Friday, October 23, 2009

Costs of greenhouse gas emission reductions

The build-up to the much awaited UN Convention on Climate Change at Copenhagen in December has re-ignited with much greater vigour, the classic debate between those who feel that emission reduction policies will impose unacceptable burdens on economic growth and those who feel that countries can cut emission without hurting economic growth. In a Wall Street Journal Report on Environment, Steven Hayward makes the case that carbon energy use is central to the world economic prospects and emission reductions are too expensive, while Robert Stavins argues that gradual reductions are both possible and affordable. Paul Krugman has elaborated on why the costs of achieving emission reductions are not as scary as opponents project and very much affordable.

Though I am inclined to side with Professors Stavins and Krugman, there are important issues to be addressed before developing countries like India can take the plunge and embrace the emission reductions bandwagon.

While it is true that developed economies have been responsible for most of the damage inflicted on the environment by way of carbon emissions, it cannot be denied that it is only a matter of time before the rapidly growing emerging economies catch up. In the circumstances, if is a foregone conclusion that the developing countries have to be active partners in any effort to control greenhouse gas emissions. The only question remains what should be the extent of their initial commitments.

Though carbon taxes, emission fees, cap-and-trade in emission permits coupled with carbon off-sets, and carbon sequestration are the favored means of emission reductions, there are sharp differences among experts about their relative effectiveness.

Recently, the US House of Representatives passed the Waxman Markey Bill, HR 2454, on climate change that seeks to cut emissions to 80% below 2005 levels by 2050 by following a cap-and-trade regime. The emission allowances, which would start with more liberal allocations, would grow tighter over the years, pushing up the price of emissions and presumably driving industry to find cleaner ways of making energy. The reduction target envisaged would seek to stabilize atmospheric concentrations at 450 ppm in CO2 equivalent terms, as against the growth trend of potentially catastrophic (would lead to rise in temperature of atleast 6 degrees Celsius and output loss worth 2-5% of global GDP every year) 1000 ppm by the end of the century.

Formidable as they are, these targets are not as insurmountable as they appear. For a start, Prof Stavins points to the fact that "from 1990 to 2007, while world emissions rose 38%, world economic growth soared 75% — emissions per unit of economic activity fell by more than 20%". Interestingly, this was despite the fact that most of the economic growth during this time, especially in China and emerging Asia, was environmentally irresponsible and damaging.

Prof Stavins advocates internationally co-ordinated efforts at emission reductions and immediate action to move towards cleaner technologies in the newer plants and activities in energy intensive industrial activity and power generation. The public good nature of such reductions, in so far as the costs are borne by the emission reducing industry while benefits are diffused across the society, means that no one country will come forward to incur the costs of emission reductions with reciprocating efforts from all others. And, since plants built today will determine emissions for a generation, there is need for immediate action to adopt clean technologies for the new plants in high emission industrial sectors - steel, cement and manufacturing plants - and power generators.

The effectiveness of cap and trade, especially on the monitoring of adherence to the emission reduction targets, has been the subject of some controversy. Both the EU ETS and the US emissions reporting have been the target of attacks on these grounds. Apart from the initial problem of arriving at the most efficient allocation of allowances (permissible emissions) among emitters, there is the much bigger challenge of monitoring emission reductions. This becomes an all the more greater challenge in developing countries where even enforcement of basic environmental safeguards are doubtful. Therefore, any emission reduction trade, involving the sale of emission reduction commitments by industries in developing countries, will be extremely difficult to monitor.

Also, cap-and-trade regimes are vulnerable to mis-directed subsidies. Under this, projects in developing countries, which use clean technologies and practices, become eligible to avail Certified Emission Reduction (CER) permits, which can then be sold in exchanges like the EU's Emission Trading System (ETS) to those who have exceeded their emission allocations. In other words, the ETS ends up subsidizing such projects. The problem with this arrangement is that it fails to discriminate between those green projects which require these subsidies (to incentivize the developers to adopt clean technologies, like say a scientific landfill) and those which would have any way come up on its own.

