps less important thanEuropeangovernmentsmightwish) such as theEuropeanUnion.Therefore,althoughonecanmaintainthatEuropecouldleadothernations on the sustainability path by example, so far that does not seem to havematerialized, and the EU seems to be a leader without followers. It is thereforereasonabletoassumethat,at least intheshort tomediumrun, theothercountrieswillmainlyfollowdomesticlogic,andthus,theconsequencesofEuropeanchoicesmustbeevaluatedwithina“businessasusual”scenariofortherestoftheworld.

Accordingto thereferencescenarioof theInternationalEnergyAgency(IEA2007,p.73), “world primary energy demand is projected to grow by more than halfbetween 2005 and 2030, at an average annual rate of 1.8%.Demand reached 17.7billiontoe, comparedwith 11.4 billion toe in 2005 – a rise of 55%.Global energyintensity–totalenergyuseperunitofgrossdomesticproduct–fallsby1.8%peryearover2005‑2030” (Figure2).Thegrowthwillbedominatedby fossil fuels thatwillconfirmthemselvesastheheartoftheworldenergysystem:“Fossilfuelsremainthedominant sourceofprimaryenergy, accounting for84%of theoverall increase inglobaldemandbetween2005and2030”.Althoughoil remains themost importantfuel,itssharenexttothetotalmixwilldecreasefrom35to32%,settling(inabsoluteterms)at160millionbarrelsaday(37%morethan2006).Theuseofcoalwillgrowby73%,raisingthereforefrom25to28%ofconsumption.Theshareofnaturalgaswillremain almost stable, as, according to theprojections, itwillmoderately increasefrom21%to22%ofthetotal.Nexttotheotherformsofenergy,theuseofelectricitywillincreasenoticeably,asitwillgrow,nexttototalconsumption,from17to22%.Finally, the greatest part of the foreseen growth is attributed to the developingcountrieswhich,thankstothecombinationofdemographicandeconomicgrowth,will be responsible for 74% of the additional demand – China and India aloneaccounting for45%of theglobaladditionaldemandofenergy. It shouldbenoted

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that,inthealternativescenarioofIEA(whichassumestheadoptionofiron‑fistedandeffective measures of energy savings and emissions reduction), in spite of thesignificant reduction of demand (11% less in 2030), the proportions are notsubstantially altered. The Paris‑based Agency also elaborates a scenariocontemplatinghighgrowth–andthatcanbeconsideredpessimisticfromthepointofviewoftheEuropeanpolicyobjectives–whichisnotconsideredhere.

Figure 2.Globalprimaryenergydemand in the reference scenario.Source: IEA(2007)

Ifthisisthefuturewearefacing,theenvironmentalimplicationisclear:instepwithenergy consumption, greenhouse gas emissions will increase. Even by limitingourselves just to the emissions linked to energy consumption, under the IEAreferencescenario,ChinaandIndiawillberesponsible,respectively,for42%and14%oftheemissionincreases,whiletherestoftheworld(ofwhichEuropeisjustapart,andnoteventhelargestone)willberesponsiblefor44%.IntheoptimisticscenarioofIEA(2007,p.98),therestoftheworldwillcausejust14%oftheadditionalemissions,whileChinawillhavethelion’ssharewith52%andIndiawillfollowwith17%.By2030,thetotalincreaseinemissionswillbeby57%above2005,orjust27%underthealternative scenario (IEA 2007, p.192). The EuropeanUnion –which in 2005wasresponsibleforlessthan15%ofglobalemissions–willseeitsshareerodeddownto12%in2015anddownto10%underthereferencescenario,orto11%in2015and9%

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in2030underthealternativescenario(IEA2007,p.199).Itisclearthatanyeffort,nomatterhowintense,willhavearelativelysmallimpactonglobalemissionswhich,atthe end of the day, are the only relevant variable for the phenomenon of globalwarming.Clini(2007,p.119)writes:“TheadvantageintermsofthereductionofCO2

emissions–thatcanbemeasuredonlyatthegloballevel–ismarginal.Thereductionof20%oftheEuropeanemissionsin2020correspondstoaglobalreductionoflessthan4%”.

Almostbydefinition,areductionofthissizeisdestinednottohaveanydiscernibleeffectonclimatebalances.Atmost,itcanslowdownbyamodestamountthegrowthofemissions,actinginsuchawaythat–inthereferencescenario,andassumingforthe sake of simplicity a linear path between the values of the global emissionsestimated by IEA for 2015 and 2020 – we would have in 2020 a level of globalemissionswhich,otherwise,wouldalreadyhavebeenreach in2017.Thequestionthatarisesiswhetheritisworthcommittingasignificantquantityofeconomicandpoliticalresources–actually,anyquantity–toachievesuchameagreobjective.

3.3.DotheEuropeanclimatepolicieswork?

Onecouldobjectthatthereissomethingmoreimportantthantheeffectivenessofthepoliciesat theglobal level.Bymeansof itsowncommitment, theEuropeanUnioncan set an example for the international community and create the conditions forwhichitsallegedly“virtuous”behaviourisfollowedbyothers.Thisisthesolutiontothe prisoner’s dilemma à la Bruxelles: the European actor greatly publicises itsactionssoastoconvinceothersthattheproblemissoseriousthatitrequirescommonaction in which all must participate, but in the absence of that action, at leastsomething isdonebysomeone.Weareback toEuropean leadership.However, toclaimone’sownleadershipisnotenough,asitisnecessaryforfactstofollowwords.Butfromthispointofview,theEUdoesnotseemveryconvincingordetermined.

AreportpublishedbytheEuropeanEnvironmentalAgencyinDecember2007(EEA2007) states that the old continentwill be able to reach, if not surpass, theKyotoobjectives– that is,anabatementofemissionsof8%belowthoseof1990by2012.That,however,istrueonlyforthe27‑memberUnion:thenewmemberStatesarestillenjoying the dubious privilege of being former Soviet countries, and as suchexperienced a suddenanddramatic contractionof emissions afterUSSR collapse.This, however, is a fact that is notdestined to repeat itself, to thepoint that – asreported by the same EEA (2007, p.6) – “a first assessment of EU27 aggregatedprojectionsfor2020showsthat,eveniftheadditionalmeasurescurrentlyplannedbyMemberStatesareadoptedandfully implemented,greenhousegasemissionswillincreasebetween2010and2020,reachinga levelapproximately2%higherthanin

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2005,andonly6%belowtheir1990level”.Thisiscertainlynotanintentionalresult,andasmileisirresistiblewhenwedetectthetonewithwhichtheCopenhagen‑basedagencyhailstheephemeralresultthat(perhaps)willbereachedin2012–atonethatsaturatesthepressreleaseinformingusofthepublicationofthestudy,andthetitle“EUwithinthereachofKyototargets”.18

ThegoalthatEuropemightmeetisevenlessastonishingifwelookattheresultsthathaveactuallybeenreachedbyEU15,thatis,bythatpartofEuropewhichhaslongsaidthatithasmadeemissionsreductionapriorityandwhichactsaccordingly.TheEU15emissionsin2007(thelastyearforwhichofficialdataareavailable)were4052.0MTonsCO2equivalent,4.3%belowthebaseline,or1.6%below2006.

A further analysis by other European Environmental Agency official documentsclaimsthat“ThepoliciesandmeasuresinplaceasoftodaywillnotbesufficientfortheEU‑15 tomeet itsKyoto target, as they are expected topushdownemissionsbetween2006and2010toanaveragelevelonly3.6%belowthebase‑yearemissions.Iftheadditionalmeasuresplannedby10MemberStateswerefullyimplementedandontime,afurtherreductionof3.3%couldbeobtained.”19Moreover,theappropriateuseoftheKyotomechanismsisestimatedtoallowforafurther3.0%reduction,whiletheuseofcarbonsinksmightinduceafurther1.4%reduction.Optimisticforecasts,therefore, suggest that an aggregate 11.3% reduction below the baseline can beachievedinthe2008‑12commitmentperiod.

Interestingly enough, last year’s estimates claimed that a 4% reductionbelow thebaseline couldbeachievedwithexistingpolicies (asopposed to3.6% in themostrecentestimate,a10%downsizing),whileanextra7%reductioncouldbeachievedbyadopting theappropriate additionalmeasures,Kyotomechanisms, and carbonsinks.WhiletheactualperformanceoftheEU15hasbeendownsized,theabilitytoachievemoresignificantreductionsbyothermeanshasbeenincreasedby10%(from‑7.0to‑7.7%).20

Toachievetheextra7.7%reduction,importantstepsneedtobetaken,includingthefollowing:

• Fullachievementoftheobjectivesforeseenwiththeexistingpolicies;

• Quickadoptionandimplementationofpoliciesandadditionalmeasures;

• Correctionoftheemissionsbytakingintoaccountsinksandland‑usechanges;

• Utilizationtothehighestpossibleleveloftheflexiblemechanisms;

• SignificantoverdeliverybysomeofthememberStates; 18http://www.eea.europa.eu/pressroom/newsreleases/eu‑within‑reach‑of‑kyoto‑targets.19http://www.eea.europa.eu/pressroom/newsreleases/eu‑15‑on‑target‑for‑kyoto‑despite‑mixed‑performances20EuropeanEnvironmentAgency,“GreenhousegasemissiontrendsandprojectionsinEurope2007”,pp.6‑7.

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• Timelyobservationofthereductiontimetable.

Allthatnotwithstanding,atleastthreememberstates–Italy,Spain,andDenmark–willnotreachtheobjectives,andprobablythis is themostaccurateforecastof thewholereport(EEA2009).

Even more interesting is the way in which the Union has, so far, reduced itsemissions.Table1reportstheyearlyvariationsdeclaredbyEEAtogetherwiththeexplanationsthat,initsannualcommuniqués,theagencyhassuppliedtoexplainthechanges. Except for one case (1999), the variation is never attributed to specificpolicies.In7yearsoutof9,asignificantroleisattributedtoclimateconditions–thatis,toafactorcompletelyexogenousandwhichcannotbepoliticallycontrolled.Then,onandoff,thegreaterorlesseruseofcoalinthemixisnoted,andthatmixdependsboth on industrial choices or long‑term policies, and on demand, which in turndependsprimarilyonthetemperatureandoneconomicgrowth(orlackthereof),aswellason internationalpricesof fossil fuels. It is thereforenotanexaggeration tostatethatifEuropegetsmoreorlessclosetotheKyototarget,itwilldependlargelyon variables that are independent from climate policies; indeed the single mostimportantvariablewillbe...weather: thewarmer(especiallybyWinter), the lowertheemissionswillbe.Theveryanalysesoftheagencythereforeshowthatregardlessofthecost,Europeanpoliciesareineffective,thusinefficient.

Year EmissionVariation

(*)

Mainreasonssupplied RealGDPGrowth21

199922 ‑2 • MeasureagainstNO2inFranceandtheUK;

• MeasuresagainstHFCsemissionsinUK;

• Shiftfromcoaltogas(GermanyandtheUK);

• MildwinterinGermany,UK,France,andtheNetherlands.

+3

200023 +0.3 • Increaseinelectricity‑relatedemissions;

• IncreaseofcoalinUK;

• ContinuousgrowthofemissionsinGreece,Spain,Ireland,Italy,Belgium.

+3.9

21http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&plugin=0&language=en&pcode=tsieb02022http://www.eea.europa.eu/pressroom/newsreleases/newsrelease20010423.

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200124 +1 • Coldwinter.

• Increaseintransportationemissions;

• Greateruseoffossilfuelsforheatingandelectricitygeneration.

+1.9

200225 ‑0.5 • Mildtemperatures;

• Loweconomicgrowth;

• Shiftfromcoaltogas.

+1.2

200326 +1.3 • Increaseofthecarbonshareinelectricalgeneration;

• Coldwinter.

+1.2

200427 +0.3 • Increaseinindustrialemissions(iron,steel,refrigeration,airconditioning).

