To deal with the problem of global warming, many economists argue in favour of removing the ‘greatest market failure the world has seen’ (Stern 2007) by imposing carbon taxes or a uniform carbon price via a permit system. This is the well-founded efficiency perspective of environmental economics, which obviously continues to hold for climate policy. But the real difficulty of climate negotiations is the issue of equity, which is always central to political debates but is especially critical in an international setup. It is evident that the decision to implement climate policies has a major impact on world income distribution. If no policy is adopted, less-developed and vulnerable countries will suffer disproportionately – climate shocks destroy part of their capital stock, making successful economic development and catching-up to wealthier countries even more difficult than it was in the past. Conversely, when adopting stringent climate policies, polluting countries expect they will have to carry a substantial burden when redirecting and greening their economies.
Costs of climate policy
The concern that fossil-intensive economies have to bear high policy costs relates to two major issues that are not always well-understood in public debate: economic dynamics and uncertainty. Dynamic policy impacts are mostly underrated, as decision makers tend to focus on the short-run effects of climate policies. These are indeed negative – less fossil fuel input results in lower output. But in the longer run, induced innovation, capital accumulation, and sectoral change affect economic dynamics, counteracting level effects and thereby reducing the costs of climate policies (Bretschger et al. 2011).
Regarding uncertainty, the fact that the size, type, and timing of future climate shocks are uncertain is often not adequately assessed. There is widespread belief that uncertainty suggests low abatement efforts. Yet, it should be the opposite – given the fact of risk aversion, a rational response to uncertainty is actually to aim to reduce it. Emissions mitigation policy is the major instrument to reduce unfavourable climate shocks. Accordingly, abatement efforts should rise with increasing uncertainty (see Bretschger and Vinogradova 2014 for a formal model with explicit solutions). These findings suggest that, on a global level, the internationally agreed targets of climate policy are efficient and can be achieved at moderate costs. But what is really critical is to determine relative costs at the country level, which result from proposed international burden sharing.
From principles to policy
From past decisions under the UN Climate Convention it has emerged that the concept of Common but Differentiated Responsibilities (CBDR) is the central common guideline for equitable burden sharing. But how can we make CBDR operational? How can we use it to reduce negotiation complexity? The basic task is to transform CBDR into so-called focal points – which have proven to be highly useful if they are part of everybody’s general expectations – suitable to build acceptance and trust among the negotiating partners. Equity principles are very effective in this respect because there is already broad political acceptance, a common understanding exists, and objective verification is possible. The best known equity principle is the ability to pay – the larger the economic capacity of a country, the more it should contribute to global policy. The second principle concerns policy cost sharing – the lower a country’s costs from a policy, the more it should contribute. A third issue is the merit principle (also called the desert principle, see Konow 2003) – the bigger the efforts of a country to solve the underlying problem, the more it should be rewarded. In the present context, efforts are considered in the field of advancing carbon-efficient technologies. The last principle requires comparing like with like, which for the climate problem means that emissions at times of abundant alternative energy sources are weighted differently to emissions at times when few alternative energy sources are available.
Equitable sharing rule
The four basic equity principles can be used to agree upon a simple rule for international burden sharing. Specifically, the rule can allocate the global carbon budget (which is compatible with the 2°C target) to the different countries in an equitable manner. Each of the principles is measured by a simple indicator, like income per capita, output per emission unit, or emissions per capita (see Bretschger 2013 for the technical details). A suitable procedure to combine the principles in a mathematical function is to use the multiplicative form, as with the well-known Cobb-Douglas function. Also, it is reasonable to assume the function to be linear homogenous and, based on the principle of insufficient reason, to weigh the principles equally. It is then easy to show (again, details in Bretschger 2013) that we are left with a simple rule stating that carbon budgets should be allocated according to a nonlinear function of current emissions per capita; the explicit expression for the budget reads Carbon budget = (Emissions per capita)0.25. The relationship is represented by the blue line in Figure 1. The proposed procedure reduces the highly complex problem of burden sharing to one single variable – emissions per capita – and a unique parameter, giving the curvature of the function. It offers a close link to the carbon budget calculated in natural sciences and, moreover, an easy calculation method for the emission budgets.
