Reflecting on a Century of Progress and Problems

As the first decade of the twenty-first century comes to a close, the problem of the commons is more important to our lives – and more central to economics – than a century ago when the first issue of the American Economic Review appeared, with an examination by Professor Katharine Coman of Wellesley College of “Some Unsettled Problems of Irrigation” (1911).  Since that time, 100 years of remarkable economic progress have accompanied 100 years of increasingly challenging problems.

As the U.S. and other economies have grown, the carrying-capacity of the planet – in regard to natural resources and environmental quality – has become a greater concern, particularly for common-property and open-access resources.  In an article that appears in the 100th anniversary issue of the American Economic Review (AER) “The Problem of the Commons:  Still Unsettled After 100 Years” – I focus on some important, unsettled problems of the commons.

100 Years of Economic Progress and More Challenging Environmental Problems

Within the realm of natural resources, there are special challenges associated with renewable resources, which are frequently characterized by open-access.  An important example is the degradation of open-access fisheries.  Critical commons problems are also associated with environmental quality, including the ultimate commons problem of the twenty-first century – global climate change.

Small communities frequently provide modes of oversight and methods for policing their citizens, a topic about which Professor Elinor Ostrom of Indiana University has written extensively.  But as the scale of society has grown, commons problems have spread across communities and even  across nations.  In some of these cases, no over-arching authority can offer complete control, rendering commons problems more severe.

Although the type of water allocation problems of concern to Coman have frequently been addressed by common-property regimes of collective management, less easily governed problems of open-access are associated with growing concerns about air and water quality, hazardous waste, species extinction, maintenance of stratospheric ozone, and – most recently – the stability of the global climate in the face of the steady accumulation of greenhouse gases.

Whereas common property resources are held as private property by some group, open-access resources are non-excludable.  My article in the AER focuses exclusively on the latter, and thereby reflects on some important, unsettled problems of the commons.  It identifies both the contributions made by economic analysis and the challenges facing public policy.

The article begins with natural resources, highlighting the difference between most non-renewable natural resources, pure private goods that are both excludable and rival in consumption, and renewable natural resources, many of which are non-excludable.

Some of these are rival in consumption but characterized by open-access.  An example is the degradation of ocean fisheries. An economic perspective on these resources helps identify the problems they present for management, and provides guidance for sensible solutions.

The article then turns to a major set of commons problems that were not addressed until the last three decades of the twentieth century – environmental quality.  Although frequently characterized as textbook examples of externalities, these problems can also be viewed as a particular category of commons problems:  pure public goods, that are both non-excludable and non-rival in consumption.

A key contribution of economics has been the development of market-based approaches to environmental protection, including emission taxes and tradable rights.  These have potential to address the ultimate commons problem of the twenty-first century, global climate change.

Themes That Emerge

First, economic theory – by focusing on market failures linked with incomplete systems of property rights – has made major contributions to our understanding of commons problems and the development of prudent public policies.

Second, as our understanding of the commons has become more complex, the design of economic policy instruments has become more sophisticated, enabling policy makers to address problems that are characterized by uncertainty, spatial and temporal heterogeneity, and long duration.

Third, government policies that have not accounted for economic responses have been excessively costly, often ineffective, and sometimes counter-productive.

Fourth, commons problems have not diminished.  While some have been addressed successfully, others have emerged that are more important and more difficult.

Fifth, environmental economics is well positioned to offer better understanding and better policies to address these ongoing challenges.

Conclusions

Although I hope you will read the full article – which is very accessible — I will summarize its conclusions here.

Problems of the commons are both more widespread and more important today than when Coman wrote about unsettled problems in the first issue of the American Economic Review 100 years ago.  A century of economic growth and globalization have brought unparalleled improvements in societal well-being, but also unprecedented challenges to the carrying-capacity of the planet.  What would have been in 1911 inconceivable increases in income and population have come about and have greatly heightened pressures on the commons, particularly where there has been open access to it.

The stocks of a variety of renewable natural resources – including water, forests, fisheries, and numerous other species of plant and animal – have been depleted below socially efficient levels, principally because of poorly-defined property-right regimes.  Likewise, the same market failures of open-access – whether characterized as externalities, following A. C. Pigou (1920), or public goods, following Ronald Coase (1960) – have led to the degradation of air and water quality, inappropriate disposal of hazardous waste, depletion of stratospheric ozone, and the atmospheric accumulation of greenhouse gases linked with global climate change.

Over this same century, economics – as a discipline – has gradually come to focus more and more attention on these commons problems, first with regard to natural resources, and more recently with regard to environmental quality.  Economic research within academia and think tanks has improved our understanding of the causes and consequences of excessive resource depletion and inefficient environmental degradation, and thereby has helped identify sensible policy solutions.

Conventional regulatory policies, which have not accounted for economic responses, have been excessively costly, ineffective, or even counter-productive.  The problems behind what Garrett Hardin (1968) characterized as the “tragedy of the commons” might better be described as the “failure of commons regulation.”  As our understanding of the commons has become more complex, the design of economic policy instruments has become more sophisticated.

Problems of the commons have not diminished, and the lag between understanding and action can be long.  While some commons problems have been addressed successfully, others continue to emerge.  Some – such as the threat of global climate change – are both more important and more difficult than problems of the past.

Fortunately, economics is well positioned to offer better understanding and better policies to address these ongoing challenges.  As the first decade of the twenty-first century comes to a close, natural resource and environmental economics has emerged as a productive field of our discipline and one that shows even greater promise for the future.

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Posted in Climate Change Policy, Economic Stimulus Policy, Energy Economics, Energy Policy, Environmental Economics, Environmental Policy, Fisheries Policy, Natural Resource Economics, Natural Resource Policy | 4 Comments

Pursuing Real Environmental Justice in California

California Governor Jerry Brown plans to move forward with the implementation of Assembly Bill 32, the Global Warming Solutions Act, under which California seeks to take dramatic steps to reduce its greenhouse gas emissions.  Questions have been raised about the wisdom of a single state trying to address a global commons problem, but with national climate policy developments having slowed dramatically in Washington, California is now the focal point of meaningful U.S. climate policy action.

California’s Plan

A key element of the mechanisms to be used for achieving California’s ambitious emissions reductions will be cap-and-trade, a promising approach with a successful track record, despite its recent demonization as “cap-and-tax” by conservatives and other opponents in the U.S. Congress.

Under this approach, regulators restrict emissions by issuing a limited number of emission allowances, with the number of allowances ratcheted down over time, thus assuring ever-larger reductions in overall emissions.  Pollution sources such as electric power plants and factories are allowed to trade allowances, and as a result, sources able to reduce emissions least expensively take on more of the pollution-reduction effort.  Experience has shown that cap-and-trade programs achieve emissions reductions at dramatically lower cost than conventional regulation.

Concerns

Yet some groups in California have been very uneasy about the prospect of cap-and-trade.  In particular, the Environmental Justice movement has opposed this approach, citing concerns that it would hurt low-income communities.  Professor Lawrence Goulder of Stanford University and I addressed such concerns in an article in The Sacramento Bee.