+2.3

200528 ‑0.8 • Reductionintheuseofcoal;

• Mildtemperatures;

• Increaseofdieselnexttogasoline(Germany).

+1.8

200629 ‑0.8 • Warmweather;

• Highoil&gasprices.

+2.9

200730 ‑1.6 • Warmweather;

• Highoil&gasprices.

+2.7

Table 1.Yearlyvariationsofgreenhouseemissions inEU15 (1999‑2005).Source:EEA.Economicgrowth(1999‑2005).Source:Eurostat.

Obviously,before the failureofEuropeanpolicies is assessed,a closer lookat theEuropeanmarketforemissionsrightsisneeded,whichstartedoperatingin2005,ayearcharacterizedbymild temperaturesaswellasbyareductionofemissionsas 23http://www.eea.europa.eu/pressroom/newsreleases/greenhouse_gas_emission.24http://www.eea.europa.eu/pressroom/newsreleases/ghg‑2003‑en.25http://www.eea.europa.eu/pressroom/newsreleases/tec2‑2004‑en.26http://www.eea.europa.eu/pressroom/newsreleases/ghg_inventory_report‑en.27http://www.eea.europa.eu/pressroom/newsreleases/GHG2006‑en.28http://www.eea.europa.eu/pressroom/newsreleases/eu‑greenhouse‑gas‑emissions‑decrease‑in‑2005.29http://www.eea.europa.eu/highlights/eea‑reports‑on‑progress‑in‑greenhouse‑gas‑emissions‑reductions‑in‑2006.30http://www.eea.europa.eu/pressroom/newsreleases/2009‑greenhouse‑inventory‑report.

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comparedtotheprecedingyear.CanweaffirmthattheEuropeanTradingScheme(ETS)hascontributedtothereduction?Orthatithadnoinfluenceatall?Orthatithasworkedsopoorlyastohavesloweddowntheabatementofemissions?Clearly,the available evidence is bare‑bone, and to make a judgement is very complex.However, it is essential to express a first evaluation because from it – and fromEurope’s ability to identify the limits and strengths of the existingmechanism –dependsnotonlytheoutcomeofthesecondphase(2008‑2012),butalsoandabovealltheformofthepolicyinstrumentsthatEuropewillprovideitselfwithinviewoftheambitioustargetssetat2020and,presumably,thepositionandcredibilityoftheEUininternationalnegotiations.

TheETSwascreatedwithadirectivein2003andwasenforcedonJanuary1st,2005,slightly over amonth before the enforcement of theKyoto Protocol.However, ithelps to remember that theenvironment inwhich theEmissionTradingDirectivematuredwasprofoundly sceptical towards the international climate treaty: up tomid‑2004, it seemeddestined to the trashbin,as itdidnot seempossible that thenumberofratifyingcountrieswouldbesufficienttoexceedtherequired55%quotaof1990totalemissions.Thatwasoneoftheconditionsrequiredbytheprotocolforitsapplication. It happened only – and surprisingly – in the Fall of 2004, with theannouncement and then the ratification byRussia,which in the pastwas alwaysferociously criticalofKyoto.The change inRussia’spositionwasdue toboth thecompletion of an internal political revolution and external factors.On one hand,PresidentVladimirPutinmanagedtomoveoffthemaininternalopponentofKyoto,the formereconomicheadcouncillorAndrei Illarionov,andmanagedtosurroundhimselfwithagrowingnumberofformerKGBofficers.Thatalsoplayedaroleinthesuddenchangeofenergypolicies,andrepresentedtheepilogueofthetransitionthatstartedwith thearrest in2003of theoligarchMikhailKhodorkovsky,headof theprivateoilgiantYukos.Theimprisonmentofthetycoonandthedismembermentofthe company (whosemajor assetsweremoved into the hands of state controlledcompaniesincludingGazprom)setoffareturntodirect,heavypublicintervention,withtheutilizationofenergyresourcestopoliticalendsaswell.Fromthatmomenton,forawesternenterprisetooperateintheenergysectorinRussiabecamemuchmorecomplex.Inpractice,asNicolazzi(2004)wrote,Putin’sdesignisthatthestatecan draw “resources from the energy lever and decidewhether, if andwhen, toaddress themonother sectors”.On theotherhand, theKremlinwas the focusofeffective pressures from Brussels and some time later then president of theCommissionRomanoProdiclaimedtheRussianadherencetoKyotoashispersonalsuccess andmade it clear that it was the price to pay for European support forMoscow’sparticipationintheWorldTradeOrganization.31

31NickPatonWalsh,“PutinthrowslifelinetoKyotoasEubacksRussiajoiningWto”,TheGuardian,22May2004,http://www.guardian.co.uk/international/story/0,3604,1222190,00.html.

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Atanyrate, thefundamentalpoint is thatwhentheEuropeanUniondesignedtheETS,itwasconvincedthatthiswouldbeagreatjumpaheadoftherestoftheworld,as Europewouldplace itself in the cosmic void created by the sinking ofKyoto,whichdidnotinvolveaverylargepartoftheplanet,rangingfromtheUnitedStatestothelargestemergingeconomies.

ETSidentifiestwophasesofapplication:afirstpilotphase(2005‑2007)followedbyasecondmomentum(2008‑2012),coincidingwiththeperiodofapplicationofKyotoand duringwhich companies and countries are called to obtain the objective ofemissionreductionsby8%nexttothe1990level.AlargecensusattheEuropeanlevelidentified12,000plantsoperating in four largesectors (energyactivities includingcombustioninstallationswitharatedthermalinputexceeding20megawatts,mineraloil refineries, coke ovens; production and processing of ferrous metals; mineralindustry including cement clinker, glass and ceramicbricks; andpulp,paper andboardactivities;fromtheendofthesecondphase,aviationwillbeaddedtotheETSsectors).At thebeginningof eachphase, a certainnumberof emissionpermits isgratuitouslyassignedtoeachofthese.ThedistributionofthepermitstakesplaceonthegroundsofanationalallocationplanwithwhicheachmemberStatedeclaresthetotalamountoftheemissionquotasthatitintendstodistributewithinitself.OnApril30th each year, the plant will have to return a number of permits equal to itsemissions. If it is unable todo so, or it didnothave away to buyquotas on themarket, itmustpayafineof€40pertonofCO2equivalentforthefirstphase,and€100pertoninthesecondphase.Thefirstphasecoversonlycarbondioxide,whileinthesecond theothergreenhousegases identifiedby theKyotoProtocolcome intoplay.32Oncethefinehasbeenpaid,thecompany’snotexemptedfromcuttingitsemissions,so€40and100respectivelydonotworkasacaponcarbonprice.Finally,thedirectivedoesnotallowthebankingofallowancesandtheirtransferfromonephasetoanother. If theenterprise thatholdsemissionquotas inexcesscannotselltheminusefultime,theirvaluecrumblestozero.

Fromthissummarydescription,thethreemainelementsofpoliticalarbitrarinessoftheETSprojectemerge:theinclusionofsomesectorsandnotothers,33theprohibitionofbankingthepermits,theirgratuitousdistributionatthebeginningofeachphaseon the basis of the historical emission record in a reference period (the so‑calledgrandfathering).Thus,thechoiceofthereferenceperiodbecomescrucialtopickthewinnersandthelosers.Keepingallthisinmindisfundamentalwhenthethirdphaseisdesigned,aphasethatwillunfoldoveralongertimeinterval(2013‑2020)andthatforesees substantial changes, ranging from the inclusion of new sectors to the

32CH4,N2O,SF6,iPFCandHFCs.33SectorscoveredbyETSareresponsibleforaroundhalforEuropeantotalemissions.Othersectors,suchasariculture,transportations,services,andbuildingsaresubjecttospecificregulationsaimedatcontainingGHGsemissions.Finally,otherbroaderpoliciesaimatreducingthewholeeconomy’semissions.

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adoptionofapermitauctioningratherthangrandfatheringsystem.Itmustbeaddedthat thenegotiationbetween thememberStates and theCommissiononNationalAllocationPlans(NAPs)becomescriticaltotheproperoperationofthemechanism,asthedifficultyofthepathofemissionreductionstowhichacountrywillbesubjectdependsonit.AfurtherproblemcomesfromthefactthatthedataonemissionsaremadepublicbytheEuropeanEnvironmentAgencywithaboutoneyeardelay(andeventwoyearsdelayforinformationabouttotalemissions).

Thisimposesthedesignofthethirdphasewithoutknowinghowthingsaregoinginthesecond‑‑andwithoutbeingabletoknowuntilmid2013.

Furthermore, the albeit small experience accumulated so far by ETS gives rise toperplexitiesabouthowwellitisoperating.Thepriceoftheallowances,whichatthebeginningofthemarketwentupfromtheinitial€7pertontosettlearound€20‑25,suddenlycrashed.ThecrashcoincideswiththepublicationofthedataonemissionsbytheETSsectors.AttheendofApril2006,eightmemberstates(CzechRepublic,Estonia, Lithuania,Netherlands, France, Spain, Sweden and Slovenia) certified tohavegeneratedcumulativeemissionslowerby46.6milliontonsthantheavailablepermits.Withinafewweeks,thepriceofCO2fellbelow€20.Theannouncementofthedataconcerningothercountriesdeliveredthefinalblowtothevalue,whichwentdownprogressivelystartingSeptember2006,andsettledpermanentlywellbelow€1perton,whereitstayeduntiltheendof2007.Itthenshotupagainover€20atthebeginningoftheyearandthebeginningofthesecondphase.Theimmediategrowthreflectstheprohibitionofbankingofexcesspermits,whichcouldn’tbetransferredto2008‑2012.

In2008, thepriceofpermits showedhighvolatilityaround€20‑25per tonne.ThevalueofallowancespeakedonJanuary3rdat€23.54,thensharplydecreaseddownto18.84onFebruary5th,afterwhichbegantoriseagainuntilJuly1st(whenallowancesexpiringinDecember2008weretradedat€29.33).Anewwaveofreductionsstartedand thenext turningpointwasonAugust1st (€21.38)whenaperiodofveryhighvolatilitytookplaceuntilOctober(duringthesemonths,pricesstayedwithinthe€20‑25band).Finally,as itbecameobvious that theeconomiccrisiswasstronger thanexpectedandthateconomicperformanceandindustrialactivitieswerehardlyhit,arapiddecreaseoccurredthatledallowancespricesbelow€15.Withthebeginningof2009,priceshadagainwidevolatility,buttheoveralltrendisstilldecreasing,andthelatestdataavailableshowedallowancesbeingtradedatorbelow€10.Interestinglyenough, even future prices reflect the downwards trend: the forward prices atDecember2012forallowancesislittleabove€10,wellbelowtheabove‑€17thatwerepaidinlate2008.

Asamatterof fact,emissions fromtheETSsector in2007 (the lastyear forwhichverifieddataareavailable)were0.8%higher than in2006;and in2006 theystood

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1.1% above 2005.34Thatisparticularlystrikingbecause,inthesameyears,totalemissionsintheEUdecreasedascomparedtothepreviousyear.Onlyin2008didemissionsfallby3%ascomparedtothe2007.35

Itisparticularlyinterestingtofocusonpricetrendsin2005‑7:Whatisthepricetrenddueto,atrendthathaseffectivelynullifiedthecostofthequotasystem?AccordingtoStefanoClò(2007),aphenomenonof“over‑allocation”infavouroftheETSsectorshastakenplace.Clòhasdefinedtwodifferentbenchmarkstoevaluatethemarket–one referring to the pre‑2005 period and the other to the year 2005 – and heconcluded that “during the first phase the EU15 member States allocated anaggregatedamountof1,657millionpermits,correspondingtothe42%oftheEU15target.Thispercentageishigherthanboththepre‑2005EU15ETSshare(41%)andthe2005EU15ETSshare(38%)...permitshavebeenonaverageover‑allocatedtotheETSsectorsbelongingtotheEU15memberStates”.Inpractice,thesectorscoveredbyETSwould have obtained an unfairly favourable treatment, and dumped on thesociety as a whole the largest part of the cost of reductions. This has twoconsequences. In the first place, ETS has given little or no contribution to thereductionofemissionsduringthefirstphase,thusnullifying–atleastinpart–thatfirstphase. So, the entire reductioneffortwillhave tobe concentrated in the fiveyearsthathavejuststarted,withasignificantimpactintermsofcosts.Inthesecondplace,toachievethisresult,ETSwillhavetobemanagedwithagreaterseverityandthe initial allocation of the quotas demands greater inflexibility. The nationalallocationplansapprovedbytheCommissionfor2008‑12reflectasensitivitytotheseissues(Brusselshasissued1,439permitsversusthe1,570requested),butthis–and,in junction, the prices of quotas,whichwent back to pre‑2006 levels – allows topredict that the second phase will have tangible costs for the enterprises andconsequentlyforconsumers,unlesseconomiccrisisissolongthatforseveralyearscarbonpricesarelowasaconsequenceoflowindustrialactivityandloweconomicgrowth(orrecession).

