8 2. CLIMATE CHANGE AND KYOTO PROTOCOL 2.1 CLIMATE CHANGE Global warming is the increase in the average temperature of the Earth’s surface
air and oceans. In the last twenty years environmental issues, including climate change, has increasingly appeared on the international agenda. Presently, throughout the world ,
the international actors are conside ring the implication of these phenomena on the
national economies and considering what national and global policies to apply. The climate change, as highlighted by the UN Commission Report, IPCC, the
Intergovernmental Panel on Climate Change, is happening quickly and at a global scal e
1
. 2.1.1 IPCC results The Intergovernmental Panel on Climate Change (IPCC) is a scientific body
established by the United Nations Environmental Program (UNEP) and the World
Meteorological Organization (WMO) in order to estimate the current trend of climate
change and its potential conseq uences
2
. According to the Fourth Assessment Report of
IPCC (2007) the amount of Global Greenhouse Gases (GHG), carbon dioxide ,
methane, nitrous oxide, sulphur hexafluoride, and two groups of gases,
hydrofluorocarbons and perfluorocarbons, have grown since pre ‐ industrial times, but
with an increase of 70% between 1970 and 2004. The g reenhouse effect is a
fundamental natural phenomenon that enabled life on the Earth, but an increase of
GHGs causes the increase in the retained solar radiation in the atmosphere and the
consequent increase in temperature. CO 2 emissions, in particular, have grown between 1970 and 2004 by about 80% and represented 77% of total anthropogenic GHG
emissions in 2004. The increased concentration of GHGs in the air, due to anthropogenic
activities such as fossil fuel combustion and deforestation, has resulted in increased
surface temperature: during the 20
th
century global surface temperature increased by
1
Fourth Assess ment Report of IPCC, 2007 2
UNFCCC website
9 0.74 ± 0.18 °C (1.33 ± 0.32 °F ). This increase, observed since the sixties, has been caused
by the increasing concentration of GHGs in the air, as a result of anthropogenic activities,
such as fossil fuel combustion and deforestation. The global warming has been naturall y
mitigated only by the gradual global reduction in the amount of direct global sun
irradiance, caused by the concen tration of atmospheric aerosols . Fig. 1. (Source: IPCC , Fourth Assessment Report (2007) ) Acc ording to the Fourth Assessment Report of IPCC (2007), the average
temperature on the Earth’s surface is going to increase between 1.1 to 6.4 °C (2.0 to
11.5 °F) during the 21st century , as we can see in Fig. 1 . These climate model projections
contain uncertainty because of the different sensitivi ties to GHGs’ concentrations and
10 the different future GHG emissions estimates, which vary model by model. However,
consequences of an increase in global temperature are note to climatologists: sea levels
will rise and the patterns of precipitations in the different climates will change. The
subtropical deserts will expand. This warming, strongest probably in the Arctic, will
cause retreating glaciers, permafrost and sea ice. It is likely that extreme weather events
will become more intense and more frequent , and that these temperature changes,
region by region, will bring perturbations in small to big ecosystems with following
species extinctions and changes in agricultural yields. Furthermore, the CO 2 increase in
the atmosphere is increasing the acidity in the oceans, with connected risks for marine
ecosystems. To prevent the worst consequences, the increase of temperature should be
arrested around 2°C above the pre ‐ industrial level, that is 1.2°C above today’s level. It
will be possible respect this ceiling if the global rising trend of GHGs concentration will
be stopped by 2020. The scientific community, although with some excepti ons
3
, is
globally agreeing that anthropogenic global warming is occurring. In the last decades,
the political international actors are debating and working on how to mitigate the
human influence on the global warming. So far, the main result reached is the Kyoto
Protocol. 3
”There is no consensus on Global Warming” appeared in The Wall Street Journal on June 26th, 2006
11 2.1.2 Economics of Climate Change Governments face the pollution reduction problem as a choice of policies. There
are man y different criteria available to take this choice. First of all, t hey need to identify
the nature of the problem. According to environmental sciences, p ollution is classified in
flow and stock : the flow pollution damage happens in the release moment; instead the
stock pollution refers to concentration of pollution in the environment. In most cases we
have stock pollution prob l em s
4
, but the policy ‐ makers instruments aim main ly at
regulating flow pollution . In order to intervene, it is fundamental to identify the relation
between stock and flows. From a welfare economic s point of view, pollution is a negative externality
caused by production or consumption. We have an externality when the decision to
produce or to consume by an agent influenc es the utility of another agent in an unintentional way, and the agent that suffers this cannot be legally com pensated
5
. In the
presence of externalities the agents do not sustain the real cost of their actions.