One expressed concern has been that a cap-and-trade policy might increase pollution in low-income or minority communities.  The apprehension is not about greenhouse gases (the focus of AB 32), since these gases spread evenly around the globe and thus would have no discernible impact in the immediate area.  Rather, it’s about “co-pollutants,” such as nitrogen oxides, carbon monoxide, and particulates, which can be emitted alongside greenhouse gases.

Because a cap-and-trade system would reduce California’s overall greenhouse gas emissions, it would also lower the state’s emissions of co-pollutants. Still, it’s possible, though unlikely, that co-pollutant emissions would increase in a particular locality.  But here it’s crucial to recognize that existing air pollution laws address such pollutants, and so any greenhouse gas allowance trades that would violate local air pollution limits would be prohibited.

If current limits for co-pollutants are thought to be insufficient, the best response is not to scuttle a statewide system that can achieve AB 32’s ambitious targets at minimum cost.  Rather, the most environmentally and economically effective way to address such pollution is to revisit existing local pollution laws and perhaps make them more stringent.

While much attention has rightly been given to the effects of potential climate policies on environmental conditions in low-income communities, it’s also important to consider their economic impacts on these communities.  Reducing greenhouse gas emissions will require greater reliance on more costly energy sources and more costly appliances, vehicles and other equipment.  Because low-income households devote greater shares of their income to energy and transportation costs than do higher-income households, virtually any climate policy will place relatively greater burdens on low-income households.  But because cap-and-trade will minimize  energy-related and other costs, it holds an important advantage in this regard over conventional regulations.

Moreover, a cap-and-trade system gives the public a tool for compensating low-income communities for the potential economic burdens:  If some emission allowances are auctioned, revenues can be used to mitigate economic burdens on these communities.

The Way Forward

All in all, cap-and-trade serves the goal of environmental justice better than the alternatives.  This progressive policy instrument merits a central place in the arsenal of weapons California employs.  Beyond helping the state meet its emissions-reduction targets at the lowest cost, it offers a promising way to reduce economic burdens on low-income and minority communities.

Posted in Climate Change Policy, Energy Economics, Energy Policy, Environmental Economics, Environmental Policy | 2 Comments

Renewable Energy Standards: Less Effective, More Costly, but Politically Preferred to Cap-and-Trade?

The new Congress is beginning to consider various alternative energy and climate policies in the wake of last year’s collapse in the U.S. Senate of consideration of a meaningful, economy-wide CO2 cap-and-trade scheme.  Among the options receiving attention are various types of renewable portfolio standards, also known as renewable electricity standards or clean energy standards, depending upon their specific design.  These approaches, which focus exclusively on one sector of the economy, would be less effective than a comprehensive cap-and-trade approach, would be more costly per unit of what is achieved, and yet – ironically – appear to be much more attractive to some politicians who strenuously opposed cap-and-trade.

True enough, these standards can be designed in a variety of ways, some of which are better and some of which are worse.  But the better their design (as a CO2 reducing policy), the closer they come to the much-demonized cap-and-trade approach.

In an op-ed which appeared on November 24th in The Huffington Post (click here for link to the original op-ed), Richard Schmalensee and I reflected on this irony.  Rather than summarize (or expand on) our op-ed, I simply re-produce it below as it was published by The Huffington Post, with some hyperlinks added for interested readers.

For anyone who is not familiar with Dick Schmalensee, please note that he is the Howard W. Johnson Professor of Economics and Management at MIT, where he served as the Dean of the Sloan School of Management from 1998 to 2007.  Also, he served as a Member of the President’s Council of Economic Advisers in the George H. W. Bush administration from 1989 to 1991.  By the way, in a previous blog post, I featured a different op-ed that Dick and I wrote in The Boston Globe in July of last year (“Beware of Scorched-Earth Strategies in Climate Debates”).

– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –

Renewable Irony

by Richard Schmalensee and Robert Stavins

The Huffington Post, November 24, 2010

One day after the election, the White House press secretary Robert Gibbs said that a national renewable electricity standard could be an area of bipartisan energy cooperation, after President Obama had said cap-and-trade was not the only way “to skin the cat.” It is ironic that while cap-and-trade — a sensible approach to reducing carbon dioxide emissions linked with climate change — is dead and buried in the Senate, considerable support has emerged for an approach that would be both less effective and more costly. A national renewable electricity standard would mandate that a given share of an electric company’s production come from renewable sources (most likely wind power), or, in the case of a “clean energy standard,” from an expanded list including nuclear and hydroelectric power.

One irony is that cap-and-trade is a market-based approach to environmental protection, which harnesses the power of the marketplace to reduce costs imposed on business and consumers, an approach championed by Republican presidents beginning with Ronald Reagan. Within its narrow domain, the renewable standard approach, which involves nationwide trading of renewable energy credits, is also market-based. Whereas cap-and-trade would raise the cost of fossil fuel, as its opponents have stressed so effectively, renewable standards would raise the cost of electricity, which its supporters seem reluctant to admit.  If renewables really were cheaper, even with Federal subsidies, it wouldn’t take regulation to get utilities to use them.

A second source of irony is that renewable or clean electricity standards are a very expensive way to reduce carbon dioxide (CO2) emissions — much more expensive than cap-and-trade. These standards would only affect electricity, thereby omitting about 60 percent of U.S. CO2 emissions. And even then, the standards would provide limited incentives to substitute away from coal, the most carbon-intensive way to generate electricity. Even more problematic, renewable/clean electricity standards would provide absolutely no incentives to reduce CO2 emissions from heating buildings, running industrial processes, or transporting people and goods. And unlike cap-and-trade, which would also affect oil consumption, the electricity standards would make no contribution to energy security. Only a very tiny fraction of U.S. oil consumption is used to generate electricity.

Increasing renewable electricity generation is no more than a means to an end for one part of the economy. Cap-and-trade keeps our eyes on the prize: moving the entire economy toward climate-friendly energy generation and use.

Those who believe that renewable electricity standards would create a huge number of green jobs have forgotten the lesson of Detroit: a large domestic market does not guarantee a healthy domestic industry. At the end of 2008, for instance, the U.S. led the world in installed wind generation capacity, but half of new installations that year were accounted for by imports. And a recent Lawrence Berkeley Laboratory study of the impacts of the economic stimulus package incentives for renewable electricity investments estimated that about 40 percent of the (gross) jobs created by new wind-energy investments were outside the United States, where many wind turbines are manufactured.

A sounder approach, for those concerned about green jobs, would focus on the long-term determinants of economic growth, such as technological innovation. That’s where cap-and-trade — which creates broad-based incentives for technology innovation — holds another edge over renewable electricity standards.

It is often argued that if cap-and-trade is dead, enacting renewable or clean electricity standards is better than doing nothing at all about climate change.  While that argument has some merit, since the risks of doing nothing are substantial, there is a real danger that enacting these standards will create the illusion that we have done something serious to address climate change.  Worse yet, it could create a favored set of businesses that will oppose future adoption of more efficient, serious, broad-based policies — like cap-and-trade.