Other authors, such asEllermanandBuchner (2006), arguedon the contrary thatover‑allocationdidn’t takeplace. Inordertoreachsuchconclusion,theydefinedabenchmark on the basis of 2005 business as usual emissions,whichproved to behigherthanboththeallocatedpermits,andtheactualemissions.However,asStefanoClò (2008, p.10) shows, their analysis “does not indicate how much the ETS iscontributingtoemissionsreductionsinEuropecomparedtothenon‑ETSsectorsandthus to which extent the member States rely on the ETS to achieve their Kyotoemissions reduction target”. By relying on a counter‑factual scenario, indeed,

34

http://europa.eu/rapid/pressReleasesAction.do?reference=IP/08/787&format=HTML&aged=0&language=EN&guiLanguage=en35http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/794.

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EllermanandBuchnerwerenotable toavoidpossiblebiasesdue to the fact that,among other reasons, the amount of emissions produced before 2005 by the ETSinstallationswasunknown(GrubbandFerrario2006).

Over‑allocation may have significant, negative consequences (Stefano Clò 2008,pp.23‑24).Assuming the overall reduction targetwill still bemet, over‑allocationmeans that part of the reduction burden will be shifted onto non‑ETS sectors.Alternatively,nationalgovernmentsmight takecareof themissingallowances,bydirectlybuyingcredits,orindirectlybysubsidizingnon‑ETSsectors:inthiscase,partof the burdenwould be shifted onto tax payers. Also, over‑allocationmake lessurgent for the ETS sectors to buy international credit,with the consequence thatnational governmentswould buy them (Neuhoff et al. 2006). Finally, the overalltargetmightsimplybemissedbecauseofover‑allocation,ifneitheroftheabovewasdone(ornotenough)–atvirtuallynoeconomiccost,butathighpoliticalcost.

The inherentlypoliticalnatureof theallocationalsoshowsanother side, that is,aunfairnessinthedistributionofpermitsamongstthememberStates.Countrieswhichare relatively less polluting such as Italy have been penalized,while othermorecarbon‑intensivenations(aboveall,Germany)issuedanexcessivenumberofpermitsinthefirstphase.Fromthispointofview,thesecondphasedoesnotseemtobringabout anything new. It is true that the Commission has cut the proposal of thememberstates;however,byfairlycutting,ithaspreservedthelackoffairness.AlltheEuropeancountriesobtainedthegreaterpartoftheimprovementinenergyintensitybefore1997(theyearwhentheProtocolwasnegotiatedinKyoto)andforreasonsthatare independentofclimatepolicies;but thosewhohavedonemorearecalledtoahardercommitmentthanthosewhoinsteadachievedless.Thosewhohaveanenergymixbasedongas, the cleanest fossil fuel,donotget rewardedas comparedwiththosewhomassivelydependoncoal.Andthosewhohaveagreatermarginalcostofemissionreductiondonotenjoyanyadvantage,althoughthatindicatesthatapieceofthepathhasbeenwalkedalready.Inthisway,wegettotheparadoxicalsituationforwhichthosewhoarelessenergy‑efficientget,infact,favourabletreatment(Table2).

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Country Balance[Megaton]

EnergyIntensity[Tep/M€2000]

CarbonIntensity[TonC02/Tep]

Austria ‑1 150 2.21

Belgium 3 203 1.97

Denmark 14.4 105 2.50

Finland 12 230 1.59

France 19.1 177 1.40

Germany 21 162 2.33

Greece ‑0.1 200 3.08

Ireland ‑3.1 112 3.06

Italy ‑9.5 152 2.42

Luxemburg 0 184 2.64

Netherlands 6.1 183 2.17

Portugal 0.4 210 2.32

Spain ‑10.8 194 2.36

Sweden 3 175 0.96

UK ‑36.4 132 2.43

Table 2. Net balance 2005 (allocated emissions – verified emissions), energyintensity and carbon intensity in EU15 in 2005. Source: EuropeanCommission2007.

Please note that amongst the countries that have recorded an important negativebalance(Italy,Spain,UK),Italyistheonlyonethathasrecorded,in2005,anear‑zeroeconomicgrowthrate.36Unlesswetakeintoaccountthepoliticaldynamicsbehindthe initial allocation, the 21million ton CO2 excess reported by Germany is notcomprehensible. It is truethat, in2005, thiscountryreduceditsemissionsby2.3%(23.5milliontons)below2004,butthatismainlydueto“ashiftfromcoaltogasintheproductionofpublic electricity andheat” and by the reduction of “emissionsfrom road transportation and from households and services”. Furthermore, adeterminingelementhasbeenamildwinterandtheconsequentlowdemandduring 36In2005,Italy’seconomicgrowthwasaslowas0.1%,ascomparedwithSpain’s3.6%,UK’s1.8%,andanaverageGDPgrowthfortheEU15of1.6%.

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thecoldestmonthsoftheyear.37Atanyrate,virtuallynoneofthatcanbeattributedtoETS.ThesamecanbesaidofFrance,whichfurthermoreproducesabout80%ofitselectricitywithnuclearpower,whichhasnoemissionsbutwhichhasbeen,andtosomeextentstillis,stronglysubsidized.

Thesubstantialfailureofthefirstphase,therefore,impliesagreatereffort–thatis,cost–inthesecondphase.Thesimplefactthatthevalueofallowanceshasgonebacktoover€20asPhase2began– leavingaside the following fall,mainlydue to theeffectsof theeconomiccrisis,not toemissions reductionsdue to theETS–bringsbackasvalidaseriesofestimatesonthecomprehensiveimpactofthereductionsthatwereimplementedbeforeorshortlyaftertheenforcementofETS.TheBrussels‑basedthinktankInternationalCouncilforCapitalFormationhasestimatedthecostforItalyofreachingoftheKyototargetsintoalossofGDPashighasupto2%peryearbelowthe business‑as‑usual by 2010 (ICCF 2005). Furthermore, the awareness of thesubstantial failure of the first phase has caused the Commission to pay greaterattentiontothesecondphaseand,lookingahead,tothethirdone.Anditisonthelatterthatitisnecessarytofocus,bothbecauseitislatetointerveneondynamicsthatarealreadyinmotion,andbecausethesizeoftheobjectiveembracedbyEuropeismuchmore ambitious:we are talking about 20% less emissions than 1990within2020,intheeightyearsfollowing2012.IftheKyotoobjectivearetobereachedandthusonDecember31st,2012theemissionsoftheEU15willbe8%lowerthan1990,Europeshouldproceedwithanaveragecutof‑2.1%peryear,whichissignificantlygreaterthanthe‑1.1%peryearneededduringtheperiod2005‑2012.38

Totheneedtosetupasystemofrulesthatiscertainandstable–aneedmadecogentby the size of the objectives andby the short time span inwhich they should bereached–andtotheneedforequity,theobservationonthehighlevelofinefficiencyofthesystemasawholemustbeadded.StefanoClòwrites:“permitsover‑allocationto ETS sectors implies that these sectors will have a lower need to recur tointernational credits to be acquired to complywith national emissions reductiontarget;thusFinanceMinistersandtax‑payerswillpayforthesedirectly,transformingtheinternationalKyotoflexiblemechanisminalargelypublic‑fundedmarkets”.Andagain:“Thisdifferenttreatment[inthevariousmemberStates]impliesthat,despitebeingsubjected to thesameEuropeanregulation,different firmscompeting in thesamemarket have to bear different environmental costs depending on the Statewheretheyarelocated”.Thisintroducesafurtherdimensionofunfairness.Thelastpointconcernsthefactthatthecompliancecosts–verylowinthefirstphaseand,probably,veryhighinthesecond–arejustapartofthepicture.Theadministration

37http://www.eea.europa.eu/pressroom/newsreleases/eu‑greenhouse‑gas‑emissions‑decrease‑in‑2005.38Inthebeginningof2005,theEU15emissionswere0.9%below1990,sointhesevenyearsbetween2005‑2012(whentheFirstandSecondETSPhasestakeplace)theEU15’semissionsaresupposedtodecreasebyfurther7.1percentagepoints.

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costoftheETSmustalsobeconsidered,and,inparticular,theeffectthatmessagesthat are alternatively reassuring or disturbing about the future regime have oninvestments.Absentcertainty,companiesdonotinvest,andtheresultisnotonlythatof reducing the reciprocal competitive pressures, but also – especially from theenvironmentalpoint of view– to reduce the rate of technological innovation andthus, paradoxically, to create an opposite thrust to the objective declared by thepolicies,thatofreducingemissions.Themissedorlateadoptionofinnovativeandmoreefficienttechnologies,infact,translatesintoarelativeincreaseofemissions.

3.4.Thenewdirective

TheEuropeanCommissionisawareofallthesecriticismsbutitfindsitselflockedbycommitmentsmadeperhapstoolightly.So,inrecentmonths,wehaveseenintenseworkofrewritingofdecisionsmade,culminating inthechangeof theobjectiveofrenewableresources from20%ofprimaryenergyconsumptionto20%ofthe finalconsumption.Thisisnosmalldifference.Noristhisdecisionwithoutrepercussionsonthetargetofemissionreductions.Infact,asClòandVerde(2007)show,thecutofemissionsby20%beyond1990wasadefactoobjectiveimplicitintheothertwothatconcernedtheenergyefficiencyandgreenenergyquotas.Thechangeofcoordinates–whichsignificantlyreducethescopeofthecommitment,althoughitstillremainsveryambitious–togetherwithotherfrictionswehavealreadyhighlighted,madearethinkingofETSindispensable.

Thenewdirectiveintroducessubstantialchanges,someofwhicharequestionable.Itsgreatest flaw is in the zone of uncertainty which the directive says it wants toeliminatebut insteadamplifies.Beyond the statementsofprinciplewhich changelittleornothing, rightoff thebat thedirective sets fairgeneralobjectives, suchasharmonizingtheemissionmarketandcreatingmaximumpredictabilityandstabilityofchoices.Furthermore,itishonestlyrecognizedthat“theenvironmentaloutcomeofthe1stphaseoftheEUETScouldhavebeenmoresignificantbutwaslimitedduetoexcessive allocation of allowances in some Member States and some sectors”.39Notably,theCommissionclaimsthatETS“representsthespearheadand‘oneofthemost important instruments’ of EU climate policy due to its ability to achieveabsolute emission reductions in an economically efficient manner”.40Thereis,though,noagreementonthisveryissue(NorregaardandReppelin‑Hill2000).

39EuropeanCommission,COM(2008)16,p.2.40EuropeanCommission,“ProposalforaDirectiveoftheEuropeanParliamentandoftheCouncilamendingDirective2003/87/ECsoastoimproveandextendthegreenhousegasemissionallowancetradingsystemoftheCommunity”,COM(2008)16,23January2008,http://ec.europa.eu/environment/climat/emission/pdf/com_2008_16_en.pdf,p.2.