Efficiency is a general pragmatic criterion sugge sted by economic theory to deal with environmental policy objectives, such as externalities. In the presence of externalities it
is impossible to reach a Pareto ef f i ci ent
6
allocation through the market system.
However, the efficien t level of an externality exists and it is not equal to zero: the
marginal cost to reduce the external effect (damage) will exceed the marginal benefi t
level at a given poi nt
7
, as shown in Fig. 2. 4
Perman et al. (2003), p. 177 5
“A negative externality implies that the social cost of production is higher than the private cost.”, Hoel, M. (1998 ) 6
Coase, R. (1960); Pigou, A. C. (1920) 7
Tietemberg, T. (1990)
12 Fig. 2: Efficient level of emissions (Source: Perman et al. (2003) ) Efficiency is not the only possible criterion. For instance, the absolute hea l th
criterion says that if a health risk depends on passing a critical threshold, the policy
target can be determined independently of the marginal benefit values. Other alternative
criteria are: arbitrary standards, best available technology, safe minimum standards and precautionary principle . The precautionary principle affirms that, in absence of scientific
consensus, if there is a suspected risk of harming the p ublic or the environment with an
action, or because of the absence of that action, the choice hierarchy should emphasis avoiding risk. If one particular policy can attain the target at lower real cost than any other, this
policy is cost‐ effective. Using a cost ‐ effective instrument involves allocating the smallest
amount of resources to pollution control, which is at the minimum opportunity cost.
Hence , cost ‐ effectiveness is a pre ‐ requisite for achieving an economically efficient
allocation of environmental pol i ci es
8
. In our case , efficiency is given by equalizing
marginal benefits and marginal damages (the cost of polluting). According to Kal dor‐ Hi cks
9
, when we cannot reach the Pareto Optimum, efficiency means to maximize the
social net benefits. Cost ‐ effec tiveness means to equalize marginal abatement costs
across sources, and is accomplished by minimizing the cost of achieving some pre ‐ determined targets. However, the final target may not necessarily be an efficient
allocation. After all, the principle of c ost ‐ efficiency explain how the overall target should
be shared among the sources: according to the least ‐ cost theorem of pollution control, in
8
Perman et al. (2003), p. 204 9
Hicks, J. (1939); Kaldor, N. (1939)
13 order to abate at the least cost the marginal cost of abatement has to be equalized across all the ab aters
10
. Taking into account the maximum sustainable amount of pollution in a given
area, the policy‐ maker will establish the socially efficient level of pollution, that is the
policy target , for which the private marginal benefit of pollution equals the public
mar ginal damage of it. The efficient level of emissions will vary across the firms, the
more polluted firm i ’s emissions are the less firm i will pollute. It will vary across the
receivers as well. However, this is mostly private information, bringing to the forefront
the problem of asymmetric i nf orm ati on
11
. We can distinguish the environmental policies available in two main categories: •
Command and control (CAC): standards. •
Market based : taxes, subsidies, tradable permits. Quantitative standards is a type of command ‐ and‐ control (CAC) instrument,
involvi ng a standard set by the policy ‐ makers , which defines how much every firm is
allowed to pollute. However, the ability to create efficient pollution quantitative
standards is costly, since knowledge of each firm’s marginal abatement cost demands an
expensive information research. In the case of asymmetric information the second best
option is to establish a common emission standard, but this results in an inefficient
solution. Another command ‐ and‐ con trol instrument is technological (qualitative)
standards , which impose the use of cleaner technologies. The e fficiency of standards, and
in general of the CAC tools, strongly depends on the effectiveness of monitoring, such as
the dimension of sanctions an d the probability of being caught, which is usually costly.