If a national renewable electricity standard is nonetheless inevitable, it should not impose excess costs on businesses or consumers.  It should pre-empt state renewable portfolio standards, since with a national standard in place, states’ programs simply impose extra costs on their citizens without affecting national use of renewables at all. And any national program should allow unlimited banking to encourage early investments. No environmental or economic purpose is served by limiting banking to two years, as current Senate legislation would do.

Carbon cap-and-trade has been killed in the Senate, presumably because of its costs.  Renewable electricity standards or clean energy standards would accomplish considerably less and would impose much higher costs per ton of emissions reduction than cap-and-trade would.  This does not sound like a step forward.

Richard Schmalensee is the Howard W. Johnson Professor of Economics and Management at the Massachusetts Institute of Technology; Robert N. Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School.

Posted in Climate Change Policy, Energy Economics, Energy Policy, Environmental Economics, Environmental Policy | 10 Comments

Why Cancun Trumped Copenhagen

As we begin the year 2011, a look back at 2010 confirms that the greatest environmental achievement of the past year was the success that was achieved at the Sixteenth Conference of the Parties (COP-16) of the United Nations Framework Convention on Climate Change (UNFCCC) in Cancun, Mexico, in early December.  I wrote about this in some detail in my December 13th essay, “What Happened (and Why): An Assessment of the Cancun Agreements.”

The challenges awaiting delegates later this year (December, 2011) at COP-17 in Durban, South Africa, will be tremendous, particularly in regard to trying to negotiate the massive divide that exists between most Annex I countries and virtually all non-Annex I countries on the fate of a second (post-2012) commitment period for the Kyoto Protocol.

However, on this first day of 2011, it may be helpful to reflect again on the recent success in Cancun, and ask – in particular – why it occurred, because understanding that could provide some valuable lessons for the organizers and hosts of COP-17 in Durban.  This was the question I addressed in a brief December 20th Op-Ed in The Christian Science Monitor, and so rather than attempting to summarize or expand it, I simply reproduce it below.


The Christian Science Monitor

Why Cancun trumped Copenhagen: Warmer relations on rising temperatures

By Robert N. Stavins
December 20, 2010

Boston —

After the modest results of the climate change talks in Copenhagen a little more than a year ago, expectations were low for the follow-up negotiations in Cancun last month. Gloom-and-doom predictions dominated.

But a funny thing happened on the way to that much-anticipated failure: During two intense weeks of discussions in the Mexican resort that wrapped up at 3 AM on Dec. 12, the world’s governments quietly achieved consensus on a set of substantive steps forward. And equally important, the participants showed encouraging signs of learning to navigate through the unproductive squabbling between developed and developing countries that derailed the Copenhagen talks.

Unprecedented first steps

The tangible advances were noteworthy: The Cancun Agreements set emissions mitigation targets for some 80 countries, including all the major economies. That means that the world’s largest emitters, among them China, the United States, the European Union, India, and Brazil, have now signed up for targets and actions to reduce emissions by 2020.

The participating countries also agreed – for the first time in an official United Nations accord – to keep temperature increases below a global average of 2 degrees Celsius. Yes, that goal is no more stringent than the one set out in Copenhagen, but this time, the participating nations formally accepted the goals; a year earlier, they merely “noted” them, without adopting the accord.

Other provisions establish a “Green Climate Fund” to finance steps to limit and adapt to climate change, and designate the World Bank as interim trustee, over the objections of many developing countries. And new initiatives will protect tropical forests, and find ways to transfer clean energy technology to poorer countries.

The Cancun Agreements on their own are clearly not sufficient to keep temperature increases below 2 degrees Celsius, but they are a valuable step forward in the difficult process of constructing a sound foundation for meaningful, long-term global action.

Small steps vs. global accords

The progress was as much about changing the mindset of how to tackle climate disruption. Significantly, the Cancun agreement blurs the distinction between industrialized and developing countries – a vital step to break through the rich-poor divide that has held up progress for years. The 1997 Kyoto Protocol assigned emission targets only to the 40 countries thought to be part of the industrialized world, which left the more than 140 nations of the developing world without any commitments. But today, more than 50 of those so-called developing countries have higher per capita income than the poorest of the countries with emission-reduction responsibilities under Kyoto.

Implicitly, the process in Cancun also recognizes that smaller, practical steps – some of which are occurring outside the United Nations climate process – are going to be more easily achievable, and thus more effective, than holding out for some overarching thunderclap in a global accord.

The parallel processes of multilateral discussions on climate change policy, including the G20 meetings and the Major Economies Forum, have been useful. For the first time at Cancun, the UN Framework Convention on Climate Change, under the new leadership of Executive Secretary Christiana Figueres, offered a positive and pragmatic approach toward embracing these parallel processes.

Fixing the past (and future)

The Kyoto Protocol, which essentially expires at the end of 2012, is fundamentally flawed, especially in dividing the world into competing economic camps. At Cancun, it was encouraging to hear fewer people holding out for a commitment to another phase of the Kyoto Protocol. It was politically impossible to spike the idea of extending the Kyoto agreement entirely, but at least it was punted to the next gathering in Durban, South Africa, a year from now. Otherwise, the Cancun meeting could have collapsed amid acrimony and recriminations.

Usefully, the Cancun Agreements recognize directly and explicitly two key principles:

1) All countries must recognize their historic emissions (read, the industrialized world); and

2) All countries are responsible for their future emissions (think of those with fast-growing emerging economies).

This also helps move beyond the old Kyoto divide.

A better dialogue

An essential goal in Cancun was for the parties to maintain sensible expectations and develop effective plans. That they met this challenge owes in good measure to the careful and methodical planning by the Mexican government, and to the tremendous skill of Mexican Foreign Minister Patricia Espinosa in presiding over the talks.

For example, at a critical moment she took note of objections from Bolivia and a few other leftist states, and then ruled that the support of the 193 other countries meant that consensus had been achieved and the Cancun Agreements had been adopted. She pointed out that “consensus does not mean unanimity.” Compare that with Copenhagen, where the Danish prime minister allowed objections by five small countries to derail the talks.

Mexico’s adept leadership also made sure smaller countries were able to contribute fully and join any meetings they wanted, avoiding the sense of exclusivity that alienated some parties in Copenhagen. That’s a sign that Mexico is one of the key “bridging states” that have credibility in both worlds. Another is South Korea. They will need to play key roles going forward.

It’s also vital to note that China and the United States set a civil, productive tone, in contrast to the Copenhagen finger-pointing. From the sidelines in Cancun, I can vouch for the tremendous increase in openness of members of the Chinese delegation.

The acceptance of the Cancun Agreements suggests that the international community may now recognize that incremental steps in the right direction are better than acrimonious debates over unachievable targets.