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Thenewdirective foresees the extensionof theETS to otherplants or sectors forwhichitispossibletomonitoremissions.41Alinearpathofemissionsreductionsisforeseen.Startingfromthemediumvalueofthesecondphase,itleadstothetargetof2020.Withinthisgeneralcriteria, thedirectiveproposalsuggeststheovertakingofthenationalallocationplans, tobeachievedbyadoptingaunifiedcommunitariancaptoreachinatimeperiodlongerthanthefiveyearsofthefirsttwophases.Infact,“providesalong‑termperspectiveandincreasedpredictability,whichisrequiredforlong‑terminvestmentsinefficientabatement.Thiscanbebestachievedbyan8‑yeartrading period until 2020 and a linear reduction of the cap that continues thereductionpathbeyond2020,therebygivingaclearmessagetoinvestors”.42Theotherfundamental choice concerning the third phase is about the passage fromgrandfathering to auctioning in the allocation of quotas, such as to guarantee“efficiency of the ETS, transparency and simplicity of the system and avoidsundesirabledistributionaleffects”.43

Thus,accordingtotheproposeddirectivebytheCommission,startingfrom2013,allquotasforthethermoelectricsectorwillbeallocatedthroughauctions.Thischoiceseemstocollimatewiththepreferencesofthemajorityofeconomists,whorecognisetwo advantages in allocation through quota auctioning: less exposure to politicalwhim(JoscowandSchmalensee1998),andtheabilitytogeneratetaxincome.Infact,theaddedvaluecreatedbythepermitsdoesnotstaywiththeenterprisesbutismadeavailabletothecollective.Thislastpointisopentointerpretation:itisnotcertain(infact,thecontraryismorelikely)thatalargerflowofresourcestopublicfinancescanbeconsideredadvantageous,both fromtheenvironmentalperspectiveandthatofpropermarketoperation.Itistruethatthechoiceofgrandfatheringcreates,duetoitsverynature,anentrybarrier.But,ultimately,it isclearthatthebarrierexistsinanauctioningsystemaswell.Thecostofentranceisinanycasehigherthanthatofthe“deregulation”scenario.Forthosewhoenter, thereis littledifferencewhethertheexpendituremustbefacedatthebeginningoftheyear,duringauctioning,oratanyothermomentbyturningtothemarket.

The firstargumentabout thegreaterneutralityofauctioningseems tohavebetterfoundations.Suchconcernsdisappear,however,assoonasonegoesonreadingtheEuropeandirectiveonemissiontrading.Inspiteoftheinitialcallforharmonizationandpredictability,theexceptionsseemfarmorenumerousthanthecasestowhichthe presumed rule is applied. One line after stating that allocation for thethermoelectricsectoristobeperformedthroughauctioningfrom2013on,thereportaddsthat,“inordertoencourageamoreefficientgenerationofelectricity,electricitygenerators could however receive free allowances for heat delivered to district

41Ibidem,p.4.42Ibidem,p.7.43Ibidem,p.7.

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heatingorindustrialinstallations”.44However,thefirmnessusedtopassfromfreedistributiontosaletothehighestbidderendshere:forallothersectors,thepassagefrom free distribution to auctioningwill take place gradually and in function ofseveralfactors.

It shouldbenoted thatenterprisesare told that, fromnowto theendof the thirdphase of ETS, a variable allowances quotawill bedistributed free of charge. Thequotawillbedifferentfromsectortosectorandfromyeartoyear,and,withinthesamesectorinagivenyear,itwillchangefromcasetocase.Butthereismore:iftheotherindustrialisedcountriesdonotcommittoreducingemissionsandif(butthereis no doubt about this) this establishes a competitive disadvantage for someEuropean enterprises, these will be able to enjoy special free‑of‑charge quotaassignments.Tothepoliticaluncertaintiesoverdistributionof freeemissionquotasisthereforeaddedthepossibilitythatfurtherfreequotas(subtractedfromwhom?Oraretheytodelaythereductionobjectives?)areassignedtothemostenergy‑hungryenterprises (whichones?And inwhich sectors?)according to the choicesofothersovereign nations. The definition of “certainty” which is in vogue in Brusselsapparently includes as avariable thepolitical choicesof anundefinednumberofforeigncountriesoverthenext12years.

Thepassagefromthereportwhichillustratesthedirectiveproposalthat“clarifies”themechanism–sotospeak–deservestobequotedinitsentirety:

For installations in other sectors [other than thermoelectric], a gradualtransitionisappropriate,startingwithfreeallocationatalevelof80%oftheirshare in the total quantity of allowances to be issued, decreasing by equalamountseachyear,arrivingatzerofreeallocationby2020. Intheeventthatotherdevelopedcountriesandothermajoremittersofgreenhousegasesdonotparticipate in an international agreement that will achieve the objective oflimitingglobal temperature increase to 2°C, certain energy‑intensive sectorsandsub‑sectorsintheCommunitysubjecttointernationalcompetitioncouldbeexposedtotheriskofcarbonleakage.45

ThiscouldunderminetheenvironmentalintegrityandbenefitofactionsbytheCommunity.TheEuropeanindustryshouldreceiveaclearcommitment thattheCommunitywilltakeappropriateaction.TheCommissionwillreviewthesituationby June2011at the latest, consultwithall relevant socialpartners,and, in the light of the outcome of the international negotiations, submit a

44EuropeanCommission,COM(2008)16,p.8.45Thatis,“theriskhighemittingindustriesareeitherdelocalizedtositesoutsidetheEUorthatcompetitorsoutsidetheEUtakeoverthemarketshareofEuropeancompanies.”Seehttp://www.europarl.europa.eu/news/public/story_page/064‑32904‑182‑06‑27‑911‑20080627STO32878‑2008‑30‑06‑2008/default_en.htm.

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reportaccompaniedbyappropriateproposals.Inthiscontext,theCommissionwillidentifyby30June2010whichenergyintensivesectorsorsubsectorsarelikelytobesubjecttocarbonleakage.Itwillbaseitsanalysisontheassessmentof the inability to pass through the cost of required allowances in productpriceswithoutsignificantlossofmarketsharetoinstallationsoutsidetheEUnottakingcomparableactiontoreduceemissions.Energy‑intensiveindustrieswhicharedeterminedtobeexposedtosignificantriskofcarbonleakagecouldreceive up to 100 % of allowances free of charge or an effective carbonequalisationsystemcouldbe introducedwithaviewtoputting installationsfromtheCommunitywhichareatasignificantriskofcarbonleakageandthosefrom third countries on a comparable footing. Such a system could applyrequirements to importers that would be no less favourable than thoseapplicable to installations within the EU, for example by requiring thesurrenderofallowances.46

Essentially,whatcanbeforeseenisanuncertain,unstableandunpredictablesystem,asthearbitrarinessoftheCommissionisatitsheight,and–presumably–theclashoflobbies in future years will rise to its height as well. The Commission’s designtherefore nullifies yet another of the advantages of auctioning – that is, the de‑politicizationofatleastthatsliceofallowancesthatwouldbeputupforauction.Itisnotclearhowallofthiscouldbeeffectedwithoutdistortingtheinternalmarket.ItseemsthattheCommissionisavictimoftheconflictbetweenefficiencyandequitythatwasdenounced,inconnectionwithacompletelydifferenttheme,byRockefeller(2007,p.52),whowroteon“theimpossibilityofencouragingwinnersandprotectinglosersat the same time”. By the same token, it isnotpossible topursueefficientallocation–wherethepermitsactuallygotothosewillingtopaymore–whichisfairat the same time. By fair, wemean being careful to not allow excessive growth(whateverthatmeans)inthecostsforsomelesssubstantialactors,whetherthesearerelativelylessdevelopedcountriesorconsumerswithlessavailableincome.

A similar uncertainty concerns the destination of the cash flow from auctioning.Although it remains available to themember states (and is therefore considerednormal tax income), “a certainpercentage of theproceeds from the auctioningofallowances should be used to reduce greenhouse gas emissions, to adapt to theimpactsofclimatechange,tofundresearchanddevelopmentforreducingemissionsandadapting,todeveloprenewableenergiestomeettheEUʹscommitmenttousing20%renewableenergiesby2020,forthecaptureandgeologicalstorageofgreenhousegases,tocontributetotheGlobalEnergyEfficiencyandRenewableEnergyFund,formeasures toavoiddeforestationand facilitateadaptation indevelopingcountries,and foraddressingsocialaspects suchaspossible increases inelectricityprices in 46EuropeanCommission,COM(2008)16,p.8.

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lowerandmiddleincomes”.47Eachofthesedestinations,aswellastherelationshipbetween them, implies a huge questionmark, as there is a very ampledefinitionwhich leaves enormous room for political arbitrariness. In some cases, such asincentives for renewable energy resources or the financing of social tariffs – thisoverlapsexistingprograms,introducesfurtherdistortionstotheelectricitymarket,andpotentiallycreatesconflictswithliberalization,sinceitlimitspricecompetitionbetweenelectricityservicesuppliers.

Itisnotthecaseheretogofurtherintothecomplex–and,needlesstosay,arbitrary–mechanismsoftherecognitionofcreditsmaturedthroughtheflexiblemechanismsofKyoto.TheCommissionstatesits intentiontodiscouragefreeridingbycompaniesthatoperateinnationswhichhavenotconcludedaninternationalagreement,exceptforthosecompanieswhichhavetheirheadquartersinthirdnationsoradministrativeentitiesconnected to theEuropeanemissionexchangesystem.Here too,what thismeans specifically, andwhich behaviours are and are not legitimate, is not andcannotbeclear.

Ingeneral,thereisnoindicationofeffortintheproposeddirectivetoputtogetherasystem which is what the Commission says it wants, and which is a clear andpredictable mechanism. The very choice of auctioning, with its function of thedepoliticisingof the initial allocation eliminatedor at any rate limited, seeminglyreducesitselftoaninfernalmechanism.Ontheonehand,themechanismactsasapre‑emptive taxonenterprises,whoobviouslywill attempt topass thecostsontoconsumers, in a total absence of transparency.On the other hand, it represents aformidable–aswellasinvisibletoconsumers,whorightfullydonotcareaboutthecostsofthemanufacturers–sourceof incomethatcanbedestinedtobothgeneraltaxation,andtoaseriesofpublicexpenditureswhichinterferewiththeprojectsinprogress and with the good functioning of the market. All that with a furtheraggravation: as the price of the emission quotas has been and probably will bevolatile, the public proceeds of the initial allocation can hardly be forecast.Consequently,governments from time to timewill find themselveswitha sortofunexpectedtreasureintheirhands,whichcanbefreelyexpended,virtuallywithoutanycriterion–averitablewindfallprofitforpublicfinances.

Theonlytrue–andwellquestionable–advantageofsuchasystemisthat,becauseofits complexity, itwill hardly be able to become the object of true public debate.Paradoxically in view of the premises, this allows an extremely high degree ofpoliticizationofthesystemineachofitsstages:intheinitialallocationofpermits,inthe possible additional allocations, in the concession of exemptions or facilitatedconditions, and in theuseof the revenues.Clearly, the supportersof a restrictivepolicyofcontrolofemissionshaveagoodgame in favouringpolicies thecostsofwhich are not visible to consumers (Stavins 1998). It is however natural to ask 47EuropeanCommission,COM(2008)16,p.9.

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ourselveswhetherallthisisinthepublicinterest–thatis,whetherthisiseffectiveinthereductionofemissions,andefficientinpursuingthisendatacontainedcostandwith the inductionof fewornodistortions in the internalmarket (under thenonobviousassumptionthatemissionsreductionsareinthepublicinterest,inthefirstplace). All in all, the impression is that the Commission is designing a sort ofmechanism which is strongly bureaucratic and politicized, and which has theundeclaredpurposeandthefundamentalfunctionofgeneratingafiscalincomeandtocreateopportunitiesforrent‑seekingforthecountries,theindustriesandthefirmsthatarepoliticallystrongerandmoreaggressive.