The derived relationship can be compared with the proposal of a uniform global carbon tax, according to Weitzman (2014). With the envisaged domestic use of tax revenue, the proposal can be represented by using the cost-sharing principle from above while setting the weight of the other principles to zero. Then, the carbon budget for each country increases linearly with emissions per capita, represented by the green line in Figure 1. Finally, the egalitarian proposal of the emerging economies’ group (BASIC 2011) suggests an equal carbon budget independent of current emissions, represented by the red line in Figure 1. Interestingly, this result also emerges when taking the three equity principles of ability to pay, cost sharing, and merit, but ignoring technical development.
From the comparison of the three proposals we obtain two major insights. First, countries with low emissions per capita (situated on the left hand side of Figure 1) naturally favour the egalitarian rule, while high emitters (situated at the right hand side) are more favourable to the tax solution. Second, the equity based rule is a compromise between the tax rule and the egalitarian split of carbon space. To provide the intuition for this, in a short summary I comment on two main aspects. On the one hand, low-emission countries get less carbon budget under the equity-based rule than with the egalitarian rule because late-developing economies have more technical alternatives to carbon use available. On the other hand, high-emission countries receive a lower budget under the equity-based rule than with the tax rule because their ability to pay for climate policy is comparatively higher. For a practical application and the use of a more refined equity weighting schemes, a dedicated website with the ‘ETH climate calculator’ has been created where the different burden rules can be compared for each country (see ETH 2015).
Based on the recent Lima Call for Climate Action, current climate policy relies on a pledge and review procedure. First, countries unilaterally announce their climate policy targets (called Intended Nationally Determined Contributions, or INDCs); this is the pledge part of the procedure. Second, the INDCs should be reviewed and compared; unfortunately, this part of the process is not very well structured. Now that many country pledges are available, policymakers and negotiators will ask: How do the countries’ pledges compare among each other, and against generally accepted guidelines? Are the ambitions of the world community sufficiently high to reach the generally agreed targets of maximum global warming? Following Aldy and Pizer (2015), an ideal metric for the review phase should be comprehensive, measurable, replicable, and universal. This is where the present research aims to make a contribution – it allows the INDC pledges to be evaluated in a more transparent and directly comparable way. The simple rule proposed here could thus serve as a guideline when assessing the current proposals and the overall ambitions of global climate policy.
Aldy, J and W A Pizer (2015) “The road to Paris and beyond: Comparing emissions mitigation efforts”, Resources Magazine, 189: 19–25.
BASIC (2011) “Equitable access to sustainable development: Contribution to the body of scientific knowledge”, Technical report, BASIC expert group, Bejing, Brasilia, Cape Town and Mumbai.
Bretschger, L (2013) “Climate policy and equity principles: Fair burden sharing in a dynamic world”, Environment and Development Economics, 18: 517–536.
Bretschger, L and A Vinogradova (2014) “Growth and mitigation policies with uncertain climate damage”, Economics Working Paper Series 14/202, ETH Zurich.
Bretschger, L, R Ramer and F Schwark (2011) “Growth effects of carbon policies: Applying a fully dynamic CGE model with heterogeneous capital”, Resource and Energy Economics, 33(4): 963–980.
ETH (2015) Climate Calculator, http://www.ccalc.ethz.ch
Konow, J (2003) “Which is the fairest one of all? A positive analysis of justice theories”, Journal of Economic Literature, 41(4): 1188–1239.
Stern, N (2007) “The economics of climate change: The Stern review,” Cambridge University Press, Cambridge.
Weitzman, M L (2014) “Can negotiating a uniform carbon price help to internalize the global warming externality?”, Journal of the Association of Environmental and Resource Economists, 1(1/2): 29–49.
This article is published in collaboration with VoxEu. Publication does not imply endorsement of views by the World Economic Forum.
To keep up with the Agenda subscribe to our weekly newsletter.
Author: Lucas Bretschger is a Professor of Economics/Resource Economics at ETH Zurich.
Image: A chimney in an industrial area emits vapour. REUTERS/Tim Wimborne.