Posted in Climate Change Policy, Energy Economics, Energy Policy, Environmental Economics, Environmental Policy, Positive Political Economy | 2 Comments

What Happened (and Why): An Assessment of the Cancun Agreements

The international climate negotiations in Cancun, Mexico, have concluded, and despite the gloom-and-doom predictions that dominated the weeks and months leading up to Cancun, the Sixteenth Conference of the Parties (COP-16) of the United Nations Framework Convention on Climate Change (UNFCCC) must be judged a success.  It represents a set of modest steps forward.  Nothing more should be expected from this process.

As I said in my November 19th essay – Defining Success for Climate Negotiations in Cancun – the key challenge was to continue the process of constructing a sound foundation for meaningful, long-term global action (not necessarily some notion of immediate, highly-visible triumph).  This was accomplished in Cancun.

The Cancun Agreements – as the two key documents (“Outcome of the AWG-LCA” and “Outcome of the AWG-KP”) are called – do just what was needed, namely build on the structure of the Copenhagen Accord with a balanced package that takes meaningful steps toward implementing the key elements of the Accord.  The delegates in Cancun succeeded in writing and adopting an agreement that assembles pledges of greenhouse gas (GHG) cuts by all of the world’s major economies, launches a fund to help the most vulnerable countries, and avoids some political landmines that could have blown up the talks, namely decisions on the (highly uncertain) future of the Kyoto Protocol.

I begin by assessing the key elements of the Cancun Agreements.  Then I examine whether the incremental steps forward represented by the Agreements should really be characterized as a success.  And finally I ask why the negotiations in Cancun led to the outcome they did.

Assessing the Key Elements of the Cancun Agreements

First, the Cancun Agreements provide emission mitigation targets and actions (submitted under the Copenhagen Accord) for approximately 80 countries – including, importantly, all of the major economies. In this way, the Agreements codify pledges by the world’s largest emitters – including China, the United States, the European Union, India, and Brazil – to various targets and actions to reduce emissions by 2020.  The distinction between Annex I and non-Annex I countries is blurred even more in the Cancun Agreements than it was in the Copenhagen Accord – another step in the right direction!

Also, for the first time, countries agreed – under an official UN agreement – to keep temperature increases below a global average of 2 degrees Celsius.  It brings these aspirations, as well as the emission pledges of individual countries, into the formal UN process for the first time, essentially by adopting the Copenhagen Accord one year after it was “noted” at COP-15.  (There’s also an abundance of politically-correct and in some cases downright silly window dressing in the Cancun Agreements, including repetitive references to various interpretations of the UNFCCC’s principle of “common but differentiated responsibilities,” as well as some discussion of examining a 1.5 C target.)

However, despite even the 2 degree (450 ppm concentration) aspirational target, the Agreements are no more stringent that the collection of submissions made under last year’s Copenhagen Accord.  But, as Michael Levi (Council on Foreign Relations) has pointed out, the Cancun Agreement “should be applauded not because it solves everything, but because it chooses not to.” As my colleagues and I have repeatedly emphasized in our work within the Harvard Project on Climate Agreements, many of the most important initiatives for addressing climate change will occur outside of the United Nations process (despite the centrality of that process).

Second, the Agreements elaborate on the mechanisms for monitoring and verification that were laid out in last year’s Accord.  Importantly, these now include “international consultation and analysis” of developing country mitigation actions.  Countries will report their GHG inventories to an independent panel of experts, which will monitor and verify reports of emissions cuts and actions.

Third, the Agreements establish a so-called Green Climate Fund to deliver financing for mitigation and adaptation. Importantly, the Agreements name the World Bank as the interim trustee of the Fund, despite objections from many developing countries, and create an oversight board, half of which consists of donor nation representatives.  In addition, the Agreements establish a goal by developed countries to mobilize $100 billion annually by 2020 to support mitigation and adaptation in developing countries, a funding target which would include public and private resources (that is, carbon markets and private finance), bilateral and multilateral flows, as well as the Green Climate Fund.

Whether the resources ever grow to the size laid out in Copenhagen and Cancun will depend upon the individual actions of the wealthy nations of the world.  However, it’s interesting that the section in the Cancun Agreements on adaptation comes before the section on mitigation.  Things have come a long way since the days when economists were virtually alone in calling for attention to adaptation (along with mitigation).  I recall when economists were therefore accused of throwing in the towel, and not caring about the environment!

Fourth, the Agreements advance initiatives on tropical forest protection (or, in UN parlance, Reduced Deforestation and Forest Degradation, or REDD+), by taking the next steps toward establishing a program in which the wealthy countries can help prevent deforestation in poor countries, possibly working through market mechanisms (despite exhortations from Bolivia and other leftist and left-leaning countries to keep the reach of “global capitalism” out of the policy mix).

Fifth, the Cancun Agreements establish a structure to assess the needs and policies for the transfer to developing countries of technologies for clean energy and adaptation to climate change, and a – as yet undefined – Climate Technology Center and Network to construct a global network to match technology suppliers with technology needs.

In addition, the Agreements endorse an ongoing role for the Clean Development Mechanism (CDM) and other “market-based mechanisms;” indicate that carbon capture and storage (CCS) projects should be eligible for carbon credits in the CDM; and offer some special recognition of the situations of the Central and Eastern European countries (previously known in UN parlance as “parties undergoing transition to a market economy”) and Turkey, all of which are Annex I countries under the Kyoto Protocol, but decidedly poorer than the other members of that group of industrialized nations.

That’s the 32-page Cancun Agreements in a nutshell.  As a member of one of the leading national delegations said to me in Cancun a few hours after the talks had concluded, “It’s incremental progress, but progress nonetheless.”

Are Such Incremental Steps Really a Success?

Recall from my November 19th essay that the best goal for the Cancun climate talks was to make real progress on a sound foundation for meaningful, long-term global action.  I said that because of some fundamental scientific and economic realities, which I will not repeat here.  In that previous essay, I also described “What Would Constitute Real Progress in Cancun” A quick comparison of my criteria from November 19th and the Cancun Agreements of December 11th tells me that the outcome of Cancun should be judged a success.

My first criterion of success was that the UNFCCC should embrace the parallel processes that are carrying out multilateral discussions on climate change policy:  the Major Economies Forum or MEF (a multilateral venue for discussions – but not negotiations – among the most important emitting countries); the G20 (periodic meetings of the finance ministers – and sometimes heads of government – of the twenty largest economies in the world); and various other multilateral and bilateral organizations and discussions.  Although the previous leadership of the UNFCCC seemed to view the MEF, the G20, and most other non-UNFCCC forums as competition – indeed, as a threat, the UNFCCC’s new leadership under Executive Secretary Christiana Figueres displays a positive and pragmatic attitude toward these parallel processes.

My second criterion was that the three major negotiating tracks be consolidated.  These tracks were:  first, the UNFCCC’s KP track (negotiating national targets for a possible second commitment period – post-2012 – for the Kyoto Protocol); second, the LCA track (the UNFCCC’s negotiation track for Long-term Cooperative Action, that is, a future international agreement of undefined nature); and third, the Copenhagen Accord, negotiated and noted at COP-15 in Copenhagen, Denmark, in December, 2009.