3.5.Thefinalcompromise

AfterthepresentationoftheproposeddirectivebytheCommissioninJanuary2008,awidedebateemergedbetweenmemberStatesand industrial sectors,whofoundseveralflawsintheproposedplan.Twoissueshavebeenemphasized:(a)theriskofcarbonleakageand(b)thehighcostsoftheplan.Atonepoint,awidecoalitionofcountries–includingItalyandtenEasternEuropeanmemberStates–threatenedtovetotheproposal,iftheirobjectionshadnotbeenconsidered.Inordertoachievethenecessary consensus, a number of concessions have beenmade.A version of theDirectiveamendedaccordinglyhasbeenadvancedbytheCommissionandapprovedby the European Parliament in December, with a strong support of the FrenchrotatingPresidency(secondsemester2008).ThenewDirectivewillreformDirective2003/87/EC,thatcreatedETS.

Therelevantchangesarethefollowing:

• ACommunity‑widequantityofallowanceswillbedefinedby30 June2010,thatwilldeclineinalinearmannerfromthemidpointoftheperiod2008‑2012by1.74%peryear(Article9);

• Allowanceswillbeeitherauctionedorallocatedfreeofcharge(Article10.1);

• Of the total allowances to be auctioned, 88 % will distributed among themember States proportionally to past verified emissions; 10 % will bedistributed between somemember States for the purpose of solidarity andgrowth;2%willbedistributedtomemberStates“whoseGHGsemissionsin2005wereatleast20%belowthereferenceyear”(Article10.2);

• TheuseoftherevenuesfromauctioningwillbefreelydeterminedbymemberStates,providedthatatleast50%oftherevenueswillbeusedforatleastonebetweenthefollowing(Article10.3):

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o to reduce greenhouse gas emissions, including by contributing to theGlobal Energy Efficiency and Renewable Energy Fund and to theAdaptationFundasoperationalisedbyUNFCCCCOP14inPoznan,toadapt to the impacts of climate change and to fund research anddevelopmentaswellasdemonstrationprojects forreducingemissionsand adaptation , including participation in initiatives within theframeworkof theEuropeanStrategicEnergyTechnologyPlanandtheEuropeanTechnologyPlatforms;

o to develop renewable energies to meet the commitment of theCommunity to using 20% renewable energies by 2020, as well as todevelopother technologiescontributing to the transition toasafeandsustainable low‑carboneconomyand tohelpmeet thecommitmentoftheCommunitytoincreaseenergyefficiencyby20%by2020;

o for measures to avoid deforestation and increase afforestation andreforestation in developing countries that have ratified the futureinternational agreement ; to transfer technologies and to facilitateadaptationtotheadverseeffectsofclimatechangeinthesecountries;

o forforestrysequestrationintheEU;

o for the environmentally safe capture andgeological storageof carbondioxide,inparticularfromsolidfossilfuelpowerstationsandarangeofindustrialsectorsandsub‑sectors,includinginthirdcountries;

o toencourageashifttolowemissionandpublicformsoftransport;

o to finance research and development in energy efficiency and cleantechnologiesinthesectorscoveredbythescopeofthedirective;

o formeasures suchas those intended to increaseenergyefficiencyandinsulation or to provide financial support in order to address socialaspectsinlowerandmiddleincomehouseholds;

o tocoveradministrativeexpensesofthemanagementoftheCommunityscheme;

• MemberStates“mayalsoadoptfinancialmeasuresinfavourofsectorsorsub‑sectorsdeterminedtobeexposedtoasignificantriskofcarbonleakageduetocosts relating togreenhousegasemissionspassedon inelectricityprices, inordertocompensateforthosecostsandwherethisisinaccordancewithstateaidrulesapplicableandtobeadoptedinthisarea”(Article10a.6);

• Theamountofallowancesallocatedfreeofchargewillbeashighas80%ofthetotalin2013,andwillgraduallybereduceddownto30%in2020andzero%in2027(Article10a.11);

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• Every5yearstheCommissionshalldeterminewhichsectororsub‑sectorsareexposedtosignificantrisksofcarbonleakage,buttheCommissionmayalsoaddasectororsub‑sectoratitsowninitiative(Article10a.13).

While someof the shortcomings of the earlier version of theDirectivehave beenapparentlyfixed,mostofthemstillremain(StefanoClò2009).Particularly,thehighlevelofuncertaintyregardingwhichsectorsandsubsectorswillenjoytheallocationof free of charge allowances is not reduced. This will comparatively reduce theamount of investments in innovation or measures that might actually reduceemissions.ThefactthatnotjusttheCommission,butalsomemberStatesareallowedtoputinplacemeasuresastoaddresstheriskofcarbonleakage–or,morebroadly,of competition from firms based in non‑restrained markets. Here the paradoxemerges:ifnoprotectivemeasureistaken,ariskofdelocalization(whichwouldatbestleavetotalemissionsunchanged)arises;ifcarbon‑intensivesectorsorsubsectorsarepartlyortotallyshelteredfromtheeffectsofETS,eitherthereductionburdenwillbeshiftedontoothersubjects,ortargetswillbemissed.

Themostrelevantchangewithrespectwiththeearlierversionofthedirectiveisthatthetransitiontowardsa100%auctioningsystemissignificantlydelayed.Insteadofreachingthetargetof100%auctioningin2020,thetargetwillbereachedin2027,7yearslaterthanoriginallyplannedaswellas7yearsafterthepolicywillbeexpired.In2013–thefirstyearofapplicationofthedirective–only30%oftheallowanceswillbeauctioned.Despitethenumerouscallsforfairnessandnon‑distorsivemeasures,thedifferencebetweensectorssuchaselectricity,thatarerequiredtobuyallowancesfrom the very beginning, and others thatwill be exempted from buying permitsmightcreatedisparitiesoftreatmentthatmaynotbefullyjustified.

Moreover,andperhapsevenmostimportantly,thepotentiallydistorsiveeffectoftheuseoftherevenuesfromauctioningisstillinplace.Theveryeffectofacap&tradeschemeissupposedlytocreatealevelledplayingfield,wherebycarbon‑basedenergysourcesandcarbon‑intensive industrialprocessesaremademorecostly, and low‑carbonorcarbon‑freetechnologiesaresubsequentlyadvantaged.Theoretically,iftheoverall cap is sufficiently stringent and ifnot toomany sectors or subsectors arerecipientof freeof chargeallowances, therewouldbe littleornoneed for furtherincentivesorsubsidies.Infact,thelattermightevendistortthewellfunctioningoftheelectricitymarketorothermarkets,byinducingapoliticalallocation,ratherthanan economically efficient allocation, of resources. On the top of that, renewableenergysourcesandotherlow‑carbonorcarbon‑freetechnologiesarealreadystronglysubsidizedthroughanumberofpolicymeasures,including(butnotlimitedto)greencertificates,whitecertificates,feed‑intariffs,mandates,etc.

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3.6.Analternativeproposal:thecarbontax

Thechoiceofasystemoftradablepermits,madebyEuropeatthemomentwhenitlaunchedETS,respondstomanyreasonableconsiderations.Theoldinstrumentsofcommandandcontrolprovedthemselvestobeinefficientandoftenevenineffective.That is evenmore true in a case suchas that of greenhouse emissions,whicharecreatedbyanextremelyhighnumberof sources (virtuallyany livingbeingemitsgreenhousegasesandevenwhenwelimitourselvesonlytohumanactivities,everyproductionprocesscreatesCO2andotherGHGs).Thecostsofinformation,andwiththemthoseofcontrolandenforcement,arethereforeveryhigh.Andnotonlythat:todefinetechnologicalorperformancestandard,inthiscase,isverycomplicated.Thatis because not all processes can obtain the same results. In some cases, it istechnologically and economically possible to pursue consumption or emissionreductions,andalternativesareavailable.Inothercases,thatdoesnothappen.Thenumberofscientificuncertaintiesandthenecessarilylong‑termprojectionofpolicies–which should take technologicalprogress into account –multiply the risks thatregulationwillfail.

In such a situation, powers of discretion are indispensable, and they represent astrongtemptationforrent‑seekers,andmakeitalmostcertainthatregulatorswillbecaptured.

Thealternativestocommandandcontrolareeconomicinstruments,which“provideanexplicitpricesignal toregulatedfirmsand individuals” (Hepburn2006,p.228).Theseinstrumentsconsistofinstrumentsbasedonpriceandthosebasedonquantity.Becausea regulationofquantitiesassignsan implicitprice to thegoodssubject toregulation–generally,apollutingsubstance,theemissionsofwhicharethetargetofreduction–inidealconditionstheresultofthetwoinstrumentswouldbeidentical.Itisalsopossibletoconceivehybridforms,forexample,regulationofquantitieswithapricecap,apricefloor,orboth.

Intheory,andintheabstract, there isnoreasontopreferone instrumentovertheother (Requate 1993). This is because they are equivalent under ideal conditions.However,whenwedescendfromtheorytopractice,thingschange.Thereareseveralissuestoconfrontthatcandirectthechoiceineitheroneortheotherdirection.Themainthemesconcerntheefficiencyofthepoliciesintherealworld,therelativeriskofregulatorycapture,theextensionofuncertainties,andalsomoregeneralquestionssuchastransparency,thedistortingeffectofthemarket,andpoliticalacceptability.Finally, considerations concerning transaction costs underlying the creation of anexplicitmarketwithinaregulationofquantitiesareofimportance.Tothisend,wewill consider here two options: the ETS on one hand – which assigns a cap togreenhouseemissionsandallowsamarketforemissionquotas–andthecarbontaxon theother,which should reduce consumption (and thus emissions) throughan

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increaseofthepricesofproductsorserviceswhicharesuspectedofcontributingtoglobalwarming,thatis,fossilfuels.

Fromatheoreticalpointofview,littlecanbesaid,especiallyintermsoftheincentivetoinnovatethatdifferentpoliciescancreate.Apparentlythereisnoapriorireasontoprefer either one (Downing andWhite 1986;Milliman and Prince 1989). Requate(1998)arguesthat,whilebothpolicyinstrumentscanbepreferableunderdifferentconditions, a tax systemmight prevent a real competition betweennon‑pollutingtechnologies. On the contrary, Weitzman (1974) shows that – in a situation ofuncertaintyaboutmarginalcosts–apriceinstrumentismore,orless,efficientthananinstrumentofquantitywhenthecurveofmarginalbenefits isrelativelyless,ormore,steepthanthatofmarginalcosts.Inthecaseofglobalwarming,asHepburn(2006,p.232)observes,“supposethemarginalcostofreducingemissions increasesquickly aswemove from eliminating the cheap, ‘low hanging fruit’ on tomoredifficult sources of emissions (e.g. aviation transport). Suppose also that, becausedamagesfromclimatechangeareafunctionofthestockofgreenhousegasesintheatmosphere, theyareonlyaweak functionofemissionsover shortperiods (e.g.5years), so that the marginal benefit from abatement is relatively flat. In suchcircumstances,apriceinstrument–acarbontax–istheappropriateinstrumenttouse.”Theseassumptionsareconsistentwiththeavailableevidence.

Infact,themarginalcostsofemissionabatementareclearlygrowingwitharelativelysteepcurve.Inthemoreenergy‑efficientcountries,suchasItaly,tocuttheemissionsis far more expensive than in countries that are less energy‑efficient, such asGermany, let alone countries that are far less efficient such as the emergingeconomies, includingChinaand India.Think, forexample, that theefficiencyofacoal‑poweredplantinEuropeexceeds40%,whileinChinatheaverageefficiencyisaround20%.IfitwerepossibletoexportEuropeantechnologytoChinaforallnewinstallations, itwouldbepossible toobtain,ata relatively lowcost,amuchmoresubstantial result of the objectives of theKyoto protocol, assuming that they arereachableandthattheyareactuallymaterializinglater.AccordingtotheprojectionsofMontgomeryandTuladhar(2006,p.4), theadoptionofanAmericantechnology(lessefficientthantheEuropeantechnology)forthenewinvestmentsintheelectricsectorinChinaandinIndiacoulddetermine,in2012,anemissionsavingsmorethanfourtimesgreaterthanthedomesticobjectivesoftheEuropeanUnion.