They are usually inefficient, because of the lack of information, and not flexible enough to adapt across different firms and different industry sectors . 10
Perman et al. (2003), p. 242 11
Dasgupta, P.; Hammond, P.; Maskin, E. (1980)
14 Market based pollution reduction instruments have a fundamental property: the
dynamic efficiency . They provide incentives for innovation and technical change by
modifying relative prices or quantities. These instruments include taxes, subsidies and tradable emissions p ermits . Emission taxes internalize the externalities by adding the
pollution cost to the pri ce
12
. An emission unit tax, also known as Pigouvian Tax , which is
equal to the marginal damage value at the efficient level of pollution, leads to emissions
reduction at the least cost to society. Subsidies work in a similar way: the government
offers a subsidy for any pollution unit reduced. In the short term taxes and subsidies
have similar results, as they both tend to bring the firms’ choices closer to social
optimum allocation. However, in the long run subsidies, unlike taxes, incentive
industrial sector expansion and the subsequent increase of em i ssi ons
13
. Tradable emission permits , another example of market ‐ based instrument , act on
the relative quantity of emissions: the policy‐ makers set the quantity standard of
pollution as a target, which is transformed into the correspondent number of
sustainable emission units. These units represent the number of tradable permits that
are allocated, for free or by auction, across the firms. The permits’ owners will sell or
buy according to their marginal abatement costs. Prices will be established by the
market and the abatement will be shared mainly among the firms with the lower
margina l abatement costs. Command and control instruments operate by imposing mandatory obligations
or restrictions on the be havior of firms and individuals, whereas i ncentive and market
based instruments change the structure of pay ‐ offs that the agents face. They create
markets for polluti on externalities , in wh ich prices generate opportunity ‐ costs. When
standards are reached the diffusion of technological development stops, instead market ‐ based instruments never stop the incentives for innovation (Dynamic Eff iciency).
Emissions taxes, subsidies or marketable permits can achieve an y emission target at
least cost, unlike a CAC regulation, which is usually not cost ‐ efficient. 12
Pigou, A. C. (1920) 13
Perman et al . (2003)
15 T able 1: Incentives for innovation created by environmental policies Policy Direct gains to innovating firm Potential rents from adoption Command and control : ‐ Standards ‐ Best available technology ‐ Performance standards Market based: ‐ Emission tax ‐ Auctioned emission permits ‐ Grandfathered emission permits None Negative. New standard raises overall compliance costs Positive. Limited to existing abatement costs High. Lowers abatement costs and taxed emissions High. Lowers abatement costs and costs of all permits purchased Small. Lowers abatement costs. None Very h igh. Tighter standards raises incentives to adopt Positive. Limited to existing abatement costs High. Lowers abatement costs and taxed emissions Small. Buying permits becomes cheaper alternative Small. Buying permits becomes cheaper alternative (Source: C. Fischer (2000) ) According to Fischer (2000), as summarized in the table above, different
abatement policies affec t innovations in different ways and also they have a different
impact on innovating firms, or on the followers that decide to adopt the new technology. CAC policies that specify a technology allow the adopters no more leeway than
the innovator. Little or no incentives remain to employ more cost ‐ effective pollution
reduction techniques. A policy mandating best available technology, instead, offers the
possibility that the innovator’s new technology would be made the standard. Then the
other firms have to follow it by mandate. Under per formance standards , adopting firms
receive the same gains from abatement cost reduction as innovator. With market based mechanisms, the development and the adoption of an
innovation widely by an industry sector can affect not only the individual firms’ cost s,
but also the prices and quantities of that sector market. Taxes set the price of emissions,
allowing the total abatement to vary. Under emission taxes , as innovation makes
abatement cheaper, the total amount of abatement will rise because it will be les s
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