Permit me, please, to quote from my November 19th essay:

Consolidating these three tracks into two tracks (or better yet, one track) would be another significant step forward.  One way this could happen would be for the LCA negotiations to take as their point of departure the existing Copenhagen Accord, which itself marked an important step forward by blurring for the first time (although not eliminating) the unproductive and utterly obsolete distinction in the Kyoto Protocol between Annex I and non-Annex I countries.  (Note that more than 50 non-Annex I countries now have greater per capita income than the poorest of the Annex I countries.)

This is precisely what has happened.  The Cancun Agreements – the product of the LCA-track negotiations – build directly, explicitly, and comprehensively on the Copenhagen Accord.  The two tracks have become one.

Alas, the KP track remains, and a decision on a potential second commitment period (post-2012) for the Kyoto Protocol has been punted to COP-17 in Durban, South Africa, in December, 2011.  It is difficult to picture a meaningful – or any – second commitment period for the Kyoto Protocol, with the United States out of that picture, and with Japan and Russia having stated unequivocally that they will not take up another set of targets, and with Australia and Canada also unlikely to participate.  But note that this issue will have to be confronted in Durban a year from now.  With the first commitment period of the Kyoto Protocol ending in 2012, COP-17 will provide the last opportunity for punting that contentious issue.

If you agree with my view – which I have written about in many previous blog posts – that the Kyoto Protocol is fundamentally flawed and that the Protocol’s dichotomous distinction between Annex I and non-Annex I countries is the heavy anchor that slows meaningful progress on international climate policy, then you will not consider it bad news that a second commitment period for the Protocol is looking less and less likely.  On the other hand, you will, in that case, share my disappointment that the issue has been punted (recognizing, however, that had it not been punted, the Cancun meetings could have collapsed amidst acrimony and recriminations).

I also wrote in my November 19th post:

The UNFCCC principle of “common but differentiated responsibilities” could be made meaningful through the dual principles that:  all countries recognize their historic emissions (read, the industrialized world); and all countries are responsible for their future emissions (think of those rapidly-growing emerging economies).

The Cancun Agreements do this by recognizing directly and explicitly these dual principles.  This can represent the next step in a movement beyond what has become the “QWERTY keyboard” (that is, unproductive path dependence) of international climate policy:  the distinction in the Kyoto Protocol between the small set of Annex I countries with quantitative targets, and the majority of countries in the world with no responsibilities.

A variety of policy architectures can build on these dual principles and make them operational, bridging the political divide which exists between the industrialized and the developing world.  (At the Harvard Project on Climate Agreements, we have developed a variety of architectural proposals that could make these dual principles operational.  See, for example:  “Global Climate Policy Architecture and Political Feasibility: Specific Formulas and Emission Targets to Attain 460 PPM CO2 Concentrations” by Valentina Bosetti and Jeffrey Frankel; and “Three Key Elements of Post-2012 International Climate Policy Architecture” by Sheila M. Olmstead and Robert N. Stavins.)

My third criterion for success was movement forward with specific, narrow agreements, such as on:  REDD+ (Reduced Deforestation and Forest Degradation, plus enhancement of forest carbon stocks); finance; and technology.  Such movement forward has, in fact, occurred in all three domains in the Cancun Agreements, as I described above.

My fourth criterion for success was keyed to whether the parties to the Cancun meetings could maintain sensible expectations and thereby develop effective plans.  This they have done.  The key question was not what Cancun accomplishes in the short-term, but whether it helps put the world in a better position five, ten, and twenty years from now in regard to an effective long-term path of action to address the threat of global climate change.

Despite the fact that some advocacy groups – and for that matter, some nations – are no doubt disappointed with the outcome of Cancun, I think it is fair to say that this final criterion for success was satisfied:  the Cancun Agreements can help put the world on a path toward an effective long-term plan of meaningful action.

Why Did Cancun Succeed?

If you agree with my assessment of success in Cancun, then a reasonable question to ask is why did the Cancun talks produce this successful outcome, particularly in contrast with what many people consider a less successful outcome of the Copenhagen talks last year.  To address this question, let me expand on some points made in an insightful essay by Elliot Diringer, Vice President for International Strategies at the Pew Center on Global Climate Change.

First, the Mexican government through careful and methodical planning over the past year prepared itself well, and displayed tremendous skill in presiding over the talks. Reflect, if you will, on the brilliant way in which Mexican Minister of Foreign Affairs, Patricia Espinosa, who served as President of COP-16, took note of the objections of Bolivia (and, at times, several other leftist and left-leaning Latin American countries, known collectively as the ALBA states), and then simply ruled that the support of 193 other countries meant that “consensus” had been achieved and the Cancun Agreements had been adopted by the Conference.  At a critical moment, Ms. Espinosa noted that “consensus does not mean unanimity,” and that was that!

Compare this with the unfortunate chairing of COP-15 in Copenhagen by Danish Prime Minister Lars Løkke Rasmussen, who allowed the objections by a similar same small set of five relatively unimportant countries (Bolivia, Cuba, Nicaragua, Sudan, and Venezuela) to derail those talks, which hence “noted,” but did not adopt the Copenhagen Accord in December, 2009.

The Mexicans were also adept at facilitating small groups of countries to meet to advance productive negotiations, but made sure that any countries could join those meetings if they wanted.  Hence, negotiations moved forward, but without the sense of exclusivity that alienated so many small (and some large) countries in Copenhagen.

The key role played by the Mexican leadership is consistent with the notion of Mexico as one of a small number of “bridging states,” which can play particularly important roles in this process because of their credibility in the two worlds that engage in divisive debates in the United Nations:  the developed world and the developing world.  We have examined this in our recent Harvard Project on Climate Agreements Issue Brief, Institutions for International Climate GovernanceMexico, along with Korea, are members of the OECD, but are also non-Annex I countries under the Kyoto Protocol.  This gives Mexico — and gave Minister Espinosa — a degree of credibility across the diverse constituencies in the UNFCCC that was simply not enjoyed by Danish Prime Minister Rasmussen at COP-15 last year.

Second, China and the United States set the tone for many other countries by dealing with each other with civility, if not always with understanding.  This contrasts with the tone that dominated in and after Copenhagen, when finger-pointing at Copenhagen between these two giants of the international stage led to a blame-game in the months after the Copenhagen talks.

As Elliot Diringer wrote, they may have recognized that “the best way to avoid blame was to avoid failure.”  Beyond this, although the credit must go to both countries, the change from last year in the conduct of the Chinese delegation was striking.  It appeared, as Coral Davenport wrote in The National Journal, that the Chinese were on a “charm offensive.”  Working in Cancun on behalf of the Harvard Project on Climate Agreements, I can personally vouch for the tremendous increase from previous years in the openness of members of the official Chinese delegation, as well as the many Chinese members of civil society who attended the Cancun meetings.

Third, a worry hovered over the Cancun meetings that an outcome perceived to be failure would lead to the demise of the UN process itself.  Since many nations (in particular, developing countries, which made up the vast majority of the 194 countries present in Cancun) very much want the United Nations and the UNFCCC to remain the core of international negotiations on climate change, that implicit threat provided a strong incentive for many countries to make sure that the Cancun talks did not “fail.”