Conversely,themarginalbenefitofemissionreductiongrowswithaverymildcurve,astheforcingofclimategrowslogarithmicallynexttotheatmosphericconcentrationofgreenhousegases.48Nordhaus(2007,p.126)writes:“ thestructureofthecostsand

48Onceaverylowthresholdispassed(about50ppminvolume),eachdoublingoftheconcentrationsdeterminesanequalincreaseoftheforcing,about3.7wattspersquaremeter.Thus,ifwemovefromaCO2

concentrationof280ppmv(thatofthepre‑industrialera)to560ppmv–double–theforcinggrowsby3.7wattspersquaremeter;ifwegofrom560to1,120ppmv,theincreaseofforcingisstill3.7wattspersquare

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damages inglobalwarminggivesa strongpresumption toprice‑typeapproaches.The reason is that the benefits of emissions reductions are related to the stock ofgreenhousegases,whilethecostsofemissionsreductionsarerelatedtotheflowofemissions.This implies that themarginal costsof emissions reductionsarehighlysensitive to the level of reductions, while the marginal benefits of emissionsreductionsareinsensitivetothecurrentlevelofemissionsreductions”.

In these conditions, an instrument of price regulation seems preferable to one ofquantityregulation.

To these considerations on efficiency we can add one concerning the properoperationofthepolicies.Fromtheinstitutionalpointofview,thecreationofamarketforemissionquotassuchasETS–destinedtohaveagrowinglevelofcomplexityandinclusiveness – implies a commitment, that is, amobilizationof resources for themanagingandthemaintenanceofthenecessaryadministrativeinfrastructureswhichisfarsuperiortothatofacarbontax(Helm2005).ThatindicatesacriticalityintheEuropeanstructure:theUnionhasdecidedtogivebirthtoanewbureaucracythatadministersasystemfromwhichthedestinyofalargepartofEuropeanproductiveactivitydepends.Thedecisionsneverhaveanexquisitelytechnicalnature,butcomefrompoliticalevaluationsorfromdifficultandunstablebalancesofpowerbetweenlobbies andmember States, andwithin each of these groups.What isworse, theboundariesbetweenthesecomponentsofthedecisionalprocessarefuzzyandhardlydistinguishable. All in all, it is virtually impossible to know whether a certaindecision– for example, to includea sector in theETS, allocationof free‑of‑chargeallowances,distributionofbindingobjectives–comesfromtheworkofoneormoretechnicalstudygroups,orfromthepersuasiveargumentspresentedtopolicy‑makersinsmoke‑filledrooms.

Thisuncertaintyaboutthefuture–andaboutthedecisionsthatwillensue–providesavalidargument in supportofa carbon taxasopposed toa cap& tradescheme.Becauseofitsnature,acarbontaxguaranteestoptransparency.Everyoneknowsthatfor each ton ofCO2produced, theywillhave topay, say, €25 (just to indicate anamount in line with the forward prices of the emission quota on ETS which isconsistent aswe shall seewith the suggestions of climate economists). To obtainmaximum transparency it would be appropriate to imagine a system oftransferability, so that the tax is (or at least may be) entirely passed on to theconsumer.Thatmeetstheneedtogivetheconsumerthefunctionofallocatingtheemissionreductions in themostefficientway, that is,away that respondsononehandtoacostcriterionandontheothertotherelativereplaceabilityofproductsatgreateremissionintensity.Inthisway,themarketwouldbefreetooperate,although meter(today,theconcentrationsareabout380ppmv).Itfollowsthat,nomatterthecomplexityofrelationbetweenemissions(aflux)andconcentrations(astock),eachemissionunitsaveddeterminesasmallerincreaseoftheforcinglessthanwasduetothepreviousunit,whichinsteadwassentintotheatmosphere.

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underasubstantialbondturnedtopenalizethoseproductiveprocessesthatarethemostenergyintensiveand,upstream,thefossil fuels.Thetransferabilityof thetaxdemands, of course, the traceability of the emissions. But that is possible withrelatively low costs, as almost all the reducible emissions come from fossil fuelscombustion.Thus,themonitoringmustconcernonlythefuelsandthepaththattheyfollowtoreachthefinalconsumer.

Apparently,thetransferabilityofthetaxlendsitselftoasubstantialobjection:itcoulddiscourageinnovationinprocessesorproductsthatcuttheemissions.Infact,thecostof innovation falls on the enterprise,while the saving (the tax that is reduced orcancelledbecauseoftheeffectivereductionofemissions)goestotheadvantageoftheconsumer.Inpart,thisproblemsolvesitself:althoughthedirectadvantagegoestotheconsumer,theultimateresultisthattheretailpriceoftheproductinquestionislowerand thus–allotherconditionsbeingequal– thedemand increasesand themarketshareof the innovativeenterprisegrowsasaconsequence.Butevenif thiswerenotenough– that is, if theadditionalprofits fromthegreatersaleswerenotsufficient to cover, in a reasonable amount of time, the cost of investments – thesystemcouldbereinforcedbyrecognizingataxcreditorotherformsofwrite‑offsofthe investments employed to reduce emissions. It is obvious that this foresees aspreadandsharingofinformationespeciallyconcerningbenchmarkingtoevaluatethe innovative contents of the investments, but it certainlydefines amore linear,predictableandcertain system than thatwhich is stronglybureaucraticandbuiltaroundETS.

Bythesametoken,acarbontaxseemslessdistortingofthemarketthanthecurrentcap&trade,becauseofasmalleradministrativestructureandgreaterpredictability.Itistruethatatax,justliketheemissionsceiling,canbereviewedatanytimeandincreased,thusnullifyingtheprojectsofenterprisethatwerebasedontheearliertax.InthecaseofETS,however,tothepossibilityofmoreorlessoccasionalchangesinthestructureofthesystem,wecanaddacertainamountofuncertaintyonhowtheETSwillbeapplied,whichsectorswillbeactuallycalledtocontribute,inwhatwaythegratuitousquotawillbeallocated,etc.Toallthat,twofurtherelementsmustbeadded. In the first place, a system like ETS required the assignment of sectoraltargets,andthusnotonlydoesitimplyasignificantdegreeofarbitrariness,butalso,dueto itsownnature, itcreatescontinuousclashesof lobbygroups.Inthesecondplace, andmore importantly, a carbon tax is the only way to call all sectors tocontribute in the most efficient way to emission reductions. Besides its internallimitations,ETSisalsolimitedtoafewsectors,andthereforecoversonlypartofthepartiesinvolvedinemissionreductions.Asaresult,ETSaddsitselftootherpublicpolicies – which can be of the command and control type but also subsidies orregulatoryincentivesofvariouskinds–whichinturninducedistortionsandhighcosts.Conversely,acarbontaxbecauseofthewayitworkswouldsubstituteforallthatandrequire,ifnotatotalcancellation(whichwouldbedesirablenevertheless),at

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least a process of resizing, rationalization and simplification of the subsidies,particularlyasconcernsrenewableenergysources.

Thisleadstoanother,two‑foldbasictheme:whatisthepurposeofatax?Itisobviousthat,inarealisticperspective,andbeyondthereasonsthatjustifyitsimposition,ataxhasthesolepurposeofcreatingpublicrevenues.Inthiscase,however,asAlbrecht(2006,pp.89‑90)explains,“Environmentaltaxescan,however,beinstalledwiththepurposetochangebehaviororwiththepurposetocollectrevenues…Consequently,thetaxrevenueswillalsoshrinkwiththetaxbase”.Itisprobable,however,thattheconsumptionreductionwilltakeplaceslowly,givenboththescarceelasticityofthedemandforenergyproductsinabroadsense(transportincluded),andthelongtimesoftheinvestmentsreturnincapital‑intensiveindustries.Thus,theconcernsforthereductionof income shouldnot lead to anyparticulardecision in the short term.Albrecht suggests (and this is consistent with the proposal here advanced ontransferabilityof the tax) insertingenvironmental tax (includingacarbontax) inageneralreformofconsumptiontaxes.Inthesecondplace,whatistobedonewiththeincome of the carbon tax? Should the member States use it, as the EuropeanCommissionwould like to dowith a part of the income from the auctioning ofpermits,tofinanceenvironmentalprograms(whatevercouldbeincludedunderthislabel,read:anything)doesnotseemareasonablesolution,as itcausesdistortions.Furthermore, the carbon tax assigns an implicit advantage to sources andtechnologiesthatare“clean”,butalsoputsthemallonthesamelevel.Conversely,incentive programs assign differentiated subsidies, further misrepresenting theoperationofthemarket.Sinceoneoftheeffectsofacarbontax–andthemainonefromthepointofviewofconsumers–istheincreaseinthepricesofconsumptiongoods includingsomethatarewidelyusedandconsidered indispensable, suchaselectricity and transportation fuels, it seems that the request to cut the reformofenvironmental taxationtofit theprincipalof fiscalneutralitymakessense.Table4showstheincreasethatsomeproductswouldundergointheabsenceofareformoftheenvironmentaltaxifa€25perCO2eqtoncarbontaxwereimposed(inlinewiththeETSprices,butmuchgreaterthanthatwhichNordhaus(2007,p.23)considerstobetheoptimalshort‑termtaxintheeventofglobalparticipation).49ThechoiceofsuchahightaxisjustifiedbothbythecoherencewiththeindicationsfromETS(whichdoesnotreflecttheoptimalobjective,buttheadministrativeoneofreducingtheemissionsby8%belowthe1990levelby2012),andbythefactthatEuropeisaloneinitseffortisnotandprobablywillnotbepartofaninclusiveglobalstrategy.

49“Intheidealworld,thecarbonpriceorcarbontaxwouldbe$27permetrictonin2005in2005prices.(Ifpricesarequotedinpricesforcarbondioxide,whicharesmallerbyafactorof3.67,theoptimaltaxis$7.4pertonCO2)”,Nordhaus(2007),p.23.

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Product Emissions Carbontax€25/tonCO2

Transportation [kgCO2/litre] [Eurocent/litre]

Greengasoline(*) 2.35 5.87

Diesel(*) 2.60 6.5

Electricgeneration [kgCO2/kWh] [Eurocent/kWh]

Naturalgas(#) 0.40 1

Oil(°) 0.73 1.82

Coal(§) 0.91 2.27

Table 4. Simulation of price increases of some energy productswith a €25/tonCO2eqcarbontaxintheabsenceofanenvironmentaltaxreform.(*)Emissionsduetocombustionalone;7‑10%shouldbeadded to take intoaccount theemissionsconcerning refining and transport. (#) Combined cyclewith 50% efficiency. (°)Steamturbines,counterpressure/condensation/conventionalwith38%efficiency.(§) Steam turbines, counterpressure/condensation/conventional with 37%efficiency.Source:ownelaborationfromvarioussources.

Clearly, we are talking about significant figures, which must be handled withextremecaution.Thedoubleobservationthat,ontheonehandthecarbontaxerodesthebuyingpowerofincomeandthatontheotherhanditisappropriatethatthetaxistransmittedtotheendconsumersoastoobtainthemostefficientallocationofthereductions,suppliesuswithanindicationastohowtoutilizethe“littletreasure”.Itcanbeprofitablyemployedtoreducetheincometaxrates,whichinturnisastronglydistortingtax.Nordhaus(2007,p.129)argues:“Ifthecarbonconstraintsareimposedthrough taxes,and the revenuesare recycledbyreducing taxesonothergoodsorinputs,thentheincreasedefficiencylossfromtaxationcanbemitigated,sothatthereisnonecessaryincreaseindeadweightloss”.