Further, global co-ordination of policies, at best a very difficult and complex challenge, may be even more difficult to achieve with a complicated cap-and-trade regime. In view of the vast variations among nations in their respective stages of economic development and costs of emission reductions, it is impossible to have a uniform policy on initial emission allowances and targets for reductions. In the circumstances, carbon taxes emerge as an effective and more practical approach towards emission reductions. It is both easier to co-ordinate such policies across nations and effectively implement and monitor their compliance. And also, carbon taxes generates revenues for the government, which in turn can be used to fund the research and development efforts to develop cleaner technologies.

There are two suggestions on the way forward. Since the primary requirement for emission reductions is the use of cleaner and environment friendly technologies, it is imperative that the access barriers to these technologies are lowered. This means that, for example, emissions generating steel or cement or power plants being set up across the world have access to these cleaner technologies. In other words, these technologies should become some sort of public good, made readily available for all such investments across the world. This presents an opportunity for the developed countries to assuage and overcome the deep suspicion among developing countries to binding emission targets.

The Economist points to a suggestion by the World Economic Forum about how private investments from developed countries in green technologies in developing countries could be protected against currency and political risk. It proposes that development banks — the World Bank or regional ones like the Asian Development Bank — would use public funds from the rich world to guarantee investors against these sorts of country risks. There are also proposals for government-guaranteed bonds for climate-related investment, as well as more direct public support for specific green funds, in the form of loss-sharing agreements and debt guarantees.

It is therefore appropriate that the developed economies, being responsible for most of the greenhouse gas emissions and damage inflicted on the environment, finance the development of clean technologies in industrial activity, manufacturing, transportation and other carbon emitting activities and share them with developing countries. A global clean technologies exchange can be established under the aegis of the UN Framework for Climate Change (UNFCC) which can collect such knowledge from across developed world. This exchange can purchase such technologies from private firms and developers on payment of a mutually beneficial and negotiated royalty.

In order to ensure that the costs of the transition are staggered over the entire transition period and thereby made affordable for all the stakeholders, it may be more effective to declare up-front gradually tightening emission standards on various emission sources like automobile, construction and industrial activities. This would save firms and investors the uncertainty and steep costs associated with sudden and one-time interventions and policy changes. This would also go a long way towards easing the opposition to emission reduction targets arising from the fear that it would impose unacceptably high costs on the economy.

Mostly Economics points attention to an speech by William Nordhaus who too feels that a "harmonized international carbon tax is likely to be a more effective" instrument to address climate change. Paul Krugman has this excellent post (and this) explaining why cap-and-trade keeps the Harberger triangles small and the net economic benefits to the society at large are considerable. See this Times article outlining the problems associated with calculating carbon emissions.

Update 1
Ed Glaeser feels that China and India holds the key on climate change reduction efforts.

Update 2
Under the Kyoto Protocol, members of the EU-15 had agreed to cut their greenhouse-gas emissions 8 percent below 1990 levels by 2012, and to get there, the EU set up its Emissions Trading System, which first got underway in 2005. Now, the EU-15, on the whole, is expected to cut emissions 13% (and 8.5% excluding all suspect measures in allowance allocations etc) below 1990 levels by 2012 just through existing and planned energy measures — including the cap-and-trade system. According to new data from the European Environment Agency (EEA), all of the EU-15 members except Austria are now on track to exceed their Kyoto obligations. See also this graphic from Economist

Update 2
Arvind Subramanian and Nancy Birdsall advocates that the developed countries abandon, or at least postpone, the primacy accorded to emissions reduction targets by developing countries, and help them obtain those at the lowest possible cost in the greenest possible way. In return, China, India and other developing countries should adopt, and be encouraged to adopt, internationally verifiable national targets for emissions-intensity, which could also be the basis for technology and other transfers from industrial to developing countries.

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