Fourth, under the pragmatic leadership of UNFCCC Executive Secretary Christiana Figueres, realism may have finally eclipsed idealism in these international negotiations. Many observers have noted that many delegations – and probably most civil society NGO participants – at the previous COPs have misled themselves into thinking that ambitious cuts in greenhouse gases (GHGs) were forthcoming that could guarantee achievement of the 450 ppm/2 degrees C cap.

The acceptance of the Cancun Agreements suggests that the international diplomatic community may now recognize that incremental steps in the right direction are better than acrimonious debates over unachievable targets.  This harkens back to what I characterized prior to COP-16 as the key challenge facing the negotiators:  to continue the process of constructing a sound foundation for meaningful, long-term global action.  In my view, this was accomplished in Cancun.

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Further Reading

In a new blog post, Trevor Houser (Peterson Institute for International Economics) argues that the surest way to kill the progress made in the Cancun Agreements is to try to turn them into a legally-binding treaty at COP-17 next year in Durban, South Africa.

For a nice table showing the correspondence of respective elements of the Cancun Agreements and the Copenhagen Accord, see the commentary on the Cancun climate negotiations by Sarah Ladislaw of the Center for Strategic and International Studies.

And for a detailed description of the major elements of the Cancun Agreements, I recommend the summary prepared by the Pew Center on Global Climate Change.

Some previous essays I have written and posted at this blog may be of interest to those who are interested in the Cancun Agreements.  Here are links, in reverse chronological order:

Defining Success for Climate Negotiations in Cancun

Opportunities and Ironies: Climate Policy in Tokyo, Seoul, Brussels, and Washington

Another Copenhagen Outcome: Serious Questions About the Best Institutional Path Forward

What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord

Chaos and Uncertainty in Copenhagen?

Only Private Sector Can Meet Finance Demands of Developing Countries

Defining Success for Climate Negotiations in Copenhagen

Approaching Copenhagen with a Portfolio of Domestic Commitments

Can Countries Cut Carbon Emissions Without Hurting Economic Growth?

Three Pillars of a New Climate Pact

Posted in Climate Change Policy, Energy Economics, Energy Policy, Environmental Economics, Environmental Policy, Positive Political Economy | 19 Comments

Defining Success for Climate Negotiations in Cancun

International climate negotiations will continue in Cancun, Mexico, during the first two weeks of December, 2010.  These will be the Sixteenth Conference of the Parties (COP-16) of the United Nations Framework Convention on Climate Change (UNFCCC).  The key challenge is to continue the process of constructing a sound foundation for meaningful, long-term global action, not necessarily some notion of immediate, highly-visible triumph.  Some of the gloom-and-doom predictions we’ve been hearing about these upcoming negotiations are therefore misguided, because they are based upon unreasonable – and fundamentally inappropriate – expectations (despite the fact that expectations have been lowered dramatically since COP-15 in Copenhagen last year).

Keeping Our Eyes on the Prize

Why do I say that the best goal for the Cancun climate talks is to make real progress on a sound foundation for meaningful, long-term global action, not some notion of immediate triumph?  This is because of some basic scientific and economic realities.

First, the focus of scientists (and policy makers) should be on stabilizing concentrations at acceptable levels by 2050 and beyond, because it is the accumulated stock of greenhouse gas emissions — not the flow of emissions in any year — that are linked with climate consequences.

Second, the cost-effective path for stabilizing concentrations involves a gradual ramp-up in target severity, to avoid rendering large parts of the capital stock prematurely obsolete.

Third, massive technological change is the key to the needed transition from reliance on carbon-intensive fossil fuels to more climate-friendly energy sources.  Long-term price signals (most likely from government policies) will be needed to inspire such technological change.

Fourth and finally, the creation of long-lasting international institutions is central to addressing this global challenge.

For all of these reasons, international climate negotiations will be an ongoing process, not a single task with a clear end-point.  Indeed, they may well proceed much as international trade talks have done, that is, with progress over many years, building the institutions (the GATT, the WTO), but moving forward in fits and starts, at times seeming to move backward, but making meaningful progress in the long term.

So, the bottom-line is that a sensible goal for the international negotiations in Cancun is progress on a sound foundation for meaningful long-term action, not some notion of immediate “success.”

Don’t Sacrifice Valuable Long-Term Achievements for Minor Short-Term Gains

It might be relatively easy, but actually quite unfortunate, for countries to achieve what some people might define as “success” in Cancun:  a signed international agreement, followed by glowing press releases.  I say it would be unfortunate, because such an agreement could only be the Kyoto Protocol on steroids: more stringent targets for the original list of industrialized countries (Annex I) and no meaningful commitments by the key rapidly-growing emerging economies, such as China, India, Brazil, Korea, Mexico, and South Africa.

Such an agreement could — in principle — be signed, but it would not reduce global emissions, and it would not be ratified by the U.S. Senate (just like Kyoto).  Hence, there would be no real progress on climate change.

What Would Constitute Real Progress in Cancun?

If it’s not reasonable to expect that a comprehensive post-Kyoto policy architecture will be identified and enacted in Cancun, what would constitute real progress?

1.  Embracing Parallel Processes

A significant step forward would be for the UNFCCC to embrace the parallel processes that are carrying out multilateral discussions (and in some cases, negotiations) on climate change policy:  the Major Economies Forum or MEF (a multilateral venue for discussions – but not negotiations – outside of the UNFCCC, initiated under a different name by the George W. Bush administration in the United States, and continued under a new name by the Obama administration, for the purpose of bringing together the most important emitting countries for candid and constructive discussion and debate); the G20 (periodic meetings of the finance ministers – and sometimes heads of government – of the twenty largest economies in the world); and various other multilateral and bilateral organizations and discussions.

By the way, the MEF includes Australia, Brazil, Canada, China, the European Union, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, South Africa, the United Kingdom, and the United States. The membership of the G20 is the same as the membership of the MEF, plus Argentina, Saudi Arabia, and Turkey.

The previous leadership of the UNFCCC seemed to view the MEF, the G20, and most other non-UNFCCC forums as competition – indeed, as a threat.  Fortunately, the UNFCCC’s new leadership under Executive Secretary Christiana Figueres (appointed by UN Secretary-General Ban Ki-moon in May of this year) has displayed a considerably more positive and pragmatic attitude toward these parallel processes.

2.  Consolidating Negotiations Tracks

There are now three major, parallel processes operative:  first, the UNFCCC’s KP track (negotiating national targets for a possible second commitment period – post-2012 – for the Kyoto Protocol); second, the LCA track (the UNFCCC’s negotiation track for Long-term Cooperative Action, that is, a future international agreement of undefined nature); and third, the Copenhagen Accord, negotiated and noted at COP-15 in Copenhagen, Denmark, in December, 2009.  Consolidating these three tracks into two tracks (or better yet, one track) would be another significant step forward.