Thereductionofincometaxes(personalandcorporate)is,inacountrysuchasItaly,apriorityregardlessofclimatepolicies(Giannino2007).Ifthisroadcouldbepursued,theimpactofEuropeanclimatepolicieswouldbemoretolerable.Andnotonlythat:a(difficult)strategyofcomprehensiveoverhaulofthefiscalsystemthatputstogetherthe introduction of carbon tax with the reduction of the income tax and therationalizationand significant reductionof subsidiesof renewable energy sourcescould,paradoxically,andalthoughthecausesarecertainlydebatable,determineanimprovementof the fiscalandnormativeenvironment inEurope,andcertainly inItaly.Atleastthedeadweightlosswouldbereduced,whichisduetotheco‑existenceofseveraltaxes,allofwhichmoredistorsivethanacarbontax.Thiswouldbedonebyintroducingcertaintyandtransparencyandbytrulydelegatingtothemarket–

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although altered by an emission tax – the task of allocating emission reduction.Furthermore, by inducing general relief of fiscal pressure, the carbon tax couldrepresent an important element in the restoration of competitiveness on the oldcontinent. Of course, such a restorationwould not be absolute, but it would beeffectiveifpartofacomprehensiveprojectandrelatedtothecurrentsituation.

Boththecarbontaxandacap&tradesystemhavetheeffectofincreasingthefinalpricesof a seriesofproducts.But,while the cap& trade seems toproceeddownmysterious paths, the tax acts in visible mode. This visibility establishes twoconsequences. Inthefirstplace, itallowsgreaterpricetransparencyandgives lessgrounds for vaguelypopulistic protests,while offering fewer reasons for policiesheavily oriented towards price control inmomentswhen, for themost disparatereasons, thepricesgobeyonda level that isarbitrarilyconsideredtoohigh. In thesecondplace,eventheregressiveeffectsofthecarbontax–whichare,insubstance,the same as the cap& trade – aremore visible. The impact on society becomes,therefore,equallyvisible,andtheneedtoupgradethefiscalsystembecomesmorefeltevenfromthepoliticalpointofview.

3.7.Wouldacarbontaxwork?

Thesimplesimulationabove,provides little informationabout therealextentofaprice‑basedpolicy.Moreinformationarerequiredinordertoassessitsusefulness.

Asitwasrecalled,acarbontaxof25€/TonCO2eqwouldimposeanextra‑costofc€5.87and6.5perlitreofgasolineanddiesel,respectively.Astoelectricity,theaverageincreaseonthegenerationcostperkWhwouldbec€1.39.Thecontributionofeachsingle carbon‑based sourceof energyhasbeenweighed for its own shareof 2007generation(in2007,7.2%of thegrosselectricitygeneration in Italycamefromoil‑fuelledplants,55%fromnaturalgaspowerplants,and14%fromthecombustionofsolidfuels–seeTerna2008).Itisassumedthat,intheshortrun,suchpriceincreasesshallnotinducechangesintheItaliangenerationmix,asmostoftheexistingpowerplants are not yet fully amortized, the life cycle for this kind of capital asset isrelativelylong,andanywaythetimeforlicensing,authorizations,andconstructionofnewplantsisatleastafewyearslong.

In2007,theaveragepriceforelectricityintheIPEX(theItalianelectricityexchange)wassome71€/MWh(GME2009),equalto0.71€/kWhor71c€/kWh.Theaveragepriceofgasolineanddieselwas,respectively,1.343and1.204€/litre(UP2009).Asaconsequence, theaverageincrease inpriceswouldhavebeenby2%forelectricity,and4.4and5.4%,respectively,forgasolineanddiesel.

To understandwhat consequencesmight follow, one should look at the demandelasticityforenergy.Priceelasticityforelectricityisgenerallyfoundrelativelylowin

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empirical studies, especially in the short run. Elasticity in the long run might,however, bemore significant.A reviewof themost recent studies, performedbyLijesen(2007),showsthatshortrunelasticityrangesfrom‑0.04(AlFaris2002)to‑1.113(Woodland1993),withanaveragevalueof‑0.32.Accordingtothesamesource,estimatesforlongrunelasticityrangefrom‑0.09(Boonekamp2007)to‑3.39(AlFaris2002),withanaveragevalueof‑0.57.Thismeansthatapriceincreaseby2%,mightbeexpected todeterminea short rundemandreductionof0.64%,anda long runreductionof1.14%.

Asfarasthedemandformotorfuelsisconcerned,Liu(2004)estimatesashortrunelasticity of ‑0.191 for gasoline, and ‑0.094 for diesel. Long run estimate are,respectively, as high as ‑0.318 and ‑0.516. A review of the most recent studiesperformedbyGoodwin,DargayandHanly (2004) foundanaverage elasticity formotorfuelsof‑0.25intheshortrun(intherangebetween‑0.01and‑0.57),andof‑0.64in the long run (witha range thatvaries from0 to ‑1.81).Thismeans thatapriceincreasebetween4.4 and5.4%would result in a reduceddemandbyaround1.1‑1.35%intheshortrun,andby2.8‑3.5%inthelongterm.

Emissionswouldbereducedaccordingly.Somecautionisneeded,though.Estimatesforpriceelasticityofenergyconsumptionareextremelydiverse–because,amongtheotherreasons,thedatatendtoberelativelypoor,andchangesinpricesgetmixedupwith changes in demand due to changes in income (and viceversa). Also,technologicalprogressandpublicpoliciesmayaffectenergyconsumptioninseveralways, which may not be fully captured in models trying to estimate demandelasticities.As a consequence, the estimates tend to have a verywide confidenceinterval.

Thismakes itmoredifficult tomakereliable forecastsof thedemandvariations inresponsetoapriceincrease,whichexactlywhatacarbontax(aswellasacap&tradesystem,fromtheconsumer’sperspective)wouldresultin.

3.8.Whichtax?

The above‑mentioned problem can be overcome if a further question is correctlyanswered.Thequestionis:Whatisthepolicygoal?Ifthegoalistoreduceemissions(orenergyconsumption)byagivenamount,atanycost,thencap&trade(orevenmore stringent “command & control” policies) is probably the better choice. If,instead,thegoalistoachievethemostefficientsettingfromanallocationalpointofview,i.e.tointernalizetheexternalcosts,thentherealissueis,inthefirstplace,tocorrectlyestimatewhataretheexternalcosts.Inthisperspective,theonlymetricthatcanbeemployedtomeasuretheexternalcostsismoney(Pearceetal.1996;Smithetal.2001).Afterthatcomplextaskhasbeenpursued,itwillbepossibletocomparethe

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cost of global warming’s impact with the costs of mitigation measures that areadopted today. It will also be possible to appropriately set prices or quantities,dependingonthekindofpolicywhichisimplemented.Naturally,suchcomparisonshouldbemadeat themargin.Tol (2003)reviewedthemostrecentstudieson theissue.Thefindingsarethefollowing:“thebestguessforthemarginalcostsofcarbondioxideemissionsis$5/tC,butthemeanis$104/tC.Thisdifferencereflectsthelargeuncertaintycombinedwith thenotion thatnegativesurprisesaremore likely thanpositive ones”. Tol et al. (2001) andPearce et al. (1996) also argue that estimatesexceeding$50pertonofCO2relyonpessimisticandunlikelyscenariosforclimatechange,impactsensitivityandeconomicvalues.Subsequently,itcanbestatedthatthemarginalcostsofclimatechangearemostunlikelytoexceed$50pertonofCO2,and they are very likely to standmuch below that threshold, with a best guessaround$5pertonofCO2.ClimatechangeimpactsarealsolikelytoincreaseastimepassesandatmosphericconcentrationsofCO2rise.Underthepresentstateofknowledge,therearemanywaystodesignacarbontax.Twowillbepresented.Nordhaus(2007,p.22)proposesa“policyramp”,wherebyacarbontaxis imposedwhichgraduallyincreases.AccordingtoNordhaus,“policiesinvolvemodestratesofemissionsreductionsinthenearterm,followedbysharpreductionsinthemediumandlongterm.Ourestimateoftheoptimalemissions‑reductionrateforCO2relativetothebaselineis15%inthefirstpolicyperiod,increasingto25%by2050and45%by2100. This path reduces CO2 concentrations, and the increase in global meantemperature relative to1900 is reduced to2.4°C for2100and3.4°C for2200”.Theadvantageofsuchanapproachisthatitwouldcreateapredictablepolicypathinthefuture,underwhichbusinessesandconsumersmightmakethemostefficientchoicesastowhichtechnologiesshouldbeemployed,andwhichwouldbethemostefficientrateofturnoverforthosetechnologies.Ontheotherhand,thepolicywouldrelyonearlyestimates for themarginalcostsofCO2emissions,soitmightbenotenoughresponsivetothenewevidence.True,itmightberevisedperiodically,butthiswould(a) reduce its predictability and (b) require a continue re‑assessment of the bestsciencebynationalgovernmentsorotherinternationalbodiesconcernedwithclimatechange.Whilesomedegreeofpolicychangeisnecessary,asscientificunderstandingof globalwarming providesmore information, a continual revision of the policymightnotbe thebestpossible solution. In fact, itwould requirepolicy‑makers tofollowthescientificdebateuptoanextenttheyarenotpossiblyqualified,andmightdetermineanevenstrongerpoliticizationofscience,whichwouldmakethepoliticaldebate between scientists asmuch vocal as the scientific debate between policy‑makers(Pielke2006;Lindzen2008).The policy would require modest costs to be undertaken immediately, but anincreasingcost inthefuture,as theconsequencesofglobalwarmingbecomemoresevere.Agradualincreasewouldbeareasonablecompromisebetweentherequestto

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addressglobalwarmingassoonaspossible,andtheneedtoimplementpoliciesthatdomakenot toomuchharmtoGDPgrowth.Onemightargue that,allelsebeingequal,afastereconomicgrowthimpliesanincreaseinemissions,whilewhenGDPslowsdown,emissionsfalltoo.Sotheeconomicimpactofthepolicywouldbesuchthatitparallelseconomicgrowth,ratherthancurbingit.Adifferentproposalcanbedeveloped,thatallowsabuilt‑incorrectionruleforthetaxasevidencebecomesclearer.KellyandKolstand(1999)andLeach(2007)suggestto test thepolicy rampbyobserving the responseofa statevariable to thepolicyitself, as well as to other factors whichmay or may not be known. A Bayesianlearning routine allows such information to be incorporated in the policy,whichwouldbecorrectedinbothdirection–thatis,becomingmoreorlessstringent–asitsgoalsbecomemoreorlessclose.Theirownresearch,however,showthatinthecaseofclimatechangeevidencemaytakealotaoftimebeforeitisproperlyunderstood,sothatcorrectionsmaynotbeappliedontimeormayrespondtowronginformationortoapoorunderstandingoftheprocesses.In taking advantage of these arguments,McKitrick (2008) propose a pricing rulewhichisdesignedinawaythatit,sotospeak,correctsitself,asareactiontoastatefunctionwhich is easily observable. The real issue, in this perspective, is not thepricingruleperse,buttofindanagreementoverthestatefunction.Infact,assumingthat temperature(oraveragetemperature)canprovidetherelevant information, itmakes a lot of difference, both in temperature levels and in temperature trends,whereyoutakethemeasure.Surfacetemperaturedata’squalityhasbeenquestioned,bothwith regard to land temperature (deLaatandMaurellis2006;McKitrickandMichaels2007)andoveroceans(Thompsonetal.2008;Christyetal.2001).Measuresfrom weather balloons are also disputable (Lanzante and Free 2008). McKitricksuggeststhatweathersatellitesmayprovidethemoststableandreliablemetricsincewhen theycollect troposphericdata (1979) (SpencerandChristy1990;CCSP2006;Randall and Herman 2008). Subsequently, it should be decided where to taketemperatures: following IPCC(2007)andCCSP(2006),McKitrickproposes to takereferencetemperatures inthetropicalregion, from20degreesNorthto20degreesSouth.McKitrick, hence, suggests that the mean temperature as measured by weathersatellitesinthetropicaltropospheremayprovideaworkabledefinitionofthestatefunction,thatistheinputofapricingruleforacarbontaxpolicy.Remarkably,“ifthepresent trend continues theNordhaus path and the state‑contingent pathwouldclosely coincide” (McKitrick 2008, p.12). The most compelling aspect of suchproposal,isthatitprovidesapolicyinstrumentthatdealswithuncertainty.Atthesame time, it doesn’t need toomuchof an information exchangebetweenpolicy‑makersandscientists,exceptfortheobviousneedtokeepcorrectingthepoliciesifitbecomeclear that anthropogenic emissionsare less (more) responsible for climatechange,orthatclimatechangeimpactsareless(more)severethanexpected.

