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Sheila M. Olmstead and Robert N. Stavins

The essential pillars of a new climate pact

By Sheila M. Olmstead and Robert N. Stavins
September 20, 2009

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THE climate change summit at the United Nations on Tuesday is aimed to build momentum for the 15th Conference of the Parties to the UN Framework Convention on Climate Change in Copenhagen in December, where nations will continue negotiations on a successor to the 1997 Kyoto Protocol, which expires in 2012. To be successful, any feasible successor agreement must contain three essential elements: meaningful involvement by a broad set of key industrialized and developing nations; an emphasis on an extended time path of emissions targets; and inclusion of policy approaches that work through the market, rather than against it.

Consider the need for broad participation. Industrialized countries have emitted most of the stock of man-made carbon dioxide in our atmosphere, so shouldn’t they reduce emissions before developing countries are asked to contribute? While this seems to make sense, here are four reasons why the new climate agreement must engage all major emitting countries - both industrialized and developing.

First, emissions from developing countries are significant and growing rapidly. China surpassed the United States as the world’s largest CO2 emitter in 2006, and developing countries may account for more than half of global emissions within the next decade. Second, developing countries provide the best opportunities for low-cost emissions reduction; their participation could dramatically reduce total costs. Third, the United States and several other industrialized countries may not commit to significant emissions reductions without developing country participation. Fourth, if developing countries are excluded, up to one-third of carbon emissions reductions by participating countries may migrate to non-participating economies through international trade, reducing environmental gains and pushing developing nations onto more carbon-intensive growth paths (so-called “carbon leakage’’).

How can developing countries participate in an international effort to reduce emissions without incurring costs that derail their economic development? Their emissions targets could start at business-as-usual levels, becoming more stringent over time as countries become wealthier. If such “growth targets’’ were combined with an international emission trading program, developing countries could fully participate without incurring prohibitive costs (or even any costs in the short term).

The second pillar of a successful post-2012 climate policy is an emphasis on the long run. Greenhouse gases remain in the atmosphere for decades to centuries, and major technological change is needed to bring down the costs of reducing CO2 emissions. The economically efficient solution will involve firm but moderate short-term targets to avoid rendering large parts of the capital stock prematurely obsolete, and flexible but more stringent long-term targets.

Third, a post-2012 global climate policy must work through the market rather than against it. To keep costs down in the short term and bring them down even lower in the long term through technological change, market-based policy instruments must be embraced as the chief means of reducing emissions. One market-based approach, known as cap-and-trade, is emerging as the preferred approach for reducing carbon emissions among industrialized countries.

Under cap-and-trade, sources with low control costs may take on added reductions, allowing them to sell excess permits to sources with high control costs. The European Union’s Emission Trading Scheme, established under the Kyoto Protocol, is the world’s largest cap-and-trade system. In June, the US federal government took a significant step toward establishing a national cap-and-trade policy to reduce CO2 emissions, with the passage in the House of Representatives of the American Clean Energy and Security Act. Other industrialized countries are instituting or planning national CO2 cap-and-trade systems, including Australia, Canada, Japan, and New Zealand.

Linking such cap-and-trade systems under a new international climate treaty would bring cost savings from increasing the market’s scope, greater liquidity, reduced price volatility, lessened market power, and reduced carbon leakage. Cap-and-trade systems can be linked directly, which requires harmonization, or indirectly by linking with a common emissions-reduction credit system; indeed, this is what appears to be emerging even before a new agreement is forged. Kyoto’s Clean Development Mechanism allows parties in wealthy countries to purchase emissions-reduction credits in developing countries by investing in emissions-reduction projects. These credits can be used to meet emissions commitments within the EU-ETS, and other systems are likely to accept them as well.

Countries meeting in New York this week, and in Copenhagen in December, should consider these three essential elements as they negotiate a new climate agreement. A new international climate agreement missing any of these three pillars may be too costly, and provide too little benefit, to represent a meaningful attempt to address the threat of global climate change.

Sheila M. Olmstead is associate professor of environmental economics at the School of Forestry and Environmental Studies at Yale University. Robert Stavins is professor of business and government at the Kennedy School of Government at Harvard University.

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