One way this could happen would be for the LCA negotiations to take as their point of departure the existing Copenhagen Accord, which itself marked an important step forward by blurring for the first time (although not eliminating) the unproductive and utterly obsolete distinction in the Kyoto Protocol between Annex I and non-Annex I countries.  (Note that more than 50 non-Annex I countries now have greater per capita income than the poorest of the Annex I countries.)

In particular, the UNFCCC principle of  “common but differentiated responsibilities” could be made meaningful through the dual principles that:  all countries recognize their historic emissions (read, the industrialized world); and all countries are responsible for their future emissions (think of those rapidly-growing emerging economies).

This would represent a great leap beyond what has become the “QWERTY keyboard” (that is, unproductive path dependence) of international climate policy:  the distinction in the Kyoto Protocol between the small set of Annex I countries with quantitative targets, and the majority of countries in the world with no responsibilities.  Various policy architectures could subsequently build on these dual principles and make them operational, beginning to bridge the massive political divide which exists between the industrialized and the developing world.

At the Harvard Project on Climate Agreements — a multi-national initiative with some 35 research projects in Australia, China, Europe, India, Japan, and the United States — we have developed a variety of architectural proposals that could make these dual principles operational.  (See, for example:  “Global Climate Policy Architecture and Political Feasibility: Specific Formulas and Emission Targets to Attain 460 PPM CO2 Concentrations” by Valentina Bosetti and Jeffrey Frankel; and “Three Key Elements of Post-2012 International Climate Policy Architecture” by Sheila M. Olmstead and Robert N. Stavins.)

3.  Productive Steps in Narrow, Focused Agreements, such as REDD+

A third area of success at the Cancun negotiations could be realized by some productive steps with specific, narrow agreements, such as on REDD+ (Reduced Deforestation and Forest Degradation, plus enhancement of forest carbon stocks).  Other areas where talks are moving forward, although somewhat more slowly, are finance and technology.

4.  Maintaining Sensible Expectations and Developing Effective Plans

Finally, it is important to go into the Cancun meetings with sensible expectations and thereby effective plans.  Again, negotiations in this domain are an ongoing process, not a single task with a clear end-point.  The most sensible goal for Cancun is progress on a sound foundation for meaningful long-term action, not some notion of immediate triumph.  The key question is not what Cancun accomplishes in the short-term, but whether it helps put the world in a better position five, ten, and twenty years from now in regard to an effective long-term path of action to address the threat of global climate change.

Further Reading

A number of previous essays I have written and posted at this blog will be of interest to those who wishe to follow developments at the Sixteenth Conference of the Parties of the UN Framework Convention on Climate Change in Cancun.  Here are links, in chronological order:

Three Pillars of a New Climate Pact

Can Countries Cut Carbon Emissions Without Hurting Economic Growth?

Approaching Copenhagen with a Portfolio of Domestic Commitments

Defining Success for Climate Negotiations in Copenhagen

Only Private Sector Can Meet Finance Demands of Developing Countries

Chaos and Uncertainty in Copenhagen?

What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord

Another Copenhagen Outcome: Serious Questions About the Best Institutional Path Forward

Opportunities and Ironies: Climate Policy in Tokyo, Seoul, Brussels, and Washington

Posted in Climate Change Policy, Positive Political Economy | 6 Comments

Both Are Necessary, But Neither is Sufficient: Carbon-Pricing and Technology R&D Initiatives in a Meaningful National Climate Policy

For many years, there has been a great deal of discussion about carbon-pricing – whether carbon taxes or cap-and-trade – as an essential part of a meaningful national climate policy.  It has long been recognized that although carbon-pricing will be necessary, it will not be sufficient. Economists and other policy analysts have noted that policies intended to foster climate-friendly technology research and development (R&D) will also be necessary, but likewise will not be sufficient on their own.

Some recent studies and press accounts, which I reference below, have identified these two approaches to addressing CO2 emissions as substitutes, rather than complements.  That is fundamentally inconsistent with decades of research, and so my purpose in this essay is to set the record straight.

Carbon Pricing:  Necessary But Not Sufficient

First of all, why is there so much talk among policy analysts and policy makers – not simply among academics – about carbon‑pricing as the core of a meaningful strategy to reduce CO2 emissions?  Why, in fact, is this approach so overwhelmingly favored by the analytical community?  The answer is simple and surprisingly pragmatic.

First, there is no other feasible approach that can provide meaningful emissions reductions, such as the 80 percent reduction in national CO2 emissions by 2050 that was part of the legislation passed by the U.S. House of Representatives and proposed in the Senate and part of the Obama administration’s conditional pledge under the Copenhagen Accord.  Because of the ubiquity and diversity of energy use in a modern economy, conventional regulatory approaches –standards of various kinds – simply cannot do the job.  Only carbon pricing – either in the form of carbon taxes or cap-and-trade – can significantly tilt in a climate-friendly direction the millions of decentralized decisions that are made in our economy every day.

Second, carbon-pricing is the least costly approach in the short term, because abatement costs are exceptionally heterogeneous across sources.  Only carbon-pricing provides strong incentives that push all sources to control at the same marginal abatement cost, thereby achieving a given aggregate target at the lowest possible cost.

Third, it is the least costly approach in the long term, because it provides incentives for carbon-friendly technological change, which brings down costs over time.

For these reasons, carbon-pricing is a necessary component of a truly meaningful national climate policy.  [I’ve written about this in many previous blog posts, including on June 23, 2010, “The Real Options for U.S. Climate Policy.”]  However, although it is a necessary policy component, carbon-pricing is not sufficient on its own. This is because there are other market failures that dilute the impacts of price signals on decision makers.

Technology R&D Policies:  Also Necessary, Also Not Sufficient

The most important of these “other market failures” is the public good nature of information.  Companies carrying out research and development (R&D) incur the full costs of their efforts, but they do not capture the full benefits.  This is because even with a perfectly-enforced system of intellectual property rights (such as patents), there are tremendous spillover benefits to other firms.  Decades of economic research – much of it by my former colleague and co-author, Professor Adam Jaffe, now Dean of Arts and Sciences at Brandeis University – has analyzed with empirical (econometric) analysis the remarkable degree to which inventions and innovations by one firm provide valuable information that leads to new inventions and innovations by other firms.

So, firms pay the costs of their R&D, but do not reap all the benefits.  The existence of this positive externality of firms’ R&D – or put differently, the public-good nature of the information generated by R&D – means that the private sector will carry out less than the “efficient” amount of R&D of new climate-friendly technologies in response to given carbon prices.  Hence, other public policies are needed to address this “R&D market failure.”

New path-breaking technologies will be needed to address climate change, and public support for private-sector or public-sector R&D will be crucial to meet this need.  But, at the same time, to address the climate-change market failure itself (that is, the externality associated with greenhouse gas emissions), carbon pricing will be necessary, for all of the reasons I gave above.  This is an application of an important and fundamental principle in economics:  two market failures require the use of two policy instruments.