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Apossibleobjectionwouldbethat,byprogressivelyupdatingthetaxaccordingtothe temperaturemeasurements in the tropical troposphere (whichare subject toarelativelywidenaturalvariability,independentfromclimatechange),onebenefitofthecarbontaxoveracap&tradescheme(morepredictability)mightbelost.Several responses can be provided. First, evenNordhaus’ policy rampwould beupdated,baseduponalessobjectivevariable–climateforecastsvs.actualclimate.This isakeypoint, intermsof limitingtheinteractionbetweenpolicy‑makersandscientificdebatestheymaynotbeabletofullyunderstand.Moreover,aconsensusmight not emerge even within the scientific community, with regard to whichprojectionsaretobeconsideredmorelikely.Secondly,carbontaxcorrectionsmaybescheduledinawaythattheydonotresultintoorapidchanges–forexample,thecarbontaxlevelmaybeupdatedeverythreetofiveyears,insteadofannually,andbydoingsoitwouldprovideanacceptablelevelofcertaintytoenergycompaniesorenergy‑intensivebusinesses.Third,companiesthemselvesmay(andinmostcasesdo)havetheirownscientificexperts, who provide the management with an assessment of the best availablescience.So, companieswouldhave theirownexpectations regarding climate, andbased upon these they can have their own forecasts about the future levels of acarbon tax.Aprobability levelmightbeattached toanypossible scenario, so thatcompaniesdohavearangeofpossiblealternativesforthefuturepolicypathsthatdependsuponapricingrulewhichisknowninadvance.Fourth,suchprocesswouldgeneratealesspoliticized,moreinformeddebateontheissue, because from the expectations regarding future temperatures, the futureinvestmentstrategieswouldderive.So,anypartywouldhaveaninterestinassessingthemost likely outcome, not the outcome thatwould bemost likely to yield thedesired policies. By the same token, it is likely thatmore informationwould begeneratedandmadeavailable,andtheunderstandingofglobalwarmingwouldbeimproved.Fifth, it is true thatNordhauspolicyrampreliesonprojections (so it incorporatessome knowledge about the future) whileMcKitrick pricing rule relies on actualtemperatures (thereby responds only to the past). At the same time, however,projections for future temperatures rely on the past record too, and the currenttemperaturesarepartofatrendthatbeganlongtimeagoandisexpectedtocontinuefor a long time in the future. Itwill take time, in fact, for emission reductions toproduceasufficientreductioninthestockofGHGsintheatmosphere,thatwillinturn slowdown thewarmingprocess. So there is a lag – that can’t be avoided –between the moment policies enter in force, and the moment when results aredelivered.Thereisadegreeofarbitrariness,hence,thatcanbebetterfilledbyrelyingonobjectivemeasuresthanbyadoptingquestionable–howevercomplex–forecastsaboutthefuture.

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Finally,theMcKitrick’spricingruleforacarbontaxhasfourmajoradvantagesoveracap&tradesystem:

(a) Itlinkstheobservedtemperature–thatis,thepasttemperaturetrend–withanestimateofthesocialcostsoftoday’semissions.Itsaimistointernalizetheexternalcosts,notto“savetheworld:”itisthereforelikelythatitwouldresultinthemostefficientmixofpresentconsumption,investmentsincarbon‑savingexistingtechnologies,andinnovation.Onthecontrary,acap&tradeschemerequiresanassessmentonwhatistheoptimumamountofemissionstoday(aflow) to reduce atmospheric concentrations ofGHGs tomorrow (a stock) inorder to achieve the goal of containing temperatures increase. Severaluncertainties and confounding factors are involved, that might inducemisunderstandings or misconceptions. In fact, a major possible (if notprobable) shortcoming of a cap & trade scheme lies exactly in thedeterminationofthecap,whichissubjecttofargreateruncertaintiesandrisksofbeingpoliticallyderailedthanthedeterminationofthetaxinaprice‑basedpolicy. The problemwould bemade even bigger by the above‑mentionedpolicy instruments that the European Union and/or other actors areconsideringinordertoputinmotionacap&tradescheme.

(b) Under a cap& trade schemewhere the cap is setwith regard to ambitiousenvironmental goals (e.g., keeping global average temperatures below 2degrees more than the pre‑industrial levels) that may not be completelycontrolledandthataresubjecttoanumberofuncertaintiesandconfoundingfactors, the scientific debatemay tend to becomemore politicized. In fact,privately‑ownedcompanies,rentseekersandnationalgovernmentsmayhaveaninterestinpromotingonespecificscientificview,thatmightleadtosettingacapmoreorlessstringent,accordingtotheirownconvenience.Undersuchascheme,therewouldbelittleroomforfindinganagreementoveranobjective,non‑politicizedindicator.

(c) ThepriceattachedtoemittingonetonofCO2wouldbefarmorecertainundera carbon tax,whose level is established througha simple,well‑known rule,thanunderacap&tradesystem.Thatisgenerallytrue,andevenmoresoasoneconsidersthatanumberofexemptionsandloopholesarecreatedinordertosaveendangeredcompanies.Pricepredictabilityoverthemedium‑longrunis a fundamental feature of a policywhich aims, among the other goals, atcreatinga framework for innovation. Ifuncertaintyrelative thecarbonpriceadds to “normal”marketuncertainties, thepayoff aswell as bankability ofinvestmentsmight become less uncertain, too. And, again,more resourcesmightbedevotedtolobbyingactivityandtopayforthepriceofpermits(that,differently froma carbon tax,mightbehardly transferredonto consumers),

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and less resourcesmightbemadeavailable for innovativeor carbon‑savinginvestments.

(d) Aninternationalagreementoveracarbontaxfollowingasimple,predictablerulemaybeeasiertoreach,thananagreementcreatingacomplexcap&tradescheme,thatnationalgovernmentscan(andmostprobablywill)manipulateinordertomeetrequestsfrominterestgroups.Becauseofitssimplicity,acarbontaxleaveslessroomforopportunisticbehaviors,andmighthelptofillthelackofmutualtrustbetweentheparties.

Asanaddendum,therevenuesfromacarbontax–beingmoreeasilypredictable–mightbeemployed inreducing incomeor labor taxes,orother taxes.Therefore,acarbontaxmaywellbemaderevenue‑neutral.Thatisfarmorecomplexinthecaseofa cap& trade scheme, both because its revenueswould bemore uncertain, andbecauseconsumerswouldn’tperceiveitasclearlyastheywoulddowithatax.Thismakesitmorelikelythatasuboptimaluseoftheproceedingsismade,asinthecaseofEuropeanUnionthatrequiresthememberStatestospendmoneyfromauctioninginsubsidizingtechnologiesorbehaviors,andbydoingsoisprobablygoingtodistortthemarketsforproductsandservices.Inturn,acarbontaxwouldmakeirrelevantanyotherkindofsubsidiesormandates,bycreatingaleveledplayingfieldandbyinternalizingtheexternal(expected)costsfromtheuseoffossilfuels.Inpractice,acap&tradesystemwherepartorallthepermitsareauctionedwouldbemorecostlytotheconsumersandbusinesses,andmoredistorsiveofthemarket,thanacarbontax.

3.9.Conclusions

This paper has critically looked at the European system of emissions trading,attemptingtoevaluateitseffectiveness,efficiency,andsustainability.Bydoingso,ithashighlightedsomeshortcomingsorrisksinthepresentandfuturepolicies.

ThefirstaspecthastodowiththepostureofETSinthethirdphase(2013‑2020).Inparticular,thechoiceofassigningquotasthroughauctioning,whichintheorymaybeareasonablechoice,hasbeentranslatedintoasystemofregulationsthatisconfused,unstable, and ultimately such as to leave a great discretionary power to theCommission and to the governments of themember States. It is not possible tounderstandhowthiscanbecompatiblewiththeobjectivesoftheLisbonstrategytobringEuropebackonthepathofaninnovativegrowththatcanbesustained,giventhatpoliticalarbitrariness isperhapsthemaindeterrentofgrowth(Stagnaro2005;SechiandStagnaro2006).NorcanitbeunderstoodwhereitisthatEuropewantstogo,giventhatthetargetsthatithasassignedtoitselfare–inthealmostunanimousjudgementoftheexperts–extremelydifficultifnotimpossibletorealize.

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The second aspect, which is a direct consequence of the first, concerns both thedefinitionofthebindingobjectivesandthewaysthoseobjectivesareimplemented.In thispaper, theobjectivesconcerningrenewableresourcesandenergyefficiencyhavenotbeenexamined,butinsubstancetheconsiderationsonthereductionofthegreenhousegasesapplytothemaswell.Thequantificationoftheobjectiveshasnotbeen preceded by an evaluation of howmuchwas possible to obtain, nor by anestimateofthecostsandimpactsontheEuropeanenergyandeconomicsystem.Bythesametoken,adiscussionofthepossiblealternativesismissing.NotsomuchandnotjusttoreplaceETSnow,buttojudgeitsoperationthroughtimeascomparedtoother instruments that could have been adopted andwhich, in spite of the littleattentiontheyhavereceivedinBrussels,couldperhapshaveobtainedbetterresultsat lower costs. Specifically, the carbon tax option has a series of practical andtheoretical advantages, not last the fact that, if the total impact on the Europeaneconomyisinprincipalthesameasthecap&trade,theadministrativecostsandthepoliticalrisksarelower.

Astothethirdaspect,thinkingaboutthecostsofclimatestrategiesmeansthinkingabout their benefits as well, and therefore the opportunity of imposing bindingdomestic targets. This is particularly important in light of both the scientificuncertainties that still remain and are quite substantial – on the globalwarmingphenomenonandonthehighprobabilitythatwillremainpoliticallyisolatedintheshorttermintheefforttoreduceemissions.Fromthisstemsthesubstantialpracticaluselessness of the European policies, even if they were justified, effective andefficient, because Europe represents an important but neverthelessminority anddecreasing(inrelativeterms)fractionofglobalemissions,.

Strictlyconnectedtothesequestionsistheissueofthepoliticalfeasibilityofclimatepolicies.Thereisvirtualunanimityamongsttheexpertsthat,fromthepoliticalpointofview,acap&tradesystemiseasiertolaunchthanacarbontax,andtheEuropeanstoryprovidesfurtherevidenceaboutthat.However,thepriceofthelesserpoliticalresistanceisasystemthatisbothopaqueandarbitrary.Onthecontrary,acarbontaxwould be more easily implemented, more stable, more predictable, and moreresponsive to the actual changes in the climate. From a certain point of view,therefore,thelesserpoliticalfeasibility,duetothedifficultyofharvestingconsensuson a tax and the need to substantially reformulate the fiscal system, is a furtheradvantageof thecarbon tax.The lesserpolitical feasibilityguarantees, in fact,notonlythatthemeasurewillbetakenonlywhenatrulylargeportionofthepopulationisopenlywillingtopaymoretoobtainacertainenvironmentalgoal.Forthesamereason,itwillbeeasiertoabrogatethetax–amovethatispoliticallylessdifficultthancancellingregulationsasencrustedwithlobbyactivitiesastheyareobscuretomost people –when and if it becomes evident that the European strategy is notsustainable,orthattheglobalwarmingisalesssevereproblemthanwhatisbelievedtoday.

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