Empirical analyses have repeatedly verified this crucial point – that combining carbon-pricing with R&D support is more cost-effective than adopting either approach alone.  Included in this set of studies are the following:  Carolyn Fischer (Resources for the Future) and Richard Newell (U.S. Energy Information Administration, on leave from Duke University), “Environmental and Technology Policies for Climate Mitigation”; Stephen Schneider (late of Stanford University) and Lawrence Goulder (Stanford University), “Achieving Low-Cost Emissions Targets”; and Daren Acemoglu (MIT), Philippe Aghion, Leonardo Bursztyn, and David Hemous (Harvard University), “The Environment and Directed Technical Change.”

Complements, Not Substitutes

An interesting, recent column, “Next Step on Policy for Climate,” by David Leonhardt in the New York Times (October 13, 2010, p. B1) might give some people the mistaken impression that technology policies are an adequate, even sensible substitute for carbon-pricing.  That was not the intended message of the column.  In fact, Leonhardt – perhaps the leading economic journalist writing today in the United States ­– indicates clearly in his column that he is skeptical of the notion of thinking of technology subsidies as an adequate substitute for carbon-pricing (in particular, cap-and-trade).  And in a follow-up post at the New York Times’ Economix, he makes clear that “these two policies are not mutually exclusive.”

Nevertheless, Leonhardt’s original column (which included a very nice profile of my colleague, Professor Michael Greenstone of MIT) focused attention on a recent report –  a report that could give the false impression that technology policies would be a sensible substitute for serious carbon-pricing.  The report in question – “Post-Partisan Power” – received significant coverage, primarily because of its sponsorship:  a combination of a prominent Republican-oriented Washington think tank, the American Enterprise Institute (AEI), and an equally prominent Democratic-oriented Washington think tank, the Brooking Institution (and a third partner, the Breakthrough Institute, a California-based environmental think tank).

The report may well garner some bi-partisan political support, because it promises a free lunch of painless, win-win solutions, a promise that will resonate with many elected officials.  Indeed, the report’s sub-title is “how a limited and direct approach to energy innovation can deliver clean, cheap energy, economic productivity, and national prosperity.”  What’s not to like? And the authors are presumably smart and politically shrewd.  I know that’s the case with the AEI author, Steven Hayward, who I debated last year in the pages of the Wall Street Journal.

To its credit, the report lays out a menu of policies intended to stimulate carbon-friendly technological change, ranging from $500 million of Federal government funding of K-12 curriculum development and teacher training to $25 billion annually of direct Federal funding of energy innovation.

For the reasons I explained above (the “R&D market failure” and the “carbon emissions externality”), both direct technology R&D policies and serious carbon-pricing are necessary, but neither is sufficient on its own.  Unfortunately, this new report ­­– and some of the press coverage surrounding it – makes the claim that such direct government funding of technology innovation is a sufficient and sensible substitute for meaningful carbon-pricing.  That claim is both unfortunate and wrong, as it is supported neither by sound reasoning nor empirical research, as I have described above.

Again, many of the individual technology policy recommendations offered by the AEI-Brookings-BI report are worthy of serious consideration (as a complement, not a substitute for an economy-wide carbon-pricing policy).  But the specifics – indeed, much of the meat – are missing.  “Reform the nation’s morass of energy subsidies” – yes, but exactly which subsidies (all of which have important political constituencies behind them) will be eliminated?  “Recognize the potential for nuclear power” – yes, and both the House and Senate carbon-pricing schemes would have provided tremendous incentives for nuclear power investment.

Overall, there should be concern about how all of this will be funded.  Where will the $25 billion per year come from?  The report appropriately states that this should not come from general revenues, and thus add to the Federal debt.  “Phasing out current subsidies for wind, solar, ethanol, and fossil fuels” could be meritorious on its own, but how much does this generate, and does it even pass a political laugh-test?  Interestingly, beyond this, despite considerable rhetoric about moving beyond debates about carbon-pricing, the report recommends that in order to avoid adding to the Federal debt, it would be necessary to impose new taxes, including increased royalties for oil and gas extraction, a tax on imported oil, a tax on electricity sales, and a “very small carbon price” (presumably from a modest carbon tax or unambitious cap-and-trade system).

The actual numbers would be helpful, and the political feasibility remains a serious question.  The political challenges that emerged in the effort to pass cap-and-trade climate legislation will not magically disappear if there’s an attempt to induce Congress to approve $25 billion in funding.  As Tom Friedman noted on October 12th in the New York Times, Congress has not come close to fully funding the outstanding requests for about $4 billion for ARPA-E (energy) research.

More broadly, despite the attraction of the AEI-Brookings-BI proposal as a potential complement to carbon-pricing (and I am serious that the proposal is of value in that context), one has to be very careful about comparing proposed new policies in idealized form (for example, precisely the right subsidies eliminated and precisely the right new subsidies introduced) with real policies with all their warts (for example, the cap-and-trade bill that was passed by the House last year).  Making such comparisons can lead to flawed analysis and misleading results.

This is not a new issue.  Robert Hahn and I wrote about this generic problem nearly 20 years ago in an article (“Economic Incentives for Environmental Protection:  Integrating Theory and Practice”) which appeared the American Economic Review Papers and Proceedings (May 1992).  At the time, our concern was that this mistake was being made not by the opponents but by the supporters of cap-and-trade and other (then essentially untested) market-based instruments.  We worried that “many analysts use highly stylized benchmarks for comparison that ignore likely political realities,” and suggested that an appropriate “comparison would be between actual command-and-control policies and either actual trading [cap-and-trade] programs … or a reasonably constrained theoretical … program.”

Likewise today, when carrying out comparisons of policy alternatives, it is fine to compare two theoretical, idealized alternatives, or to compare two real-world policies, but it is problematic and usually misleading to compare a theoretical, idealized policy of one type with a real-world example of another type of policy.

The Bottom Line

Carbon-pricing – whether carbon taxes or cap-and-trade – will be an essential part of any truly meaningful national climate policy.  Likewise, to address the “R&D market failure,” direct technology innovation policies will also be required.  Both are necessary.  Neither is sufficient.  These are complements, not substitutes.

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Postscript: Four years ago, the U.S. Congressional Budget Office (CBO) — widely recognized for its non-partisan, first-rate research — produced a study on the same topic as the AEI-Brookings-BI report, but did so with rigor and without ideology.  The CBO report — Evaluating the Role of Prices and R&D in Reducing Carbon Dioxide Emissions (September 2006) — was prepared by Dr. Terry Dinan, a long-time, respected CBO economist, and was peer reviewed by an impressive set of academic and other experts.  Sadly, the CBO paper received little press coverage, despite its high quality and its relevance.  For anyone interested in the topic of this post, particularly those who disagree with my theme, I hope you will read the CBO report.

Also, a reader of this blog post sent me a paper by David Hart and Kadri Kallas (from MIT’s Energy Innovation working paper series) that examines “Alignment and Misalignment of Technology Push and Regulatory Pull.” It’s worth reading in the context of combining carbon pricing and technology R&D policies.

Posted in Climate Change Policy, Energy Economics, Energy Policy, Environmental Economics, Environmental Policy | 12 Comments